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spk07: Good morning and welcome to Key Corp's first quarter 2022 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.
spk12: Well, thank you, operator, and thank you for joining us for Key Corp's first quarter 2022 earnings conference call. Joining me on the call today are Don Kimball, our chief financial officer, and Mark Midkiff, our chief risk officer. On slide two, you will find 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 am now turning to slide three. This morning, we reported earnings of $420 million, or 45 cents per share. Our results reflect strong underlying operating performance, expected seasonality, and the impact of current market conditions. Our results also included 4 cents per share of additional loan loss provision in excess of net charge-offs. One of the standouts this quarter was our strong loan growth. Average loans were up 4 percent from the last quarter, driven by both our consumer and commercial businesses. Adjusting for the planned runoff of PPP and the sale of our indirect auto business, we grew loans by 15 percent year over year. Our strong loan growth benefited net interest income, which came in above our expectations. We also revised our net interest income outlook higher, reflecting both stronger loan growth and the ongoing benefit from higher interest rates. In our consumer business, we continue to focus on adding and deepening client relationships and our two growth engines, consumer mortgage and Laurel Road. We originated $2.6 billion in consumer mortgages in the first quarter, and Laurel Road had a record quarter with originations of $820 million. It's worth noting that our Laurel Road results were accomplished with the federal student loan payment holiday remaining in place. The outlook for this business remains strong with a new offering for nurses, the largest segment of the healthcare industry, planned for May 6th. National Nurses Day. We also experienced strong core loan growth in our commercial businesses as we grew our targeted industry verticals. Additionally, we benefited from a 2% increase in CNI line utilization. In the first quarter, we raised over $24 billion in capital for our clients, retaining 23% on our balance sheet. This is a 500 basis point increase from the amount retained in 2021. As we discussed at our recent investor day, this is exactly the way our business model is designed to work, offering our clients the best solution and execution both on and off balance sheet through various market conditions. This quarter, we were able to offer attractive balance sheet alternatives for our clients. Our pipelines and outlook for loan growth across our franchise remain strong, which will continue to provide us with an opportunity to deploy our liquidity into higher yielding assets. Market conditions impacted several parts of our business this quarter. Fee income reflected a slowdown in capital markets activity late in the quarter, which adversely impacted our investment banking results. We also experienced various mark-to-market adjustments that Don will cover in his remarks. Importantly, our long-term outlook for our investment banking business remains positive. Our pipelines remain strong. we will also continue to add senior bankers to support our growth. Expense levels this quarter reflected normal seasonality as well as lower production-related incentives, consistent with our variable cost structure in many of our businesses. Also benefiting expenses this quarter was lower prepaid volume related to state benefit programs. We also remain committed to delivering sound profitable growth by maintaining our risk discipline. Credit quality remains strong this quarter, with net charge-offs as a percentage of average loans of 13 basis points. Non-performing loans and criticized loans also declined this quarter. We continue to support our clients while maintaining our moderate risk profile, which has and will continue to position the company to perform well through all business cycles. Our capital remains a strength, providing us with sufficient capacity to support our clients and return capital to our shareholders. Looking ahead, we are encouraged by our first quarter business trends and outlook, which has led us to make a number of positive revisions to our full year 2022 guidance. These include stronger loan growth based on the pipelines we see across our company, higher net interest income, driven by loan growth, liquidity deployment, and our interest rate positioning. And lastly, lower net charge-offs, reflecting our strong risk profile. Importantly, we remain confident in our ability to generate positive operating leverage again in 2022 and make continued progress against each of our long-term goals. Don will cover the specifics of our full-year guidance in his comments. Overall, despite market headwinds, Key delivered another solid quarter. I remain confident in our future and our ability to create value for all of our stakeholders. Now, before I turn it over to Don, I want to take a minute to share some exciting news as it pertains to ESG priorities and commitments. Tomorrow, April 22, is Earth Day. Fittingly, earlier this week, we published our 2021 ESG report. It is designed to complement our annual shareholders report, which was released last month. Our ESG report provides all stakeholders with an update on our priorities and progress as both a responsible bank and citizen. In 2021, we refreshed our ESG strategy with input from our stakeholders, identifying four major priorities, climate stewardship, financial inclusion, diversity, equity and inclusion, and data privacy and security. Specific to climate stewardship, we are committed to leveraging our expertise, our relationships, our market influence, and our resources to help address the pressing challenge of climate change. We are proud to announce a number of expanded climate commitments included in our ESG report. These include commitments around sustainable financing, an area where we are a market leader. We look forward to continuing an open and transparent dialogue with all of our stakeholders as we work to address the needs of our communities. With that, I'll turn it over to Don to provide more details on the results of the quarter and our outlook for the balance of 2022. Don? Thanks, Chris.
