KeyCorp

Hello and welcome to Key Corp's first quarter 2020 earnings call. As a reminder, this call is being recorded. At this time, I'd like to pass it over to President and Chief Operating Officer Chris Gorman. Please go ahead.

Thank you, Operator. Good morning and welcome to Key Corp's first quarter 2020 earnings conference call. Joining me on the call today are Beth Mooney, our Chief Executive Officer, Don Kimball, our Chief Financial Officer, and Mark Mitkiff, our Chief Risk Officer. Slide two is our statement of forward-looking disclosure and non-GAAP financial measures. It covers our presentation materials and comments, as well as the question and answer segment of our call. I'm now turning to slide three. It is an extraordinary time with the spread of COVID-19 causing a heavy human toll throughout the country and has impacted all of our daily lives in ways none of us could have anticipated. Despite the unprecedented challenges we are facing, I have been encouraged by our collective strength and resiliency, and I'm confident that this resiliency will carry us through this crisis. So let me start by giving you a brief overview on where things stand here at Key. First, our business resiliency plans are in effect, and we have maintained our operational effectiveness across our organization. In every decision we have made, the health and safety of our clients, colleagues, and communities in which we operate have remained our top priority. Secondly, we are committed to playing a critical role in providing capital and assistance to our clients and supporting broader initiatives to strengthen our economy. To date, we have approved over 11,000 credit extensions and more than 38,000 applications have been submitted through the newly introduced Payroll Protection Program. I'm now moving to slide four. I want to address our financial outlook, which in the near term will be impacted by the economic fallout from the COVID-19 pandemic. Importantly, we are operating from a position of strength. Our business model and clear strategy position us well during this period of economic and financial stress, but importantly, will provide us with significant opportunities through the recovery phase. I want to affirm our long-term targets have not changed. And on the other side of this crisis, we expect to continue to deliver positive operating leverage and strong financial returns. In this environment, credit quality also plays a critical role. Although some would continue to view Key through the lens of the financial crisis, the reality is that we are a different company today in terms of our strategy, our risk profile, and our leadership team. We have significantly reduced our exposure to high-risk sectors and industries and have positioned Key to perform well through all phases of the business cycle, including highly stressed environments like the one in which we are operating today. Our moderate risk profile also informs our credit decisions and the way we underwrite loans. Don will share more detail with respect to our credit measures and our adoption of CECL. The final section of this slide focuses on capital and liquidity, both clear strengths for our company. Key, along with other major banks, have participated in several rounds of government-mandated stress tests since the financial crisis. These tests have shown that Key would remain well capitalized through periods of severe economic and financial stress while continuing to support our clients. Our liquidity position also remains strong with a combined 50 billion in liquid assets and unused borrowing capacity. Let me close my remarks by reaffirming our confidence in the long-term outlook for our company. Although our industry clearly faces near-term challenges, we believe the steps we have taken over the past decade to strengthen and reposition our company will set key apart. We have a consistent and targeted business strategy focused on relationships. We have a strong capital position and disciplined approach in the manner in which we deploy our capital. We have significant sources of liquidity. We have dramatically de-risked our company over the last several years. And also, we have a management team that is dedicated to helping our clients and our communities manage through these challenging times. And finally, Since this is Beth Mooney's last earnings call as CEO, I want to acknowledge the outstanding leadership she has provided our company. Beth will offer a few remarks after Don, but I just want to say it is not lost on any of us that our strong foundation and clear sense of purpose is in no small part due to Beth's leadership over the past nine years. As I have said before, I could not have asked for a better partner, and we wish her well in the next stage of her journey. With that, Let me turn the call over to Don to report on the quarter.

