The takeover rumors swirling around KeyCorp, whose stock has fallen about 20% this year, is music to the ears of investors who hold the banking company's bonds.
The spread between KeyCorp bond yields and treasury yields has been stable since the Cleveland company announced a restructuring plan including up to 3,000 layoffs and the sale of its credit card portfolio. But the bonds, which trade at a wider spread than those of its peers, could prove to be a bargain, especially if a takeover materializes, says Allerton P. Smith, a bond analyst at Donaldson, Lufkin & Jenrette.
Bond investors like restructurings because they generally involve cost-cutting, and that reduces operational risk. Bondholders would probably gain even more if $83 billion-asset KeyCorp is acquired, because any buyer is likely to carry a higher credit rating, meaning the spreads would tighten on KeyCorp bonds and their price would go up.
KeyCorp's 10-year bonds trade at about 123 basis points over treasuries. The bonds of potential acquirers such as Chase Manhattan Corp. and Bank of America Corp. trade at less than 113 basis points over treasuries, according to one trading desk.
KeyCorp's stock gained last week when it made its restructuring announcement but have fallen back again, reviving takeover talk. It missed the analyst consensus estimate for third-quarter earnings per share by a penny because of revenue shortfalls in its investment banking and capital markets businesses. In trading Monday, KeyCorp fell 18.75 cents, to $25.75, while the American Banker index of the top 225 U.S. banks fell 3%.
The stock's loss of value "makes me wonder whether this should elevate their attractiveness to a potential buyer," Mr. Smith said. "They are cheaper to acquire and it is clear there are cost-saving opportunities."
KeyCorp has been shedding less-profitable business lines and said it will reinvest the proceeds in higher-growth business such as e-commerce services for business customers and asset management and retirement services. Still, many analysts perceive the bank's strategy as lacking a clear commitment to certain business lines.
"A lot of people are surprised they are still around as an independent," said an analyst who requested anonymity. "Of the top five banks likely to be acquired, KeyCorp is on the top of everyone's list. It is viewed as a somewhat unfocused company."
Moreover, he said, "For as many people that own KeyCorp bonds because they [like] KeyCorp, just as many own it because they are hoping it gets bought out by a stronger firm."
Eric J. Grubelich, an analyst at Keefe, Bruyette & Woods Inc., said cost cutting may be good news for bondholders in the short-term, but nothing beats a strong plan that boosts growth in the long-term. "You like to see anything that improves operating leverage. But at the end of the day you want to make sure you have a decent strategy in place."
