KeyCorp Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
October 20, 2021

There are 13 speakers on the call.

Operator

Officer and Mark Mitkiff, our Chief Risk Officer. On Slide 2, 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'm now moving to Slide 3. This morning, we reported another strong quarter with net income of $616,000,000 or $0.65 a share.

Operator

We delivered positive operating leverage and expect to generate positive operating leverage for the full year. We delivered record 3rd quarter revenue, which was up 8% from the year ago period. Our results were driven by growth in both net interest income and non interest income. Non interest income reached a record 3rd quarter level, up 17% from the same period last year. The increase was driven by broad based growth across our fee based businesses, including Investment Banking, which was up 61%.

Operator

I am especially proud of the way our teammates continue to serve our communities and clients, and in doing so, creating new and deeper relationships across our franchise. In our consumer business, we experienced record growth in net new households in the 1st 9 months of the year. Our Western franchise is growing at a rate of over 2 times the rest of our footprint and younger clients continue to be our fastest growing segment. Additionally, our consumer business generated a record $4,200,000,000 in loan originations for the quarter, which reflects growth from our consumer mortgage business and Laurel Road. Through the 1st 9 months of the year, our consumer mortgage originations have exceeded 20 twenty's full year record level of $8,300,000,000 Laurel Road had another strong quarter as we continued to add and expand high quality relationships through our National Digital Bank.

Operator

Importantly, what really sets Laurel Road apart is our targeted client approach, which results in high value digital relationships nationally. Currently, 75% of our volume is coming from outside our footprint. Laurel Road is part of a broader health care initiative across our company that has established Key as one of the leading health care banks. Moving on to our commercial businesses. We had another strong quarter.

Operator

Our Investment Banking business generated fees of $235,000,000 a record third quarter level and the 2nd highest quarterly level in our history, we experienced growth across the entire platform. Our broad and comprehensive platform has enabled this business to grow consistently over the past decade. Our Investment Banking business has grown at an 11% compound annual growth rate over the last 10 years. We are on pace to generate double digit growth again in 2021. Expenses this quarter reflect higher production related incentives and the investments we continue to make in our franchise, in digital, in analytics and in our teammates.

Operator

Year to date, we consolidated 73 branches or approximately 7% of our branch network. These consolidations will drive future cost savings and support ongoing investments. We will continue to look for opportunities to right size our footprint. Shifting to credit quality. Our trends remained very strong this quarter.

Operator

Non performing loans and criticized loans were all down from the prior quarter and net charge offs to average loans were 11 basis points. 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. Finally, we have maintained our strong capital position, while continuing to return capital to our shareholders. Our common equity Tier 1 ratio ended the quarter at 9.6%, above our targeted range of 9% to 9.5%. In the Q3, we entered into an accelerated share repurchase program facilitated by the capital relief from the sale of our indirect auto portfolio.

Operator

The accelerated share repurchase program is part of our previously disclosed $1,500,000,000 share authorization. In total, we repurchased 593 in stock in the Q3. Dividends also remain a priority. Our dividend yield remains above 3%. Our Board of Directors will consider a dividend increase at our meeting next month.

Operator

I will close by restating that it was another strong quarter. We generated positive operating leverage by growing our top line and managing expenses, while continuing to make investments for our future. As always, we remain committed to our disciplined approach to risk management and returning capital to shareholders through both dividends and share repurchases. I will now turn the call over to Don, who will provide more details on the results of the quarter. Don?

Speaker 1

Thanks, Chris. I'm now on Slide 5. For the Q3, net income from continuing operations was $0.65 per common share. Our results reflected a net benefit from our provision for credit losses, which was largely driven by our strong credit metrics and positive economic outlook. Importantly, we delivered positive operating leverage this quarter and as Chris said, we expect to deliver positive operating leverage for the year.

Speaker 1

Total revenues were up 8% compared to the same period last year. We had year over year growth in both net interest income and non interest income. Our return on tangible common equity for the quarter was 18.6%. I'll cover the other items on this slide later in my presentation. Turn to Slide 6.

Speaker 1

There were 2 major items that impacted loan growth this quarter PPP loans and the sale of our indirect auto portfolio. Average PPP loans declined $3,300,000,000 this quarter as we helped clients take advantage of loan forgiveness. We also sold our indirect auto portfolio last month. The sale impacted our Q3 average results by approximately $800,000,000 and $3,300,000,000 on an ending basis. Average loans were down from the year ago period reflecting the reduction in PPP balances and lower commercial line utilization.

Speaker 1

Compared to the prior quarter, average loans were down 0.7%. Adjusting for the sale of the indirect auto portfolio, our loans were up approximately $100,000,000 on average and up over $1,000,000,000 on an ending basis. Adding to the comments on our core loan growth, adjusting for both the indirect auto loan sale and PPP loans, our linked quarter total loan growth would have been 4.3%. We continued to see strong consumer loan growth driven by Laurel Road and Consumer Mortgage. On the commercial side, we were pleased to see a slight uptick in utilization.

