KeyCorp (KEY) Earnings Call Transcript & Summary

All right. Well, I think we're just about [indiscernible]. We'll get started here. Delighted to have Chris Gorman, CEO of KeyCorp. It's his first time at our Strategic Decisions Conference, but I've had the pleasure of meeting with Chris going back over a decade now and what led to build out the whole investment bank and more broadly [ differentiated ] corporate franchise. I mean more recently, as he focused the entire organization on the strategy, which I'm sure he'll articulate better, but I always think of it as the term targeted scale as really setting them apart. So Chris, thank you for being here to start. Maybe let's start at the top. You mentioned on the earnings call back in April 2023 was a reset year. You've been candid about some of the interest rate challenges. But it was also pretty notable, the shift to focusing on offense and that pivot and calling that pivot back in April.

Maybe walk us through where is that shift occurring, where the biggest push is going forward where you can play offense?

Sure. Well, first of all, thank you so much for having me. And this is a great conference, and I think it's nice to be part of a conference that is much broader than just financial. So thank you. I appreciate being here. So as you correctly pointed out, last year was a transitional year for us. But I really think, in many ways, it was our finest hour. And I say that because we knew when the banking crisis of last spring hit that we were going to have to take immediate and decisive action, decisive action, first of all, to protect our deposits, which, in fact, we did. Our deposits grew 2% year-over-year and underneath the surface, the actual composition of our deposits really improved from a client perspective. We ended up with 5 billion fewer broker deposits and as a consequence, 5 billion more consumer deposits. And that really goes back to our focus around primacy that's gone on for many, many years where we're focused on having the operating account. So the first thing was deposits. The second thing is we knew that it was inevitable that banks were going to be required to carry more capital, and we knew we had to make some adjustments there. And we went about the business of shrinking our RWAs. And we were successful in shrinking our RWAs by about $18 billion, which is about 11% of our RWAs. And we did that by doing a few things. One, we've always been a relationship bank, and we've always required that people had more than just a borrowing relationship with us. And so we come through our portfolio. And where we didn't have the kind of relationship we would hope to have had, we either -- we went back to our clients and said, gee, either we need to get deposits or we need to do this or we need to do that. And in many ways, this was a very positive discussion. In other instances, we went through with a fine-tooth comb and said, do we have the right RWAs applied against all of our loans, and we're pretty conservative. And in some instances, Brian, we actually had too many RWAs applied against some of our exposures. And so we're able to adjust those with really no collateral damage at all. And then lastly, we just very, very prescriptively figured out where we wanted to be. And we ended up with only 6% of our loans being kind of credit only. So as a result of all those actions and taking down our RWAs, our CET1 went from -- organically, from 9.1% to 10.3%. Our wholesale borrowings went from 22% to 14%. And all the while we were able to grow our business, which I think is really important. Net-net, we grew our commercial business last year by 6% while we were going through this exercise. Speaking of growth, the other thing that we did and it goes to your -- the genesis of your question about kind of pivoting to growth, and it's really growth that we never pivoted away from. Last year, we took out $400 million of expenses. We have an expense base of about $4.4 billion. And the reason we did that is we wanted all last year to continue to be able to invest in technology. We spent about $800 million a year in technology but we also want to continue to invest in certain businesses that are asset-light businesses because in -- the way this is going to play out in the future is people that have the asset-light businesses are going to be in a better position when all this rule-making ends. And so whether it's Basel III end game, whether it's long-term debt, whether it's LCR, having this notion and focusing on asset-light business is important. And where we're focused in terms of playing offense is as follows: one, we're going to continue to focus on our payments business. We think we're a leader in payments. We've been -- we partnered with fintechs for the last decade. We've been investing in embedded banking, which is really software to help people that are middle market businesses run their business. I talked about primacy earlier. So we'll continue to invest in, first and foremost, in payments. The next area where you're going to see us continue to invest, we think, and you mentioned it in your intro, that was nice of you to say. We think we have a market-leading integrated corporate and investment bank. And we're going to continue to invest in that business. It's fully built out in terms of capabilities. The opportunity for us is to go out and to continue to hire bankers. And so you'll see us continue to do that. And then lastly, an area that's not as developed is the whole -- is our whole private client business. And by that, I mean, we start from a very good place. We have $57 billion of AUM, which for a bank our size is a really outsized AUM. One of the areas where, in the past, we haven't been as impactful as we would like to be is in the mass affluent space. And so 3 years ago, we made some strategic hires. We've changed the comp system, so people are focused on people that have investable assets of $0.5 million to $2 million. And that's a business that we think we can continue to grow. Last year, we grew $2 billion of AUM in that business. And within our bank, we have a lot of people that we're not serving that we should be able to because we have a very sophisticated wealth platform. It has a -- we have a trust company, et cetera, built in there. And here's a few interesting stats as it relates to our mass affluent opportunity. Right now, we have 3.5 million customers, 1 million of them have -- and we have -- since we have primacy, we know what's going in and out of their accounts. We have 1 million of our 3.5 million customers have at least $250,000 of investable assets. Right now, our penetration rate of that group, that 1 million people, is 10%. And but these are people that really know us trust us, do business with us. We're penetrated to the tune of 10%. So an opportunity there. We also have 250 small business customers. Those customers, too, are good candidates for our mass affluent strategy. And then lastly, but importantly, we have about $20 billion of loans that are first mortgages that are on our balance sheet to doctors and dentists through -- principally through our Laurel Road platform. They, too, either currently have 250,000 or more to invest or will so in the not-too-distant future. So when we talk about playing offense, Brian, that's kind of a quick round trip of what we did last year to position us to play the offense that we're playing this year.

