KeyCorp (KEY) Earnings Call Transcript & Summary

Okay. We're ready to start with the next company up is KeyCorp. From Key, we've got Chris Gorman, a long time Key leader, who became Chairman and CEO at the beginning of the month; and Don Kimble, Key's CFO, is also here. We will jump right into Q&A. But as we've been doing all day, if there are questions, please enter them into the webcast if you've had signed up for the conference. And I'll try to weave them in. So Chris, Don, welcome. Thanks for joining.

Well, thanks for having us, Matt.

Chris, I want to start off just kind of big picture. You've been, obviously, part of the leadership team at Key for many years and influential in driving a lot of the decision-making. But at the same time, I'm sure you've had some ideas or tweaks that you thought about making about -- once you became CEO. At the same time, the world has changed. So a 2-part question. I guess one, like what were some of the things on your list before the crisis? And two, how has the crisis maybe tweaked some of that thinking?

Well, sure. I really view it as a dual mandate. There are a whole series of actions that we're taking to deal with the current crisis. And it's a real crisis, right? It's an economic crisis. It's a health care crisis. It's a humanitarian crisis. But we also have to be spending a lot of time making the right long-term decisions for our business to position ourselves for continued future success. And so let me just make a couple of comments on sort of where I see the longer-term vision, and it starts with digitization. One of my top priorities will be to advance the pace of digitalization really across our whole company. I think the current crisis has greatly accelerated our and our clients' transformation, I think probably as much as 5 years, if you look at the way people have changed, just how they do business both internally and externally. One data point to share with you, we have 3x as many -- 3x the increase in first-time digital deposits and also depositors. And think about it, a number of our customers that have never dealt with us before digitally are doing so now. Think about older customers and in certain parts of our franchise, we have an older client base. Also think about small businesses that, just out of habit, dealt with the branches, they now are dealing with us digitally. And once people deal with us digitally, I don't think they're coming back. I think they like getting advised at critical moments, but the ability to do frictionless transactions I think is something that isn't going to change. Next thing I want to focus on is the energy around serving our relationship clients, both commercial and consumer. On the consumer side, we made a pretty significant change in leadership at the beginning of this year. And I think we're really off to a really good start in terms of achieving targeted scale in consumer. We also now, Matt, have a couple of growth engines, specifically Laurel Road and residential mortgage. And neither one of those existed in their present form just 18 months ago. We're going to continue to invest in these businesses, and I would expect those businesses to continue to drive growth. On the commercial side, it's really more about continuing to do what we do well. Over the years, we've built a leading integrated commercial and investment bank, focused on middle-market clients in our 7 industry verticals, and we're going to continue to invest in that business. We're able to offer our clients a full complement of products, namely advice, capital payments, and we'll continue to focus on that. The next thing that we talk to the team about focusing all the time on is expense management. That will continue to be a focus. And that's because I think if we foster this culture of continuous improvement, balancing savings with the right investment in people and technology, it gives us the opportunity to continue to advance the business and grow it. And if you think about this environment, whether it's occupancy costs, whether it's the size of your branch network, those clearly will change. And conversely, the capital that, that frees up and the bandwidth that, that frees up will give us the opportunity to double down on technology in terms of additional investment. And then finally, we'll be disciplined in the way we manage and deploy our capital. First and foremost, to support our clients, to support our businesses but also making sure that we return the appropriate levels of capital back to our shareholders. So we think as we come out of this containment phase, we always talked about the pandemic in 3 phases: containment; recovery; normalization. We're kind of at the end of the beginning, the containment phase. We think we're in pretty good shape as we look forward.

And following up on some of those long-term objectives. I guess, first on digitalization. There's been a lot of focus, I think, in the banking industry on technology on the consumer side. And maybe it's talked about a little bit less on the commercial and corporate side. You're obviously overweight commercial corporate and talk about maybe the digital offering there. And maybe kind of evaluate yourself in terms of how competitive are you on the commercial corporate side with respect to digital? How are you on the consumer side? And where is the focus going forward?