spk13: I'm now on slide five. For the first quarter, net income from continuing operations was 45 cents per common share, down 16 cents from last year. Our results in the current quarter reflect the benefit of strong core operating performance combined with the challenge of the current market conditions. Our strong loan growth, up 4.4 percent from last quarter, resulted in better than expected net interest income and positions as well for future growth. The challenging market conditions at the end of the quarter were reflected in a few areas. including investment banking fees and market-related adjustments in other income. Finally, the increase in our allowance this quarter reflected a qualitative adjustment to reflect the economic uncertainty given the current events with Russia and Ukraine. Absent the qualitative adjustment, our provision would have approximated our net charge-off level. I'll cover the other items on this slide later in my presentation. Turning to slide six. Average loans for the quarter were $103.8 billion, up 3 percent from a year-ago period and up 4 percent from the prior quarter. Strong loan growth continued through the first quarter. Commercial loans increased 4 percent from last quarter. Line utilization rates improved this quarter, increasing 200 basis points. PPP loan balances were $1.2 billion on average this quarter, compared to $7 billion last year and $2.3 billion last quarter. Our consumer business continued its strong performance as we saw residential real estate originations of $2.6 billion resulting in an increase in balances of 8.6% from last quarter. We achieved record Laurel Road originations of $820 million this quarter despite the ongoing federal student loan payment holiday. Year-over-year comparisons were impacted by the sale of our indirect loan portfolio late in 2021. If we adjust for the sale of the indirect auto portfolio last year, as well as the impact of PPP, our core loans were up year over year by approximately $14 billion, or 15%. Our outlook for 2022 now reflects an increase for loan growth for the year of mid-single digits on a reported basis, or mid-teens growth on a basis adjusted for both PPP and the sale of the indirect auto portfolio. Continuing on to slide seven, Average deposits total $150 billion for the first quarter of 2022, up $12 billion, or 9%, compared to the year-ago period, and down $1 billion, or 1%, from the prior quarter. The current quarter change was consistent with previous seasonal trends. Compared to the previous year, we have experienced nice growth in both commercial and consumer deposits. Our cost of interest-bearing deposits remained unchanged at six basis points. We continue to have a strong, stable core deposit base with consumer deposits accounting for approximately 60 percent of our total deposit mix. Turn to slide eight. Taxable equivalent net interest income was $1.02 billion for the first quarter compared to $1.012 billion a year ago and $1.038 billion for the prior quarter. Our net interest margin was 2.46 percent for the first quarter compared to 2.61 percent to the same period last year and 2.44% for the prior quarter. Year over year and quarter over quarter, both net interest income and net interest margin reflect the PPP forgiveness. The current quarter reflected $21 million of net interest income from PPP, down $30 million from the prior quarter and $38 million from the prior year. This negatively impacted net interest margin by six basis points compared to the last quarter. PPP is impacting key disproportionately compared to peers given the success we achieved in delivering this product to our customers. Offsetting this impact was the benefit from deploying some of the excess liquidity through strong loan growth. We have increased our 2022 outlook to reflect the strength of our loan growth as well as the impact of higher interest rates. Our current rate outlook follows the forward curve and a beta assumption beginning in the high single digits in the second quarter and treading toward the 30 percent level later in 2022. This outlook results in a high single-digit increase in net interest income from 2021, or between 6 and 9 percent. Adjusting this for the impact of PPP, our growth would have been 11 to 14 percent. Also included in the appendix is additional detail on our investment portfolio and asset liability positioning. Moving on to slide nine. As mentioned before, our non-interest income was negatively impacted by changing market conditions late in the quarter, which impacted several line items. Non-interest income was $676 million for the first quarter of 2022, compared to $738 million for the year-ago period and $909 million for the fourth quarter. Compared to the year-ago period, the decrease was primarily driven by market-related adjustments included in other income, representing about $50 million of the year-over-year variance. This included both changes in write-downs of certain holdings and reversals of derivative reserves last year. The reductions in cards and payments fees are related to the lower level of prepaid card activity from the state-supported programs, which is offset by a corresponding reduction to the related expense. Additionally, during the quarter, our consumer mortgage fees were lower, reflecting higher balance sheet retention and lower gain-on-sale margins. These declines were partially offset by stronger corporate services income resulting from customer derivative activities. Compared to the fourth quarter, non-interest income decreased $233 million, primarily driven by lower investment banking and debt placement fees coming off the record level in the fourth quarter of last year. Market-related adjustments negatively impacted the quarter over quarter variance by $55 million, as last quarter included market-related gains and this quarter experienced losses. I'm now on slide 10. Total non-interest expense for the quarter was $1.07 billion compared to $1.07 billion last year and $1.17 billion in the prior quarter. Compared to the year-ago quarter, our expenses reflect lower production-related incentive compensation offset by higher salaries, including the impact of our direct investments into the businesses. On the non-personnel side, our other expense category reflects lower prepaid card-related expenses offset by higher travel and entertainment expense and FDIC assessments. Now moving to slide 11. Overall, credit quality continues to perform well. For the first quarter, net charges remained low and were $33 million or 13 basis points of average loans. Non-performing loans, delinquency, and criticized classified levels all remained relatively stable. Based on this performance, the quantitative level of our allowance remained flat with last quarter. However, we did add a qualitative adjustment to our allowance to reflect the economic uncertainty given the current events with Russia and Ukraine, as well as potential impact of higher rates. The qualitative adjustment is driven by the impact from changes in the overall economy and their potential impact on our customers. As a result, our provision expense exceeded our net charge-offs by about $50 million. We have no direct exposure to Russia or Ukraine. Now on to slide 12. We ended the first quarter with a common equity Tier 1 ratio of 9.4% within our targeted range of 9 to 9.5%. This provides us with sufficient capacity to continue to support our customers and their borrowing needs and return capital to our shareholders. Importantly, we continue to return capital to our shareholders in accordance with our capital priorities. On slide 13 is our full year 2022 outlook. The guidance is relative to our full year 2021 results, and ranges are shown at the bottom of the slide. Importantly, using the midpoints over guidance ranges would support Chris's comments about delivering another year of positive operating leverage in 2022. Average loans will be up mid-single digits on a reported basis, excluding PPP and the impact of the sale of our indirect auto loan business, average loans would be up mid-teens. We expect average deposits to be up low single digits. Non-interest income is expected to be up high single digits, reflecting growth in average loan balances and higher interest rates, offset by lower fees from PPP forgiveness. Our guidance is based on the forward curve with eight additional expected rate increases. This would assume a Fed funds rate of 2.25% by the end of 2022. On a reported basis, non-interest income will be down mid single digits, reflecting the lower prepaid card revenue related to our support of government programs and our first quarter actual results. We expect non-interest expense to be down low single digits. Once again, adjusting for the expected reduction in expenses related to prepaid cards, expenses would be relatively stable. For the year, we expect net charge-offs to be in the range of 15 to 25 basis points. Given our strong credit trends, we would expect loss rates to remain below the targeted range early in the year and move to modestly higher levels later in the year. and our guidance for the GAAP tax rate is approximately 19%. Finally, shown at the bottom of the slide are our long-term targets, which remain unchanged. We expect to continue to make progress on these targets by maintaining our moderate risk profile and improving our productivity and efficiency, which will drive returns. Overall, it was a solid quarter, and we remain confident in our ability to grow and deliver on our commitments to all of our stakeholders. With that, I will now turn the call back over to the operator for instructions on the Q&A portion of the call. Operator?