Speaker 1

Continuing on to Slide 7. Average deposits totaled $147,000,000,000 for the Q3 of 2021, up $12,000,000,000 or 9% compared to the year ago period and up 2% from the prior quarter. The linked quarter and year ago comparisons reflect growth in both commercial and consumer The growth was partially offset by continued and expected decline in time deposits. So interest bearing deposit costs came down 1 basis from the 2nd quarter filing a 2 basis point decline last quarter. We continue to have a strong stable core deposit base with consumer deposits accounting for approximately 60% of our total deposit mix.

Speaker 1

Turning to Slide 8. Taxable equivalent net interest income was $1,025,000,000 for the Q3 of 2021 compared to 1.006 $1,000,000,000 a year ago and $1,023,000,000 from the prior quarter. Our net interest margin was 2.47% for the Q3 of 2021 compared to 2.62% for the same period last year and 2.52% for the prior quarter. Both net interest income and net interest margin were meaningfully impacted by the significant growth in our balance sheet compared to a year ago period. The larger balance sheet benefited net interest income but reduced net interest margin due to the significant increase in liquidity driven by strong deposit inflows.

Speaker 1

Compared to the prior quarter, net interest income increased $2,000,000 and the margin declined 5 basis points. Lower interest bearing deposit costs and the benefit of the day count were partially offset by lower earning asset yields and continued elevated liquidity levels. For the quarter, total loan fees from PPP loans were $45,000,000 compared to $50,000,000 last quarter. We've also included in the appendix additional detail on our investment portfolio and our asset liability positioning. In the Q3, our sensitivity to rising rates moved higher and we ended the period with over $25,000,000,000 in cash and short term investments.

Speaker 1

Moving on to Slide 9. We continue to see strong growth in our fee based businesses, which have benefited from our ongoing investments. Non interest income was $797,000,000 for the Q3 of 2021 compared to $681,000,000 for the year ago period and $750,000,000 in the 2nd quarter. Compared to the year ago period, non interest income increased 17%. We had a record Q3 for investment banking debt placement fees, which reached $235,000,000 driven by broad based growth across the platform, including strong M and A fees.

Speaker 1

Additionally, corporate services income increased $18,000,000 and commercial mortgage servicing fees increased $16,000,000 Offsetting this growth was lower consumer mortgage fees due to a lower gain on sale margin. Compared to the 2nd quarter, non interest income increased by $47,000,000 The largest driver of this quarterly increase was the record 3rd quarter investment banking and debt placement fees. I'm now on slide 10. Total non interest expense for the quarter was $1,112,000,000 compared to $1,037,000,000 last year and $1,076,000,000 in the prior quarter. Our expense levels reflect higher production related incentives and the investments we have made to drive future growth.

Speaker 1

The increase from the year ago period primarily reflects higher incentive and stock based compensation attributed to our higher fee production and Key's increased stock price. The quarter over quarter increase in expenses was primarily driven by 2 areas. The first, personnel expense related to one additional day of salary expense in the quarter and slightly higher employee benefits. The second was an increase in other expense of $18,000,000 largely related to a pension settlement charge and higher charitable contributions. Now moving to slide 11.

Speaker 1

Overall credit quality continues to outperform expectations. For the Q3, net charge offs were $29,000,000 or 11 basis points of average loans. Net charge offs The current quarter included $22,000,000 related to the sale of the indirect auto loan portfolio. Our provision for credit losses was a net Benefit of $107,000,000 This was determined based on our continued strong credit metrics as well as our outlook for the overall economy and loan production. Non performing loans were $554,000,000 this quarter or 56 basis points of period end loans, a decline of $140,000,000 or 20% from the prior quarter.

Speaker 1

Now on to Slide 12. We ended the Q3 with a common equity Tier 1 ratio of 9.6%, which places us above our targeted range of 9% to 9.5%. This provides us with efficient 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. We repurchased $593,000,000 of common shares during the quarter and our Board of Directors approved a 3rd quarter dividend at $0.185 per common share.

Speaker 1

Of the $593,000,000 in common share repurchases, $468,000,000 were related to the initial settlement of our accelerated share repurchase program representing 80% of the 585 The remaining $125,000,000 were purchased in the open market. The remaining 20% of the ASR will be settled in the 4th quarter. On Slide 13, Similar to prior years, we provided guidance for the Q4 relative to our Q3 results. Guidance ranges are listed at the bottom of the slide. Importantly, using midpoints of this outlook would imply our PPNR is at or above our full year 2021 outlook provided last quarter.

