Q4 2023 KeyCorp Earnings Call
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Often twenty-three fourth quarter earnings call at this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. If you would like to ask a question. Please.
Press, one then zero on your telephone keypad, you will hear acknowledgment that your line has been placed in Q. As a reminder, this conference is being recorded I would now like to turn the conference over to Chris Gorman Keycorp's, Chairman and C. E. O. Please go ahead.
Well. Thank you for joining us for Keycorp's fourth quarter 2023 earnings Conference call. Joining me on the call today are Clark Khayat, our Chief Financial Officer, and our Chief Risk Officer, Derek Banhart, who succeeded Mark Midkiff at the beginning of this year.
Slide two you will find our statement on forward looking disclosures and certain financial measures.
<unk> non-GAAP measures. These statements cover our presentation materials and comments as well as the question and answer segment of our call I am now moving to slide three.
Speaker Change: Morning, We reported earnings of $30 million or <unk> <unk> per share. Our results included $209 million of after tax expenses were <unk> 22 cents per share from three items that Clark will describe in more detail later.
Speaker Change: For the year, we reported EPS of <unk> 88 <unk>.
Speaker Change: Including 27 impact from similar types of expenses.
Speaker Change: Fourth quarter closes out a challenging year for the industry and for key.
Speaker Change: While our business fundamentals remained solid throughout the year, we acknowledge that our balance sheet coming into the year with not well positioned for the rapid rise in interest rates that transpired.
Speaker Change: We took a number of necessary steps as we move through the year to enhance our balance sheet liquidity and capital position in preparation for potential changes in capital rules.
Speaker Change: <unk> ourselves to be a simpler smaller more profitable bank. These actions also had some near term financial impacts as a result, we missed our own expectations and yours.
Speaker Change: As we turn the page to 2024 I think it is really important to step back and recognize that key accomplished a number of positive things last year and as a result, I am confident we have laid the groundwork as we move forward.
Speaker Change: First and most importantly throughout the year, the tremendous work and dedication of our teammates allowed us to continue to serve and support our clients through turbulent market conditions, particularly in the first half of the year.
Speaker Change: I am very thankful and proud of our teammates as they set aside the noise affecting our industry stepped up and continue to focus on executing on our strategic priorities.
Speaker Change: Vastly serving our clients.
Speaker Change: Our focus on relationship.
Speaker Change: <unk> continued to guide our balance sheet optimization efforts in.
Speaker Change: In 2023, we reduced loans by $7 billion as we deemphasize credit only and other non relationship business.
Speaker Change: Despite this meaningful reduction in lending we.
Speaker Change: Grew the number of relationship clients and households, we serve across both our consumer and commercial businesses.
Speaker Change: And grew deposits by $3 billion in.
Speaker Change: Tumor we grew relationship households by 3% with about two thirds of new relationships coming from younger demographics.
Speaker Change: Relationship deposits grew by 1%.
Speaker Change: Commercial clients grew 4% and commercial balances grew 5% as a result of our continued focus on privacy.
Speaker Change: About 96% of our commercial deposits were from clients that had an operating account with key as of December.
Speaker Change: As a result of our ability to raise relationship deposits, while reducing loans, we were able to meaningfully reduce our reliance on wholesale funding as the year progressed.
Speaker Change: We also continued to raise significant capital for the benefit of our clients.
Speaker Change: Over $80 billion in 2023, leveraging our unique distribution capabilities. This proven and mature underwrite to distribute model is a key differentiator for us.
Speaker Change: On expenses, we made significant headway in simplifying and streamlining our businesses.
Speaker Change: We exited certain capital intensive and non relationship businesses, such as vendor finance as we have previously done with indirect auto.
Speaker Change: In November we announced a number of organizational changes, including the reorganization and consolidation of our commercial banking and payments businesses.
Speaker Change: We also realigned our real estate capital business with those of our institutional bank by aligning product based teams to the client facing businesses. They serve we are reducing overhead and complexity and creating a better client and prospect experience.
Speaker Change: Altogether. These actions we took in 23 impacted fix.
Speaker Change: 6% of our teammates.
Speaker Change: Additionally, we continued to rationalize our non branch non operation Center real estate footprint, which has declined by 34% over the past three years.
Speaker Change: We do not take these decisions lightly but the reality is we need to make the difficult decisions today to earn the right to invest in the opportunities of tomorrow last year's actions freed up over $400 million on an annualized basis that we will redeploy to deliver <unk>.
Speaker Change: For our clients and drive future growth.
Speaker Change: More broadly these actions combined with our ongoing disciplined expense management have enabled us to hold core expenses essentially flat at $4 $4 billion annually over the past two years and that is in spite of inflationary headwinds facing our industry.
Speaker Change: On the capital front, our risk weighted assets decreased by $14 billion from the beginning of the year.
Speaker Change: Exceeding our full year optimization goal of $10 billion.
Speaker Change: Concurrently we also increased our common equity tier one numerator through net capital generation.
Speaker Change: As a result, our CET one ratio increased by 90 basis points to 10% at year end, well above our targeted capital range of nine to nine 5% or.
Speaker Change: Our capital metrics, including <unk> also improved as lower interest rates and the continued pull to par over time of the unrealized losses in our investment portfolio drove over $1 billion of improvement in our OCI over the past year.
Speaker Change: Tangible book value and tangible common equity ratios both improved meaningfully.
Overall, our capital position remains strong we are well positioned relative to our capital priorities and the currently proposed future capital requirements. In fact, we think we're advantaged relative to other category for banks, given our underwrite to distribute model.
Speaker Change: Asset and capital light businesses that we have including a scaled wealth business with $55 billion.
Speaker Change: Assets under management.
Speaker Change: Also I want to comment on credit quality, which I believe is the most important determinant of return on tangible common equity and shareholder value over time.
Speaker Change: Credit quality remains a clear strength of key our credit measures reflect the derisking, we have done over the past decade.
Speaker Change: And our distinctive underwrite to distribute model.
Speaker Change: Net charge offs were 26 basis points in the fourth quarter and 21 basis points for the full year.
Speaker Change: Our npa's, which we firmly believe had very low loss content remained well below our historical averages.
