Q1 2023 KeyCorp Earnings Call
Okay.
Ladies and gentlemen, good morning, and welcome to Keycorp's first quarter 2023 earnings Conference call. As a reminder, this conference is being recorded I would now like to turn the conference over to the Chairman and CEO , Chris Gorman. Please go ahead.
Good morning, and thank you for joining us for key Corp's first quarter 2023 earnings Conference call. Joining me on the call today are Clark Khayat, our Chief Financial Officer, Don Kimble, Our Vice Chairman and Chief administrative officer, and Mark Midkiff, Our Chief risk Officer on Slide two you will find our statement on forward looking disclosure.
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 moving to slide three before I comment on our quarterly results I wanted to touch on three areas that I know have been top of mind for investors, namely deposits capital.
And credit quality.
<unk> strengthened.
Strengthened each of these areas over the last decade, we have derisked, our business and built a differentiated franchise that is well positioned for all business conditions, including the current environment.
Keys relationship based business model provides us with strong granular deposit base and with attractive lending and fee based opportunities.
Our long term standing strategic commitment to privacy that is serving as our client's primary bank continues to serve us well.
Over 60% of our deposit balances are from consumers wealth clients small businesses and escrow accounts.
Over 80% of our commercial balances are core operating accounts.
The diversity of our deposits extends across client type account size industry and geography are.
Our deposits come from $3 5 million retail small business private banking and commercial customers with 56% covered by FDIC insurance and additional 10% of balances that are collateralized.
In the first quarter, our period end deposits remained stable and balances from March 31 to present remained relatively unchanged.
With respect to capital.
Keith position remains strong with a common equity tier one ratio of nine 1%.
This positions us well to execute against our capital priorities, including supporting our clients.
We are also aware of the heightened focus on accumulated other comprehensive income Aoc.
<unk> improved this quarter by 13%, which drove a 20 basis point improvement in our tangible common equity to tangible asset ratio or.
Our capital position will benefit from the expected 2 billion improvement in a OCI by 12 31 24.
Credit quality remains strong once again, reflecting our proactive and intentional de risking over the past decade.
In our consumer bank, we serve a wide range of clients our weighted average FICO score at origination is above 770 <unk>.
Our commercial bank, 82% of our credit exposure is to relationship clients and 56% of our C&I portfolio is investment grade.
We have built a strong originate to distribute model that strengthens our risk management and allows us to offer our clients a one.
Ride range of on and off balance sheet financing options in the first quarter, we raised $26 billion for our clients.
Another area of getting attention is commercial real estate.
Our largest exposure is multifamily, including a growing affordable housing segment. There exists a significant shortage of available housing broadly and affordable housing specifically in the United States today as such affordable housing will continue to receive bipartisan government support.
<unk>, we have limited exposure to high risk areas, such as office lodging and retail.
We also have unique insights into commercial real estate through our third party commercial loan servicing business not only is this a great business with over $630 billion of servicing assets, but the business provides us with unique insight into the markets, which vary greatly by asset type and geography.
Each of these three areas that I've covered deposits capital credit quality provide a foundation and support the long term earnings power of our company.
With that as a backdrop, let me move to slide four it touch on a few quarterly highlights before I turn it over to Clark to cover the quarter in detail.
This morning, we reported earnings of $275 million.
Or <unk> 30 per common share our results included $126 million or <unk> 14 per share as a result of both our increase in allowance for credit losses, and the expense actions, we previously announced.
Build in our allowance for credit losses is principally model driven and reflective of a greater range of outcomes as we look ahead.
Our strong credit quality and guidance for net charge offs, however remain unchanged our.
Actions this quarter were part of a company wide effort to improve efficiency and support reinvestment back into our business. We completed actions this quarter, which represented over 4% of our expense base or $200 million.
An annualized benefit.
This will allow us to hold non interest expense relatively flat in spite of persistent inflation.
Our results this quarter were driven by year over year growth in both our consumer and commercial businesses.
In our consumer business, we grew new households at a pace supporting our Investor day targets.
Our commercial businesses also continued to add and expand relationships.
Recent market disruption has provided us with further opportunity to acquire clients and Opportunistically add high quality bankers to the platform.
Net interest income declined from the fourth quarter, reflecting higher interest bearing deposit costs and a shift in funding mix net interest income was also negatively impacted by our receive fixed rate swaps.
Which are used to hedge our floating rate portfolio.
Flops and treasuries reduced net interest income by $317 million this quarter and lowered our net interest margin by 72 basis points.
Given the short duration of our swaps and treasuries and the meaningful repricing opportunity, we will see significant benefit to our net interest income beginning late this year and extending into 2024 and beyond we have continued to take actions to lock in the net interest income.
Benefit going forward.
We'll cover our interest rate positioning in detail during his presentation.
Our fee based businesses in the first quarter showed several areas of strength, but overall reflected expected weakness in capital markets.
Although the market remains challenging we did experience a record first quarter in our M&A advisory business, while we do not anticipate a significant pickup in our capital markets business in the first half of the year. We continue to expect deal activity to pick up sometime in the second half.
As I pointed out on the prior slide credit quality remained strong this quarter with net charge offs as a percentage of average loans of 15 basis points are credit losses remained near historic lows and we remain confident in the way we have positioned our portfolio consistent with our moderate risk profile.