Speaker 1

We have adjusted our guidance to reflect our strong Q3 performance, especially in our fee based businesses as well as the continued strength in our credit quality. Average loans will be up low single digits excluding the impact of the sale of our indirect auto portfolio. We expect continued growth in both our core commercial and consumer balances. Average deposits should remain relatively stable in the 4th quarter. Net interest income is expected to be down low single digits reflecting lower PPP forgiveness in the 4th quarter and the impact of the auto loan sale.

Speaker 1

Non interest income should be relatively stable off our record Q3 performance with momentum in most of our fee based businesses through year end. We will also benefit from what we expect to be another record year for our Investment Banking business. We expect non interest expense to be down low single digits in the 4th quarter. Moving on to credit quality, we expect our net charge offs to be below 20 basis points for the 4th quarter. Credit trends were strong in the Q3 and we expect a strong finish to the year.

Speaker 1

And our guidance for our GAAP tax Rate has remained unchanged at 20%. 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 efficiency which will drive returns. Overall, it was another strong quarter and we remain confident in our ability to deliver on our commitments to all of our stakeholders. With that, I will now turn the call back to the operator for instructions of the Q and A portion of the call.

Speaker 1

Operator?

Speaker 2

Thank And first, we're in the line of Steven Alexopoulos with JPMorgan. Please go ahead.

Speaker 3

Hey, good morning, everyone.

Speaker 1

Good morning.

Speaker 3

I wanted to start. So on the IB and debt placement fees, Right. This has moved from, I think you were $160,000,000 per quarter pre pandemic. Now you're running consistently over $200,000,000 per quarter. And we know this is an unusual year for debt issuance.

Speaker 3

How should we think about this line over the intermediate term? And do we eventually just go back to 160?

Operator

So good morning, Steve. It's Chris. As we look at this line, we always look at it kind of on a trailing 12 basis. I don't think we're going back to $160,000,000 Over the last decade, we've grown this as I mentioned at a compound annual growth rate of 11%. We continue to add bankers.

Operator

We continue to further penetrate these niches that we're in. It's a unique business, 7 industry verticals serving the middle market, it is the deal business. But having said that, we feel really good about the long term trajectory of the business. I'll give you one statistic you might find interesting. This year we added 5% in terms of incremental bankers and the call activity is up 20%.

Operator

So, I think we're in the right sectors. I think we continue to invest in the business and I think it's a unique business. I don't think it's going back to 160. I do think over time, it will continue to be a double digit grower.

Speaker 3

Okay. So we should consider this current run rate as a baseline, Chris, is that right?

Operator

I don't know if I would consider it as a baseline. I mean, we always look at it on a trailing 12 basis. But I do think we can continue to grow it Steve. As you know you guys were in the deal business too. You can't sort of annualize 1 quarter, But I do think you can look at long term trends and we'll continue to grow it.

Speaker 3

Yes. Got you. Okay. And on the PPP, can you guys give out What the fees recognized in the quarter were and maybe Don do you have the balance end of period balances on PPP?

Speaker 1

Sure can. The total loan fees realized this Quarter were $45,000,000 that was down from $50,000,000 last quarter. The average balance for PPP loans was $4,200,000,000 and the ending was at $3,100,000,000

Speaker 3

Okay. That's helpful. If I could squeeze one more in for you, Chris. There's been quite a bit of activity In M and A this year, it's actually a record year. Have you been active at all in exploring M and A opportunities either bank or non bank?

Speaker 3

Thanks.

Operator

We Steve, we're always out there talking to people, particularly in the non bank space. We have a pretty good track record of buying entrepreneurial businesses and integrating them. Obviously, this year we bought AQN, which is an Analytics firm, we have a long history of investing in and partnering with FinTech Companies. So we'll continue to be very, very active around sort of niche businesses, whether it's investment banking, boutiques. And then we're always out there.

Operator

Our job is to always be out there in the marketplace and see what there is out there that could create a lot of value. And so we're out there, but particularly focused on these niche businesses.

Speaker 3

Got you. Great. Thanks for taking my questions.

Operator

Sure. Thank

Speaker 2

you. And next we'll go to Ebrahim Poonawala with Bank of America. Please go ahead.

Speaker 4

Hey, good morning.

Speaker 5

Good morning.

Speaker 6

I guess, if we could just follow-up a little bit on The outlook, you've talked about positive operating leverage this year. As we look beyond 2021, You mentioned an opportunity to right size the branch footprint. Give us some perspective on how big that is? And as we look forward, some of the PPP revenues How do you think about maintaining that positive operating leverage? You've heard other banks talk about inflationary pressures impacting expenses.

Speaker 6

So I would love your perspective on that.

Operator

Sure. Well, thank you for the question. First of all, operating leverage is very important to us. We're really proud of the fact that We have operating positive operating leverage on a year to date basis. We will have positive operating leverage for the year 2021.

Operator

We have not yet pulled together our plans for 2022. We will share that guidance with everybody in our January call. But I can tell you positive operating leverage is a very important part of how we run the business. It's a huge area of focus. When we have all of our business leaders in, we're investing heavily in these businesses, but we have to be able to get the growth for the investment.