spk07: Thank you, ladies and gentlemen. If you wish to ask a question, please press 1, then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1-0 command. Once again, if you have a question, you may press 1, then 0 at this time. Our first question will come from the line of Peter Winter with Wedbush Securities. Please go ahead.
spk11: Good morning. I wanted to ask about the loan outlook. It was a nice surprise to see that increase in loans. So two-part question. Could you just talk about the growth dynamics between commercial and consumer? Because on the consumer, I would have thought, some pressure just on resident mortgage with the higher rates and Laurel Road, just given the extension of the student debt moratorium.
spk12: Sure, Peter. So we were fortunate to have growth really on both sides, both the consumer and the commercial side. On the consumer side, one of the things to keep in mind on our residential mortgage business is that it is a relationship-based business. Also, it's a business that's not very mature and that we just started it really in 2016. So it has a really good trajectory. As Don mentioned, we had a very productive quarter, and frankly, the application backlog is greater going into the next quarter. So we feel good about that. The other thing that we've done is we've built it to really focus a lot on purchase. More than half of the business is directed at purchase, which is obviously more durable. Now, having said that, we certainly expect, like all mortgage businesses, to be down in absolute terms, but we will gain share on the mortgage side. As it relates to Laurel Road, obviously we've got a really great niche there, and we're going to continue to play that where there's 1.1 million doctors and dentists in the United States, and we're going to expand it in early May to the 4 million nurses. And so I think that's a business you'll see us be able to continue to grow. Now, on the commercial side, we obviously benefited from utilization that was up 200 basis points, so that obviously is a benefit. We also are in certain areas that are just very capital intensive. If you think about affordable housing and renewables, both of which we are in the number two position in North America, those are businesses that are repeat customers and we're able to provide a lot of capital to. The other thing I would share with you, and I mentioned this in my remarks, if you think about going from 18 percent on balance sheet to 23 percent on balance sheet due to some market dislocation, that in and of itself on 24 billion of capital raised is another 1.2 billion or so. So that's kind of on both sides what's driving it. One other thing I should mention, we also obviously entered the year with 8 percent more bankers than we had last year, which is also helpful.
spk11: Thanks, Chris. Very helpful. And then just another question. I understand you lowered the outlook on fee income. It seems to imply that most of the pain is felt in the first quarter, and you're looking for, based on the guidance, just a pretty strong rebound in the second quarter and for the rest of the year. Can you just provide a little bit more color and maybe some guidance to what you're looking for in the second quarter?
spk12: Sure. Well, we never provide specific guidance on the second quarter, but just as it relates to, you know, our investment banking fees, you know, our pipelines are actually up. Now, the realization of those pipelines obviously is somewhat market dependent, but your assumption is correct. Weaker first quarter than we would have expected and the rest of the year generally in line. Don?
spk13: The other thing that I'd like to highlight there too, Peter, is that within that other income category, we did have losses of about $25 million this quarter compared to gains in the previous two quarters, whether it was year-over-year or quarter-quarter. And we wouldn't expect those to continue. And then we're also expecting to see continued growth in a few of our categories we've talked about before with the the wealth management, asset management, investment services, and cards and payments-related revenues as well. We think will be nice additions to that growth for the second quarter through the fourth quarter of this year. Got it. Thanks for taking my questions. Thank you.
spk07: Thank you. And our next question comes from the line of Ibrahim Poonawalla with Bank of America. Please go ahead.
spk00: Good morning.
spk13: Good morning.
spk00: I guess, Don, maybe I wanted to focus just on the size of the balance sheet. We did see you mentioned seasonality in deposits, but give us a sense of your outlook on deposits. I think you and Chris have talked about some level of consumer deposits that you think could leave the bank. So what's the outlook for consumer deposits, and then how do we think about the size of the balance sheet? I also saw some repayment on the debt side, too, so would appreciate any color there.
