KeyCorp (KEY) Earnings Call Transcript & Summary

All right. Up next, we are once again happy to have KeyCorp. KeyCorp managed the pandemic in the position of strength, provided the market, all the risk management -- showed the market all the risk management changes that made over the past 10 years were in fact true as credit performance was amongst the best in the group. More recently, it's focused its business on generating peer-leading fee income, developed a differentiated consumer strategy through home lending and digital provider Laurel Road and continues to enhance its digital capabilities to achieve a greater customer experience as well as targeted scale in the areas that it plays. Here to join us from the company is Chairman and CEO, Chris Gorman and also joining us on stage is Chief Financial Officer, Don Kimble. So with that, I'm going to turn it over to Chris for a short presentation, and then we're going to get into Q&A.

Well, great. And thank you, Ryan. Ryan and I were just chatting on how wonderful it is to be together in person. And so it's great to see everyone here again. I'm joined, as Ryan just mentioned by Don Kimble, our Chief Financial Officer. On Slide 2, you will find our statement on forward-looking disclosure and non-GAAP financial measures. This, of course, covers my remarks as well as the Q&A. Most of our time today will be devoted to your questions, but I did want to start with just a few opening comments, if I could. I'm now turning to Slide 3. 2021 has been another extraordinary year with some unique challenges and opportunities. There's one thing though that has been constant, and that is the way our team has continued to support our clients and our communities. And I will tell you, I could not be prouder of our team. We expect to deliver another year of strong financial results, with record levels of performance in many parts of our business. Let me highlight just a few of them, if I might. I'll start with operating leverage. We have delivered positive operating leverage in 7 of the past 8 years, and we expect to deliver it again in 2021. Through the first 9 months, we achieved record revenue growth. Year-to-date, both revenue and pre-provision net revenue are up 10% from the prior year. The growth is coming from across our franchise. In our consumer business, we achieved record net new household growth. The strongest growth is coming from the western part of our franchise where we operate in 5 of the 10 fastest-growing states. We also have 2 strong growth engines, Laurel Road and consumer mortgage, which combined have generated over $11 billion in high-quality consumer loan originations through the first 9 months of this year. In our Commercial business, we continue to benefit from our targeted, industry focus and the breadth of our platform. This year, we expect to reach another record in investment banking fees. And by the way, our investment banking fees have grown at an 11% compound annual growth rate over the last decade. We have continued to benefit from ongoing investments in our teammates, in digital and in analytics. These investments have accelerated our growth, improved our efficiency and importantly, enhance the client experience. Foundational to everything we do is having a strong balance sheet and maintaining our moderate risk profile. We have significantly reduced our risk profile over the past decade by focusing on relationships in being very, very targeted and who we do business with. The most recent Federal Reserve stress test results provided yet another important data point with respect to the successful derisking of our business. On a relative basis, we ranked as pure leading in both stress losses and capital consumption. Lastly, we have been and will continue to be very disciplined in the way we manage and deploy our capital, focusing on both the return on and the return of capital. Year-to-date, we have returned 84% of our net income to shareholders in the form of dividends and share repurchases. Last month, we announced a 5% increase in our common share dividend, which is now $0.195 per share. This year, we have also repurchased over $1 billion in common stock through the third quarter. I'm now moving to Slide 4. We have strong momentum heading into 2022. We identified 4 strategic pillars that have and will continue to accelerate our growth. First, I'll start with primacy. At our core, we are a relationship bank. We know 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, namely primacy, spans across both our consumer and commercial businesses and is supported by the investments we have made, including the acquisition of AQN Strategies, a leading consumer-focused analytics firm. This is really important. You simply cannot be a leading digital bank without leading analytic capabilities. It's absolutely foundational to being a digital bank. The next pillar is health care, which, as everybody knows, makes up almost 20% of the U.S. economy. This strategic pillar focuses on collaboration and coordination across our entire enterprise. Key is a leading health care bank. We have accelerated our growth with acquisitions of both Laurel Road and Cain Brothers. Cain Brothers has one of the largest and most experienced team of investment bankers devoted exclusively to the health care industry. Laurel Road has originated over $5.5 billion in high-quality loans to health care professionals since our acquisition in April of 2019. Earlier this year, we launched our national digital bank, Laurel Road for Doctors, which, by the way, has exceeded our expectations. We have already added 5,000 new health care households since our launch at the end of March. And it's interesting, half of these new health care households are already using multiple products. Additionally, this targeted client focus has allowed us to expand our geographic reach. 