Keycorp (KEY) — Q4 2018 Earnings Call Transcript

Thank you, operator. Good morning and welcome to KeyCorp fourth quarter 2018 earnings conference call. In the room with me is Don Kimble, our Chief Financial Officer; Chris Gorman, President of Banking, and Mark Midkiff, our Chief Risk Officer. Slide two is our statement on forward-looking disclosure and non-GAAP financial measures. It covers our presentation materials and comments as well as the question-and-answer segment of our call. Now, I am moving to slide three. As you have seen with our headlines this morning, Key reported strong results for the fourth quarter. This finishes what has been a very successful year for our company as we continued to grow, invest for the future and deliver on our financial commitments. For the fourth quarter, we reported GAAP earnings per share of $0.45. Our EPS results included $0.03 from a pension settlement charge and costs associated with our efficiency initiative, which we refer to as notable items in our materials. Adjusting for the $0.03 of notable items, it brings our core earnings per share to $0.48 for the quarter. To provide a consistent view of our financial trends and prior period comparisons, my remarks this morning will focus on the adjusted core numbers, which exclude notable items in all periods. Our strong fourth quarter built on the momentum we continue to see across our company. Highlights for the quarter included solid revenue growth, well-managed expenses, strong credit quality with a meaningful decline in nonperforming loans and further improvement in criticized and classified loans. Improved efficiency and return measures were both up almost 400 basis points from the year-ago quarter, and disciplined capital management, which includes returning a significant amount to our shareholders through dividends and share repurchases. Don will spend more time on the fourth quarter detail, so I will focus most of my comments on our full-year performance. 2018 was our sixth consecutive year of positive operating leverage. Our return on average tangible common equity increased during the year, reaching 17.5% in the fourth quarter. For the year, we reached a record level of revenue of $6.4 billion, reflecting continued growth in loans and deposits, as well as achieving all-time highs in several of our fee-based businesses, including investment banking and debt placement fees. The growth in both spread and fee income reflects the breadth and depth of our business model and our ability to acquire and expand relationships with our targeted clients. Expenses remained well controlled as we drove efficiencies across our company, while continuing to make investments in areas where we have targeted scale and reach. Yesterday, we announced an exciting new opportunity to build out our digital consumer lending platform with the acquisition of Laurel Road, which I will discuss later in my remarks. Over the past year, we improved our cash efficiency ratio by over 300 basis points and we remain on a path to achieve our $200 million cost savings target in 2019, which represents approximately 5% of our total expenses. We expect to reach our targeted cash efficiency ratio range of 54% to 56% by the second half of 2019. Our credit quality has remained strong with net charge-offs to average loans remaining below our over-the-cycle range of 40 to 60 basis points throughout the year and 27 basis points for the fourth quarter. Our non-performing loans declined by over $100 million from the prior quarter and represented 61 basis points of period-end loans. The linked quarter improvement was consistent with our previous comments that the increase in our third quarter NPL level was temporary and was not indicative of a trend. Other credit metrics, including criticized and classified loans, which we look to as leading indicators, improved again during the fourth quarter. As noted in our recent Investor Day, during my time as CEO, we have dramatically enhanced our risk practices and improved our risk profile. We continue to remain consistent and disciplined in our credit underwriting and portfolio management, and we are committed to outperform through the business cycle. We believe that our steadfast commitment to maintaining our moderate risk profile will continue to serve us well. In terms of capital management, we have consistently delivered on our stated priorities of supporting organic growth, growing dividends and prudently using share repurchases. And consistent with our 2018 capital plan, we increased our common stock dividend by 62% in 2018 and our dividend yield now stands at over 4%. We also repurchased over $1.1 billion of common shares throughout the year. Key's common equity Tier 1 ratio ended the quarter at 9.92%. Again, it was a strong finish to the year, with broad-based growth across our franchise, record annual revenue, well-managed expenses that drove meaningful improvement in both efficiency and returns, maintenance of our moderate risk profile, and continued capital returns to our shareholders. Now, let me turn to the announcements that we made yesterday, and I am now moving to slide four. From a transaction standpoint, we have acquired the digital lending business from Laurel Road Bank. This business operates under the name Laurel Road and is a leading digital-first consumer lending platform, focused on student lending refinancing, primarily targeted at advanced degree medical professionals. To be more specific, approximately 70% of the clients are doctors and dentists with another 20% being lawyers and MBAs. The overall demographics of this target client base is extremely attractive, including an average age of 33, average FICOs of 760, and income of approximately $185,000. Strategically, this is a strong complement to Key’s approach of building targeted scale against specific client segments. Moreover, it closely aligns with our enterprise healthcare focus. While this distinctive platform is on the path to having scale in the business with student lending, it is also a concept we shared at our Investor Day. The Laurel Road team has been proactively expanding its product set to build broad-based relationships with these targeted clients and prospects. In the last year alone, the team has developed and launched personal and secured loans, mortgage and deposits, all delivered digitally on their industry-leading platform. In October, we also shared our views on the power of strategic partnerships to execute our strategy. Laurel Road believes this as well and has constructed a network of over 150 affinity partners with whom they are the preferred provider to these targeted client segments. The winning formula for clients, partners and Laurel Road matches our model and our clients, the way we at Key approach this business. Over the past several years, we have spent significant time developing a distinctive partner capability. In that process, we have interacted with many different fintech teams and other potential partners. To date, we have not yet found a business model or a management team with whom we are this closely aligned, which was a critical factor in our desire to engage in this transaction as well as the alignment with our relationship strategy targeted in an attractive and complementary client segment. And with that, let me turn the call over to Don.

