KeyCorp

KeyCorp delivered slightly underwhelming results, with total revenue growth of 7% year over year. Along with earnings, the bank raised its 2026 net interest income guidance by 1% at the high end and loan growth guidance by 1.5% at the midpoint.

Why it matters: Management had previously guided to a stepdown in investment banking fees from the strong first-quarter level, but the actual decline was still disappointing, down 5% year over year and 14% sequentially. A bifurcation has persisted for several quarters between behemoth investment banks that take the lion's share of large and mega deals and those focused on the middle market mergers and acquisitions space, as larger M&A deals have dominated advisory fee income profit pools. More importantly, Key not only underperformed Wall Street investment banks (with growth of 28% at JPMorgan and 50% at Bank of America) but also trailed PNC's 80% growth, despite PNC sharing a similar middle market M&A focus.

The bottom line: As we incorporate the latest results and updated guidance, we don't expect to make a material change to our $22.70 fair value estimate for no-moat-rated KeyCorp. We view shares as fairly valued. Key's management is confident in delivering over a 20% sequential increase in investment banking fees in the third quarter and maintained its mid-single-digit growth for 2026. Our current full-year expectation for KeyCorp is 5% growth in investment banking fees.

Coming up: KeyCorp expects to close its previously announced acquisition of Clearwater UK, a middle market M&A investment bank, in the second half of 2026, pending regulatory approval and customary closing conditions. We have not included the acquisition in our base-case forecast for KeyCorp. This acquisition should expand KeyCorp's investment banking distribution in both the UK and the European continent. KeyCorp and Clearwater had a prior joint venture and have maintained a client referral relationship for the last five to six years.

Loan growth of 1.1% sequentially trailed the US banking industry's 1.7% growth based on the Federal Reserve's H.8 data. While commercial lending was a strong growth driver, consumer lending balances declined by 1.8%. We expect the bank's decision to run off residential mortgages and other consumer lending to be a growth headwind for KeyCorp in the short to medium term.

We are increasing our fair value estimate to $23.10 per share from $22.90. The increase is mostly driven by the time value of money. We have also updated our interest rate projection. Our base-case scenario now includes a 25-basis-point increase in the federal-funds rate in December as well as the 25-basis-point hike in September. We expect the Federal Reserve to start cutting short-term interest rates in the second half of 2027.

Our long-term rate assumptions are unchanged. KeyCorp is not as rate-sensitive as some of the other regional banks under our coverage. We now expect the bank to grow its net interest income at a compound annual growth rate of 3.6% over 2025-30, up by 0.1% from our last projection. Our valuation is equivalent to 1.7 times the bank's tangible book value as of June 30, 2026 (and 1.5 times TBV after removing AOCI effects). We use a cost of equity assumption of 8.9%.

We forecast loan growth of around 3.6% in 2026, with the bank continuing to see some deliberate runoff of its mortgage and other consumer loans, partially offset by growth in commercial loans. We expect average loan balances to grow by around 4% in 2026. We expect another year of NIM expansion of around 20 basis points in 2026, to 2.94%, following a 51-basis-point expansion in 2025. This leads to a 9% increase in 2026 net interest income. We expect the bank's longer-term net interest margin to normalize to around 2.86% as the higher-yielding hedges eventually roll off its balance sheet. We forecast its net interest income to grow at a CAGR of 3.4% from 2025 to 2035.

We expect fee income to grow at 3.6% in 2026, driven by broad-based growth in deposit service charges, investment banking fees, and asset-based fees, with some headwinds in the bank's commercial mortgage servicing income. In the long run, we forecast annual fee income growth of around 2.8%.

We expect expense growth of 3.8% in 2026, driven primarily by compensation expense. We expect expense growth of 2.8%-3.5% thereafter. By the end of our 10-year forecast, we expect the bank's efficiency ratio to reach 62.3%, missing management's ambitious target range of 54%-56%.

We project credit costs will remain a bit elevated in 2026. We model a net charge-off ratio of 41 basis points, in line with 41 basis points in 2024 and 2025. We expect a return on tangible common equity of 13.7% through the cycle compared with our estimate of the bank’s cost of equity at 8.9%. This again falls short of management’s target return range of 16%-19%.

We assign KeyCorp a Morningstar Economic Moat Rating of none because it does not possess durable cost advantages or meaningful switching costs consistent with our bank moat framework. While we project the bank will earn returns above its cost of capital (8.9%), we still forecast it will tend to be on the lower end of its peers on a normalized basis. We would like to see more improvement in the bank’s deposit franchise before awarding this bank a moat.

We believe bank moats are derived primarily from cost advantages and switching costs. We see cost advantages from three primary factors: a low-cost deposit base, excellent operating efficiency, and conservative underwriting. Regulatory costs must also be considered. We argue that KeyCorp exhibits no strong signs of cost advantages or strong switching costs.

