KeyCorp Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 17, 2024

There are 12 speakers on the call.

Operator

Thank you, everyone, for standing by. Welcome to the 2024 Third Quarter Earnings Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. Call.

Operator

As a reminder, this conference is being recorded. Would now like to turn the conference over to Brian Mouni, KeyCorp Director of Investor Relations. Please go ahead.

Speaker 1

Thank you, operator, and good morning, everyone. I'd like to thank you for joining KeyCorp's Q3 2024 earnings conference call. I'm here with Chris Gorman, our Chairman and Chief Executive Officer and Clark Hyatt, our Chief Financial Officer. As usual, we will reference our earnings presentation slides, which can be found on the Investor Relations section of the key.com website. In the back of the presentation, you will find our statement on forward looking disclosures and certain financial measures, including non GAAP measures.

Speaker 1

This covers our earnings materials as well as remarks made on this morning's call. Actual results may differ materially from forward looking statements, and those statements speak only as of today, October 17, 2024, and will not be updated. With that, I will turn it over to Chris.

Speaker 2

Thank you, Brian, and good morning, everyone. I'm on Slide 2. Before I hand it over to Clark to review our financial results, I want to provide my perspective on a quarter that represented significant progress for Key as we position ourselves for the future. First, we received the initial $821,000,000 a little less than 1 third of the anticipated minority investment from Scotiabank at the end of August. We used approximately $700,000,000 of the proceeds to reposition our securities portfolio.

Speaker 2

In retrospect, this trade was fortuitously timed. Long dated securities were sold near recent bond market highs in mid September, which enabled us to sell over $7,000,000,000 of market value securities out of a total available for sale portfolio of $37,000,000,000 At this point, we have fully invested the proceeds at better than anticipated yields in more liquid, less capital intensive, shorter duration agency MBS. We anticipate these actions will add over $40,000,000 to quarterly net interest income in the 4th quarter. As for the remainder of the $2,800,000,000 Scotiabank minority investment, we are now through the public comment period, and we continue to expect to receive regulatory approval by the Q1 of 2025. Secondly, we saw the long anticipated step up in our net interest income this quarter, up 7% quarter over quarter.

Speaker 2

This reflected a combination of a more meaningful amount of low yielding short term swaps and treasuries maturing as well as proactive management of our funding costs. We also continue to grow our client deposits, up 4% year over year and 2% sequentially. We achieved this NII growth despite some near term impact as a result of the Fed's 50 basis point rate cut in mid September. We mitigated a portion of the cut through a very proactive and disciplined deposit repricing plan, which is a testament to the preparedness of our consumer and commercial deposit teams. As a result, our beta in the initial Fed cut is anticipated to be higher than we had previously modeled and communicated.

Speaker 2

Thirdly, we continued to see strong momentum across our most important fee based organic growth initiatives. Investment banking and debt placement fees were very strong at $171,000,000 one of the best third quarters in our history. Activity was broad based with volumes particularly despite the Q3 pull through. Pipelines are stable compared to June 30 levels and up meaningfully compared to year end year ago levels. M and A backlogs, which we have said in the past, have a 2 to 3 times multiplier effect, were near record levels and up 10% compared to the prior quarter.

Speaker 2

At this point, I am confident we will hit the high end of our full year target for investment banking fees of 6 $100,000,000 to $650,000,000 with an opportunity to exceed the high end if our pipelines pull through prior to year end, again, assuming markets remain hospitable. In commercial payments, leveraging our focus on primacy, commercial deposits were up 5% year over year and 2% sequentially. As a reminder, 93% of these balances are tied to an operating account. Underlying core treasury service activities remain strong, growing in the low double digits. We believe we are well positioned in this area benefit as rates continue to decline.

Speaker 2

Our 3rd party commercial mortgage servicing business posted a record quarter due to a small portfolio acquisition over the summer. Additionally, active special servicing balances reached a record $7,500,000,000 As a reminder, this is a countercyclical off us business that also provides us with unique insights into the commercial real estate market. We are currently seeing high rates of transfers into special servicing concentrated in office and, to a lesser extent, multifamily, even as we have also seen resolutions accelerate as we move through the year. In Wealth, assets under management reached an all time high of $61,000,000,000 up 16% from the prior year. Sales production was a record this quarter and we are on track for a record year.

Speaker 2

While the entire Wealth business is performing well, we continue to see particularly strong traction in our Mass Affluence segment. This quarter, we enrolled an additional 5,000 households and added $620,000,000 of assets to the platform. In only 18 months, we have added over 36,000 households and about $3,600,000,000 of new household assets to Key. As a reminder, over $1,000,000 of Key's retail households have investable assets of over $250,000 and only about 10% have an existing investment relationship with us. So there remains a significant opportunity to continue to grow in the Mass Affluence segment.

Speaker 2

Lastly, with respect to credit, we continue to demonstrate a conservative derisked credit profile. Nonperforming assets and loans as well as provision for credit losses were essentially flat. Net charge offs, as expected, were up and reflected a few specific C and I credits that were known and had been mostly reserved against. Importantly, criticized loans declined by $132,000,000 We also saw marked improvement in our net credit upgrades to downgrades trends, which while still slightly negative, moved back to our trailing 13 quarter average. We believe that NPLs are peaking and criticized loans will continue to decline from current levels.

