KeyCorp Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
January 19, 2023

There are 13 speakers on the call.

Operator

Morning, and welcome to KeyCorp's 4th Quarter 2022 Earnings Conference Call.

Speaker 1

As a reminder, this conference is being recorded. I would now like

Operator

to turn the conference over to

Speaker 1

the Chairman and CEO, Chris Gorman. Please go ahead.

Speaker 2

Well, thank you for joining us for KeyCorp's Q4 2022 earnings conference call. Joining me on the call today are Don Kimball, our Chief Financial Officer Clark Caiatt, our Chief Strategy Officer. Upon Don's planned retirement, Clark will assume the CFO role and also 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.

Speaker 2

I am now moving to Slide 3. This morning, we reported earnings of $356,000,000 or $0.38 per common share. Our results included $265,000,000 of provision for credit losses, which exceeded net charge offs by $224,000,000 or $0.20 a share. The additional provision builds our allowance for credit losses, Adjusting our credit models to reflect a more cautious economic outlook. Our results reflect continued growth in both our consumer And commercial businesses.

Speaker 2

In our consumer business, we have added new households with younger clients being our fastest growing segment. Our commercial business also has continued to add and expand relationships. In 2022, we raised a record level of capital for our clients. Net interest income was up 2% from the 3rd quarter, reflecting continued relationship based loan growth supported by stable deposits. Deposit costs continued to move higher with a step up in deposit rates late in the quarter.

Speaker 2

At the end of the Q4, nearly 60% of our deposits were in low cost retail and escrow balances. In our commercial businesses, over 80% of our deposits are from core operating accounts. Our average loan balances increased 3% from the prior quarter as we continue to add relationships and offer the best execution with both on and off balance sheet solutions. We continue to benefit from investments we have made in our business, Including the healthcare sector, in 2022, we continued to grow relationships with significant healthcare providers and expanded our Laurel Road business. Despite the student loan payment holiday, we originated over 1.5 $1,000,000,000 of Laurel Road loans last year and increased our member households by over 30%.

Speaker 2

Additionally, we expanded our offering to nurses, added new products and capabilities and completed the acquisition of Gradfin. Since acquisition, Gradfin has held nearly 30,000 individual consultations for refinance and public service loan forgiveness. These consultations are with prequalified credentialed prospects, all new to Key. Our fee based businesses in the 4th quarter Reflect the continued slowdown in capital markets activity and the impact of changes to our NSFOD fee structure. Investment banking and debt placement fees were up $18,000,000 from the prior quarter, but down meaningfully from the year ago period reflecting broader capital markets trends.

Speaker 2

The new issue equity market is virtually non existent And the M and A market continues to be engaged in price discovery. Our pipelines remain solid, particularly in M and A. However, the pull through rates Continue to be adversely impacted by market uncertainty. We have also continued to see more activity Moving on to our balance sheet. In 2022, we raised a record $136,000,000,000 of capital for our clients, of which 23% was retained on our balance sheet, well above our long term average of 18%.

Speaker 2

Credit quality remained strong this quarter with net charge offs as a percentage of average loans of 14 basis points. Non performing loans declined again this quarter and delinquencies criticized and classified loans All remain near historically low levels. 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, including a 5% increase in our common stock dividend in the 4th quarter. Before I turn the call over to Don, I want to share some thoughts on our outlook and priorities for 2023 beyond.

Speaker 2

First, We will continue to execute on our differentiated business model and strategy. We will focus on expanding our presence in our fastest growing markets and targeted industry verticals. As we demonstrated again in 2022, We are uniquely positioned to support clients through various market conditions. Secondly, we will continue to benefit from our balance sheet and interest We have been very deliberate and intentional in the manner in which we have managed our interest rate risk with a longer term perspective. Although our positioning is providing less current benefit, we have significant upside over the next 2 years as swaps and short term treasuries mature and reprice.

Speaker 2

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 $1,100,000,000 Thirdly, we will maintain our strong credit quality. We've spent the last decade de risking our portfolio, positioning the company to outperform through the business cycle. Despite our strong credit metrics, we built our loan loss reserve this quarter, which using our 2023 net charge off outlook now represents almost 5 years of coverage. To put this in perspective, our reserve is now above our CECL day 1 level, while non performing loans and delinquencies We need to make targeted investments in our business by reducing expenses. Although expense management It has been an ongoing area of focus.

Speaker 2

We will be accelerating our cost takeout plans early in 2023. We will pursue cost opportunities across our company, including areas where we can leverage technology, automation and process improvement to reduce redundancy, improve efficiency and enhance effectiveness. Our 2023 targets Represent a cost reduction of approximately 4% relative to our full year 2022 level. The acceleration of our expense reduction plans will benefit us in 2 ways. First, we cannot grow if we are not investing.

Speaker 2

This will give us the capacity to continue to drive our targeted scale strategy, investing in points of differentiation. With the benefit of our cost reduction plans, we expect to hold expenses relatively stable this year compared to our full year 2022 results, which would be a significant accomplishment given inflationary pressures and our commitment to continue to invest in our future. I am confident in our long term outlook and our ability to create value for all of our stakeholders. With that, I'll turn it over to Don to provide more details on the results for the quarter and our 2023 outlook. Don?

