Q3 2020 KeyCorp Earnings Call
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Good morning, and welcome to Keycorp's third quarter 2020 earnings Conference call. As a reminder, this conference is being recorded I'd now like to turn the conference over to the Chairman and CEO, Chris Gorman. Please go ahead.
Thank you operator, and good morning, and welcome to Keycorp's third quarter 2020 earnings Conference call. Joining me for the call today are Don Campbell, our Chief Financial Officer, and Mark Midkiff, Our Chief Risk Officer Slide two is our statement on forward looking disclosure and non-GAAP financial measures. It covers our.
Presentation materials and comments as well as the question and answer segment of our call.
I am now turning to slide three.
As you saw in our press release. This morning, we reported third quarter earnings per common share of 41 cents.
Our EPS was more than double that which we reported in the prior quarter and up from the year ago period, which was impacted by notable items.
Despite the challenging environment, we generated pre provision net revenue of $1.9 billion and added 1 billion to our reserve for credit losses through the first nine months of this year.
Revenue in the third quarter was up 3% from the year ago period.
Our net interest income continues to reflect the low rate environment elevated liquidity and changes in balance sheet mix.
Average loans reflects strong performance from consumer mortgage and lower load offset by Paydowns of consumer line draws that were made earlier in the year, our consumer mortgage business generated funded volume of more than 2.3 billion this quarter, which was up more than 75% from the year ago.
Oh period, and 5% from last quarter.
Over one half of our originations were purchase mortgages, our pipelines remain strong and we expect to show sustainable growth and continued market share gains.
Lower road continues to originate high quality loans that provide us with an opportunity to build broader digital relationships with these targeted clients in.
In the third quarter Laurel road originated over $400 million.
We believe that both Laurel road and consumer mortgage will continue to be relationship based growth engines for our consumer business with.
With our strong consumer platform, we have decided to discontinue originating indirect auto loans. The current portfolio of approximately 4.6 billion will run off over time.
Now, let me turn to fee income we had another good quarter noninterest income was up from the year ago period, reflecting stronger than expected performance investment banking and come and consumer mortgage had another solid quarter cards and payments and service charges on deposit accounts both power.
Hi, good strong linked quarter increases.
Don will discuss our revenue outlook in his remarks, we believe we are well positioned to continue to grow both our commercial and consumer businesses.
Our expenses this quarter reflect higher variable costs related to cards and payments activity and production related incentives as well as elevated pandemic related costs associated with keeping our teammates and our clients safe.
Through our continuous improvement efforts, we are maintaining our focus on expenses, improving our efficiency, while continuing to invest for growth, particularly our digital capabilities across the franchise credit.
Credit quality remained solid this quarter as we have remained true to our moderate risk profile throughout the cycle net charge offs for the quarter were 49 basis points in the deck, we have updated our disclosure on commercial portfolio focus areas. Don will cover these focus areas in his comments, but I will just say.
That these portfolios have generally performed consistent with or better than our expectations. The qual.
The quality of our loan book is also reflected in the level of loan deferrals last quarter. Our deferrals were the lowest in our peer group based upon public disclosures.
As of September Thirtyth loans subject to forbearance terms were less than 2% of total loans, that's down from 4.3% at June 30.
This equates to less than 1% of clients in both our commercial and consumer businesses.
In the third quarter, our provision expense exceeded charge offs by $32 million our.
Our allowance for credit losses, as a percentage of period end loans now stands at 1.88% or 2.04%, excluding PPP loans final.
Finally, we have maintained our strong capital position, while continuing to return capital to our shareholders in the third quarter, our common equity tier one ratio increased to 9.5%, which is at the upper end of our targeted range of 9% to 9.5% in September we paid a common stock.
Dividend of 18.5 cents per share the same amount we paid in the second quarter I will.
I will close by restating that this was another good quarter for key which demonstrates our underlying strengths. It starts with our dedicated team and their unwavering commitment to first and foremost our clients being very targeted about where we can compete and where we can win next costs, maintaining a strong focus on expo.
Senses, while investing for the future a big part of this investment going forward, we'll continue to be digital.
Credit continuing our strong risk management practices, and lastly capital focusing both on the return on and the return of capital.
Im confident in our ability to manage through the current environment and over time achieve our long term financial targets and importantly deliver value for all of our stakeholders.
Now, let me turn the call over to Don to go through the results of the quarter Don.
Thanks, Chris I am now on slide five as Chris said, we reported net income from continuing operations of 41 cents per common share.
Results also reflected momentum across our businesses, including growth in our balance sheet and fee income as well as continued strong risk discipline and capital management.
I'll cover many of the remaining items on this slide and the rest of my presentation. So.
So turning to slide six.
Total average loans were $105 billion up 14% from the third quarter of last year driven by growth in both commercial and consumer loans commercial loans reflect an increase of over $8 billion from PPP loans can.
Consumer loans benefited from continued growth from Laurel Road, and as Chris mentioned strong performance from our residential mortgage business law.
Floral road originated over $400 million of student consolidation loans this quarter, and we generated $2.3 billion of consumer mortgage loans. The investments. We have made in these areas continue to drive results and importantly add high quality loans to our portfolio.
Linked quarter average loan balances were down 3%, reflecting paydowns from the heightened commercial line draws earlier this year.
