KeyCorp’s deal for student lender raises eyebrows

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KeyCorp’s decision to acquire a 5-year-old online student lender, announced late Wednesday, is not sitting real too with analysts and investors.

Though the Cleveland company on Thursday reported record revenue for 2018 and announced plans to reduce overhead by cutting more branches, analysts who joined a conference call to discuss Key’s fourth-quarter results mostly wanted to talk about Key’s planned acquisition of the digital lending platform of Laurel Road Bank in Darien, Conn.

Erika Najarian, who covers Key for Bank of America Merrill Lynch, asked Chairman and CEO Beth Mooney whether “now is really the time to layer in [new] consumer risk, given we’re late in the cycle.”

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Mike Mayo, an analyst with Wells Fargo, questioned why Key would take the risk of building a national consumer-lending business when a safer play would be to follow the lead of other large banks and build a digital deposit-gathering platform.

Market reaction was similarly downbeat. On a day when markets rose across the board and the KBW Nasdaq Bank Index was up 1%, Key’s shares fell 2.5%, to close at $16.33.

Key executives pushed back against the criticism, arguing that the acquisition represents an opportunity for the $140 billion-asset company to gain scale in two key lending segments: student loan refinancing and mortgages.

They noted, too, that Laurel Road has “outstanding” customer satisfaction ratings and that most of its clients are prime borrowers with high incomes.

According to Mooney, about 70% of Laurel Road’s clients are medical professionals, and 20% are lawyers or hold MBAs. The average customer’s income is $185,000, and the average FICO score is 760.

“Strategically, this is a strong complement to Key’s approach of building targeted scale against specific client segments,” Mooney said.

Clark Khayat, Key’s chief strategy officer, said Key was drawn to Laurel Road’s customer acquisition strategy, which focuses on building links with trade groups and other professional organizations and seeking new business within their memberships. That approach stands in contrast with that of competitors, most of which follow a “broad, mass-market” approach, Khyat said.

Key plans to close its deal for Laurel Road in mid-2019. The acquisition is expected to be dilutive to earnings by 2 cents a share this year but accretive thereafter, said Christopher Gorman, Key’s president of banking.

One major change Key plans to make after completing the deal is to retain most of the loans that Laurel Road originates on its balance sheet.

Laurel Road, which made about $1.2 billion of loans in 2018 and a total of $4 billion since starting in 2013, sells most of its originations.

To be sure, Key is focusing primarily on Laurel Road’s lending capabilities, but it isn’t ignoring possible deposit synergies.

“We are really focused on being core funded. We are not looking to use this platform or any other platform to drive out-of-footprint deposits for the sake of deposits,” Khyat said.

Key, he added, will "use the Laurel Road platform to drive consumer relationships and lending and where it makes sense continue to expand that relationship with deposits — but we’d want deposits in a case where we have a broader relationship with that client.”

For the fourth quarter, Key reported net income of $459 million, up from $181 million a year earlier. Key’s 2017 results were impacted by merger-related charges and the effect of tax reform.

For all of 2018, Key reported profit of $1.8 billion and record revenue of $6.4 billion.

Period-end loans totaled $89.6 billion, a 3.6% year-over-year increase, driven by strong growth in commercial-and-industrial and consumer indirect auto lending. Deposits increased 2% year over year to $107.3 billion.

According to Key executives, persistent attention to cost control contributed significantly to the bottom line in 2018. Fourth-quarter noninterest expenses totaled $1 billion, down nearly $100 million from a year earlier, and Mooney promised no letup in 2019.

“It’s continually a part of our focus. It’s not a one-and-done,” Mooney said.

As part of that effort, Key shuttered 38 branches last year and, like fellow regional BB&T, plans to “ramp up” the rationalization process in 2019.

“We think with the technology, with the digital capabilities we have, we have the capability to keep our clients and thin out some of the branches,” Gorman said. You’ll see us step that up over last year.”

Key operates more than 1,100 full-service branches in 15 states.

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