Thank you, Beth. I'm now on slide six. As Beth said, we reported fourth quarter net income from continuing operations of $0.45 per common share. Adjusting for the notable items, a pension settlement charge and costs related to our efficiency initiative, primarily severance, earnings per share was $0.48. Our adjusted results compared to the $0.36 per share in the year-ago period and $0.45 in the third quarter. The severance cost this quarter, which totaled $24 million was due to early actions taken to achieve our $200 million cost savings target and reach our cash efficiency ratio goal of 54% to 56% by the second half of 2019. I will cover many of the remaining items on this slide in the rest of my presentation. So, I'm now turning to slide seven. Total average loans of $89 billion were up 4% from the fourth quarter of last year, driven by growth in commercial and industrial loans, which were up 9%. Linked quarter growth in average balances was primarily from commercial industrial loans and commercial real estate. Importantly, our growth continues to be driven by building and expanding core middle market relationships in our targeted areas. Our business model positions us to offer our clients a wide range of financing alternatives, both on and off-balance sheet. In 2018, approximately 16% of the total capital we raised for our clients went onto Key’s balance sheet. Our C&I lending continues to be broad-based, done through our footprint as well as our targeted industry verticals. Commercial real estate where we saw some balance sheet growth this quarter is primarily an originate-to-distribute model that drives fee income and strong returns while providing flexibility in managing portfolio risk. In the fourth quarter, we placed $5 billion of commercial mortgage loans in the market and a total of over $13 billion for the full-year 2018. In 2019, we expect to continue to grow loan balances as we support our relationship clients. The tone and sentiment with our clients remains positive and our pipelines remain solid. That said, we remain committed to our moderate risk profile and we will continue to walk away from business that does not meet our risk parameters. Continuing on slide eight. Average deposits totaled $108 billion for the fourth quarter of 2018, up $2.3 billion or 2% annualized compared to the third quarter, and up 4% from the same period one year prior. The cost of our total deposits was up 11 basis points from the third quarter, reflecting higher interest rates as well as the continued migration of our portfolio into higher yielding products. Growing deposits and being core funded remains foundational to the way that we run our business. We experienced strong deposit growth this quarter, both consumer and commercial, by consciously using market rates in a very-targeted way to retain and deepen existing relationships with our best clients. Importantly, we are not acquiring new rate-sensitive deposits only business. As expected, our deposit betas continued to move higher. The incremental beta in the fourth quarter was 60%, bringing our cumulative beta to 33%. On a linked quarter basis, deposit growth was primarily driven by the penetration of our existing retail and commercial relationships as well as short-term and seasonal deposit inflows. We continue to have a strong, stable core deposit base with consumer deposits accounting for 61% of our total deposit mix. Turning to slide nine. Taxable equivalent net interest income was just over $1 billion for the fourth quarter 2018, and net interest margin was 3.16%. These results compared to taxable equivalent net interest income of $952 million and a net interest margin of 3.09% for the fourth quarter of 2017, and $993 million and 3.18% in the third quarter. Purchase accounting accretion contributed $23 million or 7 basis points to our fourth quarter results, compared to $26 million or 9 basis points in the third quarter and $38 million or 12 basis points in the fourth quarter of 2017. Excluding purchase accounting accretion, net interest income was up $71 million or 8% from the fourth quarter 2017. The increase was largely driven by earning asset growth and our positioning to benefit from higher interest rates. Net interest income excluding purchase accounting accretion increased $18 million or 2% from a prior quarter, benefiting from earning asset growth and higher loan fees, partially offset by higher deposit betas. The net interest margin was negatively impacted by deposit growth exceeding loan growth for the quarter, and excess funds were deployed into the investment portfolio. Moving onto slide 10. Key's non-interest income was $645 million for the fourth quarter 2018, compared to $656 million for the year-ago quarter and $609 million from the prior period. Comparison from the year-ago period reflects record results for investment banking and debt placement fees in the fourth quarter of 2017 and the sale of our insurance business in the second quarter of 2018. We continue to see positive momentum in many of our fee-based businesses with linked-quarter increases in trust and investment services, investment banking and debt placement fees, and corporate services. That said, investment banking and debt placement fees achieved a new record level in 2018 as we continue to experience strong growth across our capital markets platform. In the fourth quarter, our results benefited from strength in our commercial mortgage and M&A advisory. Corporate services income increased as well, reflecting higher derivatives and trading income, and trust and investment services income grew, largely due to stronger brokerage commissions. Turning to slide 11. Fourth quarter non-interest expense was $1.012 billion, or $971 million excluding notable items consisting of a $17 million pension settlement charge and $24 