The pay downs on the lines were greater than expected and now the utilization rate is below the start of the year.
Importantly, we have remained disciplined with our credit underwriting and have walked away from business that does not meet our moderate risk profile.
We remain committed to performing well through the business cycle, and we manage our credit quality with this longer term perspective.
Continuing on to slide seven.
Average deposits totaled $135 billion for the third quarter of 2020 up $25 billion or 22% compared to the year ago period and up 5% from the prior quarter.
The linked quarter increase reflects.
Broad based commercial loan growth, assuming a commercial deposit growth as well as growth from consumer stimulus payments and lower consumer spending this guy.
This growth was offset by a decline in time deposits primarily related to lower interest rates.
Growth from the prior year was driven by both consumer and commercial clients total interest bearing deposit costs came down 20 basis points from the prior quarter, reflecting the impact of lower interest rates and the associated lag in pricing.
We would expect deposit costs continued to decline about six to nine basis points in the fourth quarter.
Continue to have a strong stable core deposit base with consumer deposits accounting for over 60% of our total deposit mix.
Turning to slide eight taxable equivalent net interest income were $1 billion for the third quarter of 2020 compared to $980 million, a year ago and $1.025 billion for the prior quarter.
Our net interest margin was 2.62% for the third quarter of 2020 compared to 3% for the same period last year and 2.76% for the prior quarter.
Both net interest income and net interest margin were meaningfully impacted by the significant growth in our balance sheet in the third quarter of 2020.
The larger balance sheet benefited from benefited net interest income that reduced our net interest margin due to the significant increase in liquidity driven by strong deposit inflows.
Compared to the prior quarter net interest income decreased $19 million driven by lower commercial loan balances. The net interest margin was primarily impacted by continued elevated levels of liquidity elevated.
Elevated liquidity levels negatively impacted margin by 13 basis points with all other drivers netting to an additional one basis point of pressure on the margin.
The lower than expected commercial loan balances contributed an additional five basis points of margin compression.
Recently, we have received several questions about the future impact of our interest rate swap maturities on our net interest margin.
On slide 20 in the appendix, we provide a schedule that details maturities of our swaps.
Also it is important to understand that this portfolio is only one of the fixed rate asset classes.
As all banks are impacted by maturities of fixed rate loans and investment securities. We.
We also shown on this slide that our level of these assets combined as a percentage of total earning assets is in line with peers.
Moving on to slide nine our fee based businesses had another strong quarter noninterest income was $681 million for the third quarter of 2020 compared to $650 million for the year ago period, and $692 million in the second quarter.
Compared to the year ago period, noninterest income increased $31 million. The primary driver was an increase of $35 million and consumer mortgage business as we continue to grow the business and see record levels of originations cards.
Cards and payments income also increased $45 million related to the prepaid card activity from the state government support programs.
Compared to the second quarter of 2020 noninterest income decreased by $11 million the largest driver of the quarterly decrease of $22 million of lower operating lease income as we had gains on leveraged leases in the prior quarter, which impacted the quarter over quarter comparison.
Consumer mortgage income was down $11 million following a record quarter for related fees in the second quarter.
These were primarily partially offset by an increase in cards and payments related income and higher service charges on deposit accounts.
Though down quarter over quarter investment banking and debt placement fees had another solid quarter and given the volatile environment come in at $146 million for the quarter.
Industrial turning to slide 10 total nine.
Total noninterest expense for the quarter was 1.03.
Zero, three $7 billion compared to $939 million last year and $1.13 billion in the prior quarter.
The increase from the prior year is primarily related to $52 million of payments related cost reported in other expense as well as COVID-19 related expenses to ensure the health and safety of our teammates.
Higher personnel costs from the year ago quarter reflect lower deferred loan origination cost merit increases and higher employee benefit costs.
Compared to the prior quarter noninterest expense increased $24 million. The increase was largely due to higher payments related costs as well as personnel costs related to elevated employee benefits, primarily healthcare, which was up $15 million last quarter.
Moving on to slide 11.
Overall credit quality remains solid for the.
For the quarter net charge offs were $128 million or 49 basis points of average loan.
Our provision for credit losses exceeded net charge offs by $32 million or three cents per share.
Nonperforming loans were $834 million this quarter or 81 basis points of period end loans compared to $585 million or 63 basis points from the year ago quarter.
Additionally, delinquencies actually improved quarter over quarter, a six basis point decrease in our 30 to 89 day past dues in the 90 day plus category also declining quarter over quarter.
We continue to monitor the level of assistance request, we receive from our customers over the past quarter in the number of requests for loan for balances have decreased dramatically.
As of September Thirtyth loan subject to forbearance were less than 1% based on the number of accounts for both commercial and consumer loans and less than 2% when using outstanding balances.
Turning to slide 12, as Chris mentioned, we updated our disclosure that highlight certain portfolios that are receiving greater focus in the environment.
These areas represent a small percentage of our total loan balances.
Each relationship in these focus areas continues to be subject to active reviews and enhanced monitoring and.
Importantly, as a group they continue to perform consistent with our expectations.
Turning to slide 13 that shared a summary of our deferrals compared to peers at a recent Investor Conference.
As shown here, our deferral level was peer leading in the second quarter as noted.
