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KeyCorp
1/21/2021
Good morning and welcome to Key Corp's fourth quarter 2020 earnings conference call. As a reminder, this conference is being recorded. I'll now turn the conference over to the chairman and CEO, Chris Gorman. Please go ahead, sir.
Oh, thank you, John. And good morning and welcome to Key Corp's fourth 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. This morning, Key reported record revenue and earnings. But before we get into the details of the quarter, I want to share a couple of broader and contextual comments. I am very proud of the way our team continues to navigate the pandemic and related economic downturn. Their dedication, combined with our investments and talent and digital capabilities, continue to serve the company, our clients, our communities, and our shareholders well. Throughout 2020, we successfully executed what I call our dual mandate. By that, I mean responding to the pandemic, which is a real humanitarian and economic crisis, while continuing to position Key for both growth and success. We have taken countless steps to ensure that our teammates and our clients are both safe and well served. Additionally, we provided billions of dollars in credit to our clients. In 2020, we originated more than 43,000 loans amounting to $8 billion through the first round of the Paycheck Protection Program. In fact, we are currently assisting our clients through the second round of the Paycheck Protection Program as we speak. As part of our National Community Benefits Plan, we provided billions of dollars in support to our communities. This included affordable housing, home lending and small business lending in low and moderate income communities, transformative philanthropy, and renewable energy financing. Our commitment also includes programs to advance social justice and economic inclusion across all the communities we serve. And finally, I want to thank our teammates for rising to every challenge in 2020 in a way that kept our clients at the center of everything we do. I am now turning to slide three. Getting back to our performance in the fourth quarter, we achieved a record level of revenue for both the quarter and the year. The growth in net interest income and fee income. Net interest income was up almost 4% from the prior quarter, with an eight basis point increase in our net interest margin. Fee income, also a record, up double digits for both the prior quarter and the year-ago period. We continue to benefit from investments that we have made across our company, which drove both fee income and balance sheet growth. Let me touch on three specific areas. First, consumer mortgage. We achieved record volume in the fourth quarter with $2.5 billion in funded loans. For the full year, our consumer mortgage originations were $8.3 billion, up 90% from the prior year. This drove both balance sheet growth as well as a 179% increase in fee income. Approximately one half of our originations last year were purchase mortgages. Our pipelines remain strong, and we expect to continue to both grow and take share. The second area I will highlight is investment banking. This is an area where we have invested in talent and made targeted acquisitions to enhance our capabilities, including areas such as healthcare and technology. In the fourth quarter, we generated $243 million in fees, which represents a record quarter. We enjoyed broad-based growth across the platform with particular strength in M&A and loan syndications. 2020 was a record year for investment banking and debt placement fees. Our investment banking pipelines remain strong. We believe this business will continue to be a growth engine for us in the future. The third area is Laurel Road, and more broadly, the investments we have made in digital across our company. Laurel Road continues to originate high-quality loans that provide us with an opportunity to build broader digital relationships with healthcare professionals. Last year, Laurel Road originated over $2.3 billion in loans. At the end of March, we will launch our digital bank serving the healthcare segment, expanding our consumer franchise nationally. This launch will broaden our offering for Laurel Road clients to include deposits, additional lending products, and other value-added services. We believe that both Laurel Road and consumer mortgage will continue to be relationship-based growth engines for our consumer business. Our expenses this quarter were elevated. They were elevated due to higher production-related incentives, severance, and the funding of our philanthropic foundation. Additionally, COVID-related expenses and costs associated with our prepaid card also remained elevated again this quarter. Don will cover the outlook in his remarks, but we expect expenses to come down in 2021 while concurrently investing in talent and digital capabilities. This year we will also be accelerating the pace of branch closures. We expect to consolidate over 70 branches representing 7% of our network. Most of these closures taking place in the first half of the year. Our decisions are driven by client behavior as more activity continues to move to our digital channels. It's also informed by our robust analytics. We expect limited client attrition as a high percentage of the impacted branches are located within two miles of another key facility. Importantly, we expect to continue to grow our retail business while reducing operating expenses and improving overall profitability. Credit quality remained strong this quarter with net charge-offs of 53 basis points within our targeted over-the-cycle range. Additionally, non-performing loans declined by almost $50 million this quarter. We will continue to support our clients while maintaining our moderate risk profile and concurrently positioning the company to perform well through the business cycle. Finally, we have maintained our strong capital position while continuing to return capital to our shareholders. In the fourth quarter, Our common equity Tier 1 ratio increased 30 basis points to 9.8%, which is above our targeted range of 9 to 9.5%. The results of our recent stress tests affirm that Key is a different company today, with loss rates and loss-absorbing capital among the best in our peer group. Our strategic positioning allows us to continue to execute against each of our capital priorities, supporting organic growth, paying dividends, and of course, share repurchases. Last week, our board of directors authorized a new share repurchase program of up to $900 million over the next three quarters. We also approved our first quarter common stock dividend of 18.5 cents a share. In closing, despite the challenging environment of the last year, we were able to support our clients, invest in and grow our businesses while maintaining our strong risk practices. Our success was driven by our dedicated team, the strength of our business model, and our relentless focus on executing our strategy. I am confident in Key's future. We are positioned to succeed and continue to deliver on all of our commitments. I will now turn it over to Don, who will provide details on our quarter in addition to our outlook for the coming year. Don?