75% of our new business is coming from outside of our traditional 15-state footprint. In the first quarter of 2022, we will take the next step on our journey and expand Laurel Road services to nurses, with over 4 million nurses across the country, this represents a huge growth opportunity for us. We are excited to continue to grow and expand health care relationships across our enterprise. The third pillar is digitizing the enterprise. Laurel Road is part of a broad enterprise-wide effort on building our digital and analytics capabilities. Digitizing the enterprise, creates a streamlined, more efficient experience for both our clients and our teammates. Although we are still early in our journey, we are seeing tangible results. Nearly 85% of our clients who consider Key to be their primary bank are digitally active. Our digital sales are up 30% year-over-year. Internally, we are replacing clunky handoffs with digital solutions in the front, middle and back office. We also have a proven history of acquiring and successfully integrating entrepreneurial businesses in order to better serve our targeted clients and prospects. To that point, on November 22, we announced our most recent acquisition, XUP Payments, a B2B-focused digital payments platform that enables simple and intuitive client onboarding and servicing. XUP is integrated with processors, third-party risk tools and customer relationship management systems, all focused on providing an integrated and seamless payment experience. While our partnership to date has been focused in the merchant space, XUP's capabilities span products and will touch many different parts of our existing client base. We were an early partner and equity investor in XUP, and our acquisition was a very natural next step for us. XUP's deep expertise overlaps very nicely with many areas in which we have strong market positions, namely health care, technology and real estate. This will accelerate Key's growth in our targeted verticals and further our digital capabilities, and importantly, embedded banking strategy, which obviously is the wave of the future. Finally, we are growing the number of bankers on our platform. This year, we have increased our senior banker population by 7%, and I will tell you, we are far from finished. Our new bankers have found that they are more productive on our platform. And importantly, we have seen a very significant increase in pitches to clients and prospects. I've been doing this for a long time. There is a direct correlation between the level of pitching and the amount of business that you complete. We continue to believe that our platform is under leveraged. We have the focus and the expertise to continue to grow within our 7 industry verticals, and we have built scale in a very targeted way, which has resulted in Key being a leader in a number of niche, high-growth areas. Let me give you a few examples. Health care. We rank #1 for health care M&A deals in terms of number of deals. Renewables financing, we ranked #2 in North America. Affordable housing, we ranked #3 in the United States. Technology, an area of ever-increasing importance in all aspects of our economy, that's an area where we've doubled both the number of bankers we have and doubled our business. Let me bring this to life for you with just a few specific examples of how this gives us trajectory to grow and continue to grow our business. So far this year, we've completed almost $3 billion of originations, both on and off balance sheet, in the affordable housing space. For us, that's up 30% year-over-year. In the renewables area, last quarter alone, we raised $4.5 billion of capital on behalf of our clients. In renewables on a year-to-date basis, we've raised $17 billion. And finally, Key remains one of the leading health care banks. Across our enterprise, health care today makes up 8% of our revenues and that number is growing. I'll wrap up my comments on Slide 5 with the rhetorical question, why Key? We continue to believe that Key is a compelling value proposition. We have a distinctive business model with a strategy built around targeted scale, and that is a true differentiator. We have many avenues for sustainable growth supported by ongoing but very targeted investments. We are proven risk managers focused on sound, profitable growth. Over the last decade, we have successfully derisked our business, while concurrently growing our company. We have been very disciplined in our capital and our management of capital, returning significant amounts of capital to our shareholders. Finally, I believe our current valuation does not reflect the company that we are today. That is a company that's uniquely positioned to grow and generate strong returns. With that, I thank you for your time and your interest, and I will take a seat and turn it over to Ryan for the Q&A portion. Ryan?