spk13: Sure. As far as the deposits, we have about $150 billion of deposits for the first quarter. With our guidance being up low single digits for deposits compared to the previous year, that would imply deposits remain around that same general range. What we're seeing is nice household growth in our retail business, and we expect that to continue. We're also seeing growth in our core operating accounts on the commercial side. We're up to 83% of our commercial deposits are our core operating account balances, and so that's very important for us. And so we expect that to continue to grow, that where we saw seasonality this quarter is that some of our state and government-related deposits and also some of our escrow deposits are at seasonal highs in the fourth quarter, and we do see those come down a little bit in the first quarter. And then we would see pressure for some of the excess balances outside those core operating accounts going forward, which would be offset by the other growths that we would expect to see by growing the households and new commercial customers. As far as the rest of the balance sheet, our long-term debt did decline a little bit. I would say that we'll be probably seeing a few issuances here over the next few quarters and probably especially in that Tier 2 category as we're focused on continue to support that capital with the balance sheet growth that we are seeing. So we think we're in good shape as far as the deposits, pleased with the trajectory we have, and I'm more pleased with the customer growth we're seeing there as well.
spk00: So fair to assume you expect earning assets to grow from here, from what we saw in 1Q?
spk13: We would expect some growth in earning assets, that's correct, with the loan growth assumptions and seeing some growth modest growth on the liability side, correct?
spk00: Got it. And just one quick question on the investment banking debt fees. I appreciate that loan growth picked up as a function of the tougher cap markets backdrop. Talk to us, if you can, just about the expense leverage in that business if it were to remain weaker for a prolonged period of time. Is there any specific expense offset to that that we should think about?
spk13: Yeah, we've talked before about for the investment banking fees, for the capital markets revenues overall, there's about a 30% correlation with just the incentive compensation alone. And so you saw that clearly in our numbers for this quarter. Our incentive comp numbers were down one quarter in year over year, given the production overall. And so there is that variable component to the business. And as Chris mentioned, we have been adding senior bankers, and we still expect that We're going to see growth opportunities going forward, and so we'll still expect to grow that. But if we see a different economic outlook, we can toggle back on some of those investments if we just don't see the opportunity and return for those investments near term.
spk00: Got it. Thanks for taking my questions.
spk13: Thank you.
spk07: Thank you. Our next question will come from the line of Stephen Alexopoulos with J.P. Morgan. Please go ahead.
spk04: Hey, good morning, everyone. Good morning.
spk13: Good morning.
spk04: Not to beat a dead horse on the IB debt placement fees, but this is where I wanted to start. So if we look at this quarter, your launch point is basically the same as where it was last year. I think a lot of us were surprised even at the investor day that the message was you thought you could grow that over where we were in 2021. Maybe can you dial us in, Don, like what are you expecting for full year 22 for that line item?
spk13: Well, Steve, what we are seeing is strength in the pipelines. The pipelines are up year to year. We're seeing activity still going forward. As far as the first quarter, on March 1st, we were thinking an IB&D fees would have been about $40 million higher than where they actually came in at. And so we saw a number of transactions basically pushed. And so we're seeing some of those close here in the second quarter. But our outlook would essentially be that based on the pipelines, we're going to see it recover to where we would have expected going into the year for the second through fourth quarter. But I don't want to make a commitment that it could be up year over year. Some of that's based on the market volatility that we're seeing and seeing what's going to happen from this point forward. But we are expecting to see a significant pickup from the first quarter levels for the rest of the year.
spk04: Okay. I mean, do you think you can hold it flat, Don, where you were last year? Is that a stretch goal at this point?
spk13: Steve, I think what we've got here really is showing strong growth in our revenue outlook. The fee income category we're showing moved down as far as our outlook for this year, which implies basically the January 1 guidance adjusted for the actual results in the first quarter. So that's not assuming that we make the recovery of that shortfall in the first quarter, but we think we will show strong growth from here and excited about the pipelines and the prospects from this point forward. Okay.
spk04: Okay, that's helpful. And then I wanted to follow up on Ibrahim's question on deposits. I was actually surprised you kept the deposit guidance. I mean, what we're hearing from other banks is that businesses are finally starting to use deposits to invest in their business. And we know the Fed's now about to embark on QT. And this is probably even more important than NIM when we think about NII for 2022. Could you drill down further why you're not expecting deposit balances to fall as just liquidity comes out of the system overall?
spk12: Steve, we spent a lot of time when we were really, we had so much liquidity, we spent a lot of time really focusing on what commercial deposits we wanted. And as Don mentioned in his comments, 83% of our commercial deposits are operating accounts. And so that's probably a pretty good place from which to start. So having said that, there's no question that commercial deposits will have a higher beta than consumer deposits, and we will see how it plays out. But we feel pretty good about our our assumptions with respect to betas and also the composition of our commercial deposits.
spk04: Okay. But, Chris, I hear you on the 83% being operating accounts, but when you drill down to the account level, don't you find operating accounts are inflated where they were from even a year or two years ago? I think there's some risk that operating account balances contract as well as the Fed moves forward with QT.
spk12: I do think there's a risk, particularly if interest rates start moving up at 50 basis points at a crack. Actually, on our balance sheet, the more elevated deposits are really on the consumer side at this point.
spk04: Okay. And if I could squeeze one more in. Don, the NII guidance, is that the current forward curve? Is that what you're assuming?
spk13: That's correct. It's up eight additional rate moves or eight 25 basis point increases. There might be some 50s in there that we would expect. And it gets to a Fed funds rate of two and a quarter by the end of the year. Okay.
spk04: Thanks for taking my questions.
spk13: Thank you.
spk07: Thank you. Our next question comes from the line of John Pancari with Evercore ISI. Please go ahead. Good morning.
