Fitch Affirms KeyCorp L-T IDR at 'A-' Following Large Regional Bank Review; Outlook Remains Negative

NEW YORK--()--Fitch Ratings has affirmed the Long-Term and Short-Term Issuer Defaut Ratings (IDRs) of KeyCorp (Key), and Key Bank, N.A. The Rating Outlook is Negative. The affirmation reflects the strong earnings profile, stable and diverse business model, and its consistency of performance through time.

The rating action follows a periodic review of the large regional banking group, which includes Keycorp (KEY), BB&T Corporation (BBT), Capital One Finance Corporation (COF), Citizens Financial Group, Inc. (CFG), Comerica Incorporated (CMA), Fifth Third Bancorp (FITB), Huntington Bancshares Inc. (HBAN), M&T Bank Corporation (MTB), MUFG Americas Holding Corporation (MUAH), PNC Financial Services Group (PNC), Regions Financial Corporation (RF), SunTrust Banks Inc. (STI), US Bancorp (USB), Wells Fargo & Company (WFC), and Zions Bancorporation (ZION).

Company-specific rating rationales for the other banks are published separately, and for further discussion of the large regional bank sector in general, refer to the special report titled 'Large Regional Bank Periodic Review,' to be published shortly.

KEY RATING DRIVERS

IDRS, NATIONAL RATINGS AND SENIOR DEBT

Fitch's affirmation of KEY's IDRs is supported by the company's strong capital position, solid asset quality performance, diversified revenue mix, and reduced risk profile. Although gradually improving, the company's earnings measures fall on the lower end of most large regional banks.

Ratings incorporate KEY's strong capital position, which is amongst the highest of its peer group with a TCE of 9.60% and CET1 ratio of 11.10% for second quarter 2016 (2Q16). KEY received no objection to its capital plan this year, and quantitatively, projected loan losses for 2016 CCAR were slightly below peer averages, which importantly included the First Niagara Financial Group acquisition, which closed in August 2016 and received OCC approval in September 2016. Post-closing of FNFG, KEY has estimated a pro forma CET1 ratio of 9.5%.

Additionally, given the company's reduced risk profile over the years, credit performance continues to be better than peers with an average of net charge-offs (NCOs) of 0.27% and nonperforming assets (NPAs) of 1.18% over the last five quarters. KEY estimates that its through-the-cycle loan losses are expected to fall between 40 basis points (bps) and 60bps. Given current NCOs levels at 28bps for 2Q16, Fitch expects some credit deterioration for KEY, as well as the industry, as credit losses are likely at unsustainably low levels. Further, KEY's securities portfolio has virtually no credit risk with approximately 99.7% of its holdings related to agency securities, the highest levels among the large regional banks.

KEY's exposure to the energy sector is very manageable. At June 30, 2016, KEY reported $3.1 billion of oil and gas commitments, which represents about 2% of total loans outstanding. Although KEY has reported a rise in commercial NPAs, absolute NPA levels continue to reflect solid credit quality.

Fitch also considers the company's diversified revenue base as a rating strength evidenced by noninterest income contributing roughly 44% of total revenues, consistently above the peer group average. The company has benefited from its solid commercial platform that reflects its middle-market focused capital markets business.

KEY's profitability measures tend to fall on the lower-end of peer averages such as return on assets (ROA) and net interest margin (NIM) for the large regional group, although the gap to the peer group averages is closing. Some of this may be attributed to the company's above average operating costs and lower loan yields given large component of commercial and industrial (C&I) loans tied to LIBOR rates. KEY's NIM is also modest, although, positively, the company has experienced less NIM compression than some of peers. Incorporated in the affirmation is that profitability will trend positively and pull to peer-averages over time. Further, the company's cost savings initiatives should also lead to improvements in profitability.

Fitch's affirmation of KEY also reflects our view that the FNFG transaction will strengthen KEY's franchise in key markets. Post-closing, KEY would have an improved and strong market position in upstate NY as well as other key markets. Additionally, the FNFG franchise has a strong retail deposit base which is currently undervalued given the low rate environment and excess liquidity in the market.

KEY's projected improvements to its efficiency ratio and pre-tax-cost saves of $400 million are also viewed positively. Further, KEY's pro forma CET1 ratio of 9.5% is considered appropriate given the risk profile of the combined entity. The company has also identified $300 million of revenue synergies that are not included in the model of the acquisition.