Chris, maybe to just dig right in. We're going to get guidance early next year on the earnings call. But clearly, Key and the industry do face some headwinds. Can you maybe just talk about the opportunities and challenges in delivering positive operating leverage, which has been a pillar for the company as we look into 2022?

Sure. There are clearly both challenges, and in our case, certainly, opportunities. So let's start with the challenges. The challenges are, first and foremost, we were very, very successful in PPP. We knew that would be sort of won and done, Ryan. We financed 66,000 businesses, which is not inconsequential, but we knew that, that would obviously run off. What won't run off is the fact that those 66,000 customers will never forget that we were there, basically, let's face it, if forgivable loans are the same as free equity, they're not going to forget that. So that's one headwind that we have to deal with. The next headwind that we have to deal with are rates. And as you think about rates that's a double-edged sword for us. It's a double-edged sword because the pressure is real, but also the opportunity is real. We are sitting on $25 billion right now of excess liquidity. And I think we've been very disciplined in figuring out just exactly how we sort of feather that into the market. We're making about 8 basis points on that and the money that we invest will make about 1.6%. So there's a pretty big arbitrage there. The next thing that I think is a challenge, and it's going to be a challenge for everyone, is just straight up inflation. I mean I do think interest rates are going higher, which will help the last comment I made, but inflation is real, and we'll be dealing with that. The other thing that we have on the other side is the ability to manage some of our expenses. As you know, we had inflated expenses around prepaid. Those will go away. We also, in the second half of this year, have closed 73 branches, and that will all be benefiting us as we look to next year.

And maybe more near term, you guys give guidance for 4Q that included loans up low single digits ex the auto sale or mid-single digits ex PPP. It's sort of a tongue twister. And a handful of other things, stable fees, expenses down a bit. Now that we're more than 2 months into the quarter, can you maybe just give us an update on how things are progressing relative to your expectations? And Don, feel free to chime in here, too?

We feel good about the guidance that we gave. I mean we -- as we now have a couple of the months under our belt, the guidance that we gave at the end of last quarter, I think is solid guidance. I think we're on that path. We feel good about it.

Chris, your core loan growth in 3Q was stronger than most of your peers and your outlook was highly optimistic. Can you maybe just talk about what is driving some of your optimism? And can you maybe break it down commercial versus some of your consumer initiatives? Obviously, you highlighted a handful of really positive things that you're seeing in health care and renewables and affordable housing, curious if you could expand on both consumer and commercial?

Sure. I'd be happy to, Ryan. So let's start with on a core basis, our linked quarter growth, I think, was 4.3% last quarter, which was we felt like it was a strong number. And kind of what's driving that. If you look on our -- if you look on our consumer side of the equation, we have Laurel Road, which has been strong. Laurel Road is interesting because Laurel Road is having a strong year in spite of the fact that there's been a federal student loan payment holiday all year long. That will burn off next month. Next is our mortgage business. Our mortgage business has really been a bright spot. It's a relationship-based business. But when we bought First Niagara, we were at $2 billion. Last year, we were at $8.3 billion. In the first 3 quarters of this year, we said we were at $10.5 billion of originations and had record backlogs. So that obviously is driving part of the loan growth. And then kind of probably what we're most known for and what we've consistently grown over many, many years is our C&I book. And I feel good about that as well. First, we're -- as I mentioned, we're clearly adding clients, we're clearly adding bankers. That's helpful, I said we grew that by 7%. Other areas that kind of -- I look at is kind of sort of giving us some insight into that growth. Our leasing book, our leasing book is principally, it's in health care, and it's in technology, which is obviously health care is hardware and software and technology is mostly in the cloud-type financing. But we see that is up about -- the backlog is there about 14% year-over-year. And then our M&A backlog, as I've said before, is at record highs. And we have a relationship-based business. So a lot of the M&A work that we do is buy-side work. And that often, not always, but often pulls through additionally.