Thanks, Chris. I'm now on slide five. As Chris said, it was a very strong quarter for us, with record net income from continuing operations of $0.56 per common share, up 37% from the prior quarter and 24% from the prior year-ago period. Return on average tangible common equity for the quarter was over 16%, up over 400 basis points from the third quarter. I will cover the other items on this slide later in my presentation. Turning to slide six. Total average loans were $102 billion, up 9% from the fourth quarter of last year, driven by growth in both commercial and consumer loans. Commercial loans reflect an increase of over $7.5 billion from the PPP loans. Consumer loans benefited from the continued growth from Laura Road and, as Chris mentioned, strong performance from our consumer mortgage business. Laura Road originated $590 million of loans this quarter. and $2.3 billion for the full year, up over 20% from the full year of 2019. We also generated another record $2.5 billion of consumer mortgage loans in the quarter, bringing the total for the year to $8.3 billion. The investments we have made in these areas continue to drive results and, importantly, add high-quality loans to our portfolio. Lint quarter average loan balances were down 3%, reflecting paydowns from the heightened commercial loan draws as well as a small reduction in PPP balances related to initial forgiveness. Line utilization rates are at the pre-pandemic levels, given the strong liquidity levels in the environment. 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 $136 billion for the fourth quarter of 2020, up $23 billion, or 21%, compared to the year-ago period, and up 0.6% from the prior quarter. The linked quarter increase reflected broad-based commercial growth, as well as growth from higher consumer balances. The growth was offset by a continued and expected decline in time deposits. Growth from the prior year was driven by both consumer and commercial clients. The total interest-bearing deposit cost came down 11 basis points from the third quarter of 2020, exceeding our guidance of a 6 to 9 basis point decline. We continue to have a strong, stable core deposit base, with consumer deposits accounting for over 60% of the total deposit mix. Turning to slide 8, taxable equivalent net interest income was $1.043 billion for the fourth quarter of 2020, compared to $987 million a year ago, and just over $1 billion from the prior quarter. Our net interest margin was 2.70% for the fourth quarter of 2020, compared to 2.98% for the same period last year, and 2.62% from the prior quarter. Both net interest income and net interest margin were meaningfully impacted by the significant growth in our balance sheet compared to the year-ago period. The larger balance sheet benefited net interest income but reduced the net interest margin due to the significant increase in liquidity driven by strong deposit inflows. Compared to the prior quarter, net interest income increased $37 million and the margin improved by eight basis points. The increase in both net interest income and the net interest margin quarter over quarter are largely due to the lower interest-bearing deposit cost and the higher loan fees from PPP forgiveness. we saw the average rate paid on interest-bearing deposits decline 11 basis points from the prior quarter. The forgiveness of the PPP loans accelerated about $28 million of additional fee recognition this quarter. These were partially offset by continued elevated liquidity levels, which had a five basis point negative impact on the margin. Moving to slide nine, our fee-based businesses hit all-time highs in the fourth quarter. non-interest income was $802 million for the fourth quarter of 2020 compared to $651 million for the year-ago period and $681 million for the third quarter. Compared to the year-ago period, non-interest income increased $151 million. The primary driver was a record quarter for investment banking and debt placement fees, which reached $243 million, up $62 million from the year-ago period. Stronger M&A and loan syndication fees drove most of the increase this quarter. This business also had a record year with $661 million of total fees. Record mortgage originations drove consumer mortgage fees this quarter, which were up $22 million from the fourth quarter of 19. Cards and payments income also increased $30 million related to higher prepaid card activity from the state government support programs. Compared to the third quarter, non-interest income increased by $121 million. The largest driver of the quarterly increase was once again the record quarter for investment banking, which was up $97 million. Commercial mortgage servicing fees also had a strong quarter, up $14 million. I'm now turning to slide 10. Total non-interest expense for the quarter was $1.128 billion compared to $980 million last year and $1.037 billion in the prior quarter. The increase from the prior year is primarily in personnel costs driven by higher production-related incentives from our record fee production, as well as higher severance costs. Year-over-year, payments-related costs reported in other expense were $40 million higher driven by higher prepaid activity, and we incurred COVID-19-related expenses to ensure the health and safety of our teammates. Compared to the prior quarter, non-interest expense increased $91 million. The increase was largely due to $40 million of higher production-related incentives, $22 million of severance, $12 million of higher stock-based compensation related to the share price, and a $15 million additional contribution to our charitable foundation. Marketing expense was also up $8 million from the prior quarter. Turning to slide 11, overall credit quality remained strong. For the fourth quarter, net charge-offs were $135 million or 53 basis points of average loans, slightly below our guidance range. Our provision for credit losses was $20 million. This was determined under the CECL methodology and based on our continued strong credit metrics and leading indicators, as well as our outlook for the overall economy, credit migration, and loan production. Non-performing loans were $785 million this quarter, or 78 basis points of period in loans, compared to 834 million, or 81 basis points, from the prior quarter. Additionally, 30 to 89-day delinquencies actually improved quarter over quarter, with a nine basis point decrease, while the 90-day plus category remained relatively flat. 