Operator:

Good morning and welcome to KeyCorp’s Second Quarter 2024 Earnings Conference Call. As a reminder this conference is being recorded. I would now like to turn the conference over to the Head of Investor Relations Brian Mauney. Please go ahead.

Christopher M. Gorman:

Thank you, Brian. I'm on Slide 2. This morning, we reported earnings of $237 million or $0.25 per share, which is down $0.02 from the year ago quarter, but up $0.05 sequentially. On a quarter-over-quarter basis, revenue was essentially flat as we offset the expected pullback in investment banking fees from a record-first quarter with growth across the balance of the franchise. Expenses remained well-controlled, and credit costs were stable. Importantly, we continued to deliver on our clearly defined path to enhanced profitability as we detailed a little over a year ago. Net interest income grew from what we continue to believe will be this cycle's low in the first quarter, and we remained confident in our ability to deliver on our NII commitments for both the full year 2024, as well as the fourth quarter exit rate. Deposit value creation continues to be a positive story for Key. This quarter deposits grew by 1% sequentially, while the pace of increase in deposit costs continued to decelerate. Additionally, non-interest bearing deposits stabilized at 20% of total deposits. We were also pleased to see client deposits up 5% year-over-year. Consumer relationship households are up 3.3% annualized year-to-date. Finally, we continue to be very disciplined with respect to pricing. Our cumulative deposit data stands at 53% since the Fed began raising interest rates. With respect to non-interest income, we have made continued progress against our most important strategic initiatives. In our wealth management business, targeting massive fluid prospects, production volumes hit another record in the second quarter as we added 5.6 thousand households and over $600 million of household assets to the platform. Since launching this business in March of last year, we have added over 31,000 households and about 2.9 billion of new household assets to Key. Within our existing customer base, we believe we have a great opportunity, over 1 million Key retail households have investable assets of over $250,000 and only about 10% are existing customers in our investment business. Overall, as a company, our assets under management have now reached $57.6 billion. In commercial payments, we continue to see strength in our commercial deposits with 9% growth year-over-year and a relatively flat beta since year end. Cash management fees are growing at approximately 10%. Our Primacy focus has made this a core competency for us. We continue to see momentum as our clients are more focused than ever on working capital solutions and driving efficiency in their own businesses. Additionally, our focus on verticals like healthcare, real estate, and technology create meaningful deposit opportunities and our embedded banking strategy was well-timed given the growth we're seeing in that market. In investment banking, as we have previously communicated, our second quarter fees were below those of the first quarter. Our positive outlook for the business, however, remains unchanged. Our pipelines are higher today than last quarter, year-end, and year ago levels. Our M&A pipeline remains near record levels and the near-term outlook for other investment banking fee revenue streams have improved. At this point, we expect a stronger second half of the year consistent with our prior guidance. Our national third-party commercial loan servicing business also continues to perform well. This is a counter-cyclical business that also gives us unique insight into the commercial real estate market. We continue to feel very good about our growth prospects for this business. Lastly, on loans, broadly loan demand remains tepid, and the pricing environment remains competitive. It has also taken some time after our focus on improving our liquidity and capital ratios last year to get our machine fully up to speed. Despite recent volume trends, we are optimistic we will start to see stabilization and potentially some growth in the back half of the year. Our pipelines are building. In the middle market, our pipelines are over 50% higher than last quarter. And in our institutional business, engagements broadly are picking up as well. Turning to capital. This quarter, our Common Equity Tier 1 ratio improved by roughly another 20 basis points to 10.5%. Our marked CET1 intangible capital ratios also improved. As reported a few weeks ago, we have received the results of the Fed's stress test or D-Fest, which implied a preliminary stress capital buffer for Key of 3.1%, which is up 50 basis points from the SCV we received in 2022. I'll make just a few comments. First, even under this preliminary buffer, we have plenty of excess capital. Our 10.5% CET1 ratio compares to what would be a new 7.6% implied minimum. So the results continue to illustrate our strong capital position. Secondly, we, like others in our industry, don't have insight into the Fed's models. The Fed's modeled loan losses for Key, particularly for our commercial real estate and first-lien mortgage portfolios, are inconsistent with our internally run stress tests. We look forward to a continued constructive dialogue with our regulators on this topic. Looking forward, I am excited about what lies ahead for Key. We have been discussing our net interest income pivot for each of the last several quarters. The pivot is now upon us. NII headwinds that we have experienced will now become NII tailwinds as we go forward. Concurrently, I'm also encouraged by the business momentum we continue to see across the franchise. We demonstrated momentum in wealth management and commercial payments begin this past quarter and we are driving meaningful client deposit growth across the entire franchise. Lastly, investment banking and loan pipelines are up meaningfully from prior periods. With that, I'll turn the call over to Clark to provide more details on our financial results. Clark?

Operator:

Thank you. [Operator Instructions]. One moment please for the first question. And we go to the line of Ebrahim Poonawala with Bank of America. Please go ahead.

Christopher M. Gorman:

Good morning Ebrahim.

Clark H. I. Khayat:

Yes. Okay. Thanks, Ebrahim. And maybe I'll just kind of reground everybody in the whole thing, and then I'll get to your question because I'm sure this is not -- you're not unique in the NII question for the fourth quarter. So first of all, I think we've been really consistent or tried to be that a lot of this pull-through will happen in the second half of 2024, which we would expect will materialize as you see on the slide, and you noted. So we've talked a lot about the structural roll-off in swaps and treasury. So just a reminder, $5.5 billion of treasury is maturing in the second half at an average yield of about 47 basis points. $3.2 [ph] billion of swaps at about 60 basis points and then $2 billion of securities repricing at roughly low to mid-2% yield. So just that's the piece on the left that you referred to. There's another $10 million to $15 million in day count and fees. So again, we feel fairly good about that pulling through. We do expect deposit costs to continue to rise. So let's assume one cut coming in December. We guided to a mid-50s beta if there's no cuts. So a little bit of drift up. If there's one cut in December, that won't be impacted materially. We will see some benefit on betas if there's a cut in September, but we will also see the impact, obviously, of loan yields coming down, and that will happen in advance, not just because the loans reprice immediately, but SOFR will reflect that, as you know, a little bit before that cut. So there's a little bit of negative drag in 2024 if there's a first cut in September. As you commented, right, loan balances will be the variable. So we've been a little weaker in the quarter than planned. As Chris said, our pipelines are strengthening materially. I think that's a function of ongoing engagement with our teams, with clients, and prospects. As you said, middle market is up 50% plus on the pipeline side. So we do expect and are starting to see some traction in the back half. I think if there's a little bit lighter loan growth than what we guided to, we'll still be okay getting there. And if it's materially lower, then that's a different conversation. What the real implication is, I think, and probably where your question is going is, what does that mean for 2025 and the size of the balance sheet and the loan book going there. So look, I do think we all expect rate cuts to come, although I'm certainly not very good at predicting the economy, so I won't try to do that. But should we get some rate cuts, we do think that will create more client activity. We're already, as we talked about in pipeline and engagement dialogue seeing client interest in that. I think that means even if we start on a lower exit rate on loans, we will see good strong growth going into 2025 on loans. In the 12 years I've been at Key other than the last 12 months, we've been a leader on commercial loan growth, and I don't see anything today that would cause me to believe that will be different going forward. But I do think it's valuable maybe to add a couple pieces of content on 2025 that we really haven't covered. We've been laser-focused on 2024 swaps and treasury. So let me just add something that we've included in the appendix on Slide 20, which just gives you some sense of maybe some repricing opportunity in 2025 as well. And that is about $20 billion of additional asset repricing that comes next year. Those yields are low 3%, and that comprised of $5.2 billion of swaps coming off at $180 million. So some more swap pickup, not as meaningful as what we're seeing today, but not unmeaningful at those levels. Another $11 billion plus of fixed rate loan repricing that are coming off at 4.15 and then $4.2 billion of fixed rate securities that are about $275 million. So definite opportunity there. You'll also get the full year move and impact of the fourth quarter treasuries that will come off the books and swaps and then as rate cuts come in, we'll have the full year 2025 to deploy that beta into our consumer book. So I do think there are headwinds or tailwinds for us, sorry, as we get into 2025. And I think we have confidence we'll be able to grow loans and add clients on the commercial side as well.

Christopher M. Gorman:

So Ebrahim, it's Chris. Look, couple of things, one, the normal migration from criticized to nonperformers, it's playing out exactly as we would have expected it to. Stepping back for just a second, our C&I book, 53% of it is investment grade, 70% is secured. And so most of them have very low utilization in terms of borrowing. So we start from a pretty good place. Your question is a good one though, as to where sort of the action is. And let me tell you where we're seeing some people impacted by the higher for longer scenario. Consumer goods, some business services, some equipment businesses. On the other side of the equation, we're starting to see actually healing in the health care sector. So think about seniors housing, think about facilities-based health care we're seeing that kind of going in the other direction. The other thing that we always look at is what's the mix of downgrades to upgrades and downgrades still exceed upgrades, but that ratio is starting to close. So that's kind of how we're thinking about it. Obviously, C&I is a very broad category in general. But that's kind of sort of how we're thinking about it.

Ebrahim Poonawala:

Thank you for taking my questions.

Robert Siefers:

Good morning guys, thanks for taking the questions. So Clark, appreciate that sort of walk through on the NII. I still have sort of an NII related question. Maybe when you look at sort of the deposits that -- so the deposit base looks like it's going to come in better than you had anticipated previously. Can you maybe walk through what kinds of deposits you're going and what -- sort of what the spread looks like on those, so I think there's probably some question if we dial back the loan growth expectation, but we're still getting funds in that will go into something, just sort of what that spread looks like in your view?

Robert Siefers:

Perfect. Okay, thank you Clark. And then a little bit of a ticky-tack question on the swaps commentary on Slide 13. So you cite the $950 million annualized opportunity, which was -- that's down a little from $975 million last quarter. So I've gotten a couple of questions, does that represent a reduction in expectations or is it that we've just already absorbed that difference and the $950 million is what's still remaining in the future?

Robert Siefers:

Okay, perfect. Alright, good, thank you for taking the questions.

Kenneth Usdin:

Hey guys, good morning. Just a follow-up on just the loans in the context of the whole balance sheet. So I'm just wondering if you can give us a little bit more color on just how much of the loan growth versus what we see in HA when we see your peers, is this you guys just being more conservative and can you talk a little bit about like how much did you keep of your originated, did that change, and where specifically when you mentioned earlier, Clark, the pipeline, like what areas do you see those pipelines coming in, is it more just a straight up commercial? Thanks.

Kenneth Usdin:

Great, thank you for that color. And the second question is just when we think about just the entirety of the balance sheet, your RWAs have come down a lot over the last year. So CET1 is growing. CET1, even with AOCI, we can see in Slide 24, up to 7.3%. The stress test went a little bit tougher. So just how important is managing to that with AOCI number, if at all, relative to your 10-3 [ph] regular way and just how you're thinking about just managing your capital position vis-a-vis the loan book and RWA growth? Thanks.

Kenneth Usdin:

Okay, got it. Thank you Chris.

Operator:

Our next question is from Erika Najarian with UBS. Please go ahead.

Clark H. I. Khayat:

Sure. So let me handle the first one, Erika. So look, on improved funding mix, we're still sitting on something on the order of kind of $7 billion of FHLB advances. So we have some opportunity to continue to bring that down. We brought broker down close to $6 billion over the last year, but still some opportunity to manage that as well. And then on the margin, we can kind of calibrate where we think overall deposit costs will be based on the size of the balance sheet and the loan book. So we do think we have some opportunity to do that and a little bit of leverage here in the back half of the year on maturities around things like CDs and MMDAs. So we're looking at that very dynamically. We're watching our loan pipelines as they materialize, and we feel like we should be able to pivot one way or the other based on how much traction we're getting on loans.

Erika Najarian:

Got it. And my second question is a follow-up to Ken's question about capital. I think what struck me on Slide 11 is, I'm not sure how different the forward rate versus flat rate scenario are in terms of treasuries that don't decline by that much. But how time versus rate, although granted you only have 25 basis point difference in terms of the belly of the curve here. It is really what's going to heal the AOCI. And obviously, the stress test is a -- was a bit of a negative surprise. As Clark said, you guys have always been a premier grower in commercial. And if macro comes back, you would think that Key is in a position to outperform peers. So that and, I guess, how much is this adjusted AOCI impacting, if at all, your growth plans, it seems to be impacting your multiple and how investors think about you, but perhaps sort of square that for your investor rate in terms of how your RMs are going to market versus the sort of -- the difference between adjusted and reported? And Clark, just a quick confirmation that should we assume a flat balance sheet from the 170.6 through the end of the year? Thank you.

Clark H. I. Khayat:

Yes. And I would just add to that, right. We do have consumer loans that continue to come down, and that gives us both liquidity in capital to redeploy into commercial there. So to Chris' point, right, that's not something we're viewing as a limiter in the field. As far as the balance sheet through the rest of the year, I think relatively flat is a good place to start. As I said to your -- in response to your optimization question, that can move around a little bit, but I wouldn't expect it to be meaningfully large moves on earning assets.

Clark H. I. Khayat:

Yes. I mean -- and I appreciate your consistency on that particular item, Erika. It's -- look, it's something we spend a lot of time looking at and understanding which I think a lot of us did. We obviously had some peers do some things by the way, in places where we had already made moves. So auto in particular, where we had exited back in 2021. There are some opportunities for us to do that but frankly, we don't see a huge value in getting that additional CET1 at the moment. If something were to change, we know how to execute the transaction like that. We have a couple of portfolios that are likely prime candidates for that. But it's not clear to me at this moment that that's a lever that we need to pull to drive improved capital.

Erika Najarian:

Got it, thank you so much.

Gerard Cassidy:

Hi Chris, hi Clark. Chris, I know this is not really quantifiable, but obviously, you've been at this for quite some time. But I took interest in your comments about your pipelines and how strong they are. Can you give us some confidence on -- there's pipelines and there's pipelines. How confident are you that these are real that they could pull through as you look at it over the next 12 months?

Gerard Cassidy:

Very good. And then as a follow-up on the credit, your Slide 10, I think you guys mentioned that there seems to be some improvement in the health care area and in the C&I, I think you said it might have been durable consumer. The question on the C&I portfolio, obviously, you guys have been very strong in capital markets for a number of years. And part of that, I presume you work with your sponsors, the private equity guys and in earning the fees from those folks, they tend to also use your balance sheet. Is there any evidence that on the private equity side or the loans to non-depository financials that category. And I know it includes insurance companies and less riskier borrowers, but is there any evidence that there's any credit concerns in that category of loans?

Clark H. I. Khayat:

And Gerard, that portfolio that would drive kind of that financial concentration we've been in that 20-ish years. I think maybe there's one loss in that time frame, like literally one credit. It's super clean, great returns, and it is actually the portfolio that we entered into that forward flow agreement with Blackstone, and that was entirely to manage the credit risk concentration, not for any concerns about the quality of that portfolio.

Clark H. I. Khayat:

Yes, so today we are putting forward starters on in 2025 for the purpose of getting a little bit liability sensitive going forward, and we're putting those on kind of in the 4% range. So obviously, that depends on how forward starting and how long they are, but that compares to the 180 quite favorably, obviously. And even the 278 that sits out there in 2026. So definite benefit there. On the fixed rate consumer loans at 415, those are probably, well, one, the student loan market just isn't there for a variety of reasons, rates and sort of give an overhang and the forgiveness in the holiday from the government. But if you were going to put on kind of the jumbo mortgage market, that's probably in the 6.5% to 7% range, but that isn’t incredibly vibrant at the moment either. But those would be the kind of comparison points. And then on your -- yes, if you did C&I, you'd be at 7%. So that would be the way we'd probably think about that replacement rate. And then on the securities, that $274 today is coming on kind of 5.5 to 5.75-ish range.

Operator:

Next, we have a question from John Pancari with Evercore. Please go ahead.

Christopher M. Gorman:

Hey John, it's Chris. We -- I don't disagree with your assumptions. But obviously, we're not yet coming out with sort of what our view is of 2025.

Clark H. I. Khayat:

When you say upside, just so I understand, you're talking about increase in rates or data.

Clark H. I. Khayat:

Yes, yes. Look, so we guided to kind of mid-50s. If there were no cuts, one cut will have a maybe minor impact on that. If that cut is in December, it is just not a lot of time to implement that. And the reality is, I guess, technically, if that cut occurs, the beta cycle is sort of over so the question is, is your beta on that first cut positive or negative. I think it would be in December, again, not a lot of impact. If we do get a cut in September as well, as I said, I think you're going to have a little bit of drift just by nature of the stickiness of the consumer book, but we think we'd have kind of a plus or minus 20 beta coming down. What that does on the overall cost, again, you get kind of into the technical definition of data cycles ending. But I think you'd see in a September cut rates start to really flatten through the back half of the year, whereas with one cut in December, they may still be up a bit.

Operator:

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

Christopher M. Gorman:

Yes, Matt, it's Chris. That is the range that we believe will do -- our revenues will be in the back half of the year. We ended the first half of the year right around $300 million, and we've guided all along to $600 million to $650 million, and that's unchanged.

