KeyCorp

Good morning and welcome to Key Corp's Third 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.

Well, thank you for joining us for Key Corp's Third 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 $513 million, or 55 cents, per common share. Our results included six cents per share of additional loan loss provision in excess of net charge-offs. Revenue was up 5% relative to the second quarter, driven by higher net interest income, with a 13 basis point increase in our net interest margin. One thing that sets Key apart is our approach to managing interest rate risk. We have been very deliberate and intentional in managing with a long-term perspective. While our net interest income is expected to be up double digits this year, our balance sheet positioning presents a unique and significant upside for Key over the next two years. Even in the event that rates remain at current levels, we will experience a meaningful benefit as our securities and swaps reprice. If we were to reprice our existing short-term treasuries and swaps at today's interest rates, we would have an annualized net interest income benefit of over $1.2 billion. Our balance sheet benefits from our strong, stable deposit base. Approximately 60% of our deposits are in stable, low-cost retail and escrow balances. In our commercial businesses, approximately 85% of our deposits are from core operating accounts. We grew our loans again this quarter as we continue to add and expand relationships with our targeted clients. Our growth came from both our commercial and our consumer businesses. We remain diligent in our underwriting practices and have walked away from business that does not meet our moderate risk profile. Our fee-based businesses continue to reflect current market conditions. Investment banking and debt placement fees were up $5 million from the prior quarter but down meaningfully from the year-ago period, reflecting the slowdown in the capital markets. The new issue equity market is virtually nonexistent, and the M&A market is currently engaged in price discovery. Our pipelines remain solid, particularly in M&A. However, the pull-through rate continues to be adversely impacted by market uncertainty. We continue to see more activity moving onto our balance sheet. In the third quarter, we raised a record $39 billion for our clients, of which 23% was retained on our balance sheet, well above our long-term average of 18%. We will continue to do what is best for our clients, including offering on and off balance sheet solutions. Importantly, we continue to make progress with respect to our targeted scale sectors, which are not only high growth opportunities for key but areas that matter to both our country and our economy. We have made a conscious decision to invest and focus our resources in certain vital growing sectors, including healthcare, renewable energy, and affordable housing that impact both our clients and our communities. Both renewable energy and affordable housing are areas of investment in recently passed federal legislation. Combined, the Inflation Reduction Act and the Bipartisan Infrastructure Bill have allocated over $300 billion for energy transition. In healthcare, we are growing relationships with significant healthcare providers and expanding our low-growth business, including our recent market extension to include nurses. We are also very pleased with the early results from our May 2022 acquisition of GradFin, Since the GradFin team joined Key, they have held over 14,000 individual consultations for refinance and public service loan forgiveness. These consultations are with pre-qualified credentialed prospects, all new to Key. Our expenses continue to reflect our investments in our teammates, digital, and analytics. We continue to balance expense discipline with investments for the future. Credit quality remained strong this quarter, with net charge-offs as a percentage of average loans of 15 basis points. Non-performing loans declined from the prior quarter. We remain committed to delivering sound profitable growth by maintaining our discipline with respect to risk. We will continue to support our clients while maintaining our moderate risk profile, which positions 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. Our fourth quarter guidance keeps us on a path to deliver positive operating leverage again in 2022 and concurrently make progress against each of our long-term goals. We also continue to make tangible progress against the three commitments we announced earlier this year at our investor day. These goals for 2025 are as follows. Growing relationship households in our consumer business by 20%, growing our senior bankers by 25%, and growing our Laurel Road member households to 250,000 from 50,000. We are on pace to achieve all three measures. We have grown consumer households and Laurel Road members, as well as the number of our senior bankers, although Our senior banker hires have been slower in the back half of this year, reflecting current market conditions. Overall, Key delivered another solid quarter. I remain confident in our future and our ability to create value for all of our stakeholders. With that, I will turn it over to Don to provide more details on the results of the quarter and our outlook. Don?