KeyCorp tends to have a higher cost of deposits than the other banks we cover. Despite having a better mix of non-interest-bearing deposits, KeyCorp has historically had to pay slightly higher rates on its pool of interest-bearing deposits. KeyCorp lost 26.4% of its non-interest-bearing deposits in 2023, the worst among our regional bank coverage (average lost 17.6%), reinforcing our view that KeyCorp doesn’t have a strong deposit franchise. The swaps portfolio also worked against the bank in the current rate-hiking cycle, as the bank was trying to lock in rates when facing ultralow rates during covid but missed some of the asset repricing benefits from higher rates in 2023. As a result, the bank’s net interest margin and credit-adjusted net interest margin (adjusted for loan-loss provisioning) were the lowest among our regional bank coverage in 2022 and 2023, though its net interest margin started to recover in 2024.

KeyCorp has historically run less efficiently than top banks we cover, averaging a mid-60s efficiency ratio. This stems from its dispersed branch network, lower deposit market share concentration, and investment banking focus. The bank's footprint spans 16 states, split between Eastern markets (Midwest/Northeast) and Western markets (Washington, Oregon, Alaska, Colorado, Utah). Given this fragmentation, we forecast KeyCorp's efficiency ratio stays on the high end relative to moaty peers. Its investment banking fee income, with a higher compensation ratio than traditional banking, further weighs on efficiency.

In terms of credit costs, KeyCorp has not historically been a solid underwriter, generally performing worse than its peers through the past several downturns. While KeyCorp did not make it through the 2008-09 global financial crisis unscathed, we believe it has been a more conservative lender since then, having rotated out of the riskier and out-of-footprint construction loans that had hurt it in past cycles. The bank's performance during the pandemic confirms this. Looking ahead, we think the bank's credit costs should be generally in line with the broader US banking industry.

Regulatory costs matter at the industry level and for KeyCorp specifically. The US banking system has improved over the last decade, with capital levels at all-time highs and stronger postcrisis regulation. Despite intense competition, the largest banks by assets have earned higher returns on equity for decades and still do. Our long-run outlook is positive, given the US' stable democracy, steady GDP growth, and reserve currency status. KeyCorp is not large enough to be considered a global systemically important bank and therefore avoids some of the more onerous regulatory capital requirements. It is large enough to be subject to the Federal Reserve's stress tests because it has more than $100 billion in assets, but it only has to go through the full process every two years. The bank also avoids extra liquidity coverage and funding ratio requirements. Overall, because the bank avoids much of the additional regulation that larger peers face, we view its regulatory burden as slightly advantageous. While we think KeyCorp could benefit from some additional scale, it is small enough to avoid some of the extra costs faced by its largest peers. Further requirements will be triggered if KeyCorp surpasses $250 billion in assets. We view the March 2026 Basel III endgame proposal and 2025 stress test changes as mostly positive. The key change for banks between $250 billion and $700 billion in assets is including accumulated other comprehensive income in common equity Tier 1 capital, which KeyCorp should handle well. KeyCorp already has an adjusted CET1 ratio (adjusting for AOCI) of 9.8%, above its regulatory minimum of 7.7% at the end of June 2026.

Switching costs exist in banking services, but KeyCorp lacks the attributes to earn a moat from them. Its average fee income ratio of 40% is high among regional peers, driven mainly by wealth and trust management, investment banking, and digital banking at Laurel Road. Scale and reputation matter in these businesses, and KeyCorp is competitive but not a standout. These segments are useful add-ons that diversify revenue and serve clients well, but don't yet provide durable structural switching cost advantages.

KeyCorp has a stronger focus on capital markets, using these services to complement its commercial banking operations. It doesn't have a large trading business, focusing primarily on merger advisory, debt underwriting, and equity underwriting. High-level indicators of an investment bank's intangible assets include league table position, participation in high-profile transactions, and revenue generated by its bankers. In the middle market where KeyCorp focuses, deal sizes and services rendered don't scale as much as those of dominant investment banks. We also wonder how returns will evolve over the next 10 years as larger peers migrate more into the middle market and as private credit (nonbank lenders) expands aggressively into this area.

KeyCorp's investment banking fees could be a major fee income growth driver if recently hired senior bankers' productivity gets up to speed.

KeyCorp's net interest margin could expand further from a larger earnings asset mix from commercial lending.

If the bank is successful in increasing its fee income penetration with its commercial lending clients, it could improve its return profile further.

In the event of a recession, the bank would face lower balance-sheet growth and higher credit costs.

KeyCorp has an odd branch footprint that may be difficult to truly optimize, leading to structurally lower efficiency and less revenue synergies compared with peers.

KeyCorp's runoff of its residential mortgage and other consumer loans will drag on its balance sheet growth in the next few years.