Speaker Change: Quality of our loan portfolio continues to serve us well with over half of our C&I loans rated as investment grade or the equivalent.
Speaker Change: Our consumer clients have a weighted average FICO score of approximately 768 at origination.
Speaker Change: As a reminder, we have limited exposure to leverage lending office loans and other high risk categories too.
Speaker Change: Two thirds of our commercial real estate exposure is multifamily of which approximately 40% is in affordable housing, which continues to be a significant unmet need in this country.
Speaker Change: As we move to 2024 I want to provide my key takeaways from the guidance that Clark will walk you through in more detail shortly.
Speaker Change: First we have a clearly defined net interest income opportunity moving forward as our short term swaps and treasuries re price, particularly in the second half of the year.
Speaker Change: Importantly, we believe this can be achieved across a range of interest rate scenarios. As a result of the significant work that team has done over the past year to improve our balance sheet resiliency.
Speaker Change: We began to see some of that work pay off this quarter as our net interest income grew slightly relative to the third quarter.
Speaker Change: Our momentum makes me confident that we saw our net interest margin bottom out in the third quarter of 2023.
Speaker Change: Secondly, we have leading positions and meaningful growth opportunities across capital markets payments and wealth management, we have consistently invested through the cycle and these differentiated fee businesses, where we have targeted scale.
Speaker Change: We continue to see good client engagement and our pipelines remain strong.
Speaker Change: Any normalization in the capital markets represents an upside opportunity for key not only for fees, but from the balance sheet management perspective that I spoke about earlier.
Speaker Change: And thirdly, while the macroeconomic outlook remains highly uncertain.
Speaker Change: Based on our current assumptions, we anticipate we will generate modest moderate positive operating leverage for the full year 2024.
Speaker Change: Finally, we continue to expect that we will outperform the industry. This cycle with respect to credit credit quality remains one of our most significant strengths over the next several quarters. We continue to expect to operate below our through the cycle net charge off range of 40 to 60 basis points.
Speaker Change: In summary.
Speaker Change: We acknowledged 2023 was a challenging year difficult, but necessary decisions were made and actions were taken but at this point. We are nearly finished with that process.
Speaker Change: Our balance sheet is now appropriately sized for the environment in which we are operating.
Speaker Change: We are better positioned for changes in interest rates up or down.
Speaker Change: Our demonstrated ability to manage and grow our deposits.
Speaker Change: Posits proves to be a strong foundation.
Speaker Change: We are now in a position where we can be more opportunistic as we turn the page to 2024 before I turn it over to Clarke I want to take a moment to acknowledge last week, we announced burned patterson's retirement from GE as head of IR Burn has led key through a 112 earnings releases and countless meetings.
Clarke: With investors and other stakeholders.
Clarke: I'm, so grateful burn to have worked alongside you.
Speaker Change: I have tremendous appreciation burn for the great relationships you have throughout our industry and within our company. So thank you again Brian.
Speaker Change: At the same time I am pleased to welcome Brian money as our new director of Investor Relations with more than 25 years of experience in our industry, Brian brings a depth and variety of experience and capabilities to the role.
Speaker Change: He has big shoes to fill and I'm very pleased that Brian has joined the team with that I will turn it over to Clarke to provide more details on the results for the quarter quarter Clark.
Clarke: Thanks, Chris I would echo your comments on burn and a warm welcome to Brian as well.
Clarke: I am now on slide five for the fourth quarter net income from continuing operations was <unk> <unk> per common share down <unk> 26 from the prior quarter and down 35 from last year.
Clarke: Our results this quarter were impacted by three items totaling <unk> 22 per share first $190 million from an FDIC special assessment second $67 million from an efficiency related expense and third $18 million from a pension settlement charge for a total of $275 million pre tax or 209.
Clarke: Million dollars after tax.
Clarke: Breakdown of these items can be found in the last page of our slide presentation.
Clarke: Our fourth quarter results were generally consistent with the guidance. We provided last month as expected we saw stability in the net interest income.
Clarke: This quarter and our net interest margin increased by six basis points relative to the third quarter as we began to see some early benefits from our swap and treasury portfolios fees.
Clarke: Fees declined 5% sequentially on the better end of the range, we provided last month.
Clarke: Growth was primarily attributable to the three items I mentioned without these items expenses would have been relatively stable compared to the third quarter.
Net charge offs as a percent of loans remained low at 26 basis points, and we added $26 million to our allowance for credit losses to reflect some modest migration of the portfolio.
Clarke: Primarily in real estate and the still uncertain macro outlook.
Clarke: Additionally, as Chris highlighted in his remarks, our results reflect our focus on privacy and building relationships, our improved capital position and our strong risk discipline.
Clarke: Turning to slide six.
Clarke: Average loans for the quarter were $114 billion down 3% from both the year ago period and prior quarter.
Decline in average loans was primarily driven by a reduction in C&I balances, which were down 4% from the prior quarter. The reduction reflects our planned balance sheet optimization efforts, which prioritize full relationships and deemphasize credit only and non relationship business.
We reduced risk weighted assets by $4 billion in the fourth quarter and as Chris mentioned by approximately $14 billion in 2023.
Clarke: The majority of the decline in risk weighted assets. This quarter was from lower loan balances with some reduction in unused commitments also contributing.
We would expect modest <unk> reductions in the first half of 2024.
Clarke: Turning to slide seven keys long standing commitment to privacy continues to deliver a stable diverse base of core deposits for funding.
Clarke: Despite a year of market volatility, we grew period end deposits year over year by $3 billion.
Clarke: And average deposits were relatively stable compared to the year ago period and prior quarter.
Clarke: On a sequential basis commercial deposits grew 4%, which we attribute primarily to seasonal build and consumer deposits grew 1%.
Clarke: The increase in commercial and consumer deposits was mostly offset by a $2 billion decline in broker deposits on average as we continue to improve the quality of our funding mix by growing core relationship balances and reducing reliance on wholesale funding and broker deposits.
Clarke: Since the end of the first quarter, we generated almost $13 billion of liquidity by reducing loans and growing relationship deposits and reduced wholesale borrowings by $12 billion.
