KeyCorp

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

KeyCorp is a regional bank holding company, primarily operating in the Midwest, Pacific Northwest, and Northeast United States. It offers a range of banking and financial services, including commercial, consumer, and investment banking.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

KeyCorp operates in a highly regulated industry that can significantly affect its profitability, but it also provides some barrier to entry for new entrants.

Business Overview:

KeyCorp operates through two primary segments: Consumer Bank and Commercial Bank.

Consumer Bank

  • Revenues: Generates revenue through interest income from loans, overdraft fees, wealth management, and payments.
  • Focus: Provides financial services to individuals and small businesses through various channels including digital and physical.
  • Key Products: Includes checking and savings accounts, mortgages, credit cards, personal loans, and wealth management services.
  • Recent Trends:
    • Growing deposit balances through the addition of new consumer clients.
    • Experiencing reduced revenues from service charges on deposit accounts and card & payment fees driven by both regulators and client initiatives.
    • Has seen growth in unsecured consumer loans.

Commercial Bank

  • Revenues: Earns revenue primarily from interest on loans, advisory, and underwriting fees
  • Focus: Offers services for middle-market and corporate clients.
  • Key Products: Includes commercial lending, treasury management, equipment financing, and investment banking.
  • Recent Trends:
    • Has grown its loan portfolio, but this growth has slowed over the year given changes in economic outlook.
    • Increased revenue generation through interest rate hikes, which has helped to drive net interest income.

Financials:

KeyCorp’s financials paint a picture of a bank adapting to a dynamic market, and while it has maintained and even increased some metrics, it has had a tough year with respect to earnings.

  • Net Interest Income: Net interest income (NII) is the largest contributor to earnings and has increased in recent times due to interest rate hikes. However, there is continued pricing pressure in funding as deposit betas increased faster than expected.
  • Noninterest Income: This part of revenue has seen a decrease, especially in investment banking and service charges on deposit accounts.
  • Operating Expenses: Noninterest expense continues to increase. Increased personnel expenses, technology expenses, and professional fees. It is expected to be higher still in 2023 due to some restructuring initiatives.
  • Loans: Commercial loans still contribute the largest share of the loan portfolio and continue to grow. The growth of consumer loans was particularly strong in the first half of 2023, though this was partially offset by higher mortgage prepayments.
  • Credit Quality: Credit quality remains strong as a whole, but there is increased exposure in consumer credit, and it is expected to continue to face pressure due to the economic conditions.
  • Net Income and EPS: Due to a myriad of factors (especially credit conditions), net income and earnings per share saw a steep decline between 2022 and 2023.
  • Capital: CET1 capital was 10.4% at September 30, 2023, slightly above their internal target, but is still below prior years and is expected to be at or below guidance for the remaining period of 2023.

Moat: 2/5

KeyCorp does not possess a traditional “wide moat”, primarily due to the high competition and lack of differentiation in the banking industry. Although the bank does offer a full range of services that increase switching costs to their current customers, they are not high enough to allow it to be an outstanding franchise. However, there are a few factors that contribute to some strength in KeyCorp’s competitive position:

  • Switching Costs (Narrow Moat): The switching costs for retail customers are quite high due to the inconvenience and psychological barriers that exist to switching checking and savings accounts, and is also true for commercial and institutional clients that rely on a bank’s technology and relationship management. This effect is further augmented by the fact that most customers don’t have knowledge of bank fee structure or pricing mechanisms. While these costs are meaningful, other banks can overcome them by offering monetary incentives or benefits that will prompt them to switch, especially since financial services, generally, are not known for being highly differentiated products.
    • Rating: 2/5 - A limited moat due to switching costs that does not prevent competition
  • Intangible Assets (Narrow Moat): As mentioned before, in the financial industry, brands matter to a degree, especially since it establishes trust and reliability. KeyCorp has a long history and is an established name, therefore it does have a certain degree of brand recognition and trust with its customers. However, compared to large commercial banks with well established nationwide brands, the power of KeyCorp’s brand is not significant.
    • Rating: 1/5 - A very weak moat due to limited brand recognition and no pricing power.
  • Network Effect (None): There is no meaningful network effect in the operation of this company.
    • Rating: 0/5 - No network effect
  • Cost Advantages (None): In a commodified service like the banking industry, scale becomes less of an advantage as low cost fintech or specialized banks are able to compete and outperform on service and price. There are limited economies of scale to the business model since most banks are offering largely undifferentiated products.
    • Rating: 0/5 - No cost advantages.