And maybe to dig into each of these, you mentioned briefly some of the areas you're differentiating in payments. We do hear about the payments opportunity from a lot of banks. So for clients to say, look, it's tough to differentiate, walk you through how Key is really different in outgrowing the market, what in payment stands out?

Sure. So first and foremost is we've been focused on primacy for some time, which really -- was really, really helpful, particularly in the crisis of last spring. So think about 85% of our commercial clients where we have the operating account. And so that is just -- it's just really, really important. So this notion of focusing on primacy. Next is because we're set up by industry verticals, we're able to have treatments that are unique to whether it's technology companies, whether it's health care companies, whether it's people that are in the multifamily business. So actually having software that helps these companies run their business. And then the next step is embedded banking. And of course, everyone in the room and listening to this experiences embedded banking on a consumer level all the time. Anytime you get a number, you call the car, you track the car, you rate the driver, you pay the driver, the driver rates you, it's all on the same app. That is effectively embedded banking for consumers. We're doing that, obviously, for our targeted verticals. So that's what's going on in payments. And it's really helpful as people run their business. And then the other thing that we have, of course, like everyone, we have purchase card. We also have merchant card. We do a good job there. But where we're really distinguishing ourselves is really 2 places. One is this long-standing focus on primacy and the other is this notion around treatments that are specific to our industry verticals that help people run the business.

And the primacy point is, what, you get the first look or the first pitch to bring payments to that client [Indiscernible] I mean, it's operating account?

It's amazing how sticky it is. If you have the operating account, you are in great position, one, to have very sticky deposits. So if someone's whole business is flowing through this operating account, it's not as though people talk about deposit flight and people -- deposit beta has -- when you talk about operating accounts, that's just not a consideration. And also because you're embedded into their whole business, you're in a position to, a, understand their business better; b, have a lot of data and be able to offer them things that you have insights that others just wouldn't because you see all the flows. Yes.

Maybe in investment banking. First -- we'll come back to the market. When you think longer term, what are the competitive [ leverages ] you got on that business? And where is the greatest opportunity to keep growing and expanding?

Sure. Well, I think there's a great opportunity to keep growing it. We -- it's hard to believe, but we actually launched our corporate and investment bank almost 20 years ago now, so we've been at this a long time. It's not an easy business to pull together because it requires the coordination of a lot of people. We, at this point, have, as I mentioned, everything that we need to be competitive. So our competitive advantage is for someone -- 4,600 banks in the United States, I think there's 10 or so that have the capabilities that we do with regard to our integrated corporate and investment bank. So for someone to compete with us, they have to have a balance sheet, have all the capabilities we have, be focused on the middle market and be focused on 1 of our 7 industry verticals. Now we're certainly not alone. But you can imagine, as you go through each of those screens, you go from a potential of 4,600 possible competitors to literally a handful. Now there's a lot of people that have a lot of expertise. I, at one point in my career, worked at a boutique. People that work at boutiques are incredibly clever. They typically have 1 or 2 products. But without a balance sheet, it's really hard to compete for this middle market business. And so we typically hire people from boutiques just because we think they can be really impactful once they plug in to our balance sheet. The people that have our capabilities generally are a significantly larger than we are and are focused on larger companies. One of the nice things is, as you go down the pyramid, it gets a lot wider and there's a lot more businesses. Now on the flip side, middle market companies don't transact as often as some people that are serial transactors. So we think we have a real -- there's a real moat around this business. The biggest moat might not be obvious until I start talking about it. But the biggest moat is you have to be committed to go to the market based on industry verticals. So there's a lot of people that have -- that purchased, for example, an M&A boutique that is a really good business. But to have an integrated corporate and investment bank, you have to move away from the standard generalist/geographic approach to being committed to the industry verticals. And I just think that makes you a lot more impactful as a banker. So those are some of the things that I think give us a unique competitive advantage.