million of efficiency-related expenses. This compared with $1.098 billion in the fourth quarter of 2017, which included $85 million in notable items and $964 million in the prior quarter. The table on the bottom left side of the slide breaks out the notable items incurred in both the current and year-ago periods. Compared to the prior quarter, non-interest expense increased $48 million on a reported basis or $7 million excluding notable items. This $7 million increase reflects higher business services and professional fees and higher other expenses, partially offset by the elimination of a quarterly FDIC surcharge. Business services and professional fees reflect a number of corporate initiatives related to CECL, our payments business, and technology enhancements. Over half of the increase in other expenses related to the pension settlement. Other expenses in the fourth quarter also included higher operational losses, insurance reserves, and additional investment in our payments business, along with other seasonally elevated expenses. As Beth said, we remain committed to our $200 million cost savings target this year, and reducing reported expenses by low single-digit range. We expect to reach our cash efficiency ratio target of 54% to 56% by the second half of the year. Moving on to slide 12. Our credit quality remains strong, and we continue to be consistent and disciplined in our underwriting. Net charge-offs were $60 million or 27 basis points of average total loans in the fourth quarter, which continues to be below our over-the-cycle range of 40 to 60 basis points. The provision for credit losses was $59 million for the quarter. As expected, non-performing loans were down this quarter with NPLs declining by $103 million from the prior quarter and now represent 61 basis points of period-end loans. Other leading indicators, such as criticized loans and delinquencies, all showed improvement this quarter. Turning to slide 13. Capital also remains the strength of our company with the common equity Tier 1 ratio at the end of the fourth quarter of 9.92%. As Beth mentioned earlier, we have remained true to our capital priorities, including returning a significant amount to our shareholders. Quarterly common share dividend increased by 62% over the past year from $0.105 to $0.17 per share. We continue to repurchase common shares, which totaled $278 million this quarter and over $1.1 billion for the full-year 2018. On slide 14, we've provided our outlook for 2019. This builds on our performance in 2018 and reflects our expectations for another year of strong positive operating leverage and continued momentum across our company. Average loan balances are expected to increase to the $90 billion to $91 billion range, once again driven by our commercial businesses. Average deposits should continue to grow, reaching the $108 billion to $109 billion range. Net interest income should be in the $4.0 billion to $4.1 billion range. Our outlook assumes no interest rate increases in 2019. We expect non-interest income to be in the range of $2.5 billion to $2.6 billion with growth in most of our core fee-based businesses. We also look for another year of growth in our investment banking and debt placement business. Additionally, we expect non-interest expense to be down low-single-digits from a reported 2018 level, in the range of $3.85 billion to $3.95 billion. This range includes the realization of the $200 million in runaway cost savings and reaching our targeted cash efficiency ratio of 54% to 56% in the second half of the year, which includes the impact of our Laurel Road acquisition, adding approximately $50 million to the range. We see nothing on the horizon that changes our expectations on credit quality with net charge-off and provision expense remaining below our targeted range of 40 to 60 basis points. Our loss loan provision should slightly exceed our level of net charge-offs to provide for loan growth. Our GAAP tax rate should increase slightly to the range of 18% to 19%. Our guidance also assumes some variability over the course of the year. The first quarter will reflect an expected decline related to seasonality including a lower day count and customary step down in capital markets activity from strong fourth quarter levels. Additionally, the first quarter carries an increase to employee benefits costs, which will elevate personnel expense by about $30 million. The guidance also includes the impact from the Laurel Road acquisition as Beth discussed. Laurel Road will add less than $50 million to both income and expense in 2019 and will be dilutive by approximately $0.02 for the year and accretive thereafter. The near-term dilution reflects a change from their gain-on-sale model to our plans to place these attractive loans on our balance sheet. With the expected mid-year closing and the gradual build-up of our loan balances in the second half, it will also have a very modest impact on our full-year loan growth. While adding slightly to our efficiency ratio in the first year, it does not change our commitment to reach our cash efficiency ratio target of 54% to 56% in the second half of 2019. Overall, 2019 should be another good year for Key, building on our momentum with strong operating leverage, focused risk management, and continuing EPS growth. On the bottom of the slide are our long-term targets. We are already operating within the range of 3 of the 4 measures and believe we will reach our efficiency ratio during the year. That said, we have significant upside remaining to improve returns and deliver value to our shareholders. We remain confident in our ability to continue to move toward the top tier of our peer group and believe over time, the market will recognize our progress and improved results. I’ll now turn the presentation back over to Beth.