Thanks, Chris. I'm now on slide six. This morning, we reported first quarter net income from continuing operations of 12 cents per common share. The current quarter's results have clearly been impacted by COVID-19 pandemic. There's been impacts that include provision expense exceeded net charge off by $275 million. Time means everything. In the first quarter of CECL, we experienced the impact of a global pandemic. Through February, our credit quality and economic outlook resulted in a stable allowance for loan losses compared to January 1 level. The vast majority of the increase reflects the changed economic outlook. Market-related valuation adjustments totaled $92 million. These adjustments include $73 million of reserves on our customer derivatives, reflecting the market-implied default rates given the significant increase in credit spreads. The remainder of $19 million is due to trading losses or portfolio marks, once again related to the widening credit spread in the market. One other area of impact was our investment banking and debt placement fees. The actual results for the quarter are approximately $40 million below our expectations in the pipeline from just a month ago. I'll cover many of the remaining items on this slide in the rest of my presentation. Turning to slide seven. Total average loans were $96 billion, up 7% from the first quarter of last year, driven by growth in both commercial and consumer loans. Commercial loans reflect about $7 billion in growth in the month of March alone, including increased line draws and short-term liquidity facilities provided to customers. It is important to note that approximately 70% of the C&I draws in March came from investment-grade customers. Consumer loans benefited from the strong growth from Laurel Road and our residential mortgage business. Laurel Road originated $600 million of student consolidation loans this quarter, and we generated $1.3 billion of residential mortgage loans. The investments we have made in these areas continue to drive results, and importantly, adding high-quality loans to our portfolio. Link quarter average loan balances were up 3%. For next quarter, line draws and other commercial loan growth are expected to slow from the March level. We will, however, show strong growth reflecting the impact of the CPP program As Chris mentioned, we have processed over 38,000 applications representing $9 billion of requests, and the fundings are occurring quickly. This program is critical to our customers, and we are pleased to support these efforts. Importantly, we have remained disciplined with our credit underwriting, and we have walked away from business that does not meet our moderate risk profile. We are a different company than we were a decade ago. We remain committed to performing well through the business cycle, and we manage our credit quality with this longer-term perspective. Continuing on to slide eight, average deposits sold $110 billion for the first quarter of 2020, up $3 billion or 3% compared to a year ago period, and down 2% from prior quarter. The late quarter decline reflects the expected reduction in several temporary deposit balances early in the quarter. Growth from the prior year was driven by both consumer and commercial clients. It is also important to note that deposit flows since February have funded the loan growth, continuing to support our strong liquidity position. Total interest-bearing deposit costs came down 14 basis points from the prior quarter, reflecting the impact of lower interest rates in the associated lag in pricing. We would also expect deposit costs to continue to decline approximately 30 to 35 basis points in the second quarter. We continue to have a strong, stable core deposit base, with consumer deposits accounting for 65% of our total deposit mix. Turn to slide 9. Taxable equivalent net interest income was $989 million for the first quarter of 2020, compared to $985 million in the first quarter of 2019 and $987 million in the prior quarter. Our net interest margin was 3.01% for this quarter, compared to 3.13% for the first quarter of 2019 and 2.98% for the prior quarter. Compared to the prior quarter, net interest income increased $2 million, driven by an improved balance sheet mix and strong long growth. Our net interest margin for the quarter reflects the improved balance sheet mix. Looking into the second quarter, as a result of the expected originations of the PPP loans, we would expect net interest income to increase from the first quarter level. Net interest margin should decline as the yield on these loans is lower than other loan products. Moving to slide 10, key non-interest income was $477 million for the first quarter of 2020. compared to $536 million for the year-ago quarter and $651 million in the prior quarter. The current quarter clearly reflected the impact of the pandemic on our market-sensitive businesses. Other income, a negative $88 million for the quarter, reflected $92 million of market-related valuation adjustments. This included $73 million of reserves for our customer derivatives due to significant increases in credit spreads. The cumulative reserve recorded for this portfolio now exceeds the total losses recognized in this area through the Great Recession. The reserves will come down if credit spreads narrow from the March 31st levels. The remaining portion of the market-related valuation adjustments include $19 million of trading losses or marks, also driven by the increased credit spreads. Two other areas of note, operating lease income for the quarter included an $8 million valuation adjustment. Consumer mortgage income reflected $1.3 billion of originations with higher gain on sales levels offset by $9 million of MSR impairment. Going into the second quarter, we would not expect further meaningful market-related valuation adjustments. Most other fee income categories would be down slightly reflecting lower activity levels. Investment banking and debt placement fees are challenging to predict at this time. I'm now turning to slide 11. Spence levels trended down this quarter as the results reflected the benefit of efficiency improvements and lower variable compensation. Adjusting for notable items in the prior quarters compared to the year-ago period, non-interest expense declined $6 million despite the addition of Laurel Road in April 2019. Compared to the prior quarter, adjusting for notable items, non-interest expense declined $27 million. Lower incentive compensation costs correlated to revenues contributed to this decline. business services, and