You said you feel good about C&I. You were one of the few who actually saw utilization uptick last quarter, but it still remains 500-or-so basis points below pre-pandemic levels. And you and I were talking before, as you're out in the market, Chris, and talking to corporates, I guess what is driving their decision to borrow? Is it clarity on the supply chain, some other factors? Do we need to wait to see liquidity normalize? What do you think is going to be influencing the decision to borrow in 2022?

So that's a great question, and it's one that I think we and the whole industry have struggled with. So we thought that it had bottomed out at the end of the second quarter, and we were right in that there was a slight uptick from quarter 2 to quarter 3, maybe from -- as you point out, from 28 -- from 27% to 28%. It hasn't continued to build. And so the question that you'd ask is, well, why is that? And I think it's mostly driven around the supply chain. I think our clients would be happy to go long inventory if they could they simply can't get the inventory. I think that will come back to our historic level, which is around 33%. Each percentage point is about $1 billion to us given the size of our loan book. What I think -- and I don't think that clears up until late 2022. I mean I'm out talking to our clients all the time. It's a problem. People are sourcing parts, air freighting parts from all over the world. I mean it's a real challenge. It will get sorted out. The interesting thing will be -- for the last 15 or 20 years, everyone has been taking out working capital, just grinding it down. And I think going forward, especially since people can pass through price increases and there's a lot of inflationary pressure, I think once people can get the inventory, I think not only will it go back to where it's been historically, I think it will actually go higher. I think people will carry more inventory. If inventory is appreciating through inflation, why wouldn't you, right?

Makes total sense. One of the things you mentioned in your prepared remarks was Laurel Road, and it's obviously been a huge success with over $5.5 billion of originations. Now you're on the verge of expanding it to nurses, which will increase the, call it, the TAM to $4 million given that there's 4 million or so nurses out there. What do you think this means for Laurel Road's growth rates over the medium term? And to get a little bit of ahead of ourselves, once we add nurses, what's next to go for Laurel Road?

So we've been really pleased with Laurel Road. As you mentioned, we bought it in April of 2019. We've refinanced $5.5 billion worth of loans. And then this year, it's interesting, there aren't really a lot of platforms out there that are complete digital platforms that are relationship based. A lot of digital platforms solve one pain point. What's interesting is we've built this platform that's a relationship-based platform. So doctors and dentists starting in March, they can open checking accounts, savings accounts, get credit cards, et cetera. So as we think about it, next up are the nurses and that's a huge opportunity. And by the way, the way you get to nurses is a combination of some of the strategic alliances we have with about 100 health care providers, but also that's a little bit more personalized in terms of the nurses. So we're putting together a game plan around that. My goal is for us to continue to focus on health care until we get this absolutely right. It's a huge opportunity. If you think about 20% of the GDP being in health care and you think about what we can do, Ryan, for these large health care complexes, whether it provides strategic advice, raise capital, payments, what we can do for doctors, what we'll be able to do for nurses, you could make an argument that there's other homogeneous groups. You could think of things like large law firms, large accounting firms. That's not where we're going to go. As you know, I believe very heavily in targeted scale. We're going to get -- we're going to take advantage of this health care opportunity, which I think is huge.

Even beyond Laurel Road, there's been some clear improvement in your broader consumer business. I was talking to Victor about this last month when I saw him, and particularly on the lending side, but also from a profitability perspective. Can you maybe just talk about what's driving the improved performance on the consumer side of your business? And what's next in terms of the improvement from here?

Yes. So I'm very pleased with the trajectory of our consumer business. As I think you just referenced, we made a leadership change there, and I'm a huge believer in focus. I think if you ask people to do 100 things, by definition, nothing matters. And so we came up and we started talking about what are the 4 pillars, Ryan, that really drive our business? And the first was primacy. We talked about that having the operating account. The second is health care. And I would offer to this group that 20% of all of our mortgages, for example, are the doctors and dentists, just FYI. In terms of digitizing the enterprise, making it easier, once you get our teammates more focused, making it a lot easier for them to do what they do, and also, of course, hiring bankers. We're in the service business and we're only as good as the people. The other thing that we've done is really focus a lot on what we're doing out West. We're fortunate enough in our consumer business that's 25% of our deposits. We happen to be in 5 of the 10 fastest-growing states in the country. Because of in-migration, the growth rates in many of our Western markets are above 5%, which are significantly higher than some of our other growth rates. And so as a consequence, we've focused on the West. We're growing at twice the rate in the West. We're garnering more clients and, frankly, younger clients out there. So those are some of the levers we're pulling on the consumer business.

