KeyCorp (KEY) Earnings Call Transcript & Summary

This is Jason Goldberg, and I cover the U.S. large-cap bank stocks here at Barclays. Welcome to our 19th Annual Global Financial Services Conference. Next up, very pleased to have KeyCorp. From the company, we have Chairman and CEO, Chris Gorman; and Chief Financial Officer, Don Kimble. Before I turn it over to them, please keep in mind, in the upper left-hand corner of your -- upper right-hand corner, rather, of your screen, there are 2 buttons. One is Ask a Question. Simply click on that button, you'll be able to ask a question. There is a delay in getting it to me. So the earlier you do it in the presentation, it increases your chances of it getting asked, should we have time. And also, there's a button called Survey. If you click on that, throughout the presentation, you'll be able to ask -- or be able to answer our polling questions from the audience. You'll be able to talk to those at the end or certainly publish those results tonight. And with that, let me turn over to Chris.

Well, thanks, Jason. It's great to be at your conference again this year. I'm joined here in KeyCorp's Board room by Don Kimble, who's our Chief Financial Officer. On Slide 2, you'll find our statement on forward-looking disclosure and non-GAAP financial measures. This covers my remarks as well as the Q&A that follows. I'm now turning to Slide 3. Most of our time today will be devoted to your questions, but I'd like to start with a few opening comments. Key continues to be a growth story that, in my opinion, is not fully recognized by the market. Year-to-date, our revenue growth is the second highest of our peer group. And importantly, Key is well positioned to continue to deliver sustainable growth and strong returns. It starts with having an outstanding team and a distinctive relationship-based business model built around targeted scale in our businesses and the clients that we serve. We continue to deepen penetration of high-growth sectors and markets. I will cover some of these areas later in my presentation. Our growth is supported by targeted investments we have made and continue to make in digital, in analytics and in our teammates. Also critical to our success are strong risk management practices that support sound, profitable growth. And finally, we have been very disciplined in our management of capital, having returned a significant amount of capital to our shareholders. I'm now moving to Slide 4. We have built targeted scale by executing on our distinctive strategy, which has resulted in increased market share in high-growth sectors and meaningful niches. On the commercial side, we have built a strong, leading commercial and investment bank, focused on middle-market clients in 7 industry verticals. We have built scale in a very targeted way, which has resulted in Key being a leader in a number of high-growth areas. Let me just mention a few of them, if I could. Health care, we are one of the top advisers to facilities-based health care providers. Renewable energy financing, we rank #2 in North America. Affordable housing, we rank #3 in North America. We believe that affordable housing will continue to be a growth area. We're proud to be part of the solution for what we see as a very pressing and growing need in our country. Technology, an area of ever-increasing importance in our economy and an area where we have doubled our investment banking business. These areas have helped drive our record performance in 2020. We achieved record revenue, record fee income, record investment banking results for the year. Importantly, we have continued our momentum in the first 6 months of 2021, with record first and second quarter investment banking performance. Simply stated, we are most successful when we are most focused. In our consumer businesses, we experienced record growth in new households for the first 6 months of the year, in every one of our markets and in every age group. Our new client growth over the past 6 months exceeds our growth in any full year period over the last decade. Importantly, our strongest growth has come from younger clients in the Western part of our franchise. Today, approximately 25% of our deposits are in the 10 fastest-growing states in the United States. And I think that's worth repeating because I think that's a fact that is often misunderstood. 25% of our deposits are in the 10 fastest-growing states. We also have 2 strong growth engines in consumer mortgage and Laurel Road. Consumer mortgage originations reached another all-time high last quarter, and we expect to exceed last year's record of $8.3 billion this year. Laurel Road, a born-digital company serving health care professionals, has originated $5 billion in high-quality loans since our acquisition in April of 2019. Since our launch of our national digital bank, Laurel Road for Doctors, at the end of March, we have added 3,500 new doctor and dentist clients, half of those clients are already multiple product customers. I'm now on Slide 5. We have identified 4 strategic pillars that we have and will continue to focus on in order to accelerate our growth. The first is primacy. We are, at our core, a relationship bank. And we know that we can best serve our targeted clients when we own the