KeyCorp (KEY) Earnings Call Transcript & Summary

[indiscernible] Internally is how is the broad market performing versus our expectations, and there was a strong second quarter. We weren't as strong in some of that natural business mix versus some of the league tables. The other piece is we tend to zoom out and really think about capital markets on more than a quarter basis because it's hard sometimes to time exactly when the transaction is going to happen. But our view is when we get into a specific quarter, and we guided up, as you said, 20% plus, which we feel good about based on current activity, it really is a bottom-up client activity. It has a little bit less to do with kind of the broader market trends in a particular quarter, we tend to see those trends play out a little bit more over time assuming they apply to our book, right? So we're not a big trading business, right, but we're bigger and obviously, things like syndications, M&A. We continue to see very strong pipelines. -- record pipelines we talked about in M&A. We haven't seen those pull through. We're starting to see some of that pull through, but I would not call it normalized. And I wouldn't say the sponsor behavior is normalized either. The guide that we've given on '26 and '27 as it relates to returns doesn't require those to be sort of going full go. So if those markets opened up and really started going, I think there's some upside there. But right now, we're seeing, again, good client activity and expecting to see that pull through. The 1 place that rates really does impact in the near term is kind of commercial mortgage placement. So as rates go up, people tend to want to sort of watch and in the market a little bit on a permanent rate before they hit the market.

Got it. And you touched on Clearwater. It's now closed. Maybe just talk about just how that impacts your overall franchise and just kind of the strategic rationale for that business?

Yes. So we've, obviously, over time, done a fair amount of capital markets add-ons. Clearwater is a firm based in the U.K. with some European footprint. Where we've been a referral partner now for 5 or 6 years. We've co-led some transactions together or referred. So we know the partners, we know the principles, good cultural fit between the businesses, and we've operated quite well as a team. So it felt like this is just a formalization of a prior referral relationship. So on the integration side, on the cultural fit side, on the overall execution of a transaction, it felt very low risk, and it gives us now very connected distribution into the U.K. and Europe and vice versa. So there is a natural fit there that we feel benefits the firm strategically over time. As I said, it's pretty neutral from a PPNR standpoint this year. We'd expect it to add something in the sort of $60 million to $70 million of revenue next year. Again, market neutral. If the market remains constructive, we'll see what happens. But -- and that doesn't necessarily require us to be realizing a ton of synergies on top of that. Just -- it's a very solid business with folks that we know. So it's consistent with us and kind of lower risk. We'll continue to look at transactions that sort of fit that either by expanding distribution capabilities or filling or building industry net. So we've been an industry focused bank for decades now, and that served us well, and these platforms tend to be most productive when they're not generalists but are kind of equally focused on certain industry groups.

And when we looked at the change in fee guide, it was solely due to Quiport.

Yes.

Got it. And then maybe away from capital markets. When you just think about fee income in general, where do you see the biggest opportunities for growth?

Yes, for us, it continues to be payments and wealth. So the payment side, we've seen low double-digit growth in those platforms. Year-over-year, we continue to see really good deepening of client relationships. We've had a focus on payments now for over a decade. If you were sort of in our pipeline meetings, you hear people talk about payment attachment. When we make a loan, we expect the payment -- the deposits and the payment products to be connected to that loan and then sort of get those clients up and running as quickly as we can. You talked earlier about hybrid accounts. Just recall, those are sort of your noninterest-bearing and your interest-bearing deposits in 1 pool. We do the calculation on compensating the balances for the client. We apply the excess rate we've agreed to. It also gives us opportunity to deepen those relationships through additional payments products. and we've done a phenomenal job expanding that. And what that means is we either get more hard fees or we get more compensating balances that show up but is noninterest-bearing. So that's been a phenomenal opportunity for us. We'll continue to do that. And then if you think about wealth, second quarter, we had a record AUM for Key at $74 billion. We continue to drive great traction in our mass affluent segment. And we continue to be pretty lightly penetrated even though we've added something around 60,000 accounts in the last 2.5, 3 years. And we just -- we see pretty good runway there, and we'll continue to invest in that. I think both of those areas from an M&A standpoint are challenging for banks just given the multiples in those businesses. So at this point, we're kind of a decade plus into making equity investments, commercializing fintech capability in the payment space, and we feel very capable and very experienced doing that. We'll continue to do that where it makes sense. On the wealth side, it's a much more organic story because it's just a little bit harder to make those deals.