spk06: Good morning, John. Just a question on the expense side. So it sounds like you did, you know, you do expect potentially somewhat lower capital markets revenue for the full year despite the recovery, and you lowered your overall non-II guidance, you know, partly also reflected in the first quarter. But you kept your expense range for the year. Does that, you know, does that reflect some of the better loan production, or is it just a function of the range? Thanks.
spk13: Yeah, there is some of the range there. I would say that keep in mind, too, the impact for the first quarter wasn't all IB&D fees. Some of it was the market valuation adjustments. And there really isn't any IC attached to that. We don't pay on those revenues to any of our business units. And so there isn't that correlation. So only a portion of it was the timing within the IB&D fees. And so If you look at our outlook for expenses going forward, there is an increase assumed there for the second through fourth quarter compared to the first quarter levels, and that's reflective of the increased revenue that we're expecting throughout the capital markets areas.
spk12: And, John, the only thing I would add to that is we will continue to invest in our business. And so that too, you know, we're obviously always taking expenses out, but at the same point, we're making investments.
spk06: Got it. Okay. Thanks, Chris. And then on the loan growth side, the increased loan growth guidance up to the mid-teens level now, could you just possibly unpack that a bit in terms of how you think that growth could break down by CNI, CRE, which also saw some pretty good growth, and consumer? Thanks.
spk13: Yeah, the CRE growth that you're seeing really is because the affordable housing that we're seeing come through. And so we are seeing growth there. I would say that as far as the prospective growth, it's really reflective of what we've seen over the last three quarters. Each of the last three quarters, we've grown our average loans about 4% from the previous quarter and annualized about 16% clip. I would say that in the third and fourth quarter of last year, it was more focused on the consumer. We did get benefit this quarter from commercial with the utilization rates picking up 200 basis points, and so that also grew at a 4% clip. Going forward, we think that split will remain fairly consistent, both commercial and consumer, showing about 4% growth rates to end up being that mid-double-digit kind of growth adjusted for PPP and direct auto. Got it.
spk06: Okay, thanks, Don. If I could just ask one more. Do you have what your new money loan yields are for your new loan production that you're putting on? I don't know if you have to break that out by bucket. I'm just curious because I know you made a point to mention that you're seeing a loan growth opportunity to actively put liquidity to work in higher yielding areas.
spk13: Thanks. Yeah, the liquidity to work in higher yielding areas is in the loan growth, and what we're seeing – on the commercial side as spreads are still a little tighter today than what they were a year ago. But we're seeing a decent pickup there compared to what we're yielding on cash or the short-term investments we have in the portfolio. As far as Laurel Road, we target a price spread to the cost of funds for that type of asset duration of about 200 to 225 basis points. If that were a fixed-rate loan and an average life of four years, you would have something in the 4% type of handle for the yield there. And with the residential mortgages, we're seeing a nice mix of arms and 15-year product. We do have some 30-year jumbos, but those are declining, and those would be consistent with what you would see in the jumbo rate market going forward. So that's just a little bit of flavor as far as the spreads. Great. All right. Thanks, Don. Thank you.
spk07: Thank you. Our next question comes from Gerard Cassidy with RBC. Please go ahead.
spk03: Hi, Chris. Hi, Don. Hey, Gerard. Chris and Don, can you guys elaborate on the positive operating leverage outlook you're talking about? It's going to continue to be positive, but if the world changes from where we are today, what are some of the levers that you guys have on the shelf to be able to use to make sure that you do achieve your positive operating leverage goals?
spk12: Sure. So, the first thing is we have several businesses that are really variable cost businesses. So, Gerard, that's a huge advantage. That is why you see our expenses on a linked quarter basis. They're down $100 million linked quarter. The other levers that we have is we're always focused on continuous improvement. And every place we can, and this is not new, we've been talking about this for some time, we are replacing clumsy handoffs with software, front, middle, and back office. And those continue to provide benefits. Other areas where we focus, last year, for example, we had some kind of one-time things we contributed, for example, to our foundation in a large way. So we had some one-time things last year. And then the other thing that I think is a huge opportunity for us on the expense side is just real estate. I mean, the world has changed dramatically since pre-pandemic, and we, like a lot of people, as leases come up, I think we've used the number of 25% of our non-branch, non-ops real estate. I think it's probably... probably even higher than that. So those are a few things that we have going for us, levers that we can and will pull if required.
spk03: Very good. And then, Don, it looked like from the average balance sheet, you have about $45 billion or so available for sales securities. Can you share with us your thinking on are they all going to remain in that category? I know you don't have to take any AOC marks, AOC I marks through your CET one ratio, since you're not in an advanced approach bank. Um, but can you just share with us what you're thinking on whether some should be moved into health and maturity and then what was the AOC I mark in the quarter? If, if you have that.
spk13: Yeah, sure. That, um, one on, on the 45 billion and, and AFS, uh, Keep in mind that about $9.5 billion of that is in short-term treasuries. And so we bought those throughout last year and had a life of two to three years. And so we'll see that burn off over time. Another $2-plus billion is in the securities we had from the indirect auto securitization transaction. And so we will see that, again, wind down over time. And so the majority of the growth that you would have seen in that category compared to a year ago was from those two areas. And so it was fairly stable absent those two changes. With that, we continue to evaluate whether or not we should have new purchases going into health and maturity versus AFS. We'll continue to reevaluate that. economically it's not much different for us as far as where it sits. There is an accounting implication to it, and we're seeing the impact of that through the AOCI, that it's up over $2 billion linked quarter, and it's driven by both the marks on the investment portfolio as well as the swap book. And compared to our peers, we have a higher percentage of assets in that category or those categories. And that really reflects the impact of our balance sheet overall. Our loans are about 70% floaters and 30% fixed compared to most peers are at 50-50. And for whatever reason, the loans don't get marked to market, but the investment securities and the swaps do. And so it comes through a little bit disproportionate for us as well.
