KeyCorp and the Key to Capital

| About: KeyCorp (KEY)

Here’s a snippet from KeyCorp’s most recent 10-Q  filed on May 6, 2008 for the period ending March 31, 2008.

Capital adequacy. Capital adequacy is an important indicator of financial stability and performance. Key’s ratio of total shareholders’ equity to total assets was 8.47% at March 31, 2008, compared to 7.89% at December 31, 2007, and 8.37% at March 31, 2007. Key’s ratio of tangible equity to tangible assets was 6.85% at March 31, 2008, above Key’s targeted range of 6.25% to 6.75%. Management believes Key’s capital position provides sufficient flexibility to take advantage of investment opportunities, to repurchase shares when appropriate and to pay dividends.

In that same filing, they said their Tier 1 capital was 8.33%.

Only a month has gone by since Key’s last report, but a lot has changed. Here’s a summary of their decision on June 12, 2008 to cut the dividend in half and raise $1.65 billion. The press release (click here) indicates that an adverse IRS ruling of about $1.2 billion caused management to pursue this capital. I don’t think the market that whacked the shares by over 20% believes them that this is the sole problem with capital. Raising $400 million extra with highly dilutive offerings might be one clue. Cutting the dividend by 50% to save $200 million per year might be another clue.

I doubt that management still believes what it believed just a month ago that their “capital position provides sufficient flexibility to take advantage of investment opportunities, to repurchase shares when appropriate and to pay dividends.”

I have written repeatedly about my dislike of buybacks when they are done for the wrong reasons. Okay, so Key didn’t buy any shares in the last two quarters, but they bought 16 million shares in the first 3 quarters of 2007. Back then, the stock traded between $31 and $40 per share with an average of about $35/sh. Not only were those purchases expensive compared to today’s $11.73, but wouldn’t it be nice to have the $500-600 million in the capital they spent on themselves? Was that a good opportunity to “repurchase shares when appropriate”?

So what about their dividend policy decisions? They raised quarterly dividends in 2007. In 2006, it was $0.345/sh. In 2007, it was $0.365/sh. And they raised them a few months ago to $0.375/sh. Small raises really, but raises nonetheless. They had to (I guess) to keep up their record of 43 years of consecutive dividend increases. After one quarter and a one-time tax ruling, they decide to cut dividends by 50%. So much for the record.

Key is not alone. Many banks have spent their capital in prior years on buybacks and dividends and expensive acquisitions (aka “investment opportunities”). During that time, stocks were heading higher and there appeared to be no downside. Now, the reverse is true.

I know people far smarter than me have assured everyone that the worst is behind us. They apparently know more about the key to capital than I do.