We Remain Positive on KeyCorp After In-Line Results

Early Thursday morning, KeyCorp (KEY) reported in-line third-quarter results, with revenues of $1.55 billion falling just short of consensus of $1.56 billion, and adjusted earnings per share of $0.35 matching consensus. Notably, during the quarter, the company realized a $5 million gain adjustment in merchant services and a $36 million charge on merger-related activity, making a pretax net impact of $41 million or about $0.03 per share.

By segment, Key's revenues rose year over year despite sequential declines. Community Banking revenue was $959 million, an increase of 2.5% year over year. Corporate Banking revenue was $560 million, representing a slight advance of 0.7% year over year. In Key's other segment, revenue was $30 million for the third quarter.

Net interest income was $962 million for the quarter, rising 22% year over year. Reflecting benefits from the First Niagara acquisition, the net interest margin was 3.15% during the quarter, up from 2.85% during the third quarter last year. Sequentially, net interest income decreased $25 million and net interest margin narrowed 15 basis points. The decline in income and margins reflected a drop in purchase accounting accretion of $52 million. Excluding these accretions, net interest income increased $145 million year over year and $27 million sequentially.

Noninterest income was $592 million for the quarter, and increase of roughly 8% year over year. Driving the growth was a full-quarter impact of the First Niagara acquisition and continued growth in the company's core businesses. Sequentially, growth in Key's fee-based businesses supported revenue during the quarter, as revenue climbed in investment banking, debt placement fees, mortgage-servicing feeds, and cards and payments income. Fresh off the record Investment Banking fees from last quarter, IB has been an underrated storyline for Key, and momentum is building toward another year of solid growth in the division.

In addition to the broader market selloff today, explaining the stock's decline this morning are concerns over loan growth. At first glance, average loans are increasing year over year, but the increases here are largely attributed to the First Niagara Integration. Taking a deeper look at the quarter, sequentially, loan growth rose just 0.4%, and dating back to the fourth quarter of 2016 average loans have remained stagnant at about $87 billion.

Despite these concerns, we want to point out that net chargeoffs have been steadily decreasing for Key, suggesting that although the average balance growth has not changed, it could be improving the quality of the loans, which is just as important. Surely Key could deliver looser loan provisions that would spur balance growth, but that is not a recipe for success. Higher-quality loans allow Key to get the greatest return on the capital it lends, and this improving trend is encouraging for health of the business.

Looking ahead, management guided fourth-quarter average loan balances to be between $87 billion and $87.5 billion, which is slightly below consensus expectations and continues this trend of stationary growth, but again, we point out the importance of higher quality.

Management did not change their other full-year 2017 expectations, seeing deposits between $102.5 billion and $103 billion, net interest income between $3.8 billion and $3.9 billion (which excludes an additional rate hike this year, promoting potential upside should one occur in December), and non-interest income in the range of $2.35 billion and $2.45 billion.

Overall, while today's trading is rather muted, we point out that many of the larger financials sold off after reporting earnings only to bounce back in trading a few days later. In addition, today's action is accelerating the downtrend of Key's shares, and we would suggest waiting for the selloff to shake out (much like what occurred with Citigroup (C) ) before adding to a position below basis.

We also want to mention how quickly sentiment in financials can shift, as it was only just a month ago we bought Key shares in the mid-$16 range. Despite the weakness in loan forecasts, we believe that the credit quality improvement offsets the lagging trend as management has worked hard to clean up the balance sheet, which will lead to success.

Lastly, we are maintaining our price target and optimism in Key as the company represents one of the most profitable regional banks in the country. With expectations of an additional rate hike in December (and the potential for more in 2018), along with an improving economic environment with the potential of fiscal stimulus, which could spur consumer spending, there are reasons to remain positive on Key.

Action Alerts PLUS, which Cramer co-manages as a charitable trust, is long KEY and C.