spk03: And, Don, just on the duration, you said that the new investments are coming in around two, maybe three years. if I heard you correctly, and what's the overall duration of the portfolio?
spk13: I apologize, Gerard. The short-term treasuries had a maturity of two to three years. The overall duration of the portfolio now is close to five years, and it would typically be buying CMO structures that are in that range, and we do buy some 15-year pass-throughs there, but that would also be around that same type of duration. And if we look at the yield on those new purchases going forward, it's currently in that 3% to 3.5% range. It'll be a nice pickup compared to the 2% yield that we're seeing on the runoff of the existing portfolio. Great. Thank you for the insights. Appreciate it. Thank you.
spk07: Thank you. Our next question comes from the line of Erica Najaran with the UBS. Please go ahead.
spk01: Hi. Good morning.
spk13: Good morning, Erica.
spk01: Chris, I just wanted to ask you this directly because this talk is indicating downstream market. You know, a lot of analysts have asked you this different ways already, but, you know, should, you know, core fee income like investment banking, you know, should the pipeline not materialize, you know, as much as it's indicating? Is your commitment to positive operating leverage strong enough that you will adjust expenses in order to achieve that, even if the core fee income outlook gets worse?
spk12: That's correct. We're committed to having positive operating leverage, and as I was just sharing with Gerard, we have a lot of levers that we can pull, including we could cease to make some of the investments we're making. We don't see that as the base case, but that's obviously an option that we have.
spk01: Got it. And my second question is for Don. Don, a few follow-ups on how we should think about the balance sheet as we think about a rising rate environment. Number one, to Ibrahim's question on earning asset growth, should we assume that earning asset growth should be about equivalent to that 2% deposit growth that you are forecasting for the year? Second, you know, cash end of period looks like it's now under $4 billion. Have we reached the bottom in terms of, you know, absolutes, hash levels? And third, I'm wondering if you could give us an update on, you know, the value of each 25 basis points to the NIM. And I'm guessing that obviously the value would be greater in the first 100 versus the next 100 given deposit data.
spk13: That's a loaded question there. I'll try to take care of those, Erica, in order here. As far as the average balance sheet growth, year over year, I think that low single digits or about 2% growth is appropriate. I would say that the incremental growth from here probably is lower than that. That would be implying that our deposit balances are relatively stable and we will have some growth in some of our debt, but not a lot. As far as the cash position, what we've talked about before is that cash plus that short-term treasury position is really a view of our excess liquidity. And so that was about $20 billion at year end, and it's about $12 billion on a combined basis here at the end of the first quarter. We do see that cash position coming down from that $3.8 billion. We typically run that in the $2 billion range, and so we would expect to see that come down, but not dramatically from where it is today. And then as far as the impact for net interest income for a 25 basis point increase in rates across the board, it would be upper $50 million range as far as the NII impact. As far as the NIM impact, I'd have to go back and work through the math on that, but it would be based on that same upper $50 million range. We are forecasting that over the next early rate increases, deposit betas will be low. And as we mentioned in the speaker notes, that second quarter we would expect deposit betas to be in the upper single-digit range and then transitioning to the 30% range in the second half of the year. So we would expect to start to see that deposit beta pick up as you would see rates go up that 100 basis point plus range compared to where we started the year.
spk01: I think, sorry to add a third question, but, Don, your peers are thinking, you know, 25 for the next, I guess 25 to 30. I guess that's pretty much in line. Do you think that 30% is a conservative forecast or it's about appropriate relative to what you're saying? You know, I thought the 83% of your commercial deposits being operating was a very strong statistic. Yeah, yeah.
spk13: I would say that compared to where we were before, that 30% is a strong number and is reflective of what we are expecting for that commercial performance given that strong operating account level. And many of our commercial deposits are contractually set as far as how they reprice based on changes in rates. We do think there could be some upside, but we think it's a reasonable forecast given the pace of rate increases and what we're starting to hear or speculate as far as the market change overall.
spk01: Okay. Thanks for taking my question.
spk13: Thank you.
spk07: Thank you. Our next question comes from the line of Mike Mayo with Wells Fargo Securities. Please go ahead.
spk08: Hi. Not to miss the forest, the trees, and you can confirm these numbers, but going back to the base case, First quarter operating leverage, negative 3%. Your 2022 guidance using midpoints, up 4%. That's, you know, so you're saying you're going to come from behind, you know, kind of like the Cleveland Cavaliers in the 2016 NBA Finals, right? And, you know, if you don't, then you won't meet those expectations, and I'm not sure you have a LeBron. So in very simple terms, how do you go down by, you know, three, three percentage points, to up 4% by the end of the year.
spk13: A couple of things on that, Mike. As first quarter, we would have expected to see some decline in our operating leverage compared to the year ago first quarter that we knew that we had some gains in the first quarter of last year in that other income category. And so we thought we would see some pressure there. So our initial outlook would have suggested a positive operating leverage without the changes that we just made. And to your point, Mike, we are forecasting a better PPNR and therefore better operating leverage number for us with this outlook, including the rate changes and our balance sheet growth and what we had before. So we think that's a real positive. And I think that, you know, to your point and what Chris had answered before, I think some of the strength in the model and why we have confidence in our ability to achieve that positive operating leverage is many of our growth categories are highly variable. And so if the growth doesn't come through, we'll see the cost come down because it doesn't come through there. And so we feel confident in our ability, and I think we've got 17,000 LeBrons running around here trying to deliver our business and have success. So we're optimistic about where we're going forward.