Speaker 2

Thanks,

Speaker 3

Chris. I'm now on Slide 5. For the 4th quarter, net income From continuing operations with $0.38 per common share, down $0.17 from the prior quarter and down $0.26 from last year. Our results included $0.20 per share of additional loan loss provision in excess of net charge offs as we continue to build our reserves reflecting a more cautious economic outlook. For the full year, we delivered positive operating leverage, marking our 9th time in the last 10 years.

Speaker 3

This is a testament to our differentiated and resilient business model and our ongoing focus on disciplined expense management despite the inflationary environment. Turning to Slide 6, Average loans for the quarter were $117,700,000,000 or up 18% from the year ago period and up 3% from the prior quarter as we continue to add and deepen client relationships across our franchise. Commercial loans increased 17% from the year ago quarter, driven by growth in commercial and industrial loans and commercial real estate balances. Relative to the year ago period, consumer loans increased 20 2%, reflecting growth in consumer mortgage and Laurel Road. Compared with the Q3 of 2022, commercial loans grew 3% And consumer loans were up 2%.

Speaker 3

Our commercial growth continues to reflect the strength in our targeted industry verticals and higher line utilization. Our consumer business continues to benefit from residential real estate originations, which were just under $1,000,000,000 for the 4th quarter. Approximately 1 third of our originations came from targeted healthcare professionals. Continuing on the Slide 7, Average deposits totaled $145,700,000,000 for the Q4 of 2022, down 4% from the year ago period And up $1,400,000,000 or 1% compared to the prior quarter. Year over year, we saw declines in non operating commercial deposit balances and retail The increase in deposit balances from the prior quarter reflect higher commercial deposits due to seasonality and our focus on maintaining our relationship business.

Speaker 3

Consumer balances declined in the quarter driven by inflationary spending and the movement of interest of rate sensitive balances. Interest bearing deposit costs increased 49 basis points from the prior quarter and our cumulative deposit beta was 19% Since the Fed began raising interest rates in March of 2022. We continue to view our strong deposit base as a competitive strength with approximately 60% of our balances in core consumer and escrow deposits. In addition, over 80% of our commercial deposits were from core operating accounts. Turning to slide 8.

Speaker 3

Taxable equivalent net interest income was $1,200,000,000 for the 4th quarter compared to $1,000,000,000 in the year ago period and $1,200,000,000 in the prior quarter. Our net interest margin was 2.73% for the 4th quarter compared to 2.44% in the same period last year And 2.74 percent for the prior quarter. Year over year, net interest income and net interest margin benefited Higher earning asset balances and higher interest rates. Quarter over quarter, net interest income and the net interest margin were negatively impacted by higher interest bearing deposit And a change in the funding mix. Later in the quarter, we experienced changing market conditions and customer behavior.

Speaker 3

Market rates increased more than we expected and the migration from non interest bearing to interest bearing commercial deposits picked up. This resulted in a higher deposit beta, Our outlook for 2023 has our cumulative deposit beta Income opportunities and asset liability position. Based on our feedback from our shareholders, we have also included detail on the maturities of our interest rate swaps And short term treasury securities. As Chris mentioned in his remarks, we have been very intentional in the way we manage interest rate risk with a long term perspective. Although our position has provided less near term benefit, we have significant upside over the next 2 years as our swaps and short term treasuries mature We expect this to drive both our net interest income and our net interest margin higher over the next few years.

Speaker 3

We believe this is a true differentiator. Moving to slide 9, non interest income was $671,000,000 for the The decline in non interest income from the Q4 of 2022 reflects a $151,000,000 decline in investment banking debt placement fees, Along with a $35,000,000 reduction in other income, primarily from market related gains in the year ago period. Additionally, service charges on deposits were $19,000,000 lower due to changes in our NSF ODP structure that we implemented in September, As well as lower consumer mortgage income down $16,000,000 Partially offsetting these declines was an increase in corporate service income up $13,000,000 due to higher derivatives income. Relative to the prior quarter, non interest income declined $12,000,000 Service charge on deposit accounts accounted for the majority of the decline down $21,000,000 once again reflecting our new NSF ODP terms. Additionally, corporate services income decreased $7,000,000 driven primarily from a valuation adjustment benefit in the prior quarter.

Speaker 3

Investment banking fees increased $18,000,000 I'm now on to Slide 10. Total non interest expense for Quarter was $1,160,000,000 down $14,000,000 from the year ago period and up $50,000,000 from last quarter. Our expenses reflect our ongoing investments in digital, analytics and our teammates. Compared to the year ago quarter, we saw declines across Most non personnel line items, including business services and professional fees and operating lease expense. Personnel expense remained flat compared to the year ago period, reflecting higher salaries and employee benefits, offset by lower incentive and stock based compensation.

Speaker 3

Compared to the prior quarter, Natura's expense is up $50,000,000 Higher non personnel costs drove most of the increase. Other expense increased $17,000,000 reflecting a pension settlement charge in the 4th quarter. Also professional fees were higher in the quarter, Some of which were temporary in nature. Personnel expense also increased reflecting lower deferred costs from slower loan originations. Moving on to Slide 11.

Speaker 3

Overall credit quality remains strong. For the 4th quarter, net charge offs were $41,000,000 or 14 basis on average loans, which remain near historical low levels. Non performing loans were $387,000,000 this quarter or 32 basis points of period end loans, A decline of $3,000,000 from the prior quarter. Our provision for credit losses was $265,000,000 for the 4th quarter, Which exceeded net charge offs by $224,000,000 The excess provision increases our allowance for credit losses Reflecting a more cautious model driven assumption set. For our CECL modeling, we start with the Moody's consensus scenario.