Thanks, Don. And before moving to the Q&A, I'll make a few closing comments. Despite the volatility that was experienced late in the year, I am pleased with our results and the momentum we have and share Don’s confidence in our outlook. Over the past several years, we have made incredible progress across our company and we have delivered a step change in our financial performance. We are now approaching peer-leading levels of return while remaining disciplined with risk and capital. In the fourth quarter, we increased our return on tangible common equity target to 16% to 19%. As Don pointed out, we remain on a path to achieve our long-term targets. Our stock valuation, however, does not reflect our stronger performance, competitive positioning, and improved risk profile. We continue to believe that Key offers a compelling investment opportunity, given our track record and focus on sound, profitable growth supported by a dividend yield of over 4%. I remain optimistic about Key's future, and I'm proud of the momentum and accomplishments of our team in 2018. As we look forward, we are well-positioned to grow revenue, control and reduce expenses, manage risk, drive further efficiency improvements, and ultimately drive higher returns for our shareholders. I will now turn the call back over to the operator for instructions for the Q&A portion of our call.

Good morning, everyone.

Good morning.

Hey. Don, quick question just on the cost outlook, a lot of moving parts this year. You guys typically have, I guess, more seasonality in the quarterly cost base, just to begin with, given the investment banking component. And we're layering in the acquisition, but then you have the cost savings. So, I was just hoping you could maybe give a little more color on how you would expect the quarterly base to kind of trajectory flow throughout the year. In other words, is there a quarter like the 2Q that represents a high-water mark and then we start to come down, or would the fourth quarter be the low-water mark for the year and that we get the run rate cost savings? How do you see that all panning out?

Great. Like you said, there are a number of moving parts. One, we did highlight the first quarter; we do expect to see a pick-up in expenses reflecting the $30 million of higher benefit cost. Now, that would be offset slightly by the impact that we expect investment banking to have placement fees to be lower in the first quarter compared to the fourth quarter, which tends to be a high point. Those two items will impact the first quarter. As our continuous improvement and efficiency improvements we’re making, we should see some small amounts come through in the first quarter, start to build in the second quarter, and really for the second half of next year the majority of those $200 million in run rate should be reflected in our expense levels. So, we would expect to see the improvements come through there. Laurel Road, we talked about having an acquisition in mid-year of ‘19, and that really drives that roughly $50 million in expenses. You would see that in the second half of the year. So, that would minimize some of the bottom line reduction regarding expenses that we will be achieving on expense savings, but still would—in my mind show probably the low point in expenses being in the third quarter and fourth quarter being up a little bit just to reflect the seasonality we typically see in our capital markets-related revenues really typically being stronger. Again, I think those all combined still get us to that 54% to 56% efficiency ratio range in the second half of the year.

Okay. That's perfect. Thank you for that. And then just a quick question on the margin outlook. So, you had a little liquidity build that you discussed. In the slide presentation, you note that some of the deposit inflows were kind of short-term and/or seasonal. So, one, how does that all play out? I imagine some of that’s securities portfolio that comes down if the deposits are indeed seasonal. But, would that allow the margin maybe to see a little lift here in the near-term, as an offset?

We would say that our margin outlook for ‘19 would be relatively stable with what we're seeing for ‘18. In ‘18, we're at 3.17 for the full year and 3.16 for the fourth quarter. They’re both pretty tight already. We do think that there could be a little bit of improvement in the overall liquidity positions. Right now, our guidance would suggest the deposit growth with about equal loan growth. So, we don't see a significant change in the overall liquidity position. Not also including any assumed rate increases for ‘19. Therefore, we wouldn't see a lot of lift from that either.

Good morning.

Good morning.

I was just wondering, when I look at the loan growth in the fourth quarter, it was more broad-based than what we've seen in the past, which was more reliant on C&I. I’m just wondering if you can give some color behind the change, and do you think that’s sustainable going forward?

I believe that if you examine the average balances, you would notice growth in commercial real estate. What happened was some portfolio building in the third quarter that continued into the fourth quarter due to our usual loan sales. We mentioned that for the quarter, we sold about $5 billion worth of commercial real estate balances. On page 21 of the earnings press release, you can see that our total loan sales for the quarter were $5.5 billion. This is significant considering the challenges in the markets and what we achieved for our customers. The commercial real estate balance was primarily a timing issue. However, we are still seeing growth in consumer categories, especially in indirect auto lending. We expect that as we integrate with Laurel Road, we will also observe other loan growth components later in 2019.

And just a follow-up. Can you talk about maybe some potential flexibility you might have to fund loan growth? The loan-to-deposit ratio has been steady. I'm just wondering if you would let that kind of trend upward or maybe use securities and excess liquidity to fund some of the loan growth, putting less pressure on deposit costs.

Good question. I would say that we are very focused on having our balance sheet core funded. We're doing that through growth in our deposits with our existing customers. We're not out there trying to get wholesale deposits and more of a digital channel base. We’re growing those with our existing customers and adding to those relationships, deepening those relationships on the deposit side. We continue to do that. Our outlook, as I mentioned, would suggest that loan growth and deposit growth are about equal for next year, and we like it that way. My preference longer term is to have a little bit higher loan-to-deposit ratio and have less liquidity on the balance sheet to put near term. We're not seeing that in our outlook.