Despite the market disruption, we have not lost focus on driving our targeted scale strategy and investing in points of differentiation.
And our wealth business for example, which currently has $54 billion in assets under management, we are bringing the power and capabilities of our private bank to better serve mass affluent clients through our retail channel.
Our Laurel road business is expanding to serve the distinct needs of health care professionals through hospital system partnerships.
In our commercial businesses, we are empowering our relationship managers with a comprehensive suite of tools to enhance productivity and to better support our clients.
I remain confident in key and the long term outlook for our business. We have durable relationship based businesses that will continue to serve our clients our prospects and deliver value to our shareholders.
Lastly, I would like to thank our 18000 employees for what they do each and every day to serve our clients with that I'll turn it over to Clarke to provide more details on the results of the quarter and our 2023 outlook Clark.
Thanks, Chris and good morning, I'm now on slide six.
For the first quarter net income from continuing operations was <unk> 30 per common share down <unk> <unk> from the prior quarter and down 15 from last year driven in part by two notable items.
We incurred $64 million of restructuring expense or <unk> <unk> per share, which included $36 million of severance and other related costs and $28 million of corporate real estate related rationalization and other contract terminations or renegotiations.
Our results also included $94 million of additional provision expense in excess of charge offs or <unk> <unk> per share as we continue to build our reserves, reflecting a more cautious economic outlook and view on home prices.
Turning to slide seven.
Average loans for the quarter were $119 8 billion up 16% from the year ago period, and up 2% from the prior quarter as we continue to support relationship clients.
Commercial loans increased 15% from the year ago quarter relative to the same period consumer loans increased 16% reflecting growth in consumer mortgage.
Compared with the fourth quarter of 2022 commercial loans grew 3% our commercial growth.
Continues to reflect the strength in our targeted industry verticals and support for our relationship clients.
Continuing on to slide eight average deposits totaled $143 4 billion for the first quarter of 2023 down 5% from the year ago period, and down $2 3 billion or 2% compared to the prior quarter.
Year over year, we saw declines in retail deposits driven by elevated spend due to inflation normalization from pandemic levels and changing client behavior due to higher rates commercial balances, which included $6 billion of broker deposits remained relatively flat the.
The decrease in deposits from the prior quarter reflects a continuation of the same trends.
Interest bearing deposit cost increased 62 basis points from the prior quarter and our cumulative deposit beta was 29% since the fed began raising interest rates in March 2022.
Our outlook for 2023, now assumes accumulative cumulative deposit beta, peaking in the low <unk>.
Turning to slide nine we wanted to provide incremental detail on the granularity and composition of our $143 billion deposit portfolio.
At the end of the first quarter approximately 54% of our deposits came from consumer and small business clients, an incremental 6% of deposits are from low cost stable escrow balances.
The remaining approximately 40% of our deposits comes from our large corporate and middle market commercial clients over 80% of commercial segment deposit balances are core operating accounts.
Our total deposits our total deposits, 56% are covered by FDI fee insurance, while an additional 10% are collateralized.
We maintain access to enough liquidity to cover over 150% of uninsured and uncollateralized deposits.
The quality of our deposit base derives from the strength of our relationship based strategy, which has benefited key both from a balanced stability and cost perspective at.
At period end, our loan to deposit ratio was 84%.
Now moving to slide 10 taxable equivalent net interest income was $1 1 billion for the first quarter compared with $1 billion in the year ago quarter, and $1 2 billion in the prior quarter.
Our net interest margin was 247% for the first quarter compared to $2, 46% for the same period last year to 73% for the prior quarter.
Year over year net interest income and the net interest margin benefited from higher earning asset balances and higher interest rates, partly offset by higher interest bearing deposit cost and a shift in funding mix.
Relative to Q4, our net interest margin was negatively impacted by 22 basis points related to higher interest bearing deposit costs and 22 basis points from a change in funding mix and liquidity and loan fees, partly offset by 18 basis points related to higher interest rates and earning asset growth.
As Chris noted earlier, our swap portfolio in short dated treasuries reduced net interest margin by 72 basis points in the quarter.
Additionally, the net interest income was lower reflecting two fewer days of the quarter.
Turning to slide 11, as previously mentioned key themes the benefit significantly from the maturity of our short dated swap book in treasuries.
This opportunity is consistent with the $1 billion of upside we've been talking about over the last few quarters. While we recently offered more detail on the swaps and treasuries by quarter in interest rate. We thought it would be valuable include a view on the realization of that potential value in both timing and amount of.
The chart on Slide 11 shows this with the forward curve. We do not include we do include the value should short term rates remain at current levels and a higher for longer scenario as well.
We've also gotten questions about how we plan to lock in this value.
As we've shared we have taken a measured but opportunistic approach to adding hedges to address this potential.
This is on slide 11 reflects the additional hedging activity we've undertaken beginning in Q4.
The point here is to provide one more level of depth to clarify the timing and magnitude of this opportunity as it demonstrates we continue to see significant future value in NII is the swaps and treasuries mature.
Moving to slide 12, noninterest income was 688 million in the first quarter of 2020 compared to $676 million for the year ago period, and $671 million in the fourth quarter.