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 forbearance has decreased dramatically. As of December 31st, loans subject to forbearance terms were less than $600 million, down from a peak of $5.2 billion. equating to about a half a percent of our outstanding balances. One more observation this quarter, and as Chris mentioned earlier, in late December, the results of the most recent stress test results were published. Key's results reinforced the commitments we have been making over the past several years that we are a different company with a better risk profile than Key showed through the Great Recession. Our stress credit losses from the test were peer-leading, We've been managing the company over the last decade to outperform during challenging times and believe we have positioned the company to achieve this. Turn to slide 12. We updated our disclosure that highlights certain portfolios that are receiving greater focus in this environment. These areas represent a small percentage of the 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. Now on to slide 13. Key's capital position remains an area of strength. We ended the fourth quarter with a common equity tier one ratio of 9.8%, up 30 basis points from 9.5% in the third quarter. This places us above our targeted range of 9 to 9.5%. This provides us with the sufficient capacity to continue to support our customers and their borrowing needs, and return capital to our shareholders. Importantly, the results of the recent stress test support and highlight our strong credit profile and loss-absorbing capital. Last week, our Board of Directors approved a new share repurchase authorization of up to $900 million for the next three quarters. They also approved our first quarter 2021 common dividend of 18.5 cents per share. On slide 14, we provide our full year 2021 outlook. This builds on our performance in 2020 and reflects our expectation that we will deliver positive operating leverage for the year. Guidance range definitions are provided at the bottom of the slide. Average loans are expected to be relatively stable, although at this point, I would expect a little downward bias to this range. This reflects participation in the next round of PPP and continued growth in our consumer loan portfolio from both Laurel Road and our consumer mortgage business. We expect deposits to be up low single digits, and we will continue to benefit from our low-cost deposit base. Net interest income should be relatively stable. Our net interest income will benefit from our higher loan fees related to PPP forgiveness and continued deployment of some of the excess liquidity offset by the ongoing impact of low rates. Noninterest income should be up low single digits, reflecting growth in most of our core fee-based businesses. As Chris mentioned, noninterest expense should be down in 2021, somewhere in the low single-digit range. We will continue to benefit from our continuous improvement efforts and accelerated branch closures. We also plan to continue to invest in talent and to stay at the forefront of our digital offerings. Moving on to credit quality. Net charge-offs to average loans should be in the 50 to 60 basis point range, which is consistent with our through-the-cycle range of 40 to 60 basis points. And our guidance for our GAAP tax rate should be around 19% for the year. Our guidance also assumes some variability over the course of the year. First quarter will reflect normal seasonality, including a lower day count and an increase in personnel expense driven by heightened employee benefit costs. Finally, shown at the bottom of the slide are our long-term targets. As Chris said, we expect to deliver positive operating leverage for 2021. We also maintain our moderate risk profile and over time continue to improve our efficiency and overall returns. I'll close with where Chris started, recognizing the effort of our team to support our clients and to deliver strong results for both the quarter and the year, despite the challenging environment. We are well positioned as we head into 2021 and plan to deliver on our commitments to all of our stakeholders. With that, I'd like to turn the call back over to the operator for instructions for the Q&A portion of the call.
John? Thank you. And ladies and gentlemen, if you would like to ask a question on the call, please press 1, then 0. To remove yourself from the queue, you may repeat the 1-0 command. And we do ask if you would please lift your handset before pressing any numbers and avoid placing yourself on mute. Our first question comes from the line of Scott Seifers with Piper Sandler. Please go ahead.
Good morning, guys. Thank you for taking the question. Good morning. I'm just curious. I guess I can infer it from the upload single-digit guide on fees, but was hoping you could provide a little more thoughts on your outlook for investment banking. It ended up being just a terrific end to the year, but maybe thoughts on how you see the year playing out just in terms of the nuance. I feel like last year, It was kind of, you know, less traditional M&A, sort of other drivers within investment banking or that line item that drove it, whereas this year maybe it's more the traditional stuff that we would think of. You know, how do you see it planning out, and do you think you can sustain this level or grow upon this level of annual revenues in total there?