Operator

And to date, obviously, we're getting that, but we'll continue to focus on positive operating leverage. You mentioned inflationary pressures. I don't think there's any question that there's inflationary pressures in the financial services industry and within Our customer base, we clearly are seeing those and those will be a challenge I think for everyone in the economy.

Speaker 6

And I guess one for you. So looking at your ALM slide disclosure at the end, Just talk to us on how you're managing the balance sheet as we think about cash deployment given the steepening in the curve we've seen? And where do you want the bank set up 12 months from now in terms of NII sensitivity to 100 basis points higher interest rates?

Speaker 1

It's a great question. That's something we challenge all the time that you might see from the materials that this quarter we had some activity in our bond portfolio with purchases of traditional core investments of about $3,700,000,000 compared to runoff of $2,100,000,000 that we Saw from the cash flows off the existing portfolio. In addition to that, we bought some short term treasuries of about $4,000,000,000 and also the Auto securitization transaction ended up increasing our overall bond portfolio by $2,800,000,000 as well. And so We ended the quarter at about $49,000,000,000 of total investments which is up from the average of $43,000,000,000 What I would say is that we've seen a nice tick up in rates that the purchases we made in the Q3 had an average yield of $1.35 those same types of investments at the start of the Q4 in the $150,000,000 to $160,000,000 range. And so that would probably give us some opportunity to lean a little heavier into Portfolio purchases in the Q4 and beyond and we'll continue to assess that.

Speaker 1

We're sitting right now on $25,000,000,000 of excess Liquidity compared with cash positions and short term treasuries and we do plan to put that to work over time And probably see a clip of something in that $4,000,000,000 to $5,000,000,000 range near term instead of the $3,700,000,000 that we purchased in the 3rd quarter And maybe moving that up as we get more and more comfortable with where rates are positioned for the long term.

Speaker 6

That's helpful. And any changes, Don, on Slide 19, I think you lay out $36,000,000,000 in portfolio hedges. Is that what's rolling off? Is that number expected to stay steady state over the next year?

Speaker 1

Yes. Of those hedges $22,000,000,000 really are true asset liability hedges. The remainder are both debt hedges and also some very specific security hedges For the maturities for the next 12 months for all 2022, that's a $4,600,000,000 number as far as the maturity of those Swaps. And so and just to put that in perspective, the average received fixed rate for those $22,000,000,000 in swaps is 1.2% and the current go to rate for us would be about 1.1%. So we're seeing markets start to Rates start to pick up and close that gap that we have as far as that rollover risk.

Speaker 4

Got it. Thanks for taking my questions.

Speaker 7

Thank you.

Speaker 8

And next

Speaker 2

we'll go to Scott Siefers with Piper Sandler. Please go ahead.

Speaker 4

Good morning, guys. Thanks for taking my questions. Good

Operator

morning, Scott.

Speaker 4

I was hoping to talk about loan growth for just a second. You're certainly starting to see more of a recovery. I'd say the magnitude of yours once you Sort of wade through all the noise has maybe been a little bigger than some others out there. To a degree, things like Laurel Road and mortgage, which you guys have talked about quite a bit, Officers use some flexibility, but I was hoping you could speak to the commercial side and sort of what's differentiating you guys there? And maybe some comments about what you're seeing in terms of pricing structure those kinds of things please?

Operator

Sure. Let me start and then Don, I'm sure you'll have some comments on this as well. We are pleased with the trajectory of our loan growth, Scott. You mentioned on the consumer side our 2 growth engines. Those will both continue.

Operator

So we feel good about those. As it relates specifically to the commercial side, we've seen a lot of activity around energy, around affordable housing. We're significant players in healthcare and technology. All of those sectors have been active and the pipelines look strong. As it relates to pricing and structure, We are not giving on structure at all.

Operator

And I would say there's been sort of a continued erosion of pricing. Think about sort of from pre pandemic to current sort of a BBB credit and erosion of maybe 25 basis points That would be kind of a good benchmark.

Speaker 1

I would agree Chris. And as far as the commercial loans linked quarter absent PPP, we're seeing those balances up over $1,000,000,005 I would say of that about $500,000,000 is coming from increased utilization rates that we saw it go up about 50 basis points. We saw a little bit of growth in our commercial real estate portfolio and that really is aided by our focus on affordable housing And some other areas there that have been paying dividend for us. And then the core commercial portfolio itself grew by about $500,000,000 And I'd say that A good chunk of that is coming from customer growth and we're seeing the benefit of the additional calling efforts that Chris mentioned and the Addition of more bankers on the street to help us drive that growth.

Speaker 4

Okay. Perfect. Thank you very much. And then Maybe Don, just a question on the indirect portfolio sale. Does that have any bearing on what you think about sort of the steady state Reserve level, I can't imagine it will be huge just given the starting size of that portfolio, but just would be curious to hear any of your thoughts.