Decline in noninterest income from the year ago period reflects a $24 million or decline in service charges on deposit accounts due to changes in our NSF fee structure that we previously discussed and implemented in September and lower account analysis fees related to interest rates.
Additionally, investment banking debt placement fees declined $18 million, reflecting lower syndication fees, partly offset by an increase in advisory fees, while corporate services income declined $15 million, reflecting lower loan fees and market a market related adjustments in the prior period.
The decline in noninterest income from the fourth quarter reflects a $27 million decline in investment banking and debt placement driven by lower advisory and syndication fees recall that Q1 is historically the low point for investment banking activity in the year.
Other income decreased by $20 million, driven by visa litigation assessment and market related adjustments.
Additionally, corporate services income decreased by $13 million, reflecting lower derivatives volumes.
Moving on to slide 13.
Total noninterest expense for the quarter was $1 8 billion up $106 million from a year ago period, and up $20 million from last quarter inclusive of $64 million of restructuring charges related to actions. We completed this quarter to take out $200 million in annualized cost.
As we shared on the Q4 call. We took these steps proactively to support investment in our business in the face of continued inflation.
Compared with the year ago quarter and in addition to restructuring charges personnel expense increased reflecting an increase in salaries and head count partly offset by lower incentive compensation.
Compared to the prior quarter and in addition to restructuring business services and professional fees declined $15 million in marketing expense declined $10 million.
Additionally, other expense increase in the first quarter by $9 million.
Reflecting an increase in the face of FDIC assessment great.
Moving now to slide 14.
Overall credit quality remained strong for the first quarter net charge offs were $45 million or 15 basis points of average loans, which remained near historically low levels.
Our provision for credit losses was $139 million for the first quarter, which as we pointed out exceeded net charge offs by $94 million.
30 to 89 day delinquencies to period end loans were down one basis point to 14 basis points, while 90, plus day delinquencies remained stable.
The excess provision increases our allowance for credit losses, reflecting a more cautious model driven assumptions.
Despite the increase in the allowance our outlook for net charge offs in 2023 of 25 to 30 basis points remains unchanged and well below our through the cycle levels of 40 to 60 basis points.
Moving to slide 15.
With regard to commercial real estate in particular, key's exposure is well controlled.
Quality remains strong.
Over the past decade, we meaningfully repositioned, our commercial real estate book by sharply, reducing our exposure to construction and homebuilders and reducing the level of commercial real estate loans on our books we.
We focus on relationship lending with select owners and operators.
Our improved risk profile has been demonstrated in keys. Most recent stress test results were projected losses in our commercial real estate book stayed at eight 2% compared to 11, 5% per peers.
Now on slide 16, our liquidity position is strong our period end cash balances at the federal reserve stood at $8 billion.
And we maintain flexibility with significant levels of unused borrowing capacity from additional sources, we would expect to maintain a higher cash balances until the market stabilizes our levels of additional available liquidity have not changed materially since the end of the quarter.
On to slide 17.
We ended the first quarter with common equity tier one ratio of nine 1% within our targeted range of nine to nine 5%.
This provides us with sufficient capacity continues to support our relationship customers and their needs.
We completed $38 million of open market share repurchases in the first quarter related to our employee compensation plan.
Given market conditions, we do not expect to engage in material share repurchases in the near term.
We will continue to focus our capital and supporting relationship client activity and paying dividends.
Over the last six weeks there has been significant discussion of OCI and its potential inclusion in CET, one capital levels for category for banks, we've historically chosen to put most of our portfolio purchases and available for sale and given the recent market rise in rates, we saw significant increases in the negative mark as time passes and if rates have come down we've seen our OCI market decrease.
By 13% from $6 3 billion at 12, 31 to $5 5 billion and $3 31.
We share on slide 16, the expected reduction in the Aoc Mark from $3 31.
To the end of this year at the end of 2024.
Over that timeframe, the Aoc mark declined by approximately 40%.
While this analysis assumes the forward curve, it's important to note that 90% of the value is for maturities and cash flows that is not rate dependent.
Although we have no unique insight into the path of potential regulatory changes as we've seen historically when bank capital regulations have changed they carry with them comment periods and a reasonable phase in time frame.
Our view is that for any new requirements or reduction in OCI, Mark and more significantly our earnings would allow us to organically accrete capital to required levels over the necessary period.
Slide 18 updates our full year 2023 outlook the guidance is relative to our full year 2022 results.
We expect average loans to grow between 6% to 9% importantly, most of this growth has already occurred relative to 2022. So we don't expect material loan balance growth will continue to support relationship clients by recycling capital throughout the year.
We expect average deposits to be flat to down 2%.
Net interest income is now expected to decline by 1% to 3% driven by higher interest bearing deposit costs and a continued shift in funding mix.
Our guidance is based on the foreign curve, assuming a fed funds rate, peaking at five 1% in the third quarter and starting to decline in the fourth quarter.
These interest rate assumptions, along with our expectations for customer behavior, and the competitive pricing environment are very fluid and we will continue to impact our outlook prospectively.
Noninterest income guidance is unchanged, we continue to expect it to be down 1% to 3%, reflecting the implementation of our new NSF fees.