As noted earlier, we have seen a dramatic reduction in the deferral levels during the third quarter.
Now on to slide 14, we have.
We have continued to maintain a strong level of capital. We ended the third quarter with our common equity tier one ratio of 9.5% up 40 basis points from 9.1% in the second quarter.
This places us at the upper end of our targeted range of 9% to 9.5%.
We believe that this provides us with sufficient capacity to continue to support our customers and their borrowing needs and return capital to our shareholders and.
In the third quarter, we paid a common dividend of 18.5 cents per share, which was consistent with our second quarter level.
Importantly over the last four quarters, beginning with the fourth quarter of 2019, we have earned $1.14 cents per share well above our current dividend run rate of 74 cents per share.
On slide 15, we have provided our outlook for the fourth quarter.
We expect average loans to be down low single digits, reflecting lower period end balances coming into the fourth quarter consumer loans should continue to grow.
We expect deposits to remain relatively stable core.
Core net interest income should increase low single digits with a relatively stable net interest margin, reflecting the expected benefits from the repayment of PPP loans. The benefit of repayment is expect is estimated to be 20% to $25 million.
Noninterest income in the fourth quarter will remain relatively stable, reflecting an expected decline in consumer mortgage offset by growth in investment banking and debt placement fees.
Noninterest expense are expected to be down low single digits, but are highly dependent on the level of variable costs, including production related incentives.
Charge offs are expected to be in the 55 to 65 basis point range next quarter.
And finally shown on the bottom of the slide our long term targets on a reported basis, we will not achieve all the targets. This year as we emerge from a pandemic in the economy strengthens we expect to be back on the path that would lead us to operate within all of our targeted ranges.
With that ill now turn the call back over to the operator for instructions of the Q and a portion of our call John.
Thank you.
Ladies and gentlemen, if you wish to ask a question. Please press one then zero on your telephone keypad you may withdraw your question at any time by repeating the one zero command and if you are using a speakerphone. Please pick up the handset before pressing the numbers. Once again, if you have a question you may press one than zero this time.
And first in line of Scott Siefers with Piper Sandler. Please go ahead.
Good morning, everyone. Thank you for taking the question all right.
All right.
Let's see Don maybe wanted to ask first just on the decision to stop.
Stockbridge anything indirect auto so that $4.6 billion that a run off how long is it going to take for those to run up I'm imagining three years or last.
But I guess more importantly, do you guys feel like you can outrun that runoff and still generate net growth.
For example.
Mortgage and Laurel roadways got strong origination.
Yes.
Sure Scott the average life of that portfolio is about two and a half year. So it will take probably in total about five years before fully runs off.
So we will see declines each year and those balances and Chris can highlight a little bit more as far as the the rationale and thoughts as far as the.
Exit of those originations and also why we're excited about the consumer loan now loan origination capacity, we can generate so sure. So Scott we've talked a lot about relationships, we've talked a lot about targeted scale and Frank.
Frankly, the indirect book was from a quality perspective, it's it's just fine.
From a return perspective, obviously, you can't generate the kind of relationship returns that we would expect because it's a single product can firstly as you look at our consumer business as you well know two years ago, we really didnt have a mortgage business. This year will originate more than $8 billion two years ago, we didnt have a low low.
Business. This year will generate will generate more than 2 billion and we have big plans, obviously to continue to grow both of those so the premise of your question do we think we can outrun it in our consumer business, we do and we think we can do it on a relationship basis and really use our capital to support our clients or for other.
Things, whether its stock buybacks or whatever that we think are better use of capital.
All right perfect. Thank you. Thank you very much I appreciate that and then separately just sort of a top level question and now that.
Sort of coming out of that.
Coming out of that the worst of the pandemic gives you a lot of thanks to to be kind of applying lessons learned from below.
Ability to operate.
Without the same.
Certain infrastructure just curious how you guys are thinking about that the branch footprint. If you might see any opportunities for for something broader to do on the cost side here as we sort of stare down a challenging revenue environment for the next couple of years.
Sure Scott we think.
The pandemic certainly accelerated.
Some trends that were already there just to give you some texture. When we bought first Niagara We had 1600 branches today, we have 10 77.
We've invested heavily in digital our digital take up more than 60% of our of our customers are now digitally active and so we actually think there is a significant opportunity to take.
Take a look at the fleet and we're in the final throes of planning that and you will have more to say on that in January but in addition to some other things that are fundamental changes. We do think there will be a change in on kind of how we look at the density of our branches and as you know we're in some fast growing areas, where we have.
Relatively thin branch footprints and we think we can replicate that and get the mix right of digital and physical and other parts of our franchise.
Okay, perfect all right sales will sort of stay tuned till January on that so yes, all right well. Thank you I appreciate it.
Our next question is from Ken Zerbe with Morgan Stanley. Please go ahead.
Thanks.
Don you mentioned that you expect to $20 million to $25 million of TPP accelerated amortization and fourth quarter. I think you are actually one of the only banks I have heard of so far at least that's building that in I think most are looking at first quarter has the FDA actually opened up the portal or the forgiveness portal and they are the approving loans or is this.
A question Mark in terms of whether or not it actually goes into fourth quarter not just based on DSP.