spk08: Okay, and did I do the math right? So you're basically guiding for up 2% revenues and 2% down expenses?
spk13: That's correct. That's correct, yes.
spk08: Okay, and then just separately, I mean, Netflix was in the news because subscriber growth went down or something, and I guess if you measured your own subscriber growth, I don't know, customer growth, is it up and how much is it up or down? And how much do you measure that? Clearly, it's gaining wallet share with greater loan utilization. So I get that. But how much are you growing customers, say, in Laurel Road or elsewhere?
spk12: Sure, Mike. And as you know, on Investor Day, we made some commitments. And we'll be reporting on those twice a year. So we'll report on it for the first time this fall. But I can tell you, to use your analogy, we are growing subscribers in our retail business, which is really household relationships. We clearly are growing subscribers as it relates to Laurel Road. It was a record quarter both in terms of funded volume and number of new households. And the other equivalent that obviously we'll be talking about is just the number of bankers that we have out on the street that then translates into subscribers as they're out calling on people.
spk08: And so how many new households at Laurel Road this past quarter or year over year or however you measure, if you disclose it?
spk12: We're not disclosing it until September, and then, Mike, what we'll do is we'll roll forward. I can tell you that it's up, and then we'll actually report on it twice a year. We'll report in September.
spk08: All right. Thank you. Sure.
spk12: Thank you.
spk07: Thank you. Our next question comes from the line of Betsy Gracek with Morgan Stanley. Please go ahead.
spk09: Hi. Good morning. Good morning. I was looking at the slide 18 on the ALCO position, and I know earlier you spoke about this with Gerard as it relates to the quarter. I just wanted to understand how the changes that you've made in the ALCO book are likely to impact not only NII over the rest of this year and into next, but also the AOCI, because it looks like you've done some stuff to try to protect against AOCI risk and 2Q. And I raise it because obviously we all know that the 10-year is backed up since March 31st. So, you know, some color there would be helpful. Thanks.
spk13: Sure can. As far as what we've done, we have shown some of our asset sensitivity come down a little bit, and that's just based on some of the positioning that we did throughout the quarter. One of the things I think is unique for us that's helping us position the balance sheet and helping us position our earnings overall is that the We had about $6 billion of CMBS agency securities in the portfolio where we did a forward starting swap for those. It actually converted those to floating. We actually wound down about $3.5 billion of those swaps in the first quarter and will unwind another $2.5 billion in the second quarter. with those unwinds, it really converts that floating component to fix and adds an additional 75 basis points and yields that $6 billion over the remaining life of the securities. And so we think that will be a nice lift up for us going forward. On the overall swap position, it was fairly stable for the core cash flow swaps that we use for asset liability purposes. And we'll continue to reassess that and we'll start to think about how we can manage that position overall. As far as the rate changes since quarter end, that's where we've been able to take advantage of that with some of these forward starting swaps, like I mentioned, and we'll start to see some of that help the position overall going forward as well.
spk09: Okay. So based on the backup in Longin that we've had since March 31st, how much less impact would you say you'd be exposed to if this rate is what, you know, prints on June 30, relative to what we experienced in 1Q.
spk13: Michael Heaney- Betsy, I don't have that exact math right now, but we can go through that and let you know. But I would say that our rate position and our outlook for NII going forward would not be changed from reflecting the current rates and current curve today compared to what it would have been as of March 31st.
spk09: Okay. And then just other question I had is on funding the loan growth that you're looking for in the rest of this year. You know, it seems like in this quarter there was a partial funding from deposits, partial funding from cash, and I'm just wondering if I'm thinking about the rest of the year, given that you're looking for deposit growth to slow and really, as you mentioned earlier, be flat here from here on. How are you thinking about funding that loan growth? Is it drawing down more on cash or is it, you know, more drawing down on securities or just the cash flow from the securities book? That would be helpful. Thanks.
spk13: Sure. You hit on all the levers that we're looking at, that essentially that we would see that cash position come down a little bit from where it is. I would say that the bond portfolio puts out about $1.8 billion to $2 billion a quarter of cash flow just from the maturities. And as I mentioned earlier in the call, we would expect to have some debt issuances through the second and fourth quarters of this year to help reset that. And so all of those combined will be used to help fund some of that future growth and are reflected in our forecast. Thanks so much. Thank you.
spk07: Thank you. Our next question comes from the line of Ken Houston with Jefferies. Please go ahead.
spk02: Hey, thanks. Good morning. Don, just one more follow-up on the balance sheet. So your 4.4 rate sensitivity, the forward starting swaps, I guess, do we know how much is still yet to start and how much would those forward startings change that 4.4% sensitivity, if at all?
spk13: Well, the forward starting that we didn't close out by the end of the first quarter was $2.8 billion. And then the other component, I think we've got about an additional billion and a half that are forward starting that will start later in the year that are already reflected in that, but will be fully phased in by the end of the year.
spk02: Okay. And then just, you know, is this your comfort zone with where you want the asset sensitivity to sit in that four and a half percent zone? I know you brought it down a little bit, but do you anticipate either adding more or changing the other complexities of what you're adding on the fixed rate side to change that at all from here?