Clarke: Our total cost of deposits was 206 basis points in the fourth quarter and our cumulative deposit beta which includes all interest bearing deposits was 49% since the fed began raising interest rates in line with our prior guidance of approaching 50% by year end 2023.
Clarke: The higher rate environment continued to impact our deposit mix as our noninterest bearing deposits declined by 1% sequentially to 22%.
Clarke: Pressure on deposit pricing appears to be abating across the franchise that we expect some mix shift to continue as long as rates remain high.
Clarke: Turning to slide eight.
Clarke: Taxable equivalent net interest income was $928 million for the fourth quarter down 24% from the year ago period and up slightly from the prior quarter.
Clarke: Our net interest margin was 2.07% for the fourth quarter compared to 273% for the same period last year and 2.01% for the fourth quarter.
Clarke: Prior quarter.
Clarke: Year over year net interest income and the net interest margin reflect the impact of higher interest rates as increased cost of interest bearing deposits and borrowings outpaced the benefit from higher year, earning asset yields.
Clarke: Additionally, the balance sheet experienced a shift in funding mix from noninterest bearing deposits to higher cost interest bearing deposits.
Relative to the third quarter the increase in net interest income and net interest margin were driven by actions taken to manage key interest rate risk elevated levels of liquidity and an improved funding mix. The increase was partly offset by higher interest bearing deposit cost, which exceeded the benefit from higher earning asset yields.
Clarke: While the planned reduction in loan balances adversely impacted net interest income sequentially. It benefited keys net interest margin.
Clarke: Our net interest margin and net interest income continue to reflect the headwind from our short dated treasuries and swaps, which together reduced net interest income by $345 million this quarter or by $1 4 billion for the full year.
Clarke: And lowered our net interest margin by 77 basis points this quarter.
As previously discussed during our third quarter earnings call in October we terminated seven $5 billion of received fixed cash flow swaps, which was scheduled to mature throughout 2024.
Last quarter, we said that net interest margin would bottom and it did throughout 2024, we would expect continued benefit from the maturities of our short term swaps and treasuries, especially as more mature in the back half of the year.
Clarke: Moving to slide nine.
Clarke: Noninterest income was $610 million for the fourth quarter of 2023 down $61 million from the year ago period, and down $33 million from the third quarter.
Clarke: The decrease in noninterest income from a year ago reflects a $36 million decline in investment banking and debt placement fees, driven by lower syndication fees and M&A advisory.
Additionally, corporate services income declined $22 million, driven by lower customer derivatives trading revenue.
Clarke: The decrease in noninterest income for the third quarter reflects a $13 million decrease in other income primarily driven by a gain on our loan sale in the prior quarter.
Speaker Change: I'm now on slide 10.
Speaker Change: Total noninterest expense for the quarter was $1 4 billion up $216 million from the year ago period, and up $262 million from last quarter as mentioned fourth quarter results reflect $275 million of impact from FDIC assessment efficiency related expenses and pension settlement charge.
Speaker Change: Efficiency related expenses included $39 million related to severance and $24 million of corporate real estate rationalization and other contract termination or renegotiation costs.
Speaker Change: Excluding these items expenses were relatively stable in the quarter and down compared to the year ago period.
Speaker Change: We continue to proactively manage our expense base and simplify and streamline our business. So we can continue to reinvest in all our businesses.
Speaker Change: Moving to slide 11, overall credit quality and our related outlook remains solid.
For the fourth quarter net charge offs were $76 million or 26 basis points of average loans.
Speaker Change: This compares to $71 million in the prior quarter.
Speaker Change: Criticized outstandings to period end loans increased 50 basis points this quarter driven by movements in real estate healthcare and consumer goods.
Speaker Change: While nonperforming loans and criticized loans continue to move up off their historical lows. We believe key is well positioned in terms of potential loss content over half of our Npls are still correct.
Speaker Change: Our provision for credit losses was $102 million for the fourth quarter, including $26 million of reserve build in our allowance for credit losses to period end loans increased from 154% to 160%.
Speaker Change: Turning to slide 12.
Speaker Change: We significantly increased our capital position throughout 2023, we ended the fourth quarter with common equity tier one ratio of 10% up 20 basis points from the prior quarter and up 90 basis points from the year ago period.
Speaker Change: We remain focused on building capital advance of newly proposed capital rules, while continuing to support relationship client activity and the return of capital as.
Speaker Change: As such we expect to stay above our current targeted range of 90% to 95% and do not expect to be buying back our stock in the near term.
Speaker Change: Our ci position improved by $1 $4 billion this quarter.
Speaker Change: The right side of this slide shows key go. He is go forward expected reduction in our Aoc are mark based on two scenarios. The forward curve as of December 31, which assumes 6% <unk> rate cuts in 2024, and another scenario where rates remain at their current levels.
Speaker Change: And the forward curve scenario the OCI Mark is expected to decline by approximately 24% by the end of 2024 and 34% by the end of 2025, which would provide approximately $1 $8 billion of capital build through that timeframe.
Speaker Change: And the flat rate scenario, we still achieved 90% of that benefit between now and year end 2025.
Speaker Change: Said differently, we still accrete, one $6 billion of capital rates remain flat to current levels driven by maturities cash flow and time.
Speaker Change: Slide 13 provides our outlook for 2024 relative to 2023.
Speaker Change: Given uncertainty regarding eventual timing and extent of fed interest rate cuts in 2024, our guidance reflects outputs from a few potential scenarios ranging from the December 31, foreign curve, which assumes 625 basis point cuts over the course of 2024, starting with an initial cut in March.
Speaker Change: So in a scenario to a scenario more closely aligned with the fed's dot plots, which currently assumes three rate cuts.
Speaker Change: We expect average loans to be down 5% to 7%, mostly reflecting the actions we have already taken over the course of 2023 and.
Speaker Change: In other words, the vast majority of the decline in average loans is a function of our reductions in 2023 and are reflected in our year end balance.
Speaker Change: We expect period end loans at the end of 2024 to be relatively stable compared to the end of 2023 with some decline in the first half of the year offset by growth expected in the second half of 2024.