We are hearing earlier that several other banks are using the same type of assumptions or if not even more aggressive as far as the prepayment, but the the FDA has opened we've actually started to see some of the request from customers go through and actually get funded here recently too. So it's still is more of a trickle, but but but we're starting to see volumes and activity levels pickup and that.
So what gives us a.
The basis for our outlook.
Okay, that's great and.
And then the other question I had.
I guess, what are you guys planning to do the excess liquidity on the balance sheet like how quickly can you deploy if you want to deploy it whereas are going into.
Yes, we've been looking at all different kinds of uses of that and whether or not we can.
Put it to better use than just sitting in cash our challenge right now is is that.
We tend to keep a fairly conservative investment portfolio, and really don't want to venture into credit risk in that area and so the the returns on similar.
Similar type of age.
Agency Securities that we would invest in are right around 100 basis points.
And so we will continue to assess that to see if we lean into that a little bit more.
I would say that we on a trial basis started to do a buy some longer dated assets and put some forward starting swaps against that will convert that asset to a variable rate to say five years down the road, which.
That is better aligned with our overall strategy and risk profile and so we'll consider doing things like that but the near term I think we will continue to see elevated levels of liquidity, including cash and.
Jeff Treasury bills, just because we feel that thats, a more prudent for us to do in this environment.
All right great. Thank you. Thank you.
And next we'll go to Erika Najarian with Bank of America Merrill Lynch. Please go ahead.
Hi, good morning, good morning.
My first question is for you guys.
For you Don I think that.
Investor conversations have turned from.
No simply Chris.
Simply credit she is thinking about things on a normalized basis.
Basis, and so as I think about the progression of net interest income from that billion checks. So if we exclude PPP any PBP impact I'm wondering if you could help us in terms of the wall Q.
What the quarterly run rate could look like in 2021, ECP because obvious.
Obviously, the run off of the indirect portfolio is new news.
Verses.
Hi, cash levels that Ken just mentioned that you could possibly redeploy first is I think there was a $40 million swing in hedge income contribution from this quarter to perhaps fourth quarter at 21. So.
So any help.
You can give in terms of how we think about where are you.
Where your net interest income can you could bottom and.
Of course, not assuming any loan growth or any changes in the rate environment.
We will provide more specifics on on 2021 and January I would say that as far as some of the moving parts that.
You are right that our swap portfolio will continue to mature overtime I would say that as we highlight on slide 20 that there are.
There are number of fixed as a fixed rate type of asset classes, including the swaps the low.
The loan portfolio and also the investment portfolio and I would say that.
As we look at how we're positioned compared to others. We think that we're right in line with peers as far as that relative mix as far as fixed rate assets.
As we look at the going forward, we think that our margin will probably bottom out something fairly close to where we're at today with the.
Time, having a redeployment of some of that liquidity into other loan categories, whether it's consumer or at some point in time seeing some commercial loan growth back up again, and so the pressure from these rates than in the impact on the maturity in the rollover those fixed rate asset classes would be offset by the utilization of some of those liquidity source.
It is and so that would include in that outlook.
Some reinvestment of Orbitz can be prepayment of those PPP loans.
Got it.
Just a follow up question and maybe this one is this is for Chris clearly.
Clearly 2020 was an exceptional year.
As we think about 2021 and certainties.
Sort of tease that a potential announcement and how you're thinking about infrastructure and branches for January.
Do you think is the way the revenue headwinds with efficiency opportunities. You think you can get back on positive operating leverage track next year.
I do I do.
And you know continuous improvement Erika is.
Part of our culture, each year, we've taken out sort of 3% to 5% and use that as raw material to invest and we will continue to do that I think there is some fundamental changes in the way banking is done and.
I am confident in both the trajectory of our earning strings streams and also our ability to to manage our expenses, we do have kind of a.
Situation this quarter in that half of the year over year increase is attributable of prepaid cards.
Im not saying that that's completely.
Nonrecurring, but I will say that we have invested a bunch of time energy people and technology to tamp that down so the answer to your question is yes.
Great. Thank you. Thank you.
And next from on line of Matt O'connor with Deutsche Bank. Please go ahead.
Good morning.
I just want to follow up on the exit of the indirect auto and then it's not that big of a deal, but it's also a portfolio that you've been growing I think pretty nicely.
Just in the past year here I think that was kind of one of the strategic additions you got for first Niagara. So I'm just wondering like has something changed in the marketplace.
And the last I don't know.
Three or six months or maybe just elaborate on kind of the timing now, especially at a time when there's just not a lot of loan growth for the industry overall.
So Matt.
The real timing as we've now successfully from from a standing start built the Laurel road platform and our platform.
We acquired first Niagara and 2016, we really Didnt have an engine for consumer loans and it was a good bridge it being indirect auto was a good bridge, but we've always stayed pretty true to the notion that we're a relationship bank and we're focused on targeted scale, where we can be relevant and as we look at that.
Folio in conjunction with the returns.
It just didnt.
Achieve what we wanted it to do vis-a-vis investing our capital elsewhere now as in terms of anything changing in the market. This isn't what drove the decision, but as you know the automobile market right. Now is very hot our analyst thinks that sales at retail next year will be up like 9.5% the value of used.
Goals right now because of shutdowns due to COVID-19.
