DBRS Confirms KeyCorp’s “A” Rating, Trend Still Negative

DBRS has today confirmed the ratings of KeyCorp (Key or the Company) and its operating bank subsidiary, KeyBank N.A., including KeyCorp’s Issuer and Senior Debt rating of “A” and Short-Term Instruments at R-1 (low). All ratings, with the exception of KeyCorp’s R-1 (low) Short-Term Instruments rating and FDIC Guaranteed debt, remain on Negative trend. The rating action follows a review by DBRS of the Company’s operating performance, financial fundamentals and future prospects.

Key’s 2008 net income loss of $1.47 billion was primarily the result of three items: 1) Key’s $1.26 billion in net charge-offs (NCOs), 2) $838 million in charges related to leverage leases, and 3) $465 million in (non-cash) goodwill impairment. Key’s loan loss provisions of $1.84 billion in 2008 reflected a $575 million reserve build above NCOs to reach $1.80 billion. The reserve equates to 147% of non-performing loans or 2.36% of total loans. These metrics are either at or above the peer group average.

DBRS notes that 2008 adjusted (excluding one-time charges) income before provisions and taxes (IBPT) of approximately $1.9 billion was able to fully absorb the annual provisions.
Spread income held up relatively well earlier in the year but declined due to weakening demand and margin pressure in the fourth quarter. Meanwhile, fee income levels reflected the higher costs and volatility of the current operating environment. DBRS expects weak loan demand and margin pressure to continue to weigh modestly on net interest income, volatility to continue in fee revenue and expenses to rise due to higher collection costs and other charges. The rating confirmation reflects the fact that the Company has been able to navigate the difficult environment, while keeping its core franchise value intact, something many banks have been unable to do. Earnings are being used for their designated purpose, that is, to offset the cost of doing business through the cycle, enhance capabilities and build capital.

DBRS believes that further deterioration in Key’s asset quality is probable, given the continuing problems in the residential construction and residential housing sectors, compounded by a recessionary economy that is beginning to pressure a broader range of commercial credits. DBRS expects the Company’s relatively strong loan loss reserves, now 2.36% of total loans, to help absorb future credit losses and also expects provisioning levels to remain elevated as loan weakness broadens. For these reasons and performance metrics that are at the lower end of its rating range, DBRS continues to maintain a Negative trend on the Company’s ratings. Credit costs in marked excess of IBPT, performance degradation or signs of franchise weakening could lead to negative rating actions. Declining credit costs and non-performers with revenue stability could return the trend to Stable.

The negative credit environment, particularly in the residential real estate construction sector and residential mortgages, drove non-performing assets (NPAs) to 1.91% of loans and real estate owned in the fourth quarter, up from 1.61% in the prior quarter and 1.08% in Q4 2007. Key continued to aggressively work down troubled exposures which have been designated “exit portfolios”, including residential homebuilder, marine & RV, student, and national home equity loans, through transfer, writedowns, loan sales and payments in the quarter. Nevertheless, ongoing weakness in commercial real estate construction loans in California and Florida and a $132 million increase in commercial and industrial and lease non-performers over the quarter more than offset the 47% (or $79 million) decline in non-performing loans held for sale in the quarter. Additionally, OREO increased from $64 million to $110 million in the quarter. Fourth-quarter NCOs increased to 1.77% of average loans from 1.43% in the prior quarter, and were up sharply from 0.67% at Q4 2007.

With respect to capital, Key added $2.5 billion in capital during the fourth quarter, participating in the U.S. Treasury Capital Purchase Program, and also reduced its quarterly dividend by two-thirds to $0.0625 per common share, preserving an additional $275 million (estimated) in capital annually. The Company finished the year with an estimated Tier 1 ratio of 10.81%, which is average for its peer group. DBRS notes, however, that preferred shares now constitute 29% of shareholders equity, which is a weaker form of capital.

Key’s loan portfolio is approximately 66% core funded; the Company has maintained adequate liquidity with moderate rollover risk (Key issued $1.5 billion in new term debt under the FDIC’s Temporary Liquidity Guarantee Program in Q4 2008) and adequate liquidity coverage at the bank holding company level. These strengths, coupled with solid franchise value and adequate capital, underpin DBRS’s current ratings for Key.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Banks and Bank Holding Companies Operating in the United States, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.