Sure, Scott. Well, thanks for the question. You know, just – Just to step back for a second, you know, our integrated corporate and investment bank is a unique and growing franchise. It's unique among all of our peers. It's really hard both to coordinate and collaborate and get it done from a cultural perspective. And as you know, Scott, we've been at it for a long time. And we've made a bunch of significant investments. If you think about the investments we've made in technology and in healthcare, within any year, there's always variability but as we step back and look at that business over the past five years it's had a compound annual growth rate of about eight percent and so um and if you look at you know from 2015 to present i think we've had one year where we were down slightly i think last year down like three percent so i'm just giving you that as kind of a backdrop as we look forward there's no question that it's the transaction business and there's a lot of variables that clearly are not within our control. Having said that, for us, it's a relationship business. We continue to grow it. Our pipelines today are strong. Our pipelines are in good shape. What's interesting about our business is whereas a lot of people had a huge lift from investment-grade debt through the pandemic, that really is not core to our business. Our business was really driven Scott by a big surge in MNA and syndications in some cases related syndications. So we feel good about the trajectory of the business and we'll continue to invest in it.
Terrific. Thank you. And then I guess more of a ticky tack guidance question in expenses. I know you have the 22 million in severance costs in the fourth quarter. Will there be any further charges, or did you sort of take care of all of those in the fourth quarter? And if there are any, are those included in the full year 21 guide?
We would typically have some severance throughout the year. We would not expect to have any of that size going forward into each of the quarters in 2021. So the normal recurring level would be reflected in that guidance, but not assuming any significant charges on top of that.
Okay, perfect. Thank you very much, guys. Thank you.
Our next question is from the line of Bill Karkash with Wolf Research. Please go ahead.
Thank you. Good morning. I wanted to ask about loan yields. Although there were some quarters of relative stability in Key's loan yields during the last ZERP cycle, the overall trajectory of loan yields was lower until we exited ZERP. I believe you guys have about 70% percent of your loan book is indexed to the short end of the interest rate complex. And so a lot of it's repriced already, but there's still some. And, you know, that dynamic happened not just for you guys, but for other banks as well. So can you discuss whether you expect downward pressure on loan yields to persist in this ZERB cycle as well? And, you know, are you simply going to work through to offset those headwinds? And in general, is there anything, I guess, different about this cycle that leads you to expect those dynamics to play out any differently this time?
Sure. A couple things there. One, on the loan book, keep in mind that a significant portion of the swaps that we enter into from a balance sheet perspective are matched up against the commercial loan book. And so it does convert some of those over to fixed rates. And we've talked over the last couple of quarters about the impact of those swaps going forward. And so you will see some very modest pressure on yields coming from that as those swaps roll over. On the consumer book, we are seeing rates coming down as far as the new originations compared to what was the existing book. But we're also seeing improved credit quality for those new originations. And we're also seeing margins a little wider on the consumer originations compared to the current rate environment than where we've been historically. And so that will also help. And so there will be some pressure going forward, but I would say that – We still have other levers to help offset that, including the full-year benefit of the repricing of our deposit book that we realized in the fourth quarter, and then also just this excess liquidity position. We think over time we can start to absorb some of that and maybe reinvest that over time as well. Yeah, got it.
Thanks Don. That's super helpful. Maybe along the similar lines, can you talk about PPP? How much PPP contributed to loan yields this quarter and how we should expect that contribution to loan yields and NII to trend from here? you know, maybe any color on how long the benefits of PPP, you know, 1.0 and 2.0 are going to last, you know, just largely through the rest of 21, or do they extend to 22?
And that's my last question. Thank you. That's great. And we've mentioned just briefly that in the fourth quarter, we had about a billion three of the PPP loans become forgiven. And so that accelerated about $28 million of fee income for the quarter. And so, you know, That roughly added about six basis points or so as far as the overall margin, and so that clearly was additive. If you look at that first wave of PPP loans, we had about $8 billion of issuance. As I mentioned, we had about $1.3 billion of forgiveness this quarter, and so that puts about $6.7 billion. We would expect about 80% of that initial $8 billion to be forgiven, and so you'll see that come throughout the rest of the year, I would say, that For example, we would expect about a billion dollars of forgiveness in the first quarter. And so that's a little less than what we would have seen in the fourth quarter, but still continue to show that kind of a pace. The next wave of PPP will be helpful for that, and we would expect to see about $2.5 billion of originations in the second quarter. And so some of that decline that we would be expecting from that forgiveness will be directly offset by the new originations. And we probably start the end of the first quarter with balances of over $8 billion. And so I think that is helpful as far as just the perspective there. As far as the fee income component to it, if you look at both the normal accretion of the fee income plus the acceleration coming from the forgiveness, that was about $110 million of fee income for 2020. We would expect for the first wave of those $8 billion of loans, that number would be up to around $120 million or so as far as the fee income from both normal accretion and also the impact of forgiveness. And so we have a little bit of a lift on a year-over-year basis from that. And then on top of that, we would have the benefit from the new Wave 2 of the PPP program coming through with loan yields and fee income realization from those credits as well. So the vast majority by the end of 2021 should be realized, or does it spill over into 2022? I would say that the vast majority of the first wave will clearly be addressed in 2021. We'll probably see some of this next wave continue to hang over into 2022 as well. And so I would say that that incremental lift that we're getting from that will be realized in both 2021 and 2022. Thank you so much, guys. Appreciate it. Thank you.