Speaker 1

It really doesn't have a huge impact on it at all. If you look at the reserve levels we had there, they were a little bit less than the average for the overall loan book, but generally in line. So not much of a change there that the one thing we continue to watch is that our credit metrics Continue to improve and exceed our expectations as far as the relative performance there. And so that's been the main driver as far as some of the adjustments We've seen down as far as our overall reserve levels.

Speaker 4

Yes. Perfect. All right. Thank you guys for taking the questions.

Speaker 1

Thanks, Scott.

Speaker 2

Next, we'll go to Bill Karkash with Wolfe Research. Please go ahead.

Speaker 8

Thank you. Good morning, Chris and Don. Good morning. I wanted to follow-up on the operating leverage dynamics implicit specifically in the Investment Banking fee income line item. Clearly, there's a relationship between That fee income and how you compensate your producers, but how does the rate of growth in revenues in that line item compare to the corresponding expenses over time?

Speaker 8

How accretive is it to your consolidated operating leverage?

Speaker 1

Yes. I would say that historically we've seen that operating Margin holding fairly well for that business even though we've been investing in it. As we see variances from quarter to quarter, we typically See an increase in incentive compensation to about 30% of the change in revenues. And while it's not a strict Formula, it tends to work out to be about that range. And I would say as far as the efficiency ratio for this business, it's a little higher than what the core would be overall, but isn't too dilutive to the entire company.

Speaker 8

Got it. That's helpful. And then separately, Can you give a little bit of color on how you'd expect Laurel Road's mortgage volumes and mix to evolve in a higher mortgage rate environment?

Operator

Yes. So Bill thanks for your question. So just as you step back and you look at our mortgage business broadly, right now about 20% of our volume is to doctors. So it's not an inconsequential piece across all of Key. Additionally, Our purchase volume right now is about 50%.

Operator

We're up 60% year over year. I think the MBA would say those are relatively flat. So I would expect that we'll continue to grow fairly aggressively on the purchase side as it relates to Laurel Road. And obviously as interest rates go up, the refinance piece of it will obviously be impacted by that.

Speaker 1

And also keep in mind our target customer for this Laurel Road business. It really is those doctors that are coming off the residency and Locating to their permanent assignment. And so step 1 typically is to consolidate their student loans and step 2 would be to buy a house And establish more of a permanent residence. And so even though rates are going up, we would expect to some strong purchase volume coming from that targeted customer base as well.

Speaker 8

Got it. If I may squeeze in one last one. Was the strategic rationale behind the Exiting of indirect the indirect auto lending business simply a result of your desire to focus on direct relationships With your customers and with that sale, have you now fully exited indirect consumer lending?

Operator

So, Bill, there's no question you're correct there. I mean, we are a relationship bank and specifically we believe in targeted scale. And if you think about that being really focused on who you do business with and being a relationship bank, clearly the indirect auto business just is not a relationship business. And so we made the decision to exit the business and then the transaction that we completed Just recently with the accelerated share repurchase just made a whole lot of sense for us because it freed up capital, had a great IRR and frankly enabled us to eliminate the tail risk at a time when the value of used automobiles was quite high. So that was kind of the strategic logic between exiting the business and executing the transaction we did recently.

Speaker 8

Understood. That makes a lot of sense. Thank you for taking my questions.

Operator

Sure, Bill. Thank you.

Speaker 2

Our next question is from Ken Usdin with Jefferies. Please go ahead.

Speaker 5

Hey, thanks. Good morning. Don, just to follow-up on the swap comment, you gave that 4.6 number and talked about it. But I just I want to understand the broader strategy with the swap book, the 22 now and that 4,600,000 just wondering just how you're thinking about either replacing some of those? And if you could remind us what the benefit was from hedge income hedge swap income in this quarter and how you'd expect that to traject?

Speaker 5

Thank you.

Speaker 1

Sounds good. The whole thought as to the size of the swap book is really to get the end target as far as our asset that we have been biasing our position to be much more asset sensitive than we typically would. We're now in our we talk about a 6% Asset sensitive position in our slide deck and that's higher where it would be traditionally. But also available to us Going forward into next year is the redeployment of liquidity. So some of that will be taking out the cash position which is a variable rate asset, Low earning variable rate asset, but still variable rate and replacing it with long dated investment securities and we typically have about a 4 year average life for those securities.

Speaker 1

And so we'll have to take that in consideration as to whether or not we just do more of that or we do additional replacements for the swaps. Right now we've not been replacing any of the swap maturities and we'll continue to reassess that going forward. So That's just generally how we would manage the overall asset sensitivity position of the company. As far as the benefit from the swaps in the 3rd Quarter, we got about $76,000,000 of net interest income coming from the swaps. We could see that come down slightly over the next couple of quarters.

