Keycorp (KEY) — Q1 2018 Earnings Call Transcript

Thank you, Operator. Good morning, and welcome to KeyCorp's First Quarter 2018 Earnings Conference Call. In the room with me are Don Kimble, our Chief Financial Officer, and Chris Gorman, our President of Banking. Slide 2 is our statement on forward-looking disclosure and non-GAAP financial measures. It covers our presentation materials and comments, as well as the question-and-answer segment of the call. I am now turning to Slide 3. The first quarter was a good start to the year for KEY with continued momentum in our core businesses as we grew and expanded relationships with our targeted clients. With a more positive economic backdrop and improving client sentiment, we are seeing strong activity and healthy dialog in our markets from clients large and small. We continue to take share and our pipelines remain strong. Our results this quarter reflect the strength of our business model and competitive positioning. Earnings per common share was up 19% from the prior year and we generated a return on tangible common equity of 15% for the quarter. Reported revenue was up over 3% from the first quarter of last year and adjusted for purchase accounting accretion, revenue growth was 4.6%, driven by a higher net interest margin, solid loan growth, and strong performance from our fee-based businesses. The growth in average loans this quarter was broad-based and was primarily in commercial and industrial loans, which were up over 3% linked quarter. The growth reflects our success in growing and expanding middle market and corporate relationships, as well as the momentum we had coming out of the fourth quarter, the strong pipeline, and activity to carry it into the first quarter for closing. Our fee-based businesses once again reflected our ability to offer a full range of solutions to our clients, including off-balance sheet financing alternatives that help drive our investment banking and debt placement fees to a record first quarter level. Capital markets execution enables KEY to meet our clients’ needs, drive fee income, manage portfolio risk and generate attractive returns on capital. While the mix of on and off-balance sheet activity can vary in any given period, this quarter, we saw strength in both and our results continue to be a clear reflection of the success of our model. Expenses were elevated in the quarter as a result of higher benefits and severance, as well as the acceleration of certain technology costs and investments. Don will walk through the expense line items in his comment. But importantly, we remain committed to achieving our 2018 expense guidance and believe that the first quarter level will be the high point for the year. Given our outlook for revenue growth and lower expenses, we expect to move toward the high end of our long-term efficiency ratio target of 54% to 56% by the end of this year. As we have discussed previously, we continue to execute on efficiency opportunities across our company, including realizing the remaining benefit from the First Niagara expense savings that will be fully captured in our second quarter results. We've also started implementation on a number of expense initiatives, including several that are a carryover from last year when resources were devoted to the integration of the acquisition. We have a high degree of confidence in achieving these incremental savings as we move through the year, which will come from additional branch consolidations, savings from third-party vendor contracts, realizing efficiencies in the middle and back-office areas, and the realignment of several business units. The final two sections on the slide highlight our stronger position in terms of both risk management and capital. Credit quality remains the strength with net charge-offs to loans at 25 basis points. We remain committed to maintaining our moderate risk profile. And our approach to capital has also remained consistent, maintaining our strong capital position, while returning a large portion of our earnings to shareholders through dividends and share repurchases. Earlier this month, we submitted our capital plan through the CCAR process and our plan was consistent with our stated capital priorities. Overall, it was a solid start to the year. I was pleased with the growth we are seeing across our franchise. Expenses reflected some seasonal factors, and other timing differences are expected to come down over the course of the year, and we remain on a path to make meaningful progress approaching the upper end of our efficiency ratio target this year. Now, I’ll turn the call over to Don for more detail on the quarter.