Christopher M. Gorman:

Well, that -- one of the things we talked about in my initial comments is we're clearly really growing our mass affluent business. That was the business where we brought in 30,000 new customers and about $3 billion of total assets to Key. So that's really the -- that's a big driver of that line.

Operator:

Next, we go to Manan Gosalia with Morgan Stanley. Please go ahead.

Christopher M. Gorman:

Sure. Well, first of all, thank you for the question. The three things that really drive that are, as you point out, loan growth, your view of the macro economy, and then idiosyncratic to the actual credits. I could see a scenario depending on how this plays out, where we evaluate what the total reserve is. But I think it's premature right now only because it's still unclear to us exactly what path the economy is going to take. But as we get more clarity, we'll continue to evaluate it.

Christopher M. Gorman:

Right. We've constantly been looking at it and adjusting it based on the three metrics that I just shared with you. One, our view of the macro economy; secondly, the size of the book, which obviously is going down in this instance and also just the idiosyncratic look at things like migration and what we have in terms of nonperformers and so forth.

Operator:

Next, we go to Steve Alexopoulos with J.P. Morgan. Please go ahead.

Clark H. I. Khayat:

Look, I think with two cuts we're going to be closer to the bottom end of our range. But I would tell you just from an overall health of the business, I'd take the second cut because I think it drives more loan demand, I think it buys more capital markets activity. I think it gets people more engaged in economic investment. So I think it's a trade we certainly would make going into 2025 versus, I guess, maximizing what's in the fourth quarter.

Christopher M. Gorman:

So Steve, the answer is, as we look forward, it will be a more normal expense year for the company as we continue to come out of the position that we're in. We have been investing though and the reason we've been able to invest is we took $400 million of expenses out last year just for the purpose of being able to invest in people and in technology and in the businesses that we're trying to grow like our private client business, our payments business, our investment banking business. So expenses will go up in 2025, as you see the pull-through of the earnings that we're talking about, but we have not starved the business. We've continued to invest in our migration to the cloud. We've continued to spend $800 million a year in our tech area. So -- but in order to be able to continue to invest in the business, I think you can imagine that expenses will go up in 2025. But it's not because of deferred expenses. It's just because business continues to grow.

Steven Alexopoulos:

Yes. Got it. Okay. That's great color. Thanks a lot.

Michael Mayo:

Hi, I think I'm missing something very basic, and that is that you have the same -- no change to the fixed asset repricing, you have less favorable loan growth guidance, yet you still have the same NII guidance, so what am I missing in my logic?

Michael Mayo:

You said middle market pipelines are up 50% quarter-over-quarter. Is that correct, and how much is middle market of your total commercial?

Michael Mayo:

So even though you had -- even though you have such strong backlogs and it seems like you have a certain degree of conviction, you still thought you should guide loan growth lower, is that correct?

Michael Mayo:

And then just a separate topic, Chris. In terms of the merger environment, I feel like the topics died down here recently, but you said that you'd be willing and able to pursue another first Niagara sort of deal. Is that still the case and under what circumstances do you think it would become more likely, would it be more likely after the election, what do you think the tone is in D.C. and what's your appetite?

Michael Mayo:

And then last question, investment banking, I know your mix is different. You're more loan syndications, you have mergers, but relative to the big banks, I know it's not apples-to-apples completely, but it just doesn't really compare so favorably to them, on the other hand, you said you have record backlogs in investment banking, so what areas of investment banking are you seeing the record backlogs?

Matthew O’Connor:

Got it, thank you.

Operator:

And next, we go to Peter Winter with D.A. Davidson. Please go ahead.

Clark H. I. Khayat:

Sure. One, our consumer lending, we -- as you know, Peter, we don't have a huge credit card book. It's really mortgage, home equity, personal loan, student loans. That has an enormous amount of volume in the mortgage market, the jumbo mortgage market or nonconforming market or the student loan market, which is generally what has been on balance sheet for us. We continue to support clients where we can, particularly in held-for-sale mortgages, but I would suspect as we go forward, you will see us do -- and rates come down and those businesses get a little stronger, you'll see us support those clients very actively, but probably do a little bit more of that off-balance sheet. So we'll view that a little bit more as a fee income generators as we service those clients. We will always have some room on the balance sheet to accommodate good clients as it relates to nonconforming structures as an example. But that will be probably less so than it's been in the last few years.

Clark H. I. Khayat:

In terms of what we've seen this year?

Clark H. I. Khayat:

Yes. I mean, I'd have to go back and look for sure, but you have student loans and mortgages, right. They just have structural paydowns every month. So we'll see that book continue to come down at a sort of normalized rate. I think it will accelerate as rates come down, but they have to come down quite a bit, frankly, for a lot of refi. So I think what you're seeing is probably illustrative of what you'd expect going forward. But definitely, I don't know of any unique thing that happened in the second quarter that would have driven consumer loan growth down more than expected.

Christopher M. Gorman:

Well, the first parameter would be to really have a firm understanding of where the BASEL III Endgame is going to be because until we know what the phase-in period is and what capital is going to be required it's -- that's just -- I think that's a very important piece of the equation. And for us, obviously, we had mentioned we've been under earning. And as our balance sheet heals that will give us an opportunity at the appropriate time to revisit that. But we've been very clear, we're not going to engage in any buybacks this year for sure because we, in fact, don't even have a plan approved by the Board. But going forward, obviously, like everybody, we'll be taking a look at it.

Clark H. I. Khayat:

Closer to 5%. So it would be the upper end...

Clark H. I. Khayat:

Yes, we can wrestle on those semantics. But yes, closer to that closer to the 5% down.

Operator:

And I'll now turn the conference back to Chris Gorman for closing remarks.

Operator:

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

Operator:

Thank you, everyone, for standing by. Welcome to the 2024 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Brian Mauney, KeyCorp’s Director of Investor Relations. Please go ahead.

Chris Gorman:

Thank you, Brian. I’m on Slide 2. This morning, we reported earnings of $183 million or $0.20 per share which incorporates $0.02 per share impact from an additional FDIC special assessment charge this quarter. I would characterize our underlying results as solid. Revenue was essentially flat sequentially despite expected first quarter seasonality as investment banking reported its best first quarter result in our company’s history. Fees were up 6% against both the prior quarter and prior year. Retail relationship households were up 2.5% year-over-year and commercial clients were up 6%. Customer deposits were up 2% year-over-year and essentially flat on a sequential basis. We continue to reduce our reliance on higher cost brokered CDs and wholesale borrowings. Expenses remained well controlled at $1.1 billion. Nonperforming assets and credit losses remained low. Additionally, we continued to build our credit reserves this quarter. Our capital ratios, including tangible common ratios were flat to improved across the board, despite the impact of higher interest rates on the fair value of our available-for-sale securities. We ended the quarter with a common equity Tier 1 ratio of 10.3%, up 120 basis points from a year ago, representing our fastest rate of organic capital build over a 12-month period since the industry began tracking this metric. I’m also encouraged by the momentum we are seeing in areas where we have a differentiated advantage and have been investing. While only one quarter, I am encouraged by the strong broad-based results we saw in our capital markets business, across M&A, equity and debt capital markets and our commercial mortgage group. We also are seeing broad momentum across our targeted industry verticals, such as health care, power, industrials and renewables. While I would expect to see some pullback in fees in the second quarter, our pipelines are up from a year ago and from year-end levels. Market conditions are clearly starting to normalize. We also continue to raise significant capital on behalf of our clients. In the first quarter, we raised over $22 billion, holding 12% on our balance sheet and distributing the balance in the capital markets. To this end, last month, we announced a strategic forward flow origination partnership with Blackstone. This partnership will allow us to accelerate growth and manage credit concentration risk within our differentiated commercial platform and is another example of how we are delivering best-in-class execution for our clients. This deal also further validates our distinctive underwrite-to-distribute model, in that one of the largest private credit providers has recognized our platform for its ability to originate, soundly underwrite and service at volume with our high-quality clients. As markets evolve, we will continue to evaluate the potential for arrangements with other leading providers like this one, which allow us to offer a distinctive experience for our clients while concurrently managing our risk. Turning to Wealth Management. We recently launched Key Private Clients where we have the opportunity to penetrate a large growing mass affluent segment within our consumer base and with our commercial business owners. In this mass affluent segment, we enrolled another 6,000 households in this quarter and doubled production volumes compared to last year. This new business has added over $2 billion of household assets in just over a year. Overall, our assets under management have now surpassed $57 billion. Before I turn it over to Clark, I want to touch briefly on credit quality. As I mentioned earlier, our nonperforming loans, net credit losses and delinquencies remain at low historical standards with credit losses below our full year 2024 and through-the-cycle targets. In the first quarter, we saw an uptick in criticized loans, which was driven by our belief which, by the way, we have held for some time now, that we will remain in a higher-for-longer environment as inflation remains sticky. With that in mind, this quarter, we performed a deep dive on over 90% of our clients that we believe would be most impacted under a higher-for-longer scenario, encompassing over 80% of our non-investment grade commercial exposures. Performing this deep dive confirmed our view that there will be low loss content in these loans. Approximately 96% of accruing criticized commercial loans are current and 93% are current when also including non-accruing loans. Over 85% of our criticized real estate loans have recourse. I continue to feel very good about our ability to hit our net charge-off guidance of 30 to 40 basis points this year. In summary, while it’s still early in the year, we are on pace to deliver against the commitments that we detailed at the beginning of this year. Key is back to playing offense. And I remain excited about our future and our ability to generate sound profitable growth moving forward. I also want to take a moment to thank our teammates for their continued commitment to our clients and our communities. I am very proud to share with you that for the 11th consecutive exam cycle, since the passage of the regulation in 1977, Key received an outstanding rating from the OCC for meeting or exceeding the terms of the Community Reinvestment Act. This achievement reflects our collective commitment to our purpose and an enormous amount of hard work and dedication from every teammate at Key. With that, I’ll turn it over to Clark to provide more details on the results of the quarter. Clark?

Operator:

[Operator Instructions] And our first question is from the line of Ken Usdin from Jefferies. Please go ahead.

Clark Khayat:

Yes. Thanks, Ken and great question. I would point you to 15 and just say, if you look at the two ends, the swap and UST roll-off, that’s a pretty predictable number. We think we’ve been good about disclosing the details there. That’s, I think, pretty straightforward math. It will be a little bit better in a no cut than in a cut scenario, as you know, but it’s within a bound range when you think about two cuts versus zero. And then on the other side, the impact from loan growth, which, again, we think is coming, but will be a little bit back-end loaded has a relatively minimum in-year impact. So the range of outcomes on loan growth, while we – we’d rather have more in year, I don’t think is a huge driver in this number. So it really is those two pieces in the middle and the trade between how much more you get from asset repricing, net of loan yields, if there are cuts versus what the impact of funding is and those sort of work to offset each other a little bit, but in a way that we think is relatively muted for the course of the year. And then just the other point I’d make is the $886 million well on the low end for the quarter was within the guide. And obviously, when we gave you the guide for Q1, we had in mind hitting not only the full year guide, but importantly, the fourth quarter exit rate and we continue to confirm our ability to do that. Is that helpful?

Chris Gorman:

Well, good morning, Ken, so it’s a good question. Let me hit the loan growth kind of head on. We have always demonstrated an ability to grow loans. Having said that, sort of three things all have to be present for us to grow loans. One, there has to be demand. Right now, there is not a lot of loan demand out there. So that’s point one. You see it in kind of flat utilization among other things and not a lot of investment. The second thing is, it has to be in our clients’ best interest for us to, in fact, provide those loans. And you probably noticed that we raised $22 billion, but only put 12% on our balance sheet, and that’s because we can better serve our clients, whether it’s through the forward flow arrangement with Blackstone that you referenced or a variety of other markets. And the third thing is that they have to – the loans that are available to put on our balance sheet have to fit our risk profile and they have to fit our return requirements. And right now, there’s not a lot of loans like that from our perspective. Having said that, what’s interesting about bank loans is because there’s excess capacity, the best time to make bank loans is when there’s a downturn. And our house view is, we are going to see a downturn, and that will be a great time for us to really use our balance sheet. Your question, though, the implications of your question really are broader than just the loan growth. And let me just spend a little bit of time talking about how we’re positioning Key. We think that no matter how things play out, all banks like Key are going to have to carry more capital. And as a consequence of that, what we’re focusing on is really serving our clients through capital-light type businesses, specifically payments, which we’ve invested in for a long time, investment banking, which we referenced, our wealth business, which we think we have an opportunity to really grow, and lastly, something that we frankly haven’t capitalized on the degree that we could or should have to date, and that’s business banking. We’re a really good commercial bank. We’ve never really capitalized on the opportunity, in my opinion, to gather the deposits. That’s a business bank is a very deposit-centric business. So I just wanted to give you some insight of how we’re thinking about the business model going forward and how we continue to reposition Key.

Chris Gorman:

Sure.

John Pancari:

Morning.

John Pancari:

Just on that loan growth topic, I know you had also indicated you do expect new loan origination to pick up as you look through 2024. I mean in what areas do you think that you’re going to be able to see the better opportunities begin to emerge? I know demand is modest as you just said, in loan utilization weaker. So what areas do you see that anecdotal evidence of a pickup that could drive accelerating originations and balance sheet growth as you look through 2024?

John Pancari:

Got it. Thanks for that Chris. Just related to that, is any of the weakness related to bond market disintermediation right now?

John Pancari:

Okay, thanks. And then lastly, on the IB and capital markets revenues, I know you indicated that you do expect some pullback in fees in the second quarter. In what areas is that in the IB area, just given the levels that you saw this quarter? And maybe if you can help quantify the magnitude of that pullback that you could see in the second quarter.

John Pancari:

Okay, great. Thank you.

Operator:

Thank you. Next question is from Scott Siefers from Piper Sandler. Please go ahead.

Chris Gorman:

Yes. Actually, it was completely proactive. I just – I’m of a mindset that we’re in this higher-for-longer. And as a consequence, we have been stressing all of our portfolio. And we – any time we do that, we start with anything that’s leveraged because that’s most vulnerable. And we also focus a lot on real estate. And so as we go through and we make assumptions that perhaps these rates will stay where they are for some time, that’s what’s driving it. And also we made some assumptions about – my view is we probably will have a recession. And that’s part of the – my macro view is part of the calculus as well.

Clark Khayat:

Yes. Hey Scott, it’s Clark. Thanks for the question. So look, we feel good on the guide kind of relatively stable, plus or minus 2%. That incorporates, as we talked about progression towards normalization. If we get something fuller, I think we can absorb that. Obviously, we weren’t expecting coming into the year to additional FDIC charge. So that’s an extra component. We will continue to look at ways to absorb that intelligently. But we think we can cover the impact of a strong investment banking year, which again, we expect to see even if the second quarter is a little bit later. So we did count, we think for that pretty well.

Operator:

And the next question is from Manan Gosalia from Morgan Stanley. Please go ahead.

Chris Gorman:

Good morning.

Clark Khayat:

Hey Manan, it’s Clark. Thanks for the question. First of all, I think it’s just important to understand the rationale behind the partnership, and that is largely to support more clients not to manage capital or move loans off the balance sheet. It’s really for us, largely in our specialty finance area. That’s been growing very aggressively. It’s been an outstanding business, but we do think thoughtfully about managing credit concentrations, and this is the opportunity to do that and not limit the amount of clients we can serve. So I think that strategic rationale is really important. As it relates to underwriting, we basically run the business, do the underwriting, Blackstone has an option to participate in these credits if they fit their box. But obviously, if we entered and announced a relationship, we’ve been very deep with them on what the box looks like and what it reflects. And we think our business reflects market conditions as does their appetite. So we would expect this to go well. It’s a one-year deal, and we will test the relationship over the course of the year. We hope it goes very positively because if it does, we’re supporting a lot more clients and prospects in growing our business. And again, given our we think differentiated distribution model; we don’t necessarily always need to grow the balance sheet to grow the business. But this is a case where we would expect to actually do both. We’d expect to continue to grow this portfolio, but moderate some of that growth with a partner, we’ll get a modest asset management fee to do that one that we think makes sense to both sides and again we’ll test it through the year and if there’s more opportunities to do this with Blackstone or others will investigate those were they allow us to serve more clients and serve them better.

Clark Khayat:

Yes, I mean last I check, Blackstone wasn’t in the business of taking deposits or providing payment services and we are, so we like those kind of deals.

Chris Gorman:

Sure. Let me start if I could on what we are seeing in our servicing business. Our servicing business as you can imagine we look at what goes at in and out of active special servicing and as you can well imagine office continues to be the largest area by far. We have seen some multifamily start to go into our active special servicing. Those are typically deals that we’re done it very low cap rates that were highly leveraged and as a consequence are very sensitive to the significant rise in interest rates. As it relates to our strategic reviews I mentioned we start with anything that’s leveraged, but a few industries that I would bring out to your attention, one, obviously is real estate we spend a lot of time like in a real estate very sensitive to interest rates. The other one is health care. Health care is an area where we have a very significant strategic hold and there’s no question that there’s going to be a lot of consolidation in health care because a lot of health care companies are under a myriad of cost pressures. And the other thing – area where we saw some was just consumer services broadly. Those are the areas.

Chris Gorman:

Sure.

Ebrahim Poonawala:

Hey good morning.