Speaker 3

This quarter, the consensus estimates reflected a marked slowdown in the economy and meaningful reductions in home prices, both of which impacted our allowance levels. Despite the increases in the allowance, our outlook for net charge offs in 2023 of 25 basis points to 30 basis points Remains well below our through the cycle loss levels of 40 to 60 basis points. Now on to slide 12, We ended the Q4 with 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 to return capital to our shareholders. We will continue to manage our capital consistent with our capital priorities, but first, supporting organic growth in our business.

Speaker 3

2nd, paying dividends. In the Q4, our Board of Directors approved a 5% increase, which now places our dividend at placed through the Q3 of 2023. We did not complete any share repurchases in the 4th quarter. On Slide 13 is our full year 2023 outlook. The guidance is relative to our full year 2022 results.

Speaker 3

Importantly, using the midpoints of our guidance ranges would result in another year of positive operating leverage in 2023. We expect average loans will be up between 6% 9% and average deposits will be flat to down 2%. Net interest income is expected to be up between 6% 9%, reflecting growth in average loan balances and higher interest rates. Our guidance is based on the forward curve assuming a Fed funds rate peaking at 5% in the Q1 and starting to decline in the 4th quarter. These interest rate assumptions along with our expectations for customer behavior and the competitive pricing environment are very fluid and will continue to impact our outlook prospectively.

Speaker 3

Non interest income is expected to be down 1% to 3%, reflecting the implementation of our new NSF ODP structure Last year and continued challenging capital markets activity, at least for the first half of the year. Non interest expense to be relatively stable with the benefit of the cost takeout opportunities Chris described in his remarks, along with ongoing investments that we will make in our business. For the year, we expect credit quality remains strong and net charge offs will be in the 25 to 30 basis point range, well below the through the cycle range of 40 to 60 basis points. Our guidance for our GAAP tax rate is approximately 19% to 20%. Finally, shown at the bottom of our slide are our long term targets, which remain unchanged.

Speaker 3

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 a very good finish to another successful year for Key. We remain confident in our ability to grow and deliver on each of our long term targets. With that, I'll now turn the call back over to the operator for instructions on

Speaker 1

and You may withdraw your question at any time by repeating the 1 0 command. If you are using a speakerphone, please pick up the handset before pressing the numbers. Your first question comes from the line of John Pancari from Evercore. Please go ahead.

Speaker 4

Good morning. Good morning, John.

Operator

I know you mentioned that you saw a step up in deposit rates late in the Q4. I wonder if you could give us a little more detail of what products and the magnitude that you saw, maybe your How you see that following through? And then related to that, you also cited a higher than expected Sure, on deposit cost as well, not just a step up, but a greater than expected amount of pressure. And just trying to get a Bill, around what area surprised you and why do you think, given the outlook around Positive pressures in rates, what was what attributed to the surprise there? Thanks.

Speaker 3

Sure can, John. And As far as late in the quarter and late November, December, we started to see a different migration pattern as far as some of the deposits and the rates. We saw market conditions start to pick up as far as rates and many products. Our expectation coming into the quarter was Continuing to drift up some of the money market rates on deposits, but customers were migrating more towards time deposits, Which had a higher incremental cost than what our assumptions were as far as deposit money market deposit accounts. We also saw a shift away from non interest bearing accounts at a faster pace than what we would have expected late in the quarter.

Speaker 3

And so both of those had an impact of driving net interest income down for the current quarter compared to what we would have expected even coming into the end of the quarter And is also reflected in our outlook going forward. And Clark, I don't know if you want to offer up any thoughts as far as Trends going forward as far as the deposit rates and betas and what have you?

Speaker 5

Sure. Thanks, Don. A little bit more just to get your question down, a little more pressure on the commercial side On the consumer side, which would not be unexpected, we did see, as Don mentioned, a rotation out of non interest bearing to interest bearing. And we saw the ending balance of non interest bearing around 29%. That's a little bit of seasonality and we've seen that come back.

Speaker 5

That's a ratio kind of high 20s that we would expect through the year and that's a little bit better than where we've been historically, which we could would have been sort of mid-20s. In terms of products and rates, as Don said, CDs coming through, we'd expect Betas for the year to be mid to high 20s as Don said in his prepared remarks. And again, a little bit more movement to CDs than money markets than we expected, but we've factored that in. And again, that sort of stable high 20s Non interest bearing ratio for the year.

Speaker 2

John, it's Chris. It's interesting. Customer behavior is really hard to model. We wouldn't have expected that the cumulative beta for the 1st 3 quarters would have ever been as low as 9%. And as we got to the end of the year, it really accelerated.

Speaker 2

A lot of it was on the commercial side. A lot of it were Excess deposits in places like our private banking area. So it's been interesting. This has been the steepest rate of increases In the Fed's history, and I think some of the conventional curves are sort of out the window.

Operator

Okay. Thanks, Chris. That helps. And then I know you mentioned the need for investment and that you're focusing on Ratcheting up investment in certain areas. So I want to see if you can give us additional color on what changed there in terms of areas that you're investing That necessitated the greater pullback in cost elsewhere.