marketing both were down seasonally this quarter. Turning to slide 12, CECL has adopted January 1 of this year, resulting in an increase to our allowance for loan losses as of the end of the year of $204 million, consistent with previous disclosures. Through February, our CECL reserves remained very stable, reflecting the credit quality of the portfolio and the economic forecast were consistent with the start of the year. By the end of the quarter, the economic outlook changed considerably, reflecting the expected impact of the pandemic. While no one knows the depth or duration of the economic downturn, we updated our CECL reserves to incorporate a severe downturn in economic activity with a recovery beginning late in the year. This change in the economic outlook resulted in provision expense exceeding net charge-offs by $275 million. As we progress through the current quarter, we will better be able to refine our outlook, including the potential depth and duration of the downturn. It should also provide additional insights into the benefits from the various programs implemented by our government to help our customers and the economy. Now turning to slide 13, despite the build in our allowances, our credit quality metrics remain strong as of March 31st. Net charge-offs were $84 million, or 35 basis points, of average net total loans in the first quarter, which continues to be below our over-the-cycle range of 40 to 60 basis points. Non-performing loans were $632 million this quarter, reflecting a $45 million increase from our reclassification resulting from the adoption of CECL. Adjusted to this reclassification, NPLs increased $10 million from the prior quarter. Now, performing loans represent 61 basis points of period-end loans, flat with the prior quarter and prior year. Crit-side loans increase modestly, reflecting the impact of market conditions and loan rating changes in our oil and gas portfolio. During March, the increase in the commercial line draws and temporary liquidity facilities generally related to our highly-rated customers. At the end of the quarter, the percent of our commercial loan book outstanding to investment-grade customers actually increased by 200 basis points. One other area we continue to monitor is the level of assistance requests from our customers. As of the end of last week, we had received approximately 11,000 requests from our retail customers, about 0.7% of accounts. We also received approximately 800 additional requests from our commercial customers. While this is still early, the class levels have been less than we originally expected. Turning to slide 14, we received questions about the exposure of certain industry or customer groups given the current environment. Included on this slide is a summary of those areas. As you can see, most of those areas represent a small portion of the overall portfolio and are diversified by type and geography. We have implemented an enhanced monitoring process, providing more active reviews, often weekly, of relationships that might be more vulnerable to the current environment. Outstanding balances shown are as March 31st and reflect some of the draw activity that occurred late in the quarter. Now on to slide 15. Capital ratios this quarter reflected the impact of the balance sheet growth and lower earnings. Most of our planned capital actions for the quarter were completed before the economic outlook turned. As a result, our common equity Tier 1 ratio was 8.95% as of March 31st, down 49 basis points from year end. This level is slightly below our targeted range, but well above the stressed capital buffer levels required by the Fed. Our capital target was established to provide sufficient capital to operate in stressed environments. recognizing we would be operating at levels below the target as we experience the impact of those environments. This capital level provides a sufficient capacity to continue to support our customers and their borrowing needs, and based on our current outlook, maintain our dividends. As a reminder, our capital priorities continue to be to support organic growth, to continue our strong common dividend, to repurchase shares in excess with excess capital, The new guidelines for the stress capital buffer are also helpful in addressing our capital actions. As announced earlier, we suspended our share buybacks through the second quarter. On slide 16, we provided our best insights and high-level comments for the second quarter. Given the uncertain economic outlook for the full year, we have removed our guidance for full year 2020. There is still a wide range of scenarios on the depth and duration of the economic downturn. Also impacting this will be the benefit of various programs to help bridge the retail and commercial customers. As we move through the second quarter, we expect to have more clarity on the economic impact of COVID-19 and the support provided to our clients, allowing us to provide more visibility on our full-year outlook. Loan growth should remain strong, reflecting the balances as of the end of the first quarter, the production levels expected from the PPP loan program, and continued strength in our commercial and consumer loan originations. Deposits will show good growth, driven by both consumer and commercial areas. This growth would support much of the loan growth noted above. Net interest income is expected to be up from the first quarter level, driven by growth in loans. We expect net interest margin to decline, reflecting the dilutive impact of the PPP program. For non-interest income, we would not expect further meaningful market-related valuation adjustments. Most other fee income categories would be down slightly, reflecting lower activity levels. Investment banking and debt placement fees are challenging to date at this time. Non-interest expenses are expected to be relatively stable for next quarter. That charge-off should increase slightly to around the lower end of our target range of 40 to 60 basis points. The environment continues to change rapidly, which can impact the outlook and the comments we've provided. Finally, shown at the bottom of the slide are our long-term targets. Given the economic downturn, we would not expect to achieve all these targets this year. However, as we emerge from the current crisis, we expect to be back on the path that will lead us to operate within these target ranges. Importantly, we have not wavered from our commitment to achieve our long-term targets. Before we turn the call back over to the operator, Beth would like to add some closing comments.