Keycorp (KEY) — Q1 2022 Earnings Call Transcript

Well, thank you, operator, and thank you for joining us for KeyCorp's First Quarter 2022 Earnings Conference Call. Joining me on the call today are Don Kimble, our Chief Financial Officer; and Mark Midkiff, our Chief Risk Officer. On Slide 2, you will find our statement on forward-looking disclosure and non-GAAP financial measures. It covers our presentation materials and comments as well as the question-and-answer segment of our call. I am now turning to Slide 3. This morning, we reported earnings of $420 million or $0.45 per share. Our results reflect strong underlying operating performance, expected seasonality, and the impact of current market conditions. Our results also included $0.04 per share of additional loan loss provision in excess of net charge-offs. One of the standouts this quarter was our strong loan growth. Average loans were up 4% from the last quarter, driven by both our consumer and commercial businesses. Adjusting for the planned runoff of PPP and the sale of our indirect auto business, we grew loans by 15% year-over-year. Our strong loan growth benefited net interest income, which came in above our expectations. We also revised our net interest income outlook higher, reflecting both stronger loan growth and the ongoing benefit from higher interest rates. In our consumer business, we continue to focus on adding and deepening client relationships and our two growth engines, consumer mortgage and Laurel Road. We originated $2.6 billion in consumer mortgages in the first quarter, and Laurel Road had a record quarter with originations of $820 million. It's worth noting that our Laurel Road results were accomplished with the federal student loan payment holiday remaining in place. The outlook for this business remains strong with a new offering for nurses, the largest segment of the healthcare industry planned for May 6, National Nurses Day. We also experienced strong core loan growth in our commercial businesses as we grew our targeted industry verticals. Additionally, we benefited from a 2% increase in C&I line utilization. In the first quarter, we raised over $24 billion in capital for our clients retaining 23% on our balance sheet. This is a 500 basis point increase from the amount retained in 2021. As we discussed at our recent Investor Day, this is exactly the way our business model is designed to work, offering our clients the best solution and execution, both on and off balance sheet through various market conditions. This quarter, we were able to offer attractive balance sheet alternatives for our clients. Our pipelines and outlook for loan growth across our franchise remain strong, which will continue to provide us with an opportunity to deploy our liquidity into higher-yielding assets. Market conditions impacted several parts of our business this quarter. Fee income reflected a slowdown in capital markets activity late in the quarter, which adversely impacted our investment banking results. We also experienced various mark-to-market adjustments that Don will cover in his remarks. Importantly, our long-term outlook for our investment banking business remains positive. Our pipelines remain strong. We will also continue to add senior bankers to support our growth. Expense levels this quarter reflected normal seasonality as well as lower production-related incentives, consistent with our variable cost structure in many of our businesses. Also benefiting expenses this quarter was lower prepaid volume related to state benefit programs. We also remain committed to delivering sound, profitable growth by maintaining our risk discipline. Credit quality remains strong this quarter with net charge-offs as a percentage of average loans of 13 basis points. Nonperforming loans and criticized loans also declined this quarter. We continue to support our clients while maintaining our moderate risk profile, which has and will continue to position the company to perform well through all business cycles. Our capital remains a strength, providing us with sufficient capacity to support our clients and return capital to our shareholders. Looking ahead, we are encouraged by our first quarter business trends and outlook, which has led us to make a number of positive revisions to our full year 2022 guidance. These include stronger loan growth based on the pipelines we see across our company; higher net interest income, driven by loan growth, liquidity deployment, and our interest rate positioning; and lastly, lower net charge-offs, reflecting our strong risk profile. Importantly, we remain confident in our ability to generate positive operating leverage again in 2022 and make continued progress against each of our long-term goals. Don will cover the specifics of our full year guidance in his comments. Overall, despite market headwinds, Key delivered another solid quarter. I remain confident in our future and our ability to create value for all of our stakeholders. Now before I turn it over to Don, I want to take a minute to share some exciting news as it pertains to ESG priorities and commitments. Tomorrow, April 22 is Earth Day. Fittingly, earlier this week, we published our 2021 ESG Report. It is designed to complement our annual shareholders' report, which was released last month. Our ESG report provides all stakeholders with an update on our priorities and progress as both a responsible bank and citizen. In 2021, we refreshed our ESG strategy with input from our stakeholders, identifying four major priorities: climate stewardship; financial inclusion; diversity, equity, and inclusion; and data privacy and security. Specific to climate stewardship, we are committed to leveraging our expertise, our relationships, our market influence, and our resources to help address the pressing challenge of climate change. We are proud to announce a number of expanded climate commitments included in our ESG report. These include commitments around sustainable financing, an area where we are a market leader. We look forward to continuing an open and transparent dialogue with all of our stakeholders as we work to address the needs of our communities. With that, I'll turn it over to Don to provide more details on the results of the quarter and our outlook for the balance of 2022. Don?