Just to jump around a little bit. You referenced the West. There was a Reuters article out that associated Key as a potential bidder on Bank of the West. Maybe just remind us what the M&A priorities are? Would you be interested in a bank deal of this size? And if not, what would be your focus towards M&A?

Yes. Well, as you can well imagine, we would never comment on a specific rumor like that. But I would tell you, for us to focus on a depository, it would be a really high bar. And specifically, the high bar would be around a couple of things. One, what are the financial metrics? And what does it do for us strategically? I just mentioned our 4 pillars. How would it advance those 4 things? And how does it advance our strategy? And so I would certainly never say never, but that's not really a principal focus of mine. I mean where we have been focused and we've really done a lot is on these niche acquisitions. I mean if you just -- we just went through just this year, for example, we started with AQN, I mentioned that's the analytics firm. In the second quarter, we basically hired a huge group of M&A practitioners all around renewable energy. In the third quarter, Don did, I thought, a really great deal of exiting our indirect auto book, which is not a business that appeals to us because we're a relationship bank. I just mentioned XUP, which was an acquisition that we did just in November, and we've been hiring bankers all year. That's kind of where -- that's really where we focus. But having said all that, I had the privilege of leading our First Niagara acquisition. In that deal, we took out 42% of the costs, and we kept the good people and we kept the clients. I mean so these -- I mean, these deals merit consideration. But I'm just sharing with you kind of how I think about them.

Sure. We've referenced them several times and I want Don to think that he's going to make a trip to New York and I could ask any questions here. So maybe we're going to shift gears to him for a couple of minutes and after we've spent some time talking about a lot of the strategic things, so maybe just to dive a little bit deeper on what Chris had outlined some of the headwinds as we think about operating leverage to NII, whether it's PPP, the indirect auto sale. Can you maybe just talk about, Don, the drivers of NII into 2022? We obviously know some of the headwinds, what could be some of the surprises to the upside?

The upside, I think, is just the ability to put some of that liquidity to work. We've talked about -- and Chris mentioned $25 billion of excess liquidity at the end of the third quarter. Just to turn around and start to deploy some of that would be very, very helpful, but we've talked here recently about instead of reinvesting about $3 billion a quarter, we're looking at $4 billion to $5 billion a quarter, which means that investment portfolio grows by $2 billion to $3 billion each quarter and start to soak up some of that excess liquidity. And as Chris highlighted, that's a 150 basis point plus type of pickup for that. So that's a huge benefit for us. But I think the real engine that we have is just the loan growth. Chris highlighted that in the third quarter, backing out the impact of PPP and the indirect auto loan sale, we grew at 4.3%. If you look at our guidance, which is up low single digits, excluding the impact of the securitization transaction, if you factor in the PPP impact, it's about that same type of range. And so it's showing that kind of growth and momentum will be very helpful for us. And then I'd say that the other piece that will be going for us is I think we do expect rates to move up at some point in time. And we think those first are early movers as far of the rates, the deposit betas will be very, very low, if next to 0 for many of those that we'll see the commercial deposits maybe tick up a little bit, but retail deposits probably won't move. And so I think each one of those will be additive to our overall NII position to help offset some of the headwinds we're seeing for some of the other areas.

I won't ask you if you're going to sustain 17% loan growth. But in terms of the deployment of liquidity, $4 billion to $5 billion gross and $2 billion to $3 billion net, we've obviously seen interest rates bounce around the tone right yesterday, they were on their lows. How dependent is the deployment on the rate backdrop as opposed to a more structured program to get a lot of that liquidity put to work over the next 4 to 6 quarters?

