Key Shares Dip on Loan Worries - TheStreet

Key Shares Dip on Loan Worries

The bank sees higher loan charge-offs due to a deteriorating portfolio of loans to homebuilders.
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KeyCorp

(KEY) - Get Report

shares slid more than 11% Wednesday after the bank said it expects to charge off more debt than it previously expected due to soured loans to homebuilders.

The Cleveland-based bank said in a

Securities and Exchange Commission

filing late Tuesday that it expects net loan charge-offs this year to be in the range of 1% to 1.30% of average loans, up from a previous estimate of 0.65% to 0.90% of loans. Key said in the filing that charge-offs in the second quarter and possibly the third quarter would run "above this range as

Key deals aggressively with reducing exposures in the residential homebuilder portfolio."

Key also expects "elevated" net loan charge-offs in its education and home equity loan portfolios.

As the economy worsens, banks with exposure to hard-hit housing areas such as the Midwest, California and Florida have been struggling with their residential and commercial real estate exposures. Two other Midwest banks,

National City

(NCC)

and

Fifth Third

(FITB) - Get Report

, have also been hard hit by the housing downturn.

Key announced in December that it would

cease conducting business

with "out of footprint" homebuilders, after recording additional reserves to address continued weakness in the housing market. It also said it was exiting "dealer-originated home improvement lending activities," which involve prime loans but are largely out-of-footprint, Key says.

Several equity analysts slashed their earnings estimates for this year and next year on Key.

"Management indicated that while the company is being more aggressive in reducing its exposure to residential homebuilders and the related problem areas, it is also seeing a more recent decline in the housing market," according to Peter Winters, an analyst at BMO Capital Markets, a unit of Bank of Montreal.

While the primary reason for the elevated charge-offs is because of Key's deteriorating homebuilder portfolio, Key last quarter "moved its student loan portfolio from held for sale to held to maturity in order to reduce market risk," Winters writes in a note. "The national home equity portfolio ($1.2 billion) is almost entirely comprised of second-lien loans and management recognizes that the recovery rate on these loans is limited when the loans go bad."

Winters adds that unlike several of Key's regional banking competitors, the bank is well capitalized, "which allows the company to handle the increase in credit costs and gives it more flexibility to aggressively address its credit issues and get the problems behind it sooner than some of its peers, in our view."

However, Goldman Sachs' analyst Brian Foran says it is now likely that Key will have to cut its dividend to preserve capital.

In addition to the residential real estate problems experienced by Key, "California and Florida residential construction is a seemingly manageable 2% of

Key's loans (including commercial construction this rises to 6%), but the nonperforming ratio in these portfolios is over 30%," Foran writes in a note. "Put another way, 2% of the portfolio is producing 40% of the

nonperforming assets. As a result, although overall charge offs were flat at 67 basis points in

the first quarter, the

nonperforming assets ratio increased 35%," last quarter.

Foran estimates that Key has exposure to several troubled homebuilders, including

WCI Communities

(WCI)

,

Standard Pacific

(SPF)

,

Technical Olympic

(TOA)

,

Meritage

(MTH) - Get Report

,

MDC Holdings

(MDC) - Get Report

,

KB Homes

(KBH) - Get Report

and

Hovnanian

(HOV) - Get Report

.

Key currently pays a quarterly dividend of 37.5 cents a share.

"A 100% dividend payout ratio may prove unsustainable in the current environment," Foran writes. "

We are now forecasting a 50% dividend cut to preserve capital."

Shares, were down 10.3% to $19.69 in recent trading.