Ebrahim Poonawala:

I just had one follow-up, Chris. When you think – when you talked about your outlook for a recession, the stress testing on your loan book for the higher-for-longer, I guess the markets have generally been wrong expecting higher rates to push the economy into a recession. I guess from your perspective, bottoms up, when you assume higher-for-longer, do you see a lot of pain within your loan book six, 12, 18 months out that causes you to have that view? And I’m just trying to wonder – are higher-for-longer enough in a world where the economy could continue to surprise to the upside in terms of growth. Just how do you think about it, especially when you’re stress testing these loans?

Ebrahim Poonawala:

That’s helpful. And I guess just bigger picture, I mean, I think it’s been an interesting last 12 months for Key in terms of RW [ph] optimization expense focus, et cetera. Remind us, as we look forward strategically, like the one or two things you’re most focused on? Is it still in terms of optimizing the balance sheet expenses growth, like how – what should we be thinking about as you think about just coming out of this and where the next leg of growth comes for the banks?

Ebrahim Poonawala:

Got it. Thank you.

Operator:

Thank you. The next question is from Mike Mayo from Wells Fargo Securities. Please go ahead.

Chris Gorman:

Hey, Mike.

Chris Gorman:

Sure. That’s a great question. Obviously, we, on a percentage basis, are more canted towards advisory. These are middle market companies, a lot of them aren’t going to the equity markets very often. And if there are huge equity deals, those are always led by both bracket firms. So ours is heavily canted towards M&A. The good news there, Mike, is that we’ve talked before, M&A pulls through a lot of the other things that we do, financing, hedging, et cetera. So we feel good about where we’re positioned. But the difference probably as you go – if you went through all the numbers, the difference would be that some of the largest banks, obviously, are the players in investment-grade issuance and the players in large equity issuance.

Mike Mayo:

And then when you talk about the multiplier effect from mergers because you said backlogs are up quarter-over-quarter, backlogs are up year-over-year. I guess you expect some good growth this year after the second quarter. How can you quantify that multiplier effect? Is that like 1.2x, 1.5x, 2x, does it vary?

Mike Mayo:

And then last one on that. Where is KeyBanc Capital Markets revenue when you look out over, say, a 10-year horizon? Because I know the whole industry was down by almost half last year and you’re kind of bouncing off low levels. But specifically for you guys, where are you?

Mike Mayo:

All right. Thank you.

Operator:

Thank you. Our next question is from Gerard Cassidy from RBC Capital Markets. Please go ahead.

Chris Gorman:

Good morning.

Gerard Cassidy:

Clark, you mentioned about the loan portfolio, how you purposely exited single credit relationships and Chris, you talked about building the business bank deposit base better. Can you guys give us some more color on these types of credits that you’ve pushed out, were they syndicated loans since it was only a loan relationship? And then the second, getting back to that business bank. Chris, how does that differ from the commercial banks? I think you said it’s two different business lines.

Gerard Cassidy:

And Chris, when you talk about the deepening of the relationship with these customers, that may only have a loan or deposit relationship. Aside from payments, what are those other products that you can use to deepen that relationship to make it more profitable?

Gerard Cassidy:

Very good. And then as a follow-up question, I know you guys addressed what you did in the deep dive for looking at the portfolios. In the criticized loan increase, can you give us the number one, two or three reasons a loan moved into criticized? Was it a loan-to-value degradation? Or was it a debt service coverage? What was kind of the main factors that pushed them into criticized?

Gerard Cassidy:

Appreciate it. Thank you, Chris.

Operator:

Thank you. Our final question will come from the line of Peter Winter from D.A. Davidson. Please go ahead.

Chris Gorman:

Good morning, Peter.

Chris Gorman:

Yes. So I don’t think those things are incongruent. We clearly are playing offense. We’re out hiring people. We’re focusing on the business that I’m mentioning. Having said that because of our business model we are not seeing huge loan demand and so if you think about utilization, we’re basically flat at 32% and we’ve been flat at 32% for the last few quarters. Our loan book is building, and there’s no question that our backlog is not – is higher than it was, but it’s not at historical standards.

Clark Khayat:

And Peter, I might just say, sorry, it’s Clark. I might just say thematically, and I think Chris has hit this a couple of times, but maybe just to summarize a little bit. I think for us, when we say we’re playing offense we think that looks like disciplined loan growth in our targeted verticals, which we’ve been, I think very consistent about over time. I think it’s funded by quality deposit growth from commercial and consumer clients. And it’s monetized through a series of we think leading fee platforms that build that broader relationship. So we think that’s the recipe. And when we’re doing those things and they don’t always come together and they don’t always come necessarily in that order. But when we’re doing and running our business in the relationship manner that we intend to, that’s what it feels like.

Clark Khayat:

Yes. I’m focused on confirming guidance for this year, Peter, but it’s a totally fair question. I do think it’s a function a little bit of the shape of the curve and absolute rates. But as I’ve said before, I think based on the business model we have in a normal kind of upward sloping to at least flatter yield curve, I think that’s achievable. So it is a function, I can’t predict where that yield curve is going to be in 2025. But I think as our positions burn off, we get more to the type of balance sheet we want to have and you get a little bit more normalized rate environment, regardless maybe of even absolute levels of rates, but just direction of the curve, I think that’s very achievable.

Clark Khayat:

Yes. Thank you.

Janet Lee:

Hello. This is Janet Lee on for Steve Alexopoulos. Just following-up on John’s question earlier on investment banking and capital markets; are you maintaining your stance that you are progressing towards this normal level of $600 million to $650 million range for IBs this year? Because if I look at absent a double-digit decline in IB fees in the second quarter. It looks like you’re on pace to exceed that normal level. Is that a fair way to describe? And where is that decline in IB fees expected in the second quarter, mostly coming from? Is that debt capital markets, commercial mortgage, can you provide more insight?

Janet Lee:

Okay. And just one follow up on your loan review. I understand that office CRE is a very small portion of your overall portfolio. And as you’ve done the reappraisals on the properties on I guess, including office, if you have, like what percentage of decline you’re generally seeing on your office? And what’s happening to the updated cash flows from the landlords? Any insight you could share on that?

Janet Lee:

Got it. Thanks for taking my questions.

Operator:

We do have a question from Gerard Cassidy from RBC Capital Markets. Please go ahead.

Chris Gorman:

Yes. So this is just a lot more formalized in that we actually work together, and we actually service it and we’re together focused on this certain asset class. But to your point, we’ve been distributing the preponderance of everything we originate forever, including to a lot of the credit funds. So it’s just – it’s a formalization and most importantly it’s a forward flow agreement. So whereas we’ve always participated on a deal-by-deal basis, this is an arrangement as we go forward.

Gerard Cassidy:

I got it. And then just a quick follow-up on it. Have you guys just worked with Blackstone in the past before this agreement? Or is this your first initial foray with them?

Gerard Cassidy:

Got it. Okay. Thank you.

Operator:

Thank you. And we have a question from John Pancari from Evercore. Please go ahead.

Chris Gorman:

That’s correct. So we’re looking at straight up cash-on-cash. What’s the cash flow? What’s the ability to service the debt based on the cash flow?

Chris Gorman:

That’s right.

Chris Gorman:

Yes. So it’s a conservative perspective for sure. I’ll give you an example. We have – because I just looked through all these. We have a company that has a market cap of, say, $24 billion, but they’re having some near-term operational challenges. They, for example, would be on the list of criticized assets, just to give you an idea.

John Pancari:

Right. Okay. Got it. Thanks Clark. All right. Appreciate it.

Mike Mayo:

Just a big picture question. You stressed weak loan growth and I’m just wondering is that a sign the economy is not as strong as people think it is? I mean you’re in a lot of different states in the U.S. Or is it simply your commercial clients saying, "Hey, we want the borrowers going to wait for rates to drop"?

Mike Mayo:

Okay. So this is more concern among the decision makers about what’s their ultimate cost of capital due to the volatility in rates than it is some underlying, hey, we’re going into a recession right now.

Mike Mayo:

Okay. All right. Thank you.

Operator:

And at this time, there are no further questions in queue. Please continue with your closing remarks.

Operator:

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect.

Clark Khayat - Chief Financial Officer:

Vernon Patterson - Executive Vice President, Investor Relations

[Call Starts Abruptly]:

I would now like to turn the conference over to Chris Gorman, KeyCorp's Chairman and CEO. Please go ahead.

Clark Khayat:

Thanks, Chris. I would echo your comments on Vern and a warm welcome to Brian as well. I am now on Slide 5. For the fourth quarter, net income from continuing operations was $0.03 per common share, down $0.26 from the prior quarter and down $0.35 from last year. Our results this quarter were impacted by three items totaling $0.22 per share, first, $190 million from an FDIC special assessment, second, $67 million from an efficiency related expense, and third, $18 million from a pension settlement charge, for a total of $275 million pre-tax or $209 million after tax. A breakdown of these items can be found in the last page of our slide presentation. Our fourth quarter results were generally consistent with the guidance we provided last month. As expected, we saw stability in the non-interest income line this quarter and our net interest margin increased by 6 basis points relative to the third quarter as we began to see some early benefits from our swap and treasury portfolios. Fees declined 5% sequentially on the better end of the range we provided last month. Expense growth was primarily attributable to the three items I mentioned. Without these items, expenses would have been relatively stable compared to the third quarter. Net charge-offs as a percent of loans remained low at 26 basis points and we added $26 million to our allowance for credit losses to reflect some modest migration of the portfolio, primarily in real estate and the still uncertain macro outlook. Additionally, as Chris highlighted in his remarks, our results reflect our focus on primacy and building relationships, our improved capital position and our strong risk discipline. Turning to Slide 6. Average loans for the quarter were $114 billion, down 3% from both the year ago period and prior quarter. The decline in average loans was primarily driven by a reduction in C&I balances, which were down 4% from the prior quarter. The reduction reflects our planned balance sheet optimization efforts, which prioritize full relationships and deemphasize credit only and non-relationship business. We reduced risk-weighted assets by $4 billion in the fourth quarter and as Chris mentioned, by approximately $14 billion in 2023. The majority of the decline in risk-weighted assets this quarter was from lower loan balances with some reduction in unused commitments also contributing. We would expect modest RWA reductions in the first half of 2024. Turning to Slide 7, Key's long-standing commitment to primacy continues to deliver a stable, diverse base of core deposits for funding. Despite a year of market volatility, we grew period-end deposits year-over-year by $3 billion and average deposits were relatively stable compared to the year ago period and prior quarter. On a sequential basis, commercial deposits grew 4%, which we attribute primarily to seasonal build and consumer deposits grew 1%. The increase in commercial and consumer deposits was mostly offset by a $2 billion decline in broker deposits on average as we continue to improve the quality of our funding mix by growing core relationship balances and reducing reliance on wholesale funding and broker deposits. Since the end of the first quarter, we generated almost $13 billion of liquidity by reducing loans and growing relationship deposits and reduced wholesale borrowings by $12 billion. Our total cost of deposits was 206 basis points in the fourth quarter and our cumulative deposit beta, which includes all interest-bearing deposits, was 49% since the Fed began raising interest rates, in line with our prior guidance of approaching 50% by year-end 2023. The higher rate environment continued to impact our deposit mix as our noninterest-bearing deposits declined by 1% sequentially to 22%. Pressure on deposit pricing appears to be abating across the franchise that we expect some mix shift to continue as long as rates remain high. Turning to Slide 8. Taxable equivalent net interest income was $928 million for the fourth quarter, down 24% from the year ago period and up slightly from the prior quarter. Our net interest margin was 2.07% for the fourth quarter compared to 2.73% for the same period last year and 2.01% for the fourth quarter the prior quarter. Year-over-year net interest income and the net interest margin reflect the impact of higher interest rates as increased cost of interest-bearing deposits and borrowings outpaced the benefit from higher year earning asset yields. Additionally, the balance sheet experienced a shift in funding mix from noninterest-bearing deposits to higher cost interest-bearing deposits. Relative to the third quarter, the increase in net interest income and net interest margin were driven by actions taken to manage key interest rate risk, elevated levels of liquidity and improved funding mix. The increase was partly offset by higher interest-bearing deposit costs, which exceeded the benefit from higher earning asset yields. While the planned reduction in loan balances adversely impacted net interest income sequentially, it benefited Key's net interest margin. Our net interest margin and net interest income continue to reflect the headwind from our short dated treasuries and swaps which together reduced net interest income by $345 million this quarter or by $1.4 billion for the full year and lowered our net interest margin by 77 basis points this quarter. As previously discussed during our third quarter earnings call, in October, we terminated $7.5 billion of received fixed cash flow swaps, which were scheduled to mature throughout 2024. Last quarter, we said that net interest margin would bottom and it did. Throughout 2024, we would expect continued benefit from the maturities of our short-term swaps and treasuries, especially as more mature in the back half of the year. Moving to Slide 9, non-interest income was $610 million for the fourth quarter of 2023, down $61 million from the year ago period and down $33 million from the third quarter. The decrease in non-interest income from a year ago reflects a $36 million decline in investment banking and debt placement fees, driven by lower syndication fees and M&A advisory. Additionally, corporate services income declined $22 million driven by lower customer derivatives trading revenue. The decrease in non-interest income from the third quarter reflects a $13 million decrease in other income, primarily driven by a gain on a loan sale in the prior quarter. I'm now on Slide 10. Total non-interest expense for the quarter was $1.4 billion, up $216 million from the year-ago period and up $262 million from last quarter. As mentioned, fourth quarter results reflect $275 million of impact from FDIC assessment, efficiency related expenses and pension settlement charge. Efficiency related expenses included $39 million related to severance and $24 million of corporate real estate rationalization and other contract termination or renegotiation cost. Excluding these items, expenses were relatively stable in the quarter and down compared to the year-ago period. We continue to proactively manage our expense base and simplify and streamline our business so we can continue to reinvest in all our businesses. Moving to Slide 11. Overall credit quality and our related outlook remains solid. For the fourth quarter, net charge-offs were $76 million or 26 basis points of average loans. This compares to $71 million in the prior quarter. Criticized outstanding to period end loans increased 50 basis points this quarter driven by movements in real estate, healthcare and consumer goods. While nonperforming loans and criticized loans continue to move up off their historical lows, we believe Key is well positioned in terms of potential loss content. Over half of our NPLs are still current. Our provision for credit losses was $102 million for the fourth quarter, including $26 million of reserve build, and our allowance for credit losses to period-end loans increased from 1.54% to 1.60%. Turning to Slide 12, we significantly increased our capital position throughout 2023. We ended the fourth quarter with common equity Tier 1 ratio of 10%, up 20 basis points from the prior quarter and up 90 basis points from the year-ago period. We remain focused on building capital in advance of newly proposed capital rules, while continuing to support relationship client activity and the return of capital. As such, we expect to stay above our current targeted range of 9% to 9.5% and do not expect to be buying back our stock in the near-term. Our AOCI position improved by $1.4 billion this quarter. The right side of this slide shows Key's go-forward expected reduction in our AOCR mark based on two scenarios. The forward curve is December 31st, which assumes 6 FOMC rate cuts in 2024 and another scenario where rates remain at their current levels. In the forward curve scenario, the AOCI mark is expected to decline by approximately 24% by the end of 2024 and 34% by the end of 2025, which would provide approximately $1.8 billion of capital build through that time frame. In the flat rate scenario, we still achieved 90% of that benefit between now and year-end 2025. Said differently, we still accrete $1.6 billion of capital rates remained flat to current levels, driven by maturities, cash flow and time. Slide 13 provides our outlook for 2024 relative to 2023. Given uncertainty regarding eventual timing and extent of Fed interest rate cuts in 2024, our guidance reflects outputs from a few potential scenarios ranging from the December 31st forward curve, which assumes 625 basis point cuts over the course of 2024, starting with an initial cut in March to a scenario more closely aligned with the Fed's dot plots, which currently assumes three rate cuts. We expect average loans to be down 5% to 7%, mostly reflecting the actions we have already taken over the course of 2023. In other words, the vast majority of the decline in average loans is a function of our reductions in 2023 and are reflected in our year-end balance. We expect period-end loans at the end of 2024 to be relatively stable compared to the end of 2023, with some decline in the first half of the year, offset by growth expected in the second half of 2024. We expect average deposits to be flat to down 2%. Net interest income is expected to be down 2% to 5%, mostly reflecting the lower fourth quarter exit rate relative for the first half of 2023. This equates to net interest income in 2024 that is up low-single-digits relative to our annualized fourth quarter exit rate. I'll provide more color on our net interest income outlook shortly. We expect non-interest income to be up 5% or better with upside if capital market activity normalizes and market levels and GDP trends remain constructive. Non-interest expense should be relatively stable at about $4.4 billion as we realize the benefits from our 2023 efficiency actions. We will continue to tightly manage our cost base, including executing on additional opportunities to simplify and streamline our organization. At the same time, we will continue to protect and invest in our franchise, including most importantly our people. As Chris mentioned, our guidance suggests moderate positive operating leverage in 2024, driven by meaningful expansion in the second half of the year outpacing tough comparisons in the first half. For the year, we expect credit quality to remain strong and net charge-offs to continue to modestly increase to the 30 to 40 basis point range, still well below our over-the-cycle range of 40 to 60 basis points. Our guidance for our GAAP tax rate is approximately 20%. Turning to Slide 14. Given heightened investor focus on this topic, we wanted to provide a little more granularity than we have in the past, about the pacing of our net interest income opportunity as we move through 2024. Hopefully by now you're familiar with our well-defined net interest income tailwind as the impact of our short-term swaps roll-off and treasuries mature, especially in the back half of 2024. The ultimate opportunity remains largely unchanged at approximately $900 million. As a reminder, the benefit increases each quarter as more of the swaps roll off and treasuries mature, culminating in the full amount in the first quarter of 2025. So, this all builds quarter by quarter since the initial set of swaps came off the books in the first quarter of 2023. As we turn the page on 2023, we are nearing the halfway point of this journey. Since we're now through three full quarters, we're sharing a three-part view. First, on the left in light gray are the three quarters of benefit we've already realized. In total for 2023, that was approximately $85 million of additional income. The next four bars show the progression through 2024. As you see the value builds from each quarter's tranche and accrues in the following quarter. Each bar represents the value for the quarter. In other words, in 1Q '24, we expect to realize $78 million of additional net interest versus 1Q '23 from these positions. For 2024, we estimate the benefit to ultimately $500 million in total, which is the sum of the four quarterly bars. This would represent an increase of more than $400 million over the benefit received in 2023, which as previously mentioned was approximately $85 million. The final bar to the far right, which has been the main focus of this discussion over the last year or so is the first quarter 2025 number. This shows the benefit currently estimated for the quarter at approximately $220 million for essentially the entire swap and short-term treasury portfolios rolling off. Again, this is incremental to 1Q '23 and represents an annualized value of approximately $900 million. We believe the reinvestment of these fixed rate assets and swaps represents an outsize the opportunity for Key relative to our peers, but it's also important to remember that this is just one component that drives our net interest income outlook. On Slide 15, we provide other key inputs and assumptions driving our NII outlook, deposit betas, balances and mix, loan growth as well as seasonal factors. Putting this all together, we expect our first quarter NII to be down 3% to 5% from the fourth quarter. From there, we expect to grow and start to accelerate in second half of the year as the pace of swaps and U.S. Treasury maturities pick up meaningfully at nearly $5 billion in aggregate per quarter. From the fourth quarter of 2023 to the fourth quarter of 2024, we expect our quarterly net interest income to grow 10% plus and exit the year north of $1 billion. We would also expect the net interest margin to improve meaningfully to the 2.40% to 2.50% range by the end of 2024. This will put us on a strong trajectory as we enter 2025. With that, I will now turn the call back to the operator for instructions for the Q&A portion of our call. Operator?