Next question is from Ken Usden with Jefferies. Please go ahead.
Hey, thanks. Good morning. Hey, Don, just to follow up on that last point, so all of that what you just ran through on PPP is inside your NII guidance for this year?
That's correct, yes.
Okay, got it. And then secondly, just on the loans, you know, I heard your point earlier about some of the moving parts, and can you just reconfirm for us just how much do you think Laurel Road can do this year and how much more the mortgage business can grow as an offset to the plan runoff in the auto portfolio on the consumer side?
Sure can. As far as consumer loans, that relatively stable outlook for total loans would assume consumer loans in aggregate grow about $2 billion from 2020 to 2021. And that growth really coming from both residential mortgage and from Laurel Road is Just to put that in perspective, we had almost $600 million of originations from Laurel Road in the fourth quarter. Just continuing at that pace would be in the $2.5 billion type of range as far as 2021 originations from that category. On the residential mortgage side, that despite what we're seeing and hearing in the industry, that we think that we could actually show stable to maybe even increasing our overall residential mortgage originations in 2021. That Keep in mind that we are at the early stages as far as rolling out that platform throughout our branch network, seeing strong growth there. And of that $2.5 billion in the fourth quarter and of the $8.3 billion for the full year, about half of that was for purchase money as opposed to refinance. And so we think that there still will be opportunities to continue to show growth there. And that's adding over a billion dollars a quarter as far as the new loan originations in the residential mortgage side. And so that consumer growth in those two areas specifically are at the foundation of how we can get to that kind of relatively stable outlook for total loans.
Got it. And then just to follow up on expenses, given the plan for expenses to be overall flat, I'm just wondering if You have some variability in the investment banking stuff, but just in terms of the cadence of it, given the plans to reduce branches and the severance-related benefits that you get over time, is there any way to understand the cadence of how expenses trajectory the year, whether or not you're ending lower than you're starting, that type of thing? Thanks.
Great question, and I think you've hit on some of the challenge there, which is that a number of our drivers of our revenue growth really have a variable cost component to it as far as the origination, and so that's a little bit of a challenge. I would say that as we look going into the first quarter, we would tend to have some seasonality in those numbers, and we highlighted a little bit as far as the benefit expense being up in the first quarter. We would expect expenses down considerably from where they were in the fourth quarter, but probably up from what we were seeing last year. Last year, our revenue outlook was negatively impacted by some market valuation adjustments that also had a corresponding adjustment to our incentive compensation. And so we think that we'll be in a position to generate positive operating leverage for the first quarter and have positive operating leverage for the full year. And I just want to restate that as far as our expense outlook, we are saying it's down low single digits, so down 1% to 3% as opposed to stable. And so That's after funding the investments we're making as part of our strategic initiatives as well. Okay. Thank you, Don.
Thank you. Next, we'll go to Saul Martinez with UBS. Please go ahead.
Hey, good morning. So I just wanted to back up a little, just make sure I understand the mechanics on the PPP dynamics through net interest income. So on the You know, there's an incremental, I guess, $10 million, so pretty modest on the first waves of PPP. And then on top of that, you overlay the second round, which I think you said was $2.5 billion. So, you know, if we were adding that second round, you know, and obviously recognizing that these are five years and the fee rates might be lower, I mean, how much of an incremental lift is that? From the second round, are we talking – it seems like a modest number, but are we talking in the neighborhood of something like $10 million a quarter? If you could just kind of help us square away sort of the full year and connect the dots fully on the full year 21 versus the full year 20 tailwind that you get more broadly from PPP. Sure can.
As far as the – the impact of that second wave. We talked about $2.5 billion in the first quarter. I would say that the full year average probably will be somewhere around $3 billion related to that next wave of the PPP loans. If you look at both the stated coupon on those loans and the realization of the fee income, it tends to be something a little north of 2% type of yield. So you're going to pick up over 200 basis points on those balances through the year. So you're probably looking at something for the full year, somewhere around $60 million, kind of a lift from that compared to just having it sit in cash.