Speaker 2

In summary, I am proud of the significant progress we made as a company this quarter. We announced the strategic minority investment from Scotiabank, closing on the initial onethree tranche a few weeks later. We deployed most of that, successfully completing onetwo of our anticipated securities portfolio restructuring. At the same time, we continued to drive broad based momentum across the franchise, grew our pipelines, delivered the 1st meaningful leg of the uplift in net interest income that we've been communicating over the past year and took proactive actions across the deposit books to prepare ourselves for the rate cuts, all while continuing to demonstrate a strong credit risk profile. As a result, despite the one time impact of restructuring, we improved our CET1 ratio this quarter by another 35 basis points to 10.8%.

Speaker 2

With that, I'll turn it over to Clark to provide more details on our financial results.

Speaker 3

Thanks, Chris, and good morning, everyone. I'm now on Slide 4. In the Q3, we reported earnings per share of negative $0.47 including $0.77 impact from the previously disclosed securities portfolio repositioning. Excluding the repositioning, EPS was $0.30 per share. As Chris mentioned, in mid September, we sold roughly $7,000,000,000 market value of mostly long dated CMOs and CMBS, which had a weighted average yield of about 2.3% at an average duration of almost 6 years.

Speaker 3

And at this point, we have reinvested all of the proceeds, mostly in October when we saw term rates rise by 30 to 40 basis points. As a result, we will see roughly 260 basis point yield pickup on approximately $7,000,000,000 of securities starting in the Q4. The new securities will also provide liquidity and capital benefits relative to what was previously owned. As a reminder, we currently contemplate doing a similar magnitude repositioning upon receiving the 2nd tranche of the Scotiabank investment assuming we get Fed approval. Reported revenue was down approximately 55% sequentially and from the prior year, but excluding the securities repositioning, revenue was up 6% sequentially and up 3% year over year with growth across both net interest income and fees.

Speaker 3

Expenses remained well controlled, down 1% compared to the prior year, a little better than we previously expected. This implies about 400 basis points of positive operating leverage on a year over year basis, excluding the securities portfolio repositioning. Credit costs were essentially flat to the 2nd quarter and included a $60,000,000 release of our allowance for credit losses, reflecting primarily 3 charts off credits that had specific reserve allocations held against them as well as lower loan balances. Our common equity Tier 1 ratio increased to 10.8% and tangible book value increased nearly 16% sequentially. Moving to the balance sheet on Slide 5.

Speaker 3

Average loans declined 2.5% sequentially to $106,000,000,000 and ended the quarter just above $105,000,000,000 The decline reflects continued TEPIC client demand, flat utilization rates, our disciplined approach as to what we're willing to put on the balance sheet and the intentional runoff of low yielding consumer loans as they pay down and mature. Additionally, we built the business to be able to serve clients with on and off balance sheet solutions, whichever works best for them. This quarter, we raised $28,000,000,000 of capital for our clients. And as Chris mentioned, we had a very strong quarter of investment banking fees. At the end of the Q3, we warehoused approximately $600,000,000 of loans for commercial clients that you can see in loans held for sale.

Speaker 3

Additionally, throughout the quarter, we refinanced about $300,000,000 of CRE loans off our balance sheet into permanent mortgages through our Capital Markets Group. We continue to have active dialogue with clients and prospects and our loan pipelines continue to build. On Slide 6, average deposits increased 2.5% sequentially to nearly $148,000,000,000 reflecting growth across consumer and commercial deposits. Client deposits were up about 4% year over year as we managed broker deposits down by roughly $2,200,000,000 from year ago levels. Reported non interest bearing deposits declined 1% to 19% of total deposits.

Speaker 3

And when adjusted for non interest bearing deposits in our hybrid accounts, this percentage remained flat linked quarter at 24%. Both total and interest bearing deposit costs increased by 11 basis points during the quarter. 7 basis points of the increase reflected reduction of roughly $4,500,000,000 of FHLB funding, yielding almost 5.6% that was replaced with lower cost client deposits. Our overall interest bearing costs increased just one basis point this quarter. As Chris mentioned, we've been proactive across our deposit book in preparation for the Fed easing cycle that we all anticipated would begin last month.

Speaker 3

Ahead of the cut, we shortened CD tenors and took promo rates down. And on the commercial side, we moved significant amount of deposits into indexed accounts. Following the cut, we took rates down further across both front and back book and consumer. In commercial, we effectively passed along the majority of the cut to clients. Our deposit beta on the first rate cut is expected to be low to mid-30s, which would benefit our 4th quarter net interest income.

Speaker 3

Moving to net interest income and the margin on Slide 7. Tax equivalent net interest income was $964,000,000 up 7% or $65,000,000 and the net interest margin increased 13 basis points from the prior quarter. A well communicated net interest income opportunity is now providing more benefit as a greater portion of low yielding short term swaps and treasuries mature. Scotiabank Investment and our mid September securities portfolio reposition had a roughly $12,000,000 about 2 basis points to 3rd quarter NII and NIM respectively. Turning to Slide 8, reported non interest income was negative $269,000,000 and included a $918,000,000 loss related to the securities repositioning as well as a $14,000,000 Visa related charge.

Speaker 3

Adjusting for those items, non interest income was up 3% year over year. Investment banking and debt placement fees increased over 20% from the prior year and 36% from the prior quarter, reflecting a strong quarter for syndication, debt and equity underwriting fees. Commercial mortgage servicing had a record quarter, reflecting higher active special servicing balances and growth in the overall portfolio. At September 30, we serviced about $690,000,000,000 of assets on behalf of third party clients, including about $230,000,000,000 of special servicing, dollars 7,500,000,000 of which was in active special servicing. Given lumpiness of some of these fees and as interest rates come down, we would expect 4th quarter commercial mortgage servicing fees to look more like the 2nd quarter.