Thanks, Beth. I’m on Slide 5. We reported first quarter net income from continuing operations of $0.38 per common share, compared to $0.32 per share in the same period last year and $0.36 in the fourth quarter, with previous results adjusted to exclude notable items. Our return on average tangible common equity increased to 14.9% in the first quarter. Our cash efficiency ratio was affected by higher expenses in this quarter. As Beth mentioned and I will elaborate on later, we have plans to lower our expenses and expect to approach the high end of our efficiency ratio target of 54% to 56% by the end of this year. In the first quarter, we had a GAAP effective tax rate of 13%, due to recent tax law changes and credits from investments and tax-advantaged assets. I will discuss the remaining items on this slide later in my presentation, but I’ll now move to Slide 6. Total average loans reached $87 billion, an increase of $921 million from the fourth quarter. The growth in the first quarter was driven by commercial industrial loans, which rose over 3% linked quarter on an annualized basis. This growth stemmed from our core relationship business in both the Community Bank and the corporate bank, with strong business activity seen in our new and overlapping markets. Importantly, we maintained our underwriting standards and remained selective, focusing on our targeted client segments. This quarter’s growth also reflected the ongoing momentum from year-end and carried over from deals that were postponed into the first quarter, along with strong pipelines. Loan pay-downs remained high this quarter and we expect this pattern to continue throughout the year. On the consumer side, we experienced growth from expanding our auto lending business into existing areas and dealer relationships. We are also entering the second quarter with ending loan balances of $88 billion, an increase of $1 billion from this quarter's average balances. Moving on to Slide 7, average deposits amounted to $103 billion for the first quarter, down $1.2 billion or 1% on an annualized basis compared to the fourth quarter. The cost of our total deposits increased by 5 basis points from the fourth quarter, reflecting recent rate hikes and the continued shift of our portfolio into higher yielding products. Compared to the previous year, we saw growth in retail and commercial deposits, as well as certificates of deposits, while experiencing a shift towards higher cost deposits. We also noted a 10% increase in consumer non-interest bearing deposits. Demand deposit accounts and money-market accounts decreased from the prior year, primarily due to a mix shift and a managed exit from certain higher cost corporate and public sector deposits. On a linked-quarter basis, the change in our deposit balances was mainly driven by a decrease in non-interest bearing deposits, which were elevated in the fourth quarter due to seasonal factors and short-term escrows. These declines were partially offset by growth in our consumer non-interest bearing deposits. We continue to have a strong and stable core deposit base, with consumer deposits representing 61% of our total deposit mix. Turning to Slide 8. Taxable equivalent net interest income was $952 million for the first quarter of 2018. The net interest margin was 3.15%. These results compared to taxable equivalent net interest income of $929 million and a net interest margin of 3.13% for the first quarter of 2017, and $952 million and a 3.09% margin in the fourth quarter. Purchase accounting accretion contributed $33 million, or 11 basis points to our first quarter results. This compares with $38 million or 12 basis points in the fourth quarter and $53 million or 18 basis points in the first quarter of 2017. From the first quarter level, we continue to expect purchase account accretion to decline by approximately 10% per quarter in 2018. Excluding purchase accounting accretion, net interest income was up $43 million from the first quarter of 2017. The increase was largely driven by higher rates and lower managed deposit data. Excluding purchase accounting accretion, total revenues would have increased by $67 million or 4.6% from the first quarter of 2017. Net interest income increased $5 million from the quarter excluding purchase accounting accretion as the benefit of higher interest rates and lower short-term earning assets with the lower levels of liquidity was partially offset by the day count and the impact of taxable equivalent adjustment. We expect our core net interest margin, excluding purchase accounting accretion, to move modestly higher for the remainder of this year, which assumes continued growth in our balance sheet and a rate increase mid-year and another toward the end of the year. Reflecting March rate increase as well as the expectations for the remainder of the year, we are increasing our net income outlook for the year by $50 million to now be in the range of $3.95 billion to $4.05 billion. Moving to Slide 9. KEY’s non-interest income was $601 million for the first quarter of 2018 compared to $577 million for the year-ago quarter as we continue to benefit from investments in several of our fee-based businesses. Growth from the prior year was largely driven by record first quarter for investment banking debt placement fees, which were $143 million, up $16 million from the year-ago period as we benefit from the acquisition of Cain Brothers, as well as strength across our capital markets platform. We also saw momentum in many of our other fee-based areas, including commercial leasing and deposit services. Compared to fourth quarter 2017, non-interest income decreased by $55 million. The decrease was largely driven by seasonal impacts in several fee-based businesses, including investment banking debt placement, cards and payments, and corporate and life insurance. Turning to Slide 10. KEY’s non-interest expense was $1.006 billion for the first quarter of 2018, which compares to $1.013 billion in the fourth quarter with the prior quarter adjusted for a number of notable items, including merger-related charges and the impact of tax reform and related actions. The current quarter reflected a number of seasonal and timing items, which impacted the comparison with the fourth quarter. Excluding notable items from the prior period, personnel costs were up $28 million from the fourth quarter. The drivers of this increase were $31 million in higher employee benefits costs, primarily due to seasonal increases in employer taxes and healthcare-related expenses, and approximately $11 million in the acceleration of technology development costs into the first quarter. We also incurred $5 million in severance costs this quarter. Offsetting these increases in the personnel line was a decline of $24 million in incentive compensation. The increase in personnel costs was more than offset by a net $35 million reduction in non-personnel expenses, despite the impact of $4 million increase resulting from purchase accounting true-up and $3 million of higher operational losses. We expect that our elevated expense level this quarter will represent the high point for the year, and we will achieve our targeted expense range of $3.85 billion to $3.95 billion for 2018. Contributing to our lower expense run rate will be the remaining First Niagara cost base of $50 million, which should be fully reflected in our second quarter results. Additionally, as part of our ongoing continued improvement culture, we are implementing plans across the Company that will contribute to our results this year. As Beth mentioned, these cost reductions include additional branch consolidations expecting to close 40 branches this year; additional savings from third-party vendor contracts; realizing efficiencies from middle and back-office functions; realignment of several business units; and adjustments to staffing models throughout the organization. With these efforts, we expect to be approaching the high end of our long-term efficiency ratio target of 54% to 56% by the end of this year. Again, we’re maintaining our full-year guidance for non-interest expense of $3.85 billion to $3.95 billion. Moving on to Slide 11. Our credit quality remains strong. Net charge-offs were $54 million or 25 basis points of average total loans in the first quarter, which continues to be below our targeted range. Provision for credit losses was $61 million for the quarter. Non-performing loans were up $38 million or 8% from the prior quarter, but represented 61 basis points of period-end loans. At March 31, 2018, our total reserve to loan losses represented 1% of period-end loans and 163% coverage of non-performing loans. Turning to Slide 12, capital remains strong for our company with a common equity Tier 1 ratio at the end of the fourth quarter of 10%. We continued to repurchase common shares during the quarter, totaling $199 million. We submitted our capital plans earlier this month with the requested capital actions, which are consistent with our earlier messages about increasing the common dividend to a level approaching our long-term targeted payout range of 40% to 50%. Our requested share repurchases will also move our capital closer to our long-term common equity Tier 1 target of 9% to 9.5%. Slide 13 presents our outlook for 2018. With the exception of the higher net interest income and adjustments to our tax rate guidance, our outlook remains consistent with what we shared in January. We expect average loan balances to increase to the $88.5 billion to $89.5 billion range with deposits growing less than loans. Net interest income is anticipated to be in the range of $3.95 billion to $4.05 billion, assuming one more increase in the middle of the year and another later on. In our appendix, we updated our net interest guidance, including our interest rate sensitivity slide with different rate and balance sheet assumptions. We expect non-interest income to fall between $2.5 billion and $2.6 billion as we continue to drive growth from our core businesses and realize First Niagara revenue synergies. We anticipate non-interest expense to range from $3.85 billion to $3.95 billion, with the first quarter being the high point in expenses for the year. Net charge-offs are expected to remain below our targeted range of 40 basis points to 60 basis points, and our loan loss provision should slightly exceed the level of net charge-offs required for loan growth. Given our lower starting point this quarter, we've adjusted our full-year guidance for our GAAP tax rate down to 17% to 18%. As Beth mentioned, this was a good start to the year for us with ongoing growth throughout our franchise. Although there were some fluctuations and seasonal impacts in our expenses, we remain confident in our outlook and expect to make significant progress this year toward achieving our long-term goal. I'll now turn the call back over to the operator for instructions for the Q&A portion of the call.

