KeyCorp

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

Well, thank you, Operator, and good morning and welcome to Key Corp's third quarter 2020 earnings conference call. Joining me for the call today are Don Kimball, our Chief Financial Officer, and Mark Midkiff, our Chief Risk Officer. Slide two is our statement on 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. As you saw in our press release this morning, we reported third quarter earnings per common share of 41 cents. Our EPS was more than double that which we reported in the prior quarter and up from the year-ago period which was impacted by notable items. Despite the challenging environment, we generated pre-provisioned net revenue of $1.9 billion and added $1 billion to our reserve for credit losses through the first nine months of this year. Revenue in the third quarter was up 3 percent from the year-ago period. Our net interest income continues to reflect the low rate environment, elevated liquidity, and changes in balance sheet mix. Average loans reflect strong performance from consumer mortgage and lower load, offset by paydowns of consumer line draws that were made earlier in the year. Our consumer mortgage business generated funded volume of more than $2.3 billion this quarter, which was up more than 75 percent from the year-ago period and 5 percent from last quarter. Over one-half of our originations were purchase mortgages. Our pipelines remain strong, and we expect to show sustainable growth and continued market share gains. Laurel Road continues to originate high-quality loans that provide us with an opportunity to build broader digital relationships with these targeted clients. In the third quarter, Laurel Road originated over $400 million. We believe that both Laurel Road and consumer mortgage will continue to be relationship-based growth engines for our consumer business. With our strong consumer platform, we have decided to discontinue originating indirect auto loans. The current portfolio of approximately $4.6 billion will run off over time. Now let me turn to fee income. We had another good quarter. Non-interest income was up from the year-ago period, reflecting stronger than expected performance. Investment banking and consumer mortgage had another solid quarter. Cards and payments and service charges on deposit accounts both posted strong linked quarter increases. Don will discuss our revenue outlook in his remarks. We believe we are well positioned to continue to grow both our commercial and consumer businesses. Our expenses this quarter reflect higher variable costs related to cards and payments activity and production-related incentives, as well as elevated pandemic-related costs associated with keeping our teammates and our clients safe. Through our continuous improvement efforts, we are maintaining our focus on expenses, improving our efficiency while continuing to invest for growth, particularly our digital capabilities across the franchise. Credit quality remains solid this quarter as we have remained true to our moderate risk profile throughout the cycle. Net charge-offs for the quarter were 49 basis points. In the deck, we have updated our disclosure on commercial portfolio focus areas. Don will cover these focus areas in his comments, but I will just say that these portfolios have generally performed consistent with or better than our expectations. The quality of our loan book is also reflected in the level of loan deferrals. Last quarter, our deferrals were the lowest in our peer group based upon public disclosures. As of September 30th, loans subject to forbearance terms were less than 2 percent of total loans. That's down from 4.3 percent at June 30. This equates to less than 1 percent of clients in both our commercial and consumer businesses. In the third quarter, our provision expense exceeded charge-offs by $32 million. Our allowance for credit losses as a percentage of period-end loans now stands at 1.88 percent or 2.04 percent, excluding PPP loans. Finally, we have maintained our strong capital position while continuing to return capital to our shareholders. In the third quarter, our common equity Tier 1 ratio increased to 9.5%, which is at the upper end of our targeted range of 9% to 9.5%. In September, we paid a common stock dividend of 18.5 cents per share, the same amount we paid in the second quarter. I will close by restating that this was another good quarter for Key, which demonstrates our underlying strengths. It starts with our dedicated team and their unwavering commitment to first and foremost our clients, being very targeted about where we can compete and where we can win. Next, costs, maintaining a strong focus on expenses while investing for the future. A big part of this investment going forward will continue to be digital. Credit, continuing our strong risk management practices. And lastly, capital, focusing both on the return on and the return of capital. I am confident in our ability to manage through the current environment and, over time, achieve our long-term financial targets and, importantly, deliver 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 net income from continuing operations of 41 cents per common share. Results also reflected momentum across our businesses, including growth in our balance sheet and fee income, as well as continued strong risk discipline and capital management. I will cover many of the remaining items on this slide in the rest of my presentation. So turning to slide six, total average loans were $105 billion, up 14% from the third quarter of last year, driven by growth in both commercial and consumer loans. Commercial loans reflect an increase of over $8 billion from PPP loans. Consumer loans benefited from continued growth from Laurel Road and, as Chris mentioned, strong performance from our residential mortgage business. Laurel Road originated over $400 million of student consolidation loans this quarter, and we generated $2.3 billion of consumer 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 down 3%. reflecting paydowns from the heightened commercial line draws earlier this year. The paydowns on the lines were greater than expected, and now the utilization rate is below the start of the year. Importantly, we have remained disciplined with our credit underwriting and have 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 $135 billion for the third quarter of 2020, up $25 billion, or 22%, compared to the year-ago period, and up 5% from the prior quarter. The linked quarter increase reflects broad-based commercial loan growth, excuse me, commercial deposit 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 20 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 about six to nine basis points in the fourth quarter. We continue to have a strong, stable core deposit base with consumer deposits accounting for over 60% of our total deposit mix. Turning to slide eight, taxable equivalent net interest income was $1 billion for the third quarter of 2020 compared to $980 million a year ago and $1.025 billion for the prior quarter. Our net interest margin was 2.62% for the third quarter of 2020 compared to 3% for the same period last year and 