Good morning.

Good morning.

On the loan growth. Just looking at the commercial trends, end-of-period versus average, it doesn't appear that you saw a lot of a benefit at all from the capital markets seizing up in December. Some of the other regionals have seen some benefit from that. Could you just talk about it, if you saw that at all and if that could impact the outlook at all? Thanks.

John, it's Chris. We actually did not get the benefit of that impact. As we look across our book, our clients are doing very well. Some of our clients actually at the end of the year paid down part of their loans. As Don mentioned, we had a really, really strong quarter as we moved $5.5 billion of financings off our balance sheet. We did not see a pickup in loan balances based on what was going on in the capital markets.

That's helpful. And then just to confirm one thing on the expense side. I'm pretty sure I know the answer here. But, the midpoint of your expense guidance for 2019 of about $3.9 billion is up a bit from the midpoint of what you implied in your range coming out of your Investor Day of about $3.85 billion. And that change is mainly the Laurel Road—incorporating the Laurel Road. Is that correct?

100% of the gap, yes. Laurel Road adds about $50 million to our expense base outlook for 2019.

On an annual basis? Okay.

It’s for the full-year impact of ‘19. If you look at Laurel Road for an entire year, it would be north of that $50 million number.

Got it. But your cash efficiency ratio range remains intact, because you're also dialing in the revenue impact from Laurel Road, correct?

That is correct.

And what is that, how much is the revenue?

We expect Laurel Road to be about $0.02 dilutive. For the $50 million in expenses, it suggests a revenue number of approximately $20 million for the year. The reason for this difference is that we are transitioning from a sales model to a retention model.

Got it. Okay, thank you. Then lastly, on the credit side, your charge-off guidance still for well below the 40 to 60 through cycle basis-point range for charge-offs. Can you give us a little more color? I mean, how long you think it'll turn below that when you look at the portfolio? Why not get more specific at this point in the cycle regarding your charge-off guidance?

I would say that as we look at our portfolio today, it’s still very, very good, very solid. In this last quarter, we talked about our non-performing loans being down; our criticized and classified loans were down $300 million to $400 million as well. We're seeing continued improvement in the trends there. We don't see anything that would change significantly from where we're at now. I'd say as far as down the road, multiple years, I don’t know, Mark, do you have any insights or thoughts you'd add to that?

I only would add that we're obviously at a very low level and continue to be at a low level as we kind of move into ‘19.

We're just not seeing early indicators that would suggest that’s going to change anytime soon. So, I'd be reluctant to put a timeline out there.

I guess kind of a follow-up on the Laurel Road acquisition. I just want to make sure I fully understand this. So, they no longer do gain on sale. Everything that they originate, presumably, I'm going to say 100% student lending, that goes onto your balance sheet and that, I guess, new balance sheet growth drive this $20 million this year of revenues. Then does it just continue to layer on as you grow that? What size or target balances would you expect over the next year or two or three?

Put things into perspective there a little bit that Laurel Road originated about $1.2 billion in total loans this past year. I’d say that the credit quality and nature of those loans, and more importantly the nature of those relationships we think are consistent with our targeted customer base, and we’re very excited about that. It goes beyond just the student loans as well; they've already implemented a mortgage lending capability and they've looked at other products that could add to that offering as well. It really is more of a relationship strategy for us than just the student loan origination. We do believe we’ll continue to have the opportunity to put those on balance sheet, and we'll see that annuity continue to build as that portfolio continues to mature and develop over the next couple of years.

Got you. Okay. And would you anticipate continuing any part of the gain on sale model or is…

I think that's an option for us. Where we see a good quality relationship, we’ll probably retain it. One of the things we talk about is their ability to originate mortgage loans. If it's a conforming mortgage loan, we will probably sell that in the secondary market, like we do with our existing portfolio. So, I think that's more of our approach moving forward.

And in terms of the yields that you would get on these new originations, how do they compare versus your current portfolio yields? Where are they at generally?

Generally, they're a little stronger than some of our consumer loan yields today. I think it provides a nice upside for us.

And then, just really the last question. In terms of the tax rate, it looks like it jumped up about—sorry, for your guidance, looks like it’s about 2 percentage points higher than where it was this year. Any reason for that?

I would say that the primary driver there is an outlook for a lower tax credits from some of the business models we've deployed in the past. It's just a slower rate of that. With the higher level of earnings, the incremental earnings growth is really taxed at the marginal rate, and that helps drive that tax rate up as well.

I guess, I thought—I would have thought the expense outlook, at least the high-end might have been a little bit lower, because if we look at it versus this year, it implies relatively flat costs. I know you've got the acquisition that adds 50, but you also have about $70 million of one-timers this year that you called out. It just seems like if you kind of adjust all those things, the high-end of your expense outlook is relatively flat costs. I can appreciate that some of the initiatives are stated in or phased in throughout the year. But, just from Investor Day, it seemed like there was real effort to shrink the cost base on a full-year basis.