Sure. So it's -- both of them are large area of focus for us. Since you asked about commercial, let me start there. We've made some fairly significant partnerships and investments on digital on the commercial side. Interestingly, in the PPP program, one of the things that enabled us to be so successful at it is we had purchased in the last 24 months, a front-end called Bolstr, which we were able to use basically as the front-end of the machine for SBA. So that was investments we have made. We also spend a lot of time looking at our digital interfaces, we call it KBBO, which is what we use for small business, and KeyNavigator, which is what we use for our larger businesses. Those are both new front-ends. And we're constantly looking, we're constantly going through user testing that to make sure that those front-ends are what people need to really run and manage their business each and every day. And as you know, on the consumer side, we also -- excuse me, on the commercial side, we also formed partnerships with a lot of people on the payments front. And if you think about some of those partnerships that we formed, that really enables people to manage their business, and we've been doing that really for some time. As it relates to the consumer side, I think we've made terrific progress, certainly in the last 24 months. And I think if you think about post First Niagara, we have a new front-end for all of our consumers. And then, of course, Laurel Road was really a step change function for us. And we see Laurel Road as not only the digital platform that it is -- and by the way, that business has exceeded our expectations really kind of across the board, but we see it as also an accelerant to some of our other digital capabilities. As we've talked about now that people can end-to-end refinance their student loan, the next stage will be that they'll be -- we'll be able to -- and we're doing it right now, kind of end-to-end mortgages. And then I think there's an opportunity for us to take that business to the third level where we have really a unique offering, in this case, for medical professionals, doctor and dentists, of which they're probably 1.1 million of them in the country. Does that answer your question?

Yes, that's helpful. And then I guess that's a good segue into next thing. Like, you've talked about a leadership change at the start of the year on the consumer side. You've talked about the focus on Laurel Road, the residential mortgage and getting even more digital and leveraging that. I guess what exactly are you looking for those areas to do differently? Or is it just that you're trying to move a little bit faster?

It's both. One, I just think that -- I think -- as I said, I think the COVID-19 has been a real accelerant of where the market was already going, and we were already investing heavily, that being just the movement to digital. So in terms of investment, in terms of speed. And then what I mentioned on our consumer side that we're in the process of achieving and we will achieve is this whole notion targeted scale, knowing exactly who we want to do business with, where we win and how we win. We clearly have that on the commercial side. And I think for a bank of our size, there's a real opportunity to cut up -- to carve up similar niches on the consumer side.

And on expenses, it's been several years in a row now, good cost control. And obviously, in the current environment, there's a lot of focus at Key and other banks to support employees, customers, government programs, all of which I would imagine is a drag on efficiency in the near term. But longer term, how do you balance the need to invest in some of the areas that you just talked about to support growth, but also to maintain the cost discipline that you've been showing for many years now?

Matt, this is Don. And that's a great way to describe it as using balance because that's something we have to do all the time. And you mentioned technology and Chris has highlighted that we're continuing to be very committed to investing in technology and enhancing that digital offering that we can provide to our customers. And as we've talked before, our total technology spend is somewhere in that $700 million to $800 million range each year. And then included in that is about $200 million that we put up against the development activities, which would include upgrades to the core system, would include investments in cybersecurity, regulatory/risk management and new business capabilities. And that new business capabilities for us historically has been about half of that development budget. And given the focus, given what we're experiencing now, we do believe that we're going to need to step up some additional investments in digital, but at the same time, keeping that balance that we can leverage our continuous improvement culture that Chris talked about to help fund the investments we're making there and probably reprioritize where we're spending some of that technology budget.

And if you think -- I guess whatever banks give tech spending, I think a lot of investors try to compare the tech spending at regionals to some of the money centers. And of course, money centers are multiples to multiples and multiples, bigger than you. They're also global. And they're also in other businesses that require a lot of spend. So I don't think it's exactly comparable. But I do wonder if the current crisis makes scale that much more important. And I'm wondering, Chris, if that's something that you've thought about for Key. And you certainly have added scale in the last several years. But do you think the scale that you have now is what you need in kind of this new paradigm?

Yes, Matt, we think we have everything we need to be successful. When we think about scale, we think about targeted scale, whether it's in health care, technology, real estate, consumer, industrial, or it’s scale in the sense that I talked about, Laurel Road, or it's scale in the sense of our third-party commercial loan servicing business. We clearly, being the size that we are, and frankly, with our strategic focus, we're not trying to be all things to all people. That, for us, I don't think is the right strategy. What we're trying to be is really, really relevant to our targeted clients. And we clearly think we have the dollars that we need to spend to be relevant. And conversely, by the way, if we have certain areas where we're doing business that we don't think we're relevant, those are businesses that we would always reassess and make sure that we're focused on places that we can win and drive the business.