We will probably be more incremental as far as how we are deploying it, but we do lean in when we see opportunities for buying. I'd say one of the things that's been helpful even with the rates backing up, we've seen a little bit of strength in that 3- to 5-year portion of the curve, and so that's allowed us to continue to buy a little bit even though we would have expected that with the rate pressures we wouldn't have had some buying windows. But I'd say that we don't want to place all of our bets into one category and allowing us to just do that incrementally, I think, is a better approach for us.

Chris, there was a talk on the earnings call last time around the trajectory of the investment banking business. Tough problem to have when you're coming off of what was going to prove to be a record year. But given how you've extended the product offering, you've added bankers, is this going to continue to be a growth area for the bank? And where do you think the greatest opportunities are for KeyCorp to drive share gains in the investment banking business?

We do see it as a growth business. Ryan, as you know, it's been a growth business for us for the last decade. And I think -- we've all -- and we've grown it in good markets, average markets, bad markets. It's a unique platform in that, there just aren't a lot of integrated banks serving the middle market really focused in the way we are on certain niches. It's a business that we're going to continue -- we will continue to grow it. We'll continue to grow it principally by hiring people. It's an under-leveraged platform. We are successful in getting people to come on to the platform. I mentioned that we've grown our bankers by 7%. We're out recruiting right now. I think we can continue to grow it. One of the things that I think people miss a bit about that business, it's a relationship business, about roughly 1/3 to 1/2 of the -- of our actual customers in any given year did business with us the prior year. But even within that, say, 33% to 50%, a lot of them are multiple customers intra the same year. So I mentioned a couple of areas in my opening remarks. We are financing, obviously, the people that are building affordable housing. They do -- I mean, basically, capital is the raw material for affordable housing. So one of those clients would do multiple transactions in a given year. The same goes for the 12-year history we have in renewables. So those are the kind of things that I think will continue to grow it. I don't think we need necessarily to add a new vertical. I don't think we need any more products. The way we'll grow that is to really exploit this underleveraged and unique platform that we have.

I've got 2 more questions that I want to get through. I've got a handful more though. But the capital level still sit above the targeted range. You obviously, at least I believe, proved to have successfully transitioned to a much more lower credit risk profile. How do you think about where capital can grow? And you're talking about 9% to 9.5% could capital levels even go lower than that over an immediate time frame?

Well, let me start with that, and then I'll let Don add to that. We think 9% to 9.5% is the right -- we run a pretty conservative bank. We're in a cyclical business. We certainly think we could run our business below 9%. We generate a lot of capital every single quarter. But I sort of like the conservative 9% to 9.5%. Don, what would you add to that?

I would agree. I think we'll continue to assess that, that our outlook would suggest we're going to continue to grow operating earnings, and operating earnings are a source of capital. And so we see that play through, we could maybe have an opportunity down the road to reassess. But we've got opportunity just to bring that down inside that range, and we'll be looking to do that over the next several quarters as well.

Chris, we got about a minute left here, and I wanted to come back to something that you referenced. Obviously, the stock has had a very good year, but still does continue to trade a discount to some peers. And what do you think investors are missing about Key? Again, and maybe in the context of maybe this could be a quick plug for the March Investor Day of what's yet to come?

Let me start with the plug for March Investor Day, March 1 at the Plaza Hotel here, so that's the plug. Now let's get to what I think the -- I think people are missing. I mean we're a growth story. I talked about our organic growth of 10% year-over-year, both top line and PPNR, that will continue. We are making investments to grow our business. And so that's one thing that I think is misunderstood about our business. The next is the derisking, and I've been part of this for the last decade, we have completely derisked our business. And so if you think about -- over the last -- I'll give you a number that I think you might find interesting. We've raised $87 billion for our clients over the last 12 months. We've put $17 billion of that on our balance sheet. So we have -- that is a huge part of derisking because there's a lot of capital sources out there that, for example, are more than willing to offer 10-year nonrecourse debt. We serve our clients by placing it, but that's not something we have an interest. So the 2 things, growth and the derisking are the 2 things I think the market is missing.

Great. Well, we are in over time. So please join me in thanking Chris and Don.

Thank you.

Thanks.