Speaker 6

Thanks.

Speaker 2

Yes. So it's really a continuation of the investment, John, that we've been making. And the point I was making there was we're not going to cease to invest as we take out costs. And when we were at Investor Day a year ago, we talked About growing our consumers by 20% by 2025, focusing really on our growth markets. And we're having a lot of success with our younger customers and we're going to continue to focus both products and marketing in that regard.

Speaker 2

Also, we talked about hiring bankers. We talked about we think we have these unique platforms that are under leveraged and we talked about increasing our banker population by 25 Admittedly, last year, we tapered off in the back half For the year, the market was obviously overheated and also frankly, we saw the downturn coming in the economy. We think we'll be it will be a very good And then lastly was Laurel Road and the Commitment we made around Laurel Road where we've continued to invest is that we were going to grow our members From $50,000 to $250,000 this year, we successfully grew by 30% and we've made a lot of investments Expanding to nurses, having a full product line there, buying Gradfin, being a leader in public Service loan forgiveness and we're also going to get into the income based forgiveness game as well. So those are the three areas. And so it wasn't really New investments so much.

Speaker 2

It's a continuation of the investments we've made in critical areas of the business, including around things Like continuing to migrate to the cloud and investing in digital.

Operator

Okay, Chris. No, that helps clarify that. I appreciate it. And That's it from me and best of luck to you, Don.

Speaker 3

Thank you so much.

Speaker 1

Your next question comes from the line of Manan Gosalia from Morgan Stanley. Please go ahead.

Speaker 7

Hey, good morning.

Speaker 8

Can you give us some more color

Speaker 7

on the reserve bill this quarter? To your point, your NCO Our guide for 'twenty three is well below your long term target. So I guess what changed in the macro environment that necessitated the reserve And I guess is this you being a lot more conservative and should we expect The reserve ratio to stabilize from here? Or could there be factors that drive that reserve ratio higher?

Speaker 2

Sure, Manan. First of all, thank you for your question. And you're right, despite the fact that we have really good credit metrics, We did in fact build the reserve. And so if you kind of step back for a second, kind of look at the macro perspective, We believe the economy is clearly slowing. We think the probability of a recession has increased from The Q3 to Q4 of last year, our base case by the way is that there will be a mild recession.

Speaker 2

There's really 3 drivers of The first is the macro view, which I just described, which is the driver for us. The second is loan growth, and we obviously have some loan growth. The third is really idiosyncratic risks, specific portfolio, specific credit. That is not driving our reserve build at all. So just to Kind of bring it to life for you.

Speaker 2

From the 3rd to the 4th quarter, as we look at our models, we looked at GDP declining by about 2 thirds From sort of 1.3 percent to 0.4%. Unemployment going from, say, in the 3rd quarter, we thought it would peak at 4 point 1, we now think it will peak around 5%. But significantly, when we look at things like home price index, In the Q3, we thought homes were going up by 1.3%. In the 4th quarter, as we modeled it, it was a decline of 4.6%. So fairly significant quarter over quarter change of 5.9%.

Speaker 2

Now to bring it back to kind of our portfolio, We, for example, have $21,000,000,000 of mortgages. That's about 18% of our loan book. It's booking about the FICO scores on those are, say, 761 from memory or some such number. We also say that 40% of our mortgages are $800,000,000 or above. And I share this texture for you because we are not worried about our mortgage book, but as we drive our CECL models, which are forward looking, the macro drivers have Significant impact, and I'm just using that as an example for why the reserve bill.

Speaker 2

Does that answer your question?

Speaker 7

Yes, that's really helpful. Thanks so much for the color. And then if you could just round that out with how you're thinking About the NIM and just managing the NIM as you go through 2023, earlier on you were in the camp The Fed keeping rates high for longer, has that changed and has that changed how you're managing putting on any additional swaps or hedges on the books?

Speaker 3

Well, sure. As far as how we're managing it right now, our assumption set is basically that we would just continue at this point in time to replace roll off of swaps that we have that we're continuing to evaluate that. I think the challenge that we all have is just with this inverted yield curve is when do you pull the trigger to Start to lock in some of that rollover risk and outlook. And so right now, we've not embedded any of that into our base But it's something we'll continue to have as optionality to take care of that in the future.

Speaker 7

Great. Thanks so much.

Speaker 9

Thank you.

Speaker 1

Your next question comes from the line of Ebrahim Poonawala from Bank of America. Please go ahead.

Speaker 8

Hey, good morning.

Speaker 2

Good morning, Ebrahim.

Speaker 8

I guess just want to follow-up on credit. So talked about the consumer book and the FICO's. When we look at the commercial book, both on the C and I, CRE, Just talk to us about the idiosyncratic risks, means the leverage lending book you provide on Slide 15 relatively small. But when we think about the impact from higher rates, Pooling demand and you talked about mild recession as your base case. Like where within the CRE and the C and I portfolios Do you expect delinquencies to start moving higher and where's the loss content?

Speaker 2

Sure. Well, Ebrahim, thanks for the question. So You started at the right place where we focus. We focus any place where there's leverage. And obviously, if you think about leverage finance, which by the way for us is only about 2.5 Percent of our entire loan book and it's focused in our 7 industry verticals and it has a pretty high turnover.

