UPDATE 2-RESEARCH ALERT-KBW raises KeyCorp to 'outperform'

* Cites valuation, capital levels

* Shares rise as much as 5 percent (Recasts; adds details from note, background, dateline; updates share movement)

NEW YORK, July 7 (Reuters) - Keefe, Bruyette & Woods Inc upgraded KeyCorp (KEY.N) to "outperform" from "market perform," citing valuation and capital levels, and called the Midwest regional lender one of the more inexpensive large U.S. banks.

Shares of Cleveland-based KeyCorp rose as much as 5 percent in early trading on the New York Stock Exchange.

KeyCorp's pro forma tangible common equity ratio, a measure of capital strength, was strong at 7.8 percent and was one of the best among large-cap banks, analyst David Konrad wrote.

The bank's recent capital-raising more than covered the $1.8 billion buffer demanded by U.S. regulators following a "stress test" of its ability to handle a deep recession. KeyCorp was one of the 10 banks told to raise capital after undergoing the tests.

"We remain comfortable with our loss rate assumptions in our stress case scenario for KeyCorp," Konrad said.

Nevertheless, he said losses could exceed the brokerage's stressed assumptions in commercial construction and commercial real estate portfolios, given recent deterioration in these asset classes.

KBW widened its 2009 loss forecast for the bank to $1.91 per share from $1.88. It maintained a share price target of $8.

The shares were up 4.1 percent at $5.29 in morning trading after rising as high as $5.32 earlier in the session. The stock has lost 40 percent of its value since January. (Reporting by Sweta Singh; additional reporting by Brenton Cordeiro in Bangalore; Editing by Jarshad Kakkrakandy and John Wallace)