Speaker 1

And then The question will be going forward is what happens with rates and as the short term rates move up you would see that number come down, but we would have seen an offsetting impact The rates on the commercial loans going up benefiting from those higher rates. And so that's Again, just a summary of where we're positioned today and what impacts there might be going forward.

Speaker 5

Yes. And as a follow-up, so if you were to Let's say that all of that the 4.6 go and not replace. Do you have an idea of where that 6% asset sensitivity would turn into?

Speaker 1

I would say that that would probably take us up as far as asset sensitivity, but I don't have the exact rate Fair. And one of the things we'll be monitoring is just what our outlook would be for rates overall and what's the other changes in the balance sheet. So since those swaps are fairly short in duration, it wouldn't have a huge impact in overall asset sensitivity, but it's just something prospectively that we'd have to evaluate.

Speaker 5

Understood. And if I could just ask that last clarifying one Don. Can you just give us what the total PPP income was this quarter versus last?

Speaker 1

The total which will include the interest on the individual loans was $56,000,000 including the $45,000,000 in fees. Last quarter that was $69,000,000 including $50,000,000 of fees. And so that's just the relative change from quarter to quarter.

Speaker 5

Perfect. Thank you, Don.

Speaker 1

Thank you.

Speaker 2

Next, we'll go to Matt O'Connor with Deutsche Bank. Please go ahead.

Speaker 9

Good morning. Just a couple of follow ups on some individual fee categories. Service charges for you guys and others Are bouncing back nicely. Do you think that's obviously some seasonality and just kind of inherent recovery, but do think it might also be a bit of a leading indicator that some consumers are spending down their excess liquidity and could start borrowing more? Or what do you think is driving that?

Speaker 1

Well, one, if we look at the individual balances of our retail customers, we're seeing balances maintained if not growing across the board even though the smallest customers as far as average deposit balances. And so we're not seeing a lot of change there that I would say that to your point some seasonality, some Activity level. We're seeing activity levels pick up and that's driving service charges up. And more importantly for us is we're seeing household and customer growth. And We've had record growth for the 1st 9 months of this year that exceeds what we had previously originated as far as net new households in a full year.

Speaker 1

And so we're seeing strong growth there which also does translate to increased fee activity for us as well.

Operator

Matt, just to give you some numbers from the Q1 of 2020, our merchant business is up 49%, Purchase cards up 39%, retail payments in general are up 28%. So to Don's point, there's a lot of velocity.

Speaker 9

Okay. And then separately, the trust fees were down a little bit and flat linked quarter and flat year over year, obviously a good backdrop in Markets. Just what's going on there? And then remind us how much money market waivers are embedded in those results as well for when rates Raj and you recover that. Thank you.

Speaker 1

As far as the trust fee income that the biggest driver there really was Commercial brokerage activity and that was down linked quarter and year over year. If you look at the core private banking revenues, those were up for each of those periods And retail investment sales are down slightly linked quarter because of seasonality and but up year over year. And so Those are the main drivers there. And then I'm sorry Matt as far as your last question I forget what that was. I apologize.

Speaker 9

Any money market waivers that are embedded in that line that when rates rise you'll recover?

Speaker 1

Really don't have any money market waivers there at all. We don't manage any money market funds and so that really doesn't trip our revenues there.

Speaker 9

Okay. That's helpful. Thanks for the reminder.

Speaker 7

Okay.

Speaker 1

Thank you.

Speaker 2

Next question is from Peter Winter with Wedbush Securities. Please go ahead.

Speaker 10

Good morning. Good morning, Derek. Chris, I wanted to ask on capital. I'm just wondering with the improved credit risk Profile, the outlook for the economy is getting better. Would you consider moving the capital target maybe to the low end Of 9% to 9.5% or even take it below the low end?

Operator

Peter, we still believe that 9% to 9.5% is the right number as we think about our business. Now there's obviously a lot of variables. Could we be in the lower Portion of 9 to 9.5 depending on the scenario we could, but we do not intend to lower the target of 9 to 9.5 of CET1.

Speaker 10

Okay. And then, Don, if I can ask, just In terms of the Q4 outlook, could you talk about the average loan growth and that net interest income excluding PPP and then also with the net interest income excluding the impact of the sale of the indirect auto?

Speaker 1

Sure could. As far as the average loan growth that we've talked about up low single digits up 1% to 3% including the impact of the indirect auto. If we added on the impact of the PPP forgiveness and loan balance expectations there that would add another $1,800,000,000 to the overall loan growth, so almost 2%. So that would take it from a low single digit To a mid single digit kind of growth expectation on a linked quarter basis. And so something similar to what we reported essentially this quarter.

Speaker 1

As far as the NII outlook, I would say that there's 2 things that are Impacting an outlook for the Q4. You hit on 1 which is PPP and we would expect probably in the neighborhood of a $10,000,000 or so type of decline in PPP revenues. The other is the indirect auto loan Sale that as a result of the sale, our net interest income will be down, but our fee income will be up. We essentially receive 75 basis points for servicing those loans. And so you will see a decline in NII of about $10,000,000 and an increase of fee income in the range of $5,000,000 to help offset that and those are kind of the moving parts and pieces.