Our up 15 or 20% that's not what drove that decision, but that is a fundamental macro driver that's out there.
And then I understand how mortgage is in relation to your product, but just remind us on the oil road, how you transform that into more of a relationship product versus kind of a one off.
Sure. So this is something that we're frankly very excited about we're building a national digital bank and its going to be focused on health care professionals and so weve already obviously built.
Loan consolidation business Thats all digital then in many cases within six months.
Thing like 50% of those customers that refinance their doctor and Dennis long Dental school loans by home. We've now built a complete digital mortgage.
Application and where we can take it from there is on a national basis to be really focused Matt around doctors and dentists and terms of opening accounts et cetera, and that will open up then the opportunity for us in the case of Dennis most because they're mostly independent business people as opposed to doctors who are poor.
At a large groups that will give us an avenue to do a lot with them. So we see Laurel road is a platform that we've grown a lot. It's been achieved everything we hoped it would and we think theres a lot to do on top of it and then one other area, where we're up we could potentially focus is expand beyond doctors and dentists, but within healthcare.
Our health care as you know is a.
18% of the GDP go into 20 kind of four trillion go our six trillion going atrium some.
That's how we're thinking about it.
Thanks.
And ladies and gentlemen, just a quick reminder, if you do have a question you May press one than zero and next we'll go to Gerard Cassidy with RBC. Please go ahead.
Morning, Chris Good morning, Don Good morning.
Can you guys share with us.
Thank you mentioned on the call that you're at the top end of your capital guidelines of 9%.
We know the share repurchase programs has been temporarily suspended by the federal reserve at least through the end of the year.
Can you see in this you're thinking of share repurchases for 2021, and where you'd like to bring capital ratio down to and because the change in the stress test where the fed does not approve any longer and banks plan to buy back stock.
Paid a dividend as long as use of past required minimal capital ratio.
You've got to even do not into the optionality to kind of do the buyback the way you see that some could you give us some thoughts on PJM will consider a Dutch auction.
This suspension goes into the second half of next year in your capital ratios in the high Ninetys to do one big buyback at one time to bring down the capital ratio.
Gerard this is Don as far as the share repurchases, we feel very good about where our capital position is today I would say to your point that we would it.
We would expect that the capital ratios to continue to increase as long as we're not buying back shares and so we highlighted that we are up 40 basis points. This far.
As far as the consideration for for when we would be back in the buy shares that we'd want to have a little bit better clarity as far as the clear direction on the economy, and where thats heading and and making sure that.
Due to have the the capital either support our customer support our organic growth and continue to support the dividend and so those would be a priority for us above just the share buyback.
One other potential consideration is that with the impact of the Cecil accounting change and how it impacts our capital ratios that theres about a 30 basis point or so impact that we'll see over time, there as well but that.
We do feel very good about where were at from a capital perspective, I do believe that it will increase and if.
If if available and things allow and permit we could consider adjustments that would allow us to.
Probably more proactively manage that overall share count with either a large share repurchase program or or market purchases like we've done in the past.
Very good and then circling back to credit.
Obviously key in the past has had issues with credit during a recession and I know it's been in gold management into peak to investors, that's not going to be the case this cycle.
If we exclude seeing movement no change in mix and your portfolio today versus what it was like it was seven and you take a look at obviously the government fiscal programs that have been implemented to help people through this downturn.
What are you guys seeing today that really strange shoe is different than what you've seen in the past when the behaviors of your borrowers.
Yeah, maybe I'll go ahead, and start Gerard and Chris and Mark might have some thoughts to add to that but I would say that the biggest difference that I would see and this is just coming in midstream into this but the.
A key really have pivoted to a relationship strategy and if you take a look at where the portfolio was before the last crisis that it was more.
It was more transaction oriented as opposed to a relationship and so we had outsize exposure and some commercial real estate developers and it was more on the.
The project as opposed to an ongoing study steady stream of cash flow for us and so I would say that the migration to that relationship strategy is having a huge payback for us.
On the consumer side, we're feeling similar trends that it's a very high quality very consistent portfolio and and as as we talked earlier, we really want to continue to have that more on a relationship type of approach as opposed to.
Transactions and Chris what we add to the what I would I would add its been a 10 year journey.
After the financial crisis, we sat down and evaluated where we lost money, how we lost money in it we basically it was principally in real estate. It was project level real estate. It was where we didnt have a deep relationship in some cases that were it was business that was.
Indirect business third party business and we went about the business of de risking our portfolio and we have we have been disciplined enough that we have forgone revenues.
Such that we can position ourselves. So we have the capital and the ability to support our clients and targeted prospects and environment like this the other thing I would just remind everyone of is of the capital we raise for our customers Gerard.
Only 18% of it goes on to our balance sheet and so that too is something that I think is unique for us and that we can serve our clients without necessarily putting it on our balance sheet, but it's you're exactly right. It's been a long journey.
Great. Thank you. Thanks.
Thanks to our.
Our next question is from the line of Bill current cash with Wolfe Research. Please go ahead.
Thank you good morning, Christian Don Thanks for the disclosure is on slide 20.
I wanted to ask about the hedging program run off on the bottom right side of the slide is the.
