KeyCorp (KEY) Earnings Call Transcript & Summary

And good morning. My name is Chris Gorman. I'm the Chairman and Chief Executive Officer of KeyCorp. And I want to just let the RBC team know that we're really pleased to be part of the conference this year. I'm joined this morning by Don Kimble, Don's our Chief Financial Officer. On Slide 2, you'll find our statement on forward-looking disclosures and non-GAAP financial measures. This covers my remarks as well as the Q&A. Most of the time this morning is going to be devoted to your questions, but I wanted to start and just give a few overview comments. First, the rhetorical question, what is different about Key today? And I would start with the strength and depth of our management team, and that includes a lot of digital know-how, digital capabilities, and we've really refreshed the team. Secondly is our distinctive business model. We continue to develop our distinguish -- our distinctive business model, both on the commercial and the consumer side. Our expense discipline, which is fairly well documented, we continue our expense discipline. And next is our stronger financial profile, and that really manifested itself in a record year last year, 2020. And importantly, is our reduced risk profile. Over the last decade, we've been actively reducing our risk profile, and that will continue to inure to our benefit. Key is stronger and well positioned to both grow and achieve our long-term financial targets. It's worth noting that our long-term financial targets depicted on the bottom of this slide remain unchanged. Our unique relationship-based business model positions us to both grow our consumer and our commercial businesses. On the commercial side, we have built a strong, leading commercial and investment bank. We're focused on middle market clients in 7 industry verticals. We have built scale in a very targeted and deliberate way, which has resulted in Key being a leader in a number of high-growth areas. And I thought I would just mention a few of them this morning. First, renewables financing. In Renewables, we ranked #2 in North America. Healthcare, which, of course, as everybody knows, is 18% of the GDP on its way to 20%. We are one of the top advisers as it relates to facilities-based healthcare. Affordable housing, we rank in the top 5 nationally. We believe affordable housing will continue to be a growth area, we're proud to be part of this important solution in this pressing need across our country. We're also one of the largest commercial mortgage servicers with servicing assets in excess of $300 billion that too is a top 3 market position. In addition to that, we're also named special servicer on another $155 billion of servicing assets. A special servicer, we provide strategic advice generating fees for overseeing restructuring situations. This is a countercyclical advisory business and our broad servicing presence in general, provides us with unique insights into the real estate market. These targeted growth areas helped drive our record performance in 2020. We achieved record revenue, record fee income, and record investment banking results for the year. Our investment banking result -- business has grown at an 18% compound annual growth rate over the last 5 years. Simply stated, we are most successful when we are most focused. On the consumer side, we experienced the strongest household growth we've seen in years. In the second half of 2020, we added more new customer households than in any full year since our acquisition of First Niagara. This momentum has continued into 2021. I'm excited about our 2 relationship-based growth engines: Laurel Road and our consumer mortgage business. Combined, these 2 businesses generated over $10 billion in high-quality loan originations last year. And as you can see from the slide, both of these efforts are relatively new. Our consumer mortgage business generated over $8 billion of loans. That's up 90% from 2019. This business delivers high quality loans, fees, and importantly, relationships. Laurel Road, a born digital company serving medical professionals originated $2.3 billion in loans last year and over $4 billion since our acquisition just in April of 2019. On March 30, this month, National Doctors' Day, we will be launching our national, digital affinity bank targeted specifically at healthcare professionals with whom we can build broader digital relationships. This offering will include deposits, additional lending products, and other value-added services, all