Speaker Change: We expect average deposits to be flat to down 2%.
Speaker Change: Net interest income is expected to be down 2% to 5%, mostly reflecting the lower fourth quarter exit rate relative to the first half of 2023.
Speaker Change: This equates to net interest income in 2024 that is up low single digits relative to our annualized fourth quarter exit rate.
Speaker Change: I'll provide more color on our net interest income outlook shortly.
Speaker Change: We expect noninterest income to be up 5% or better with upside of capital market activity normalizes and market levels and GDP trends remain constructive.
Speaker Change: Noninterest expense should be relatively stable at about $4 $4 billion as we realize the benefits from our 2023 efficiency actions.
Speaker Change: We will continue to tightly manage our cost base, including executing on additional opportunities to simplify and streamline our organization at the same time, we will continue to protect and invest in our franchise, including most importantly, our people.
Speaker Change: As Chris mentioned, our guidance suggest moderate positive operating leverage in 2024, driven by meaningful expansion in the second half of the year outpacing tough comparisons in the first half.
Speaker Change: For the year, we expect credit quality to remain strong and net charge offs to continue to modestly increase to the 30 to 40 basis point range still well below our over the cycle range of 40 to 60 basis points.
Speaker Change: Our guidance for our GAAP tax rate is approximately 20%.
Speaker Change: Turning to slide 14.
Speaker Change: Even heightened investor focus on this topic, we wanted to provide a little more granularity than we have in the past about the pacing of our net interest income opportunity as we move through 2024.
Speaker Change: Hopefully by now you are familiar with our well defined net interest income tailwind as the impact of our short term swaps roll off and treasuries mature, especially in the back half of 2024.
Speaker Change: The ultimate opportunity remains largely unchanged at approximately $900 million.
Speaker Change: As a reminder, the benefit increases each quarter as more of the swaps roll off and treasuries mature, culminating in the full amount in the first quarter of 2025.
Speaker Change: So this all builds quarter by quarter since the initial set of swaps came off the books in the first quarter of 2023.
Speaker Change: As we turn the page on 2023, we are nearing the halfway point of this journey since were now through three full quarters, we're sharing a three part deal.
Speaker Change: First on the left in light Gray are the three quarters of benefit we've already realized.
Speaker Change: In total for 2023 that was approximately $85 million of additional income.
Speaker Change: The next four bar show the progression through 2024 as you see the value builds from each quarter's tranche and accrues in the following quarter.
Speaker Change: Each bar retro represents the value for the quarter.
Speaker Change: Other words in <unk> 'twenty, four we expect to realize $78 million of additional net interest income.
Speaker Change: Versus <unk> 23 from these positions.
Speaker Change: For 2024, we estimate the benefit to be approximately $500 million in total which is the sum of the four quarterly bars. This would represent an increase of more than $400 million over the benefit received in 2023, which as previously mentioned was approximately $85 million.
Speaker Change: The final bar to the far right, which has been the main focus of this discussion over the last year or so is the first quarter 2025 number this.
Speaker Change: This shows the benefit currently estimated for the quarter at approximately $220 million for essentially the entire swap in short term treasury portfolio is rolling off.
Speaker Change: Again, this is incremental to <unk> 23, and represents an annualized value of approximately $900 million.
Speaker Change: We believe the reinvestment of these fixed rate assets and swaps represents an outsized opportunity for key relative to our peers, but it's also important to remember that this is just one component that drives our net interest income outlook.
Speaker Change: On slide 15, we provide other key inputs and assumptions driving our NII outlook deposit betas balances and mix loan growth as well as seasonal factors.
Speaker Change: Putting this altogether, we expect our first quarter NII to be down 3% to 5% from the fourth quarter from there we expect to grow and start to accelerate in the second half of the year as the pace of swaps in U S Treasury maturities pick up meaningfully and nearly $5 billion in aggregate per quarter.
Speaker Change: From the fourth quarter of 2023 to the fourth quarter of 2024, we expect our quarterly net interest income to grow 10% plus and exit the year north of $1 billion.
Speaker Change: We would also expect a net interest margin to improve meaningfully to the $2 four zero to 250% range by the end of 2024. This will put us on a strong trajectory as we enter 2025.
Speaker Change: With that I will now turn the call back to the operator for instructions for the Q&A portion of our call operator.
Operator: Thank you, ladies and gentlemen, once again, if you'd like to ask a question. Please press one then zero on your telephone keypad.
Operator: And our first question will come from Peter Winter with D. A Davidson one moment please Mr <unk>.
Mr Winter I apologize here go ahead, Mr Winter Alright, great.
Operator: Great. Thank you good.
Speaker Change: Good morning, Peter.
Peter J. Winter: Good morning.
Peter Winter: A lot of good color on the net interest income.
Peter Winter: With those slides, but can you just go into a little bit more detail about the moving parts to the net interest income opportunity.
Peter Winter: And maybe some other factors that impacts your outlook and then secondly, if you could talk about the quarterly NII progression you gave us the first quarter down.
Peter Winter: Down, 3%, but clearly it's going to be a pretty meaningful impact.
Peter Winter: In the second half of the year.
Speaker Change: Sure. Thanks, Peter I. Appreciate the question I know this is a point of interest so.
Speaker Change: Let me provide a little bit of context to the guide and the trajectory in.
Speaker Change: Hopefully it would be helpful. I think first maybe just start with the puts and takes which I think is the nature of your question, there and im going to just categorize sort of the big movers I think one loan balances.
Speaker Change: Which again, we guided kind of down 5% to 7% for the year.
Speaker Change: Asset yields I'm going to separate those from the swaps and treasuries because I just want to identify those separately.
Speaker Change: Deposit balances deposit pricing and funding costs, and then the swaps and treasury portfolio. So if you think about those as kind of five key levers.
Speaker Change: On the guide if I go full year 'twenty three to full year, 'twenty, four which we've said.
Speaker Change: Down 2% to 5% the headwinds there are going to be the loan book, so down 5% to 7% obviously thats.
Speaker Change: Can impact NII deposits flat to down.