Is the right way to read this chart that if we multiply the weighted average yield by the notional value of the on and off balance sheet hedges, we get the quarterly contribution from the hedging program and if so it looks like the declining hedging benefit would translate into.
160 million dollar headwind in 21, and 114 million headwind in 22 is that the thought process.
I would say that this assumes that we have no replacement of the swaps going forward. So this is just the run off of the existing book and so depending.
Depending upon where the yield curve moves and how that would work.
Reposition we could see some some some differences there.
And then also would assume that were taking no other actions on balance sheet to minimize or mitigate some of that impact.
Understood and if I may just as a follow up so beyond the hedging portfolio run off can you discuss a little bit maybe just some color on the front book back book dynamics, if the low rate environment persists, maybe just give us a sense of how much you are receiving in pay downs of that book loans and securities that would have to get redeployed.
What the yield differential is between new money rates now and what's coming off.
Sure Ken that.
Generally our loan portfolio has an average life of three years and so just to use that as a proxy for for what kind of a roll off that we would have on on the portfolio and repricing. If you take a look at.
Our cnine most of our commercial portfolios they tend to be LIBOR based.
I'd say that the spreads on new originations are fairly consistent overall with what the back book would have and not seen a lot of change and that overall repricing for for for for that portfolio. We have seen a little bit more acceptance of some floors being placed on the products and so that will be helpful for us going forward.
But that.
That book as a general rule doesn't have a lot of repricing our risk from from from that perspective, if you look at some.
If you look at some of the fixed rate portfolios residential mortgage it's a fairly new portfolio for us we are seeing growth there that.
I think that the current yield on that portfolio on balance sheet is around to a.
Three.
50, or so as far as residential mortgage current production is closer to a 3% kind of overall yield for that portfolio. So.
A little bit below current average rates, but the but not significantly different.
As far as some of the other consumer categories, whether it's a home equity or lower road student loans or some of the other categories, where we're looking at probably about a 80 basis point or so gap between what the existing portfolio is compared to what the law.
Legacy book is on that side.
For the investment portfolio that for the core portfolio, excluding the true treasury bills that weve been adding as far as some of the excess liquidity position we're.
We're seeing a roll off of those yields and run the 240 in a replacement yield of around 1%. So about 140 basis points of of shift there.
Keep in mind too that as we highlighted on the deposit side we.
We're expecting to see our average interest bearing cost of deposits decreased by six to nine basis points in the fourth quarter and we should see some additional opportunities for.
Benefit there going forward as well and so probably at a slower pace, but still helping to offset or or minimize some of the exposure there.
That's super helpful. Thank you for the trip for all the additional details. Thank you.
And next we'll go to Ken Usdin with Jefferies. Please go ahead.
Hey, Thanks, guys.
Guys I was wondering if you can dig in a little bit more on the outlook for loans. So obviously on not surprising to see the declines this quarter from the pay Downs and you mentioned that loans will continue to.
The tricare tracked going forward, a little bit, but what do you see in terms of just any change and improvement and activity on the manufacturing side on inventory et cetera that we might look forward and start to see a point of stabilization. Some others are even pointing to growth. So you're just your broader outlook on the inflection potential inflection loans. Thanks.
Sure Ken it's Chris Good morning.
So there is no question that as we look at our Cnine book the utilization is below where we would have thought it would be right now it's frankly below the beginning of the COVID-19 crisis I think theres a few things that that can serve as a driver to the loan growth on the CNS side, one is an end.
Inventory rebuild and.
And as the economy ramps up I'm going to state the obvious as the economy ramps down. These companies so awful lot of cash as it ramps up they consume cash I think that could give us an opportunity as well. The other thing that is going on M&A discussions at.
In the beginning of the second quarter were nonexistent as we look at what are the discussions we're having with our customers day in and day out.
I think people are really starting you won't see it in the fourth quarter, but people are really starting to think strategically.
Just this week I met with three clients and they're in areas that you would think they might still be hunker down and they are really starting to think strategically. So I think the levers on the Cnine book will be transactional, but even before transactional.
Yes, I'd like to see obviously, some greater utilization I think those are those are a couple opportunities.
Okay, and then on the follow up to that on the corporate activity. So just wondering if you could talk a little bit more about the pipeline for investment banking and what the mix of investment banking has been in terms of like the public versus private and see a remark CRB markets like is any of that kind of back to a normal or still have.
Good pipelines ahead could fill that into thank you.
Sure. So as we look forward I would describe the pipelines are solid the.
The real variable was our M&A business, which is a strong business would basically.
Was was nonexistent as I mentioned kind of in the second quarter. Our backlogs now can in M&A are equal to what they were going into the crisis and obviously a lot of deals went away. So I find that I find that's been.
I find that's encouraging as I look at our our fees. This this quarter, we were about a $146 million. We I believe will be up in the fourth quarter I don't think it will be at the record kind of we've been we've had $200 million quarters before I don't think we'll be at 200 million, but we'll certainly be somewhere between 146.
Some 200, the pipelines are pipelines are solid the real estate.
Commercial mortgage business is obviously in this rate environment continues to be pretty strong.
Thanks, Chris.
And next we'll go to John Pancari with Evercore ISI. Please go ahead.
Good morning.
Good morning.
