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Morningstar | KeyCorp Posts Strong 2018 Performance, Increasing FVE to $22

There was not much in no-moat KeyCorp’s fourth-quarter performance that changed our long-term view of the company. After updating our model, we are increasing our fair value estimate to $22 per share from $21. We continue to expect a more competitive banking environment, with higher costs on interest-bearing deposits and minimal NIM expansion going forward.

Overall, the key metrics came in largely as expected and management has reiterated or increased their long-term targets. The full year’s return on tangible equity came in at our estimated 14.9%, up 400 basis points from last year. We expect that the bank may be able to slightly increase return on tangible equity in the future, but overall we view current levels as around what investors should expect in the future. The full year net interest margin came in at 3.18%, up a basis point from last year. We’re projecting that the interest margin has very limited room to improve in 2019 and beyond. Noninterest expenses were down 3% from last year, and we are predicting that the bank can largely maintain these gains. We think that management is well positioned to meet its efficiency goals as we anticipate revenue will grow in the higher range of low-single digits and noninterest expenses will grow at a circumscribed rate of less than 1%. Commercial loans grew at a healthy rate of 1.4% year over year. All of this led to KeyCorp growing their bottom line EPS 51.8% from last year to $1.70, which is well in line with our expectations.

The big news from the quarter was the announcement that KeyCorp will purchase Laurel Road, an online loan originator. Although the purchase price was not disclosed, management indicated that the net effect would dilute EPS by about two cents, which we don’t think is a material dilution to our $1.83 EPS for KeyCorp in 2019. Laurel Road targets wealthy professions, with a stated average income of about $185,000, so we think that KeyCorp will gain access to an attractive client base. We agree with management that this deal makes sense strategically and we think that this business will help KeyCorp balance their commercially focused loan portfolio with more consumer loans. We like the consistent strategic focus of the bank to buy or partner with technologically forward platforms to help increase the bank’s capabilities, improve their offerings for customers, and increase the customer base over the longer term. We believe KeyCorp is building a competitive digital platform for retail clients, which we see as the right move as competition with larger banks with bigger tech budgets heats up. We also like management’s comments about remaining funded by core deposits and not looking to grow aggressively outside of their own footprint simply for the sake of chasing growth. This reaffirms the bank’s more conservative approach post the crisis.

For our recent analysis of deposit costs and net interest margins, please see our December 2018 Financial Services Observer, "The Return of the Bank: Net Interest Margins Reach a Turning Point."