primary operating account. Relationship clients are almost 3x more profitable than single-product clients. This pillar spans both our consumer and commercial businesses and is supported by the investments we have made in digital, analytics and our teammates, including our recent acquisition of AQN Strategies, a leading consumer-focused analytics firm. Simply stated, you cannot be a leading digital bank without leading analytical capabilities. The next pillar, health care, which, as everybody knows, makes up almost 20% of the U.S. economy. We are one of the leading health care banks and have accelerated our growth with additions of Laurel Road and Cain Brothers. This strategic pillar focuses on collaboration and coordination across our entire company to better serve our targeted clients. I've already mentioned the opportunity we have with Laurel Road. We also continue to grow and expand all of our health care relationships. We are able to provide a full set of solutions, raising capital, payments, wealth management and, of course, strategic advice. Digitizing the enterprise is also one of our pillars. This spans our consumer and commercial businesses and focuses on creating better, more efficient experience for both our clients and our teammates. Building off of our primacy pillar, over 90% of our primacy clients, those who identify Key as their primary bank, are digitally active. We have a proven history of acquiring and partnering with fintechs. Additionally, we also have a proven history of successfully integrating entrepreneurial businesses in order to better serve our targeted clients and prospects. Internally, we are replacing clunky handoffs with digital solutions in the front, middle and back office. And then finally, we are growing the number of bankers on our platform. This year, we have increased our senior banker population by 5%, and we plan to continue that expansion. This has resulted in a 21% increase in client pitches this year. We continue to believe that our platform is under-leveraged. We have the focus, the expertise to continue to grow within our 7 industry targets. I'm now moving to Slide 6. Foundational to everything we do is maintaining our moderate risk profile, focusing on sound, profitable growth. Our credit metrics remain strong, whether measured by our peer-leading performance in the latest stress testing or our strong credit performance throughout the pandemic. It is a testament to the strength of our strategy and our targeted business model. Nearly 50% of our C&I loan portfolio is investment grade, and that's clearly a distinguishing characteristic relative to many of our peers. Our commercial portfolio is focused on middle-market companies in our 7 industry verticals where we have experienced bankers and industry expertise. We can offer these clients both on and off-balance sheet financing solutions. We are uniquely positioned with market insight into who we want to do business with and, frankly, those that we don't want to do business with. Over the past 12 months, we have placed with others, approximately 80% of the capital we have raised for the benefit of our clients. On the consumer side, our portfolio is a super-prime portfolio with a weighted average FICO score at origination of 770. I'm now on Slide 7. We have been and we will continue to be disciplined in the way we manage and deploy our capital, focusing on both the return on and the return of capital. At the end of the second quarter, our common equity Tier 1 ratio was 9.9%, above our targeted range of 9% to 9.5%. We believe that operating within our targeted range provides us with sufficient capital to support our customers and our businesses while concurrently returning capital to our shareholders. Our stated capital priorities remain unchanged: first, support organic growth; secondly, dividends; third, share repurchases. As previously announced, our Board of Directors will evaluate an increase in our common stock dividend in the fourth quarter. Last week, we entered into an agreement to sell the remainder of our indirect auto portfolio, which was discontinued at the end of last year. We also entered into an accelerated share repurchase program of up to $585 million of common stock, which was included in our recent $1.5 billion share repurchase authorization. All of these actions support our commitment to manage and deploy our capital, consistent with our stated priorities. And then wrapping up on Slide 8, Key is a compelling value proposition. We have a distinctive business model with a strategy built around targeted scale, which we believe is a real differentiator in the regional bank space. We have many avenues for core sustainable growth, supported by ongoing and very targeted investments. We are good risk managers, proven throughout the pandemic and in our peer-leading stress test results. We have been disciplined in managing our capital, returning significant amounts of our capital to our shareholders. I believe that our current valuation does not reflect our strong competitive position. I will end by reaffirming our commitment and confidence to reaching our long-term targets and delivering value for all of our stakeholders. With that, Jason, I'll conclude my opening remarks and open it up for questions. Thanks.