Structure last year and continued challenging capital markets activity at least in the first half.
Our noninterest expense outlook is also unchanged, we expect it to be relatively stable driven in part by the actions. We took last quarter to accelerate cost savings, which includes the impact of the $64 million restructuring charge.
For the year, we continue to expect credit quality to remain strong and net charge offs to be in the 25% to 30 basis point range well below our over the cycle range of 40 to 60 basis points.
Our guidance for our GAAP tax rate is now 20% to 21%.
We feel confident in the foundation of our business the relationship driven value of our deposit book the durability of our balanced franchise and our improved risk profile.
Near term headwinds, we continue to be focused on execution in 2023, and the strong long term earnings power of our company.
With that ill now turn the call back to the operator for instructions on the Q&A portion of the call operator.
Thank you, ladies and gentlemen, if you would like to ask a question you May press. One then zero on your telephone keypad, you will hear acknowledgment that your line has been placed in Q you may remove yourself from the queue by repeating the same one zero command one moment. Please for the first question.
We go to the line of Ebrahim <unk> with Bank of America. Please go ahead.
Good morning, Good morning, Abraham how are you.
Good.
So maybe just starting on deposits.
With me.
From mid to high <unk> low <unk> I guess, Chris Clark.
A sense of just in terms of your comfort level.
<unk>.
If default would go away if the fed is done with one more hike why the low forties data should be the right number in terms of your confidence level and just.
The good of the analysis that went behind that assumption.
Sure, we'll get into that analysis, and just a second but theres no question that we early were surprised at how low the betas were in as of late we've been surprised that the steepness of the curve. So to your question is a good one before I turn it over to Clarke, Let me just give you a little bit of context on our deposit base.
Our total cost of deposits.
In the.
Deck, there is 99 basis points.
Our cost of interest bearing deposits are $1 36, as we mentioned our cumulative beta is 29 and as you just brought up we now expect betas to peak in the low <unk>, but I just want to talk a little bit about the composition of our deposit base.
We are a business that is more heavily cantered to commercial than.
<unk> retail.
If you think about those deposits. These are people that we've helped through many cycles. Most recently we've helped through PPP.
Over 80% of these accounts are operating accounts and so when people talk about whats ensured whats not insured I think one thing that some people Miss is if youre running a two or three or $400 million business and we have the operating account.
Those deposits are going to go anywhere because its a living breathing thing.
I thought I would just give you that context, because when we think about deposits, we always kind of bifurcated by category, but getting back to your question.
Give us the rigor behind the 40 low <unk>.
Our confidence in saying, yes. So.
I'd start I think with balances Ebrahim I think we feel very good about.
Where our balances sit today relative to where they have been relative to the market, we're in and relative to competitors. So.
It starts with balances and then you get to pricing.
As we've talked about in the past we've been more focused on retention of deposits and acquisition of new deposits and I think that is reflected in the beta to date.
The other point since last sort of third quarter fourth quarter as.
As we've watched the market develop I think we while we would not purport to have perfect information about behavior, we have a much better view on how customers are interacting.
The commercial betas have mostly played through so we've we've seen those come up.
Many of those as we've talked about before are indexed.
And others.
Been a lot of conversation and engagement with commercial clients. The consumers are always slower to move and we believe at this point, we have a better view on how they're behaving the types of accounts they want and how competitors are reacting. So when we look at the 40 <unk>.
So 40% number up a bit from the from the high Thirty's.
We have some confidence that we can deploy beta in across the retail franchise, but also in some targeted customer sets too.
Not only retain but potentially acquire some deposits going forward.
Got it thanks for that and just maybe a quick one on the slide 11 the.
The bar chart with DNI upside from swaps and Tianjin He's gone off.
Give us a sense of sensitivity for each 100 basis points lower next year versus today, what does that mean for that upside that you need.
There.
Yes, so what's embedded in the in the chart on the page Ebrahim as the foreign curve, which is coming off I don't have in front of me exactly what those rates are but they are coming down pretty significantly over that timeframe.
I can follow up with a little more sensitivity, but effectively.
You can think about the forward curve in that 720 range as we talked about annualized.
Maybe the right comparison is if rates didn't move at all in the spot rate just sort of played out you would get back to that $1 billion number. So you see a little bit of a sensitivity between quote higher for longer version, where the spot rate just sort of sticks versus the forward curve, which is coming down fairly significantly over the next seven quarters.
I think in the prepared remarks, you said you were taking actions to lock that in.
How are you doing that.
I think we've shared before but I'm happy to talk about it. So if you think about 2023, we had at the beginning of the year about $6 2 billion.
Receive fixed swaps rolling off of $1 seven in the first quarter at a rate of 6262.
So that was sort of the highest of the two year rate the.
The rest will roll off through the year. So another $4 5 billion, we're not replacing those so we're going to we're going to allow on that portion the natural asset sensitivity of that loan book to come through next year. Another $7 5 billion of swaps mature and we've essentially replaced those with the combination of forward starters at an average rate of three.
Three 4%. So there is there is some negative carry on that but in the forward rate. They actually are a bit in the money by the end of the year and then the other half with floor spreads that kick in at $3 40, and the value of that as you can imagine as we get all of the floating rate value above $3 40 until the forward curve comes down and if we werent.
