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KeyCorp's Earnings Saved by Lower Credit Costs

Source: KeyCorp

The tide seems to be turning at Ohio-based KeyCorp (NYSE: KEY  ) . For the three months ended Sept. 30, the bank earned $229 million, or $0.25 per common share, compared to $211 million, or $0.22 per common share, in the same quarter last year.

"Key's results reflect another quarter of improved performance as we continued to grow our businesses, improve efficiency and execute on our capital priorities," said chairman and chief executive officer Beth Mooney.

Despite Key's bottom-line performance, its income statement reveals the telltale signs of the same industry headwinds that have affected its industry peers. While net interest income at the bank was up by $6 million on a year-over-year basis, it nevertheless declined by $3 million compared to the second quarter.

As we saw with Bank of America and Wells Fargo, among others, the culprit was a lower yielding asset portfolio that wasn't offset by a comparable fall in Key's cost of funds. The contraction between these goalposts led to a 12-basis-point year-over-year decrease in the bank's net interest margin, a pivotal metric that measures the profitability of a lender's balance sheet.

On top of this, Key's noninterest income followed a similar, albeit reversed, pattern. Relative to the second quarter, fee-based income was up by $30 million. But compared to the same time period last year, the figure was off by $59 million.

While many of its core businesses expanded their contributions to the bottom line, KeyCorp's ambiguous "other income" declined by $53 million "due to a $54 million gain associated with the redemption of trust preferred securities one year ago."

The one other notable noninterest income line item was the 73% year-over-year decline in mortgage banking income. This is a trend we've seen at virtually all of the major mortgage lenders to report thus far this quarter. However, the relative magnitude of the decrease at Key was much larger than at any of its peers.

Given these offsetting trends, and particularly the sharp decline in noninterest income, you'd be excused for wondering how exactly Key's earnings improved. And the answer, which was also the answer to a similar puzzle at Wells Fargo, is that Key's loan loss provisions (which are effectively treated as an expense) plummeted by $81 million over the last 12 months.

Of all the things Key did well, other the three-month stretch, two immediately stick out.

The first concerns credit quality. At the end of the third quarter, Key's net charge-off ratio had fallen all the way down to 28 basis points. This is a long way from where it was during the financial crisis and is essentially at a normalized rate, as it's challenging to get net charge-offs to come in below this level, even in the best of times.

Additionally, although Key's management claims loan growth isn't a top priority, it reported an 11% increase from the prior year in commercial, financial, and agricultural loans. Assuming these are ultimately paid back -- as the CEO of M&T Bank puts it, "the only good loan is one that's repaid" -- this performance will pay off in many quarters to come.

The bottom line is that KeyCorp had a solid, if not ho-hum, quarter.

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9/30/2016 4:01 PM
KEY $12.17 Up +0.12 +1.00%
KeyCorp CAPS Rating: ****