Speaker Change: As a little bit of drag, earning asset yields will drop year over year as rates get cut and then depart deposit and funding costs will be up for the year is that fourth quarter kind of annualized number rolls through.
Speaker Change: As of the headwinds what we have.
Speaker Change: Coming our way hedges swaps and the treasury portfolio as they mature throughout the year and then a better funding mix as we move through and become more and more and more reliant on deposits as we have this year. So that's sort of.
Speaker Change: Dimensionalize, what that year over year look.
Speaker Change: Shakes out to be if you take the fourth quarter of 'twenty three annualized.
Speaker Change: And you compare that to the full year 'twenty four we're guiding up.
Speaker Change: Low single digits, there the biggest difference being that the funding cost.
Speaker Change: That really is pretty flat from fourth quarter through 'twenty, four which was not the case if you did the year over year comparison.
Speaker Change: Do you still get the benefits of swaps and treasuries coming in during the year in a better funding mix. So you start to see that down 2% to five flipped to up low single digits.
Speaker Change: We talked a little bit about the first quarter being down, but let me just go fourth quarter to fourth quarter. So I think that exit piece is important.
Speaker Change: Youre going to have deposits down a bit in earning asset yields down of debt going from fourth quarter, a 23% to fourth quarter 'twenty four but you get a nice pick up in the quarterly swap and treasury portfolio. Our overall funding costs should be down in that quarter as rates have been cut throughout the year.
Speaker Change: And then again you still have some benefits of funding mix and all that together, we think is 10% plus quarter to quarter NII growth. So we think thats a nice pick up kind of end of year to end the year and then as you roll into 2025 do you have that last 5 billion tranche of treasuries.
Speaker Change: In swaps maturing in the fourth quarter that accrues to the first quarter at 25, So we start to hit the ground running really nicely with a very steep trajectory as we enter 2005.
Speaker Change: So I'll stop there there was a lot a lot of stuff, but just trying to give you the components that are moving around.
Speaker Change: And just what are you expecting or assuming in terms of the forward curve.
Speaker Change: The timing of the rate cuts.
Speaker Change: So our guide of two to five kind of incorporates a couple of different views.
Speaker Change: Kind of the range being the current forward down six with the first cut in March.
Speaker Change: Incorporating the lesser cuts on the three fed dot plots I think our general view is more aligned to four cuts with the first one middle of the year, but we're trying to provide guidance that I think incorporates all of that and as you know when those cuts occur in the magnitude of that will will roll through to how we manage our deposit pricing.
Speaker Change: Right.
Speaker Change: Got it thanks, and then Brian congratulations.
Speaker Change: The announcement, it's just been a pure pleasure.
Beth Elaine Mooney: Working with you in the investment community.
Speaker Change: We will be missing you.
Speaker Change: Thank you Peter.
Speaker Change: Next we'll go to the line of Scott <unk> with Piper Sandler. Please go ahead.
Scott: Good morning, everybody. Thanks for all the.
Scott: Hey, Thanks for all the moving pieces in the NII color I guess, you've discussed the 3% sort of normalized margin I know, we get sort of one one.
Scott: Final uplift between fourth quarter of next year and first part of 2025, So I think the way you've guided to fourth quarter next year gets you a lot of the way there, but certainly still some room leftover is the 3% normalized margin.
Scott: Kind of where you are.
Scott: Our bogeying and what has to happen to get us to that sort of range.
Speaker Change: Yeah. Thanks, Scott. So if you just go back and we talked a little bit about this and it's.
Speaker Change: Overly simplistic to be clear, but if we took.
Speaker Change: Second third fourth quarter of 'twenty, three and put the impact of swaps and treasuries back in the margin we'd be.
Speaker Change: <unk> hundred 81 to $2 84 in those quarters, which we think is pretty reflective of what we've got right now and thats with this sort of oddly longstanding downward yield sloping downward sloping yield curve. So I think.
Speaker Change: That range as we get into 'twenty five feels like.
Speaker Change: Achievable and I think getting to that longer term three probably need just to have a more traditional upward sloping yield curve.
Speaker Change: That tends to accrue a little bit to all of our benefit on NIM.
Speaker Change: But I do think that $2 80, plus is pretty reflective of the underlying core ability of the business as it stands today.
Perfect. Thank you and then either Clark or Chris just.
Speaker Change: On the fee guidance feels it feels like you're approaching with an abundance of conservatism regarding be.
Speaker Change: Capital markets outlook, just curious if you could maybe put a finer point on what sort of recovery you are.
Speaker Change: What kind of upward leverage there might be if things do normalize.
Speaker Change: Scott happy to address that so.
Speaker Change: If you take what we just reported of 136 million specifically on the line you asked about it.
Speaker Change: Investment banking and debt placement fees that would annualize at about $5 44.
Speaker Change: Conversely, if you took sort of the business and removed 2021 and said that's an outlier.
Speaker Change: But traditional run rate is at least kind of $650 million. So I think we I think we have been conservative and that's why we when we gave guidance. We said noninterest income up five plus and then we put the qualifier upside of capital market capital markets activity normalizes.
Speaker Change: We don't see it really normalizing until the back half of the year. However, it's an interesting phenomenon. When the 10 year went above 5% and then came back down as you can imagine people started to transact and so we're seeing the beginning of it now but yes.
Speaker Change: Yes. It is.
Speaker Change: A conservative number the other thing that fee number is you saw that we had a step down with respect to our derivatives and hedging income a lot of that is tied to the balance sheet and as we go through 2024, and we get back to growing the balance sheet after going through our exercise.
Speaker Change: <unk> youll see that come back as well.
Speaker Change: Okay perfect. Thank you very much for that and then finally burn best wishes. Thank you so much for everything.
Speaker Change: Thank you Scott.
Speaker Change: Next we'll go to John <unk> with Evercore. Please go ahead.
John: Good morning.
John: Good morning, John.
John: First congratulations best of luck Euro Logan.
Speaker Change: And Brian welcome.
Speaker Change: Looking forward to working with you again.
Speaker Change: <unk>.
Speaker Change: Question on the.
Speaker Change: A little bit more on the NII dynamics I wanted to get your thoughts on.