The higher rate environment, we would benefit from actually not hitting that floor. So we think we've manage the downside.
Risks they are quite well and preserve some of the upside. The reason, we wouldn't do or haven't done more all floors or floor spreads at this point is just the cost of volatility is pretty high so we're trying to balance.
The kind of the risk reward on that trade.
Thanks for taking my questions sure.
Next we'll go to the line of Scott <unk> with Piper Sandler. Please go ahead.
Good morning, guys. Thank you for taking the questions because we.
From the margin of 247, now and then that kind of I guess.
Aspirational margin there.
<unk> tried to doing some swaps I.
I guess one of the big things has been sort of what happens between between here and there or do you have a sense for when based on what you see now when the margin would bottom where that might be.
And then kind of more specifically when it would start to inflect upward to I know the treasury start to treasuries and swaps that's more of a 2023 and then into 2024, but when we get a margin inflection this year or is that something that do we continue to bleed out a bit.
Through the remainder of the year before it and then flex back up how do you think about that dynamic.
Yes. Good question Scott. So we would originally thought Q1 was the low point, we think that's now Q2.
And then we will start to see some stabilization and uptick in the back half of the year.
And again part of that is that.
Really the swap book starts to roll off we begin to see some treasuries, although they are fairly light in 2023.
Yes.
Okay. That's perfect. Thank you and then Chris maybe just a thought on.
Investment banking rebound in the second half I mean, what does that look like.
Your mind, how powerful could it be and it's been such an odd environment, you've got the VIX at a level, where historically there'd be a lot of activity now.
But it certainly feels very uncertain and I think we've all been surprised by overall lack of activity. So when you when you start to look out over the remaining several months of the year, what what's sort of your best guess as to how a rebound might play out.
I think you have to go through sort of the price discovery and I think there is a bid ask basically.
Equities as you can see there is some deals getting priced you can see there's some high yield that's getting done, but I think Scott what it's going to take is for kind of buyers and sellers to readjust their expectations and I think my experiences that process takes a while.
Eventually people adapt to kind of what the new normal is and as I said in my comments I actually think it will come back sometime in the second half our pipelines are down about 10% from last year, which in the Grand scheme of things. If you think about this time last year is.
It's not bad so the pipelines are good we actually had a nice quarter in terms of advisory, but a lot of our clients frankly are sitting on the sidelines. There are deals to be done and frankly, we're advising many of our clients that now is not the perfect time either to enter into the financing market or to complete a transaction.
But it will it will come back in the pipeline is building some deals we'll just go away.
But it will come back.
Yes.
Perfect. Thank you all very much.
Thank you Scott.
Our next question is from John <unk> with Evercore. Please go ahead.
Okay.
Good morning.
Morning, John Good morning.
Just a couple of questions regarding the NII.
For the year can you just share with us your thought of the noninterest bearing deposit mix shift.
Do you view that progressing and then and then also on the.
On the progression for the second quarter, just regarding Scott's question on the margin you mentioned that.
See a pull back again in the second quarter and then inflection can you maybe help us size up.
Out of margin compression incrementally in the second quarter.
Sure.
From noninterest bearing we've seen that come down.
29% to 'twenty six 'twenty seven.
We think that that would make its way to the mid <unk>, but I will say that.
One caveat in there and that is.
We have been using it that I believe we've talked about this but we've been using what we refer to as a hybrid account with many of our commercial clients, where we're taking noninterest bearing deposits and in some of their excess balances and keeping them together in one interest bearing account. So we've moved balances out of noninterest.
Bearing into those accounts they would reflect on the balance sheet as a decline in noninterest bearing.
It allows us to maintain those balances in a technically interest bearing account, but at very attractive rates. So.
Again, we can we can break that out over time, but I would say the noninterest bearing decline probably isn't quite as stark as it would appear on its face.
As it relates to net interest income.
Second quarter, we'd expect that to be down kind of 4% to 5% in Q2.
With NIM.
NIM coming down in part because we're carrying a little bit excess.
Liquidity post.
Early March period.
And we would see that come down.
Thank maybe another.
Six to eight basis points.
And then as I responded to Scott's question kind of stabilize and start to come back up in the second half of the year.
Got it okay, alright, that's helpful.
Care to venture a projection in terms of the magnitude of the inflection in the back half.
Not at the moment.
We haven't we haven't provided that.
Yes, but but you did you would see our obviously our guide for the year.
On NIM being down a little but that's obviously can requires to be stronger in the second half and we expect to see that.
Got you Okay. Thanks, and then just separately on regulation.
Wanted to see if you can maybe provide some comments around how youre thinking about the most likely areas.
Regulation, where you expect some measures under the regulators around inclusion of NCI.
T Lac FDIC.
Capital buffer risk, maybe if you could just comment on that.
I'm interested in your comments on that as well.
I'd be happy to comment on that the premise of your question. There is no question that we will be experiencing we're going to have to carry more capital and there'll be more regulation.
I personally think.
T lack is.
Is going to be part of that or some.
Debt securities It looks like T lack.
I also think that we'll probably have to carry more capital. We as you can imagine have run all kinds of scenarios, we feel comfortable that based on the burn down of our OCI based on the earnings power of the company.