Speaker 3

Trust and investment services fees grew 8% year over year as assets under management grew to a record level of $61,000,000,000 On Slide 9, 2nd quarter non interest expenses were $1,090,000,000 up 1% quarter over quarter and down 1% year over year. On a year over year basis, higher personnel costs were more than offset by lower fraud losses, marketing expenses and a modest reduction in the estimated FDIC special assessment charge. Sequentially, the increase was driven by higher incentive compensation from stronger investment banking fees. Moving to Slide 10, credit quality remains solid. Net charge offs were $154,000,000 or 58 basis points of average loans and 90 day delinquencies picked up a few basis points.

Speaker 3

Net charge offs were elevated due to 3 credits, 2 consumer goods companies and 1 equipment manufacturer that were largely reserved. Nonperforming loans and assets were essentially stable, up 2.5% 2%, respectively, compared to the prior quarter. NPAs as a percentage of loans remain low at 70 basis points. Criticized loans declined by 2% in 3rd quarter, reflecting lower rates and increased loan modifications with credit enhancements. We believe NPAs are peaking and criticized loans will continue to decline from here assuming no material macro deterioration.

Speaker 3

Turning to Slide 11. We continue to build our capital position with the CET1 ratio up 35 basis points to 10.8 percent as of September 30. Our marked CET1 ratio, which includes unrealized AFS and pension losses, improved nearly 130 basis points to 8.6%. Our AOCI improved by about $1,900,000,000 to negative $3,300,000,000 at quarter end, reflecting lower interest rates and the securities reposition in mid September. We expect AOCI to further improve by about 1 third by year end 2025 and about 40% by year end 2026, with approximately half of that improvement reflecting a second contemplated securities portfolio repositioning once the full investment from Scotiabank closes.

Speaker 3

Slide 12 provides our outlook for full year 2024 relative to 2023. We currently expect net interest income to fall in the middle of the full year guidance range of down 2% to 5%, albeit with about 150 basis points of positive impact from the Scotiabank Investment and the securities portfolio restructuring this past month. Net interest margin should come at around 2.4% for the 4th quarter. We are tweaking our year end loan forecast by 1% to down 5% to 6%. We are also positively revising our average deposit guidance to up 1.2 1% to 2%, including expectations for client deposits to grow by 3% to 4%.

Speaker 3

We now expect fees excluding this past quarter's securities portfolio restructuring to grow 6% or better this year depending on how the capital markets environment plays out in the 4th quarter. Given the strong fee momentum and our higher stock price, we expect expenses to be up approximately 2% this year. This also includes the funding of our charitable foundation. As we previously communicated, we expect the full year net charge off ratio to be closer to the high end of the 30 to 40 basis point range, given lower loan balances than we had expected coming into the year. For the full year, we expect provision for credit losses to come in around $400,000,000 which is unchanged from what we'd expected back in January.

Speaker 3

Moving to Slide 13. The last time we are updating the net interest income opportunity from swaps and short dated treasuries maturing as we sold the remaining roughly $3,000,000,000 of treasuries yielding 50 basis points that were to mature in the Q4 at the end of September, meaning we now expect the final chunk of benefit from this opportunity to come in the Q4. The cumulative annualized opportunity ended up being about $830,000,000 of which 80% has been achieved to date. Finally, on Slide 14, we've laid out for you the path of how we intend to get from the $964,000,000 of reported net interest income in the 3rd quarter to the Q4 exit rate that we had targeted at the beginning of the year. Regardless of whether the Fed cuts 50 or 75 basis points in the 4th quarter, we believe 4th quarter NII will be at least 10% higher year over year, which equates to $1,020,000,000 or better in the Q4.

Speaker 3

We expect about $40,000,000 of incremental benefit from the September portfolio restructuring and initial tranche investment from Scotiabank. We expect another $50,000,000 or so of benefit from fixed rate asset repricing, including from the accelerated sale of short term treasuries I just described. We also think we can drive a modest amount of commercial loan growth and some further funding optimization, offset by some short term impact from the expected Fed rate cuts. While fewer cuts would be better for 4th quarter NII, that is largely a timing impact. Keep in mind that we would expect to capture more benefit of any rate cut over the ensuing 6 to 12 months and rate cuts would likely provide benefits to other parts of our business such as higher client transaction activity, more demand for credit and improvements to capital.

Speaker 3

With that, I will now turn the call back to the operator who will provide instructions for the Q and A portion of our call. Operator?

Speaker 4

Thank

Speaker 2

you.

Operator

Your first question comes from the line of Scott Siefers from Piper Sandler. Please go ahead.

Speaker 5

Thank you. Good morning, everybody. Thanks for taking the question.

Speaker 6

Good morning, Scott. I think

Speaker 5

you might have touched on this a bit toward the end of your remarks, but there's been so much movement in your balance sheet over the last 90 days, not only the new capital and the repositioning, but now it looks like the funding profile is starting to look a little different with the improved deposits outlook as well. Maybe just some thoughts on the updated rate sensitivity of the company as a whole. And as you look at things, what would be sort of best and worst that you would like just in terms of what happens with the rate path?

Speaker 3

Hey, good morning, Scott. Thank you. So look, we've been moving towards rate sensitivity. That's obviously often viewed over kind of a 12 month period. So the as all of us in the industry have talked about, the early cuts take a little bit of time to work their way through, particularly on the deposit side.