spk13: We could see that continue to trend down a little bit. We tend to be focused on about a plus or minus 3% range, and depending upon what we're seeing for Our expectation for rates versus what the market would have, I think you could see that close down a little bit, but not a lot from that 4-4 level.
spk02: Okay, so we're pretty much looking at, like, what the balance sheet should look like aside from the growth dynamics that you've talked through.
spk13: You will see the impact of the growth dynamics, correct, but not seeing material changes from here as far as the overall balance sheet, correct? Okay, great. Thanks, Don. Thank you.
spk07: Thank you. Our next question comes from the line of Matt O'Connor with Deutsche Bank. Please go ahead.
spk10: Good morning. You've had a lot of growth in commercial real estate this quarter and really over the past year or so, and mentioned it's coming from affordable housing. Maybe just remind us what type of loans those are, just the risk dynamics of it, and if there's some sort of government backing or encouraging or how those are appealing.
spk12: Matt, it's Chris. These loans are what you would typically see kind of in a multifamily environment. The affordable feature of it changes a little bit some of the economics, but actually the lending parameters don't change. There's not a backstop per se, but as you know, we have dramatically de-risked our real estate book over the years. We have very, very little construction. At one point, I think we had, going into the global financial crisis, I think we had like 42% in terms of construction. Today, that is a high single digit. So it's a very solid book with solid developers that we know. And as we've mentioned before, it's a huge unmet need that I believe will continue to be funded.
spk10: And it's somewhat maybe related or unrelated. The corporate service income line, what's the key driver there that was very strong? Are there loan fees in there, or what's the key drivers there?
spk13: There were some loan fees there, but more of it, Matt, was in derivative production that we saw in the quarter and have seen over the last couple of quarters going forward on that category.
spk10: Okay, thanks. Thank you.
spk07: Thank you. Our next question comes from the line of Brian Foran with Autonomous. Please go ahead.
spk05: Hey, good morning. Don, or I guess Don and Chris, on slide 12, you know, you show the CET1 on top and the TC on the bottom. And, Don, you made a bunch of great points about the funkiness of the AOCI concept. It's very logical and very consistent with what we hear from other banks. So I want to acknowledge that. But, you know, is As you think about capital this cycle, clearly CET1 is the main one. Is the TCE matter at all? Is there any level of TCE that would, you know, make that a limiting factor? Or is TCE just kind of, you know, not relevant this cycle because it's about rates, not credit?
spk13: That's a great question, Brian. I would say that our, as you suggested, our primary focus is on common equity tier one ratio. And so that's the one that we're managing to and using. And so that's our focus as we look at our capital priorities as far as supporting that organic growth, making sure we maintain that strong dividend, and then using share buyback to manage within that range. The TCE ratio is clearly impacted because of the dramatic change we saw in rates. What helps us in that side is that, as I mentioned before, between those short-term treasuries and the swap book, A third of that AOCI adjustment actually goes away in the next two and a half years. And so we'll see that burn in fairly quickly. And so that will help us in deciding what's the appropriate level of TCE. We do watch that. We do pay attention to it. We do have some goals and objectives there as far as we don't want to see it drop below certain levels. but we're still above that threshold, and it hasn't required us to make any additional changes to how we're managing our capital or overall balance sheet.
spk05: Great.
spk13: Thank you. Thank you.
spk07: Thank you. Our next question comes from the line of Scott Seifert with Piper Sandler. Please go ahead.
spk14: Morning, guys. Thanks for taking the question. I think I kind of asked and answered, but, Don, maybe I'll take that one that hopefully is fairly straightforward. Other fee income, so you had the market-related adjustments, so that led to the loss of $4 million or so versus a typical number kind of in that $50 million to $60 million range. With the losses kind of behind you, does that revert straight back up to $50 million, or would that necessitate some sort of recovery in that? In other words, does it split the difference with no change in market dynamics? How should that all flow through?
spk13: Yeah, typically before last year, we would have seen something in the 20s for that category, so it's more of a split the difference there, like you said, Scott, and that would be our expectation going forward. Okay, perfect.
spk14: All right, I think that does it, so thank you very much. Thank you.
spk07: Thank you, and we do have a follow-up question from Gerard Cassidy. Please go ahead.
spk03: Thank you. LeBron, I mean Don, can you touch upon Chris's comments? I think In his opening remarks, he talked about the student loan holiday. Have you guys kind of tried to dig into your customer base about the potential that once the holiday ends or the deferments end, how much refinancing business is sitting there for you guys to capture?
spk12: Yeah, Gerard, it's Chris. We clearly think there's a backlog. We've seen it before just when people thought the holiday was ending. that we've seen ramp-ups. So I'm sure there are people out there that logically have deferred, and if and when it were to end, I think there's some pent-up demand. We've seen that play out with sort of the couple deadlines that have been out there and have been extended.
spk03: And, Chris, is it more for the existing customer base, or is it just the general pool of medical school debt that's out there that you guys would try to go after?
spk12: No, we would go after the entire pool of medical school debt. So there's the medical school debt that's with the government, and there's also the refinance debt. Very good. Thank you. Thank you.
spk07: Thank you. There are no further questions in the queue at this time. I'll pass it back to Chris for any closing remarks.
spk12: Thank you, operator. And again, thank you for participating in our call today. If you have any follow-up questions, you can direct them to our investor relations team, 216-689-4221. This concludes our remarks. Thank you so much.
spk07: Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and for using AT&T Conferencing Service. You may now disconnect.
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