Peter Winter:

Clark, a lot of good color on the net interest income with those slides. But can you just go into a little bit more detail about the moving parts to the net interest income opportunity and maybe some other factors that impacts your outlook. And then secondly, if you could talk about the quarterly NII progression, you gave us the first quarter down 3%, but clearly, it's going to be a pretty meaningful uptick in the second half of the year?

Peter Winter:

And just what are you expecting or assuming in terms of the forward curve and the timing of the rate cuts?

Peter Winter:

And then, Vern, congratulations on the announcement. It's just been a pure pleasure working with you and the investment community will be missing you.

Operator:

Next, we go to the line of Scott Siefers with Piper Sandler.

Clark Khayat:

Yes. Thanks, Scott. So, if you just go back and we've talked a little bit about this and it's overly simplistic to be clear. But if we took second, third and fourth quarter of '23 and put the impact of swaps and treasuries back in the margin, we'd be 281 to284 in those quarters, which we think is pretty reflective of what we've got right now and that's with this sort of oddly longstanding downward sloping yield curve. So, I think that range as we get into '25 feels like achievable and I think getting to that longer term three, probably needs us to have a more traditional upward slipping yield curve just that tends to accrue a little bit to all of our benefit on NIM. But I do think that 280 plus is pretty reflective of the underlying core ability of the business as it stands today.

Chris Gorman:

Sure, Scott. Happy to address that. So if you take what we just reported of $136 million specifically on the line you asked about investment banking and debt placement fees, that would annualize at about 5.44. Conversely, if you took sort of the business and removed 2021 and said that's an outlier, the traditional run rate is at least kind of $650 million. So, I think we have been conservative, and that's why we, when we gave guidance, we said non-interest income up 5 plus and then we put the qualifier upside of capital markets activity normalizes. We don't see it really normalizing until the back half of the year. However, it's an interesting phenomenon when the 10-year went above 5% and then came back down. As you can imagine, people started to transact. And so, we're seeing the beginning of it now, but yes, it's a conservative number. The other thing that's in that fee number is, you saw that we had a step down with respect to our derivatives and hedging income. A lot of that is tied to the balance sheet and as we go through 2024 and we get back to growing the balance sheet after going through our exercise on RWAs, you'll see that come back as well.

John Pancari:

First, congratulations, Vern. Best of luck. You're a legend. And Brian, welcome. Looking forward to working with you again. Question on the, a little bit more on the NII dynamics. Wanted to get your thoughts on, if we do see the cuts materialize as you had baked in your expectations, what type of deposit beta you expect is achievable on the initial cuts? And how would you think about accumulative on the way down? And what is factored into your net interest income outlook in terms of that beta?

Clark Khayat:

Yes. So maybe broadly, John, on the NII guide, we would expect some drift up, particularly in the first quarter on deposit pricing just as rates stay high. As Chris said, when the cuts come, I think a good way to think about that commercial book, as we've talked about the index nature of it, as Chris just referenced, is sort of kind of an almost automatic mid-teens beta on a cut, because of that how that index pulls through. So the question really is going to be what happens to the consumer book and how quickly can we move that. I think a 25 basis point cut with a kind of long waiting period. Does it provide a lot of opportunity to reduce? If we start to see bigger cuts or cut sooner or more rapid cuts that allows us to deploy those price reductions into the book. So right now, as I’ve said, we're really looking at kind of our view is more like the four cuts starting in the middle of the year. We think we'll probably have some stabilization, maybe a little a bit of consumer drift through that time period. And then we'll start to proactively move rates down. But given the timeframe and 2024, hard to say exactly what the beta will be on the way down for the year. But it's really going to pick up in '25. We'll see some benefit in '24, but on the consumer book, it's just going to lag a little bit. And candidly, that's just going to be as much a competitive function of competitive environment as anything else. But we are taking some actions in the consumer book today to prepare for cuts. We're not cutting rates, but preparing our franchise to be ready for that. And I think we'll be very proactive when that opportunity shows up.

John Pancari:

Got it. Okay. And then separately, on the credit front, can you give us a little bit more color on the 25% increase in nonperformers in the quarter? And maybe a little more color on the criticized asset increase? And I know your commercial real estate NPL ratio now is 6.9%. What was that last quarter? Was that the biggest increase in the nonperformers?

John Pancari:

And just one clarification, so it was primarily C&I related in terms of the NPA increase or CRE?

Operator:

Next, we go to the line of Manan Gosalia with Morgan Stanley.

Chris Gorman :

Sure. So, we are about where we need to be in terms of going through our whole portfolio. As we went through and we're looking and focused on RWAs, really was sort of in three buckets, and we actually went account by account. And I've often said that on a risk-adjusted basis, stand-alone credit properly graded can't return its cost of capital. And so we were extremely prescriptive across the entire firm of going through that. On top of that, we exited some businesses like vendor finance that, by the way, is a credit-only business. And then on top of that, there were certain areas where we were conservative in terms of our capital treatment, where we could actually reduce RWAs without, in fact, having any impact on NII. That process is really over. When I say the process is over, we will continue, obviously, to look through our portfolio. But in terms of really seeing the step down in RWAs, as you saw last year, $14 billion, that's behind us. And so as we look forward, Clark talked about sort of the lag from the starting point on loan growth. But as you know, we have the ability to generate loan growth here at Key. We've got a long history of that. We'll be back kind of focused on serving our clients. Now having said that, I personally have a view, everyone is sort of coalesced around the soft landing. I think inflation is still pretty sticky. I think there's a bunch of drivers out there. We're managing the business for a short recession in 2024. And obviously, that goes into our thinking, because if you think about working capital in the context of a shrinking economy, that shrink some loan demand. The other thing that we have to grow through, and this is by design, is we're going to have $3 billion of runoff in our consumer business. I hope that helps kind of on the puts and takes. When there's business to be done from a loan perspective, I'm confident that we can get it.

Manan Gosalia:

That's very helpful. And then for my follow-up, as we look out into 2025, there's a lot of puts and takes here on the NII side. But what's the most optimal rate environment for Key? Is it six rate cuts and then an upward sloping yield curve, is that the most optimal environment? Or would you rather see a higher short-end rate and a flatter yield curve?

Operator:

And our next question is from Erika Najarian with UBS.

Clark Khayat:

Yes. So thank you, Erika. Good question, as always. So the decline in the first half, again, is the continuation of some actions we took to manage RWAs last year. So again, relationship -- non-relationship and credit-only related clients coming down. We don't have anything factored in at the moment around RWA management related to credit-linked notes. As you and I have talked about before, we're doing our homework to understand those opportunities, but it's not part of the guidance at the moment. Really, it would be that loan reduction, and that will put a little bit of pressure on first quarter, as will the fact that rates remain high in the first quarter under almost any cutting scenario, and we'll have a little bit of beta drift. So that's really the first quarter pressure. But I think your point about kind of a clean balance sheet entering the second half is the right one. And I think, again, we're suggesting kind of a tepid recession kind of mid to late year and if that doesn't come through, and we see a more constructive economic environment, I think there's some opportunity to grow loans. But I do think as we progress through the year, you'll see NIM expand, you'll see NII grow nicely and you'll see the balance sheet, I think, on the right trajectory.

Clark Khayat:

Yes. So the second one, Erika, is easy. We've -- I think we've provided that breakout before we'll deliver it. That's not a problem at all. On the first, I think, look, it's a fair point because not all of those commercial deposits are contractually indexed. So, I think that's the right question. There's always a little bit of -- it’s easy to negotiate with the client when you're giving them rate, and it's a little bit harder when you're taking it away. But I would say, our view is while it may not perfectly pull through, we have spent a lot of time with these clients. We've been in front of them, probably more than we would care to admit over the last year, but in a way that I think we have a good understanding of how those dynamics would work. And we expect that the component of what we think is our indexed will come through. And just as a reminder, the -- when we say indexed, it's not all 100% index. So there's a range of that. So bringing a client down is indexed kind of 50% doesn't feel as challenging to negotiate than somebody who's coming down at 100% plus. And so the book is pretty broadly distributed across 20% to 100%, and we're going to actively engage those clients to make sure we can manage the book appropriately.

Vernon Patterson:

Thanks, Erika.

Matt O'Connor:

Just a quick clarification. The fee guidance of 5%, you walked through a lot of detail on that on banking. Does that assume the 4Q annualized level, the kind of up $100 million more normal level or somewhere between?

Operator:

Next, we move on to the line of Gerard Cassidy with RBC.

Chris Gorman:

Sure. It's a great question, and it's developing quickly. So principally, they are customers of ours, and let me explain what I mean by that. As you well know, we distribute 80% of the capital we raised. So we are distributing, all the time, a lot of paper to these private debt funds, and it's an important part of our underwrite-to-distribute model. As we've said many times, for banks, a stand-alone properly graded credit can't return its cost of capital. That is not the situation for the private debt funds. They have the benefit of leverage on leverage. We have to be a relationship bank. We have to be able to provide all of the payments capabilities, all of the capital markets capabilities. And that's actually an opportunity for us because I think what you'll see is as these private debt funds continue to grow, they'll need to partner with banks and they'll want to partner with banks that have sophisticated capabilities around things like payments and capital markets, but don't necessarily want to hold on a risk-adjusted basis, paper that doesn't return, it doesn't hurdle. So, I look at it, frankly, as an opportunity for us. I think we're well positioned for that.

Chris Gorman :

Well, we don't have a lot of exposure because you'll remember, Gerard, we exited a lot of these what we call gateway cities, probably 5 years ago based on affordability, based on cap rates. But we do have a fair amount of insight in that we have this third-party commercial loan servicing business. And we are the named special servicer on over $200 billion of loans. And in that area, 44% of what's in active special servicing, which is really what's in workout is office. But the fastest-growing segment over the last quarter was, in fact, multifamily in some of these gateway cities. So we're not seeing it in our portfolio because it's not an area of focus, but we are picking it up through for the reconnaissance we get through our third-party commercial loan servicing business. Just one little add-on to that, that I think the group might find interesting that I did when I was talking to the leaders there. Actually, what is in special servicing is down -- we had a record year in 2023, as you can imagine. What is in active special servicing actually ticked down, which I think is just an interesting data point for all of us that kind of follow the market.

Chris Gorman:

Well, fortunately, I wasn’t around for that, but I’m sure Vern will be happy to sign it for you, Gerard.

Mike Mayo :

Well, Chris, one of your competitors' CEOs said scale has never been more important and that competitor is larger than you are. And so pulling back the lens, how do you think about scale and how it's changed in the past year? And I have two specific questions before you give that broader answer. What percent of the value of commercial relationship is from the deposits? That's a specific number. And then what percent of the revenues that you get from your typical commercial relationship is fee-based versus lending-based, because I think that gets to the larger value proposition of Key?

Mike Mayo:

Yes. I mean I think this kind of goes to the stickiness of corporate deposits and how that's changed over the past year. And you answered the question of fees. How much of the value of your commercial relationship is deposit driven and you have the cash from treasury management and other services that you provide corporate treasurers, is that still sticky? And is that like 20%, 30%, 50% of the value, as some have said? And then just another follow-up is just what does all your thinking mean about acquisitions, if and when the unrealized securities losses go down for you and the targets? Are you looking to be in that game or not?

Operator:

Next, we go to Steven Alexopoulos with JPMorgan.

Clark Khayat:

Yes. So, a couple of questions in there, and thank you for acknowledging no normal environment has existed. But the structural piece, I would say, Steve, relative to Key over the last 20 years, but particularly going into the crisis, would be, I think the loan book profile is quite a bit different. So if you think about the quality of the borrowers, the 55% of C&I being investment grade, the structural differences in our CRE portfolio, the largely residential real estate, collateralized kind of super prime consumer, all of those things kind of lean you towards a little bit lower base NII just because of the quality of that portfolio.

Clark Khayat :

I mean, yes, card, which we have, but it's highly transactor based versus balance based. Now given that, you would expect credit losses to be better, and we think they will be certainly better than us historically, but you would expect better on a relative basis. And your other question would be, okay, how do you monetize those clients to make sure that you're getting the right returns and getting business on it. We think we do that really well in the commercial business. We think we're doing that better and better as you go down market in commercial with things like payments, and we think we're getting much better on wealth and building the wealth business and the consumer space. So we think we're building those capabilities and have the opportunity to do that. But I do think if you look back over time, there's probably a base structural nature of NII that's a little bit lower, given the quality of the portfolio. And that's very intentional. You've heard Chris talk about that at length. We have been tight on expenses. We've been doing that largely to maintain our ability to invest. And the short answer is hard to predict exactly what we do. I think it's a function of how much expansion do we see, how much investment capacity does that create? And frankly, how much high-quality investments are there in front of us. Our first investments are always going to be good clients and our people. And then in this world, you've got to continue to invest in technology. I actually think on an infrastructure basis, we've done a really good job over that -- on that over the last decade, and we'll continue to do that. But we're going to continue to make sure that we can invest and build the franchise the way we need to, to be competitive.

Steven Alexopoulos:

Got it. Okay. If I can ask one other question. So, Chris, it's interesting to hear you're so bullish on credit. I say that because if you listen to every other person they have on CNBC, all they point to is all this pressure coming on commercial real estate to a regional bank like you guys. Can you just say to the investors that are on the line right now, what's happening? I mean you had commercial real estate loans come up for renewal in the fourth quarter. I know you don't have a large office portfolio, but I'm sure some of them came up for renewal. What's happening? Are you able to renew because the LTV, like you said, was 60%? You've got a higher cap rate, they're getting renewed. There's a perception that it's nothing more than extend and pretend and you're just -- the banks are just kicking the can down the road. So I'd love to hear your view on what's now happening as these loans are coming up for renewal?

Steven Alexopoulos:

Got it. May be unique, but still nonetheless, not the overhang that maybe some are being led to believe.

Operator:

Next, we go to Ken Usdin with Jefferies.

Chris Gorman :

Thanks for the question, Ken. Whenever I'm talking to our team, I tell everybody, we're all risk managers. We're all responsible for revenue, and we're all responsible for managing expenses. We're spending, as I mentioned, about $1.1 billion a quarter. There are always things that we can do better to create the raw material to continue to invest. And in our business, unfortunately, the real cost is people. And if you look point-to-point, we have 1,369 less people on the team today than we did a year ago. And obviously, that will pull through. There's also -- you also get a big pickup when you exit businesses like we did in vendor finance, where you can take out front, middle and back office. So we did a lot of the heavy lifting, Ken, last year. I don’t see that level of heavy lifting continuing, but it’s something that we just have to stay after every single day. Thanks for the question.

Bill Carcache :

I was hoping you could give some color on the sentiment you're hearing from your clients for the soft-landing scenario to play out. It seems like we would need to see the disinflation trends, not just continue from here, but there would also need to be a reacceleration in loan growth. And I guess maybe first, do you agree with that? And if so, how likely do you think we are to see loan growth reacceleration from here based on what you're seeing and hearing from your clients?