If we could switch to credit quality for a few questions here. Obviously, the key area of focus for investors, along with net interest margins, but I think credit is kind of the biggest wildcard. In April, you guided to just a modest rise in charge-offs for the second quarter. Is that still the latest thinking? If I can try to pin you down on that. And I guess assuming that it is, when do you think the losses will start to materialize, especially for a bank like Key, where if you're overweight commercial, they tend to be a little lumpy. And I think the deals that you've heard today so far is maybe commercial losses will show up earlier than, say, consumer, but still obviously, a lot of unknowns with that.

Sure, Matt, this is Don again. And I would say that at this point, we see no changes to our second quarter outlook for net charge-offs. We still expect to be at the lower end of that 40 to 60 basis point range. And we've continued to see the portfolio migrate consistent with what we would have assumed as part of that March 31 allowance. And so I think sometimes it's lost, but we have meaningfully improved our risk profile over the last decade, and we're a different bank today, and we think that should position us very well. I think from your additional question there as far as where will you see the losses earlier? I think you're probably right. I think with the forbearance programs that are in place, you could see some of the consumer losses pushed out not only into the third but maybe even into the fourth quarter just because many consumers would have had forbearance granted to them that would take them through June, and then you would start the clock as far as delinquency status for those consumer loans. And so you would see the losses a little bit later. On the commercial side, I think Key, like most banks, will be taking a look at the underlying relationship and risk assessing that relationship and so you could very well see those losses occur earlier. And especially, in areas where there might be higher risk to the overall industry that they're in or the segment that they're in. And so you could see those earlier in the commercial side than the consumer side.

In the reserve build side, it's a consensus view that reserve build will certainly continue in 2Q. And I think the debate is, will the build be as much as it was in 1Q? And is it possible that reserve build will be done in the second quarter if we get this recovery in the back half of the year? What are your thoughts on that?

Well, again, we haven't provided specific guidance for the second quarter as far as overall provision. We talked about charge-offs. And part of the challenge, we saw this play out in the first quarter that as of the 1st of March, we probably wouldn't have assumed much of a reserve build in the first quarter because at that point in time, the economic outlook hasn't changed. And we really hadn't seen the early stages of the virus and the impact of the pandemic on the economic outlook. And so we really won't have a clear idea of that until the end of the second quarter. As I mentioned earlier, the credit profile of the organization and the individual migration of those portfolios has been fairly consistent with what we would have assumed as far as at March 31 CECL reserve. And then we'll just take another snapshot as of June 30 and see what happens there as far as the outlook, as far as the depth, the duration of the downturn. And also the economic support that the treasury and others are providing because I think that's something that gets lost as far as the loss content. So more to come there, but to your second part of the question there, Matt, that with CECL, we should be reserving for our estimate of lifetime losses for the entire portfolio. And so as long as that economic outlook plays through and there aren't significant changes there, you wouldn't see a need to continue to build that reserve except for different migration of the portfolio or more importantly, a growth in that portfolio. And so to your point that if that economic outlook at the end of the second quarter does play through. And it's true, you might not see a need for additional reserve changes post that.

And it was clear that your longer-term strategy is to grow Laurel Road and leverage it throughout other parts of consumer. And I appreciate it's only, I think, 1% or 2% of loans right now. So it's not a big piece. I think before the crisis, we would have all viewed doctors and dentists as impeccable credit. But given some of the shutdowns throughout the country, it's not as clear, I think, to some as maybe it would have been before with a lot of the offices closed. So how is your kind of thought process on this portfolio, maybe in the near term, change just from a credit quality perspective, if at all?

Sure. So Matt, let me just start out by reiterating how pleased we are with Laurel Road in general. It's been just over a year since we've owned Laurel Road. And the business has just exceeded our expectations by virtually all measures. April, for example, was the second best month ever from a volume perspective. We continue to be impressed with the strength and the depth of the team. And as I mentioned earlier, we think Laurel Road gives us many opportunities. The first is this notion of targeted scale around doctors and dentists. But secondly, as an accelerant of our digital capabilities, whether it's digital mortgage or other things that we're doing strategically. As it relates to credit, the portfolio continues to perform well. These doctors and dentists generally have a FICO score that exceeds 760. In terms of deferral requests, we have seen an increase in deferral requests. One interesting thing that's happened just -- since the pandemic is 25% of the Laurel Road customers that requested a deferral have either made additional payments or have proactively left the forbearance status. So you combine that with the fact that most states are beginning to open up for dentistry and nonessential medical service, we wouldn't expect a material increase from here. And the only proviso, I'd say, on top of that is that's assuming there's not a significant wave 2. If there is, obviously, we'd see them impacted. But in general, there's a pretty big backlog out there for people that need these services.