Speaker 7

Great. Thanks for taking my questions.

Speaker 1

Thank you.

Speaker 2

Next, we'll go to Eric Chan with Wells Fargo Securities. Please go ahead.

Speaker 11

Hi, guys. I have a question that relates to tech. So as you guys have retooled the bank, I was just wondering if you could speak a little bit about How the role of FinTech partnerships have changed for Key? And if possible, perhaps you could give us a number of FinTech partners that you guys currently work with?

Operator

Sure, Eric. Thanks for your question. So our relationship with FinTech Partners has really been both important and helpful for us. As a bank, we were in early, and I think it's really helped us successfully execute our targeted scale strategy. Frankly, it's helped us kind of with our client service strategy, our sales strategy.

Operator

It's also clearly contributed to our thinking as we developed our technology roadmap. We are clearly tied into the entire FinTech ecosystem and our unique Strategy is both known and understood by the FinTech community, which is helpful. Going to your question of How many relationships we have? I would say today we have probably 10 client facing relationships. We literally have dozens of infrastructure relationships with Fintechs.

Operator

Because we're sort of known in the whole ecosystem, we see a lot, maybe 15 or 20 opportunities every single month that we kind of sort through. Kind of if you step back and take a look and think about kind of from a strategic perspective. Our targeted scale strategy just makes us a great partner because we have such distinct client groups. And obviously, as you're developing software, that's really helpful. What we have done at Key in Laurel Road is we've built this National Digital Affinity Bank, which is a relationship approach to digital banking.

Operator

What Fintechs Really, our best at is really solving one pain point and doing it extremely well. So it's been a good relationship Probably for I can certainly say for us, and I'm sure it's been a good relationship for the Fintechs as well.

Speaker 11

Yes, that's helpful. And then just kind of a follow-up on to that. So how do you guys determine which strategy to Follow when it comes to actually building in house or partnering a fintechs, so to say. Just kind of like on a high level, what are your thoughts there?

Operator

Yes. It starts with the client out. We are a relationship driven bank. And so We have these distinct client groups that we're pursuing. And to the extent we can partner, invest With a fintech that can make us more impactful in the market serving that specific client set, we will enter into some partnership, we'll invest in them.

Operator

To the extent it doesn't help us compete and win in the marketplace and solve a specific pain point for our targeted customers, we take a pass. Now as I mentioned, that's on the client facing stuff. In the infrastructure space, we have dozens and dozens and obviously the criteria there is, Is it cheaper and faster to buy it versus build it?

Speaker 11

Great. Thanks so much.

Operator

Thank you.

Speaker 2

Next question is from Gerard Cassidy with RBC. Please go ahead.

Speaker 1

Hi, Chris. Hi, Don.

Operator

Good morning, Gerard.

Speaker 4

Can you guys

Speaker 12

give us some color? Credit obviously has been great for you and your peers. You've already given us guidance for the 2nd quarter net charge off number, which is lower than your long term numbers that you have for 40 to 60 basis points through the cycle. When do you think we start creeping up for a normality?

Speaker 4

And I'm not talking about

Speaker 12

a recession, but do You think you stay at this lower level for another quarter or 2 and then we start creeping up later in 2022 or into 2023?

Operator

So let me take a pass at that, Gerard. The answer is we don't know. We've got really good clarity. Obviously, as we look into the 4th We gave guidance of 20 basis points. Interestingly enough, our results this quarter while we report 11 basis points.

Operator

It's really closer to 2 when you take out the $22,000,000 that relates to indirect auto. I think we are in, I can speak for key. I think the de risking that we've gone about for the last 10 years is going to serve us extremely well. We won't stay at a level this low, but I actually think as we look into 2022, You're still going to see us below our targeted range of 40 to 60 basis points.

Speaker 1

Gerard, I would agree with Chris' comments there are a couple of things to think about. One is that as far as our overall credit quality position for many of the metrics today we're actually Better than what we were pre pandemic. So if you look at non performing loans, non performing assets, the delinquency stats for Consumer and commercial loans are all better than where they were pre pandemic. Our criticized and classified are a little higher than what they were before the pandemic, but coming down dramatically. And we've seen incremental improvements this quarter that are outpacing what we've seen before that.

Speaker 1

And so That would suggest that things are going to be good for some time. But at the same time, I would think that you're probably going to see the Consumers start to turn a little sooner. They've been the beneficiary of so much stimulus. And if that starts to slow and go away like we would expect it to, You would start to see some of that start to return to more normal levels over time as well. And then the commercial customer while it's still flush with liquidity that We just aren't seeing the early signs of that there's going to be some challenges down the road.