Bill Carcache :

Understood. Very good. That's very helpful. And let me also add my congratulations. Vern, all the best and looking forward to working with you as well, Brian.

Chris Gorman :

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. Have a good day all.

Operator:

Good morning, and welcome to KeyCorp's Third Quarter Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to the Chairman and CEO, Chris Gorman. Please go ahead.

Clark Khayat:

Thanks, Chris. I'm now on Slide 5. The third quarter net income from continuing operations was $0.29 per common share, up $0.02 from the prior quarter and down $0.26 from last year. Our results were generally consistent with the guidance we provided for the quarter and we've affirmed the full year outlook we shared at our last earnings call. As Chris highlighted in his remarks, our results reflect the strength of our core business, focus on primacy, balance sheet optimization and our disciplined risk management. I'll cover each of these strategic focus areas in my remarks this morning. Turning to Slide 6. Average loans for the quarter were $117.6 billion, up 3% from the year-ago period and down 3% from the prior quarter. Total loans ended the period at $115.5 billion, down $3.5 billion from the prior quarter. The decline in average loans was driven primarily by a reduction in C&I balances, which were down almost 4% from the prior quarter. The reduction reflects our balance sheet optimization which prioritizes full relationships and deemphasizes credit-only and non-relationship business as we prepare the balance sheet for a Basel III endgame rules. The reduction in loans contributed to the decline in risk weighted assets representing roughly half of the RWA decline this quarter. RWAs were also impacted by our optimization efforts to which we were able to apply more attractive capital treatment to existing portfolios. Importantly, this allowed us to manage RWAs proactively while minimizing impacts in net interest income. Turning to Slide 7. Key's longstanding commitment to primacy continues to support a stable, diverse base of core deposits for funding. This quarter, average deposits totaled $144.8 billion, relatively stable from the year-ago period and up nearly $2 billion from the prior quarter. The increase in average deposit balances from the prior quarter was driven by an increase in both consumer and commercial deposit balances. Importantly, we've continued to improve the quality of our funding mix by growing core relationship balances and reducing wholesale and broker deposits. This quarter, broker deposits declined by $2.6 billion on average and $3.2 billion relative to period end balances. At the end of the quarter, we took advantage of our improved funding profile and called $1.2 billion of outstanding bank debt for redemption. We expect to redeem the debt at the end of October. Our total cost of deposits was 188 basis points in the third quarter and our cumulative deposit beta, which includes all interest bearing deposits, was 46% since the Fed began raising interest rates in March 2022. Higher interest rates resulted in the continued deposit mix shift this quarter. We've seen this mix shift slow and we are testing reduced rates in certain markets. We did not deploy higher rates in our retail business against the July interest rate hike. We continue to expect that our cumulative deposit beta will approach 50% by the end of the year. Turning to Slide 8. Taxable net interest income was $923 million for the third quarter, down 23% from the year-ago period and down 6% from the prior quarter. Our net interest margin was 2.01% in the third quarter compared to 2.74% for the same period last year and 2.12% for the prior quarter. Year-over-year, net interest income and the net interest margin were impacted by higher interest bearing deposit costs and a shift in funding mix to higher cost deposits and borrowings. Relative to the second quarter, the decline in net interest income reflects a planned reduction in earning asset balances from our balance sheet optimization efforts and higher interest bearing deposit costs. Our net interest margin and net interest income continue to reflect a headwind from our short-dated treasuries and swaps. Our swap portfolio and short-dated treasuries reduced net interest income by $370 million and lowered our net interest margin by 80 basis points this quarter. We believe that NIM bottomed in the third quarter as we see continued benefit from maturity of swaps and treasuries. Consistent with our previous comments we expect that we are at or near the bottom on NII. In the third quarter, we executed $6.7 billion of spot pay-fixed swaps. In October, subsequent to the quarter end, we terminated $7.5 billion of received fixed cash flow swaps which were scheduled to mature throughout 2024. The swap termination locked in the AOCI position of those swaps, which will amortize throughout 2024 on the original maturity schedule. This should have no impact to our AOCI position at the end of 2024, but will guard against future hikes or reduction in rates that is slower than the forward curve predicts. These actions along with the planned maturity of our short-term treasuries make Key less liability sensitive, protect capital and reduce our exposure to higher rates. Turning to Slide 9. As Chris mentioned earlier, our balance sheet positioning, which has been a near-term drag on earnings, represents a clear and well defined opportunity. Based on the forward curve which continues to adjust to higher levels, we project an annualized net interest income benefit of approximately $1 billion from the maturities of our short-term treasuries and swaps by the first quarter of 2025. We'll continue to take a measured but opportunistic approach to lock in this benefit. Moving to Slide 10. Noninterest income was $643 million for the third quarter of 2023, down $40 million from the year ago period and up $34 million from the second quarter. The decrease in noninterest income from the year-ago period reflects a $23 million decline in corporate services income due to lower customer derivatives trading revenue. Additionally, service charges on deposit accounts declined $23 million driven by the previously announced and implemented changes in our NSF/OD fee structure and lower account analysis fees related to interest rates. The increase in noninterest income from the second quarter reflects a $21 million increase in investment banking and debt placement fees and an $18 million increase in other income from higher trading income and a gain on a loan sale. I'm now on Slide 11. Total net interest expense for the quarter was $1.1 billion, up $4 million from the year-ago period and up $34 million from last quarter. Compared to the year-ago quarter, computer processing expense increased $12 million driven by technology investments and personnel expense increased $8 million driven by higher salaries and employee benefits partially offset by lower incentive and stock-based compensation. The increase in expenses relative to the prior quarter was driven by personnel expense, which increased $41 million from incentive and stock-based compensation, a majority of which was from production-related expenses and a higher stock price at the end of the quarter. As we continue to proactively manage our expense base and simplify and streamline our businesses, this will improve the client experience, reduce complexity in costs and provide flexibility to continue to invest for the future. Our goal, as expressed previously, is to again keep core expenses flat in 2024. We expect to have additional efficiency-related expenses in the fourth quarter connected with these efforts. With that complete, we would estimate those charges to be in the range of $50 million. We'll provide full 2025 guidance during our fourth quarter earnings call. Moving now to Slide 12. Overall, credit quality and our related outlook remain strong. For the third quarter, net charge-offs were $71 million or 24 basis points of average loans. While non-performing loans and criticized loans continue to move up from their historical lows, we believe Key is well positioned in terms of credit migration and potential loss content. Our provision for credit losses was $81 million for the third quarter and our allowance for credit losses period-end loans increased from 1.49% to 1.54%. Turning to Slide 13. We ended the third quarter with a common equity Tier 1 ratio of 9.8%, up 50 basis points from the prior quarter and well above our targeted range of 9% to 9.5%. Going forward, we expect to stay above our current targeted range. We will determine and share any changes to that targeted range once the new capital rules are finalized. We will remain focused on building capital in advance of newly proposed capital rules and continue to support client activity and the return of capital. We do not expect to engage in material share repurchase in the near term. The right side of this slide shows Key's expected reduction in our AOCI mark. The AOCI mark is expected to decline by approximately 27% by the end of 2024 and 39% by the end of 2025, which will provide approximately $2.5 billion of capital build through that timeframe. During the third quarter, the AOCI position decreased by $500 million in structural burn down. The increase in rates, specifically in the five-year timeframe, increased the position by approximately $1.1 billion, which resulted in a net change of $600 million. Importantly, only 10% of our projected $2.5 billion of AOCI reduction between now and 2025 is driven by the benefit of lower rates represented in the current forward curve. Said differently, more than 90% of this reduction will occur even if rates remain flat to current levels driven by maturities, cash flows and timing. Given the proposed capital rules, we believe our reduction in AOCI marks along with our future earnings and balance sheet management would allow us to organically accrete capital to the required levels. Slide 14 provides an outlook for the fourth quarter relative to the third quarter as well as the full year compared to the prior year. Our guidance uses the forward curve as of September 30, which holds Fed funds flat at 5.5% through August of 2024 ending 2024 at 5%. Balance sheet trends are tracking as anticipated. We expect average loans to be down 1% to 3% in the fourth quarter versus the prior quarter as we continue to optimize our balance sheet and recycled capital to support relationship clients. We expect average deposits to be relatively stable in the fourth quarter. Our outlook assumes a cumulative deposit beta approaching 50 by year end. We also expect to continue to improve our funding mix and liquidity. On a linked quarter basis, net interest income is expected to be relatively stable in the fourth quarter changed from our previous guidance of flat to down 2%. Our guidance for noninterest income has changed to up 1% to 3% reflecting stronger fee income in the third quarter compared to the fourth quarter. Our full year outlook for fees remains unchanged. Noninterest expense is expected to remain relatively stable in the fourth quarter, excluding the potential FDIC special assessment charge, additional efficiency-related expenses and an expected pension settlement charge of $15 million to $20 million. We expect credit quality to remain solid and net charge-offs to average loans to be in the range of 25 to 35 basis points in the fourth quarter below our expected over the cycle targeted range of 40 to 60 basis points. Guidance for fourth quarter GAAP tax rate is 18% to 90%. Once again, our full year outlook for 2023 versus the prior year has not changed. We feel competent in the foundation of our business and in our strategic efforts to strengthen capital and liquidity, manage risks and improve earnings. With that, I'll now turn the call back to the operator for instructions for the Q&A portion of the call. Operator?

Scott Siefers:

Good morning, everyone. Thanks for taking the questions. So great news that we kind of hit the low on the margin and are at or near the bottom on NII. I guess I'm curious. Does that outlook contemplate any further risk weighted asset reductions that might be outside the scope of the 10 billion you've articulated for this year? And I guess along those lines, do you see a need to do anything beyond what you'll do this year? It looks like you're kind of ramping up the capital base more quickly. So how are we thinking about overall balance sheet size within the scheme of bottoming a NII trajectory?

Scott Siefers:

Okay. Perfect. That's good. Thank you. I did have an expense question. I think you largely hit it in there. So I'll refrain from asking about that one. I guess maybe a broader question though. Clark, I think you talked about a 3% margin in a normal environment. I think that's still well above what would be implied by the extra 1 billion or so of benefit through next year. So maybe just sort of top level, what else would have to happen to get you there? How are we sort of thinking about that, that 3% normalized margin?

Scott Siefers:

Okay. Perfect. All right. Thank you guys very much.

Erika Najarian:

Hi. Good morning. I guess my question was on the RWA mitigation. So I'm going to follow up in terms of Clark's answer to that question. So you're pointing us to the 10 billion as the right area, which is a lot, it’s a lot of RWA to take out. And I guess I'm wondering, number one, could you give us a sense of how much has already been taken out and what's to come? And second, as we think about the net interest income trajectory for next year, there's a comment of the NII bottoming about here or in the fourth quarter, consider the cost of the RWA mitigation that you have left?

Erika Najarian:

Got it. And, Chris, I guess the follow up to there is, Basel III endgame clearly gives the banks time. And as you mentioned, the moves that you're making in terms of improving the margin, being mindful of balance sheet size, being mindful of the expense base, the target would be to improve CET1 generation from here. I guess how do you balance the notion of, okay, we have this 10 billion of RWA reduction, check, that's done, and potentially we're ready to be a little bit more aggressive in the market or not. You told me, one of your peers said that they're ready for loan growth next year versus the notion of with U.S. Bank being freed from its Category II commitments, whenever everyone runs a data on adjusted CET1, Key sort of ends up at the bottom of the list. So how do you balance in terms of running the bank day to day, right, versus how your investors are thinking about KeyCorp in sort of this new world order for regulation?

Erika Najarian:

Thank you.

Peter Winter:

Good morning. You guys mentioned that capital markets should be up in the fourth quarter. But I was just wondering, just between higher rates and the geopolitical risks, just how you're thinking about the outlook for capital markets over the medium term?

Peter Winter:

Got it. And then, Chris, if I could ask about the dividend? You have 70% plus payout ratio. Can you just talk about your commitment to maintaining that dividend? And is there any risk that you could be forced to cut the dividend?

Operator:

And the next question will come from Ken Usdin from Jefferies. Please go ahead.

Clark Khayat:

Sure. So just to be clear, on that page, Ken, you'll see an incremental 6.7 billion of pay-fixed swaps. Those were put on to provide some AOCI protection to higher rates. And then the termination of the 7.5 billion of 2024 pay-fixed swaps that we've been obviously talking about now for a couple of quarters. Also done really to guard against higher rates or the prospect of higher rates or as we said kind of rates that remain higher than the forward curve, which is relatively flat down through '24, but has some cuts in the back end. So anything that's sort of there or higher we'll get some protection from both of those positions. I would think about in terms of reducing our kind of NII at risk to higher rates kind of by half to a staged 200 basis point rise, so kind of an extreme scenario, but we're kind of reducing that liability sensitivity there just to protect both capital and earnings.

Clark Khayat:

So if I think about the NII fourth versus third, Ken, the swaps and treasuries maturing, which we've talked about and think about, like, if rates don't change, the swap terminations won't have a huge impact versus what we've already shared. It's really protection against rates going up. The payers will add a little bit of NII because we're picking up a little bit of incremental positive carry there. And then you'll see the benefit of a pull through in the quarter of lower wholesale borrowing.

Clark Khayat:

And then all that incorporates I think this was, sorry, implicit or maybe explicit in your question, it all incorporates RWA reduction and the loan reduction specifically that we talked about.

Clark Khayat:

Yes. So we're seeing about anywhere, just call it roughly $1 billion of cash flow per quarter, coming out of that book. We've used some of that sort of through the course of this year as cash and just short-term liquidity just given some of the things that have happened. You'll see us start to deploy that back into the portfolio in a variety of different ways, but really focused on bringing the duration of that overall portfolio down.

Operator:

Thank you. And the next question is from Gerard Cassidy from RBC. Please go ahead.

Chris Gorman:

Hi, Gerard.

Chris Gorman:

Thanks for your question. Unfortunately, I think because there's excess capacity in the loan market in general, I don't think you're seeing the kind of increase in spreads that you would expect to see at this point in the cycle in the private loan market. And I don't think you're seeing, frankly, some of the changes that you would expect to see broadly in terms of structure. So I think -- as you know, I've said many, many times on a risk adjusted basis, a properly graded standalone credit rarely returns its cost of capital. So if I'm right about that, by definition a lot of that stuff in my opinion is underpriced. Now the other thing that we are seeing, obviously, and we have great visibility in, is our third party commercial loan servicing business where we have over 640-some-odd-billion that we service, but we have over 200 billion that is special servicing. So that's where we're servicing, basically, where the workout [ph] agent for very complex deals that we're not a part of. And that business has already set a record for the year at this point in the cycle. So that gives you a little bit of an insight into what's going on out there. Clark, would you add anything to that?

Gerard Cassidy:

Very good. Thank you for those insights. And then as a follow-up question, Clark, on the hedging strategy, you've given us a lot of detail. And we all acknowledge forecasting interest rate is very difficult. In fact, I find it very interesting. If you go back to the Federal Reserve's June 21 dot's forecast for the Fed funds rate, at the end of '23 they were forecasting a 0.625 Fed funds rate. They missed it by 500 basis points. So my question for you guys, the long tail risk, what is that for next year? Everybody sees, you've been very clear about the benefits by the net interest income on an annualized basis first quarter '25. Everybody sees that. What could go wrong? Or what's that long tail risk that we need to just keep our eyes on or you guys are keeping your eyes on?

Gerard Cassidy:

And Clark, on the comment about rates coming down more rapidly, which is a good way -- I'm glad you guys are thinking about that, though it doesn't seem likely. But if it did happen, would your funding costs, your deposit rate you think, would they fall as quickly as what would happen on the asset side of the balance sheet from your guys' experience or would they lag?

Gerard Cassidy:

Great. Thank you so much.

Operator:

The next question is from the line of John Pancari from Evercore. Please go ahead.

Chris Gorman:

Good morning.

John Pancari:

On the only expense outlook, just wanted to [indiscernible] a little bit more color. I know third quarter came in a little bit above expectations, and some of that is on fee revenue. But as you look at fourth quarter and your flat expectation for 2024, can you maybe talk about the puts and takes there, like, what are some of the areas where you could see pressure? And where do you really see an opportunity to pull back and keep the number stable? Thank you.

John Pancari:

And in that real estate rationalization and the third party contracts, are they the main areas of opportunity as you look at 2024 as well?

Chris Gorman:

John, it's Chris. We will continue to work across the board of all of these things. We’re down from an FTE perspective in the last year, about 900 people, teammates. And so as we continue to focus on simplifying our business, streamlining our business being a smaller, simpler, more profitable company, a lot more to say on that as we wrap up the fourth quarter.

Chris Gorman:

So we've never given numbers around the SNC book. Everyone obviously just got their SNC results. And I can tell you in all my time in this business, our results were the absolute best we've ever had. But we've never disclosed the numbers in terms of dollars or amounts.

Chris Gorman:

No, we really -- it's just something that we haven't disclosed on in the past. But as I said, we just got our results back, John, and just very, very pleased with them.

Operator:

The next question is from the line of Manan Gosalia from Morgan Stanley. Please go ahead.

Chris Gorman:

Good morning, Manan.