Matt, just to echo that, I think a lot of the steps that have been provided to help support businesses and especially in the health care profession, either from a forbearance or from a PPP loan or others, really help provide that bridge. And this is truly the type of customer base that we want to continue to support that way. And I think that bridge will be successful in helping to allow that customer to get to the other end and have a strong customer relationship post this time.

I think that was helpful. If we could maybe switch to PPNR or essentially profit before the cost of credit. The first quarter was better than expected. But I think most people and banks have been guiding to more pressure on 2Q, whether it's from NIM or lower volumes in fees. But maybe talk about the PPNR, not just for 2Q, but as this quarter is played out, I would assume there's been some improvement later in the quarter and kind of how you think about the trajectory for the rest of the year?

Sure, Matt. And as far as the net interest income, as we've said before, we do expect that to grow. But we would expect to see some pressure on margin and a couple of reasons for that pressure. One is that the PPP loans, while they will be additive to net interest income, will put some pressure on margin. And so we'll have a growth in revenue, but lower margin. We've said that would cost us about 7 basis points. We also know that our liquidity position is much higher than where we typically would target. And this is because of the growth that we've seen in deposits in late March through the first part of this quarter. And so we would typically target about $1 billion worth of cash at the Fed each day, and we've been running north of $4 billion a day. And so that could add another 3 to 5 basis points of margin pressure for us. Even though, again, in this case, it wouldn't be detrimental to net interest income. And the last piece is the impact of lower rates. And as we've talked before, as rates move, our deposit pricing tends to lag a little. And so that will put about 3 to 5 basis points of incremental pressure on the margin and also create a little bit of pressure on net interest income this quarter as well. But with all 3 of those factors, we would expect to see the net interest income grow. On the fee income categories, we would think that several of those will likely be lower, reflecting the impact of the environment and some of the activity in transaction volumes that would be different. But we would not expect to see any additional reserve builds as far as the market-related valuation adjustments. And as we -- you remember that, that cost us over $90 million in the first quarter. And so we would not expect to see that. Fee income also this quarter will benefit from an additional approximately $20 million of cards and payments-related revenue, supporting many government assistance programs that we help to sponsor. And then on the expense side, the expense management, as Chris mentioned earlier, is continuing to remain a focused area for us or area of focus for us. And so we would expect to see discipline remain there. One item that I would mention on the expenses is that we would see an increase of about $20 million from that same prepaid card activity that I mentioned before. So this program will not negatively impact PPNR, but will increase both expenses and fee income accordingly. And then beyond that, linked quarter expenses will also be impacted by our annual merit increase, the additional expenses we have supporting our clients and employees through the challenges of COVID-19 and also production-based compensation. And so I would expect that PPNR would be generally in line with what our guidance would have implied, and that we'll continue to update our outlook as part of the second quarter earnings results.

A specific on the NIM. We've seen LIBOR rates finally come in. And obviously, that price is used to price most of the commercial loans out there for you and others. Do we start seeing that in the second quarter? Or is there a lag on the repricing, so there'll be more drag in the third quarter?

Most of the change in LIBOR does come through in the current quarter as it relates to the loans. And many of our deposits are now more priced on changes in Fed funds. And so it's not as much of a dramatic impact there. And so you will see much of that come through in the first quarter and -- or excuse me, in the second quarter and then in the third quarter, you would see the remainder given the full quarter impact.

And then specific on some of the loan categories here on the PPP loans. I think you talked about processing $9 billion in round 1. Do you have any updates on the actual amounts that were funded in both round 1 and round 2?

For us, Matt, there is not a huge difference in round 1 and round 2. And that's because in round 1, we were able to get about 90% of our clients approved in the first round. And so as a consequence, we're less active in round 2. We got basically the remaining 10% as well as a couple of thousand other applications. But I'm immensely proud of what our team did from a standing start in a couple weeks, doing about 10 years' worth of volume. But round 2 is not a big push for us, frankly, because we were so effective in round 1.