Chris, I appreciate that. And remember, for those listening in to the Barclays construct, upper right-hand corner, you could click the button for Ask a Question, and you'll be able to ask a question.

Maybe the first place to begin is you executed that trade on Friday evening. Just how did you kind of think about the sale of the loans? I think last year, we talked about why you got out of the business. Maybe this year, talk about why you kind of accelerate the exit. Obviously, there's economic give and take, obviously, an advantage of getting rid of the whole book all at once versus assuming had to give up some of the economics. So just how do you kind of weigh a decision like that?

Yes. Well, first of all, Jason, it all starts with our focused strategy. We are a relationship bank, and there's really nothing that's relationship-oriented about being in the indirect auto business. So first of all, how we thought about the business, how we looked at the returns of the business, and then when we thought about the transaction, it did a few things for us. One, the return on the actual transaction with -- affiliated with the accelerated stock repurchase, obviously, has a strong IRR. And then secondly, it frees up capital. And I think freeing up capital, having a good return, and then we were able to, although it will be re-categorized not in the loan book, but it will be an earning asset, we kept a lot of the assets on the books. Then the last thing, it was a very interesting and fortuitous time to exit because, as you well know, the value of used cars has gone up significantly. So we were able to drive what we thought was really a great deal for the shareholders.

Yes. And then the loan growth is obviously, I think, the big topic in investors' minds. Are you seeing any pickup in commercial lending? And have utilization rates begun to move higher this quarter?

Yes. So if you kind of step back, sort of the headline number is -- our forward view for 2021 is unchanged, adjusted for the asset sale that we just talked about that we announced Friday, obviously. Overall, loan balances are up in June to August. And so we take -- and we're taking that momentum into September. So you asked specifically about utilization. We had said at the end of the second quarter that we thought that the decline in utilization had bottomed out, and it did. We've seen, on a quarter-to-date basis, a 50 basis point pickup in utilization in C&I. We expect to grow our C&I book in the second half of the year. And kind of what gives us confidence there is we've got -- I look at our backlogs, our leasing backlogs are up about 35% year-over-year, which is really important because those are kind of investments in technology and health care. Speaking of technology and health care, those are obviously strong drivers of loan growth for Key. We also have other areas, like I mentioned in my comments, around renewable energy, which has a large appetite for capital and affordable housing. And then lastly, Jason, I would share with you, from the C&I perspective, is we have a record backlog right now in our M&A business, and some of that invariably manifest itself in loan growth. On the consumer side, we continue to be encouraged by the momentum we have in our 2 growth engines, that being Laurel Road and our mortgage business, both of which continue to have a lot of momentum.

So it sounds like your outlook is a little bit more optimistic than some of the other regionals that have presented so far at this conference. Do you think it's mix, strategic positioning, your markets? I guess what do you think is differentiating you if this kind of trend continues?

Yes, I think it goes back to our focus. And if you think about what's going on in our consumer business, it's really in 2 asset classes: it's mortgage and relationship-based mortgage, where years ago, we really weren't even in the business. So we have the benefit of really good trajectory there. Obviously, Laurel Road is a huge area of focus. We've originated $5 billion worth of loans to doctors and dentists since we bought the business just in 2019. And then I really think our industry focus really helps us in terms of driving loan volume on the C&I side, particularly when we're focused on certain areas that are very capital intensive, and I mentioned a couple of them.

Can you maybe expand on your outlook for Laurel Road and kind of future expansion plans with that business?