Speaker 2

But you're exactly right, where there's leverage and you go into a mild recession and you have declining EBITDA, You have to watch that very closely. We feel good about that portfolio. Nothing has bubbled up to the surface, but as you can imagine, we're modeling it very, very regularly. The next area that you mentioned, which I think is really appropriate is real estate. And real estate is an area that we look at What we've done with our real estate business is we've completely rebuilt it around a business that not we not only put Real estate loans on our books, but we also distribute a lot of paper.

Speaker 2

So it's a little bit of a different business than a lot of our competitors have. Fannie, Freddie, FHA, the life companies, the CMBS market, etcetera. So we distribute a lot of risk. We're also focused Very specifically on certain asset classes. And the certain asset classes that we're focused on, 1st and foremost, multifamily in It's broadest sense, but within multifamily on affordable housing.

Speaker 2

We're watching those closely. So far, the rent Uptakes are good. Rent is the rents are still holding firm. So we feel really good about that portfolio. The portfolio that we look at very closely and fortunately we have very little of it.

Speaker 2

There's actually 2 portfolios. First is B and C Class office space in Central Business Districts. Right now, we're down to $250,000,000 But we're watching that very closely because those buildings are multi tenant buildings. And the reality is whether it's key cutting expenses And getting rid of occupancy costs or any other business, I think that's a real risk going forward. So we're watching that closely.

Speaker 2

The other area where we only have about $1,000,000,000 of exposure is in retail. And Retail is an area where we keep a close eye. So that's kind of how we're thinking about it. And as you can imagine, we are Genuinely modeling this portfolio as we look at the delta between where they're borrowing and where their debt rolls over.

Speaker 8

Got it. And I think in there you mentioned that you're actively de risking some of these loans. What's the market for that terms of being able to get out of some of these credits without having to take a big mark to market or credit charge?

Speaker 2

There hasn't been there really hasn't been a lot of movement yet. I think people are still just Like in the M and A environment, I think people are in price discovery. Obviously, if you take my example of B and C Class Office, There's a lot of people that have impaired equity, but I think people are going to have to frankly endure some more pain before There's a meeting of the minds on kind of how to restructure, how to bring in fresh equity, etcetera.

Speaker 8

Got it. And just one question, Don, on NII. Do you think the mid to high 20s beta is conservative enough? I'm just wondering In a world of 5% plus Fed Funds QT, like a lot of banks are kind of nudging their expectations a bit higher. Do you think that sets you up for more downside risk over the next few quarters?

Speaker 8

Just give us a sense of your comfort level with that beta guidance?

Speaker 3

I'll go ahead and offer up some thoughts and then ask Clark to go ahead and chime in as well. But I would say that keep in mind that as Chris mentioned earlier on, We really were kind of best in class for the 1st few quarters of this rate increase cycle that our cumulative deposit beta is at 19 Most of the peers I'm seeing are closer to the 30% already. We did do a thorough scrub as to where we see rates going. And I think what you're seeing and why we have confidence in our deposit beta assumptions is the fact that we have Shifted our priority and focus over to more primacy both on the commercial and consumer side and we think that will continue to pay dividends for us As far as keeping our overall deposit costs down. Clark, anything you would add there?

Speaker 5

Yes. The other point I would add is just that it's less For us about new deposit acquisition, we're always going to acquire deposits from new clients and new relationships, but A lot of what we're looking at this year is managing clients from product to product and that just allows us a little bit more flexibility on pricing. Ebrahim, the only thing

Speaker 2

I would add, I agree with everything that Don and Clark said. So the thing that I will share with you though, this is sort of uncharted territory. And while we're really pleased with the trajectory of our deposit betas, we're not going to win the deposit battle deposit beta battle and Win the beta battle and lose the deposit war because it's very important that we serve our clients and we keep them here at Key.

Speaker 8

Makes sense. All right. Thank you very much.

Speaker 1

Thank you. Your next question comes from the line of Steven Alexopoulos from JPMorgan. Please go ahead.

Speaker 6

Hey, good morning, everyone.

Speaker 2

Good morning, Steve. Good morning.

Speaker 6

I wanted to start on the loan outlook. So If I look at where period end and average loans end in 2022, it appears that you're not looking for much loan growth in 2023 on a period end basis. Can you confirm that and maybe give some color on why such a sluggish outlook? I don't know if you're tightening the credit box or whatnot.

Speaker 3

Steve, this is Don. And as far as the outlook, period end balances sometimes can be a little misleading. So if you just look at take a look at the 4th quarter average for total loans At $117,500,000,000 our midpoint of our guidance range is in the $120,000,000 range and all of that really is coming from commercial. And so With this change in our economic outlook that also influenced our or determined what our allowance was, we've also pulled back on some of the loan growth outlook. You also see Steve that our consumer loan balances are flat throughout next year and what our expectation is there is that We'll continue to have residential mortgage originations, but that we'll continue to see some of the home equity balances trade down and relatively flat on other consumer categories.

Speaker 3

And so It is very modest incremental growth from here, but we think it's appropriate given the backdrop of the economic outlook we have.

Speaker 6

Got it. Okay, Don. That's helpful. And then on the reserve build, if the reserve build was a change in the economic assumptions and not idiosyncratic risk, Why did this specific reserve not go up materially in some of these consumer categories? I know they're smaller, but home equity, consumer direct card, I would have thought if you change the unemployment rate, etcetera, we would have seen an increase in those as well.