Chris Gorman:

So it's a great question. When I was answering Erika's question -- it's Chris. When I was answering Erika's question, we're not going to be leaning into RWA reduction in the manner that we have this year. But make no mistake, we will continue to go through every portfolio we have and rationalize our RWAs because that's the raw material for us to also be expanding our client base. So we're not done on the RWA side. The point I was trying to make is, at this point in the cycle, we're going to be doing both.

Chris Gorman:

Yes, good question. So historically, Manan, we would have been kind of 2 billion on any given day. I think we went as high as 11 or 12 this year in the kind of 6, 7, 8 range in the quarter. I think we would migrate that down to 4 to 5 over time. But your view on as treasuries mature, holding those in cash or a shorter duration, treasury portfolio is the right way to think about it.

Operator:

Thank you. The next question is from the line of Matt O’Connor. Please go ahead.

Clark Khayat:

I would think the range of kind of 4.4 billion, Matt.

Clark Khayat:

We said 15 to 20, in that range.

Clark Khayat:

Yes, that's just -- Matt, that's us just very critically writing our portfolio. There'd be a few categories in there, as we look through it. Transportation would be one, healthcare would be another. There's some consumer product type businesses there. But we take a fair amount of pride in -- and Mark Midkiff is here in the room with us really going through with a fine tooth comb. I don't think there's any additional lost content there. But at this point in the cycle, and you start looking at anyone that has floating rate debt, I think you need to look at that pretty critically. So that's really the genesis of it going from 3.3% to 3.9%.

Clark Khayat:

Thanks, Matt.

Ebrahim Poonawala:

Good morning.

Ebrahim Poonawala:

Just want to add a quick follow up, Clark, for you. So I guess going back to some of the discussion you had with Ken, when we look at the 46 million in NII that's going to come in from the roll off in the fourth quarter, your NII guidance is flat. So ex that 46 million, NII would be down 5% quarter-over-quarter. And I appreciate there are a bunch of moving pieces. As we think about the core level of NII beyond fourth quarter RWA optimization, depository pricing, like, what's your expectation for those deposits -- for NII, sorry? Does that NII hold flat or do you still expect that NII just on a core basis to drift lower?

Ebrahim Poonawala:

If we remove the lift from the Slide 9 that you have from the swaps and the treasury maturities, if we didn't have that, what in your view would NII do through the next few quarters?

Ebrahim Poonawala:

That's helpful. All I'm trying to get to is if you're at 920 million in the fourth quarter, the roll off should take that 900 million to 1.1 billion something in that vicinity. And I'm just trying to think what would be the mitigations to get into a 1.1 billion quarterly NII by the end of next year, but that was good color. Thank you. That's all I have.

Bill Carcache:

Thank you. Good morning, Chris and Clark. I wanted to follow up on the points you've made around the NII opportunity from repricing. There's a debate around the possibility that some of the upside from the repricing of the swaps and the securities could be offset by the need to further reduce RWA levels beyond that $10 billion level that you've highlighted. And I think you've talked around some of the surrounding points, but maybe if you could speak to that specifically, that'd be helpful?

Bill Carcache:

Understood. That is helpful. If I may ask separately, I wanted to ask if you have a -- feel like you have a good handle on key customers that had put on swaps when we were still in a low rate environment and are now going to be facing pressure from rates resetting higher? Is there any color that you can give on that dynamic? I know that credit metrics are very good. But I guess any color on that dynamic across your commercial portfolio? And to the extent that you feel that’s contemplated in the allowance that would be great?

Bill Carcache:

Understood. Thank you for taking my questions.

Operator:

Thank you. And the next question is from Steven Alexopoulos from JPMorgan. Please go ahead.

Chris Gorman:

Hi, Steve.

Chris Gorman:

So we'll give -- as we mentioned, we're going to give guidance with respect, Steve, to 2024 when we report our fourth quarter numbers, but we do feel the urgency to continue to do more on expenses. And just to remind you, we took out 200 million of expenses in the first quarter, which is about 4%. And we are actively right now, as I mentioned, simplifying our business. We're shrinking RWAs. We will come out with more detail in the fourth quarter. But yes, we do feel a sense of urgency to rationalize the cost base, particularly because, as I said, we're going to be a smaller, simpler company.

Chris Gorman:

We'll know more when we finish our planning for 2024, Steve.

Clark Khayat:

Sorry, Steve. It's Clark. Can you just be a little clearer? How does it change?

Clark Khayat:

Got it. I don't have that number in front of me. It's obviously up given where we're really sort of focused on the five year. So we have taken as we talked about some steps to at least mitigate that. But clearly when rates are moving at this magnitude, you can't cover all of it. So we continue to watch that closely. We managed TCE I think reasonably well in the quarter given some of those changes that you've talked about. But we're really focused on managing, assuming as Chris said to the contemplated new capital rules and timeframe making sure that we're in a position to get our capital the right level as things phase in and markets move and we'll take the steps that we need to take to be compliant with those rules.

Clark Khayat:

Sure. Thanks, Steve.

Chris Gorman:

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 at 216-689-4221. That concludes our remarks. Thank you again and have a good afternoon. Goodbye.

Operator:

Good morning, and welcome to KeyCorp's Second Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to the Chairman and CEO, Chris Gorman. Please go ahead.

Clark Khayat:

Thanks, Chris. I'm now on Slide 5. For the second quarter, net income from continuing operations was $0.27 per common share, down $0.03 from the prior quarter, and down $0.27 from last year, driven in part by two notable items. Our results included $87 million of additional post-tax provision expense in excess of net charge-offs or $0.09 per share as we continue to build our reserves. We also incurred $21 million of notable post-tax expenses or $0.02 per share. This includes severance costs, refunds on fees and related claims and a Visa, Class B fair value adjustment. Turning to Slide 6. Average loans for the quarter were $120.7 billion, up 11% from the year ago period and up less than 1% from the prior quarter as we continue to support relationship clients. Commercial loans increased 12% from the year ago quarter. Relative to the same period, consumer loans increased 7%. Compared with the first quarter of 2023, commercial loans grew 1%, while consumer loans remained relatively stable. Total loans ended the period at $119 billion, down $1 billion from the prior quarter. Continuing on to Slide 7. Key's long-standing commitment to privacy continues to support a stable, diverse base of core deposits for funding. Our total cost of deposits was 149 basis points in Q2 and our cumulative deposit beta was 39% since the Fed began raising interest rates in March 2022. We remain focused on balance sheet management with an eye toward minimizing the total cost of funds. Average deposits totaled $142.9 billion for the second quarter of 2023, down 3% from the year ago period and were relatively stable across the quarter, down approximately $500 million on average. Year-over-year, we saw declines in retail deposits, driven by elevated spend due to inflation, normalization from elevated pandemic levels and changing client behavior due to higher rates. The decrease in average deposit balances from the prior quarter reflects a continuation of the same trends. Regular seasonal outflows that we saw in April were more than offset in May and June. Deposits ended the period at $145.1 billion, up $1 billion from the prior quarter. Turning to Slide 8. Taxable equivalent net interest income was $986 million for the second quarter compared with $1.1 billion in the year ago and prior quarters, down approximately 11% against both periods. Our net interest margin was 2.12% for the second quarter compared to 2.61% for the same period last year and 2.47% for the prior quarter. Year-over-year, net interest income and the net interest margin were impacted by higher interest-bearing deposit costs, a shift in funding mix to higher cost deposits and growth in wholesale borrowings, which in part supported elevated cash levels. The decline in net interest income was partially offset by higher yield on loans and investments. Relative to the first quarter, our net interest margin was negatively impacted by 28 basis points related to higher interest-bearing deposit costs and 17 basis points from a change in funding mix and liquidity, partly offset by 10 basis points related to higher earning asset yields and earning asset growth. Our swap portfolio and short-dated treasuries reduced net interest income by $340 million and lowered our net interest margin by 73 basis points this quarter. Turning to Slide 9. As previously mentioned, Key has begun to benefit from the maturity of our short-dated swap book, and expects to begin to benefit more significantly from increasing swap and treasury maturities as we move forward. Based on the forward curve, we continue to expect a meaningful benefit, currently estimated at $900 million annualized in the first quarter of 2025. We have continued to take a measured but opportunistic approach to lock in this potential benefit, and this analysis includes the addition of hedging activity undertaken beginning in 4Q 2022 and since. We have not and do not plan to replace the swaps rolling off in 2023, instead allowing natural asset sensitivity of the loan book to come through and benefit from higher short-term rates. Moving to Slide 10. Non-interest income was $609 million for the second quarter of 2023, compared to $688 million for the year ago period and $608 million in the first quarter. The decline in non-interest income from the year ago period reflects a $29 million decline in investment banking and debt placement fees, reflecting lower advisory and syndication fees. Additionally, service charges on deposit accounts declined $27 million, reflecting previously announced and implemented changes in our NSF/OD fee structure and lower account analysis fees related to higher interest rates. The decline in non-interest income from the first quarter reflects a $25 million decline in investment banking and debt placement driven by lower advisory and syndication fees, partially offset by a $10 million increase in corporate services income, reflecting an increase in customer derivative activity. I'm now on Slide 11. Total non-interest expense for the quarter was $1.076 billion, down $2 million from the year ago period and down $100 million from last quarter. Compared with the year ago quarter, net occupancy expense decreased $13 million, reflecting a downsizing of corporate facilities and business service and professional fees decreased $11 million. These decreases were partially offset by a $17 million increase in technology expense and a $15 million increase in personnel expense, reflecting merit increases and higher benefit costs. Compared to the prior quarter, personnel expense decreased $79 million, reflecting lower incentive, stock-based compensation and severance. Additionally, other expense decreased $24 million in the second quarter as the first quarter included restructuring charges related to expense actions. Moving now to Slide 12. Overall credit quality remains solid. For the second quarter, net charge-offs were $52 million, or 17 basis points of average loans. Delinquencies across portfolio has remained relatively stable. Our provision for credit losses was $167 million for the second quarter, which as we have pointed out, exceeded net charge $115 [ph] million, or $87 million after tax. The excess provision increases our allowance for credit losses to 1.49% of period-end loans. Despite the increase in the allowance, our outlook for net charge-offs remains well below our through-the-cycle targeted level of 40 basis points to 60 basis points. Now on to Slide 13. We ended the second quarter with a Common Equity Tier 1 ratio of 9.2%, up from the prior quarter and within our targeted range of 9% to 9.5%. This provides us with sufficient capacity to continue to support our relationship customers and their needs. We did not complete any open market share represents in the second order being unmotivated to employee compensation, nor do we expect to engage into material share repurchases in the near term. We will continue to focus our capital and supporting relationship client activity and paying dividends. On the right side of the slide is the expected reduction in our AOCI mark. The AOCI mark declines by approximately 44% by the end of 2024, and 55% by the end of 2025. In alignment with recent public remarks from regulators, we expect that any changes will be implemented with an appropriate comments and phase-in period. Given that, our view is that for any new requirements or reduction in AOCI marks and, more significantly, our future earnings and balance sheet management would allow us to organically accrete capital to the required levels over the necessary period. Slide 14 provides an outlook for the third and fourth quarter of 2023. Third and fourth quarter guidance is given relative to each prior quarter respectively. Similar to our approach in the third quarter of last year, we have shifted our guidance to focus on quarterly results. This provides a clear view of trends heading into year-end using the forward curve as of July 1. Balance sheet trends are tracking mostly as anticipated. We expect average loans to be down 1% to 3% in both the third and fourth quarter versus the prior quarter as we continue to actively manage our balance sheet and recycle capital to support relationship clients. We expect average deposits to be relatively stable in both the third and fourth quarter versus prior periods. Our outlook assumes a cumulative deposit beta approaching 50 by year-end. On a linked-quarter basis, net interest income is expected to decline 4% to 6% in the third quarter and be flat to down 2% in the fourth quarter. As we drive more benefit from the repricing of our swaps and treasuries in 2024, we expect growth in both our net interest income and net interest margin. Our guidance assumes a Fed funds rate reaching 5.5% in the third quarter, remaining flat through year-end. 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. Non-interest income is estimated to be up 2% to 4% in the third quarter and up 4% to 6% in the fourth quarter versus prior periods, reflecting a gradual improvement in capital markets. Non-interest expense is expected to remain relatively stable in both the third and fourth quarters. We assume credit quality remains solid in net charge-offs to average loans to be in the range of 20 to 25 basis points in the third quarter and 25 to 35 basis points in the fourth quarter, both below our expected over-the-cycle targeted range of 40 to 60 basis points. Our guidance for the third and fourth quarter GAAP tax rate is 18% to 19%. Using our quarterly guidance, our full year outlook for 2023 versus the prior year would be the following

Scott Siefers:

Good morning, guys. Thank you.

Scott Siefers:

Hey, Clark I wanted to talk about the NII outlook. So the pace of NII degradation looks like it should slow considerably in the second half, the fourth quarter, especially. Maybe a little more color on the main factors you see that would allow that to happen. I know you sort of rationalize the beta expectation, and of course you've got the treasuries and swaps, but just curious to hear from your view, the sort of main factors in that outlook?

Scott Siefers:

Okay. That's extraordinarily helpful color. So I appreciate that. And I don't want to put words in your mouth, but in the aggregate, would your expectation be that NII ends up sort of bottoming around end of this year, maybe early next year, but then does see a more visible inflection back up as sort of the pricing dynamics weighing on funding costs, but you then start to get a more material and visible benefit from the swap and treasury maturities. Is that the best way to think about it?

Scott Siefers:

Okay. All right. Perfect. Thank you very much. I appreciate it.

Operator:

We'll go next to the line of Ebrahim Poonawala with Bank of America.

A – Clark Khayat:

Sure. So look, I think the biggest change as we've gone through the year has been the rate level. So given your commentary on sort of relatively stable rates, I think we feel very good about the trajectory we're sharing here. And I would say, overall, our deposit betas, I feel like, are very much in line with the peer group. We did some catching up because we outperformed last year, but I feel like that's very consistent with what's happening in the industry, and we just happen to have these specific headwinds right now on swaps and treasuries. But again, as those come off, we think we're prepared to get the benefit of that. So I would say that in the expected rate environment, our confidence would be good.

A – Christopher Gorman:

Sure. So that's a great question. And as you put them together, they are closely related. So if you just step back here, here's how we see the future as all the regs unfold. What's not going to change for us, Ebrahim, is we're going to remain focused on our relationship model. We're going to stay focused on targeted scale. But I think there's going to be incredible and intense scrutiny around the duration, the granularity, the composition of the deposit base, and that's one of the reasons that Clark talked about that we pivoted and made sure we protected our deposits, whereas we were kind of leading in terms of not having a lot of beta. Next gets to -- I think there's -- and this gets directly to your question. I think there's going to be a significant change in loan-to-deposit ratios. As you kind of run all this through your models and we run it through our models, I think loan-to-deposit ratios for Category 4 banks, if they're mid-80s now, they're going to be significantly less. And we are very focused on this. And so keep in mind, last year, we grew our loans kind of high double digits. I mean like around 19%, I should say, high teens. And then we were on a path to grow 6% to 9%, but that all happened in the first quarter before the events of March. And we not only stopped that growth, but actually pushed it back $1 billion by the end of this quarter, which I think is really, really important. And right now, what we're doing is we are scrutinizing every portfolio we have in the bank. I've always said that on a risk-adjusted basis, most loans -- most standalone loans don't return their cost of capital. And if you think about having to carry more capital and you think about the capital that you have being a lot more expensive, then you can rest assured there will be a lot of credit-only relationships that won't be strategic to us. So we'll preserve our capital for those relationships. As you know, we can do a lot with them. But we will be continuing to push down our assets. And you see in the guidance that Clark gave you, we're looking at average loans being down 1% to 3% in the third quarter and down 1% to 3% in the fourth quarter, we will hit that. So -- and then the second part of your question, which is also related, as we shrink the balance sheet, we're going to have to make sure that our expense base is rightsized for the future asset base of our company. And rest assured, we're looking at that as well.

Chris Gorman:

Sure. Well, the headline there is I am confident. But as a Board member, we spend a lot of time talking about strategy and talking about dividend policy. We manage the company for the long-term. And the dividend policy is no exception. Our capital priorities, as I just mentioned, are unchanged, is to support our clients, our prospects and to pay dividends. And to your point, last week, our Board did approve a $0.205 third quarter dividend. Keep in mind, over our history, we have paid out 80% very, very often. It's just been in the form of both buybacks and a cash dividend. So we're obviously paying close attention to that. I feel good about it. Let me talk a little bit about capital because it's so related. This -- in spite of some of the challenges Clark mentioned, this quarter, we grew capital. We paid a $0.205 dividend, and we built reserves. And so as we think about taking this long-term perspective, when you look at our normalized earnings power of our company, and that is the reversal of the NII headwind into a tailwind and also having a reasonable expectation around investment banking fees, the earnings power of the company is strong. We can build capital there. Clark mentioned the AOCI burn down, 44% by 12/31 2024, 55% by 12/31 2025. And then, as I just mentioned, this game plan that we have around risk-weighted assets will be important. And then the last thing that I think is really important -- and it's going to be important, I think, as the cycle continues to play out is we have a well-positioned credit book. And there's nothing that destroys capital faster and bigger hunks than having a bunch of credit losses. And so I put all those things together, we take a long-term perspective on the dividend. We feel good about it.