uniquely personalized to suit the needs and challenges of healthcare professionals. This launch expands Key's digital reach and is a great example of how we have executed on our targeted scale strategy. Critical to the success of both our consumer and commercial businesses, are the investments that we continue to make in digital and analytics. Last week, we announced the acquisition of AQN Strategies. A leading customer-focused analytics firm with deep expertise in the financial services industry. This acquisition aligns to Key's relationship strategy and underscores our ongoing commitment to employ data-driven approaches that expand our customer reach. As has been the case with our previous acquisitions, we believe AQN will be a catalyst for growth across our entire franchise. Fee income currently makes up 40% of our total revenue. As I mentioned last year, we achieved a record level of noninterest income, which was up 23% from the prior year. Our results reflected strength in investment banking, payments, and our consumer banking businesses. Our ability to reach our financial targets, including generating positive operating leverage, requires strong expense management. We remain committed to fostering a culture of continuous improvement, balancing cost savings, coupled with investments. Over the past several years, we have reduced expenses by 3% to 5% annually and reinvested a portion of the savings back into our company. This year, we will continue to realize cost savings that will allow us to meet our expense targets while continuing to invest in our businesses. One expense opportunity is our branch network. Recently, Key has consolidated, on average, 2% to 3% of our branches annually. With the rapid adoption of digital, we plan to accelerate branch consolidations in 2021, representing 7% of our network. Most of the consolidations will take place in the first half of the year. We do not expect material client attrition as most of the closed branches are in close proximity to other branches. We expect clients will continue to migrate to digital channels. Last year, we saw a 40% year-over-year increase in digital sales. Nearly 40% of new checking accounts are now originated through our digital channels. Clearly, this is an area of growing importance to our clients. We will continue to make investments to advance the pace of digitalization. We will also continue to reduce our occupancy costs. As more of our teammates move to mobile work environment, this trend will have a modest impact this year, however, will continue to benefit us for years to come. We also experienced a number of pandemic related expenses throughout 2020, which, of course, we would expect to decline over time. The cost savings provide us with the opportunity to drive productivity and efficiency across our franchise. Importantly and foundational to everything we do is our relentless focus on maintaining our moderate risk profile, focusing on sound, profitable growth. We have significantly reduced our risk profile over the past decade by focusing on relationships. And once again, by being very targeted in who we do business with. We have high-quality portfolios focused on relationship clients. In fact, over 80% of our commercial credit exposure is attributed to relationships that we define as full relationship clients. Our credit metrics remain strong. Whether measured by our peer-leading performance in the latest stress test or our strong credit performance through the pandemic. It is a testament to the strength of our strategy and our relationship-based business model. We believe that the quality of our business, coupled with our strong risk management practices, positions us to perform well through economic cycles. Lastly, we have been and will continue to be very disciplined in the way we manage and deploy our capital, focusing both on the return on and the return of capital. Our stated capital priorities remain unchanged. First, to support our organic growth; secondly, to pay dividends; and thirdly, to engage in share repurchases. We remain committed to using our capital to support the growth of our businesses and prioritizing our dividend, which has grown at a 21% annual compound growth rate over the past 5 years. I will end where I began by underscoring our commitment and our confidence in reaching our long-term targets and our commitment to deliver for all of our stakeholders. With that, Gerard, I'd like to turn it back over to you for any questions you or anyone else might have. Thank you.