Speaker Change: If we do see the constant materialize.
Speaker Change: As you had.
Speaker Change: And your expectations what type of deposit beta you expected your achievable on the initial cuts.
Speaker Change: And how would you think about a cumulative on the on the way down and what is factored into your net interest income outlook in terms of that data. Thanks.
Speaker Change: Yes, John So I'll, just I'll start with that and then I'm going to flip it over to Clark.
Clark: Couple of things to keep in mind, we have a big commercial franchise, and so 40% of our deposits $145 billion.
Clark: Our commercial and of those about two third are either index or index like now on the other side of the equation, we've been pretty conservative in assuming that as the first cuts, particularly if they arent steep cuts that will continue to get drift up on the consumer side also.
Also <unk>.
Clark: <unk> forecasted just a bit of continued transition from interest bearing to non interest bearing but we think we've sort of bottomed out there Clark what would you add to that yes. So maybe broadly John on the NII Guide we would expect.
Clark: Some drift up particularly in the first quarter on deposit pricing just as rates as rates stay high as Chris said when the cuts Tom I think a good way to think about that commercial book as we've talked about the index nature of it is Chris just referenced as sort of.
Clark: Kind of almost automatic mid teens data on a cut because of that how that index pulls through so the question really is going to be what happens to the consumer book and how quickly can we move that I think a 25 basis point cut with.
Clark: Kind of a long waiting period does it provide a lot of opportunity to reduce if we start to see that.
Clark: Bigger cuts or cut sooner or more rapid cuts that allows us to deploy those price reductions into the books. So right now as I said, we're really looking at kind of our view is more like the four cuts starting in the middle of the year.
Clark: We think we'll probably have some stabilization maybe a little bit of consumer drift through that time period, and then we will start to proactively move move rates down but.
Clark: Given that timeframe in 2024.
Clark: Hard to say exactly what the data will be on the way down for the year, but it's really going to pick up in 'twenty five we'll see some benefit in 'twenty four but on the consumer book, it's just going to lag a little bit in that.
Clark: Candidly thats, just going to be as much a competitive.
Clark: Function of competitive environment as anything else, but we are taking some actions in the consumer book today to prepare for cuts, we're not cutting rates, but.
Clark: Preparing our franchise.
To be ready for that then.
Clark: We'll be very proactive when that opportunity shows up and frankly all markets are not the same.
Out there experimenting with a few things as we speak.
Speaker Change: Got it okay. Thanks for that and then separately on the credit front can you give us a little bit more color on the 25% increase in non performers in the quarter or maybe a little more color on the criticized asset increase.
Yes.
Speaker Change: I know your commercial real estate NPL ratio now is six 9%.
Speaker Change: What was that last quarter was that the biggest increase.
Speaker Change: Non performers.
Speaker Change: Yes.
Speaker Change: Yes, I'll come back to you on the increase from third quarter I don't have that right in front of me, but on your other points. The NPA uptick really is a small list of identified credits.
Speaker Change: Most of which we feel very good about the loss content. So it is a pickup in the ratio, but we don't think thats a loss driver.
Speaker Change: On criticized look that as.
Speaker Change: A function of continued higher rates, putting some stress on what I'd call kind of the first order rating variable around debt service coverage. So that does drive rating migration in our book that rating migration does pull through to criticized and classified but when you get underneath that metric and you look at things like.
Speaker Change: Clients' willingness to build the interest reserve and the value of the collateral given we tend to underwrite at 60% or lower Ltvs out of the gate. We just don't see a lot of loss content there.
Speaker Change: Just one clarification. So it was primarily C&I related in terms of the NPA increase were CRE.
Speaker Change: There were there were three specific credits one of which was real estate.
Speaker Change: Yes.
Speaker Change: Okay, Alright, thanks, Chris.
Speaker Change: Sure.
Speaker Change: Next we go to the line of Manan <unk> with Morgan Stanley. Please go ahead.
Manan: Hi, good morning.
Manan: I wanted to extend my best of Venezuela, and just wanted to say, we really appreciate all of the Apple.
Speaker Change: Thank you.
And then on.
Speaker Change: On my question I think you said you still expect some modest reduction in the first half of 2024.
Speaker Change: Is that all coming from the loan book and.
Speaker Change: As we think about the long end of the Gov.
Speaker Change: <unk> been moving lower.
Speaker Change: You should have a lot more clarity on creating that Aoc back over time, So what would you need to start leaning into loan growth little or deploying capital elsewhere.
Speaker Change: Sure. So we are.
Speaker Change: Where we need to be in terms of going through our our whole portfolio.
Speaker Change: As we went through and we're looking and focused on <unk> really was sort of in three buckets and we actually went account by account and I've often said.
Speaker Change: That on a risk adjusted basis stand alone credit properly graded can't return its cost of capital and so we were extremely prescriptive across the entire firm of going through that on top of that we exited some businesses like vendor finance that by the way is a credit only business and then on top of the.
Speaker Change: There were certain areas, where we were conservative in terms of our capital treatment, where we could actually reduce <unk> without in fact.
Speaker Change: Any impact on NII that process is really over when I say the process is over we will continue obviously to look through our portfolio, but in terms of really seeing the step down in <unk>. As you saw last year $14 billion, that's behind us and so as we look forward.
Speaker Change: Word Clarke talked about sort of the lag from the starting point on loan growth, but as you know.
Speaker Change: We have the ability to generate loan growth here at <unk>, We've got a long history of that will be back kind of focused on serving our clients now having said that I have.
Speaker Change: Personally have a view everyone is sort of coalesce around the soft landing.
Speaker Change: I think inflation is still pretty sticky I think theres a bunch of drivers out there we're managing the business for a short recession in 2024, and obviously that goes into our thinking because if you think about working capital in the context of a shrinking economy that shrink some some loan demand the other thing that we.
Speaker Change: Have to grow through and this is by design as we are going to have $3 billion of run off in our consumer business I hope that helps kind of on the puts and takes.
Speaker Change: When there's business to be done from a loan perspective.
Speaker Change: Evident that we can get it.