And you talked about hiring bankers. Is it strengthening in particular industry vertical? Is it adding an [ ace ]? Where is the opportunity to hire right now?

So we're -- kind of across our platform, we're hiring. But we're particularly hiring right now in technology, in health care. And we're also looking at a couple of new verticals that are really kind of sub-verticals where it's sort of -- it's in contiguous areas to where we're currently operating. There's a lot of talented people out there and we're out there in the marketplace.

And then maybe coming back to the near term. Any commentary on what you're seeing in terms of market activity? Are we seeing a pickup more broadly? Or is it still just hitting the bid on tighter credit spreads.

So it's definitely in the mode of recovering. Just to give everyone an order of magnitude, the last -- I've been around this business for a long time. The last 2 years were singularly the worst years I've seen in terms of transaction activity. In the first quarter, you probably saw the numbers were clearer better. Right now, we enjoy the biggest backlog we've ever had in our M&A business. M&A business is really important to us because in a middle market company, for example, if you have the strategic relationship with the decision-maker, in addition to that work, you're able to pull through a lot of other things like hedging, financing, payments, et cetera. So having record M&A backlog is important. We're not seeing kind of a steady pull-through yet of the backlog. It's kind of starting, and I would describe it as a little bit herky-jerky unlike 2021 where everything it was kind of a straight pull, everything was done and was done immediately. This is kind of back to sort of regular way M&A where there's just a lot of puts and takes. One of the things that needs -- there's a couple of things that need to happen, I believe. The first thing that needs to happen is everyone's in price discovery. And I think as that comes together, I think you'll see a lot more transactions completed. And I think we're pretty far along on that process actually. I think people -- the biggest challenge right now is our rates. And the reason rates are such a challenge is you can get a lot of things done with a 4.5 tenure. That's not a problem at all. What is a problem is if you have a 4.5 tenure and people think for a variety of reasons, that it's going to be a 4% tenure. And then they sort of sit on the sideline because they think if I just wait a little bit, the cost of capital will be significantly cheaper. Or if it's at 4.5% and the -- so that volatility, I think, is a challenge. More broadly just on the loan demand side, similarly, I think there's a fair amount of uncertainty out in the marketplace. We don't see people yet investing in property, plant and equipment. There's a lead time of about 18 months. And I think there's enough questions out there about sort of the macro economy that people aren't making those kind of investments yet. I do see, and I just sat down with our team as recently as yesterday morning, we're starting to see some of the loan pipeline building, which I think is another sign of a bit of encouragement.

And maybe we can round out that with the near-term discussion around deposit trends. What are you seeing mix shift betas? Are we in kind of the eighth or ninth inning or any concerns around hire for longer?

So my personal assumption is that we will be hire for longer, and I've had that view for some time, if you know. I think under a hire for longer scenario, I personally think deposit betas have principally played out. I would say we're in the seventh inning stretch, to answer your question directly. I think if you look at noninterest-bearing, we peaked at 33%. Right now, we're around 20%, and I don't see that moving a lot. One of the things that I always look at it, in truth, is the trajectory of deposit betas is what is the delta between the back book and the promotional rates. These are pretty close. I mean, those used to be really wide. And those have kind of closed, which, by definition, means there's not that much room left. Our base case is that we're -- our cumulative deposit beta right now is at 50.5%. And our base case is, with rates staying flat, that it drifts up a bit to maybe mid-50s. But I think we're pretty far along. Now if rates -- if we get 50 basis points of rate increases, which is not my base case, by the way, I think all bets are off and the game kind of starts over again. I don't envision that's the case. For us, we maximize -- our best case is flat for the balance of '24 in terms of NII. And the reason for that is you don't get the deposit beta sort of drifts -- if you went up or down 25 basis points, I don't think you're getting a lot of deposit beta drift either way. Conversely, if you get a 25 or 50 basis point cut, that obviously is immediate. I mean, 62% of our loans float. So that's a [ beta ] kind of event.

And maybe kind of running out on net interest margin more broadly. When I think about where you are around 2%, your 20-year average is just about 3% and that 100 basis point gap among all banks, about $25 billion of assets. There are only [ 4 major gap ] and KeyCorps. You're a pretty unique company in terms of "underearning" on net interest margins today versus normalized. Maybe help us understand where do you pencil out a normalized market for Key over time? And what are the building blocks to get there over the next year or 2 or 3 years?