There clearly is that effort, Matt, looking. We’ll go back and look at the math on that. My math would have shown that even on the high end, we've been down about 1%, and at the low end, we would be down about 3%. So, we think that's right in the ZIP code of what we talked at Investor Day. But, I can confirm that, Matt.

And then, just a swing factor of that $100 million, is it just depending on what revenues are, or do you have a scenario at the high-end of your revenue range, and the low-end of the expense range if you can realize all your cost savings?

I would say the primary driver of movement within that range is tied to the revenue growth, and what we're seeing from movement in the markets and also from our core business model. What we’ve talked about in the past is that we can adjust that expense based on what we're seeing as far as the economic outlook and what we see as revenue growth. Part of that expense base does assume a reinvestment back in the business. That's one of the levers that we can pull, to slow that investment if we don't see the kind of upside from those investments.

To start on deposits, if we look at the $108 billion to $109 billion guidance for deposits, Don, what's the underlying assumption for non-interest bearing deposits in that guidance?

The assumption there is we would continue to see some slight reductions in those balances throughout the next year. That's primarily in the commercial side where we continue to see those customers migrating more of their deposit mix over to the interest-bearing as opposed to non-interest bearing. This year, we saw 1% to 2% kind of decline. It’s something along those lines and probably consistent with our outlook for next year.

And then, when we look at the expense guides, are there any additional efficiency-related charges such as severance included in this guidance or is this operating guidance?

This is operating guidance; we wouldn't expect those efficiency charges to be significant for next year. We would probably see something continue at about the same level of the notable items we have this quarter throughout the first half of next year.

And then, finally, you guys have been cutting expenses obviously for many years. How much longer do you think you can run with expenses in this flat to down pattern? Once we get past the $200 million, is there wood left to chop, or do expenses start drifting higher at that point?

You must have been talking to some of our line managers trying to push back on some of the targets. I would say that generally many of these savings are really taking a look at how we can make our existing processes and workflows more efficient and going from this customer back office. We’re either using technology to help achieve those or just process redesign. This $200 million will pull out a chunk of those, but we still believe there is additional ammunition left to use for that. Even though this $200 million does include some acceleration as far as from the branch consolidations just because of the changes in our consumer behaviors. We still think that they'll provide some efficiencies from right-sizing that branch distribution as well.

Okay. And that sounds like 2020 guidance, but it sounds like even beyond the second half, there's still room for you guys to keep pretty significant downward pressure on expenses. Is that right?

We can manage those, so we can continue to generate nice positive operating leverage in the future. You're right.

Steve, we talk about it and have talked about it publicly as a journey of continuous improvement. As you think about how we align, how we go to market, technology, digitization of the enterprise, process improvement, all these are things that will be continually part of our focus. This is not a one and done.

Hi. Good morning.

Good morning.

Sorry to re-ask Matt’s question another way. I’m just trying to figure out why the stock got down when the market opened. In terms of your outlook, it seems like consensus is at the lower end of your net interest income range, at the midpoint of your fee income range, and at the low end of your expense range. I guess, I just wanted to confirm that that's fair. Any move up in the range on expenses will have to do with better revenues?

I would say that as far as our outlook, one thing that consensus would not have reflected was Laurel Road. We talked about there’d be a slight dilution from that of $0.02 a share. Our expense guidance, again, the range is more tied to what we would see from a revenue perspective. If revenues are up, we would expect to probably be at the higher end of the range, given some of the costs to support that.

Got it. And regarding Laurel Road, I think, if you get the question, is really now the time to layer in consumer risk on your balance sheet given that we're late cycle. Beth, you write off some of the statistics in terms of income and FICO that were quite compelling. I'm wondering sort of what additional layers in terms of underwriting do you plan to enhance the process Laurel Road has today, especially as you're going to go to a retention model rather than originating sales.

I would offer—this is Mark Midkiff. I would just offer that we do think that what we've seen at the underwriting is very sound and very complementary but obviously will be under our lens and our buy box. I think that will be very focused around relationships where we get better overall credit performance than when you're working at a transactional level. That will be an enhancement, and of course, we've looked at this on a stress basis and feel very comfortable overall relative to our risk appetite as well. It’s just kind of a normal ongoing outlook for losses in that business.

Got it. And just one more question, if I can. Beth, you noted strong dividend growth of 62%. Given where your stock price is trading relative to your return potential, I'm wondering if your CCAR ask for 2018—sorry 2019 would perhaps be more focused on buyback than dividend growth.

Erika, obviously, we are in the early days of starting to look at CCAR 2019. We have always been talking over the last couple of years of supporting dividend growth, and this year we were approaching that 40% dividend target payout ratio. But, we will definitely look at the mix and make sure that whatever we choose for this year's capital return, we are optimizing our use of capital for our shareholders and that would be a consideration.

Got it. And one more, if I can. As we think about first quarter trust and investment management income fees rather, I’m wondering if there’s like a 9% step down in AUM. I'm wondering what the step down would be in the first quarter to reflect that step down in AUM?

