KeyCorp (NYSE: KEY) has now entered into the “strategic bull” zone. This is now a special situation classification where investors have to decide how to evaluate that Bank of Nova Scotia (NYSE: BNS) will invest $2.8 billion into Keycorp for a 14.9% stake. The breakdown is a two-tranche transaction valuing KeyCorp at $17.17 per share. There may be a lot more than meets the eye here where valuations and market prices differ. There may also be reasons for the near-term that the stated $17.17 share price might tend to act like a ceiling in the short-term rather than a floor. That view in the long-term looks much better in a normalized operating environment with lower interest rates by the Federal Reserve now more likely.
KeyCorp had closed last Friday at $14.61, and after briefly trading up above the $17.00 level it closed at $15.94 on day-1, then $15.69 on day-2 and then $15.64 on day-3. Again, the initial look is that this $17.17 share price might act more like a ceiling rather than a floor. How that is viewed over the long-term is up to KeyCorp and the markets. Wall Street analysts have so far raised their price targets in response and KeyCorp had a market cap of $14.5 billion at the time this was written.
The initial response in The Bank of Nova Scotia (NYSE: BNS) ADSs was a bit more harsh but is now almost back to the starting point as though it hasn’t mattered. BNS’s US-listed shares closed at $46.37 ahead of the news. The day-1 reaction was a close of $44.72, after a low of $4.16, for a 3.6% drop. Its day-2 move was up a bit more to $45.51 and the day-3 reaction was back up to $45.97. BNS has a market cap of $56.5 billion at the present time.
Please read disclosure statements at the end of this report regarding potential conflicts and regarding any other outside views of Wall Street analysts. There is also a CNBC interview with KeyCorp CEO Chris Gorman that should show the strategic fit and financial flexibility from this transaction.
WHY KEYCORP “NEEDED” CAPITAL
KeyBanc had not been enjoying the great bank stock rally to the same extent as larger money-center banks. If you recall the Silicon Valley scare in early 2023, there was a wild-fire spread where regional banks were hammered over fears that the customer departures would spread and that the low interest investments and loans made in the prior two-years were going perpetuate large losses after mark-to-market. KeyCorp shares from $18 to $12 in a short period of time.
And it turned out that KeyCorp’s earnings did show more weakness. The bank was under peers over regulatory capital ratios. And even though its stock had recovered to $14 before this news broke, the stock price was low enough that the dividend yield was still well above 5%.
Whether or not KeyCorp had to have this capital or not is a matter that is up to each investor individually. Having a “need” and taking advantage of an opportunistic move are two different scenarios entirely.
WAS THE DIVIDEND AT RISK?
High dividend yields can be a red flag to some investors. Those same high dividends may also not signal anything other than that the stock price hasn’t recovered. KeyCorp’s common stock dividend yield is about 5.2% at this time. JPMorgan’s common stock dividend shows a 2.2% yield versus a 2.7% yield for BofA’s common stock. That means the investment community is currently demanding that KeyCorp has to pay double the average of those two financial giants. And for an additional reference, KeyCorp has the highest dividend yield of all 9 regional bank subsector stocks within the S&P 500’s financial sector.
KeyCorp has paid the same $0.205 per share common dividend and its common stock dividend has risen only marginally over the last 5-year period.
KeyCorp’s total shares outstanding at Q2-2024 was 943.2 million, up from 935.7 million a year earlier.
Short sellers were not identifying any major concerns at the last reporting date. If there was an anticipated dividend risk or capital needs risk the short interest would have likely been much higher. Its short interest of 22.68 million shares represented a days to cover of only 1.7. That is actually a lower short ratio than both BofA and JPMorgan.
“GOOD ENOUGH” CAPITAL FOR REGULATORS?
Some investors have worried about KeyCorp versus other regional banks and versus larger financial giants. The good news for KeyCorp ahead of the news what that the bank had reported with earnings that Key’s estimated risk-based capital ratios had continued to exceed all “well-capitalized” regulatory benchmarks at June 30, 2024.