Business Resilience:

KeyCorp has faced a few challenges recently, that could affect its moat:

  • Impact of Regional Banking Crisis: The collapse of some regional banks has significantly affected the banking industry as a whole, with more scrutiny on banks from government agencies and investors. The deposit outflows were a major problem, even for banks with strong financials. While the crisis seems to be subsiding, the effects on investor and customer confidence is yet to be determined.
  • Interest Rate Sensitivity: Banks, like KeyCorp, are susceptible to the effect of interest rate fluctuations and it has been a struggle to manage the asset-liability mismatch inherent in their operations. While a rise in interest rates can improve net interest income (NII), it can also impact loan defaults and customer confidence, thus, this is something the bank has to constantly monitor and adjust for.
  • Credit Risks: Credit risk remains a constant threat for the profitability and stability of banks. As loan growth slows and uncertainty increases, the risk of loan losses can materialize more quickly, and thus a disciplined and active management is of prime importance.
  • Competition: Despite having a traditional business structure, KeyCorp’s business is highly commodified, which is facing new threats from fintech and online competitors that offer a cheaper and differentiated product. This puts pressure on the revenue and ability of banks to compete with the new offerings.
  • Regulatory Risk: The regulations in the financial industry often bring a lot of uncertainty and are constantly changing. These rules affect the business practices and financials, thus it is an issue that needs to be constantly monitored and adjusted for.

Increased regulatory risk remains a concern for KeyCorp and the banking industry as a whole. These include changes to capital requirements and increased scrutiny from government agencies.

These risks pose a significant threat to the business, however, KeyCorp also has several mitigating factors:

  • Long-term experience and deep customer relationships: The bank has survived for a long time and has established good customer relationships which can provide a psychological buffer against short term turbulences and offer repeat business.
  • Established Business: KeyCorp has strong business practices and understands the rules and requirements in place, giving it an edge over new and developing businesses.
  • Effective risk management: In recent times, KeyCorp has shown that it is capable of managing credit and operational risks through the appropriate processes, which is vital to ensuring long term stability of the business.

Understandability: 3 / 5

While regional banking is not an extremely complicated business, it can have multiple dimensions and facets which need considerable understanding. Therefore, a general understanding is relatively easy, but in-depth analysis can be complex.

  • Basic Banking Model: The core business model of taking in deposits and giving out loans is straightforward.
  • Regulatory Complexity: KeyCorp is subjected to various and sometimes overlapping regulations which, if not understood, will create issues in financial analysis.
  • Financial Reporting: Analyzing financial statements of banks, requires additional knowledge and understanding compared to manufacturing or similar businesses, which makes it a little harder to interpret.
  • Multiple Business Units: KeyCorp also has an investment and commercial banking arm, which adds complexity.

Balance Sheet Health: 3 / 5

The health of KeyCorp’s balance sheet is decent but not exemplary, as the bank is showing signs of strain and increased risk, though the management seems intent on fixing it.

  • Capital: KeyCorp’s CET1 ratio is above the minimum requirements, but there have been some discussions by the management on the need for increasing this ratio.
  • Debt: KeyCorp does have some debt, which although is lower than the equity of the company, but it is still a part of the balance sheet that should be monitored to understand the risk. There is increased discussion for new debt issuance in the latest conference calls.
  • Assets: A majority of KeyCorp’s assets are in the form of loans, which have high associated credit risk.
  • Liabilities: A large proportion of liabilities is composed of deposits, which are very sensitive to interest rate fluctuations and thus will have to be monitored as a part of liquidity risk assessment.