Just have a quick question on the efficiency ratio target. Are you guys referring to reported efficiency ratio, the 54% to 56% or are you excluding the intangible amortization?

Other than cash efficiency ratio and that’s why we use as our target, which would exclude the intangible, that’s correct.

In terms of technology spending, how do you view the potential for increased expenses moving forward? I'm interested in understanding the risk of seeing additional, perhaps accelerated, technology spending in future quarters, and whether this has been factored into your expense guidance. I'm also curious about the upside risk involved.

No, it is built into our guidance and we would expect the first quarter like expenses overall will be the high point as far as our technology spend and we will continue to manage that appropriately going forward.

And then just one last question. On Slide 7, you mentioned the migration into higher yielding products in terms of the deposit side. Can you just elaborate on how pervasive is that and what do you expect over the course of the year? Thanks.

I think you can see that in the time deposit line item, we’re seeing much more growth there than we are in other deposit products. And that’s essentially where the consumer and some commercial customers are going to get the increased rate, but we’re not seeing a lot of the core money market pricing and others change yet. And so we’re seeing that drift back into time deposits and we expect that to continue throughout the next year.

Thank you for your comments about the high watermark and the decreasing expenses. I’m curious if you could elaborate on your views regarding the cost trajectory for the rest of the year. Specifically, do you anticipate an immediate reduction in costs in the second quarter followed by some growth, or will it be a more gradual change throughout the year? Additionally, I'm interested to know if you have accounted for the typical seasonal rise in compensation costs in the fourth quarter, which usually sees the highest expenses due to investment banking, and whether you still believe you can decrease expenses despite this trend at the end of the year.