Chris Gorman:

Sure. Thank you. Ebrahim.

Ken Usdin:

Hey, guys. Just a couple of follow-ups on the loan side. Obviously, you said that your retaining a little bit -- you're back to kind of that upper teens point of your investment banking originations. And I'm just wondering, does that have any throughput in terms of the ability to generate business in the investment bank? And I guess connected just then, your confidence in the second half improvement in the investment bank, is that because you start – you're starting to see things get back out the door as opposed to keep on the balance sheet like you have been doing for the last couple of years?

Ken Usdin:

Got it. And just one more. Laurel Road, some cost factors there, too, obviously, with the debt moratorium and what happens there. But just as far as also being -- scrutinizing every incremental loan that you're making, just can you talk about the Laurel Road specifically, but how you're also thinking through that in terms of the other consumer portfolios.

Clark Khayat:

Yes. So I think largely, we're going to look to continue to distribute. I mean we do have capabilities now, where we distribute a lot of debt. We're going to expand that more consistently, I think, to the consumer side. The point I think on Laurel Road that Chris made that I just want to reiterate is we never acquired it to be a student loan only generator, that was kind of the headline. It was intended to be a full-service banking platform, and we continue to build toward that, and we think it's got some really unique. And differentiated capability around this income-driven repayment and public service loan forgiveness, and you may have seen some commentary out of the government in the past week around the IDR specifically and some of the complexities of that, which I think will accrue to our benefit over time. .

Clark Khayat:

Yeah. I think that's the right idea. I think we're also demonstrating more deposit growing capability there. And again, we're still relatively new in having those capabilities. But I think that's the right way to think about it. So, more of a fee advice and core banking generator than a loan shot.

Clark Khayat:

Yep.

John Pancari:

Good morning.

John Pancari:

Just going back to the $900 million on slide 9 of the NII pickup from treasury and swap maturities. So let me just ask it this way, aside from a change in the rate backdrop and your interest rate outlook, what could prevent you from realizing that? I know, there's a fair amount of investor skepticism around the ability of that $900 million to find its way into the numbers. From your perspective, how do you size up the risks? What are the -- the risk that you do not realize in that? What gets in the way? Is it more on the deposit side, or is it an asset side of the picture that could prevent that from being realized?

John Pancari:

Got it. Okay. All right. Thank you. And then separately, as you continue to exit the -- or as you're evaluating the non-strategic businesses and other optimization, just to confirm, any progress you make incrementally on that front that would be in addition, like to the guidance of a decline of 1% to 3% on the loan front? So, anything on the incremental optimization that would provide -- that would lead to potential incremental downside to those numbers.

John Pancari:

Okay. All right. Thank you.

Matt O'Connor:

Good morning. I want to follow-up on the kind of capital line of questions. I guess the first thing is a lot of your peers seem to be targeting 10% plus on the CET1. And obviously, there's capital proposals coming out. But I guess first question is what are your thoughts in terms of that 9% to 9.5% target moving closer to 10% to 10.5% like some of your peers?

Matt O'Connor:

Okay. And then in terms of the RWA optimization, is it possible to size that or give a range and the timing of when you'll get the benefit of that?

Matt O'Connor:

Okay. Thank you.

Operator:

We'll go next to the line of Manan Gosalia with Morgan Stanley.

Clark Khayat:

Yes. So, I think that we do have that, and you would have seen us do a little bit of that even here in the second quarter. So, I think your follow-on question around TLAC or long-term debt is the right one as well. And we'll wait, as Chris just mentioned, for the proposed and final rules. But we do think that reduction in loan to deposit over time gives us an opportunity to reduced reliance on wholesale funding.

Chris Gorman:

Sure. So, just from a CECL perspective, obviously, it's very forward-looking. In terms of what percentage is model-driven, what percent is kind of portfolio driven, I think you can assume it's kind of sort of half and half. And my assumption is that -- just to step back for a second. My assumption is that we will have -- I think the Fed is going to successfully engineer a soft landing. I think it will probably happen in 2024. Having said that, what I don't think is yet in the market is the impact of and also the impact of banks tightening down on credit. And I think both of those will have an impact on the economy. And as such, we're pretty conservative in terms of how we look at things. And so the first thing we always do is look at anything that is leveraged and anything where the cash flows could be in any way impacted by a slowing economy. So that's kind of the lens that we looked at it. There is nothing specific. There's nothing that we're particularly worried about. We kind of looked across all the portfolios.

Chris Gorman:

Yes. Right now, I feel like we have reserved what we need to reserve, for sure.

Operator:

Thank you. We'll go next to the line of Mike Mayo with Wells Fargo Securities.

Chris Gorman:

Yes, Mike, we can. Good morning.

Clark Khayat:

Yes, we would expect it to be relatively flat in the third quarter and then start to trend up.

Clark Khayat:

So I mean what I -- where I'd start there, Mike, is that if you look at the composition of our loan book in general, it is, in our view, higher credit quality, but higher credit quality comes generally with lower yields. So we have over 50% of our C&I book is investment grade, we have super-prime consumer books. So those are not going to carry the same rates broadly is something like credit card, which we have very little exposure to or personal consumer loans, which we have very little exposure to. So in that regard, we're starting probably structurally a little bit lower NII, but the counter to that is what we think is a higher credit quality book. So I'll have to go back through the specific math you have there, but -- and I'm happy to do that and talk about it offline. But I think that's at least a starting point. But we think, over time, NIM that starts with a 3 is not an unreasonable place for us to be.

Clark Khayat:

Not exactly. So the $900 million is annualized as of the first quarter of 2025.

Clark Khayat:

Correct.

Clark Khayat:

Well, I think, it's -- I mean, the obvious one right there is the 73 basis points that comes from swaps and treasuries. So that's what we're talking about. And betas, I think, getting -- or general rates and betas getting kind of more in line with historical averages, or overall funding costs. So as we just talked about, we have some opportunity to reduce some wholesale funding, which is obviously expensive, and we're still yet to see pull-through on loan spreads. So I think there's a variety of factors that could improve that, many of which we are either not experienced at the moment or haven't seen kind of broadly in the industry.

Chris Gorman:

Mike, I was just -- I mentioned this earlier in the conversation. It is based on my experience being around this business as long as I have. People will defer transactions for so long, but eventually sort of the logjam starts to break. I think we're starting to see it a little bit in the new issue equity business. And I've just been out talking to clients. And I think people that have put deals on hold now for 12 months, either these deals are going to start to happen, or they're going to move on and do something else. So, it's based on, one, just looking and scrutinizing the backlog. And then secondly, just more instinctive, as I'm out talking to people.

Chris Gorman:

Yes, for sure.

Chris Gorman:

Thank you, Mike.

Erika Najarian:

Hi. First question from…

Erika Najarian:

Hey. What was your adjusted CET1 in the quarter, including AOCI? And I presume at 9%, 9.5% CET1 target would be like your fully loaded target even after we get an NPR that would be inclusive of AOCI and CET1?

Erika Najarian:

Got it. So, my second question is for you, Chris. And I apologize if this sounds challenging, but this is sort of the big conversation that I'm having with long-term shareholders. Clearly, the stock price performance today is trying to price out some of the dividend fears that were in the market given where your yield is. And I think the big discussion I'm having with your investors is that, that 80% payout, right, that you mentioned and that happened for this quarter, it feels like three years ago sort of in the pandemic, you were getting the same question about the sustainability of your dividend. And it feels like at the end of the day, it's really the denominator that has been challenged. So, whether it's been expenses previously or steady having the balance sheet set up to have these received fixed rates that essentially imply a zero rate environment forever, it just feels like your efficiency ratio isn't just quite right and doesn't really reflect the potential of the business. So, as you think about the next three years, how are you -- what discussion are you going to have with your Board to have that earning -- the potential of your franchise really be reflected in your earnings power? I mean the NIM is the NIM, and I get the swaps. But like I feel like that -- gets wrapped up in the dividend conversation at the entire time, not necessarily because the dividend is an albatross, but it feels like that your earnings power is sensitive to vagaries of the macro?

Erika Najarian:

Got it. Okay. Thank you.

Operator:

And we'll go next to the line of Gerard Cassidy with RBC.

Chris Gorman:

Good morning.

Chris Gorman:

Sure. Well, thanks for the question. It's a great business – it's a great business because it generates a bunch of deposits through escrows, which are more important today than they ever have been in my career. It's also important because it's countercyclical. So for those of you that aren't as familiar with the business, we are the named special servicer when a large complex debt financing is put together. And so when you're the named special servicer, you get sort of what I would think of as sort of a ticking fee. And then if, in fact, it goes into default, and this is all off us real estate, we are the workout agent. And to Gerard's point, we just set for the second quarter in a row a record in terms of special servicing fees. And so I think that will continue. And this won't surprise you, Gerard, but more than two-thirds of what is in active special servicing is office. And I think that's going to continue. And I think office is going to be -- it's not going to be a challenge for Key because it's not an asset class we focus on. But I think office is going to continue to be a significant challenge.

Chris Gorman:

Yes, it's -- these are very large -- think of kind of very large advisory fees that take a lot of people. These are very complex capital structures. It's not unusual for these fees on a single deal to be $5 million, $6 million, $7 million.

Chris Gorman:

Yes. Well, this is an area where we spend a lot of time. We are -- as it relates to the C&I book, particularly focused on anything that has floating rate debt that's leveraged. And so for us, our leverage book literally is the same than it was a decade ago. It's under 2% of our loans and it's focused on our industry verticals. But we are -- there's a lot of us -- Mark Midkiff is in the room with me, who is our Chief Risk Officer, he and I and others are laying eyes on this. We feel really good about where the portfolio is. But any time you go into an environment where you have declining EBITDA and a business with a lot of leverage and the cost of capital going up, you got to pay close attention. And that's where we pay very close attention. We feel good about -- we feel really good about all of our portfolios, but that's where I spend sort of my time because that's what's most vulnerable.

Chris Gorman:

Thank you, Gerard.

Steven Alexopoulos:

Hi. Good morning, everyone.

Steven Alexopoulos:

I wanted to first follow up on your answer, Chris, to Ebrahim's question. Are you signaling that the door is not open at all in terms of potentially rightsizing the dividend?

Steven Alexopoulos:

Got it. Okay. That's helpful. And then on the fee income guide, I heard the messaging around green shoots and capital markets. But are those really needed to get us to this range, right, the up 4% to 6% and then -- sorry, up 2% to 4% and then 4% to 6%? Are there other factors, which give us some cushion, if the IDDs fees don't come back, that you could still deliver on the fee income guide?

Steven Alexopoulos:

Got it. Okay. And then finally, just a big picture view. Obviously, a lot of questions about NIM, I'm just as surprised as Mike seeing 2/12. For Clark, how do you think about managing the balance sheet and interest rate risk differently so you don't get in this situation again where the NIM is this low dividend payout ratio that's high, you're missing on the NII guidance, which is really all tied to what we're seeing on the swaps? But how do you think about big picture? So once you do get into a 3% NIM range that you sort of hang around there? Thanks.

Steven Alexopoulos:

Got it. Okay. Thanks for taking my questions.

Chris Gorman:

Well, thank you so much, operator. Thank you for participating in our call today. If you have any follow-up questions, you can direct it to our Investor Relations team, 216-689-4221. This concludes our remarks. Thank you, everybody. Have a good afternoon or good morning.

Operator:

Ladies and gentlemen, good morning, and welcome to KeyCorp's First Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to the Chairman and CEO, Chris Gorman. Please go ahead.

Clark Khayat:

Thanks, Chris, and good morning. I'm now on slide six. For the first quarter, net income from continuing operations was $0.30 per common share, down $0.08 from the prior quarter and down $0.15 from last year, driven in part by two notable items. We incurred $64 million of restructuring expense or $0.06 per share, which included $36 million of severance and other related costs and $28 million of corporate real estate related rationalization and other contract terminations or renegotiations. Our results also included $94 million of additional provision expense in excess of charge-offs or $0.08 per share as we continue to build our reserves, reflecting a more cautious economic outlook and view on home prices. Turning to slide seven. Average loans for the quarter were $119.8 billion, up 16% from the year ago period and up 2% from the prior quarter, as we continue to support relationship clients. Commercial loans increased 15% from the year ago quarter. Relative to the same period, consumer loans increased 16%, reflecting growth in consumer mortgage. Compared with the fourth quarter of 2022, commercial loans grew 3%. Our commercial growth continues to reflect the strength in our targeted industry verticals and support for our relationship clients. Continuing on to slide eight. Average deposits totaled $143.4 billion for the first quarter of 2023, down 5% from the year ago period and down $2.3 billion or 2% compared to the prior quarter. Year-over-year, we saw declines in retail deposits, driven by elevated spend due to inflation, normalization from pandemic levels and changing client behavior due to higher rates. Commercial balances, which included $6 billion of brokered deposits remained relatively flat. The decrease in deposits from the prior quarter reflects a continuation of these same trends. Interest-bearing deposit costs increased 62 basis points from the prior quarter and our cumulative deposit beta was 29% since the Fed began raising interest rates in March 2022. Our outlook for 2023 now assumes a cumulative deposit beta peaking in the low 40s. Turning to slide 9. We wanted to provide incremental detail on the granularity and composition of our $143 billion deposit portfolio. At the end of the first quarter, approximately 54% of our deposits came from consumer, wealth and small business clients. An incremental 6% of deposits are from low-cost, stable escrow balances. The remaining approximately 40% of our deposits comes from our large corporate and middle market commercial clients. Over 80% of commercial segment deposit balances are from core operating accounts. Our total deposit -- of our total deposits, 56% are covered by FDIC insurance, while an additional 10% are collateralized. We maintain access to enough liquidity to cover over 150% of uninsured and uncollateralized deposits. The quality of our deposit base derives from the strength of our relationship-based strategy, which is benefited key both from a balanced stability and cost perspective. At period end, our loan-to-deposit ratio was 84%. Now moving to slide 10. Taxable equivalent net interest income was $1.1 billion for the first quarter compared with $1 billion in the year ago quarter and $1.2 billion in the prior quarter. Our net interest margin was 2.47% for the first quarter compared to 2.46% for the same period last year and 2.73% for the prior quarter. Year-over-year, net interest income and the net interest margin benefited from higher earning asset balances and higher interest rates, partly offset by higher interest-bearing deposit costs and a shift in funding mix. Relative to Q4, our net interest margin was negatively impacted by 22 basis points related to higher interest-bearing deposit costs and 22 basis points from a change in funding mix and liquidity and loan fees, partly offset by 18 basis points related to higher interest rates and earning asset growth. As Chris noted earlier, our swap portfolio and short-dated treasuries reduced net interest margin by 72 basis points in the quarter. Additionally, the net interest income was lower, reflecting two fewer days in the quarter. Turning to slide 11. As previously mentioned, Key stands to benefit significantly from the maturity of our short-dated swap book in treasuries. This opportunity is consistent with the $1 billion of upside we've been talking about over the last few quarters. While we recently offered more detail on the swaps and treasuries by quarter and interest rate, we thought it would be valuable to include a view on the realization of that potential value in both timing and amount. The chart on slide 11 shows this with the forward curve. We do not include -- we do include the value should short-term rates remain at current levels in a higher prolonger scenario as well. We have also gotten questions about how we plan to lock in this value. As we've shared, we've taken a measured but opportunistic approach to adding hedges to address this potential. The analysis on slide 11 reflects the additional hedging activity we've undertaken beginning in Q4 and since. The point here is to provide one more level of depth to clarify the timing and magnitude of this opportunity. As this demonstrates, we continue to see significant future value in NII as these swaps and treasuries mature. Moving to slide 12. Non-interest income was $688 million in the first quarter of 2023 compared to $676 million for the year ago period and $671 million in the fourth quarter. The decline in non-interest income from the year ago period reflects a $24 million decline in service charges on deposit accounts due to changes in our NSF/OD fee structure that we previously discussed and implemented in September and lower account analysis fees related to interest rates. Additionally, investment banking and debt placement fees declined $18 million, reflecting lower syndication fees, partly offset by an increase in advisory fees, while corporate services income declined $15 million, reflecting lower loan fees and market-related adjustments in the prior period. The decline in non-interest income from the fourth quarter reflects a $27 million decline in investment banking and debt placement, driven by lower advisory and syndication fees. Recall that Q1 is historically the low point for investment banking activity in the year. Other income decreased by $20 million driven by Visa litigation assessment and market-related adjustments. Additionally, corporate services income decreased by $13 million, reflecting lower derivative volumes. Moving on to slide 13. Total non-interest expense for the quarter was $1.18 billion, up $106 million from the year ago period and up $20 million from last quarter, inclusive of $64 million of restructuring charges related to actions we completed this quarter to take out $200 million in annualized costs. As we shared on the Q4 call, we took these steps proactively to support investment in our business in the face of continued inflation. Compared with the year ago quarter and in addition to restructuring charges, personnel expense increased, reflecting an increase in salaries and headcount, partly offset by lower incentive compensation. Compared to the prior quarter, and in addition to restructuring, business services and professional fees declined $15 million in marketing expense declined $10 million. Additionally, other expense increased in the first quarter by $9 million reflecting an increase in the base FDIC assessment rate. Moving now to slide 14. Overall, credit quality remains strong. For the first quarter, net charge-offs were $45 million or 15 basis points of average loans, which remain near historically low levels. Our provision for credit losses was $139 million for the first quarter, which, as we pointed out, exceeded net charge-offs by $94 million. 30 to 89-day delinquencies to period-end loans were down one basis point to 14 basis points, while 90-plus day delinquencies remain stable. The excess provision increases our allowance for credit losses, reflecting a more cautious model-driven assumptions. Despite the increase in the allowance, our outlook for net charge-offs in 2023 of 25 to 30 basis points remains unchanged and well below our through-the-cycle levels of 40 to 60 basis points. Moving to slide 15. With regard to commercial real estate in particular, Key's exposure is well controlled and credit quality remains strong. Over the past decade, we meaningfully repositioned our commercial real estate book by sharply reducing our exposure to construction and homebuilders and reducing the level of commercial real estate loans in our book. We focus on relationship lending with select owners and operators. Our improved risk profile has been demonstrated in Key's most recent stress test results where projected losses in our commercial real estate book stands at 8.2% compared to 11.5% for peers. Now on to slide 16. Our liquidity position is strong, our period-end cash balances at the Federal Reserve stood at $8 billion, and we maintain flexibility with significant levels of unused borrowing capacity from additional sources. We would expect to maintain higher cash balances until the market stabilizes. Our levels of additional available liquidity have not changed materially since the end of the quarter. On to slide 17. We ended the first quarter 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 relationship customers and their needs. We completed $38 million of open market share repurchases in the first quarter related to our employee compensation plan. Given market conditions, we do not expect to engage in material share repurchases in the near-term. We will continue to focus our capital in supporting relationship client activity and paying dividends. Over the last six weeks, there's been significant discussion of AOCI and its potential inclusion in CET1 capital levels for Category 4 banks. We've historically chosen to put most of our portfolio purchases and available for sale. And given the recent market rise in rates, we saw significant increases in the negative mark. As time passes and if rates have come down, we've seen our AOCI mark decrease by 13% and from $6.3 billion at 12/31 to $5.5 billion at 3/31. We share on Slide 16, the expected reduction in the AOC mark from 3/31 to the end of this year and the end of 2024. Over that time frame, the AOC mark declined by approximately 40%. And while this analysis assumes the forward curve, it's important to note that 90% of the value is for maturities and cash flows that is not rate dependent. Although we have no unique insight into the path of potential regulatory changes, as we've seen historically when bank capital regulations have changed, they carry with them comment periods in a reasonable phase-in time frame. Our view is that for any new requirements, our reduction in AOCI mark and more significantly, our earnings would allow us to organically accrete capital to required levels over the necessary period. Slide 18 updates our full year 2023 outlook. The guidance is relative to our full year 2022 results. We expect average loans to grow between 6% and 9%. Importantly, most of this growth has already occurred relative to 2022, so we don't expect material loan balance growth. We'll continue to support relationship clients by recycling capital throughout the year. We expect average deposits to be flat to down 2%. Net interest income is now expected to decline by 1% to 3% driven by higher interest-bearing deposit costs and a continued shift in funding mix. Our guidance is based on the forward curve, assuming a Fed funds rate peaking at 5.1% and in the third quarter and starting to decline in the fourth 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. Non-interest income guidance is unchanged. We continue to expect it to be down 1% to 3%, reflecting the implementation of our new NSF OD fee structure last year and continued challenging capital markets activity, at least in the first half. Our non-interest expense outlook is also unchanged. We expect it to be relatively stable, driven in part by the actions we took last quarter to accelerate cost savings, which includes the impact of the $64 million in restructuring charge. For the year, we continue to expect credit quality to remain strong and net charge-offs to be in the 25 to 30 basis point range, well below our over-the-cycle range of 40 to 60 basis points. Our guidance for our GAAP tax rate is now 20% to 21%. We feel confident in the foundation of our business, the relationship-driven value of our deposit book, the durability of our balance franchise and our improved risk profile. Despite near-term headwinds, we continue to be focused on execution in 2023 and the strong long-term earnings power of our company. With that, I'll now turn the call back to the operator for instructions on the Q&A portion of the call. Operator?

