Introduction

With minimal exposure to bank issued preferreds, I am always on the lookout for ones from regional banks since I have major bank exposure already. Since the collapse of several regional banks last winter, these issues should have better yields than other financial issuers. The non-cumulative feature of these preferred should also enhance the yield as investors demand more return to compensate for the possibility of a foregone dividend payment. That said, all three KeyCorp preferred stocks that were trading during the COVID crisis never missed a payment.

KeyCorp review

Seeking Alpha describes this company as:

KeyCorp operates as the holding company for KeyBank National Association that provides various retail and commercial banking products and services in the United States. It operates in two segments, Consumer Bank and Commercial Bank. The company offers various deposits, investment products and services; and personal finance and financial wellness, student loan refinancing, mortgage and home equity, lending, credit card, treasury, business advisory, wealth management, asset management, investment, cash management, portfolio management, and trust and related services to individuals and small and medium-sized businesses. The company was founded in 1849 and is headquartered in Cleveland, Ohio.

Source: seeking-alpha.com KEY

KeyCorp has this description on their press release page:

KeyCorp’s roots trace back nearly 200 years to Albany, New York. Headquartered in Cleveland, Ohio, Key is one of the nation’s largest bank-based financial services companies, with assets of approximately $188 billion at September 30, 2023. Key provides deposit, lending, cash management, and investment services to individuals and businesses in 15 states under the name KeyBank National Association through a network of approximately 1,000 branches and approximately 1,300 ATMs. Key also provides a broad range of sophisticated corporate and investment banking products, such as merger and acquisition advice, public and private debt and equity, syndications, and derivatives to middle market companies in selected industries throughout the United States under the KeyBanc Capital Markets trade name. For more information, visit https://www.key.com. KeyBank is Member FDIC.

Source: investor.key.com

Evaluating how risky an individual bank is not an area I focus on beyond their past history with preferreds and apparent ability to keep paying dividends on the current set still outstanding. That is what I tried to cover here and did find coverage is adequate. Four other Seeking Alpha Contributors have covered KeyCorp this fall, and all gave the stock a Buy rating; another gave the stock a Hold rating. Potential preferred stock investors should include reading those in their due diligence.

KeyCorp recently posted the following about their operating results. Considering what happened last March, they opened their BancAnalysts meeting with this slide, showing the stability of their deposit base.

Their 3Q presentation started with a summary of those results.

KeyCorp did report the Net Investment Income, or NII, did drop as a result of the movement in interest rates and balance sheet adjustments. While 3Q was better than 2Q, some results were down from a year ago.

One time that is still moving in the wrong direction is Net Interest Margin, as the cost of deposits is raising faster than the rates are improving on the loan portfolio and other invested assets. For those wanting more details, there is a 3Q earnings report.

Based on the fact KeyCorp has redeemed multiple preferreds over the last decade and recently issued “H” series, default or coupon non-payment concerns seem unwarranted at this time. Again, KeyCorp did not miss any payments during 2020’s COVID meltdown.

The 2022 Annual Report showed Tier 1 capital at $17.2b, and $13.4b in Total equity to cover the $2.5b in preferreds outstanding. Tier 1 capital is the sum of a bank’s equity capital, its disclosed reserves, and non-redeemable, non-cumulative preferred stock.

LIBOR is gone: KeyCorp replacement

KeyCorp will transition to 3-mo SOFR + 26.141bps as the 3-mo LIBOR replacement on the respective conversion dates to floating rates for each issue. This only effects the Series E below.

Comparing the four issues

The four preferred issues are:

• KeyCorp, 6.125% Dep Shares Fixed/Float Perp Non-Cumul Preferred Stock Series E (KEY.PR.I)
• KeyCorp, 5.65% Dep Shares Fixed-Rate Perp Non-Cumul Preferred Stock Series F (NYSE:KEY.PR.J)
• KeyCorp, 5.625% Dep Shares Fixed-Rate Perp Non-Cumul Preferred Stock Series G (NYSE:KEY.PR.K)
• KeyCorp, Dep Shares Rate Reset Perp Non-Cumul Preferred Stock Series H (NYSE:KEY.PR.L)

Major features are compared in the next table

Factor I J K L Series letter E F G H Issued 2016 2018 2019 2022 Est. Size $500m $425m $450m $600m Coupon 6.125% 5.65% 5.625% 6.2% Call date 12/15/26 12/15/23 9/15/24 12/15/27 Floating rate SOFR+ +3.892 NA NA 5Yr USN+ + 3.132 Price (12/1) $22.65 $19.94 $20.16 $20.76 Yield 6.88% 7.08% 6.98% 7.47% YTC 10.42% NM 35.58% 11.54% If Floating today appx 9.5% NA NA appx 8.7% Click to enlarge

All four issues are non-cumulative and rank the same in the capital structure. All are eligible for the 15% tax rate. KEY.PR.J becomes callable this month. As of the end of 2022, the preferreds carried a BB+ rating (senior bonds rated BBB+) by S&P. Based on the current price, the market is not expecting either the Series F or G to Called, so those YTCs are unlikely to be achieved. From what I have seen elsewhere, the Series H has a higher YTC than the Series E as current investors want to be “paid” for accepting the possible lower of the two floating-rate formulae.