And I would say that as we look at our outlook for expenses from the first quarter level that would imply that the second through fourth quarter should on average be down about $40 million. And so if we look at what we incurred in here in the first quarter, we had the higher benefit cost of about $30 million and also we had some one-time items that would mention as far as the accounting. Purchase accounting true-up which costs us about $4 million and also elevated operating losses which cost us about $3 million. And so those three combined are in that $38 million range. We would expect the benefits cost to come down meaningfully here in the second quarter. We won’t recapture a 100% of that $30 million windfall but we do expect to see a meaningful adjustment down for that. We’d also expect those other items of purchase accounting true-up and the operating losses not to continue for that base. But we do expect to see some other things that would occur in the second quarter, which includes some of the merit increases come through and those will be offset by some of the savings that we’ll be expecting to achieve. And to your earlier question, we are also taking into consideration the increased compensation related to higher investment banking fees throughout the rest of this year as well. And so that is embedded in our guidance for this year and as a result, we would expect to see a different trajectory as far as expenses this year compared to what we would have seen in previous years and more of that’s related to the timing of some of these expense programs that we’ve talked about and making sure that we achieve those savings as part of our continuous improvement to offset those increases.

So regardless of what happens with revenue, your plan is to enter 2019 with a lower fourth quarter expense base than what we have now, correct?

It’d be our expectation based on the timing of these expense initiatives we talked about.

Following up on Scott’s questions, thanks for the insights, Don. Will expenses decrease for the remainder of the year, and should we anticipate that the first quarters will generally have the highest expenses as we move into 2019? Or are we now entering a different downward trend?

We would expect to see some seasonality in the first quarter of every year, mainly because of the benefit expenses. I would say that this first quarter, we had about $20 million of items that were elevated compared to what our expectations would have been coming into the quarter. Benefit costs themselves were about $5 million higher, we had severance costs of $5 million and then we also have the other two items I mentioned, which was the true-up of purchase accounting and also the higher operational losses, which we wouldn’t expect to continue going forward.

And then just on the topic, it’s really helpful to consider that approaching the high end of 40 to 54 to 56 is quite a distance from the 62.9 that you just reported, given everything you've mentioned. I just want to clarify, can you help us understand what approaching really means? Is it more about direction or do you actually expect to get close to that 56 side?

We mean that we will be closely approaching that 56 side.

Can you give us some additional color? You had some strong commercial loan growth in the quarter, sequentially annualized it was about 12%, I guess. Can you share with us where that's coming from maybe geographically? And Don I think you mentioned something about some overlapping, I am assuming with the First Niagara franchise some growth came from that area and the some further color on this growth.

I’ll ask Chris to provide some more color here as well. But you’re right. The growth was driven by a number of things, one is that we did have some pipelines and volumes that really got pushed out of the fourth quarter into the first quarter, and so we saw growth there. We also benefited this quarter significantly from pay-downs being lower and that was about $1.3 billion lower pay-offs this quarter than what we had in the fourth quarter. And so that was a huge benefit to us as well. And the growth was across the board, and I think Chris will highlight some of the markets, especially some of those new markets for us that contributed to it.

So if you just step back for a second, our business is one where we’re constantly out talking to our clients and things develop over time. So if you step back, we have more bankers, we have better dialogue, we have more clients, we continue to expand the clients that we have. So in any given quarter, you'll see movements like this. We had really strong performance across the board. We had strong performance in the Rocky Mountains, strong performance in the Pacific Northwest, we had strong performance in our Hudson Valley area. We also had strong performance in some of these overlap markets that Don mentioned and those would be markets like Buffalo and some of our new markets like Pittsburgh and Philadelphia. Also in our industry based businesses, we had pretty much across the board growth, so it was just a really good quarter for both on and off balance sheet growth.

And then shifting to the other side of the balance sheet on the deposit side, I may have not heard this so I apologize. Can you give us an idea of what the deposit betas are doing today? And what is your expectation and when you will get to your terminal deposit beta, is it later this year 2019 and about what level would that be when you look at it?

As far as the deposit beta this quarter, you can look at our deposit rate went up by about 5 basis points this quarter compared to the 25 basis points increase in fed fund. So calculating just that way simplistically, it’s about 25%, on a cumulative basis we’re at 22%. We would expect that 25% to continue to increase throughout the rest of this year and probably getting into the 2019 time period for future increases would be more to our normalized beta, which we've historically talked about mid-50s beta. And so we would see a gradual increase from here to that point. And those are the assumptions are baked into our net interest income guidance for the outlook for this year.

Just wanted to follow-up on Scott and Ken's line of questioning. So I thought it was very clear the way you outline some of the seasonality, Don, on the first quarter expense line. But within the revenue parameters that you laid out in Slide 13, the quarterly run rate for expenses should average between $965 million to $981 million using the midpoint to high point of your expense range.