So first of all, you were polite when you characterized it as unique. We were not well positioned for what was an unprecedented hiking site. And as a result of that, we've made a series of changes, not the least of which is right now, and I'll come back to this, basically neutral right now, back to our position in a second. But I'm a big believer in people and made a series of changes in our finance and treasury area. Clark Khayat is our CFO now. Tim Schmidt is our Treasurer, who we got from Discover and he put in new teams. We've put in new processes, new procedures, in terms of when we go into a position, when we go out of a position. Obviously, being liability sensitive. And we were synthetically liability-sensitive because our balance sheet -- because of our floating rate loans is naturally asset-sensitive, by the way. So that's kind of a little bit of a history. And so as we step back from that. So what is the opportunity from here, and what's the trajectory? We now have the benefit, and it has been a headwind, we now have the benefit of a lot of these positions earning off. And our pickup in both NIM and NII is really dependent, not on loan growth, not on absolute rates, not on the shape of the curve. Obviously, all those things would have an impact. But it's really straight up duration. And in this quarter, between our bond portfolio, between our short-term treasury or term swaps, we will reprice $3 billion worth of securities at an increase of 300 to 400 basis points. So that's in this quarter, the second quarter. Similarly, in the balance of the year, we would -- in the same 3 categories, we will reprice $11 billion. And so as you can see on our size of balance sheet, that is significant, and that's where you'll see the pickup both in NIM and NII as we progress through the year.

And when you think about the cumulative size that's $1 billion of net interest income opportunity from this kind of short dated -- shorter-dated treasury swaps rolling off, this idea that it's independent of loans, deposits, rates, is it simply because as they mature, if you put it into loan growth or you can put it into securities or you can pay out more borrowings, is it just that optionality that makes it independent of the environment?

It is that optionality, and it's the fact that it's so short durated that it rolls off relatively quickly, and it doesn't hurt either that we're in an environment with an inverted yield curve that there's a whole bunch of opportunities where we can just reinvest it. Well, I mean, the opportunity for us is that it's a 300 to 400 basis point delta between what's coming off and what we're going to be able to reinvest in. It's not like we have to reach from a credit perspective. It's not like we have to reach from a duration perspective. And if you think about all the rules, we having a pretty short durated loan portfolio is where many of us are going to end up.

Maybe on that, and if I'm hopefully quoting it right, but I think on the earnings call, you posited that mid-70s could be even normal for loan and deposits for large regionals. I definitely get the direction of travel. I was a little surprised by the specific level. Maybe just walk us through the puts and takes there.

Yes. Well, I think -- let's kind of start at the macro level. I think there is a an absolute realization that, one, the gating item for all banks is the quality, the duration, the granularity of the [indiscernible]. There's also a realization among, I think, all banks that, on a relative basis, the value of deposits are significantly greater than value of loans. So as people think about -- it goes back to me talking about an asset-light business. It goes back to me talking our ability to underwrite and distribute securities. I just don't think going forward, sort of this lending business is going to be anywhere -- even if it's done well, it's going to be anywhere near what it used to be. And so I think as you think about the wave of rule making, whether it's the Basel III endgame, whether it's the long-term debt, whether it's LCR, and I just -- I feel like we keep -- we're telling people as recently as 3 years ago that our targeted loan-to-deposit was 90% to 95%. I just don't think you're going to see those kind of ratios. We were at 77% at the end of last quarter. So there wasn't a ton of precision in my 75% other than we've run a bunch of analysis. And I really do think that you're going to see loan-to-deposit ratios, which is going to put like that, put incredible pressure on people to have a lot of their balance sheet so you can give investors the returns that they're looking for.

And in terms of how Key fits in that, not to lead the witness, but I think each quarter, you kind of give a number around the loans as a percentage of total capital you've raised for clients tend to be 20-ish percent. So you kind of have that multiplier even with a 70% loan-to-deposit ratio for every loan you're making, you can raise 5x as much money for clients.

Indeed. And especially in a market like this, where, frankly, everything is flashing green and so we can serve our clients by placing paper in a variety of markets that, frankly, is in our clients' best. And so I think that's a real competitive advantage that we have. And just to put it, the markets were so wide open in the first quarter that we only actually kept 12% of the capital we raised on our balance sheet. And where it can get really interesting is if some of these markets go into this location. If certain markets were to really back up, that's when, for a brief moment in time, because there's excess capacity in the bank lending market, for a brief moment in time, you'd be able to structure loans that you want to put on your balance sheet. And obviously, we clearly have the dry powder to do that.