Ebrahim Poonawala:

Good morning.

Ebrahim Poonawala:

So maybe just starting on deposits. We've obviously gone from mid- to high 20s beta to 30s, now low 40s. I guess, Chris Clark, give us a sense of just in terms of your comfort level that this high -- if the forward curve or at least if the Fed is done with one more hike, why the low 40s beta should be the right number in terms of your confidence level and just a rigor of the analysis that went behind that assumption?

Clark Khayat:

Yeah. So I'd start, I think, with balances, Ebrahim. I think we feel very good about where our balances sit today relative to where they have been relative to the market we're in and relative to competitors. So it starts with balances and then you get to pricing -- as we've talked about in the past, we've been more focused on retention of deposits than acquisition of new deposits, and I think that is reflected in the beta to date. The other point since last third quarter, fourth quarter, as we've watched the market develop, I think we -- while we would not purport to have perfect information about behavior, we have a much better view on how customers are interacting I think the commercial betas have mostly played through. So we've seen those come up. Many of those, as we've talked about, four are indexed and others, there's been a lot of conversation engagement with commercial clients. The consumers are always slower to move, and we believe at this point, we have a better view on how they're behaving, the types of accounts they want and how competitors are reacting. So when we look at the low 40s number up a bit from the high 30s, we have some confidence that we can deploy beta in across the retail franchise, but also in some targeted customer sets to not only retain but potentially acquire some deposits going forward.

Clark Khayat:

Yeah. So what's embedded in the chart on the page, Ebrahim is the forward curve, which is coming off. I don't have in front of me exactly what those rates are, but they're coming down pretty significantly over that time frame. I could follow-up with a little more sensitivity, but effectively, you can think about the forward curve in that 720 range as we talked about annualized. Maybe the right comparison is, if rates didn't move at all and the spot rate just sort of played out you'd get back to that $1 billion number. So you see a little bit of a sensitivity between "higher for longer version" where the spot rate just sort of sticks versus the forward curve, which is coming down fairly significantly over the next seven quarters.

Clark Khayat:

So I think we've shared before, but I'm happy to talk about it. So if you think about 2023, we had -- at the beginning of the year, about $6.2 billion of received fixed swaps rolling off, $1.7 billion in the first quarter at a rate of 2.62. So that was sort of the highest of the two-year rate. The rest will roll off through the year, so another $4.5 billion. We're not replacing those. So we're going to allow on that portion, the natural asset sensitivity of that loan book to come through. Next year, another $7.5 billion of swaps mature. And we've essentially replaced those with a combination of forward starters at an average rate of 3.4%. So there's some negative carry in that. But in the forward rate, they actually are a bit in the money by the end of the year. And then the other half with floor spreads that kick in at $3.40. And the value of that, as you can imagine, is we get all of the floating rate value above 340 until the forward curve comes down. And if we were in a higher rate environment, we would benefit from actually not hitting that floor. So we think we've managed the downside risk there quite well and preserve some of the upside. The reason we wouldn't do or haven't done more or all floors or floor spreads at this point is just the cost of volatility is pretty high. So we're trying to balance the kind of the risk reward on that trade.

Clark Khayat:

Sure.

Scott Siefers:

Good morning, guys. Thank you for taking the question. Mark, as we look sort of from the margin at 247 now and then that kind of, I guess, aspirational margin near the 320 ex-treasury and some swaps. I guess one of the big things has been sort of what happens between here and there. Do you have a sense for when -- based on what you see now, when the margin would bottom where that might be? And then, kind of, more specifically when it would start to inflect upward to. I know the treasury start to -- the treasury and swaps, that's more of an end of 2023 and into 2024. But will we get a margin inflection this year, or is that something that do we continue to bleed out a bit through the remainder of the year before it inflect back up? How do you think about that dynamic?

Scott Siefers:

Okay. That's perfect. Thank you. And then, Chris, maybe just a thought on the investment banking rebound in the second half. I mean what does that kind of look like in your mind, how powerful could it be? It's been such an odd environment. You got the VIX at a level where historically, there'd be a lot of activity now. But it certainly feels very uncertain, and I think we've all been sort of surprised by overall lack of activity. So when you sort of look out over the remaining several months of the year, what's sort of your best guess as to how a rebound might play out?

Scott Siefers:

Yeah. Okay. Perfect. Thank you all very much.

Operator:

Our next question is from John Pancari with Evercore. Please go ahead.

Chris Gorman:

Good morning, John.

John Pancari:

Just a couple of questions regarding the NII outlook for the year. Can you just share with us your thought of the noninterest-bearing deposit mix shift? How you view that progressing and then -- and then also on the progression for the second quarter, just regarding Scott's question on the margin, you mentioned that you see a pullback again in the second quarter and then inflection. Can you maybe help us size up that amount of margin compression incrementally in the second quarter? Thanks.

John Pancari:

Got it. Okay. All right. That's helpful. And you care to venture a projection in terms of the magnitude of the inflection in the back half of the next?

John Pancari:

Got you. Okay. Thank you. And then just separately on regulation. I want to see if you can maybe provide some comments around how you're thinking about the most likely areas of regulation where you expect some measures out of the regulators or around inclusion of AOCI, potentially TLAC, FDIC, stress capital buffer risk. Maybe if you could just comment on that Chris, I'm interested in your comments on that as well.

John Pancari:

Great. Thank you.

Operator:

Next, we go to Erika Najarian with UBS. Please go ahead.

Chris Gorman:

Sorry, can you ask that one more Erika. I just want to make sure I'm understanding the question.

Chris Gorman:

I mean, yes, if you think about the incorporation of the swaps, right? So, the swaps are there for exactly that purpose and they would reduce the sensitivity on the way down, that's the intent of those instruments.

Chris Gorman:

Yes, two components, right? In I think our view, the forward curve, I have not seen a view yet where rates come down below where swap rates would be. So we would -- we're going to let that roll through our natural loan rates and yields flow through in 2023. In 2024, we've effectively replaced the swap book with forward starters at a higher rate, $3.40 on average and floor spreads with a kick in rate of 3.40%. So if rates were to stay higher, we'll get the value on the floor spreads, we'll carry the negative carry on the forward starters. If the forward curve plays out, both of those will be in the money at some point in 2024.

Clark Khayat:

Yes. I think you said that well.

Operator:

And next, we move to Ken Usdin with Jefferies. Please go ahead.

Clark Khayat:

You're talking just swaps specifically, Ken?

Clark Khayat:

Yes, $2.15 in the first quarter.

Clark Khayat:

Not at this point, but we can follow up and let you know that.

Chris Gorman:

Yes. So I'll keep trying. I'm worried, I'm not being super clear. So the $6.2 billion of received fixed swaps in 2023 are going to mature. $1.7 billion of that matured in the first quarter. We're not planning to replace those to protect the loan book in year from a receive fix swap standpoint. There's another $7.5 billion that roll out through 2024, and we've taken steps to effectively replace that, not all of it exactly. It's we're in the $7 billion range, half of which is forward start received fix with an average rate of 340 -- so just think about that as replacing the existing 24 rate and now bringing that up to 340 and then the other half with floor spreads that have an attachment point at also roughly 340 just by coincidence. So that really is the protection against rates coming down, which the forward curve would project at this point, and it would lock that $7 billion or so at a $340 million yield or higher as those other swaps roll off.

Chris Gorman:

That's okay. I think maybe not doing it as clearly as possible. So I appreciate the follow-up.

Chris Gorman:

Good morning Mike.

Chris Gorman:

Yeah. So thank you for the question. Let me just, kind of, broadly talk about the quarter. Mike, there's no question it was a challenging quarter for us, but we continue to do the things that we need to do to build the franchise. And so what are those things? You mentioned expenses. We put a hiring freeze in place in November, and we took out $200 million or 4% of our expense base just in the quarter we just completed. So that's one of the things we do. We've talked a lot today about how we're managing our balance sheet. We have taken significant actions and we have the luxury of taking the actions because they're short duration, both on our swaps and on our investments to put us in a position where we can benefit from the rise in interest rates. So we've done that. And then the other thing we continue to do, as you know, is we continue to strategically invest in our business and focus on targeted scale. So my perspective is, yes, this is a challenging quarter. Yes, we have to get through this NII drag, but we have a clear path to do so. And that's what we as a team are in the business of focusing on.

Mike Mayo:

Given that extra caution, you kept your loan growth the same at 6% to 9%. So I'm trying to reconcile your more caution with your provisions with no change in your loan guidance, whereas, others have brought down their loan guidance as they tighten things up.

Clark Khayat:

Yes. So just to -- sorry, Mike. Just to be super clear, the 6% to 9% year-over-year loan growth really was resident at the end of 2022. So it really just reflects the growth that occurred in 2022, just to make that abundantly clear.

Clark Khayat:

Yes. And they never go up as much as they should because, frankly, there's too much excess capacity in the banking market. But no, they haven't moved. And that's where it really pays to have a wholesome relationship like where we can drive a bunch of other revenue, but there hasn't been the adjustment yet that there should be based on the arbitrage between the capital markets and the bank market.

Chris Gorman:

I think, over time, that's what you're going to see, right? We'll be using the capital markets as they open up to actually place paper for people. But in terms of putting new debt on our balance sheet, we're not going to do it unless we have a complete relationship and we can drive a whole bunch of revenue. And that in itself will be limiting.

Chris Gorman:

Thanks, Mike.

Manan Gosalia:

Hey, good morning. I wanted to follow up on the cost-cutting efforts that are underway to counter inflation. Just given the events of the past few weeks, how does that change? What do you think you need do on the investments, right? So as I think about deposit competition accelerating, are there any investments you think you need to make on either the technology or the product side in order to retain and grow deposits? And how much of that is embedded in your expense guide?

Manan Gosalia:

But is there anything additional you need to do given the events of the past few weeks?

Manan Gosalia:

Got it. Great. And then just on securities. I appreciate the detail on the AOCI accretion over time. I wanted to ask how do you think about the future mix and duration of the securities book just given what we've seen in the past few weeks? And just given the potential for higher regulation, would you skew the mix of your securities more shorter dated towards treasuries. Just want to get a sense of how you're thinking about that?

Manan Gosalia:

Great. Thank you.

Steven Alexopoulos:

Hey, good morning, everyone.

Steven Alexopoulos:

So first, on the deposit side. So your uninsured deposits are fairly high, but it does not appear that you saw a large degree of outflows, right, that many of your peers saw in the aftermath of Silicon Valley Bank. Could you comment on that were there notable outflows or because of the operating nature of these accounts, which you called out, Chris, was that enough of a factor where you just didn't see what many peers saw?

Steven Alexopoulos:

Okay. That's helpful. And then, Chris, on the potential for new regulation, and you said you're in a good position to organically build capital, right, in anticipation of new regulations potentially coming. Do you assume that you need to suspend buybacks for an extended period until we see new regulation in order to build that capital?

Steven Alexopoulos:

Got it. Okay. Thanks. And just one final one in terms of you responding to John's -- Cary's earlier question. This hybrid account for commercial customers, which is paying interest reads non-interest-bearing, but you're paying some interest. What was the balance in that account? And how much are you paying? Thanks.

Steven Alexopoulos:

Okay. Sounds good. Thanks for taking the questions.

Operator:

And next, we go to the line of Gerard Cassidy with RBC. Please go ahead.

Chris Gorman:

Good morning Gerard.

Chris Gorman:

Well, thanks for your question. So, basically, you have servicing then you have special servicing, where you're the named special servicer and then it goes into active special servicing. So, think of active special servicing as being the workout agent for off-us loans, whether they're CMBS or whatever. We have seen a huge surge in active servicing. And what was the number one just a quarter ago, the biggest category was retail and the fastest growing was office. And what's happened is that's flipped. Now, office is both the fastest growing and it's the largest by a significant factor. So, we do have a pretty good insight. We have an insight by class. And just so you know, office is first and then retail is second. And then we also, of course, have a geographic breakdown because real estate is always geographic. So, it does give us great insights and it is very dynamic and kind of the trends that we -- some time ago, we said we thought we'd see a lot of B and C class office buildings in central business districts. And although we, for our own book only have like $127 million of that exposure, we are seeing that play out and now office is the number one category in active special servicing.

Chris Gorman:

It's much higher than four times because you go from getting really kind of just sort of a ticking fee you're actively working on it. So, it is multiples of what the regular fees are as you go into special servicing. And when you look at our financials, you can see the bump in that line item.

Chris Gorman:

Exactly. Correct.

Clark Khayat:

Yes. So, let me just start with HPI because that's where you started. The -- as I think we may have talked about Moody's, which we use the Moody's consensus, they put out an HPI model in Q4 that was updated. They still produced their old one. We were comfortable with the old one. Now it's just the new one, which I would say is fairly draconian and sort of by -- their HPI, Clark, went from 4.6% in November to 8.8% as of February under the Moody's consensus -- so that would be the Draconian part of Draconian Yes. So that's a big mover and largely unemployment went from 4.5% to 5%. So those would be sort of the two big impacted areas.

Operator:

And ladies and gentlemen, we will now be turning the conference for closing remarks back to the CEO, Chris Gorman.

Operator:

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

Operator:

Good morning and welcome to KeyCorp's Fourth Quarter 2022 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to the Chairman and CEO, Chris Gorman. Please go ahead.