I'm on I wanted to see if we can get some incremental color on risk migration this quarter with the 24% increase in your criticized assets just wanted to see if you can give us a little bit of the granularity on what drove that migration and what asset types and then.
Also is that increase in criticized reflected at this.
At this point in your existing loan loss reserves. Thanks.
Sure I'll go ahead and answer the last part of that question first in the market help provide some of the clarity as far as the migration, but with.
As far as our loan loss reserve that we established at June Thirtyth and now at September Thirtyth, the keep in mind or seasonal that youre looking for the life of loan type of losses, and so embedded in there is the assumption that you're going to see.
Migration into criticized and classified and increased losses throughout the next several quarters and so those.
Those are all baked into both June Thirtyth and September Thirtyth, if if we look at where we're at today, whether its criticized classified charge offs and nonperforming were actually better at September Thirtyth and what our models would have assumed at as of June Thirtyth for this first quarter of that time period and so.
We're actually seeing better credit quality migration than would have been expected in contemplated as part of our our June thirtyth reserves.
As the areas of that migration, yeah, I'd echo that done better than what we would have a four.
Forecasted on the migration to the drivers really are the same things you're seeing in the focus areas in the disclosure so the consumer businesses, so consumer discretionary consumer services.
The oil and gas business. Some transportation. So it's really those are the the drivers that we see.
Okay, Alright, Thanks, and then another question just on credit.
If you.
It sounds like you're confident in the adequacy of where the reserve stands now so as charge offs continue to rise as they did this quarter.
For the fourth quarter and beyond would you expect that you would under provide for those charge offs.
Weve talked before about how the Cecil works and really there is three drivers to it one is.
What's the economic outlook, and so I would hesitate to try to speculate or guess as to what that will be as of December 31st given the environment that we're in and given the election is right around the corner as well, but that but that will clearly impact the overall reserve levels and if I look at between the second quarter in the third quarter assumption set what we saw as far as.
Economic outlook was probably in the near term performance was actually realized.
In the September summary than than what we would have assumed and the June summary, but.
Longer term the recovery rate was a little slower so unemployment levels remained a little bit higher in our September thirtyth and GDP level and recovery was a little slower than what we would have assumed and so.
Generally maybe a little bit slight negative as far as the overall impact there and so first as economic.
Outlook second would be migration of the portfolio that as we just talked about that.
Our last models that are used for Cecil will assume that the portfolio goes through a a civic migration based on the economic outlook.
And so if you perform better or worse than that migration, you would see a need to either increase or decrease the reserves in the third would be is that new loan production and as we highlighted last quarter on the call norm.
Normally for loan production that would imply a provision expense of $80 million to $100 million quarter versus the 160 that we had this quarter and so thats elevated compared to what we normally would have expected as far as just matching the loan production.
This quarter, what we did do was too.
Actually supplement what our quantitative models would have produced.
And so we added about a $100 million between model overlays and also our qualitative assessment to the reserve to bump up the reserves just to make sure that we werent recognizing too quickly the benefit of that migration and given the economic uncertainty that we're still facing right now and so we think that was a prudent thing.
For us to do and and we would have seen a lower level of provision. If we had not had done that this quarter.
Got it all right. Thanks, Tom that's very helpful.
Our next question from Mike Mayo with Wells Fargo Securities. Please go ahead.
Hi, just in simple terms why did you guys build reserves this quarter when many of your parents did and where do you think charge offs 49 basis points in the third quarter.
Peak and when do you think that happens.
Sure as far as the building the reserve I'd say, it's fairly modest and what we wanted to do was to make sure that we weren't taking to credit too early as far as the better than expected migration and also.
Uncertainty on the overall economic outlook and so we felt that was appropriate to do.
Last quarter, we were being challenged is whether or not our reserves were adequate.
And we still are a little low compared to peers as far as the reserves and so that also influenced.
Our assessment as to whether or not we want to show reserve declines this quarter and so we decided to go in.
And layering on top of that some additional model overlays and also qualitative reserves.
So if you look at our total allowance for credit losses, Mike It's at 1.8% and if our average loan life is roughly three years that would imply a charge offs of around 60 basis points for some time and.
I would say that as we take a look at what our.
Projections would have we'd probably see some continued this slight increases through the middle of next year and that would probably be the peak and then start to trail off again.
No the peak would be like double or 70 or 80 or.
Anyway, I mean, I know, it's not not many have given this but some have.
I would say that it would be elevate a little bit from the 49 basis points in more talking about 55 to 65 next quarter. They go up a little bit from there, yes, but probably not a doubling from.
Okay and then the tougher question so 2% of your loans aren't forbearance you said, that's down significantly I guess, that's 1.6 commercial 2.3% consumer.
If the music where to stop today does it at some point, you'll start with the court Barents, what would be the impact on charge offs and on revenues.
Yes, as far as charge offs I mean, one we've already built in extra reserves for those loans for forbearance and so I think thats a appropriate consideration there too if we look at the forbearance and especially on the commercial side, we're not just automatically granting forbearance, we've got to work with the customer and make sure that we understand that.
This truly is a bridge for them on an interim basis and this isn't just a delay of the inevitable and so we are taking a look at credit quality.
Without the full benefit.
Benefit of that forbearance.
I would say that on the consumer side, even though we have loans in forbearance were.