Makes sense. On expenses, even adjusting for the acquisition, book seems like a pickup in the back half of the year versus the front half. But just maybe just talk about any seasonality to that? And how you're thinking about it?

Yes. So a couple of things happen every year. We get -- we tend to have -- because of our capital markets focus, we tend to have more client activity in the back half, which drives a little bit more incentive comp. So that's very normal for us. And if it doesn't happen, obviously, we don't pay out the incentive comp, so we have some variability in that base. We tend to do a little bit more marketing in the fourth quarter and the back half of the year, and we tend to, over the course of the year, ramp up some of our technology investment spend. So that's normal. We don't see anything there that's going to pop or out of line. We are, again, seeing the Clearwater piece add to that. So we just want to reflect that in the guide because we know that will come [indiscernible].

Got it. And I guess maybe -- you guys still kind of kind of 400 basis points plus the positive operating leverage for this year. we talked earlier, kind of starting the 2027 budgeting process. Just how are you thinking about expense growth investment priorities and just operating leverage in 2027.

Yes. I mean, one, we tend to want to be very focused on operating leverage for all the obvious reasons, and we continue to feel really good about the organic growth story. So we think we've got runway again, subject to anything changing in the macro environment. We're going to invest in the business. We've added a lot of bankers. We've invested in technology. We'll continue to do that. We haven't really determined the pace of that. We're -- as you heard talking before, we started -- we're sort of in the beginnings of our '27 planning. So we'll obviously share that in January. But we feel good that we can continue to invest in the business and manage expenses in a disciplined way. And again, I feel like some of the early AI proliferation we're seeing inside of Key, and it makes me really optimistic that we're finding ways to scale that don't actually require us to add a lot of people. So if revenue came down, we might have a different conversation. But right now, if you're seeing revenue growth, I feel like we can do a lot of the current activities we're doing today through the benefit of AI. We don't have to add staffing to support more clients and more revenue because some of that work can be done on those platforms. And then maybe shifting gears to credit quality. Nonperforming assets were up $126 million in the second quarter. You talked about a few specific credits in real estate, consumer goods and agricultural sectors. I know charge-offs were relatively benign and you didn't change your charter fans for the year. But just maybe update us on those 3 credits and those sectors of concern, just what else are you watching more broadly? Yes. I think those 3 sort of reflect the overall sectors of concern. So if you think about where we're watching things, it's commercial real estate, it's agriculture, it's consumer goods, right? Those 3 whether it's rates, whether it's tariffs, whether it's labor availability, whether it's the ongoing Amazon effect or all those things sort of hit those 3 areas. That said, we're seeing all our credit metrics improved in the quarter. The NPA as we talked about last quarter, we thought we had line of sight to resolution. We're seeing that happen. Our charge-offs are coming in. I think they're going to come in below the guide. So that's 1 quarter. So we're going to continue to watch that. But if we see the current progression, we might have some opportunity to lower that view for the year. But right now, credit quality just continues to be really benign.

I guess, against that backdrop, how do we think about maybe reserve levels going forward? You actually had a release in 2Q despite the NPA rise.

Yes. I mean I feel like, one, we built through a lot of 25 just given some of the uncertainty as you noted, we did have a little bit of a release last quarter. I think we feel pretty good about our reserve levels, but the trends overall continue to improve. So at some point, you have to figure out what you're holding and how supportable that is. So I don't know where we are exactly on that, but I wouldn't see obviously a build coming unless something changes dramatically in the next 2 weeks. And I could see some opportunity to release. The question is how much, just given the trends we've seen so far in the quarter.