KeyCorp also has $525 issued overseas in a 5% Fixed/Floating Series D issue, plus KeyCorp also has over $400m in Trust Preferreds issue by business trusts formed by KeyCorp. In the spring of 2022, KeyCorp issued $600 million of 3.878% Fixed-to-Floating Rate Senior Notes due May 23, 2025, and $750 million of 4.789% Fixed-to-Floating Rate Senior Notes due June 1, 2033. The fixed-rate periods end for both issues one year before maturity. While the higher cost preferred count toward Tier 1 capital, the Notes do not, and they rank higher in capital structure. I only mention this as a sign that the markets considered KeyCorp a sound bank at the time.

Risk analysis

Being these preferred stocks are non-cumulative, how likely is KeyCorp to skip a payment? A good sign is that did not happen during the financial panic caused by COVID which saw some payments skipped by other issuers. In order to be counted as Tier 1 capital, such preferred stocks must be non-cumulative. While I could not find support for this assumption, I cannot believe a bank could continue to count non-paying preferreds as part of their Tier 1 capital, thus that inclusion should provide payment protection as one would assume they would be removed for non-payment. KeyCorp would also have to suspend its common stock dividend if a preferred payment was missed. This issuer’s strength and my best understanding of the Tier 1 rules says payments won’t be skipped until the bank is about to collapse as we saw with First Republic last winter.

Portfolio strategy

A prime question to ask about any issuer is how strong are they? As the saying goes, “Worry about the return of your money more than the return on your money!”. According to KeyCorp’s Investors page, S&P gives the bank a BBB rating; Mood’s a Baa2; Fitch a BBB+.

Another measure is the Tier 1 capital ratio. The Tier 1 capital ratio compares a bank’s equity capital with its total risk-weighted assets. These are a compilation of assets the bank holds that are weighted by credit risk. Under the Basel III accord, the value of a bank’s Tier 1 capital must be greater than 6% of its risk-weighted assets. As of 12/31/22, the bank’s Resolution Plan showed a 10.77% ratio. Key Bank’s CET1 ratio (10.75%) would rank 10th amongst the largest US banks. In my analysis, the bank and corporation appear very sound.

Assuming one is looking to expand their fixed income allocation, KeyCorp offers both fixed and fixed-to-floating choices. Also, the Call dates range from now to four years later. One approach in deciding between these four is comparing today’s yield on the fixed-rate preferreds against where they think the floating-rate will be once they start floating. Based on the data as of the close on 12/1/23, my thoughts are:

• Though Callable come 12/15/23, Series F will not be Called, nor will G next year when eligible.
• Given that the 3-mo SOFR (plus adjustment) is 5.6%, I cannot see KeyCorp being able to replace them with a lower fixed-rate coupon. With rates up from when H was issued, I would guess the fixed coupon on a floating issue could be 100bps higher than what F or G is costing the bank.
• Between F & G, I would take the one with the higher Yield.
• Between E & H, the second seems undervalued currently based on their respective YTM. At these prices, I favor the higher Yield, YTM and longer date to when the floating-rate starts that H offers.
• Operating under the assumption that all the YTCs won’t occur and that rates might have peaked for now, the Series H would be my preferred choice (pun intended).

Final thought

There are many banks with preferreds available so finding one with the right mix of features each investor wants should be possible with some leg work. To put KeyCorp in some prospective, the JPMorgan Chase & Co. 6 DEP NCM PFD EE (JPM.PR.C) p, a major versus regional bank, has these values based on a price of $25.20.

• 6.00% fixed coupon; 5.95% Yield
• Callable on 3/21/24; YTM of 3.1%

Curious if JPM has redeemed any preferreds recently, I found this Seeking Alpha article from 2022: JPMorgan Chase to redeem $2.5B of series V preferred stock. While that could be effecting the current yield on the above preferred stock, it does show that KeyCorp is paying more for their preferreds, but not an unreasonable amount more.