KeyCorp

Good morning and welcome to Key Corp's second 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.

Thank you for joining us for Key Corp's second quarter 2022 earnings conference call. Joining me on the call today are Don Kimball, our Chief Financial Officer, Clark Kyatt, our Chief Strategy 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 moving to slide three. This morning, we reported earnings of $504 million, or $0.54 per share. We delivered positive operating leverage compared to the prior quarter and the year-ago period. Our results reflect the resiliency of both our business model and our teammates as we continue to successfully navigate a rapidly changing environment. Pre-provision net revenue was up 14% from the first quarter, with a 6% increase in revenue and relatively stable expenses. Revenue was driven by growth in net interest income, which benefited from higher interest rates, and strong loan growth. Importantly, we will continue to benefit from higher interest rates over the next several years as our hedges and short-term investments continue to reprice. Our balance sheet also benefits from our strong, stable deposit base. Approximately 60% of our deposits are in stable retail and escrow balances. In our commercial business, approximately 85% of our deposits are from core operating accounts. As I mentioned, loan growth continues to be strong. Average loans were up 5% from the last quarter and 8% from the year-ago period. Adjusting for the planned runoff of PPP and the sale of our indirect auto business, average loans grew by 21% year-over-year. Our growth was driven by both our consumer and our commercial businesses. We continue to add clients and support our existing relationships. In our consumer business, we generated over $3.6 billion in loan originations in the quarter from consumer mortgages and Lower Road. Let me spend just a moment on Lower Road. We continue to see good momentum in this business, and that is despite the continuation of the federal student loan payment holiday. In May, We launched a new offering for nurses, the largest segment of the healthcare industry. While early, we are very encouraged with the response to our expanded offering. Nurses represent a sizable demographic looking for differentiated, personalized financial products and services, and Laurel Road has the unique opportunity to meet these needs. In the second quarter, we also announced the acquisition of GradFence, a leading loan counselor for healthcare professionals with a digital platform that provides fast and effective solutions for debt relief and government forgiveness programs. In June, our first month with GradFin, we held over 3,200 individual consultations for refinance and public student loan forgiveness. This acquisition aligns well with Laurel Road and our recent expansion to include nurses. These actions enhance our commitment to accelerate growth through targeted investments in niche digital businesses. In our commercial businesses, we continue to see strong loan growth in our targeted industry verticals. Additionally, we benefited from a 100 basis point increase in CNI line utilization. Our outlook for loan growth across our franchise remains strong. Fee income this quarter reflects a slowdown in capital markets activity. Importantly, we continue to offer our clients the best solutions and execution, both on and off balance sheet. This is exactly the way our business model is designed to work. In the second quarter, we raised over $36 billion in capital for our clients, retaining 22% on our balance sheet. Historically, we've retained approximately 18% on our balance sheet. Despite the slowdown in the capital markets, our pipelines remain strong, and our long-term outlook for this business is positive. We have and we will continue to invest in this business, including adding high-performing senior bankers. Now let me shift to expenses. Our expense trends this quarter reflect our strong focus on managing costs while concurrently making investments, investments in places like additional teammates, investments in digital, and, of course, analytics to drive future growth. In addition to investments in Laurel Road and GradFin that I mentioned earlier, we have also continued to invest in digital innovations throughout our business, including our recent expansion of our embedded banking platform with new end-to-end capabilities. We 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 16 basis points. Non-performing loans and criticized loans both declined this quarter. We will continue to support our clients while maintaining our moderate risk profile, which has and will continue to position the company to perform well through the entire business cycle. Our capital levels remain strong, providing us with sufficient capacity to support our clients and return capital to our shareholders. Our board of directors recently announced our third quarter dividend of 19.5 cents per share. This equates to $182 million and a dividend yield of approximately 4.5%. As is our normal practice, the Board will evaluate a dividend increase in the fourth quarter. I will close this morning by reaffirming our expectation that we will deliver another year of positive operating leverage in 2022. We recognize there is a great deal of economic uncertainty. Areas like inflation, higher interest rates, quantitative tightening, and of course, the potential for a recession. Given the economic backdrop, we remain steadfast in our focus on serving our clients, maintaining our strong balance sheet, managing our capital, and remaining disciplined in our credit underwriting. Don will cover the specifics of our full-year guidance in his comments. Overall, he delivered another solid quarter, and I remain confident in our future and our ability to create value for all of our stakeholders. With that, I'd like to turn the call over to Don to provide details on the results for the quarter and our outlook for the balance of 2022. Don?