Sure. So just to step back, it's a unique business, right, because many fintechs have built businesses around one particular product that, frankly, they're very good at and they take the friction out of. This is a relationship-based national digital affinity bank. So we started with doctors and dentists. There's 1.1 million of them. The next concentric circle, Jason, will be nurses. In the first quarter of next year, we will roll it out to nurses. And there's 4.4 million nurses, and many of those have student loans as well. What's interesting about the pattern of doctors, dentists and nurses as well, the groups are not homogeneous at all in terms of the people that participate in the industry. The needs are pretty homogeneous based on when they get out of school, when they need to refinance their student loan, et cetera. There are other groups that we're thinking about adding concentric circles, but we won't do that until we have successfully rolled it out to the 4.1 -- or I'm sorry, 4.4 million nurses in the -- probably in the first or second quarter of next year.

Interesting. It sounds like a lot more opportunities with that. Also in your remarks, you talked about a record first half for investment banking. I feel like I keep on using record and investment banking in the same sentence for Key over and over again. Obviously, the environment in the capital market space, in middle-market capital market space is competitive. Just maybe talk to -- is that a business you think you can continue to grow despite the comps getting tougher and tougher?

I really do think we can continue to grow it. I think it's a unique business, Jason. Our history is, over the last decade, I think our compound annual growth rate has been around 11%. And obviously, that's been some good markets, some okay markets and some challenging markets. It's a business we think we can continue to grow. As I mentioned, I think we're under-penetrated. There's a vast group of middle-market companies that can really benefit from strategic advice and industry expertise that I think is great kind of -- an open space, I might add. So that's a business we're going to continue to hire people. As you know, we've made some significant hiring this year. We'll continue to hire people. It's interesting, we find that when we bring bankers onto our platform because we look at all these statistics, they tend to be more productive on our platform than they were on their previous platform. And some of that is because they might come from a boutique, which is not as broad of a platform, which is easily explainable. But sometimes even our bankers that come from much larger platforms seem to be more productive. And I think -- I just think we do a nice job from a size perspective of delivering the whole firm.

Got you. And then Key has made some pretty nice improvement on the commercial -- I'm sorry, on the consumer side over the last several years. Could you maybe talk to what's driving those changes? And is it sustainable?

Yes, I definitely think it's sustainable. The first change we made is right before I took my position as Chairman and CEO, we made a change in the leadership of our consumer business. And that, as it often does, has had a trickle-down effect on some very key areas, whether it's our private banking, wealth management business, our mortgage business, just how we're approaching the marketplace. That's a business, I mentioned in my opening remarks, how we have a lot of traction on household growth. You're going to see us continue to focus on more and more households and being more and more focused in how we go to market. And I think Laurel Road is a good example of really bringing targeted scale into our consumer businesses.

Got it. And then I guess as we get to think about next year, I mean just how are you thinking about net interest income headwinds, rates, PPP wind-down, swaps rolling off, et cetera, as you kind of enter the 2022 budgeting process? How is all those factors kind of playing through your minds?

Sure. So we feel good as we look forward. And like everyone, we're starting to formulate just now our plans on 2022, and we'll be sharing all those targets with you and others in January. But as we think about it, you mentioned NII, let me start with that because one thing that seems to get a lot of discussion that I think is overplayed is our swap position. So we have about $4.6 billion swaps. If we were to reprice all of those, I think it'd be a hit of like 40 basis points, which would equate to about $18 million, which is not inconsequential. But...

Chris, maybe I can just clarify that. I apologize. But the $4.6 billion is maturities next year for the swap book. So just to make sure, we've got over $20 billion of notional amount of swaps on the balance sheet. But Chris is right that if we reprice the current go-to rate for that $4.6 billion, it would be a spread of about -- or received fixed rate of about 90 basis points. And right now, the average portfolio is at about a 130 received fixed rate. So it would be about a 40 basis point give up on that portion of it.

For sure. And so the real hurdle then from 2021 to 2022 that we have to make up is about that $18 million. You specifically -- and let me just make one more point, if I could, on that. The other thing that I think, Jason, on a relative basis, because we've done a good job of getting more balance between our commercial and our consumer business, but because of the starting point, we actually have a lot less in terms of actual levels of term debt at Key than most of our peers. And I would contend that anyone that's holding a lot of term debt runs some of the same refinancing risk that we do as we look at rolling our swap portfolio. So just on a relative basis, I've mentioned that. Now PPP, there's no question that we were an outperformer. We originated about $11 billion. I think, Don, this quarter, we'll forgive $2.5 billion or some such number, a number like that of PPP loans. So that is a challenge for us as we go into 2022. But having said that, we have a lot of additional liquidity that as we put that liquidity to work, we think can more than offset what we're seeing from the PPP book. Don, what would you add to that?