And then on the commercial line drawdowns, there was a lot, obviously, end of March. You guys have talked about slowing in April. We've heard today, April, May continue to slow. What are you seeing in your books in terms of trends in the second quarter? And then I guess, how quickly do you think these lines get repaid?

Sure. So you're exactly right. The drawdowns really peaked around the 20th of March and came down rather precipitously. So there's really not a whole lot of line draw activity. In our case, about 70% of the draws were from investment-grade clients, and that resulted in about a 200 basis point increase in the percentage of commercial outstandings that are investment grade. I expect those, Matt, to stay on our balance sheet for some time. As you can imagine, the debt markets have gotten a whole lot better. But I think that you'll see them start to get taken out in the third and fourth quarter this year. In the meantime, we sort of have both sides of the balance sheet because the proceeds from those draws are really sitting on our balance sheet in the form of deposits. And that's kind of our planning horizon on that.

Okay. Switching gears to the dividend. Obviously, an area of concern for the industry a month ago. I think some of the concerns have died down, but it's still on the mind of investors. You were very clear on the 1Q earnings call along with your peers that I cover in maintaining the dividend. And I guess my question would be what circumstances would change this view? And that you could see -- I don't think it would just be Key singled out, so it's really the industry kind of a widespread reduction in dividends, kind of like we saw in the pause in buybacks. Like, what do you think needs to happen for dividends to be reduced or suspended?

Sure, Matt. So I'm sure you saw last week, we announced our quarterly dividend of $0.185 a share. All of our stress testing, our models would indicate that we will continue to generate PPNR. We continue to believe that we have the capital and the appropriate buffer to support our clients, our business and to pay our dividend. That being said, as you pointed out in your question, there are a lot of voices in the room on these discussions. But our Board takes this seriously. We talk about it every single quarter, and we consider a number of factors. Obviously, we're continuously running stress tests. Don, would you comment on?

No, I would agree, Chris. And as far as those stress tests, even when we took a look at our severely adverse scenario that our common equity Tier 1 ratio was right around that 8% level for the floor and that was with about $4 billion of charge-offs. And so that still puts us in a capital level that would be able to support that kind of a continuation of our common dividend. We do recognize that common dividend is especially helpful and relied on by our retail shareholders. And so that's one of the reasons why we feel that's important. But also the reason why we and the rest of the industry maintain and strengthen our capital position is to support our existing customers in their growth and structure that they would need but also to be able to maintain those dividends as appropriate. And one of the largest actions that we would typically do to manage our capital levels is to use share buybacks and we and many of our peers have suspended those just to make sure that we maintain the appropriate capital support for our organic business.

I want to circle back on fees, specifically investment banking, debt placement, obviously, an area of strength for many years here and your biggest fee category both quarters. How is that tracking this quarter? And maybe more importantly, how is the pipeline and the conversations and activity levels that you are having with your customers?

Sure. It's obviously early, but I would expect that we'll have a solid quarter from an investment banking fee perspective. Well below last -- the same quarter last year, but a solid quarter. We continue to see a lot of activity in commercial mortgage and in debt capital markets. Where there are headwinds is clearly in the M&A business and the related financing businesses. And you can imagine the M&A business, those deals aren't going away, but I think the whole world is in price discovery right now. Interestingly, we just went over our pitch count with our business leaders just this morning. Pitch count is actually quite high. So it sounds kind of counterintuitive, Matt. But the decision-makers and all of our clients are very reachable and frankly, are spending a lot of time thinking about coming out of COVID-19, what do they do strategically to grow their business. When it does come back and by it, I mean the M&A market, and it will, I think we're well positioned. If you think about kind of some of the accelerant -- some of the structural changes in facilities-based health care, we bought Cain Brothers some time ago. It's been a successful acquisition and integration. I think we're really well positioned for that. Technology, as everyone on this call probably knows, has been a strong suit of ours, and I think there'll be continued investment in technology. And then the last piece, really, for reasons outside of COVID-19, I just think our renewables practice, where we're a leader in North America, both wind and solar, I think that will continue to grow. So I actually feel good about the long-term trajectory of the business. But clearly, the M&A market is basically at a standstill for the moment.

Right. No, that makes sense and is consistent with what we're hearing elsewhere. All right. Well, we are just about out of time here. So I appreciate very much, Chris, Don, you guys joining and keep participating. And that's the end of the session.

Thanks, Matt.

Thanks, Matt. Appreciate it.