KeyCorp Earnings: Net Interest Income Outlook Keeps Falling; Needs Some Headwinds To Reverse

No-moat-rated KeyCorp KEY reported weak second-quarter results. EPS of $0.27 missed FactSet consensus of $0.32 as well as our estimate of $0.41. The miss was primarily attributed to lower net interest income, which was $978 million compared with our estimate of $1,045 million, and lower fee income, which was $609 million compared with our estimate of $673 million.

Although many regional banks have been revising their 2023 NII outlooks downward, the weakening of NII has been more acute for KeyCorp than for most peers we cover. The bank now expects NII to decline roughly 13% in 2023 compared with 2022, driven by rising funding costs, slower balance sheet growth, and slower repricing on the asset side (which is not helped by the bank’s current hedging program). This is likely to be the worst 2023 NII growth rate under our coverage.

As we search for positives, KeyCorp is growing deposits once again, and at least some of the current headwinds should reverse as its hedges roll off in a more material way throughout 2024. This headwind reversal should be unique among our coverage. KeyCorp is also holding the line on expenses, which are expected to remain stable for the time being. The bank is more dependent on capital markets fees and has been more affected by the struggling capital markets environment, but this should eventually reverse, although the timing of that remains uncertain.

As we lower our NII and fee outlook, we expect a drop in our fair value estimate, likely by a mid- to high-single-digit percentage. Even so, we still view the stock as materially undervalued. We see the market’s positive reaction to this quarter’s earnings, despite overall rough results, as some vindication of our thesis that the market was being overly harsh in its valuation of the bank.