Speaker 3

One of the biggest things that Chris talked about where the larger moves where this GDP coming down and also the home price index. And so what you would have seen is the residential real estate backed Credit having a larger increase than some of the others. You also factor in the fact the position that our delinquency levels and our criticizing classified levels are Still very benign and I think that's why you're not seeing some of those other higher risk categories showing increased reserves because we're not seeing And the migration of those portfolios at this point in time.

Speaker 6

Got it. Okay. Thanks. If I could squeeze one more in, just looking at the NII guidance, the up The 9%. I know you said mid to high 20% range for deposit beta, but what is the assumption?

Speaker 6

Is it mid or high That's underlying this guidance range. And what are you assuming the mix of non interest bearing is by the end of 'twenty three? Thanks.

Speaker 5

Yes. Hey, Steve, it's Clark. So it's the mid to high question is sort of mid to high. It's not a 27 ish, 20 area for the year on the beta and then the non interest bearing percentage is 29% Roughly high 20s for the year.

Speaker 6

Okay. So staying pretty flat. Okay. Great. Thanks for taking my question.

Speaker 6

And then the

Speaker 5

period end just Was a little bit lower for seasonality, 32% before the quarter on average.

Speaker 6

Got it. Thanks a lot.

Speaker 3

Thank you.

Speaker 1

Your next question comes from the line of Gerard Cassidy from RBC. Please go ahead.

Speaker 6

Hi, guys.

Speaker 2

Good morning, Gerard.

Speaker 10

Don, I think you mentioned

Speaker 11

in your remarks that there wasn't any share repurchases completed in the 4th Quarter. Maybe Chris or Don, what's the outlook for stock buybacks? I may have missed your comments if you gave it, but what's the outlook for stock Repurchases in 2023?

Speaker 2

Gerard, we're not assuming that there's going to be any meaningful stock repurchases. As we look at Our balance sheet and supporting our clients and we look at our second priority, which is paying our dividend, I just don't see us Out there repurchasing a lot of shares based on our current modeling.

Speaker 6

Very good.

Speaker 11

And then You talked a lot about what went on with the deposit betters and the mix of deposits in the quarter. Obviously, your peers have had similar comments and the difference that we saw with Key was that the margin Was essentially flat, where others went up. How much of the borrowings, I noticed in your average balance sheet that you included in the press release, Your short term borrowings and long term borrowings have gone up and they're much more expensive of course than deposit funding. Can you share with us your thinking on how you're using those and why they have been going up?

Speaker 3

Gerard, as far as the funding, what we've Seeing is that the loan growth throughout the second half of the year especially exceeded deposit growth. And so we We're using FHLB and some other issuances to help address the funding needs. I would say that our loan growth outlook And our deposit outlook wouldn't suggest a continuation at the same pace as far as building that Other funding sources and so we wouldn't expect to see that same type of a growth rate going forward. But near term, we work fine with that. I would say Traditionally, we would look at a loan to deposit ratio in the 90% to 95% range and we're still well below that.

Speaker 3

And so we've got plenty of capacity to continue to Leverage that funding source as needed.

Speaker 11

Very good. And Don, good luck in your future endeavors. Thank you.

Speaker 3

Thanks, Gerard. Appreciate it.

Speaker 1

Your next question comes from the line of Scott Siefers from Piper Sandler. Please go ahead.

Speaker 9

Good morning, everybody. Thank you for taking the call. Don, with regard to the $1,100,000,000 of NII repricing benefits to which you guys alluded, I was wondering if you could just sort of walk through the trajectory of when and how those kick in. I mean, I see the repricing numbers in the appendix, which is very helpful, but just would be curious to hear Kind of more vocally, how you think about it? Maybe put it another way or I wonder if there's an easy frame of reference.

Speaker 9

What would Q1 'twenty three NII look like versus To say Q4 'twenty three or Q1 'twenty four, not looking for specific numbers, but is there an easy way to To say, hey, we sort of trough here and then start to accelerate meaningfully off of here and if there's a time frame around that, something like that.

Speaker 3

Good. And I will offer up a couple of quick comments, but turn it over to Clark because Clark could be the one that's here to deal with that going And I won't be around. So we'll go ahead and pass the baton from that perspective. One thing I want to highlight though, Scott, is that as we take a look, for example, you mentioned the Q1 23. Keep in mind, there are some things that impact the Q1 relative to the Q4 that are more seasonal.

Speaker 3

Day count related issues costs about $20,000,000 from where the Q4 is to the Q1. We also typically see fee income drop from the Q4 1st quarter given some of the refinance activity on the loan side. And so we would see the Q1 traditionally being the low point for both Our net interest income and net interest margin and would expect to see growth from there. And Clark has been spending a lot I'm taking a look at strategies as far as the swaps and treasury. So Clark, why don't you take it from there as far as other insights?

Speaker 5

Sure. Just to try to address your question directly, Scott, I think that really the majority of the value is going to come in 2024. If you think about what's coming off in swaps and treasuries in 2023, that number is about $7,000,000,000 to $7,500,000,000 It's It's more like 15 24. So think about that kind of 2 thirds, 1 third almost ratio. I'd say of the number we've shared, which Again, just to remind you, kind of taking all $29,000,000,000 of swaps and $9,000,000,000 of treasuries and spot pricing them.