Speaker 1

And so I think that we're going to be in a period for some time where we're going to see charge offs below the low end of guidance ranges across the industry.

Operator

I think Gerard one of the first things you'll see is In the small business sector, the inability to pass through what are some pretty significant price and wage increases. And I think that will be the beginning of a bit of a pressure on the commercial side, particularly with smaller customers that have less pricing power.

Speaker 12

Very good. And then as a follow-up,

Speaker 7

Chris, 2 things. 1, When you look

Speaker 12

at your investment banking numbers, which of course were very strong record levels $235,000,000 can you give us a flavor for How does that break out M and A advisory versus DCM, etcetera, and compare that to Q1 last year? But then second, in your prepared bullets, It looks like you pointed out that you retained 20% of the business on the loans. And I thought that seemed high because normally I thought you sold 90% of it or more off, but if any of

Speaker 4

those two questions. Thank you.

Operator

Sure. So Gerard, We've never broken out each of the different components, our investment banking fees. I can tell you that our M and A business was extremely strong. And you can imagine The Equity business was very strong given that we have a focus on technology. So those were a couple just bright spots broadly.

Operator

As it relates to our mix of what's distributed and what we put on our balance sheet, it's actually been very consistent over a long period of time. We've always Basically held of the credits that we take on, we've always held about 20% on our balance sheet. So we really haven't dialed that up at all. We've been just maintaining our moderate risk profile and taking advantage of what are some pretty attractive markets out there.

Speaker 12

Great. Thank you so much.

Speaker 2

And next we'll go to John Pancari with Evercore ISI. Please go ahead.

Speaker 7

Good morning.

Speaker 4

Good morning.

Speaker 1

Good morning, John.

Speaker 7

I appreciate the color you've given around the loan growth activity that you're seeing. I'm curious how You're thinking that interprets into 2022 in terms of the type of on balance sheet loan growth that you I was just wondering if you can give us a little bit of color on how you're thinking about that and curious how that could play into the full year? Thanks.

Operator

John, thanks for your question. We will be addressing our view on 2022 in January. But what's interesting about our model is there's a lot of variables and depending on what the market conditions are, You could see us going back to the previous question, you could see us maybe putting more on our balance sheet if some of the markets went in they're right now functioning very, very well, went into dislocation. But we'll have a specific view for you when we report January.

Speaker 7

Got it. All right, Chris. Thanks. And then separately on the expense side, I know you've talked about wage inflation. And How are you thinking about what it could add to expense levels as you look at full year expectations?

Speaker 7

I know you're not Giving 2022 guidance, but around the wage inflation topic specifically, just curious about annualized expense impact, how you think about that?

Operator

So the biggest impact to date for us has obviously been those variable structures principally in Investment Banking and in our mortgage business that are driven by business flows and the fact that those businesses have grown. Your question is a good one in that we have had to particularly at the low end of the entry level in throughout Key And also in kind of the junior banker area, we have in fact had to increase wages there. And Don can you give us some Specifics on what the impact of that is on an annualized basis?

Speaker 1

Well, our total salary expense each year is about $1,300,000,000 and I would say that those Two components probably have cost us somewhere in the range of about $15,000,000 to $20,000,000 a year. So it's A little over 1% cost as far as the impact there overall, but it's something we'll continue to evaluate. And as Chris highlighted that We're seeing that in the entry level type of positions and we're also starting to see some of that in other more specialty areas as well. And so we'll have to assess as we go into next year what kind of targets we'll have as far as salary expense overall.

Speaker 7

Got it. But that $15,000,000 to $20,000,000 per year, that's mainly on the lower end wages in the junior banker areas?

Speaker 1

You got it, yes.

Speaker 7

Got it. Okay. All right. And then lastly, just one question around your tech side of the shop. Just curious in terms of If you can update us on your the size of your tech budget and how that's been growing annually and then Perhaps how much is split between growing the bank versus running the bank?

Speaker 7

Thanks.

Operator

Sure. So broadly, our spend It's about $800,000,000 a year. Of that, about $200,000,000 is spent On development of the $200,000,000 about half of it is client facing, the other half is core. One of the great things As we've been updating our core technology over a long period of time and we actually have to spend a little less in that category which frees up more dollars for some of the development on the front end. The other thing that we also have been doing is we've been buying a lot of niche businesses that have actually brought a lot of technology to us.

Operator

Obviously, Laurel Road would be an example of that. AQN would be an example of that. And that's really tech investment that is outside of what we would think about in terms of our tech budget.

Speaker 7

Got it. Very helpful. Thanks, Chris.

Operator

Sure.

Speaker 2

And with no further questions, I'll turn the call over to you, Mr. Gorman, for any closing comments.

Operator

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, 216 689-4221. This concludes our remarks, and we appreciate everybody's time. Thank you. Goodbye.

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Earnings Conference Call
KeyCorp Q3 2021
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