Morgan Stanley Upgrades KeyCorp, Downgrades Fifth Third Bancorp

Morgan Stanley has updated its ratings on two mid-cap banks as it upgraded KeyCorp (NYSE: KEY) to Overweight and downgraded Fifth Third Bancorp (NASDAQ: FITB) to Equal Weight."We see over 200 bps of ROTCE improvement at KEY through 2018, to an above-peer 13.1%. Combined with accelerating EPS growth, we see 37% upside to the stock. FITB, however, appears more fairly valued given moderate growth, but below-peer profitability," analyst Ken Zerbe wrote in a note.Zerbe noted that Keycorp is on track to achieve its goal of $400 million in expense savings as it integrates First Niagara. Moreover, the analyst sees further upside to those expense targets, suggesting EPS estimates could end up being too low."If KEY achieves an extra $100 million of pretax expense savings, it would add $0.07 to our 2018 EPS. Achieving $300 mil of revenue synergies, using a 50% marginal expense ratio, adds another $0.11 to EPS," Zerbe highlighted.On the valuation front, the analyst said KEY is currently trading at a 33 percent discount to peers on 2017 estimated EPS of $1.30 (8.4x vs. peers at 12.5x) and a 34 percent discount on TBV (0.95x vs. 1.44x), despite faster earnings growth through 2018. Zerbe expects 18 percent EPS growth versus peers at 12 percent and a roughly 300 bps improvement in its soon-to be above-peer ROTCE to 13.1 percent (vs. peers at 12.5 percent) from redeploying capital and expense saves related to First Niagara.Meanwhile, the analyst downgraded Fifth Third due to expectations of less fundamental improvement. "We are less optimistic that FITB can meaningfully narrow its profitability or earnings growth gap versus peers, removing a potential catalyst that would drive multiple expansion," Zerbe highlighted.Zerbe expects EPS of $1.69 and loan growth of 3.6 percent in 2017, just over half the industry average. The analyst forecast 2017 ROTCE of 9.7 percent, or 180 bps below peers (and 280 bps below KEY)."While the shares appear cheap on a P/E basis (at 10.3x 2017eEPS), our P/TBV-ROTCE regression suggests the shares are broadly fairly valued at 1.07x tangible book," Zerbe added.At the time of writing, shares of KeyCorp were down percent to $1.14 percent to $10.84 and Fifth Third also fell 2.93 percent to $16.92. the analyst has price targets of $15 and $20 for KEY and FITB, respectively.