KeyCorp

Good morning and welcome to Key Corp's second quarter 2020 earnings conference call. As a reminder, this conference is being recorded. I would now like to turn the conference over to the chairman and CEO, Chris Gorman. Please go ahead.

Thank you, Greg. Good morning and welcome to Key Corp's second quarter 2020 earnings conference call. Joining me for the call are Don Kimball, our chief financial officer, and Mark Midkiff, our chief risk officer. Slide two is our statement on forward-looking disclosure and and non-GAAP financial measures. It covers our presentation materials and comments, as well as question and answer segment of our call. I'm now moving to slide three. As you saw in our press release this morning, we reported second quarter earnings of 16 cents per share. Our results included a provision for loan losses, which exceeded net charge-offs by 386 million, or 34 cents per share. Our strong results for the quarter are attributable to the resiliency and dedication of our team and their commitment to serving our clients, our strong balance sheet, and our disciplined risk management practices. Importantly, for the quarter, we generated positive operating leverage compared with the year-ago period. Additionally, we reported a record level of pre-provision net revenue. Revenue was up 17 percent from the prior quarter, also a record, reflecting double-digit growth in both loans and deposits, as well as broad-based growth of our fee-based businesses, driven by strength in our capital markets businesses, cards and payments businesses, and consumer mortgage. Our consumer mortgage business demonstrated continued momentum with a record second quarter performance. Originations of $2.2 billion were up 100% year-over-year, and consumer mortgage fee income of $62 million, more than tripled from last year. Our performance further demonstrated the success of our recent investments in residential mortgage. Our pipeline is currently at record levels, and as such, we expect continued strong performance in the second half of 2020. Expenses for this quarter reflected higher production-related incentives. Costs related to our payments business and COVID-19-related expenses, including steps that we continue to take to ensure the health and safety of our teammates. We also supported our clients by offering payment deferrals, hardship support, borrower assistance programs, and forbearance options to help provide a bridge for individuals and businesses through these uncertain times. Notably, we were very active in the Paycheck Protection Program, We were the seventh overall lender in the program and processed over $8 billion in funding to support our clients, funding that saved hundreds of thousands of jobs. Now turning to credit quality, we have continued to benefit from our strong risk culture. Our moderate risk profile informs all of our credit decisions. Net charge-offs for the third quarter were 36 basis points. In our deck, we have highlighted several commercial portfolios that continue to receive heightened monitoring in this environment. Don will cover these focus areas in his comments. These portfolios have generally been performing consistent with our expectations given the environment in which we are operating. We also increased our loan loss reserve this quarter as our provision expenses significantly exceeded net charge-offs. Our allowance to loan losses as a percentage of period-end loans now stands at 1.61%, or 1.73%, excluding PPP loans. Finally, we have maintained our strong capital position while continuing to return capital to our shareholders. In the second quarter, our common equity Tier 1 ratio increased to 9.1%, which is within our targeted range of 9 to 9.5 percent. Earlier this month, our board of directors declared a dividend of 18.5 cents per share for the third quarter, and that is consistent with our second quarter level. I will close by restating that Key had a strong quarter. We remain confident, both in our ability to achieve our financial targets and, importantly, the long-term outlook for our company. We have positioned the company to perform through various business cycles, including highly stressed periods like the one we are operating in today. We will continue to support our clients and play a role to help revitalize our economy. Key remains well capitalized, highly liquid, and committed to maintaining our moderate risk profile. Most importantly, we remain committed to delivering value for all of our stakeholders. Now let me turn the call over to Don to go through the results of the quarter.

