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Key Takes a Charge, Raises Capital

Debra Borchardt

Cleveland-based KeyCorp will issue common and noncumulative perpetual convertible preferred stock to raise about $1.5 billion. Key is expected to record a charge of up to $1.2 billion due to the adverse ruling. The case was related to tax treatment of a lease transaction. Key said it believes it complied with tax law and is considering an appeal.

In the meantime, however, the bank decided to reduce its dividend to 75 cents annually. The most recent quarterly dividend declared had been 37.5 cents per share, up from 36.5 cents a share last February. The cut is expected to save the bank $200 million annually.

"The decision to reduce our dividend after 43 consecutive years of annual increases was made after great deliberation," said CEO Henry Meyer in a company statement. "It was a record we were extremely proud of, but we must recognize the current economic realities as we manage our business for the future."

KeyCorp said the projected second-quarter charge stems from about $475 million in after-tax interest costs on the taxes claimed on the contested leveraged leases, and roughly $625 million to $725 million in noncash accounting adjustments based on the revised cash flows of the leases.

"If it had not been for the adverse court ruling on our tax treatment of a leveraged lease transaction, we probably would not have considered the capital raising actions," Meyer said.

KeyCorp shares plunged on the news, dropping 17% to $13.03, a loss of $2.67.

On a positive note, Moody's(MCO Quote) affirmed its ratings and stable outlook on KeyCorp. The holding company is rated A2 for senior debt and the company's lead bank, KeyBank National Association, is rated B- for bank financial strength and A1 for deposits.

Moody's noted that Key has considerable construction and commercial real estate exposure, and its consumer book includes a sizable marine portfolio and a large, though currently well-performing, directly originated home equity portfolio. In addition to its robust capital position, Key's ratings continue to be supported by a healthy parent company liquidity profile and good geographic and business line diversity.

Key isn't the only bank to face lease-related tax problems. In April, Wachovia(WB Quote) said that it expected to record a charge of between $800 million and $1 billion in the second quarter after a similar adverse ruling.

On Wednesday, before Key's announcement, Goldman Sachs analyst Lori Appelbaum had noted that banks have been losing these types of cases. She said she expected Key to cut its dividend and raise capital, lowering her 12-month target price to $22 from $25.

Regional banks have faced many challenges due to nonperforming loans and writedowns. Credit has tightened and loan issuance, a major source of income for banks, has dropped tremendously. Banks like National City (NCC Quote), Fifth Third Bancorp(FITB Quote) and Huntington Bancshares(HBAN Quote) have experienced large stock-price declines, and the S&P 1500 Regional Banks Index decreased 13.3% year to date.