Thanks, Chris. I'm now on slide five. For the third quarter, debt income from continuing operations was $0.55 per common share, up $0.01 from the prior quarter and down $0.10 from last year. 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. Pre-provisioned net revenues was up 9% from the second quarter, with a 5% increase in revenue driven by loan growth and by the way that we positioned our balance sheet to benefit from higher interest rates. Our results also reflect our ongoing focus on expense management and our strong risk profile. Turning to slide six, average loans for the quarter were $114 billion, up 14% from the year-ago period and up 5% from the prior quarter. We continued to add and deepen client relationships across our franchise, which drove loan growth in both our commercial and consumer businesses. Commercial loans increased 5% from last quarter, reflecting broad-based growth across our industry verticals. Our consumer business continued with its strong performance as we saw residential real estate originations of $1.9 billion. Consistent with our focus on healthcare segment, 30% of our consumer mortgage originations were to healthcare professionals. Lower road originated approximately $200 million of loans this quarter, reflecting the ongoing federal student loan payment holiday as well as the impact of interest rates. Continuing on the slide seven, Average deposits totaled $144 billion for the third quarter of 2022, down $3 billion, or 2%, compared to both the prior quarter and the year-ago period. Year over year, we saw a decline in non-operating commercial deposit balances, partially offset by an increase in retail deposits. The decline from the prior quarter reflected lower commercial and consumer balances. Both areas were impacted by a reduction in stimulus-related funds. Interest-bearing deposit costs increased 17 basis points from the prior quarter, This resulted in a cumulative deposit beta of 9%. 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. Turning to slide 8, taxable equivalent net interest income was $1.2 billion for the third quarter, compared to $1.0 billion in the year-ago quarter and $1.1 billion in the prior quarter. Our net interest margin was 2.74% for the third quarter, compared to 2.47% for the same period last year, and 2.61% for the prior quarter. Year over year, net interest income benefited from higher earning asset balances and a favorable balance sheet mix, as well as the benefit of higher interest rates. Quarter over quarter, net interest income and margin benefited from higher interest rates and loan growth, partially offset by higher interest-bearing deposit costs. Both net interest income and net interest margin reflect lower loan fees related to PPP loan forgiveness, as well as the impact of the sale of our indirect auto portfolio in the third quarter of 2021. Included in the appendix is additional detail on our investment portfolio and asset liability positioning. As Chris mentioned, we have intentionally positioned Key to continue to benefit from higher interest rates over the next few years. For example, if we were to reprice our existing $9 billion in short-term treasuries and $26 billion of swaps to today's interest rates, we would have an annualized net interest income benefit of over $1.2 billion. This positions us to continue to grow net interest income and the net interest margin over each of the next few years, even if rates do not increase. Moving to slide nine, non-interest income was $683 million for the third quarter of 2022, compared to $797 million for the year-ago period and $688 million in the second quarter. Our fee businesses continue to be impacted by the slowdown in capital markets. Investment banking and debt placement fees were $154 million for the quarter, up $5 million from last quarter, but down $81 million year over year. Compared to last year, in addition to lower investment banking fees, cards and payments income was $20 million lower, driven by lower prepaid card revenue, which was partially offset by core growth. Consumer mortgage income was also lower, reflecting lower gain on sale margins. Strength in the corporate services income from higher derivatives income partially offset these declines. Quarter over quarter, fees were down $5 million. Trust and investment services income declined, reflecting lower commercial mortgage commissions. Operating lease income was lower due to lease terminations in the quarter. Increases in cards and payments income and the $5 million increase in investment banking fees partially offset these declines. Despite the increase in other income, this line also reflects a $9 million reduction related to the visa litigation settlement. This quarter, we also reclassified certain customer-related derivative income items from our other income line to corporate services income. This change was reflected in the current period, as well as reclassified in prior periods for comparability. I'm now on slide 10. Total non-interest expense for the quarter was $1.1 billion, relatively stable with last year, and up $28 million from last quarter. Our expenses reflect our ongoing investments in digital, analytics, and our teammates. Compared to the year-ago quarter, our expenses are down $6 million. We saw a decline across most non-personnel line items, including business services and professional fees. Higher personnel costs partially offset these declines related to an increase in salaries expense. This increase included $8 million of lower deferred costs from slower loan originations, and $10 million of higher contract labor related to technology initiatives. Compared to the prior quarter, non-interest expenses up $28 million. Higher personnel costs drove this increase. This increase was caused by higher salaries related to seasonal staffing and $10 million of lower deferred costs from slower loan originations. In addition, higher incentive and stock-based compensation was driven by a $12 million increase related to the relative stock price change on incentive compensation. Partially offsetting these increases were declines across most non-personnel line items, including occupancy and business services and professional fees. Now moving on to slide 11. Overall credit quality remains strong. For the third quarter, net charges were $43 million, or 15 basis points of average loans. Non-performing loans were $390 million this quarter, or 34 basis points of period-end loans, a decline of $39 million from the prior quarter. We did see a very slight increase in our 30- to 89-day delinquencies and criticized loans this quarter, although both remain near historic lows. Our provision for credit losses was $109 million per quarter, up from $45 million in the second quarter, and exceeding net charge-offs by $66 million. The increase in the provision was driven by the change in the economic outlook. Now on to slide 12. We ended the third quarter with a common equity Tier 1 ratio of 9.1%, 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 will continue to manage our capital consistent with our capital priorities. First, supporting organic growth of our businesses. Second, paying dividends. And as we've mentioned before, our Board of Directors will evaluate a dividend increase in the fourth quarter. And third, repurchasing shares. During the quarter, our Board of Directors approved an extension of our share repurchase authorization of $790 million, which is now in place through the third quarter of 2023. We did not complete any share repurchases in the current period. As we have in prior years, we have updated slide 13 to show our fourth quarter outlook relative to our third quarter results. Using the midpoints of our guidance ranges would support Chris's comments about delivering another year of positive operating leverage in 2022. We expect average loans will be up between 2 and 4%, and average deposits up 1 to 3%. Net income is expected to be up between 4 and 6%, reflecting growth in average loan balances and higher interest rates. Our guidance is based on the forward curve, assuming a Fed funds rate of 4.25% by the end of 2022. Non-interest income is expected to be up between 1% and 3%. This reflects an expected seasonal pickup in investment banking and debt placement fees, though we would expect the fourth quarter of 22 to be well below the fourth quarter 21 results. This also accounts for the implementation of our new NSF OD fee structure, which will decrease service charges on deposit accounts by approximately $25 million this quarter. The higher interest rate environment will also impact the earnings credit in our commercial businesses, and is expected to further pressure this line item. We expect non-interest expense to be up between 1% and 3% for the fourth quarter, reflecting higher incentive compensation relative to fee production, as well as $20 million of one-time charges in the fourth quarter, including a pension settlement charge, which will flow through other expense. For the quarter, we expect credit quality to remain strong and net charges to be at the lower end of our 15 to 25 basis point rate. Our guidance for the GAAP tax rate remains the same at 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. With that, I'll now turn the call back over to the operator for instructions on the Q&A portion of our call.