And based on timing I E. There would be some comment period and some phase in period, we feel like no matter under all the scenarios that we've looked at we feel confident that key can be in a position to meet both the regulatory and the capital requirements going forward.
Alright, thank you.
John .
Next we go to Erika Najarian with UBS. Please go ahead.
Yes, hi, good morning.
Asks.
The.
Now I'll ask the question question another way.
Clark.
Loan beta of your commercial portfolio something like 52%.
The second half of 2022 and about 65% this quarter.
As we think about the protection for down shortly.
A lot of investors are.
Looking down short rates in 2023.
Should we interpret your protection.
Our sensitivity to each 25 basis points of cuts that we've seen to the upside.
A low sorry can you ask that one more time, Eric I, just want to make sure I am.
Yeah Yeah.
So I wanted to understand slide 11, its different way right.
The protection on your commercial portfolio and locking in the upside. So we saw the sensitivity to higher short rates.
So the carry through to your yield.
At about the low fifty's in the second half of last year and in the mid <unk> this quarter by the way investors are interpreting.
<unk> to the downside is a lower sensitivity.
As the fed cut right and so should we expect the key commercial yields.
Lower sensitivity cuts.
On the way down than it did two increases in rates on the way up.
Yes.
Yes, if you think about the incorporation of the swaps right. So the swaps are there for exactly that purpose and they would reduce the sensitivity on the way down that's the intent of those.
Instrument.
Okay, and what you're showing us on slide 11 is essentially.
The assumption that your.
Current swap book as it rolls.
As of yet replaced with higher received fixed rate.
Yes.
Two components right in 'twenty three.
I think our view of the forward curve I have not seen a view yet where.
Rates come down.
Below.
Where swap rates would be so we would we're going to let that roll through our natural loan rates and yields flow through in 'twenty, three and 'twenty four we've effectively replaced the swap book.
Yes.
Forward starters at at a higher rate $3 40 on average and floor spreads with.
Kick in rate of $3 40, so if rates were to stay higher we'll get the value on the floor spreads will carry the negative carry on forward starters. If the forward curve plays out both of those will be in the money at some point in 'twenty four.
Got it.
I'm, sorry to react to just put it all together in a third question but.
As investors are thinking about whether bank stocks are truly cheap I think theyre thinking about 24 EPS is at trough. So as I think about your commercial yield today right.
There are essentially sort of to hedge.
Headwinds right. So the first would be the lower received right.
<unk> fixed rate on your notional.
And the second would be.
On the other side of that.
The yield will be better protected as the fed cuts.
Thinking about.
The message on downside NII protection.
As it relates to your commercial book.
You said that well.
Okay. Thank you.
And next we move to Ken Houston with Jefferies. Please go ahead.
Hi, Good morning, just a follow up on the swaps. So maybe just asking a different way so in the back end number from the 10-K.
The reported impact from swaps in the fourth quarter was minus $162 million do you have the number of what that negative impact was in the first quarter and can you help us understand what it will look like when we see the new disclosure for the roll forward next four quarters Youre talking just swaps specifically Ken.
Yes.
Yes, $2 15 in the first quarter.
Okay.
Okay. That's $2 15, and then so last quarters next four quarters roll forward from the K was 665. After tax do you have an idea of what the new roll forward will be when we see that in the 10-Q.
Not at this point, but we can we can follow up and let you know that.
Okay and then the last question as you mentioned.
750.
The billion and that youre not going to be.
Replacing now could you maybe just flesh that out a little bit in terms of like the new.
Any change to that strategy around protection, and how youll be replacing going forward to get that incremental forward benefit from the roll off versus what youre putting on.
Yes so.
I'll keep trying im.
Worried I'm not being super clear so the $6 2 billion of receive fixed swaps in 'twenty three are going to mature $1 7 billion of that matured in the first quarter, we're not planning to replace those to protect the loan book in year.
From our receive fixed swap standpoint, theres, another $7 5 billion that roll out through 2024, and we've taken steps to effectively replace that not all of it exactly. It's we're in the $7 billion range half of which is forward start received fixed with an average rate of $3 40, So just think about that.
As replacing the existing 24 rate and now bringing that up to $3 40.
And then the other half with floor spreads that have.
At attachment point at also roughly $3 40, just by coincidence.
So that really is the protection against rates coming down, which the forward curve would project at this point and it would it would sort of locked that $7 billion or so at a $3 40 yield or higher.
As those other swaps rollout.
Got it and I know that was a.
So I apologize for re asking if that's okay I think I am.
Not doing it as clearly as possible. So I appreciate the follow up.
And next we go to a question from Mike Mayo with Wells Fargo Securities. Please go ahead.
Hi, good morning, Mike.
Yes. This is Dan.
Yes tough quarter for you guys I guess relative to expectations and you guys missed on NII NIM. These provisions and expenses you guided NII lower down 1% to 3% this year when before it was up 1% to 4%.
You said then will go down next quarter.
And so thats, just given all of those headwinds and pressures and maybe im mistaken that and correct me if I did or you ratcheting down expenses more are you being coming more cautious or are you just kind of have to take the stomach punches a higher funding and go on with it.