Speaker 3

As we noted, we took a little bit more deposit action than we had previously planned. Beta is kind of low 30s or so, which we were very happy with. And we think over the course of 2025, we'll be able to get back to more standard beta paths over time. I think on the overall rate profile, look, I think the best version of the world is the one we appear to be headed in if the soft landing is coming, which is a steepening curve right now. We got some rally in the term rates, so nearing again 4%.

Speaker 3

We all think the front end is coming down. So something that's flat to upward sloping, I think is the best profile for all of us. But on the flip side, I think we took some actions, as you noted, in getting out of higher cost wholesale funding. We funded that with deposits at a lower cost. We feel really good about that deposit base and the customer profile.

Speaker 3

We feel good about our ability to price that over time. And given that the swaps positions are coming off, we feel better just about our overall rate sensitivity. The other point I'd make is, we had a little bit of concern on the repositioning early just given the amount of cash we thought we'd be holding for potentially an extended period of time. Obviously, that cash is pretty asset sensitive. So as those rates come down, that impacts us.

Speaker 3

And we were able to get all of that into the market in the last few weeks when rate those term rates did rally and we did it at better than expected value. So that's going to help our rate sensitivity position going forward and we put that those proceeds in kind of $4.90,000 $4.95 range in a duration that's just under 4 years. So we felt very good about that repositioning And that will again, that will aid us going forward.

Speaker 5

Yes. Perfect. All right. Thank you for that color. And then sort of related one.

Speaker 5

I think last month, you all had discussed an NII improvement next year in kind of the 20 percent plus range. I think that was before you were fully invested because if I'm recalling the timing correctly, that was when you had just announced the repositioning. So, the actual investment probably a little better than you thought, which presumably should be helpful. But I guess the thrust of the question is just, we're still thinking 20% plus NII improvement next year? And maybe just if you could expand a little on sort of the main puts and takes to get there in your mind?

Speaker 3

Sure. So I'm going to start with a couple qualifiers because I feel like that's necessary. The first being a constructive macro environment kind of soft landing as folks expect. So that's point 1. Point 2 is, we're in the middle of planning for next year.

Speaker 3

So we'll give our full guidance here in January. But on the 20%, I'd say roughly half of that we think comes from the incremental impact of the repositioning. So assuming and this would be the other qualifier, assuming the second leg of this gets approved and we can do the repositioning early in 2025, so we can get the full year impact of that. We think about half of that lift comes from the complete repositioning at completion. So that's part of it.

Speaker 3

The other components would be continued fixed price fixed asset price repricing through the course of the year and that's a combination of some swaps, not the ones we've been talking about, but some additional swaps still at rates kind of below 2%. We've got a consumer book that's running down at rates like 3%. And then we've got some other fixed rate securities that are a little bit higher that won't be as valuable as they would have been previously with rates coming down. But we do have some continued opportunity there. And then the last piece, the last two pieces and I'll finish with the most important one, we do have at this point and again subject to changes we get through our planning process relatively a view on relative stability of loans through 2025, but recall that, that is a mixing of consumer coming down and being replaced with commercial.

Speaker 3

So we will need some commercial growth, not Herculean efforts, but something. Our pipelines would tell us that, that should be coming. But in fairness, it's been telling us that for a quarter or 2. So we'll see how that transpires. And then the most important piece is just continued ability to manage betas.

Speaker 3

We've talked a lot about how the commercial book is positioned. We've actually improved that throughout the year, getting more deposits into indexed. We think the use of our hybrid accounts and treasury core treasury services that are covered by deposits there will be a benefit as well. And we've taken some action in the consumer book that would give us confidence that we can get betas to the right level throughout the course of 2025. So all those components kind of make up the other half of the twenty.

Speaker 3

And at this point, we feel good that that's achievable, but we owe you a more detailed explanation when we come back in January.

Speaker 5

Perfect. All right, good. Thank you very much, Clark.

Speaker 3

Yes.

Operator

Your next question comes from the line of Mike Mayo from Wells Fargo. Please go ahead.

Speaker 6

Hey. Hey, Mike. Chris, you talk about resaying M and A backlogs are up 10% quarter over quarter. And what's the change now? Why we've seen this at the big players.

Speaker 6

And also, we've heard there's a little debate. Is the capital markets activity taking away from loan growth? Or are they separate? Are you seeing some disintermediation from lending to Capital Markets as it relates to KeyCorp? Thanks.

Speaker 2

Sure. Thanks for your question. I think the fundamental difference is the private equity universe is really starting to transact. I think they have a perspective. Obviously, there's an inverse relationship between the whole period and the returns.

Speaker 2

And in addition to that, with the 10 year, which is really what matters, sort of settling in somewhere around 4%, that is that's in an environment where I think the private equity world is very comfortable transacting. And as a consequence, I think you're really starting to see a pickup on the M and A side. And I think that will continue, by the way. With respect to the disintermediation, there's no question that it is. I mean, Mike, we raised $28,000,000,000 last quarter, and we have a pretty good eye on this because we're distributing a lot of paper in a lot of places.

Speaker 2

And there's no question in my mind that some of the Capital Markets activity does, in fact, disintermediate the banks. And I think the private capital private credit markets do as well. And of course, we distribute paper to all those places.

Speaker 3

And the only thing I might add to that, Mike, just a couple of specific examples, and we touched on this, but about $500,000,000 dollars of loans we put directly into our warehouse, they're on their way to the markets and then another $300,000,000 we refinance off the balance sheet into the market. So that's always been our model and we'll continue to do what makes the most sense for clients and I think you saw that this quarter in our strong Investment Banking piece.