Don? Thanks, Chris. I'm now on slide five. As Chris said, we reported second quarter net income from continuing operations of $0.16 per common share. Notable this quarter was our provision expense that exceeded net charge-offs by $386 million, or $0.34 per share. Our results also reflected strong growth in our balance sheet with double-digit growth in both loans and deposits. Fees were also a standout this quarter with strong results in a number of areas, including investment banking, cards and payments, and consumer mortgage. I'll cover many of the remaining items on this slide in the rest of my presentation. Turn to slide six. Total average loans were $108 billion, up 19% from the second quarter of last year, driven by growth in both commercial and consumer loans. Commercial loans reflected an increase of over $8 billion in PPP balances, or $6 billion on an average basis. Consumer loans benefited from the continued growth from Laurel Road and, as Chris mentioned, strong performance from a residential mortgage business. Laurel Road originated $700 million of student consolidation loans this quarter, and we generated $2.2 billion of residential mortgage loans. The investments we have made in these areas continue to drive results and, importantly, add high-quality loans to our portfolio. Link quarter average loan balances were up 12%. Importantly, we have remained disciplined with our credit underwriting and walked away from business that does not meet our moderate risk profile. 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 seven, average deposits totaled $128 billion for the second quarter of 2020, up $18 billion, or 17%, compared to the year-ago period. and up 16% from the prior quarter. The linked quarter increase reflects broad-based commercial growth, as well as growth from consumer stimulus payments and lower consumer spending. This growth was offset by a decline in time deposits, primarily related to lower interest rates. Growth from the prior year was driven by both consumer and commercial clients. Total interest-bearing deposit costs came down 39 basis points from the prior quarter, reflecting the impact of lower interest rates and the associated lag in pricing. We would expect deposit costs to continue to decline approximately 15 basis points in the third quarter. We continue to have strong, stable core deposit base with consumer deposits accounting for over 60% of our total deposit mix. Turn to slide eight. Taxable equivalent net interest income was $1.025 billion for the second quarter of 2020 compared to $989 million in both the year ago and prior quarter. Our net interest margin was 2.76% for the second quarter of 2020, compared with 3.06% in the same period of last year and 3.01% for the prior quarter. Both net interest income and net interest margin were meanly impacted by the significant growth in our balance sheet in the second quarter of 2020 due to the impact of government stimulus programs. The larger balance sheet benefited net interest income but reduced the net interest margin due to lower yields on the Paycheck Protection Program loans and significant increase in liquidity driven by strong deposit inflows. Compared to the prior quarter, net interest income increased $36 million, driven by higher earning asset balances partially offset by a lower net interest margin. The net interest margin was impacted by lower interest rates and a change in the balance sheet, including elevated levels of liquidity. and as I mentioned, our participation in the PPP program. Liquidity levels negatively impacted the margin by 12 basis points. Lower interest rates caused seven basis points of pressure, and PPP and other combined for six basis points of reduced net interest margin. Moving to slide nine, our fee-based businesses had a very strong quarter. Non-interest income was $692 million for the second quarter of 2020 compared to $622 million per year-ago period, and $477 million in the first quarter. Compared to the year-ago period, non-interest income increased $70 million. The primary driver was an increase of $47 million in consumer mortgage business with a record level of loan originations and related fees in the second quarter of 2020. Cards and payments income also increased $18 million related to prepaid card activity from state government support programs. Operating lease expense increased $16 million, driven by gains from leveraged leases. Service charges on deposit accounts declined $15 million in the year-ago period, reflecting lower activity levels and a larger number of fee waivers. Compared to the first quarter of 2020, non-interest income increased by $215 million. The largest driver of the quarterly increase was an improvement in other income primarily driven by $92 million of market-related valuation adjustments in the first quarter of 2020. Other significant drivers of the quarter-over-quarter increase included the record consumer mortgage quarter and leveraged lease gains that I had already discussed, as well as a $40 million increase in investment banking and debt placement fees, driven by strong commercial mortgage and debt capital markets activity. I'm now turning to slide 10. Total non-interest expense for the quarter was $1.013 billion compared to $1.019 billion last year and $931 million in the prior quarter. The year-ago quarter included $52 million of notable items, primarily personnel-related costs associated with our efficiency initiatives. Excluding these, expenses were up $46 million from the year-ago period. The increase is primarily related to two main drivers, $25 million of payments-related expenses incurred in the current quarter as well as $13 million of COVID-19-related costs due to the steps that the company has taken to ensure the health and safety of our teammates. Compared to the prior quarter, non-interest expense increased $82 million. The increase was largely due to higher incentive and stock-based compensation from strong revenue production in our investment banking and consumer mortgage businesses. Other drivers of the linked quarter increase include the $25 million of payments related to costs and other COVID-19-related expenses. Moving now to slide 11. As I mentioned earlier, the largest impact to our results this quarter is the build in our reserves. Our provision for credit losses exceeded net charge-offs by $386 million, or 34 cents per share. Overall credit quality trends this quarter remain very solid. Net charge-offs were $96 million, or 36 basis points of average total loans. Non-performing loans were $760 million this quarter, or 72 basis points of period-end loans, compared to 632 million or 61 basis points in the prior quarter. Additionally, delinquencies remained relatively stable, with less than a 1% increase in our 30 to 89 day pass dues and the 90 day plus category declining quarter over a quarter. We've also continued to monitor the level of assistance requests we receive from our customers. Over the past quarter, the percent of loan forbearance has not changed materially. As of June 30th, loans subject to forbearance terms were around 2% based on the number of accounts for both commercial and consumer loans, and about 4.5% when using outstanding balances. Turning to slide 12, we also updated a disclosure that we included in our first Q10Q that highlights certain industries or customer groups that are receiving greater focus in the environment. These portfolios represent a small percentage of our total loan balances. Importantly, as Chris mentioned, as a group, they continue to perform consistent with our expectations. Each relationship in these focus areas continues to be subject to active reviews and enhanced monitoring. The outstanding balances shown are as of June 30th and reflect some of the draw activity that occurred late in the quarter. Now on to slide 13, continue to maintain a strong level of capital. This quarter, our common equity tier one ratio increased from 8.9% to 9.1%, which places us back in the targeted range of 9 to 9.5%. We believe that operating within our targeted range will provide us sufficient capacity to continue to support our customers and their borrowing needs and, over time, return capital to our shareholders. As Chris mentioned earlier this month, our Board of Directors approved a third quarter common dividend of 18.5 cents per share, which was consistent with our second quarter dividend level. On slide 14, we've provided our best insights for the third quarter, recognizing that we're still moving through some unchartered territory. We expect average loans to be relatively stable, reflecting a reduction in commercial line draws and more modest growth in our consumer portfolio. Average deposits are expected to remain relatively stable in the third quarter. Our outlook for net interest income would be for a low single-digit increase, reflecting a relatively stable balance sheet and modest improvement in net interest margin. Non-interest income in the third quarter will likely include a step down from the record consumer mortgage fees we saw in this quarter and lower gains from operating leases. Overall, it would expect a high single-digit link quarter decline in non-interest income. Non-interest expenses are expected to be down low single digits, but are highly dependent on production-related incentive compensation, ongoing costs to support our payments business, and COVID-related expenses. Net charge-offs are expected to be in the 50 to 60 basis point range. This environment continues to change rapidly, which can impact the outlook and 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 our targets this year. However, as we emerge from the current crisis, we expect to be back on the path that would lead us to operate within these target ranges. Importantly, we have not wavered from our commitment to achieve our long-term targets. With that, I'll turn the call back over to the operator for instructions for the Q&A portion of our call. Operator?