I guess does the potential backup in rates tighten you at all?

I mean, it's 100% something we're going to watch, right? So the question is, in which areas, and we talked about commercial real estate, the way that is manifested over the last few quarters when it happens is good clients stay on they put more dollars in the interest reserves. They decide they want to extend. They put more capital operating they basically say, "Hey, we're just -- we're going to stay with you until the market changes. We're generally comfortable with that. So we'll see where that goes, but that certainly is a watch point. And then I think if you look at some of the geopolitical risk and other things that are happening, we're just -- we're always watching that, and that's been reflected in our reserve builds over the last several years, and those reserve builds have often been a qualitative offset to what our models are telling us. So the question is, do you keep building qualitatively if you see good [indiscernible].

And then on capital. CET1 Mark was like 98% last quarter within the 9.5%, 10% guide you talked about potential Basel changes we should be beneficial share repurchase, I think you can do at least $1.2 billion this year. Just how do we think about capital deployment going forward against the backdrop where maybe you don't need as much.

Yes. I mean our capital priorities remain pretty consistent. So you support client growth where you can. And obviously, we've had a fair amount of that. So we would have seen some real capital consumption in commercial loan growth this year. We're more than happy to do that. you pay the dividend. We don't see that changing or a need to change that over time. And then you think about how to monitor the overall ratio, and you tend to use those share buybacks to manage that. So we've been out there saying 1.3. I feel very good about that number. I don't see any reason to back off that. I do think -- we talked a lot about rates as it relates to deposit competition, loan demand, general economy. The 1 place where it's had a significant impact is just on the AOCI in the portfolio. So the rules aren't official, but we've been operating as if they are -- that will have an impact on our market capital in the quarter. I would expect us to be below the 9.5% in the quarter, just given that AOCI move. And I think we're very comfortable there given we've taken a very measured approach to capital return. There's nothing in front of us right now that would say don't achieve the 1.3%. We think that's the right answer. And frankly, you mentioned the Basel III, not official yet. Our expectation at this point is high probability, it looks the way it's been proposed, probably gets implemented in '27 for realization in '28. And I think we'd probably be shortsighted not to consider that aspect of it, which we think is 100-plus basis points of Mark Capital. We're not spending it today. But the question is, would you start pulling back on activities if you have some confidence that that's coming in the relative near term. So I think that's the balance. And right now, we feel very good about operating below that 9.5% given everything else going on.

Got it. And before we were talking about Clearwater, you kind of went through some non nonbank acquisition in sectors you're looking at. Maybe just shift gears to kind of bank acquisitions, I know you kind of always emphasize organic growth, but we do expect industry consolidation to pick up over the next few years. Just where do traditional bank M&A fit in with that capital higher?

Yes. I mean I would continue to say at this point, it's just not really a focus. And the question, we've sat down and said we feel very good about the organic growth opportunity. I think we've demonstrated we can do that. We've done these fill-ins because we think they're overall just incrementally accretive to what we're trying to do. And I think we feel like the risk profile of those types of transactions is manageable. But I think we are focused on executing and delivering on the commitments we've made. We've made them out now to fourth quarter '27. We feel very committed to delivering on those. And I think other things need to be different for us to really feel comfortable that the time is right for bank M&A. And that's we need to deliver. We need to get our multiples and returns in a different place. And we think we have the organic path to do that. So that's job 1, 2 and 3 at the moment. And if things change or some opportunity emerge that we weren't thinking about maybe we think differently. But right now, there just isn't anything on the horizon.

Yes, maybe sticking with the capital theme. I saw last month, you total notice redeemed $500 million of preferreds. Just thinking about the capital at going forward?