No, I would agree. We've talked externally about the -- there's over $20 billion of excess liquidity that we have in the books today. And just to reinvest that at today's rates compared to what the cash earns for us today would be about $250 million a year pickup. We've been very slow to want to reinvest that, that we expected the yield curve to move up quicker than what it has. And so we have been sitting on the cash position. But at a certain point in time, we will start to deploy that cash more aggressively and be able to leverage some of the earnings from that even if the rest of the balance sheet doesn't take hold. And so recognize that there is pressure from PPP. There are pressure points from the lower rate environment, but that is one lever that we have available to also help offset that impact.

And then as you think about our fee income line, as I mentioned, we feel like we're going into 2022 with really good momentum kind of across the board, whether it's our IM&T business, which is our investment business; our investment banking business; our cards and payments. Absent prepaid, which as we've talked with you and other investors, prepaid is about awash in terms of revenue and expense. So that's not one that we're too concerned about, having a little bit of a decline in the revenues there.

Got you. And I guess you've talked in the past about expenses to remain relatively stable. Are there additional levers you have there?

There are. Let's start with -- from a continuous improvement perspective, Jason, we're constantly looking at how we can do things more effectively. And specifically, using software and investing in software in the middle and back office where we can remove some of the clunky handoffs that all banks have that, frankly, are very people intensive. So continuous improvement is an area. We also, this year, have consolidated 69 branches, which is about 3x what we typically would in a given year. We usually consolidate just about 2%. This is obviously closer to 7%, so more than we typically would. We save about $300,000 per branch per year. So that's a savings as well. The other thing that we've been doing a lot of is just investing in our business, investing in our people. And if you think about Laurel Road for Doctors, we probably invested, when we rolled that out in the first quarter, an additional $25 million between marketing and technology. Those are areas where -- and then longer term, we've said this publicly, Don and I believe we can exit about 25% of our non-branch, non-op center real estate, which is a significant opportunity. Obviously, that will become available to us as leases come up. Don, would you add anything to that?

No, I think it really is just getting back to that continuous improvement approach to our business. And we've talked externally with the goal of Key is to continue to generate positive operating leverage, and that flows through down the business units as well. And so making sure that we continue to have the ammunition to invest back into the business that requires them to achieve additional cost savings to help fund it.

Got you. And then I guess maybe shifting gears to credit quality. I guess, first off, any areas that you're keeping a particularly close eye on in light of the fact that loan losses are so low? And I guess, we're moving towards day 1 CECL reserve levels. Is there a scenario where you think it could go below that day 1 level?

So let me take that last piece first, and then we'll talk about areas that we're always watching. So day 1, our reserve was 1.17%. We peaked at about 1.88%. And right now, we're about 1.36%. It all depends obviously on specific credit book where we see the trajectory of the economy and also loan growth. I could see a scenario at some point where we could end up below our initial reserve. I can tell you that the portfolios are all performing better than we would have expected, better than we would have modeled. Having said that, I don't think any of us anticipated the amount of stimulus that was pumped into the system that obviously is very helpful. The last part of your question you asked about is, where do we really focus? I focus on those areas where there's a lot of leverage. And for us, that's our leverage book. And it's interesting, we have about -- going into the pandemic, we had about $2 billion outstanding. And again, these are people that we know in our 7 industry verticals, and we think modestly that we have a pretty good handle on what goes on in those industries. That loan book is now down to $1.6 billion. So our portfolio, Jason, is just -- I'd be hard-pressed to point you to a direction that's of huge concern. That doesn't mean we're not looking at it all the time, but the book is very solid shape.