Speaker 5

Again, I think you'd see about a third of that benefit in the 2023 exit run rate. So the beginnings of Some steepness in that NIM and then more of that pulling through in 2024 as you'd see, again, the majority of that maybe 2 thirds to 3 quarters of that value

Speaker 9

And I guess out of curiosity, I'm a little surprised at how well the estimate Kind of held in $1,100,000,000 versus I think you were saying $1,200,000,000 last quarter just given all the changes in The way the curve has behaved, what does it take to really move that number one way or another? Is that sort of a $1,000,000,000 plus Kind of a pretty sturdy number almost regardless of the way things behave.

Speaker 3

Yes. I'd say the biggest impact there is the movement in the 2 year end of the curve and what we The longer end rates moved a lot more significantly than to your point.

Speaker 9

Okay. All right, perfect. Thank you all very much. And Don, best wishes.

Speaker 3

Thanks so much.

Speaker 1

Your next question comes from the line of Mike Mayo from Wells Fargo. Please go ahead.

Speaker 12

Hey. Hey, good morning, Mike. You guys see financing To wholesale companies from both the lending side and the capital market side and one topic during this earnings season is The capital market conditions are a lot tougher, whereas the lending conditions are not that much tougher. So When do you think these will converge? In other words, the pricing in capital markets is much more difficult than the pricing in the lending markets.

Speaker 12

Are you seeing any firming up Or not?

Speaker 2

So the answer is, Mike, it depends. And when I say it depends, it depends on kind of what the customer strata is. So 50% of our loans are to investment grade customers and the adjustments there are immediate. There's a bunch of different inputs whether people We're hedging, putting a swap on, there's multiple people looking at it, etcetera. Where there's a disconnect, And I don't really think that disconnect goes away is in those kind of quality middle market companies that One bank or one fund can finance.

Speaker 2

And I don't think we've seen not I don't think, we haven't Seeing the adjustment there that you would expect.

Speaker 12

Okay. Do you expect that to change Coming up and just your general outlook on capital markets, that's a nice tailwind at times recently has been a headwind.

Speaker 2

Sure. So I think look, I think ultimately things get repriced and it takes time whether you're talking about bank debt going into the middle market Or you're talking about people doing major strategic acquisitions. My experience is it takes literally over a year for people to kind of readjust their expectations. And so we're obviously easily 6 months into this. But I think the first half In Capital Markets, it's going to be challenging because people still remember what the business or the financing was worth, say, 6 or 8 or 9 months ago.

Speaker 2

But eventually and by the way, anyone that's a buyer is acutely aware of how things have been repriced. But those will converge. And I think it's going to be I think it will be challenging in the first half of the year, Mike. And I think this big Head up backlog will start to kind of as people go through price discovery, will start to clear out In the second part of second half of the year.

Speaker 12

All right. Thank you.

Speaker 2

Thank you, Mike.

Speaker 1

Your next question comes from the line of Ken Usdin from Jefferies. Please go ahead.

Speaker 10

Hey, good morning and Don best of wishes Well for me. I just have to come back and just super clarify Don, the 27%, 28% beta for cumulative That is interest bearing that compares to the 19% through 3 quarters? Absolutely, yes. Okay, cool. And then so just I guess the comparison question that I think continues to come up is just that many peers are talking Mid-30s, even low-40s in some of the calls that we've heard so far.

Speaker 10

So can you just kind of go one step deeper into The type of pricing assumptions and I guess within products and businesses that just gives you that much better relative confidence to peers? Thanks.

Speaker 5

Sure. Ken, it's Clark. So I'll pick that up. Again, For us, what we saw in the Q4 and what we're looking at in 2023 is much less about New to key deposits where those kind of new business rates are much higher and necessary Necessarily have to be higher to bring them in versus motion in the book of non interest bearing to interest bearing or from different account to different We can manage that transition a little more comfortably. And given that, we are avoiding, we think, in large parts The significant marginal cost of funds that the new price or new offer dollar requires in repricing the larger

Speaker 3

The only other thing I would add Ken is that right now we're at 19% cumulative. I think most of our peers are close to 30%. And so By them going to 40% is the same thing as us going to high 20s. So the incremental change from this point forward is probably fairly consistent. It's Just that we're at a better starting point than peers.

Speaker 10

Yes, that makes sense. It does seem like though to get To that point, your incremental interest bearing deposits costs have to be the betas have to be lower than the 33% in the 4th quarter to square to that?

Speaker 3

As far as the cumulative, probably not because you've only got a 50 basis point increase going forward as far as the rates in 2023. But We can go back and reverse engineer the math, but I think it still lines up.

Speaker 10

Okay. Just one quick one. Laurel Road origination outlook, can you give Your updated thoughts there? Thanks, guys.

Speaker 2

Sure, Ken. So Laurel Road, obviously, from a straight origination outlook perspective, It's been challenged. It's been challenged really by 3 things. 1 is the federal loan student payment holiday. That's a challenge.

Speaker 2

I think that's been extended The next is just the rising interest rates, which are a challenge. And the third challenge that we've had there All the discussion around student loan debt forgiveness, obviously, I think has some borrowers wanting to stay on the sidelines To preserve optionality. Having said all of that, I was impressed that we were able to originate last year 1 $500,000,000 of refinance loans. But even a bigger picture, Ken, is we are trying to create A national digital affinity bank. So first of all, those originations will come back and they'll come back when there's clarity around all the issues I just talked about.