So we should think about the tailwind then, just 21 versus 20 from PPP more broadly, being sort of that $60 million plus the incremental 10 of 120 versus 110, so something in the neighborhood of $70 million. Is that a fair way of looking at it?
Well, what I would say is that for the fee income, we had $110 million in 2020. For the first wave, that's about $120 million for that first wave of loans. And then this new origination volume of the roughly $3 billion for average would be on top of that. And so we'll actually see a lift year over year of, say, $70 million would be a ballpark. Yeah.
And that's embedded in your guidance, obviously. That is embedded in our guidance. That's correct, yes. How much of a headwind is the roll-off of the hedges in 2021? Do you have that figure, you know, how much of that goes the other way? And, you know, I presume that those hedge roll-offs and the incremental headwind is also embedded in your guidance.
Yes. The headwind is embedded in the guidance. I don't have the dollar amount for 2021 as far as the direct impact there, but it is reflected in that outlook.
Do you know offhand how much hedge benefit you got this quarter from the swaps? From the swaps?
When you say benefit, I am reluctant to know what that is because it is part of our true hedging strategy. And so as far as the cash flow swaps, the net interest income add to us for those cash flow swaps is about $90 million, which is down about $4 million from the previous quarter. Got it.
Okay. Okay. So $90 million. Okay. Perfect. Thanks so much.
Uh-huh. And next we'll go to Gerard Cassidy with RBC. Please go ahead.
Good morning, Chris. Good morning, Don. Good morning. Don, can you share with us when you look at the allowance for loan losses currently based on your slides excluding the PPP loans, it looks like you're at about 193 basis points. And at the start of the year when all of you and your peers had to convert over to the CECL reserving, I think your reserves are about 122 basis points. As we look further out, maybe end of 22, what do you think the reserve levels could get to? Do you think they could get back down to where they were in January of this year before the pandemic?
I think we could see trends in that direction. I don't know the absolute timing of that. I don't know how to predict where the economic outlook will shift over time. But I would say as we go into 2021, that the three pieces that impact our provision expense under CECL are, one, the economic outlook. And so assuming that's stable with what we would have predicted won't see any impact there. Credit migration. has been a positive for us. And each quarter, as we take a look at what our projected credit losses are, that trend continues to get better. And so that's allowing for reductions to the provision compared to normal. And then the third piece is for loan production. I mentioned on the call a couple times in the last few quarters is that that provision each quarter would be in that $80 to $100 million range. And so if If the economic outlook doesn't change and if the migration is consistent with expectations, that would imply about a $90 million per quarter provision expense on average and about $360 million for the year, which would be below what that charge-off guidance would imply. And so we would expect to see that allowance ratio come down over time. and could have some opportunity to see that come down more quickly if we continue to see the credit migration outperform like we have.
Very good. Thank you for those insights. And, Chris, a bigger question for you or a bigger picture. Obviously, Key and your peers are positioned to really benefit from a recovery in the U.S. economy coming hopefully this year as the vaccines are more widespread by the summertime. The stocks, yours included, since the Pfizer announcement in November, have had a real strong run here. And so everything is shaping up good. And as you pointed out, your fourth quarter investment banking numbers were a blockbuster. When you go home at night and you go down the elevator, what are the risks that you think about since things are shaping up pretty good for you and your peers as we look out over the next 12 months?
Gerard, I think for our entire industry, The number one risk is cyber. I think we're in the trust business, and to the extent there was a significant breach in the industry or of any particular company, I think that's the number one risk. The number two risk I think that we all need to focus on are just a whole other – cadre of competitors. If you think about a lot of the fintechs and you think about what some of those companies have been able to do in terms of garnering new clients, I think that is a strategic risk. Kind of more tactically, we think about sort of the key areas where I think you could see significant degradation in asset values. And fortunately, we're well positioned here But I think the obvious ones are travel and entertainment. I think that's, as you point out, I think that that will come back because I think the vaccine has a lot to do with that. I think hospitality industry is one that you need to focus on. The other couple areas, and as you know, we've been out of them by strategy, is both retail and office. I think those are areas that as an industry, we need to keep a close eye on. So those are kind of starting with sort of strategic down to tactical, what I think about.
Great. Thank you.
Thank you.
Our next question is from Erica Najarian with Bank of America Merrill Lynch. Please go ahead.
Yes, hi. My first question, I'm sorry for another question on your non-interest income outlook, but I'm wondering if you could – Give us a sense, Don, on what level of cash deployment or what level of investment securities growth you expect for 2021. And maybe this next one is for Chris. Embedded in that net interest income outlook, how do you see core commercial loans, XPPP, trending throughout the year within your guidance? It seems like a lot of your peers have been quite optimistic, surprising the markets. on loan growth recovery, particularly in the second half of the year?