Speaker 6

And just to follow-up on the Private Equity comment. You said the Private Equity universe is starting to transact. I got the sense there deploying some of the dry powder, but honestly monetizing the investments. But you get different stories depending on who you ask. How much of your business is driven by private equity?

Speaker 6

And how do you see the private equity factor playing out because you never had this much dry powder in a cycle like this?

Speaker 2

Sure. So I think broadly, the private equity universe represents about onethree of all the fees that are paid in the Investment Banking arena. Our mix wouldn't be much different. And your observation is good and that the private equity firms that are putting product out into the market, that's a process that takes 12 months or so as opposed to buying businesses that are available, which is relatively, there's a shorter time line on that. Thanks for your questions, Mike.

Speaker 6

All right. Thank

Speaker 5

you.

Operator

Your next question comes from the line of Gerard Cassidy from RBC. Please go ahead.

Speaker 4

Hi, Chris. Hi, Gerard. Chris, you mentioned in your opening remarks about the special servicing. I was curious or it perked my interest, you mentioned how there seems to be an accelerated resolution to the inflows that may have come in 6 months ago or 3 months ago. Can you give us any color on how that resolution is going?

Speaker 4

Is it big price discounts and then being refinanced or what are your guys seeing on the resolution side to move these properties out?

Speaker 2

So it's a combination of things, Gerrard. If you go to the office market, frankly, there's just some capitulation because there has to be and things are starting to trade, albeit at a significant discount. Not a lot of new capital coming in, frankly, to the office market. I can speak to that in greater depth in a moment. On the other hand, with respect to multifamily, and we've said before, most of the multifamily projects that are in special service and are concentrated in the Southeast.

Speaker 2

Most of them, frankly, are not financed by banks. Most of them were done relatively recently with some very aggressive assumptions, I. E, trending rates, having sub debt in them, etcetera. In those instances, we are able to attract new capital on a restructuring basis. So it's a little bit different for office visavismultifamily.

Speaker 4

Very good. And then you guys talked about the outlook for loans or what you're experiencing in loans. And we're seeing from the H8 data that comes out on Fridays that it seems like commercial and industrial loans have hit a bottom and are starting to creep up a bit. Any sense that you might be seeing that soon as well? Or is it just some of your where you're physically located and your customers is still going to be flat for or flat to down, I should say, over the near term?

Speaker 2

So there's a few things going on. And first of all, we are, without question, growing clients. So there's no doubt that we're out there bringing on new clients. We have been obviously a bit frustrated by the lack of take up of our existing clients in terms of borrowing money. And I think what's going on, Gerrard, is a few things.

Speaker 2

On the positive side, I mentioned to Mike, there is transactional finance happening. So that's a positive. On the negative side, you just have supply significantly exceeding demand. On the demand side, here's some of the things that we need to see before we get significant growth from our existing customers. 1, there hasn't been a lot of investment in CapEx and that has typically a lead time of about 18 months based on all the uncertainties.

Speaker 2

The next thing is utilization. And this one's a complex one. Everyone basically went long on inventory during the pandemic because there was a lot of inflation and there were supply chain issues. Now people are getting back to really managing their working capital. And I assume, obviously, rising rates has something to do with that as well.

Speaker 2

So I think there's just been a fundamental adjustment there. So we do see it coming back. We see it coming back first on the transaction side. We'll see it next, I think, on our clients engaging in CapEx. And I think the last piece that will happen is to really get a kick in utilization because for all the reasons I just described, these companies are throwing off a fair amount of cash as they get sort of top line declines and all the other things in the mix.

Speaker 2

Does that answer your question, Gerard?

Speaker 4

No, it does. It's good, Chris. And just one real quick. You guys in the past have always had a comment or 2 on student lending. Any changes here and rates coming down a bit on your student lending platform?

Speaker 2

Yes. So that is an upside for us as rates continue to come down. We basically had a negligible amount of originations in the last quarter in our student loan business. We think a decline of 100 to 150 basis points will get that business back to ramping up. To state the obvious, every quarter, every semester, there's a bunch of new customers at different levels.

Speaker 2

But clearly, with the hiking cycle, it's going to take a while to work through that.

Speaker 3

And we're still peeling off the moratorium. So people are just getting used to paying their student loans again or maybe not yet used to paying their student loans again. So there's probably a little bit of transition and just seeing that sticker shock a little bit and then going out and figuring out if there's a better alternative.

Speaker 4

Great. Thank you.

Operator

Your next question comes from the line of John Pancari from Evercore. Please go ahead.

Speaker 2

Across the business. And so those are relatively good underlying drivers to get to the number you're talking about without being

Speaker 6

That's helpful. Thank you. And on the expense run rate, I think

Speaker 2

Operator, can you move to the next Q and A?

Operator

Next, we'll go to the line of Matt O'Connor from Deutsche Bank. Please go ahead.

Speaker 7

Hey, everyone. This is Nathan Stein on behalf of Matt O'Connor. So you talked about the rise in C and I net charge offs this quarter, which were from the 3 credits that had been previously reserved for. I wanted to ask what industries were these loans in? And we saw the updated charge off guidance for full year 'twenty four, but are you expecting other similarly sized losses in the coming quarters?

Speaker 2

Nathan, this is Chris. So specifically, the 3 credits, 2 of them were in Consumer Products. 1 of them was in equipment manufacturing having nothing to do with Consumer Products. So those were the 3 credits. Each had their own idiosyncratic issues that I don't think you can get a huge read through on broad industries on those.