The Negative Outlook reflects Fitch's view that integration and execution risks are high given that FNFG has been an acquisitive bank and has undertaken significant investment to improve its infrastructure. Thus, Fitch views integration risk to be higher as KEY assesses and transitions FNFG's technology and infrastructure to its own platform. Fitch also believes execution risks are higher given the size of this acquisition and KEY's limited experience. Although FNFG's balance sheet is modest in complexity, KEY lacks a proven track record of successful acquisitions. Of note, KEY has identified 40% of the targeted costs saves will come from technology and third party vendors, which seems achievable.

Further, in Fitch's view, FNFG's commercial real estate (CRE) business and residential mortgage portfolio (roughly about $12 billion) should continue to experience steady credit performance. However, Fitch has noted concerns with FNFG's risk profile given aggressive growth. Further, the company also entered relatively new business lines such as indirect auto, leveraged lending, and asset-based lending at a time when competition for loans is fierce. Despite continued stable asset quality measures, we believe FNFG's historical credit metrics may not be indicative of future performance. Mitigating factors are KEY's estimated credit mark of 3% on the loan portfolio which combined with the projected capital position should support credit potential deterioration.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

KEY's subordinated debt is notched one level below its VR for loss severity. KEY's preferred stock is notched five levels below its VR, two times for loss severity and three times for non-performance, while KEY's trust preferred securities are notched two times from the VR for loss severity and two times for non-performance. These ratings are in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles and have thus been affirmed due to the affirmation of the VR.

LONG- AND SHORT-TERM DEPOSIT RATINGS

The uninsured deposit ratings of KeyBank, N.A. are rated one notch higher than KEY's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.

HOLDING COMPANY

KEY's IDR and VR are equalized with those of its operating companies and bank, reflecting its role as the bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries. Ratings are also equalized reflecting the very close correlation between holding company and subsidiary failure and default probabilities.

SUPPORT RATING AND SUPPORT RATING FLOOR

KEY has a Support Rating of '5' and Support Rating Floor of 'NF'. In Fitch's view, KEY is not systemically important and therefore, the probability of support is unlikely. IDRs and VRs do not incorporate any support.

RATING SENSITIVITIES

VR, IDRs, AND SENIOR DEBT

KEY's ratings are primarily sensitive to its ability to successfully integrate FNFG. In assessing this, Fitch will consider KEY's ability to integrate and/or consolidate information technology systems, while demonstrating progress towards achieving key financial objectives of the transaction, such as internal rate of return and expected cost savings. Positively, KEY received regulatory approval to close the transaction and has indicated that it is on track to achieve its targeted $400 million of cost saves.

Although not expected, KEY ratings would be sensitive if the credit mark on FNFG's loans or securities proved to be insufficient.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

The ratings for KEY and its operating companies' subordinated debt and preferred stock are sensitive to any change to KEY's VR.

LONG- AND SHORT-TERM DEPOSIT RATINGS

The long-and short-term deposit ratings are sensitive to any change to KEY's long- and short-term IDR.

HOLDING COMPANY

Should KEY's holding company begin to exhibit signs of weakness, demonstrate trouble accessing the capital markets, or have inadequate cash flow coverage to meet near-term obligations, there is the potential that Fitch could notch the holding company IDR and VR from the ratings of the operating companies.

SUPPORT RATING AND SUPPORT RATING FLOOR

Since KEY's Support and Support Rating Floors are '5' and 'NF', respectively, there is limited likelihood that these ratings will change over the foreseeable future.

The rating actions are as follows:

Fitch affirms the following:

KeyCorp

--Long-Term IDR at 'A-'; Outlook Negative;

--Short-Term IDR at 'F1';

--Viability at 'a-';

--Senior debt at 'A-';

--Subordinated debt at 'BBB+';

--Preferred stock at 'BB';

--Short-term debt at 'F1';

--Support at '5';

--Support Floor at 'NF'.

KeyBank NA

--Long-Term IDR at 'A-'; Outlook Negative;

--Short-Term IDR at 'F1';

--Viability at 'a-';

--Long-term deposits at 'A';

--Senior debt at 'A-';

--Subordinated debt at 'BBB+';

--Short-term deposits at 'F1';

--Support at '5';

--Support Floor at 'NF'.

Key Corporate Capital, Inc.

--Long-Term IDR at 'A-'; Outlook Negative;

--Short-Term IDR at 'F1'.

KeyCorp Capital I - III

--Preferred stock at 'BB+'.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Bank Rating Criteria (pub. 15 Jul 2016)

https://www.fitchratings.com/site/re/884135

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1012645

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Doriana Gamboa
Senior Director
+1-212-908-0865
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Julie Solar
Senior Director
+1-312-368-5472
or
Committee Chairperson
Christopher Wolfe
Managing Director
+1-212-908-0771
or
Media Relations
Hannah James, + 1-646-582-4947
hannah.james@fitchratings.com