We could see some very modest pressure on that line item for first quarter, but generally in line with what were shown in the fourth quarter levels.

Hello. Good morning. Thanks for taking the question. Could you give us some thoughts on the investment banking and debt placements line? How do you think that could evolve across a range of scenarios, one where we kind of stay in tough markets like we encountered in December, and then another, where we get something more akin to what was experienced over the last few years?

This is Chris Gorman speaking. That's a line that we're really proud of the fact that we've been able to consistently grow over the last decade. Obviously, it's market-dependent. As we see the markets right now and as they are currently functioning, we believe we will continue to grow that business in 2019 as well. That's a business that grew that top-line this year 8% in a down market. If you go back to 2015, we've grown that line 46%. It’s a business based on client relationships, serving clients, and doing so for many of the same clients many times. We feel good about where we're positioned with respect to our investment banking and debt placement line. The interesting thing, if the markets seize up a bit, that’s when it could get more interesting for us in terms of opportunities to put things on the balance sheet and serve our clients.

As Don mentioned in his comments, we only put about 16% of the capital we raised last year on our balance sheet.

I would just add that part of what I have always felt is a strength of our platform and some piece of how we look at our outlook against investment banking and debt placement fees. While market-sensitive fees obviously are important, the breadth and depth of our platform, again, we have a broad range of capabilities and we are not dependent on a certain area of the markets. Given that it’s relationship based, mid-market, we do have the option to balance sheet, but we also can do a variety of things across advisory fees for M&A. We do loan syndication, debt placements, equity raises, and more in our commercial mortgage business; we have such a breadth in that platform that we really do have confidence that can generally produce those kinds of results.

Thanks. And then, if I could squeeze in a quick one on Laurel Road. I guess, there are quite a few banks that have got similar sorts of businesses—Citizens has got something, First Republic's got something. SoFi isn’t a bank, but I think is active in that space. What is it that makes Laurel Road different from those other platforms out there, at a high level it kind of feels like the customer bases are the same 33-year-old doctor or dentist with good FICO?

We anticipated that we might have an opportunity to speak more holistically about the strategic fit as well as the strength of this platform and why we found it attractive. I have asked Clark Khayat, who is in the room and really spearheaded this transaction for us and spoke to this at our Investor Day. I'm going to ask Clark to share. We are very excited and think this is a highly disruptive not only demographic but relationship-based and differentiated platform. With that I'm going to identify that Clark is in the room and ask him to take that question.

Thanks, Beth. I’d answer it a couple of ways. One, as we talked about in October, we hit on a couple of themes, two of which were distinctive platforms; the other was targeted scale. So, on the distinctive platform front, this is a very compelling end-to-end digital platform. Contrary to many others, it's not just the digital entry point; it is legitimately end-to-end, highly efficient, highly customer-oriented. They enjoy NPS scores on the consumer side that are high 60s, low 70s, numbers that frankly most banks do not enjoy. That is a function of the process, flow and experience they've built on this end-to-end platform. We do think that is quite distinctive relative to others. You noted the customer focus, and we've talked about targeted scale by identifying client segments with whom we want to do business. This one we do think is different than most, even though others may reflect those sort of demographics. A fair bit of this is driven by a very extensive partner network they've built that positions them as partners with these trade associations, member entities, and other groups to talk directly to those end users in a way that we think is quite distinctive compared to the way a broad, mass-market business might work. There’s more to that. But I think to your question, those two points in particular are the most compelling to us and give us confidence that we not only like this customer base but also we have the opportunity to continue to grow it intelligently, leveraging the partnership network they’ve built. As Beth noted, they have begun to build an extension of products for these clients based largely on the clients asking for them. The opportunity to not only be a compelling single-product provider but then to build sustainable, durable, long-term relationships that are more broad-based across product sets with this attractive client base is another thing that's very consistent with our relationship strategy. We just think the complement to the way Key thinks about its businesses and the way Laurel Road has built this platform, we just haven't seen ones that are as consistent and compelling as this for us.

Thank you.

Hey. Good morning. Look, I hate to beat a dead horse with the expenses. But, I think the communication on the guidance is really important. So, Don, when you say low-single-digit decline, I assume you're basing that off the GAAP reported number of $3,975 million. Is that correct?

That's correct. Yes.

During the year, you mentioned around $75 million in non-core items. For the next year, I estimate there's approximately $36 million, or roughly $35 million, in FDIC expense charges that will no longer apply. Together, these adjustments amount to about $110 million. Additionally, you have the $50 million from Laurel Road. So, it seems that on an operating basis, the core figure is about 3.9, 3.91, which suggests that your guidance doesn't necessarily indicate a reduction in expenses if we consider the midpoint of the range. My question is, what am I not understanding about the various factors at play? Because, as I mentioned, after these adjustments, it appears there isn’t any significant reduction in nominal dollar terms on an operating basis.