Speaker 7

Okay. Thank you. And then if I could just ask a question on the NIM. You flagged a 2.40 level in 4Q, just given all the moving pieces. I think in September, you guys had flagged a 3% NIM with just assuming a steeper yield curve down the road, not necessarily next year, but could you provide your updated thoughts on the long term NIM just given the move in rates over the past few weeks and everything else going on at Key?

Speaker 7

Thanks.

Speaker 2

Well, Nathan, I think from a broad perspective, what we've said is and there's obviously a bunch of puts and takes in this. We've said that based on our business model, there's no reason by the end of 2025, we can't be in a range of 2.8% to 3%. And obviously, we're looking at different models every single day, but we still feel very comfortable with that.

Speaker 7

Thank you.

Operator

Your next question comes from the line of Zach Westerlund from UBS. Please go ahead.

Speaker 8

Hi, good morning. This is Zach on for Erica. My question is just around deposit betas. We saw a decent uptick in the cost of interest bearing deposits this quarter. Just kind of wanted to get your thoughts on how you're thinking about the trajectory for that deposit beta going forward?

Speaker 3

Yes, sure. So maybe just get to the quarter movement first and then transition to beta. So up 11 basis points interest bearing deposit costs in the quarter, 7 of that was an intentional move into higher cost deposits, but deposits

Speaker 5

that

Speaker 3

were lower cost than wholesale funding. So we paid off about $4,500,000,000 of FHLB advances at a higher rate. And I think the more important number versus the 11 basis points on deposit cost is overall funding costs only up a basis point. So at the end of the day, what we're managing is the overall funding costs and then obviously deposits are a critical part of that. As it relates to betas, we had expected something in the maybe low to mid-20s on the first cuts.

Speaker 3

We are expecting to be closer to lowtomid30s potentially. Some of that is we just leaned into different portfolios a little bit more aggressively than we thought we could because we felt comfortable that we understood the dynamics of those. The other piece is the 50 basis point cut in September gave us a little bit more room to take action. If that had been 25, I think you would have seen a lower beta on that first cut. So as we say pretty frequently, I think the not only absolute level of rates, but how much they're moving on any one cut tends to impact how much beta you can see as a reaction to that.

Speaker 3

So the 50 basis points on a net basis creates a little bit more drag in 2024, but it also gave us the ability to take a little bit more aggressive action on deposit pricing.

Speaker 8

Helpful. Thank you. And just as a follow-up to that, on the non interest bearing deposit front, any color that you can share on that in terms of when you think that will reach a bottom there or pivot to growth? Any thoughts there would be helpful. Thanks.

Speaker 3

Yes. So maybe just a reminder there too. So our reported number shows down a tick around 19%. Recall that we used pretty actively a hybrid account for our commercial clients that has a fair bit of non interest bearing deposits in it. If you adjust for those, which we think is appropriate, you get pretty flat at 24% quarter to quarter.

Speaker 3

So I think in aggregate, it's starting to stabilize.

Speaker 5

We would expect with rate cuts that it's going to be stable. And if the rate

Speaker 3

cuts continue, we would expect it to Great

Speaker 8

Great. Thanks for taking my questions.

Speaker 3

Sure. Thank you.

Operator

Your next question comes from the line of Manan Gosalia from Morgan Stanley. Please go ahead.

Speaker 9

Hey, good morning.

Speaker 3

Good morning. Hey, Vinod.

Speaker 9

Hey, I apologize if this has already been covered. But can you talk about expenses for 2025? Just given that you have a lot more capital to work with now, growth should be accelerating next year. You have some investment spend to make, plus you have been pretty good with managing expenses over the past few years. So just given all of that, how should we think about expenses in 2025?

Speaker 2

Sure. Fair question. We're obviously going through the planning cycle now. But I've mentioned before, and this won't change, we will be targeting kind of lowtomidsingledigits for 2025. Our discipline around expenses won't change in spite of the fact that we're going to obviously have a significant amount of capital.

Speaker 2

You do see in the Q4 and we gave guidance on this that we're investing a little bit in the Q4 and that's really just some unique opportunities that we have to kind of advance the business in light of the tailwinds that we're picking up from both the rundown of our swaps and treasuries and also the repositioning of the balance sheet that Clark walked everyone through.

Speaker 3

So the maybe one additional point just I think is embedded in Chris' comment, but I just want to make it explicitly, Manav, which is we would tell you not to annualize that Q4 number going into 25%. I don't think that's appropriate. As Chris mentioned, we're leaning into higher fee growth, so we're going to see incentive comp go up a bit, stock price is a little bit higher. We've got some unique investment opportunities we're assessing in the Q4 that we're interested in taking to get a head start on 25%. But I think the underlying point that Chris made is worth repeating, which is we don't see the benefit of higher earnings or the investment as a path to losing our expense discipline here.

Speaker 9

Perfect. And then I appreciate the comments on the near term deposit betas. But wanted to get your thoughts on just longer term as you think through the cycle, should deposit betas in the way down match deposit betas in the way up? Or given that loan growth will be stronger this time than it was when deposit when rates were going up, will deposit betas likely be a little bit slower through the cycle?

Speaker 3

Yes. Great. It's a great question with no simple answer because you hit a bunch of the moving parts. So subject to funding needs on the balance sheet that obviously drives the requirement to have deposit balances, which in effect then hit your pricing. What I would say maybe more broadly is, I think the absolute level of rates matter and the amount of movement in rates matter.