2.76% for the prior quarter. Both net interest income and net interest margin were meaningfully impacted by the significant growth in our balance sheet in the third quarter of 2020. The larger balance sheet benefited net interest income but reduced our net interest margin due to the significant increase in liquidity driven by strong deposit inflows. Compared to the prior quarter, net interest income decreased $19 million, driven by lower commercial loan balances. The net interest margin was primarily impacted by continued elevated levels of liquidity. Elevated liquidity levels negatively impacted the margin by 13 basis points, with all other drivers netting to an additional one basis point of pressure on the margin. The lower than expected commercial loan balances contributed an additional five basis points of margin compression. Recently, we've received several questions about the future impact of our interest rate swap maturities on our net interest margin. On slide 20 in the appendix, we provide a schedule that details maturities of our swaps. Also, it is important to understand that this portfolio is only one of the fixed-rate asset classes, as all banks are impacted by maturities of fixed-rate loans and investment securities. We also show on this slide that our level of these assets combined as a percentage of total earning assets is in line with peers. Moving on to slide nine. our fee-based businesses had another strong quarter. Non-interest income was $681 million for the third quarter of 2020, compared to $650 million for the year-ago period and $692 million in the second quarter. Compared to the year-ago period, non-interest income increased $31 million. The primary driver was an increase of $35 million in consumer mortgage business as we continue to grow the business and see record levels of origination. Cards and payments income also increased $45 million related to the prepaid card activity from the state government support programs. Compared to the second quarter of 2020, non-interest income decreased by $11 million. The largest driver of the quarterly decrease was $22 million of lower operating lease income as we had gains on leveraged leases in the prior quarter, which impacted the quarter-over-quarter comparison. Consumer mortgage income was down $11 million, following a record quarter for related fees in the second quarter. These were partially offset by an increase in cards and payments related income and higher service charges on deposit accounts. Though down quarter over quarter, investment banking and debt placement fees had another solid quarter given the volatile environment, coming in at $146 million for the quarter. I'm now turning to slide 10. Total non-interest expense for the quarter was $1.037 billion compared to $939 million last year and $1.013 billion in the prior quarter. The increase from the prior year is primarily related to $52 million of payments-related costs reported in other expense, as well as COVID-19-related expenses to ensure the health and safety of our teammates. Higher personnel costs from the year-ago quarter reflect lower deferred loan origination costs merit increases, and higher employee benefit costs. Compared to the prior quarter, non-interest expense increased $24 million. The increase was largely due to higher payments-related costs as well as personnel costs related to elevated employee benefits, primarily health care, which was up $15 million last quarter. Moving on to slide 11, overall credit quality remains solid. For the quarter, net charge-offs were $128 million, or 49 basis points of average loans. Our provision for credit losses exceeded net charge-offs by $32 million, or 3 cents per share. Non-performing loans were $834 million this quarter, or 81 basis points of period-end loans, compared to $585 million, or 63 basis points from the year-ago quarter. Additionally, delinquencies actually improved quarter over quarter. with a six basis point decrease in our 30 to 89-day past dues, and the 90-day plus category also declining quarter over quarter. We've continued to monitor the level of assistance requests we receive from our customers. Over the past quarter, the number of requests for loan forbearances have decreased dramatically. As of September 30th, loans subject to forbearance were less than 1% based on the number of accounts for both commercial and consumer loans, and less than 2% when using outstanding balances. Turn to slide 12. As Chris mentioned, we updated our disclosure that highlights certain portfolios that are receiving greater focus in the environment. These areas represent a small percentage of our total loan balances. Each relationship in these focus areas continues to be subject to active reviews and enhanced monitoring. Importantly, as a group, they continue to perform consistent with our expectations. Turn to slide 13. We had shared a summary of our deferrals compared to peers at a recent investor conference. As shown here, our deferral level was peer-leading in the second quarter. As noted earlier, we have seen a dramatic reduction in the deferral levels during the third quarter. Now on to slide 14. We have continued to maintain a strong level of capital. We ended the third quarter with our common equity Tier 1 ratio of 9.5 percent, up 40 basis points from 9.1 percent in the second quarter. This places us at the upper end of our targeted range of 9% to 9.5%. We believe that this provides us with sufficient capacity to continue to support our customers and their borrowing needs and return capital to our shareholders. In the third quarter, we paid a common dividend of 18.5 cents per share, which was consistent with our second quarter level. Importantly, over the last four quarters, beginning with the fourth quarter of 2019, We have earned $1.14 per share, well above our current dividend run rate of 74 cents per share. On slide 15, we have provided our outlook for the fourth quarter. We expect average loans to be down low single digits, reflecting lower period imbalances coming into the fourth quarter. Consumer loans should continue to grow. We expect deposits to remain relatively stable. Core net interest income should increase low single digits with a relatively stable net interest margin, reflecting the expected benefit of repayment of PPP loans. The benefit of repayment is estimated to be $20 to $25 million. Non-interest income in the fourth quarter will remain relatively stable, reflecting an expected decline in consumer mortgage offset by growth in investment banking and debt placement fees. Non-interest expense are expected to be down low single digits but are highly dependent on the level of variable costs, including production-related incentives. Net charge-offs are expected to be in the 55 to 65 basis point range next quarter. And finally, shown on the bottom of the slide, are our long-term targets. On a reported basis, we will not achieve all the targets this year, but as we emerge from the pandemic and the economy strengthens, we expect to be back on the path that would lead us to operate within all of our targeted ranges. With that, I'll now turn the call back over to the operator for instructions of the Q&A portion of our call.