Take $3.975 billion for the full year and back up the one-time charges and then add to that $50 million for Laurel Road, it’s $3.925 billion. I'd say that the midpoint of our range would be about 2% below that. So, I think that we are showing reductions in the non-interest expense. As we highlighted at the Investor Day, that one—the low-single-digit decline also reflected the benefits of the FDIC special assessment reduction. I would say that from the non-interest expense perspective, we expect to see it come down as we go forward.

This is Chris. I appreciate the question on the leverage loans. First, let me say that we are very focused on having our balance sheet core funded. In terms of that portfolio, we haven't moved around much over the last couple of quarters, but it approaches about 1.8% of our overall assets and we feel comfortable with that level of exposure given our approach to risk management.

Our capital markets business also operates very effectively, having a strong relationship approach while monitoring market shifts.

So, help me with my thinking—I almost see a contrast. Most of the largest banks are expanding digital consumer banking outside of their footprint, right—Citigroup, JPMorgan, Bank of America, PNC, U.S. Bancorp. And just remind us where you are in expanding with digital banking outside your footprint. On the other hand, now you have Laurel Road, which is leading with consumer lending and looking to go from a single product to multiple product relationships. I'm wondering if you're gathering deposits out of footprint by a lot of your competitors, and now you're going to be trying to leverage lending outside of your footprint; perhaps you get more deposits or just help me with that thinking.

As Don said earlier, we are really focused on being core funded. We're not looking to use this platform, or frankly any other platform at this time, to drive out of footprint deposits for the sake of deposit. We would, as you noted, use the Laurel Road platform out of footprint to drive consumer relationships and lending where it makes sense, while continuing to expand that relationship with the deposit, but we want the deposit in the case where we have a broader relationship with that client. We continue to think about supporting client relationships with deposits. We did that effectively in the fourth quarter. As we move forward, whether in footprint or out of footprint, we have many commercial clients outside the footprint today, the branch footprint. We will continue to look to raise deposits, as long as those clients have broader relationships.

We are developing our own digital banking capabilities for our clients. This is not where we would gap relative to the offerings we see of other banks coming into the market with a digital-only platform. We continue to invest in our digital capabilities; this being Laurel Road as an example of where we believe it accelerates our platform both from lending and the potential for deposit-taking. We believe we are well-positioned as we compete effectively in our markets.

Good morning.

Good morning.

So, Beth, the follow-up on the last question related to mobile and digital. What kind of adoption rate do you see with your existing client base? I know you guys have made a lot of investments in that area.

Kevin, I don't have those numbers off the top of my head. I apologize for that. But I do know that we've had very strong adoption and transactionally. As everyone has reported years ago, what happens in a branch versus mobile and digital those lines crossed, and they are not growing back. It is a clearly customer preference to be able to transact their business. You may recall several years ago with First Niagara, in advance of that integration, we deployed all new customer portals across every—from commercial to consumer to our private banking clients—to new digital platforms that enable that. It is a very, very robust platform. Additionally, we have our financial wellness, which is a digital-led experience as well, that we have consciously made sure interacts with our branch experience. That platform was digital. You may recall several years ago, we purchased HelloWallet to facilitate that. We've looked at this as how do we create not only the ability to transact in a mobile and digital world but also how can you have relationship attributes including advice and planning through our HelloWallet. We continue to support customer preferences in that regard.

We've even expanded it into business banking. As we think about digital, digital origination, and wellness, we've taken the technology and capabilities and expanded that into our business banking arena as well.

And then, with that said, how are you thinking about looking at your branch network and rationalizing your brick-and-mortar footprint?

This is Chris. Last year, we took out 38 branches. I think this year 2019 you can expect us to really ramp up in that regard. We feel like we're good at it. As we went through First Niagara, we rationalized the fleet. We think with technology and the digital capabilities that we have, we have the capability to keep our clients and thin out some of the branches. You'll see us actually step up this year over last year.

Good morning, everyone. A question on Laurel Road, if that business does $1.2 billion of originations like it did last year and all of it’s held under balance sheet, does it swing from 2% dilutive to something accretive at that point? Or maybe asked another way: what's the breakeven size in terms of balance sheet size for that business to contribute to the bottom line?

What we've said, I think just was the assumption that we acquired in mid-year that we'd only have a half year’s worth of production next year and we would expect it to be accretive in 2020 and beyond. It’s a fairly short window regarding the dilution impact of the acquisition.

Good morning, everyone. Maybe my first question for Chris. Just the discussions that you're having with your larger corporate customers related to using Key’s balance sheet versus the capital markets has there been a change in tone in those conversations over the last few months?

David, there really haven't been. When we are out talking to our clients and our prospects, we're constantly figuring out what is the optimal approach for them to take. Those discussions really haven't changed markedly in the last several months. Obviously, there were periods of time in December where markets were dislocated and people were putting off deals. But, the strategic discussions that we're having with our clients are ongoing and constructive.

And I would just add too that the relevance of our conversations is a direct function of our strong relationships and proven track record in providing solutions in all market cycles.

Again, we thank you for taking your 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. That concludes our remarks. Thank you and have a good day.