Thank you, Chris. Can you hear me, Chris?

Loud and clear.

Great. First of all, I apologize. I'm in the office today and for first, the power went out in the building, 10 minutes before your start time. So that's why I'm doing this through the telephone. And again, I apologize.

No, it works just fine. Thank you.

Great. And thank you being like Baker Mayfield doing inaudible. I appreciate that. So -- and I hear -- it sounds like I hear Don in the background, hi, Don. How are you?

You hear my left, you're right, Gerard. So somebody's got to laugh at your jokes.

There you go. Well, gentlemen, thank you very much. Chris, a very strong presentation, a lot of good content there, and I really appreciate that in kicking off our 25th Annual Financial Institutions Conference here at RBC. And maybe if we could take a step back, Chris, I'd be really interested in getting your views on -- last year was an unprecedented year in our lifetimes. And aside from the obvious impact from the tragic COVID outbreak, what were the biggest surprises for KeyCorp, and for you, and also for KeyCorp in 2020?

Well, sure. So I think -- I wouldn't say it was a surprise, but it was, for me, a high point, and that is the way our team rallied around what we needed to do in the pandemic. And what we needed to do in the pandemic is obviously support our teammates, support our clients, and be out there in the marketplace, making the appropriate adjustments. We always talked, Gerard, about what I call the dual mandate. And yes, we had to get through the pandemic, and we did a great job of pivoting to working remotely, making sure we kept our branches open, making sure when the markets were seizing about a year ago, actually, that we were there for our clients. But I think even more importantly, we needed to make sure that we positioned Key for the future. And when I think about that, I think about how we supported our clients, I think about, for example, PPP, that was, I thought, really stand out for us. And in the first round, we funded about $8.3 billion worth of loans, 43,000 customers. And I thought that was a real great kind of test of our team because everyone was on the same playing field. And I thought we performed really well for the benefit of our clients. The other thing that wasn't a surprise, but was, I think, sort of a validation of a strategy that we've been working on for 10-plus years in the series of stress tests that we had, we did really, really well. And in December, we were top of our class among our peers. From memory, I think, in terms of capital consumption, we were 7 out of 33, which is obviously a broader universe other than just our peers. So those are the areas that really stood out. Another area that didn't surprise me because we had been preparing for it was just the switch to digital. And we had been preparing for that. And once the lockdown occurred, it didn't surprise me, but it was great to see our clients really pivot to digital. Those would be some of the things I've mentioned.

Very good. Chris, in your prepared remarks, you talked about the strength of the investment banking area. I think you mentioned it's grown at about an 18% compound annual growth rate for the last 5 years. Obviously, you came to Key in the '90s with the McDonald acquisition. So this is in your DNA, the investment banking business. Can you share with us -- because this really separates you from many of your peers, the success you're having here? How are you guys achieving this success? Can you share with us some of your insights?

Sure. Well, thank you for the question and the acknowledgment. The one -- I just would add one detail here. It's really an 8% compound annual growth rate over the last 5 years. We're hoping it's going to be 18 over the next 5 though, Gerard.

Okay. Okay. Thank you.

But as it relates to the business, it's a really hard thing to pull off. And like all acquisitions, like all things in banking, it's first and foremost, cultural. And so what we were able to do many years ago now is take McDonald and merge it into Key. And we, over time, have made investment bankers, investment bankers and commercial bankers, and we've made commercial bankers, commercial bankers and investment bankers. Very hard to do. The other thing that's really hard for banks to do is to really be committed to industry verticals, and you can't have a successful integrated corporate and investment bank, unless you're willing to flip that switch and go-to-market on an industry basis. And the 7 industry verticals that we're in, obviously, we have a great amount of expertise. We know who the players are. We know who the suppliers are. We know everything going on in the industry. So just like you, Gerard, being an analyst focusing exclusively on the financial services sector, it gives our bankers a huge advantage. From a competitive standpoint, it really is a differentiator. If you think about it, if there are banks, I'll make it up, if there's 15 banks globally that can do what we do, most of them are focused on larger companies. So for someone to compete with us in our integrated corporate and investment bank, they have to be focused on the middle market. They have to be focused on 1 of our 7 industry verticals. They have to have a balance sheet because there's a lot of really fine boutiques out there that can't use their capital and can't raise capital in the manner that we can. And so all of a sudden, you go from a whole bunch of competitors to several that are good, but it really has been a source of growth for us. The other point I would make, and I'm really proud of this because this too is hard to do. Not only is it hard to build it, it's also hard to buy boutiques and significantly integrate them into the business. And whether it's Pacific Crest Securities that obviously focuses on technology, we already were in the technology business. But we obviously needed to be in a more significant way because it's such a significant part of the economy, and we did that, as you know, several years ago. And then our most recent acquisition that we successfully integrated was Cain Brothers. And Cain Brothers, they, too, have been just a great acquisition. So that's a business that we'll continue to invest in. And by continuing to invest in since we have the full platform. The investments take the Form of us out there hiring bankers. As it turns out, we have a lot of statistics on this. Successful bankers can be even more successful on our platform. And so that usually is a good selling point as we're out there in the marketplace.