The only other thing I'd add Manav is just just re ground everybody an average to average move so $118 billion of average in 2003, ending point $1 12, six so most of that.
Speaker Change: A decline in loans happened last year, we're pulling that through there may be a little bit more as we said in the first quarter maybe into the second quarter as some of that non relationship business continues to move out, but we will see the build back.
Speaker Change: Through the course of the year and expect the ending of 24 to be.
Speaker Change: Relatively stable with where we exited 23, so we will see a rebound and to Chris's point, if there is less.
Speaker Change: Softness in the economy and more opportunity then we'll lean into that opportunity.
Speaker Change: That's very helpful and then for my follow up.
Speaker Change: As we look out into 2025.
Speaker Change: There's a lot of puts and takes here on the NII side.
Speaker Change: But what's the most optimal.
Speaker Change: And for key is it.
Speaker Change: Thanks, Scott and then an upward sloping yield curve is that the most optimal environment or would you rather see higher short end rates and a flatter yield curve.
Speaker Change: I think.
Scott: Look I think an upward sloping yield curve benefits the business broadly I am not as concerned at the moment about four cuts or six cuts as we move through the year, while reliability sensitive today as we move through the year.
Scott: In swaps and treasury portfolios burn off we're going to slightly.
Scott: Become more asset sensitive naturally so we really want to be neutral and able to operate in any of those environments, but if I. If I had my choice broadly I think.
Scott: Upward sloping yield curve is always a valuable place for us to be in this business.
Speaker Change: Great. Thank you.
Speaker Change: Thank you.
Speaker Change: And our next question is from Erika Najarian with UBS. Please go ahead.
Erika Najarian: Hi, good morning.
Erika Najarian: I apologize one more question on net interest income, yes, I think the stock is a little bit soft today because.
Census was expected quarterly positive progression on the net interest margin.
Erika Najarian: Given the fixed rate opportunity I'm, just wondering in context of the modest arguably reductions Clark.
Erika Najarian: Sure.
Erika Najarian: Forecasting where you're telling us is happening for the first half of the year.
Erika Najarian: How much of that is impacting the NII trajectory.
Erika Najarian: And are those arguably being reduced.
Erika Najarian: Zero credit linked notes that could impact the net interest income.
Erika Najarian: And then as a follow up to that as we think.
Erika Najarian: The first half of the year do you feel like we've moved.
Erika Najarian: Going back to what Christian said.
Erika Najarian: Process is over is that a cleaner way to think about where your balance sheet is.
Erika Najarian: Or has to be relative to where you think the capital could be in the second half of the year in other words, there won't be any more wholesale action that can impact us.
Erika Najarian: And NIM trajectory.
Speaker Change: Yeah. So thank you Erika good good question as always.
Speaker Change: <unk>.
Speaker Change: The decline in the first half again is.
Speaker Change: The continuation of some actions we took to manage <unk> last year, So again relationship non relationship and credit only related.
Speaker Change: Clients.
Speaker Change: Im coming down we do we don't have anything factored in at the moment around our WAM management related to credit linked notes as you and I've talked about before we were doing our homework to understand those opportunities, but it's not part of the guidance at the moment.
Speaker Change: Really it would be that loan reduction and that will put a little bit of pressure on first quarter as will the fact that rates remain high in the first quarter under almost any cutting scenario and we will have a little bit of data address so thats really the first quarter pressure, but I think your point about kind of a clean balance sheet entering the <unk>.
Speaker Change: Half is the right one.
Speaker Change: And I think again, we're suggesting kind of tepid.
Speaker Change: Tepid recession kind of mid mid to late year, if that doesn't come through and we see a more constructive economic environment I think theres some opportunity.
Speaker Change: To grow loans, but I do think as.
Speaker Change: As we progress through the year Youll see NIM expand you'll see NII grow nicely and you'll see the balance sheet I think on the right trajectory.
Speaker Change: Got it and my second question is.
Speaker Change: It is a bit of a two parter then trying to squeeze it in one Clarke I think when I first met you I was very impressed by how.
Speaker Change: You were still good at understanding where you are.
Speaker Change: Funding needs.
Speaker Change: Funding sources. So my question for you is are these two thirds of your commercial deposits in commercial are they truly in next on the way down right.
Speaker Change: The original banks have warned us that their index on the way up and perhaps more negotiated on the way down and I guess the.
Speaker Change: The other question is that is it possible to breakdown on slide 14 on your maturity schedule, what would the treasuries component and then swap component only because obviously theres a lot of debate on whether or not the cutting the curve will happen, which clearly impact some of the math behind the swaps.
Speaker Change: Yes, so the second one Eric is easy we've I think we've provided that breakout before we'll we'll deliver it that's that's not a problem at all.
Speaker Change: <unk>.
Speaker Change: On the first I think look it's a fair point because not all of those commercial deposits are are contractually index. So I think that's the right question Theres always a little bit of.
Speaker Change: It's easy to negotiate with the client when youre, giving them right and it's a little bit harder when you're taking it away, but I would say.
Speaker Change: Our view is while it may not perfectly pull through we have spent a lot of time with these clients we've been in front of them.
Probably more than we would care to admit over the last year, but in a way that I think we have a good understanding of how those dynamics would work and we expect that.
Speaker Change: The components of.
Speaker Change: What we think are indexed will come through and just as a reminder, the when we say indexed it's not all 100% index. So there is a range of that so bringing a client down as index kind of 50%.
Speaker Change: It doesn't feel as challenging to negotiate than somebody who is coming down at a 100% clip.
Speaker Change: And so the book is pretty broadly distributed across 20% to 100%.
Speaker Change: We're going to actively engage those clients to make sure we can manage the book appropriately.
Speaker Change: Got it thank you Vern.
Vern: Thanks Erica.
Speaker Change: Next we move to the line of Matt O'connor with Deutsche Bank. Please go ahead.
Matt Burnell: Hi, just a quick clarification the guidance of 5% you walked through a lot of details on investment banking does that assume for <unk> annualized level.
Matt Burnell: <unk> kind of about 100 million more normal level or somewhere in between thank you.