Speaker 3

So if we hit kind of peaked at mid-50s, 56% I think beta on the way up, I think that's more than probably you would have expected at the beginning of the cycle, but it's also a function of rates moving up over 500 basis points off of 0. So your relative starting point is 0, you're moving up by 500 basis points, 5.50 basis points, that's a huge move and you're getting obviously to that 5% level. I think on the way down, I would expect it to be somewhat parallel, but probably not getting to the mid-50s, maybe it's a 50% number because you're not likely to get back to 0 unless some exogenous event occurs. So if we hit some terminal rate path that's 2.5%, 3%, I think you're going to see beta deployed and beta deployed over time fairly aggressively, but I don't think you get to the same levels just because the magnitude of the change is 50% to 60% of the way up. And that then you have to account for the other element, which is loans and required balances for funding.

Speaker 9

Got it. Thank you.

Operator

Next, we'll go back to the line of Mike Mayo from Wells Fargo. Please go ahead.

Speaker 6

Hey. Can you comment on the increase in NPLs a little bit more? Is that like how many credits is that? Is that a trend? Is that something that you guys are worried about?

Speaker 6

Was that unexpected? Thanks.

Speaker 2

Yes. Mike, it's Chris. We think that's sort of peaking. It's there's nothing in particular. It's kind of broad based.

Speaker 2

And as we said in our opening comments, we don't think it's material or reflect I don't think there's any read through from that.

Speaker 6

So next quarter, we shouldn't expect anything like that is what you're saying?

Speaker 2

Well, I think NPLs will be pretty flat as we go forward. I mean, that would be what I would assume for your models.

Speaker 3

Yes. If you're talking NCOs, Mike, the 3 credits, then yes, we don't expect that to recur. The benefit to the extent there is some there is that those were almost entirely reserved and that was a big portion of the release as well.

Speaker 6

And then one last cleanup question. So you had already thought that NII would be 20% higher next year. And then you sold $7,000,000,000 of the securities near high. So I assume you got a nice yield pickup. Better lucky than smarter, maybe it was maybe you have some great timing there.

Speaker 6

But so why wouldn't that 20% number for the increase in NAI in 2025 versus 2024 go higher because of that fortuitous investing of those securities?

Speaker 3

Yes. So I'll take lucky or good either. But just to remind you, Mike, the 20% that we shared contemplated the repositioning. So what we're talking about is marginal improvement on the reinvestment. We're really happy with where we did it and we took advantage of that pickup in rates, but that's relative to maybe it's a handful of basis points that are not that 20% wasn't had already contemplated the repositioning of that portfolio.

Speaker 3

So again, I think

Speaker 5

all the

Speaker 2

It still in fact contemplates

Speaker 5

the second piece.

Speaker 3

The second piece. Yes, correct. So it is a marginal benefit, which we'll take, but it isn't the entire magnitude of that trade that is added on top of the 20.

Speaker 6

Got it. Thank you.

Speaker 2

Sure.

Operator

Your next question comes from the line of John Pancari from Evercore ISI. Please go ahead.

Speaker 10

Good morning and sorry about the technical problems earlier.

Speaker 2

Not a problem. Good morning, John.

Speaker 10

Good morning. A couple real quick questions. On the capital markets revenue side, I know you flagged some very solid pipelines and building pipelines there and your expectation to hit the high end of the $600,000,000 to $650,000,000 guide. Chris, I know when you've had this type of confidence in the past, you actually called out the likelihood of a record year the following year as well. I believe you did that last year.

Speaker 10

Could you maybe provide your thoughts on 2025 here, just given the progression you're seeing, maybe how we see that playing out in terms of your capital markets revs as you look at heading into 25?

Speaker 2

Yes. Fair question. So clearly, sort of embedded in our guidance for 2024, if you kind of do the math, is another step up in the Q4, maybe $180,000,000 or so, if you kind of just back into it. I feel good about the trajectory. I think if we continue to have this kind of an environment where rates are stabilizing and people are able to transact, I'm optimistic about 2025.

Speaker 2

We'll give more guidance on that, John, when we gather after the end of the year. But I think you should assume that a lot of these pipelines have pretty long tails. And so we should go into 2025 with a fair amount of momentum.

Speaker 10

That's helpful. Thanks, Chris. And just two more quick ones. On the loan growth front, I believe you mentioned relative stability as you look into 2025 given the trends you're seeing, given consumer likely declining but commercial increases. Are you able to give us a better idea of the piece of growth that you think is reasonable?

Speaker 10

And what type of growth more specifically on the commercial side do you think that can help offset consumer pressure?

Speaker 3

So we'll provide a little bit more color there, but just maybe broadly think about consumer loans coming down $2,000,000,000 to $3,000,000,000 in a year just by natural kind of maturity and pay down. Now that could change based on rate levels and mortgage markets, but that's kind of a decent rule of thumb there. As it relates to where we would see some pickup in Commercial, I'll make a couple of comments and then Chris can add on to it. But in places where we have demonstrated strength and I think mostly of like affordable and renewables, which are tend to be project transactions, they tend to be construction in nature, so they build through time and then we perm them out in some form. Those I think are places where we're starting where we see in Fortable, we've been pretty consistent, but we're seeing pickup there.

Speaker 3

I think the opportunity to build that over time and those loans do take time to materialize just because they are large projects. They do build from a draw standpoint before they're ready to be fully drawn and sold. So those are two places where I just continue to feel confident about our abilities and the market. But there's some broader based opportunities, I think, as well.

Speaker 2

Yes. The only thing I'd add, Clark, is, as I mentioned earlier, I think the transactions business will generate loans because that's picking up. So the wildcard that all of us are watching is what's going to happen with our existing client base in terms of really investing in CapEx and what's going to happen with utilization. And I think that's just a watch point for all of us.