We're still very happy with the quality of the underlying customer base that.
Still have consumers that will eventually have the capacity to continue to repay that the.
Collateral values for for those products, whether it's a home equity or residential mortgage are still quite strong and so I wouldn't see that as a significant impact as far as either charge offs or or PNM before us as those would would mature markets.
I'd say the same and they do continue to come down and we also what rolls off of.
In exits were seeing really high current rates, you know sort of 90, 697% or higher so seeing good performance.
And if I can squeeze in one more Chris acquisitions Bank acquisition environment, I mean competitors are under pressure the industry's little under pressure, what's the appetite.
So as.
As you know, we we have been.
We've been successful in acquiring niche businesses and I think you can expect us to continue to look at those I'm really proud of the fact that we've been able to acquire.
Born digital companies and successfully integrate those investment banking boutiques and integrate those in terms of whole bank acquisitions, that's not really a focus of ours. Mike. We think we have everything we need to be successful and we think the right strategy is to execute our strategy to create value for the shareholders.
Alright. Thank you. Thank you.
Thank you.
Our final question will be from Steve Alexopoulos with JP Morgan. Please go ahead.
Good morning. This is generally on Steve.
I'll get to 23 million quarter over quarter increase in cards and payments income this quarter what percentage of that is from prepaid card activity supporting state government grant that it's going to start winding down in 2021 and also can you comment on the level of organic spending and transaction volumes during deployment.
Excluding the prepaid card activity. Thanks, sure can that as far as the percentage increase I would say the majority of the increase in that the cards and payments related revenues was related to the prepaid card activity keep in mind also that we saw a similar increase in the expense was linked quarter and so the.
The earnings risk for that as well.
Or changes on that front.
As far as the.
The activity for other card balances that I wouldn't say that in the third call.
In the third quarter were seeing levels that are fairly comparable to what we would have seen as far as spend on both the credit card and debit card and the.
Maybe transaction counts might be a little lower on debit card. They average ticket size is a little higher and so we're seeing getting closer to a return to normal handle Chris getting other thoughts there no. Obviously the mix has changed a bit there's people are traveling people aren't going to restaurants, but in the third quarter. It actually the spend eclipsed that of the third quarter.
Peter of last year.
Yes.
It's helpful and my follow up is on the deferral on you on 1.8 billion rather than just smart on how much of that how much of that is on loans and cobot, 19th those categories and which industry are you seeing the high speed.
Do you have thoughts on on that as far as.
I would say generally that though we're seeing a higher percentage in those industry, but I don't know that there is any one sticks no one that kind of stands out and the re deferral rates or.
You know it's been in the kind of 15% range. So it's been very very low.
All right. That's helpful. Thank you. Thank you.
And we will take another question from the line of Saul Martinez with DBS. Please go ahead.
Thanks, Thanks for squeezing.
A couple of follow ups first.
You're welcome.
The prepaid card income.
Mentioned.
The majority of the increase there for almost all the increase campaigns come from that and what is it fair to say that it seems like your guidance for fourth quarter.
Still includes pretty elevated level.
Prepaid income associated expenses is that correct and can you just help us understand what kind of magnitude is sort of baked into the fourth quarter.
I would say both.
The revenues and expenses remain elevated compared to the normal levels, but down slightly from from what we've seen in the third quarter and so there's a number of different things would drive both the revenue and expenses and we were seeing some of the activity levels for those areas declined slightly in our outlook.
Got it and secondly, I wanted to go back to the earlier question on on hedges it wasn't clear.
You glass or cash is math or not.
Based on that.
It can you just help us understand what is the sort of been eye protection that you're currently getting from your swap of just doing the math on on slide 20 seems like it's in the neighborhood.
Call, It 500 million or 730 million a quarter with a weighted average maturity of 3.4 years showing as a whole.
Six seven years.
Which would imply sort of 82 million dollar headwind.
Annually from just an X. I know this is assuming no replacement.
Due to offset but I mean is that I mean is that math broadly correct, if thats kind of the cash.
Kind of protection you're getting.
Today, and the run off will provide something close to say 80 90 $100 million.
Sure.
That completely off.
Keep in mind that as we look at our loan portfolio.
70% plus is variable.
Thats different than than many of our peers and so if you look at the swap book that we have it really is to shift the.
The actual net adjusted position to be more in line with peers as far as that overall fix percentage.
I would say as far as the math I think we're right around 27 basis points of our margin this quarter relates to the.
The the benefit from from interest rate swaps and so the the math probably isn't too far off I'd have to go back and recalculate all isn't that the numbers to make sure that were things, there, but but but.
That is if you just look at that one line item would would be correct, but keep in mind that we were also seeing a corresponding reduction in our net interest income coming from those commercial loans that are LIBOR based that we use these to hedge that impact and so.
It's difficult to say just looking at that one line item, what's the impact, but you have to look at the overall balance sheet and then on the moves on on not only the asset side to the liability side to see the true impact is going forward.
Got it alright, that's super helpful. Thank you very much.
In Q.
And with that I'll turn the call over to the company for any closing comments.
Well. Thank you operator again, we thank all of you for participating in our call. Today. If you have any follow up questions. You can direct them to our Investor Relations team 216689 for two to one this concludes our remarks. Thank you.
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