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KeyCorp wrestles with NIM pressure as it braces for major acquisition


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KeyCorp wrestles with NIM pressure as it braces for major acquisition

generated solid commercialloan growth during the secondquarter a bread-and-butterearnings driver and executives saidthey are on target to close the nearly $4.2 billion of First Niagara Financial Group in earlyAugust.  

But Key continued to grapple with heavy pressureon its net interest margin and, while trying to closely manage core costs,deal-related expenses mounted and cut into profitability.

The Cleveland-based bank on July 26 second-quarternet income from continuing operations attributable to common shareholders of$193 million, or 23 cents per share, down from $230 million, or 27 cents, ayear earlier. Costs linked to Key's acquisition of First Niagara, slated to close on oraround Aug. 1, totaled $45 million and lowered EPS by 4 cents.

Key's ability to operate efficiently and contain costs in aprotracted era of slow economic growth and low interest rates has long been asource of concern on Wall Street. Its second-quarter efficiency ratio of 69.0%was well above the 65.1% it posted a year earlier. After taking outmerger-related expenses, the ratio stood at 64.8%, the company said, relativelyflat from the year-earlier quarter and up modestly from 64.3% in the firstquarter.

Second-quarter revenue of about $1.08 billion, meanwhile, wasflat from a year earlier.

"It'sa slow process," FBR & Co.analyst Bob Ramsey said in an interview, referring to Key'sefforts to bring down the efficiency ratio.

For years Key has tried to lower itscost base and improve efficiency, but the bank has struggled to make notableadvances amid sluggish revenue growth and high regulatory, technology andstaffing costs. But its plan to buy Buffalo,N.Y.-based First Niagara, approved by regulators this month, should ultimatelyprove the catalyst it needs, the company said.

Key projected cost savings of about $400 million,or roughly 40% of the target's expense base, after it announced the deal lastyear. Key CFO Donald Kimble Jr. told analysts during a to discuss earnings that,after working with First Niagara on integrationplans, executives have "gainedeven greater confidence in our ability to achieve" that target. In fact,he said, Key executives now have an internal target that exceeds $400 million.

Costsavings will come from shuttering dozens of branches among other steps. On theearnings call, Key executives confirmed they intend to consolidate 106 branchesafter the deal closes, taking out real estate and staffing costs. The banks alsoexpects to remove redundant vendor services and shift more jobs to Buffalo,where labor costs are lower than in other areas of Key's Midwest and Easternfootprint.

Kimble also said that Key is confident in its projection of$300 million in revenue synergies from the deal. An improving top line coupledwith the deal savings should help the company bring its efficiency ratio downinto the high 50s, Kimble said.

If the interest rate environment evolves in banks' favor and rates movehigher, Kimble said, Key could see even more improvement.

Ramsey said the expensereductions and revenue expectations appear reasonable, and he said therecurrently is no reason to doubt integration will progress smoothly. "It now comes down toexecution," he said. "But I think they are where they want to be atthis stage."

Inthe meantime, low rates remain a drag. Key's second-quarter NIM of 2.76% was down from 2.89% in the first quarter and 2.88% ayear earlier. The company cited lower loan yields and loan fees, as well as thehigher liquidity levels needed to fund the FirstNiagara purchase.

Stephens Inc. analyst Terry McEvoy said in aninterview that the NIM compression likely was a primary reason Key's stock fell more than 1% inmorning trading July 26 after it reported second-quarter results. "I thinkthat's where most of the focus is," he said.

But he notedthat Key is generating loan growth. Its average loanswere up 5% from a year earlier, driven by 12% growth in commercial, financialand agricultural lending. McEvoy called that "pretty solid" expansion thatit should be able to further build upon with the FirstNiagara acquisition. Key will bring to the target'scustomers more products and services, and Key also will acquire new businesslines that it can further build up and deliver across its footprint to bolsterlending and revenue.

Whenrates eventually do rise, McEvoy said, Key should benefit notably.

Keyexecutives noted on the call that the company would commence a $350 millionshare repurchase plan shortly after the First Niagara deal closes — an effort to bolster EPS incoming quarters.

"Havingthe ability to go in and repurchase stock shows that Key has excess capitaleven after the acquisition," McEvoy said. "That is important."