That's correct and so I would just say that it's roughly on average about $40 million decline from what the first quarter level was. And again a good portion of that really comes from the removal of some of these one time or seasonal items. And so essentially the increases in incentive compensation related to stronger performance and capital markets and some of the other investments we’d be making will be offset by the impact of the cost savings we talked about and the timing of those.

And as a follow-up on the net interest income guide, you guys clearly outperformed on client activity trends among regional banks this quarter. I am wondering what average loan growth and balance sheet side you've contemplated underneath that $3.95 billion to $4.05 billion guidance.

What we've included in here is the guidance we have for total loans. And so the midpoint of that I believe was $89 billion and the midpoint of the deposits was in the $1.04 billion range, so those would both be about $2 billion increase from where we were on average basis for the first quarter. And based on how we’re positioned to-date with our ending balances for loans being up $1 billion from the average for the first quarter, I think we're off to a good start here in the second quarter.

And one last one for Beth. Beth, with the stress capital buffer proposals that had come out two weeks ago or I guess last week clearly favorable for lower risk models like KeyCorp and favorable towards higher dividend payers. I am wondering if that could potentially change how you’re thinking about capital return if the proposal is passed as written?

Good question Erika, and no it does not. But it certainly does augment and support how we have talked about our capital priorities.

If I have to look at pretax pre-provision net revenue for the first quarter, it was down 4% year-over-year. And I’m just wondering did you possibly frontload some of the expenses for the revenue enhancements last year, and so there should be better operating leverage going forward?

I would say that the pre-provision net revenue impact really was related to more of the timing and some of the elevated level of expenses this quarter that we expect to see come down throughout the rest of the year. And as far as the investments we’re making and the revenue synergies that more of those as we’ve talked about before are proportionate to the revenue. And so we still believe we’re on a path to achieve a run rate for those revenue synergies of $150 million a year by the end of this year and achieve $300 million target by the end of next year.

And then just one quick one on credit, it’s not major. But I’m just wondering there was an increase in C&I non-performing. Just wondering if you could give a little color?

It tends to be more deal specifics, so there really isn’t any trend or any specifics as far as industry seen any stress or pressure, it really is just one item at a time. So no big or unusual transactions and no industry concentrations there.

Thank you for the information on the expense trends. I want to revisit the topic regarding expenses. If revenues are weaker this year for any reason, could you discuss your ability and willingness to be more flexible with expenses and your capacity to adjust in order to achieve your efficiency targets?

You’re right on that point but keep in mind that a good portion of the revenue growth is coming from more of our fee-based businesses, and some of those are tied to the capital markets and there is a direct correlation between the expenses associated with supporting that and their actual revenues. And so if revenues don't come through, we would see a corresponding reduction in the expenses. And we’ve always talked as well as that we’re very focused on continuous improvement. And we’ve talked about times will make investments, because we’re seeing the payback and have additional revenue growth opportunities for making those investments. At times revenues won't be there, and so we’ll pull back on the expenses. And you’ve seen a little bit of that here with this quarter and what we’re talking about because the expense initiatives that were taken on for the rest of this year are probably elevated and toward the upper end of what our normal guidance range would be to make sure that we can manage to and live up to our commitments we made as far as our expense outlook.

You haven't shared any plans to reinvest your tax savings yet, unlike many of your peers. While I understand you're not making any announcements at this time and have mentioned that IT investments are ongoing without causing a significant increase in costs, what is the chance that in 2019 you will choose to reinvest some of those tax savings into IT or other areas?

I would say when the tax law changed, we did make an investment in our people and we increased our minimum wage to $15 an hour, and so that was meaningful to a lot of our employees and I feel that was an appropriate step to take. And we also had a one-time contribution to the retirement funds for those individuals as well. And so that was both we thought very constructive. We’re very focused on continuing to drive the core and we want to focus on driving positive operating leverage for the current year and we’ll expect to do the same thing in ’19 and beyond in. And for us to do that, our investments will have to be made through benefits we have from cost savings and from future revenue growth. And so it won't be a direct result or connected to the tax reform that’s occurred.

First is just a clarification on your NII guidance. This year’s slide deck you made it clear that it's on a tax equivalent basis, in previous versions I think it wasn’t explicitly specified. I just want to make sure that this numbers is on a like for like basis. I know it’s not a big number but it’s about $30 million, so I just wanted to make sure that we’re comparing the respective guides on a similar basis.

No, you're right. And the recently we added that this quarter is last quarter's call I had a question as to whether or not that was taxable equivalent or not, and it was. And so on a consistent basis, we just want to make sure that I was clear for the investors to know that.