Part of that you didn't change your mountain guidance doesn't look like you're being more cautious there. So just.
I guess im trying to say.
Is this as bad as it looks or are there some silver lining there.
And with your resiliency, maybe gained share, but that's not showing up in your guidance.
So thank you for the question, let me just kind of broadly talk about the quarter. Mike. There is no question. It was a challenging quarter for us, but we continue to do the things that we need to do to build the franchise. So what are those things you mentioned expenses.
We put a hiring freeze in place in November and we took out.
$200 million or 4% of our expense base just in the quarter. We just completed so thats one of the things we do.
We've talked a lot today about kind of how we're managing our balance sheet. We have taken significant actions and we have the luxury of taking the actions because theyre short duration, both on our swaps and our investments to put us in a position where we can benefit from the rise in interest rates.
So we've done that.
And then the other thing we continue to do as you know as we continue to strategically invest in our business and focus on targeted scale. So my perspective is yes. This is a challenging quarter, yes, we have to get through this NII drag, but we have a clear path to do so and.
That's what we as a team are in the businesses are focusing on.
And Mike I would add just add two things on the expenses. They are up because of the charge $64 million. If you took that out we'd be in good shape and I think if you annualize that number.
Right in line with our guidance relatively stable year over year.
And again, that's in the face of some inflationary headwinds I think on the provision.
You heard and saw our charge offs, we didn't change our guidance, which may beg. The question of why did you build your provision and frankly.
We're doing what we think seasonal was intended to do which was when when macroeconomic condition changes you built the reserve so.
<unk>.
We're applying that standard and that would be the reconciliation between two quarters of build and no change in the charge off guidance.
Given that extra caution.
You kept your loan growth the same it was 6% to 9%.
So I'm trying to reconcile your more caution with your provisions with no change in your loan guidance, whereas others that brought down their third loan guidance Anthony tightened things up yes.
Yes, Mike.
Our we have basically we are at the low end of our guidance for the year already so what we're going to be doing for the balance of the year is we're going to be recycling capital and to your point. There is no question that the cost of raw material has gone up significantly we're certainly not going to change our lending standards, but in term.
A pricing.
We will make those adjustments we're fortunate that we have a bunch of relationships that pay us really well and we're in a position to serve those relationships, but it's <unk>.
And I have talked before lending on a stand alone business, it's hard to return their cost of capital. So you can imagine when your cost of capital goes up that the pricing and the other things that youre doing for those customers frankly, we will have to be even greater.
Yes, so just to sorry.
Sorry, Mike just to be Super clear, the 6% to 9% year over year loan growth.
<unk> was resident at the end of 2022. So it really just reflects the growth that occurred in 2022, just to just to make that abundantly clear.
And one more follow up it seems like the capital markets pricing for risk more than the lending markets. When you have that conversation with your commercial customers and say hey, we're going to pass on this higher cost in raw materials are you seeing any additional pricing power in the London market.
I mean, it just seems like loan yields should be going up more than they've already have done yes.
And they never go up as much as they should because frankly, there's too much excess capacity in the banking market, but no. They havent moved and that's where it really pays to have a wholesome relationship like where we can drive a bunch of other revenue.
But there hasn't been the adjustment yet that there should be based off of the base.
Based on the arbitrage between the capital markets in the bank market.
I guess I'll sneak one last one and if that's the case then I missed the cost of raw materials are going up and you can't get the loan yields you desire.
May be just delever, a little bit and.
And just not as much growth, but had less risk or how do you view that trade off because just like <unk>.
I think over time, that's what youre going to see rate will be will be we'll be using the capital markets as they open up to actually place paper for people, but in terms of putting new debt on our balance sheet, we're not going to do it unless we have a complete relationship and we can drive a whole bunch of revenue that in.
Itself will be limited.
Got it alright. Thank you thanks, Mike.
And our next question is from Manan <unk> with Morgan Stanley . Please go ahead.
Hey, good morning.
I wanted to follow up on the cost cutting efforts that are underway to counter inflation.
Just given.
The events of the past few weeks, how does that change what do you think you need to do on the investments right. So as I think about deposit competition accelerating.
Are there any investments you think you need to make on either the technology product side in order to retain and grow deposits and how much of that is embedded in your expense guide yes.
Yes. Thanks.
So right question the good news for Us is.
We undertook the expense cuts so we could make those investments and we've got both on the consumer and commercial side of focus on.
Deposit and customer acquisition technology, whether its digital capabilities and consumer things like embedded banking, which we've talked about before or other payments capabilities on the commercial side. So.
That cost cutting was in part to make room for exactly those types of investments.
Is there anything additional you need to do given given the events of the past few weeks.
We'll assess that as we go forward I think we feel well prepared to handle the deposit challenges in front of the market right now and I think our numbers have shown that.
I think more than anything we're probably likely to be more offensive on the deposit side than we've been to date, and we feel well armed to do that.
Got it great and then just on.
On Securities I appreciate the detail on the OCI accretion over time.
I wanted to ask how do you think about the future mix and duration of the Securities book, just given what we've seen in the past few weeks.
And just given the potential for higher regulation.
Would you skew the mix of your security is more shorter dated more towards treasuries.