Very good. Is there any opportunity to grow through inorganic means in this specific area, Chris, in investment banking, you mentioned the acquisitions of Pacific Crest and Cain Brothers and how successful they've been by integrating them into your existing platform? Are there opportunities to do that in other verticals? Or you guys know we have what we need, and there's really no need for that over the near-term?

No. We're always looking -- I mentioned some pretty niche verticals where we have really great positioning. We're always looking for adjacencies, this whole notion of targeted scale, whether it's things like affordable housing, renewable energy. Those are just examples of niches. So we would be interested in, and we would be comfortable buying niche boutiques that we thought could really advance the cost.

Very good. Speaking about what differentiates you from some of your peers, your Laurel Road acquisition gives you some uniqueness that maybe some of your peers do not have. Can you just give us an update on what's going on at Laurel Road and the opportunity to expand their digital channel and their technology into other lending areas?

Sure. So that's -- that, too, is an acquisition that we successfully integrated. And this is a foreign digital company very -- we bought it in 2019. Last year, they generated $2.3 billion in medical refinance student loans. And so a couple of things about it. We really like that it's targeted. We also really like the customer base. So think about people, Gerard, who have graduated from medical school, by definition, they're accredited they're employed. And by the way, they'll be employed for as long as they want to be. So from a credit perspective, it's a great bet. We always look at clients, the lifetime value of a client, and you can imagine the lifetime value of a client that's making $300,000 a year that's in their early 30s and what we know that we can do with Laurel Road is really expand that relationship. So on the 30th of March, we're going to launch our national, digital affinity bank. And what that will do is it will broaden the product offering for this targeted group of customers. And there's been a lot of digital banks that have been built, but we're going to build a national, digital affinity bank. And in addition to offering banking products to the 1.1 million doctors that are out there in the United States. We'll also offer them important features. I'll give you 1 example, is unlike in the finance business where there's pretty good transparency on at what level people make, what levels of compensation. A lot of doctors, when they go to do their fellowship, or they go to become an attending physician and sign that first contract. They don't know what the market is, we clearly know what the market is because they've all digitally applied for loans with us. So I give that just as an example. The other thing that I think has been a huge help to all of Key is when we bought Laurel Road, we have about -- we picked up now the numbers about 40 full stack software engineers. And you can imagine having that kind of capability, the speed of their iterations and how they've helped us here at Key as we continue our digital transformation. So I'll stop there. But as you can tell, I'm pretty excited about what Laurel Road can do for us.

Oh, no. Absolutely. Chris, can you pivot a little bit to credit. You mentioned that because of the stress tests, your credit quality obviously is [ held-up ] pretty well. And this is a real differentiation between the Key today and the Key in past credit cycles. Can you share with us the focus that you folks have had now since the financial crisis on credit and now you demonstrated that you're lot different on credit which hopefully you will be rewarded with the best [ tax situation ] going forward?

Sure. Well, thank you for the question. So going back 10 years ago, we actually had outperformance as in worse than our peers in the financial crisis. So when we think about that, we stepped back at that point. We said what are we going to do differently? Because I am a strong believer, especially when you have our business model, keep in mind, we can raise all kinds of capital for our clients without putting it on our balance sheet. And I felt really strongly that we can have great relationships without just being the loosest money, the cheapest money, et cetera. And so the first thing we did is really define who we wanted to do business with. And so for example, in real estate, where we experienced outsized losses, we said, we're not just going to take and look at every deal we can. We're going to focus on certain developers in certain cities. In every city there are a few critical developers that build the multifamily that are the leaders in multifamily. And those are real businesses. They're not one-off. And so we really contracted our real estate business and really in that business, focused on our ability to place paper. So like the rest of our business, we can go out, Fannie, Freddie, FHA, the life companies, the CMBS market. So that's what we did there. We also looked at any other place where we had leverage, and we said, okay, we can be in the leveraged finance business in a very targeted way. But if we're going to be in the leverage finance business, it's going to be with companies that are within our 7 industry verticals that we keenly understand. And so that goes back for 10 years, and we said, we are a relationship-based bank. We're not interested in having wholesale financing. You might note that on the consumer side, we made the decision to exit the indirect auto business. As we said, that's a fine portfolio, but those are one-off credit deals. And what we're looking for are relationships. So it all goes back to this notion of knowing who you want to do business with, knowing where you can win, how you can win, having targeted scale. That's what we did 10 years ago. And to tell you the truth, we have -- we could have grown our balance sheet a lot faster. Keep in mind that right now, of the capital we raised, only 20% of it or so goes on to our balance sheet. So we're distributing a lot of paper and had been through the last cycle, and I think that really will inure to our benefit. Now the interesting thing is, at some point, and that's not now, it will be the right time to be able to lean in on using our balance sheet. But in the meantime, we have a lot of other levers that we can look at. And it's nice to see it play out through the stress test.