Speaker 2

And there's a bunch of raw material being priced right now that you'll be able to refinance advantageously. But in the meantime, what we've done is build this national digital affinity bank It has a full suite of products for doctors, a whole suite of products for nurses. We're getting a 30% cross sell On the business that we do. So there's no question that originations have been challenged and they'll continue to be challenged In the very near term, but what we're trying to do there is a lot broader. This Gradfin business that we bought is really Interesting, because they're the leader in public service loan forgiveness.

Speaker 2

And where you're going to see a lot of discussion going forward is around this Income based repayments and we're kind of uniquely qualified to be in there advising on that. Anytime we advise people, obviously, we'll bring them on as full customers. So, does that answer your question?

Speaker 10

It does. Thank you, Chris.

Speaker 3

Sure, Ken.

Speaker 1

Your next question comes from the line of Matt O'Connor from Deutsche Bank.

Speaker 2

Please go ahead. Good morning. Sorry if I missed it, but what part of the yield curve are we

Speaker 9

most concerned about as we think about Your fixed rate assets rolling and I realize it might be a variety of kind of parts because some Short term, some of the longer term. But as we think about, I think, that $1,100,000,000 you said, what part of the OCO should be watched, which obviously, Longer rates coming in, but shorter rates staying high.

Speaker 3

Yes. Matt, as far as the $1,100,000,000 it's really 2 to 3 year end of the curve and that's where we would be looking to extend those swaps when we're in a position to do that. And so it is in that portion of the yield curve. Beyond that, we also have a little over $1,000,000,000 a quarter and rollover our bond portfolio and We tend to look at some of their around the 5 year end of the curve there. We tend to do more CMO structures and shorter pass through like 15 year type pass through assets as far as Our normal investment strategy there.

Speaker 9

Okay. All right. Perfect. Thank you.

Speaker 3

Thank you.

Speaker 1

Your next question comes from the line of Peter Winter from D. A. Davidson. Please go ahead.

Speaker 4

Good morning. Chris, I heard the comments on the capital markets in the second half of the year. I was just wondering if you could give some more color About the moving parts to the fee income in 'twenty three for it being down 1% to 3%.

Speaker 2

Sure. So there's a few areas where we will get pickup and then there's a few areas where we've got some headwinds. The areas where we'll get pickup is in our Investment Banking area. We'll get some pickup in cards and payments. We'll get some pickup in trust.

Speaker 2

I want to cover the other puts and takes?

Speaker 3

Sure. The largest decline for us will be in the deposit service charges category. We mentioned that this quarter was the 1st full quarter of the implementation of the NSFOD fee. There's about another $70,000,000 impact in 'twenty three compared to 'twenty two for that. And our outlook right now also would suggest that we think that our corporate services income will be down year over year just because we've had such a strong program this year as far as derivatives, interest rate swaps and what have you for customers and we think that with less rate volatility we'll see less opportunity there That's the blended impact as to how we get to that down 1% to 3%.

Speaker 4

Got it. And then the loan to deposit ratio is now at 85%. Is there a certain level That you don't want to go above and secondly, I'm assuming that you're going to continue to let securities cash flows and use those to Kind of help support loan growth?

Speaker 3

We typically would target between 90% 95%. It's been a long time since we've been up at that level, That's where we think our balance sheet is still very efficient and access to the capital markets for that national funding source Is available and supports that. The second part of the question was I apologize, Peter, remind me.

Speaker 4

Sure. Just Using securities cash

Speaker 3

flow I apologize. Yes. What we've talked about a lot is that we've got that $9,000,000,000 of short term treasuries that start to mature later in 2023 and That can be a very good source of liquidity for us. And we're really indifferent whether that replaces funding or whether we Roll that over into new securities, but if you look at the rest of the portfolio, it's about $40,000,000,000 and we think that's a good core size. We can let a runoff there fund some of the liquidity needs on a short term basis, but Longer term, we think that that's probably a good relative size for the portfolio given our overall liquidity management position.

Speaker 2

Peter, the other thing that I would add to As you think about the puts and takes on the balance sheet is that in the Q4, for example, we Put 24% of the capital that we raised, which was $33,000,000,000 on our balance sheet. Historically, that number has been 18 So with the dislocation in all the capital markets, we're able to structure things in a manner that we want And put them on our balance sheet as these capital markets work their way out that won't it will basically start deviating back to Kind of 18% type as opposed to 24%. That's just a little bit of a different wrinkle that I think is pretty, as I said, short term over the next half year or so.

Speaker 4

Got it. Thanks. And Don, best of luck and it's been a pleasure working with you over these years.

Speaker 3

Right back at you, Peter. Thanks so much.

Speaker 1

And at this time, there are no further questions. I'll turn it back to you for any closing remarks.

Speaker 2

Well, thank you, operator, and thank you for participating in our conference call. If you have any follow-up questions, you can direct them to our Investor Relations team, 216-689-4221. And I just want to thank everybody for your interest in Key. And on that note, we will hang up. Thank you.

Speaker 1

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT and T Teleconference. You may now disconnect.

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Earnings Conference Call
KeyCorp Q4 2022
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