And to beat a dead horse, I guess a little further couple of quick questions on cost. The $15 million of cost savings that you’ve realized, how much of that was in the run rate in the first quarter and how much do you expect to incremental expense savings to filter into the second quarter and beyond?

We have said that the full amount is in the second quarter outlook, so we will have it achieved. And I would say that we were over half the way there in the first quarter, and then you would see that in some of the non-personnel related expenses, which are down $35 million on a linked quarter basis.

I have one final question about the cost. You've discussed the seasonality in detail, but I'm still unclear about why the expense line in the first quarter showed such greater seasonality compared to previous years. A few years ago, you didn't have First Niagara, but this seems very pronounced. Could you explain why this year appears so different in terms of seasonality?

You're right, first quarter of last year would have had some noise around First Niagara, so it might not have been quite as transparent as it is this year. If you look at just, for example, the benefit costs, we’re up $10 million on an adjusted basis this quarter compared to a year ago quarter. $5 million of which was timing related and so that was more pronounced of this quarter than what we would have expected. And then beyond that as far as expenses as I highlighted earlier, we really had about $20 million worth of expenses, but just broke against this quarter and we wouldn’t expect that to continue or recur. But anything that turned against us this quarter from an expense perspective and so that really made the overall seasonality and timing related issues even more pronounced this quarter than what it has been historically.

And going forward we shouldn’t on average expect this kind of seasonality in 1Q.

So a lot of details on expenses for the full-year and what you expect existing the year. But just if you can narrow down what do you expect the range of expenses to be in 2Q specifically just to reduce the risk of any miscommunication on that might be helpful.

Matt, we typically don’t given guidance specifically on a quarterly basis. But I will say that the majority of that $30 million benefit increase we should see it come down. And so I would expect to see in the neighborhood of about $25 million decline for that line item. Two of the other line items that I talked about that we wouldn’t expect to continue at that level, it would be purchase true-up, which cost us about $4 million in the elevated operational losses which were about $3 million. And so those combined would imply about a $30 million reduction on a core basis to expenses, and I think that's a good walking around assumption for this point in time.

And then just separately, the trust fees, if we look year-over-year we’re down a little bit. I'm just wondering what's driving that. Obviously, market level has been choppy of way, but cumulatively over the last year, up nicely and that's why one component of it. But just remind us what the puts and takes are there and why that's down a little bit year-over-year?

Actually, our private banking business, which is the bulk of that, is actually on a really good trajectory. You probably saw we had $39 billion of AUM and we continue to gain a lot of traction there. That was somewhat offset by challenging comp periods for both our equity and our fixed income trading businesses.

And how much are the trading revenues versus the private bank roughly about disclosed?

We've never disclosed that, but it's relatively small vis-à-vis the private banking business.

And why were those areas weak? I think, if we look at the broader and some banking universe thinking equity overall was flat to up depending on the mixes between the two?

In that business, both our fixed income and our equity business, we really are just facilitating liquidity for our clients. The equity platforms in general I think are under a lot of pressure in terms of margins. And we just didn’t have the quarter and fixed income that we've had previously.

I wanted to start, first follow up on a commentary around accelerating the tech project. I saw the headlines that KEY upgrading its lending platform, one the airplanes upgrade the entire core. And is that what's driving this accelerated tech project that's my first question?

Good question, and two of the initiatives that we've really kicked off this year have been more of the consumer lending platforms, both for residential real-estate related and also for non-residential real estate, so there are two initiatives. Those really are the area of increase for this year. I would say that in future years, we’ll continue to have a component of our technology development to continue to reinvest in the core. And so we will see opportunities there to make those investments, and those will be again more consistent with the overall plan and efforts. This year, we also have some digital investments going on that we think that will be an ongoing part of our business model as well, because we believe those are critical for us to continue to stay current and make sure that we're making the appropriate investments in the digital aspects for both our consumer and commercial customers.

And what’s the anticipated tech spend this year?

When we look at technology spend that we would tend to have captured in a couple different buckets. One is for personnel and contractors, which all will go through the personnel line item where we saw that elevated level. And that would be in the $120 million to $125 million range for this year. I would say our total technology spend is closer to $200 million, which would include some software and hardware investment as well. And that's fairly consistent with what we’ve had on a run rate. But keep in mind in some prior periods more of the efforts were focused on the integration and conversion for First Niagara. And so we’re seeing those efforts more aligned now to the platform, the digital and just ongoing core investments in the business.

And maybe for Beth. With the potential upgrade in costs which are significant upgrade the core overtime. Do you think you have enough scale at the size to make the needed investments in tech or do you think you need to get larger share?