Speaker Change: It's a little bit in between Matt probably a little more leaning towards the higher number, but we do think if markets kind of fully normalized we'd see a little bit outside so.
Speaker Change: It's better than the annualized fourth quarter.
Speaker Change: Not quite all the way to.
What we would think as normal.
Speaker Change: <unk>.
Speaker Change: Okay. Thank you.
Speaker Change: Next we move on to the line of Gerard Cassidy with RBC. Please go ahead.
Gerard Cassidy: Hi, Chris.
Good morning.
Gerard Cassidy: Chris.
Gerard Cassidy: Interesting developments over the last 12 to maybe 36 months has been the increased competition from the private credit lenders into the commercial space.
Speaker Change: Can you share with US obviously, you guys are strong big regional lender in the C&I space. What are you guys seeing from competition from those non depository lenders and the second if any of them are your customers. How do you balance their needs at the same time competing against them for lending.
Speaker Change: Sure.
Speaker Change: It's a great question and it's developing quickly so.
Speaker Change: Principally they are customers of ours. So let me explain what I mean by that as you well know we distribute 80% of the capital. We raise so we are distributing all the time a lot of paper to these private debt funds and it's an important part of our underwrite to distribute model.
Speaker Change: As we've said many times.
Speaker Change: For banks.
Speaker Change: Standalone properly graded credit can't return its cost of capital that is not the situation for the private debt funds. They have the benefit of leverage on leverage we have to be a relationship bank. We have to we have to be able to provide all of the payments capabilities all of the cash.
Speaker Change: Markets capabilities.
Speaker Change: And that's actually an opportunity for us because I think what youll see is as these private debt funds continue to grow they'll need to partner with banks and they'll want to partner with banks that have sophisticated capabilities around things like payments and capital markets.
Speaker Change: But don't necessarily want to hold on a risk adjusted basis paper that doesn't return.
Speaker Change: Doesn't hurdle, so I look at it frankly as an opportunity.
Speaker Change: For us I think we're well positioned for that.
Speaker Change: Very good and then coming back to credit you mentioned.
Speaker Change: So you have minimal or very low exposure to <unk>.
Speaker Change: Also space, which which is great in this environment and then you have the multifamily exposure, but 40% I think you said was in low cost housing.
Can you share with US what are you guys seeing in some of the markets, where there has been rapid buildup of not necessarily low cost housing or subsidized housing but normal.
Speaker Change: Housing in the multifamily are you seeing issues in that.
Speaker Change: Sub segment of the multifamily market or do you not have much exposure to those markets that are growing rapidly.
Speaker Change: We don't have a lot of exposure because you'll remember Gerard we exited a lot of these what we call gateway cities, probably five years ago based on affordability based on cap rates, but we do have a fair amount of insight and that we have this third party commercial loan servicing business.
Speaker Change: And we are named special servicer on over $200 billion of loans.
Speaker Change: And in that area, 44% of what's an active special servicing which is really what's in workout is office, but the fastest growing segment over the last quarter was in fact multifamily and some of these gateway cities. So we're not seeing it in our portfolio because thats not an area of focus.
Speaker Change: But we are picking it up through the <unk>.
Speaker Change: Further reconnaissance, we get through our third party commercial loan servicing business.
Speaker Change: One little add on to that that I think the group might find interesting that I did when I was talking to the leaders there actually what is in special servicing is down we had a record year in 2023 as you can imagine what is in active special servicing actually ticked down which I think is just an interesting data point for all of us to kind of follow the market.
Speaker Change: Great Chris Thank you and Vern really good luck on your retirement and.
Speaker Change: I do and I'm pointing out that I have on my Credenza Investor Conference book from September of 95, one we had the anthem is Elvis impersonator entertainers at night. So thank you those are great memories for thank you.
Speaker Change: Fortunately I wasn't around for that but I'm sure a hurdle the happy decided for you derive great. Thank you.
Speaker Change: Next we go to the line of Mike Mayo with Wells Fargo Securities. Please go ahead.
Mike Mayo: Hi, Mike.
Mike Mayo: Mike well, Chris one of your one of your competitors CEO said scale has never been more important and that competitor is larger than you are and so pulling back the lens.
Mike Mayo: Do you think about scale and how it's changed over the past year and I two specific questions.
Mike Mayo: Before you give that broader answer.
Mike Mayo: What percent of the value of commercial relationship.
Mike Mayo: From the deposits that's a specific number and then what percent of the revenues that you get from your typical commercial relationship is fee based versus lending base, because I think that gets to the larger value proposition of key.
For sure it will let me let me start with the.
Mike Mayo: Larger question first and then we'll talk a bit about the mix of spread income to fee income, which I do think by the way. Let me just start there I think thats a great barometer as you know throughout key we're 40% fee income, which for a category four bank as is.
Mike Mayo: As at the high end of the spectrum.
Mike Mayo: As we look at businesses like our institutional bank.
Mike Mayo: Split there in some areas is as high as 80% fees, 20% spread and it varies depending on the business because some businesses are more capital intensive than others, but that is one of the metrics. We look at to see what kind of penetration were getting.
Mike Mayo: As it relates to scale and I think it's a really good and important question.
Mike Mayo: On one hand, there is no question that if you have to carry more capital and capital is more expensive that would put more of a premium on scale than before and the same would go for things like cyber. So on the margin, yes scale would be probably more important today than it was 12 months ago, having said.
Mike Mayo: That I do not think scale is the answer for a bank like key and I say that because when you have competitors that are 20 times as big as you are the question really is what is scale and as you know what we've decided to do is focus on targeted scale to be really real.
Mike Mayo: Relevant to the customers that we try to be relevant to we're certainly not trying to compete in the same manner that the largest banks. They have a nice business model. It works for them, but thats not a business model like that that we're that we're executing.
Mike Mayo: Getting it all does that answer your question.
Speaker Change: Yes, I mean, I think this kind of goes to the stickiness of corporate deposits.
Speaker Change: And how that's changed over the past year and.
Speaker Change: You asked the question of fees, how much of the value of your commercialization deposit driven and you have the cash and Treasury management and other services that you provide.
Speaker Change: Treasurers is that.