And remember, for those in the audience, upper right-hand corner of your screen, if you click Ask a Question, we'll be happy to try and get to those. You mentioned CET1 ratio, I think, of 9.9%. You talked about a 9% to 9.5% target, so still above that. I suspect just talking about how you get to that range. But is there -- I guess given -- in light of kind of your credit quality comments, is there an ability to kind of go below that 9%, 9.5% range? Or what would you need to see to be comfortable doing that?

Well, Jason, when you consider that our starting point, even after all the things that we announced on Friday, our starting point is still above 9.5%. We're really just focused on getting into the range of 9% to 9.5%. We think that's a good place for us to operate. And so that's kind of our target is to make sure we're between 9% and 9.5%.

And near term, I would say that we are fine with that range. I would say, longer term, as we continue to improve the operating performance of the company, we'll have opportunities to take a look at what is the appropriate level. And Chris, in his comments, had talked about how we are best-in-class as far as low levels of stressed credit losses in the December stress test. We're also best-in-class as far as the state of distressed capital utilization during that same time period as well. And so I think those types of factors continue to reinforce our ability to be at the lower end of our range longer term and maybe at some point in time, adjust that even further. But we're very pleased to have the stress capital buffer approach to managing our capital going forward and allows us to probably more proactively manage in different time periods, given that position and approach.

And then, Chris, you said the Board is going to evaluate the dividend increase in Q4. Any hints on what we could expect?

No. Well, the Board will obviously spend some time thinking about it. So as I said, we'll take a look at that. Obviously, we took a big step forward on Friday in terms of share repurchases that will go into the thought process as well.

And I would just add there as well, though, that in this environment, we're not seeing the support for increasing our dividend at a level given that we're already at a 3.8% yield. So the question would be is that, do we continue to bias the return of capital more to share buybacks and dividends? So we fully expect it to have an increase there, but I wouldn't want to set the expectation that there's going to be a huge increase to the dividend, given the mix that we have right now as far as the overall market conditions.

Got you. And then I guess how do you see Key playing a role in M&A over time? And would you ever consider a bank acquisition? Clearly, First Niagara was additive. You've seen some of your peers be a bit more active of late. How does that fit into Key's thought process?

Sure. So where you'll see us continue -- where we have been playing and you'll see us continue to play is buying entrepreneurial companies that add things like people. For example, when we bought Laurel Road, we picked up 40, 4-0, full stack engineers that are based in San Diego. So you'll see us make these niche acquisitions that further our capabilities, further our technology capabilities and help us better serve our targeted clients and prospects. I'm really proud of the fact that we've been able to buy boutiques and successfully integrate them. We've been able to buy digital companies, et cetera. I think you can expect that to continue. There's a big universe of those companies out there. And frankly, we're a company that, I think, is well received by sellers. As it relates to whole bank acquisitions, first of all, I would never say never, but it's not a huge area of focus for me and for us. The window would have -- I mean the bar would be pretty high. It would have to be someone that adds a lot of value to Key and helps us with our targeted scale strategy. That would be one thing. The other thing that I will share having run the integration of First Niagara that you referenced, first of all, there's real value to be created in that I think we took out 45% of the cost and kept the people and kept the clients. So there's real value. There's also a huge opportunity cost. When you do a whole bank acquisition, a lot of the other things that you'd like to be doing for the next, call it, 24 months are put on hold. So that's kind of how I think about sort of the full range of acquisitions.

That's fair. We have a question from the audience. I appreciate the comments on the net interest income outlook and headwinds and some of the offsets with fee income and expenses. With positive operating leverage likely to return this year, do you think it can carry into next year as well?

We're just in the process right now of putting together our plan for 2022. So we'll have more to say on that in January. We -- I think we've been very direct in saying we can generate positive operating leverage this year, but we have great momentum kind of across the board.

Got it. Seeing we're approaching the end of our time frame, Chris, Don, thank you very much for participating in our conference this year, and hope to see you in person next year.

Thank you, Jason. We do as well. Have a good day.

Stay safe.