Speaker 10

Got it. Thanks, Chris. I do have one last one. Sorry about that. On the loan loss reserve, you did on a loans to on a reserve ratio basis, you did bleed the reserve modestly this quarter.

Speaker 10

Perhaps provide us a little bit of thoughts around the potential for incremental release this year as you see credit playing out given the economic outlook?

Speaker 3

Look, so we view you're right, 3 basis points, I think, down on the ACL, so pretty stable. We've built it up quite significantly over the last several quarters. I think if you did a loan kind of portfolio by portfolio mix, it might dictate that we'd be we could even be lower. But right now, we're still looking at we're being cautious around migration and where some of the late cycle pieces of this are taking us. I think if rates continue to come down and as Chris noted, the environment remains constructive that may give us some opportunity.

Speaker 3

But right now, we feel like stability is probably the right place.

Speaker 2

John, there's really three things that drive these. One is your view of the macro and you obviously have a perspective on that. The next is sort of idiosyncratic. And obviously, if we were aware of idiosyncratic things, we would be as we aggressively took on the 3 loans that we talked about today, we'd be moving on those. And the 3rd element is the size of the book.

Speaker 2

So those are kind of the three elements. And so if you think about each of those 3, obviously, it begs the question of where should the reserve be and we'll continue to evaluate it.

Speaker 10

Great. Thanks, Chris. Appreciate it.

Operator

Your next question comes from the line of Peter Winter from D. A. Davidson. Please go ahead.

Speaker 11

Good morning. Good morning. I wanted to follow-up on John's questions on the loans just for the Q4. You didn't change the full year guidance for the average, which would imply that there's going to be some decent growth in the Q4. I was just wondering if you could talk about maybe just what you're expecting for Q4 loan trends?

Speaker 3

Yes. So I mean, we took the ending point down a bit. I think that will take us to the overall kind of lower end of the average guide. Look, I think we're expecting some stability on the loan side at this point, not a huge amount of growth. I'd say some modest growth.

Speaker 3

But whether or not we get that, I don't think really impacts our view on NII in the quarter. We'd obviously like to start seeing some loan growth. So at this point, I'd say it's more stabilizing than it is really picking up.

Speaker 11

Okay. And then Chris, if I could just ask one big picture question. Obviously, you're getting the 2nd tranche of the investment from Scotia. The focus would be the securities restructuring along with organic growth. But just with now that you've built up your capital levels, just can I ask how you think about bank M and A going forward?

Speaker 2

Sure. So the premise of your question is right. So think about us raising $2,800,000,000 and we basically, in the aggregate, spend $1,400,000,000 on the restructuring. Then we have an additional $1,500,000,000 And on a pro form a basis, I think you'll see our CET1, it's a 12% and you'll see our marked CET1, it's a 10%. So clearly, we'll have dry powder that we'll be able to if there's dislocation in the market, we'll be able to take advantage of that.

Speaker 2

We'll probably run with a little higher capital, just in the near term until there's finalization of the Basel III endgame, the liquidity rules, the long term debt. But I do believe, Peter, that there will be consolidation in our industry. There certainly hasn't been for all the reasons that you are well aware of. I think last year, there were 3 significant deals completed. My experience with consolidation is when it happens, it happens kind of in waves.

Speaker 2

And clearly, with this additional capital, I think we'd be well positioned if and when that were to happen. It's not something we're focused on now, however.

Operator

Your next question comes from the line of Scott Siefers from Piper Sandler.

Speaker 5

Guys. Thank you for taking the follow-up. Clark, if possible, I wanted to just revisit the expense outlook, particularly in the Q4. It seems to be generating a lot of traffic this morning. I know you said higher stock price will impact incentive comp.

Speaker 5

Then I think you said some kind of proactive investments as well. But at a point, I think I might have heard, foundation contribution as well. Are you able to sort of parse if we're going to see maybe $100,000,000 of total expense lift in the Q4, how much of that is ongoing stuff versus what people might sort of pull out as transitory? And then, also appreciate that you suggested already not to annualize that, but just hoping for a little more deep dive in there if possible.

Speaker 3

Yes, it's a good question. I think the annual the main point which you picked up on, which was don't annualize that number, I think the fair point is some of our business is variable in nature based on performance. So hard to quantify that, but frankly, if we have the revenues that dictate we should be paying compensation on that, we would take those like at any day of the week. So I think you have to think about some of that expense growth in the context of the revenue that's driving it. As Chris said, we're potentially leaning into some unique opportunities in the quarter.

Speaker 3

Those are going to be by their nature, not necessarily recurring. And I don't have a specific number for you, but clearly, it's not appropriate to take the full amount of that. And I think we just we got to fine tune a little bit of how much expense rolls into the run rate quarter and a lot of that's going to be based on how much revenue we think it's supporting. So we just need to do a little bit more work to give you a clean look. But I do think the again, the appropriate guide at this point would be mid to single digits for next year.

Speaker 3

And we owe you, as I said, more detail when we come back at the end of the year.

Speaker 5

Got you. Okay, perfect. Thank you again.

Operator

And at this time, there are no further questions. I'd now like to turn the call back to Chris Gorman for any closing comments.

Speaker 2

Again, we thank you for participating in our call today. If you have any follow-up questions, you can direct them to Brian and our Investor Relations team. We appreciate everyone's interest in Key and hope everyone has a great day. Goodbye.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT and T Teleconference. You may now disconnect.

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Earnings Conference Call
KeyCorp Q3 2024
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