Yes, it's a great question. So we redeemed, I think, about $525 million of our Series D with that will come a little bit of redemption premium. So you'll see a little bit of noise in that preferred dividend line for us in the quarter. We have a Series E, another $0.5 billion coming up in, I think, December. In both cases, what you were getting was at the call date, a pretty meaningful step-up in the back-end floating rate. So it was very efficient for us to take those out. I suspect we will go through the same calculus and it'll probably tell us to redeem the E. Within that, our hope would be to issue the new preferred, not at the full amount of those, but maybe something on the order, but 50% of the market hasn't been as kind on that profile in the last few weeks. We watch that closely. So we'll see if that -- if there presents an opportunity there. But all of this is probably noise in the second half on the preferred dividend line, all of it to be in a more capital-efficient position over time, which frankly is very likely to lower those dividends.

Do you want to quantify the 3Q incremental impact?

I think it's probably in the order of about $5 million.

And then on Scotiabank, I know they own 15% the key. They filed to take it to just maybe update us on that and just the relationship and opportunities with them.

Yes. I mean, one, overall, I think we continue to have a very constructive relationship with them. Although at least from my seat, not a lot of interaction. So I think if you were listening to their calls, they've frequently touched on this as a financial investment. I think 1 that they're quite happy with and frankly, if you're going from 14.9% to 99, like presumably, you think there's benefit in holding more. I do think it's important just to remind people that the original deal in '24 allowed them to go to 19.9%. So there's nothing from the Key Scotia relationship here that is different. We are contemplating nor would we contemplate issuing additional shares to get there. This is really Scotia and the Fed dealing with their allowable ownership percentage within that 199. And they have basically 2 paths to get to that ownership percentage. One is go buy in the open market. We view that as positive for us. The other is to not sell to us in the back and just allow themselves to float up. I think we've seen more of the latter, and my suspicion is it's a little bit about not wanting their absolute dollar investment to go down while preserving the appropriate level of ownership. So it really doesn't have much to do with Key, but we view it as a positive sign that they're happy with the investment.

Helpful. And then, I guess, based on what we've discussed so far, -- it feels like you're on track to outperform the 15% plus 4Q 27 RGC target. Is that correct? And then beyond 2027, what do you need to do to kind of get back to that 16% to 19% ROTCE range?

Yes. Look, I think the -- we said on the call in July that we were incrementally more confident. I think that holds. Again, subject to market conditions holding. So I think that caveat is always out there, but what we're stating. I think it's not the sexiest answer in the world, but it is about continued NIM optimization and improvement over time. So getting to 3.25% and above obviously adds a lot of value to that return profile. continuing to invest and realize our fee-based businesses. So frankly, when we're adding commercial loans at the rate we are, we expect our bankers to be able to cross-sell those into our fee businesses, and we should see better fee growth performance over time. and we should be accountable for that. I think the third is continued disciplined expense management. So we think we can be in that kind of 3%-ish range over time and feel very good about doing that, well, investing appropriately because you don't want to starve the franchise. managing capital at the right level. So Basel III comes in is 9.5% still the right lower end or not. And if it is, what levers are we pulling to make sure we stand in that. And then obviously, manage you got to manage credit well because that tends to put a hole in the boat when you don't. So I think it's a pretty simple recipe, and it really comes down to executing it effectively and appropriately. But I don't think there's probably anything I said there that you haven't heard repeatedly in your long career of doing this.

No, it makes sense. We have in the minute we have remaining. I guess anything I forgot to ask anything on best is focused on.

No, look, I think despite some of the rate concerns and maybe some of the continued uncertainty, I think we feel very good about where the bank is positioned and how the business is performing clients. continue to express a lot of confidence, and we've been the beneficiary of that, and we'll continue to engage with them. I think we're on track to meet the commitments we've made, and we take that seriously. So subject to a lot of uncertainty, and it's our job to manage that effectively. We feel, as we sit here today, we feel quite good about where we are.

Great. On that note, please join me in thanking Clark for his time today.