Thanks, Chris. I'm now on slide five. For the second quarter, net income from continuing operations was $0.54 per common share, down $0.18 from last year and up $0.09 from the prior quarter. Our results in the current quarter reflect strong core operating performance and the resiliency of our business model as we continue to navigate through the current market conditions. Importantly, we generated positive operating leverage compared to both the prior quarter and the prior year and remain confident in our ability to do so for the full year. As Chris mentioned, pre-provisioned debt revenues was up 14% from the first quarter with a 6% increase in revenue and relatively stable expenses. Higher net interest income was driven by strong loan growth and the way we have positioned our balance sheet to benefit from higher interest rates. Our results also reflect our focus on strong expense management and our strong risk profile. Turning to slide six, average loans for the quarter were $109 billion, up 8% from the year-ago period and up 5% from the prior quarter. We continue to add and deepen client relationships across our franchise. which drove strong loan growth in both our commercial and consumer businesses. Commercial loans increased 4% from last quarter, reflecting broad-based growth across our industry verticals. Line utilization rates improved this quarter, increasing 100 basis points from last quarter. Our consumer businesses continued its strong performance, as we saw residential real estate originations of $3.2 billion, resulting in an increase in balances of 13% from last quarter. Consistent with our focus on the healthcare segment, approximately one-third of our consumer mortgage originations were to healthcare professionals. Laurel Road originated $445 million of loans this quarter, despite the ongoing federal student loan payment holiday. PPP loan balances were $658 million on average this quarter, compared to $7.5 billion last year and $1.2 billion last quarter. 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 $19 billion on average, or 21%. Continuing on to slide seven, average deposits totaled $147 billion for the second quarter of 2022, up $3 billion, or 2%, compared to the year-ago period, and down $3 billion, or 2%, compared to the prior quarter. Year over year, we saw broad-based growth in consumer and commercial relationships, including higher commercial escrow and retail deposits, partially offset by the expected continued decline in time deposits. The decline from the prior quarter reflects seasonal commercial outflows, including annual tax payments, as well as lower public sector deposits related to stimulus funds. Our cost of interest-bearing deposits only increased two basis points from the prior quarter. We continue to have a strong, stable core deposit base with consumer deposits accounting for approximately 60% of our total deposit mix. In addition, 85% of our commercial deposits are from core operating accounts. Turn to slide 8. Taxable equivalent net interest income was $1.1 billion for the second quarter compared to $1.02 billion in both the year-ago period and the prior quarter. Our net interest margin was 2.61% for the second quarter compared to 2.52% for the same period last year and 2.46% for the prior quarter. Year-over-year and quarter-over-quarter, both net interest income and net interest margin benefited from higher earning asset balances and a favorable balance sheet mix, as well as the benefit from higher interest rates. Quarter-over-quarter net interest income also benefited from one additional day in the quarter. Both net interest income and the net interest margin reflect the lower loan fees related to PPP loan forgiveness. The current quarter reflected $14 million of net interest income from PPP, down from $21 million in the prior quarter and $62 million in the second quarter of 2021. Included in the appendix is additional detail on our investment portfolio and asset liability position. As Chris mentioned, we have significant upside to higher interest rates over the next several years. For example, if we were to reprice our existing $9.5 billion in short-term treasuries and $27 billion of swaps to today's interest rates, we would have an annualized net interest income benefit of over $700 million. Moving to slide nine, non-interest income was $688 million for the second quarter of 2022 compared to $750 million for the year-ago period and $676 million in the first quarter. As we mentioned in our mid-quarter update last month, our fee income continues to be impacted by the slowdown in capital markets. Investment banking and debt placement fees were $149 million for the quarter, down $14 million from the first quarter. Compared