Chris, I would agree with that.

Very good. Thank you. Oh, sorry, go ahead, Don.

Sure. Just a couple of other things there as well. As Chris talked about commercial real estate. If you look at our portfolio 10 years ago versus today, that you see a much smaller percentage of that portfolio in construction. And so as Chris highlighted, we're really working with developers who are owners of those properties as opposed to just the developers and have that speculation risk associated with it. The other thing Chris talked about as far as relationship that we really encourage our loan officers, our relationship managers to be risk managers. And about 4 years ago, Vernon and I were talking about how we exited certain multifamily head concentrations and gateway cities just because we felt the risk had gone above what the returns were for those areas. And we probably called that too soon, but we really encourage relationship managers to have that kind of forward-looking type of thought process as far as how we decide which relationships and which areas to focus in.

Very good. Maybe this is for both of you, maybe, Don, you'd like to take this question. We all have seen a very meaningful move in the 10-year government bond yield since the fall or really since the beginning of the year. Can you share with us just how you guys are managing with the 10-year government bond yield going up to the levels? Is that today from where it was as recently as 3 months to go?

Sure. As far as interest rates overall, we've seen it move up across the curve. More in that 5 to 10-year portion of the curve as opposed to shorter. And with the exception of our investment portfolio, most of our balance sheet really is in that 3-year end of the curve and shorter. And we have seen the 3-year curve move up about 16 basis points from, say, the start of the year, so that is helpful. 10-year point of the curve and beyond is impacting both our bond portfolio. And so we're starting to see some greater opportunities for reinvestment there that we've seen our cash position continue to build and so we'll continue to use more of an incremental approach as far as putting some of those excess funds to work, and we're starting to see a little bit stronger returns or yields on those assets. But also impacting the mortgage business. And so we're continuing to see strong pipelines there that even with the increase in rates, we're seeing strong demand, and we would expect to see that throughout this year. And one of the things I think that surprised many people was that as far as our production targets for 2021, they're actually equal to or even better than what we saw in 2020 as far as residential mortgage production, and that really speaks to the strength of the platform that we have and the investments we've been making in that space and would expect to see returns continue at a strong level in 2021 for that area as well.

Very good. Thank you, Don. And maybe just wrapping up, Chris. We have time maybe for one last kind of question. Or just really statement. What would you like to leave with investors today at the end of this conversation, what do you want to resonate with them as they walk away from this presentation?

See, a couple of things. One is our deep and strong management team. The other is this whole notion of targeted scale. We're not -- people ask or other rhetorical question, how can smaller banks compete with the large 4 banks in the country. And my -- what I'd like people to take away is you absolutely can compete. And I think PPP is a good example with a level playing field. If you're really focused, if you really know who you want to do business with and if you make the appropriate investments targeting those clients. And we have plenty of capital to do that. And we've done it for years on the commercial side. And as you can tell from our discussion today, we're doing it right now in a significant way on the consumer side. And that's what I'd like to share with you and the rest of the folks on the call.

Chris, really, I apologize again for the start of the call, and thank you so much, and Don, thank you for joining, and I think Vernon might be in the room. So Vernon, thank you as well. So have a good day, gentlemen.

Thanks, Gerard. We appreciate it.

Okay. Take care. Bye-bye.