Sure. As far as the outlook for net interest income and some of the assumptions we have there for the reinvestment, in the fourth quarter, we increased our core investment portfolio by about $3 billion, and that was – investing at a faster pace than the runoff. And our outlook would have some of that same type of pace continuing throughout the current year. We're currently sitting on over $14 billion in cash and about $2 billion in T-bills that we think would be available for us to continue to redeploy, either through loan growth or through reinvestment. And so that would be the core assumption that we have there. Just on that component, for the roughly $6 billion that we invested this quarter, the average reinvestment yield was about a 1.28%, so down from what the runoff level would be, but reflected some of the strategy as far as investing in certain securities and then swapping them back so that, say, five years down the road, those fixed-rate securities would convert over to floating rates. our expectation would be to continue that kind of a strategy going forward. Chris, on commercial loan growth?
Sure, Eric. So a couple things. As Don mentioned, loan growth, first of all, consumer is an area that will continue to be an outlier of growth for us, and I think we're well positioned for that. Next area, if you think about commercial real estate, we have a very, very good franchise. We're actually not growing the on-balance sheet debt there, and that's by strategy. I think last year we probably placed $11 billion with our targeted customers in our real estate book. As it relates to CNI, we haven't yet seen growth. If you're looking at utilization, Erica, it is now at or below even pre-pandemic. We haven't seen people investing in property, plant, equipment, investing in people. But what we have seen, and I think is a very good sign, and you saw it in our investment banking numbers in the fourth quarter, is people are starting to make strategic moves. And so we're having great strategic discussions with our clients and our prospects. And I think people are thinking now with the election behind us, with the vaccine rollout, of really what are they going to do to grow their business. So I, too, am optimistic that we'll see an increase in line utilization and that we'll see people start to invest in their business. The other thing that would obviously be helpful for line utilization is if we had a bit of inflation, if people actually started investing and going long in inventory. And I don't think that's an unrealistic scenario as you think about the back half of the year.
Got it. And just one follow-up question on expenses, Don. Your guidance is off of the gap base of $4.109 billion?
That's correct, yes.
Great. Thank you.
Thank you. Our next question is from John Pancari with Evercore. Please go ahead.
Good morning. Good morning. I appreciate the color you gave on the reinvestment and the impact of liquidity as well as your NII guidance. Just wanted to see if you can help us in how to think about the trajectory of the net interest margin here in the coming quarters. I know there's also a PPP benefit, but I just want to see if you can give us a little bit of color in terms of how that could trend in the next coming quarters. Thanks.
Well, good. And as far as the margin, it's challenging to predict just because the timing of some of the deposit flows is also creating either pressure or change there. And so with our assumption of having deposits growing low single digits, it implies that our margin will come down slightly from where it is as of the – fourth quarter. So something slightly below the 270. And I would say that from quarter to quarter, that will be impacted based on, like you said, the PPP forgiveness timing and also the changes in the overall equity position. Okay.
All right. Thanks. That helps. And then separately, Chris, just wanted to get your updated thoughts on M&A interest, both bank and non-bank. We've clearly seen some banks there in your backyard move on some deals. And I know you've flagged competition as one of the risks that you think about. And you can certainly see that intensifying in the coming years. So basically, I want to get your thoughts on whole bank M&A from that perspective, and then also on the non-bank front.
Thanks. Sure. Thanks for your question. Well, my comment with respect to intensity of competitors was really non-banks and thinking about some of the fintechs. But as it relates specifically to your question, we're not really focused on whole bank consolidation or acquisitions really at all. We think we have everything we need to be successful. We think the best way for us to to generate value is to execute our targeted scale and go out and grow organically. So having said that, obviously, we take the responsibility very seriously of being a public company, and we know we have to go out there each and every day and create value. As it relates to non-banks, I'm really proud of the job we've done over many years of being able to buy entrepreneurial firms and successfully integrating them into our business. And I think about Kane Brothers, I think about Pacific Crest Securities, and most recently, Laurel Road, that was a born digital company that we've been able to really not only integrate into our business, but actually you know, has both Key and Laurel Road have grown. So I think you'll see us continue to go out in keeping with our focus around targeted scale, buying these niche businesses that can help us really serve our targeted client bases.
That's helpful. What areas of businesses would you emphasize in terms of the non-banks?
I think we'd probably look at the verticals that we're in, And I think we also would probably look at, you know, if you think of, let's look at what we've done. We've bought boutiques that are really focused. We've bought digital businesses and slash analytics businesses. Those are the kind of businesses that I think really turbocharge our existing 3.5 million clients.
Got it. Thanks, Chris. Our next question is from Steve Alexopoulos with J.P. Morgan. Please go ahead.