to the prior period, offsetting the decline in investment banking fees was an increase of $15 million in the other income, mostly related to larger negative market-related adjustments in the prior quarter. Commercial mortgage servicing fees also increased related to elevated prepayment fees. Year over year, in addition to lower investment banking fees, cards and payments income was $28 million lower, primarily driven by lower prepaid card revenue, which was partially offset by core growth. Consumer mortgage income was also lower, reflecting higher balance sheet retention and lower gain-on-sale margins. Strength in our corporate services income partially offset these declines. I'm now on slide 10. Total non-assist expense for the quarter was $1.1 billion, relatively stable with both last year and last quarter. Compared with the year-ago quarter, our expenses are up $2 million. Personnel expenses reflect lower production-related incentives and stock-based compensation offset by higher salaries, including the impact of our direct investments into the business. On the non-personnel side, other expense increased $8 million, and computer processing expense increased $7 million. Compared to the prior quarter, non-interest expense is up $8 million. Other expense was elevated, reflecting charges for lease terminations, higher travel and entertainment, and FDIC assessments. We also saw increases in marketing expense and net occupancy, which were more than offset from lower personnel costs, reflecting lower production-related incentives and stock-based compensation, and seasonally lower employee benefit expense. Moving to slide 11, overall credit quality remains strong. For the second quarter, net charge-offs were $44 million or 16 basis points of average loan. Non-performing loans were $429 million this quarter or 38 basis points of period-end loans, a decline of $10 million from the prior quarter. Additionally, criticized loans declined and delinquencies were relatively stable quarter over quarter. Our allowance for credit losses remained stable with last quarter. Keep in mind we added to our reserves in the first quarter, reflecting our expectation for a slowing economy. The reserve level is based on our continued strong credit metrics as well as our outlook for the overall economy. Now on to slide 12. We ended the second quarter with a common equity tier one ratio of 9.2% 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. We continue to manage our capital consistent with our capital priorities of, first, supporting organic growth in our business. And this quarter, we certainly saw strong loan growth across our franchise. Second, paying dividends. And third, repurchasing shares. As Chris said, our Board of Directors just approved a quarterly common dividend of 19.5 cents per share for the third quarter. As is our normal practice, the Board will evaluate a dividend increase in the fourth quarter. On slide 13 is our full year 2022 outlook. The guidance is relative to our full year 2021 results. To make a comparison easier, we provided both our prior guidance and our updated outlook, which is shown on the right-hand side of the slide. Using the midpoints of our guidance ranges would support Chris's comments about delivering another year of positive operating leverage in 2022. Average loans will be up between 9% and 11%. This is on a reported basis. excluding PPP and the impact of the sale of our indirect auto business last year, average loans will be up closer to 20%. We expect average deposits to be up 1% to 3%. Net interest income is expected to be up between 10% and 12%, reflecting growth in average loan balances and higher interest rates, partially offset by lower fees from PPP forgiveness. Our guidance is based on the forward curve, assuming a Fed funds rate of 3.5% by the end of 2022. Non-interest income will be down between 10% and 12%. This reflects the slowdown in the capital markets and lower investment banking revenue, as well as lower prepaid card fees related to the government support program. They stepped down in market-related adjustments relative to year-ago period. We expect non-interest expense to be down between 2% and 4%, reflecting lower production-related incentives and our continued focus on strong expense management. Included in our outlook are our ongoing investments in our business. For the year, we expect credit quality to remain strong and net charge-offs to be in the range of 15 to 25 basis points. Our guidance for our GAAP tax rate is approximately 19%. Finally, shown on 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. With that, I'll now turn the call back to the operator for instructions for the Q&A portion of our call. Operator?