As we look at it, we think we have the adequate resources to support both our business strategies and the investments that we need to enable those. And that would include people, product and capabilities as we’ve talked about in the past. So being smart in allocating and prioritizing our investments is always part of how you do this, but certainly a discipline that we believe we have and do believe we are well-positioned to compete.

If I could squeeze one more in. On the expense initiatives, you talked about realigning business unit staffing adjustments. Can you give a little more color on what you're doing there? Thank you.

We have realigned our businesses following the integration with First Niagara, identifying areas where we can enhance efficiency and effectiveness. As a result, we have merged certain functions to gain efficiencies through business alignment. Regarding our staffing models, we have identified several areas where our performance exceeds the usual models, and we are meeting our targets through normal attrition and other efforts. Our focus is on staying true to these models and achieving the anticipated synergies from the combination.

So still on the efficiency topic, so retail efficiency is 69% and that’s flat with the year ago despite the First Niagara merger savings and everything else that you're doing. If you could just give some color why that has improved despite the merger savings? And maybe it’s some allocation to the business line or maybe you're not happy with the progress, or maybe you're spending the benefits of the savings or some other reason. If you could give some color on that would be great?

And as far as the efficiency ratio for the overall Community Bank that we are seeing the improvements that we want to see that we are seeing the savings come through for the merger. The Community Bank was a disproportionate party that was impacted by some of these seasonal and/or unusual costs this quarter and that drove their efficiency ratio up. We would expect to continue to see some strong positive operating leverage from the Community Bank going forward and expect to see some of these seasonal items go away and show some meaningful progress going forward from that.

It sounds like you're quite enthusiastic about achieving a 69% efficiency ratio in that business line and you anticipate improvements. However, considering you have a technology budget of $200 million per year, I want to revisit the scaling timeline. For comparison, JPMorgan's technology budget is $11 billion, which brings up the question of whether the investment phase may take longer than you anticipate. Could you clarify if the $200 million annual expenditure on technology is accurate?

You’re right. As far as the overall spend, I would say that we can remain very competitive with that. The other thing that we have going forward is our ability to partner with fintechs and other providers. And so while we might not be developing our own capabilities like some of the larger banks might, we believe we can get some of the same benefits. And we’ve talked about that in the payment space where we have a number of strategic partnerships where we can bring to market very competitive and very technically advanced types of products and capabilities to our customers without having to develop that ourselves. And so the $200 million is just consistent with how we look at as far as the spend and believe it’s appropriately positioned going forward.

So first question is for Chris or for Don. Are you seeing any increase in your line utilization at the end of the quarter versus the prior quarter?

Actually, our utilization across both our community and corporate banks has been relatively flat.

And then moving towards your order book, I know it’s a small percentage of your overall loan portfolio. How is the order book behaving?

The order book has done very well. But again we focus on a FICO score of about 760, the delinquencies has been holding up very well and we’re fine with the performance of that business. And as we highlighted, that’s been an area of benefit to us as far as taking that product across the legacy key footprint to the dealers that we already have relationships with. And so we’re seeing some synergies from that as well.

And then my last question is on revenue enhancements from the First Niagara, it’s a follow-up to Gerard's question. Can you talk about any revenue enhancements that you're seeing from there?

Again, on that front, we do expect that those are moving in line with outlook that we expect to be at $150 million run rate by the end of this year and $300 million by the end of next year. Where we're seeing benefits already are on the commercial payments space where we continue to see a nice adoption rate going from the former First Niagara customers and some of the products and capabilities we have there. We’ve seen some strong growth as far as the capital markets related activities, especially on the commercial real estate customers from First Niagara. And we placed about $400 million of debt on that front, so that’s been a real win for us. We talked about indirect auto earlier with you Kevin as well, and so we’re seeing growth there. One thing that hasn’t shown as much on the bottom line so to speak that we’re seeing good activity is the residential mortgage. And if we look at the application volumes here for the first quarter, they’re up 41% from a year ago. And so we haven't seen volume come through as far as closed deals and that we are optimistic that we’re starting to see some pick up here in the second quarter and beyond.

And Kevin, I would add that on mortgage side part of what we talked about last year was ramping up our staffing as well as investments and making sure our platforms from underwriting through servicing we’re ready to accommodate what we saw was probably the largest driver of our revenue synergy. And so I would say we entered 2018 staffed and ready, but that is something that will definitely build throughout the year, and is reported on our income statement in the way where we will be able to track it.

Maybe back to that little pick-up in C&I non-performers, I mean I hear you say that it's nothing industry specific. But is there anything in terms of the characteristics of those companies or deals anything might leverage or interest cover that stands out as a common factor across loans that have gone into non-performing?