Hello, this is Janet Lee on for Steve Alexopoulos. So my first question is on deposits. You're guiding to deposits going up even more from here after 20% growth in 2020. Is this a function of your customers still holding on to cash in their accounts, or does this bake in any assumption about new client acquisitions from your successful PPP?
Well, I would say it's on all fronts, and so we are assuming growth on a continued basis. One is that we, in the last three quarters, have shown a lot of strong retail household growth and with a focus there on primary operating accounts for the retail customers. Throughout our commercial customer base, we have increased efforts around making sure that we have that expanded business full depository slash operating account relationship there as well. And so those will be helpful. It would also reflect the assumptions like we saw last year that as the PPP loans were originated, a good portion of those proceeds were deposited into deposit accounts with our customers. And so we would expect to see some lift from that. And then just the most recent round of stimulus also adds deposit balances and Each quarter this year, we've tried to estimate where our deposit flows will be, and I think each quarter we probably underestimated where they actually come through. And so I think the customers continue to have liquidity and continue to build those positions, and that's essentially why we're assuming that we'll have continued growth there as well.
Don, the only thing I would add to that is we have a very successful third-party commercial loan servicing business where we are named primary servicer on $300 billion worth of commercial real estate. That business has grown very, very well, and that generates deposits. And we also, from a strategic perspective, are very focused on primacy with both our consumer clients and our commercial clients, and we're getting a lot of lift there.
That's helpful. And it's positively surprising to hear that you expect overall residential mortgage originations to remain stable to potentially increase in 2021 versus 2022. So are you saying that the consumer mortgage income line on your fee income, is that going to be stable or is it going to go down like single digits? And how does it fit into the overall see income guidance of up low single digits? Like where are the other like offsetting line items that are going to see bigger drop?
Yeah, as far as the outlook for 2021, we would expect that line item to come down slightly, more reflecting the impact of the extremely high levels of gain on sale we experienced, especially in the third quarter of this year. So we saw that come down in the fourth quarter and would expect to see ongoing pressure there. So even though the origination volumes would be stable to maybe up, we would expect to see some pressure there. As far as the other categories on fee income that We would expect good growth in service charge line item, that those categories were under pressure throughout a good portion of, say, second and third quarter of 2020, and we would expect to see growth coming from that category and especially reflecting the impact of the low rates. We would expect to see good growth in trust and investment services line item between what we're doing from a retail and commercial brokerage slash account activity there. just our overall investment management strategy, we would expect to see some growth there. And then even though we've had a record year for investment banking and debt placement fees, we do expect that to grow again for 2021. And so we've got a good pipeline in that business. We've got a good team, and we're expecting to add bankers to that area throughout 2021 as well, which will help deliver those results also.
Great. Thanks for taking my questions.
Thank you. And we'll go to Peter Winter with Wedbush Securities. Please go ahead.
Thanks. Good morning. Good morning. I just wanted to follow up on line utilization. Where is it today, and where do you think it can go? And kind of what's the sensitivity for every 1% increase to commercial loans?
So, um, this is Chris, this is an area that frankly, uh, through the pandemic, we've, um, we've been challenged to really pin down on where we think it's going to go. If you think about people drawing on their lines and then paying back those draws, we're about at 50% in our CNI book right now, which Peter is a little bit below, um, where we would have been pre pandemic. And I think the real catalyst there is, one, our clients are sitting on a lot of cash. So arguably, they'll have to burn down some of their cash before they start to utilize their lines. So they have elevated cash positions. That's the first thing. And the second thing that I mentioned is there's plenty of slack now in the global supply chains. And so people aren't really investing and going long-term. per se on inventory. So I think you'd need those two things to happen. The biggest driver of both of those, obviously, is to get real economic growth. Don, what would you add to that?
No, I think that's right. I mean, as far as the 50%, that implies roughly about $50 billion in outstanding balances on those lines for us. So just to put that in perspective, if that would increase by 1%, then that would show that 1% growth on the $50 billion.
on it. That's helpful. And then just one question, just an interesting comes the outlook of uplifting the digits that 2020 is on a gap basis as well. Is that right?
I'm sorry, repeat that, please.
Sure. Sorry. The fee income outlook. The 2020 base, that's a gap number.
The 2020 base is the gap number, and our FTE adjustment isn't assuming much of a change on a year-over-year basis there. But I guess if we would have a tax rate change, we would start to see that. But it runs usually about $29 to $30 million a quarter, or a year, excuse me, a year for the FTE adjustment.
Okay. Got it. Thank you. Mm-hmm.
And with no further questions in queue, I'll turn it back to the company for any closing comments.
Thanks, John. Again, we thank you for participating in our call today. If you have any follow-up questions, you can direct them to our investor relations team. They can be reached at 216-689-4221. Thank you for your interest in Key, and this concludes our remarks.
Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.