Want to get a sense of how youre thinking about that yes. It's a good question hard to answer in a vacuum, but my sense would be youll see higher quality portfolios, although ours is pretty high quality today.
And youll, probably see shorter duration or more floaters. So.
It will be interesting to see if thats the way it shakes out the broader impacts of bank security portfolios moving.
Moving in that direction, and how that might impact the market more broadly.
Great. Thank you.
And next we have a question from Steven Alexopoulos with Jpmorgan. Please go ahead.
Hey, good morning, everyone.
Steve.
So first on the deposit side. So youre your uninsured deposits are fairly high but it does not appear that you saw a large degree of outflows right. Many of your peers saw in the aftermath of Silicon Valley Bank.
Could you comment on that where there are notable outflows or because of the operating nature of these accounts, which you called out Chris was that enough of a factor where you just didn't see with many peers.
Yes, just just to be clear, 66% of our deposits are either uninsured or either insured or collateralized, Steve. So that's 0.1, but I don't know I can't speak to other People's book.
Like everyone. We saw some deposits move out, particularly in places like high net worth individuals. We saw some in the smaller end of kind of small business and business banking, where basically the deposit as the business and the person or sort of synonymous.
A couple larger excess deposits.
Move but in general the reason we've enjoyed such stickiness of the deposit is kind of the comments that I made earlier. These are operating accounts, where businesses and these are businesses that have been clients a key for a long time and.
Frankly, there wasn't even a lot of angst.
I was very pleased with the stickiness of the deposit and the core deposit base.
And you said you were in a good position to organically build capital right anticipation of new regulations potentially coming do you assume that you need to suspend buybacks for an extended period.
Until we see deregulation in order to build that capital.
Yes, I don't really plan, we don't plan on executing any buybacks until there's clarity as to what the capital framework is going forward. So.
I don't anticipate that we'll be doing any share repurchases until there is clarity.
Got it okay.
Thanks, So just one final one in terms of your responding to John's areas.
Areas earlier question. This hybrid account for commercial customers, which is paying interest rates noninterest bearing but you are paying some interest what was the balance.
And then accounted how much are you paying.
Yes.
We will have to follow up I don't have that specific number in front of me, but we will we'll follow up with you Steve.
Okay sounds good thanks for taking my questions.
And next we go to the line of Gerard Cassidy with RBC. Please go ahead.
Good morning, Chris Good morning, Clarence good.
Good morning Gerard.
You touched on in your opening remarks about the third party company that services commercial loans and gives you an insight into pipelines and what may be coming down.
So to speak can.
Can you share with us.
Is that company.
Are they seeing increase in activity from commercial mortgages that are in.
Commercial mortgage backed security products that did the special servicer on and is that starting to pick up yet and if not what are they saying.
Well thanks for your question. So so basically you have.
Servicing and then you have special servicing where youre the named special Servicer and then it goes into active special servicing so think of active special servicing is being the workout agent or off us loans, whether theyre <unk> or whatever.
We have seen a huge surge in active servicing and what what was the number one just a quarter ago the big.
Category was retail and the fastest growing was office and what's happened is that's flipped now office, both the fastest growing and it's the largest by a significant factor. So we do have a pretty good insight we have an insight by by class.
Offices first and then retail is second and then we also of course have a geographic breakdown because real estate is always geographic so it does give us great insights and it is very dynamic and kind of the trends that we.
Some time ago, we said, we thought we'd see a lot of.
B and C class office buildings in central business districts, and although we for our own book only have like $127 million of that exposure.
Are seeing that play out and now office is the number one category in active special servicing.
And can you remind us I don't know if you have this number in active special servicing I know that these are greater than your regular servicing by what factors in the two times higher fee four times on energy.
It's much higher than four times, because you go from getting really kind of just sort of a ticking fee to you're actively.
Working on it so it is it is.
<unk> of what the regular fees are as you go into special servicing.
You look at our financials, you can see the bump.
In that line item.
Which is in the commercial mortgage servicing fees is that correct exactly correct.
And then as a follow up Clark you identified.
The provision was hired to build up reserves due to seasonal accounting can you share with us some of the metrics maybe neutral to us.
HP and housing price index or unemployment and the unemployment rate.
Your assumptions in the fourth quarter and how did the change in the first quarter to support the increase in the provision for loan losses.
So let me just start with hei, because thats, where you started.
The.
I think we may have talked about Moody's, which we use the moody's consensus they put out an HPA.
Model in Q4 that was updated they still produce their old one we were comfortable with the old one now it's just the new one which I would I would say, it's fairly draconian and sort of by yes. They.
Theyre Hei Clark went from up.
Four 6% in November to eight 8% as of February under the Moody's consensus so that would be the draconian part.
And yes, so that's a big mover.
And largely unemployment went from four 5% to five so those would be sort of the two big impacted areas.
Thank you.
And ladies and gentlemen, we will now be turning the conference for closing remarks back to the CEO Chris Gorman.
Well I want to thank everyone for joining us today. This concludes our first quarter call. If you have any questions as always reach out to Vern Patterson. Thank you. So much have a good day goodbye.
Ladies and gentlemen that does conclude your conference for today. Thank you for your participation you may now disconnect.
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