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KeyCorp, Regions Slump After Downgrades

Both stocks lose roughly 5% after Merrill Lynch slaps sell ratings on the two regional banks.


(KEY) - Get KeyCorp (KEY) Report


Regions Financial

(RF) - Get Regions Financial Corporation Report

each slid roughly 5% on Friday after Merrill Lynch slapped sell ratings on the two regional banks citing further credit concerns, particularly in their commercial real estate portfolios.

Ed Najarian, a senior bank analyst at Merrill Lynch, downgraded both Key and Regions to sell from neutral.

Key's rating was lowered because of an expected "very weak return" on tangible common equity through 2010, "diminished" earnings power due to credit quality deterioration and factors that could keep revenue growth in check, and a recent increase in the bank's stock price that "belies its weak EPS growth outlook," Najarian writes in a research note.

Regions has "diminished core earnings power" owing to credit weakness and asset sensitivity, Najarian writes in a separate note. The Birmingham, Ala.-based bank's valuation is also high, he says, given his outlook for a low return on equity this year and fairly high cost of capital.

Najarian predicts a weak credit outlook for both Key and Regions, since both banks have exposure to loans to homebuilders, and the declining performance of these loans will lead to higher charge-offs.

He cut his earnings estimates on Cleveland-based Key by 20 cents this year to $1.85 a share and for 2009 by 15 cents to $1.95 a share. He cut his earnings estimates on Regions by 15 cents this year to $1.90 a share and by 10 cents next year to $2.


The ongoing decline in home prices appears to be accelerating in certain geographies and is contributing to a rapid rise in foreclosure rates," he writes in the note regarding Key. "These forces should drive higher mortgage and home equity losses." He estimates that by year-end Key's loan-loss reserves will total $1.4 billion this year, but notes that "more loan-loss reserve build may be necessary."

Regions' $6.2 billion residential construction portfolio is concentrated in Florida and Atlanta and includes $3.5 billion of troubled vacant building lots and land, "which could experience particularly high loss content," Najarian believes.

"This is

Regions main source of nonperforming asset growth," he writes. Region's "rapid buildup of

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nonperforming assets and 90+ day delinquencies ... without similar magnitude of loan-loss reserve build leaves

the bank's future EPS vulnerable to continued credit quality deterioration throughout its consumer and commercial loan portfolios."

Additionally, the rapid increasing amount of delinquencies combined with the bank's "asset-sensitive" balance sheet, as well as a competitive deposit environment, could pressure its net interest margin through next year.

Regions "has few potential offsets to these considerable earnings headwinds," Najarian writes.

The added loan-loss reserves would likely further worsen what is likely to be an already disappointing year for bank earnings. Earlier this week, several banks presenting at the UBS Financial Services Conference, including

Bank of America

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JPMorgan Chase

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Fifth Third

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Washington Mutual

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, discussed the likelihood for further loan-loss reserving for a variety of consumer-related loans.

Merrill's downgrades contributed to a relatively sour day for financial stocks. The

NYSE Financial Sector Index

most recently dropped 0.73% to 7,673.01. Of the large-cap stocks that make up the

Dow Jones Industrial Average


American Express

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(C) - Get Citigroup Inc. Report

, were among the worst performers. The

KBW Bank Index

, which is comprised of the nation's largest 100 banking companies, fell 2.2% to 80.81.

Shares of Key lost $1.26 to $23.83, while Regions dropped $1 to $29.32.