There really aren't any common threads there at all, but what we're seeing in our small leverage portfolio that are relatively stable and it continues to perform well. It is more of a deal-by-deal basis that we're seeing some increases there, and it's very slight. And it's up from the fourth quarter but down from the first quarter of last year, and as the percentage of total loans at 61 basis points, which is still pretty low compared to the industry overall.

And more broadly, we started to see some more press on rising leverage in the corporate sector. We've heard from one or two other banks comments on that as the sign that we might be getting later in the cycle. Do you agree that that's a concern or how do you think about that?

So there is really two things, one is our book. Our leverage book has been flat for some period of time, so that's a book that is a small percentage of our total loan portfolio and secondly it has a lot of velocity. With respect to leverage in general and what we're seeing in the marketplace, there is in fact rising levels of leverage in some transactions in some parts of our business and obviously that's something we watch very closely.

Focusing a little bit more on the revenue side. You had a pipeline for investment banking debt placement, just curious about the step down that we have this particular quarter. Do you think that's a temporary pull-back or do you think that this is more normal levels and there is a little bit of pull through or acceleration as rates were going up that people are trying to do deals faster than the rates were climbing. So just thought about that revenue stream as you move through the rest of the year?

What I think you’re really seeing is a pretty typical seasonality that we experienced in that line. We always look at that line on a trailing 12 basis. And so if you look at, for example, in absolute terms this is a record first quarter for us. If we look at our backlogs now vis-à-vis a year ago, our backlogs are actually better than they were a year ago. So we feel pretty good about where the business is. There was one thing and we noted there were a few pay downs in the first quarter and when you have fewer pay downs, typically that can adversely impact the fee line and investment banking and debt placement fees as well. But we feel really good about where the business is and particularly where it is vis-à-vis this time last year.

Don, I have two questions for you. First, regarding the roll-up of security yields and the re-pricing of our interest rate swaps, there seems to be an increase in those yields. Could your net margin continue to rise if the Fed stops raising rates, considering the benefits from medium and longer-term rates? Secondly, the tax rate decreased this quarter. Is that related to the stock price and potential benefits, or was that an unusual item? Just two points I wanted you to address. Thanks.

As far as the overall margin, we do believe that there’ll be a lift there as far as the cash flows are for our investment portfolio. I think we highlighted that new purchases were coming on at about a point higher than what the roll-off of the portfolio, and we’re seeing about $1.2 billion plus of the cash flow each quarter now on the investment portfolio, same thing on the swap books. We had about $1.4 billion of maturities to the swap book and the rollout rate versus the new rate for those replacement swaps is about 160 basis points wider. And so we’re seeing lift there as well. And so we think those would both be additive. And so when we think that there could be some lift there, we would refer to the core margin as being relatively stable even if rates don't go up with maybe some slight bias for something with lift there because offsetting that would be the continued drift to the portfolio on the deposit side more on the time deposits and also seeing some of the impact as far as a continued reduction in purchase accounting accretion, which would decrease our margin by about a basis point a quarter. And then as far as the taxes, you're right but they’re really two components that drove that each in the $10 million range as far as the benefit this quarter, one was for the employees' stock purchases and vesting that occurred; and that really is more heightened as far as the first quarter based on when some of the stock plans do vest; the other was higher tax credits. And the way that we would look at that is it did have a benefit to us this quarter, but that really essentially offset some of the timing issues we saw on the expense side. And so we feel pretty good about the quarter being at $0.38 and feel that both of those essentially offset each other and provide for a baseline for us going forward.

One of your competitors is mentioning that there is increased competition in the market due to the effect of tax reform. Have you contemplated increased competition on loan yields in your NII guidance and are you seeing some of that increased competition in your markets today?

I’ll take the first crack at this and hand it over to Chris to get more color on the competition. But I would say that pricing on the commercial front has been extremely competitive here over the last year plus. And we’re not seeing any change or acceleration of that competition, or any more pressure on the pricing after the tax reform than what we did before. And so I don't want to characterize this as there isn't some impact there, but I would say that it’s the continuation of what we’ve been seeing. Our outlook for the net interest income guidance for us does assume that we continue to see a very competitive marketplace as far as pricing for new loan volumes and repricing.

One thing I would add is that in the real estate sector, the level of activity has intensified even more than in the commercial and industrial area. This is evident in our business as our approach to serving clients has not changed. We are seeing substantial growth in commercial mortgages, which have increased by 21% quarter-over-quarter. We are focused on identifying the right solutions to meet our clients' funding needs.

Thank you, Operator. And again, we thank you all for taking time from your schedule to participate in our call today. If you have any follow-up questions, you can direct them to our Investor Relations team at 216-689-4221. And that concludes our remarks for today. Thank you.