While KeyBanc noted that it continued to be comfortable with its current capital position, the move will allow KeyBanc to accelerate its capital improvement, its earnings improvement and to give it a better strategic position. When completed, the $2.8 billion should increase KeyCorp’s June 30, 2024 CET1 capital ratio by 195 basis points — up to 12.4%. Here are two other metrics that should stand out:
- The move will also boost KeyCorp’s tangible book value per share by more than 10%. When KeyCorp reported earnings a month earlier, the stated book value per share of $13.09 was up from $12.84 in Q1-2024 and up even more from $12.18 in Q2-2023.
- KeyBanc’s Q2-2024 earnings also noted that its common equity tier 1 (CET1) ratio rose 23 basis points to 10.5% — up from 10.3% in Q1-2024 and up from 9.3% in Q2-2023.
- At the end of Q2-2024, KeyCorp’s return on average tangible common equity from continuing operations had risen to 10.39%, up from 7.87% in Q1-2024 and versus 11.04% a year earlier.
- Compared to Q1-2024, taxable-equivalent net interest income increased by $13 million and the net interest margin increased by just 2 basis points for the second quarter of 2024.
- KeyCorp had been able to reinvest maturing securities into higher yielding and “still liquid investments” and had been able to replace its low-yielding interest rate swaps with higher-yield interest rate swaps.
- The key earnings mixed news showed lower loan balances, higher funding costs, and an unfavorable funding mix — partly offset the increase in net interest income and the net interest margin from higher yielding reinvestments.
WHAT SCOTIABANK GETS
Scotiabank will explore commercial opportunities together with KeyBanc while KeyBanc will evaluate the potential repositioning of its available-for-sale securities portfolio. This may even lead to an ultimate buyout of KeyCorp. Just don’t expect that any time soon.
One reason the impact of this stake hasn’t been even stronger is that the deal is a two-part investment and the second part, the larger tranche, will require approval by the Federal Reserve. BNS’s $2.8 billion investment will be made with $800 million for about a 4.9% stake that will close in between August and Q4-2024. The second tranche of $2 billion, requiring Fed approval, is for the 10% stake that is expected to close in 2025.
When the Bank of Nova Scotia news broke about taking a stake in KeyCorp, this did at least bring up a question about whether this might be the first step toward an outright acquisition.
S&P commented that the BNS stake in KeyCorp advances BNS’s growth strategy “to deploy incremental capital in a low-risk manner and strengthen its position in North America.” That said, the stake is relatively small to accomplish much on the surface.
HOW ANALYSTS VIEW THE DEAL
Oggonomics always reminds investors that no individual analyst calls, good or bad, should ever act as the sole reason for an investor to buy or sell an investment. That decision should be made with financial advisors and is ultimately the decision of each investor individually.
Citigroup reiterated its Buy rating and raised its price target to $19.00 from $18.00. One issue Citi brought up was that its CET1 is now estimated at 9.2% and this should get it better positioned with regulators. They further noted that the deal also shows a clean credit-quality book that is positive for KeyCorp’s multiple.
Morgan Stanley raised the firm’s price target on KeyCorp to $20 from $18 and keeps an Equal Weight rating on the shares.
Wedbush Securities reiterated its Neutral rating but raised its price target to $17.00 from $16.00.
A report from National Bank of Canada analyst Gabriel Dechaine had noted that when Scotiabank first outlined its plan to focus more on its North American market, NBC assumed it would be focused on organic growth. Now this sets a stage whereby BNS gets a 14.9% stake in a larger regional bank that it can go after more (or all) of the bank after a 5-year standstill agreement ends. If that holds true then Scotiabank is more likely to be in more of a capital conservation mode over the next few years.
Back in July, a month before this deal was even known, UBS had downgraded KeyCorp shares to Neutral from Buy and lowered its target down to $15 from $16.
DISCLAIMER
The writer of this article had started to accumulate a position in KeyCorp just ahead of the news solely as a dividend rotation out of BofA Preferred Shares. In a falling and expected easing rate environment ahead, and having used options earlier in 2024, KeyCorp was screened, along with two other banks not mentioned in this report, to be a suitable dividend and growth replacement that would have otherwise been left in a “bond alternative” class. It is anticipated that the position in “KEY” shares will grow in the weeks and months ahead.
WHAT THE CHART SAYS
KeyCorp’s long-term stock chart is not the poster child of bank growth. While the stock had recovered handily to $25 briefly in 2022, even with the recovery so far the stock is not even back to its pre-COVID levels of 2020. The 10-year chart below is from FinViz and shown using monthly candlesticks.