Thanks, Chris. I'm now on Slide 5. For the first quarter, net income from continuing operations was $0.45 per common share, down $0.16 from last year. Our results in the current quarter reflect the benefit of strong core operating performance, combined with the challenge of the current market conditions. Our strong loan growth, up 4.4% from last quarter resulted in better-than-expected net interest income and positions us well for future growth. The challenging market conditions at the end of the quarter were reflected in a few areas, including investment banking fees and market-related adjustments and other income. Finally, the increase in our allowance this quarter reflected a qualitative adjustment to reflect the economic uncertainty given the current events with Russia and Ukraine. Absent the qualitative adjustment, our provision would have approximated our net charge-off level. I'll cover the other items on this slide later in my presentation. Turning to Slide 6. Average loans for the quarter were $103.8 billion, up 3% from a year ago period and up 4% from the prior quarter. Strong loan growth continued through the first quarter. Commercial loans increased 4% from last quarter. Line utilization rates improved this quarter, increasing 200 basis points. PPP loan balances were $1.2 billion on average this quarter compared to $7 billion last year and $2.3 billion last quarter. Our consumer business continued its strong performance as we saw residential real estate originations of $2.6 billion, resulting in an increase in balances of 8.6% from last quarter. We achieved record Laurel Road originations of $820 million this quarter despite the ongoing federal student loan payment holiday. Year-over-year comparisons were impacted by the sale of our indirect loan portfolio late in 2021. If we adjust for the sale of the indirect auto portfolio last year as well as the impact of PPP, our core loans were up year-over-year by approximately $14 billion or 15%. Our outlook for 2022 now reflects an increase for loan growth for the year of mid-single digits on a reported basis or mid-teens growth on a basis adjusted for both PPP and the sale of the indirect auto portfolio. Continuing on to Slide 7. Average deposits totaled $150 billion for the first quarter of 2022, up $12 billion or 9% compared to the year ago period and down $1 billion or 1% from the prior quarter. The current quarter change was consistent with previous seasonal trends. Compared to the previous year, we have experienced nice growth in both commercial and consumer deposits. Our cost of interest-bearing deposits remained unchanged at 6 basis points. We continue to have a strong, stable core deposit base with consumer deposits accounting for approximately 60% of our total deposit mix. Turning to Slide 8. Taxable equivalent net interest income was $1.02 billion for the first quarter compared to $1.012 billion a year ago and $1.038 billion for the prior quarter. Our net interest margin was 2.46% for the first quarter compared to 2.61% for the same period last year and 2.44% for the prior quarter. Year-over-year and quarter-over-quarter, both net interest income and net interest margin reflect the PPP forgiveness. The current quarter reflected $21 million of net interest income from PPP, down $30 million from the prior quarter and $38 million from the prior year. This negatively impacted net interest margin by 6 basis points compared to the last quarter. PPP is impacting Key disproportionately compared to peers given the success we achieved in delivering this product to our customers. Offsetting this impact was the benefit from deploying some of the excess liquidity through strong loan growth. We have increased our 2022 outlook to reflect the strength of our loan growth as well as the impact of higher interest rates. Our current rate outlook follows the forward curve and a beta assumption beginning in the high-single digits in the second quarter and trending towards the 30% level later in 2022. This outlook results in a high single-digit increase in net interest income from 2021 or between 6% and 9%. Adjusting this for the impact of PPP, our growth would have been 11% to 14%. Also included in the appendix is additional detail on our investment portfolio and asset liability positioning. Moving on to Slide 9. As mentioned before, our noninterest income was negatively impacted by changing market conditions late in the quarter, which impacted several line items. Noninterest income was $676 million for the first quarter of 2022 compared to $738 million for the year ago period and $909 million for the fourth quarter. Compared to the year ago period, the decrease was primarily driven by market-related adjustments included in other income, representing about $50 million of the year-over-year variance. This included both changes in write-downs of certain holdings and reversals of derivative reserves last year. The reductions in cards and payment fees are related to the lower level of prepaid card activity from the state-supported programs, which is offset by a corresponding reduction to the related expense. Additionally, during the quarter, our consumer mortgage fees were lower, reflecting higher balance sheet retention and lower gain-on-sale margins. These declines were partially offset by stronger corporate services income resulting from customer derivative activities. Compared to the fourth quarter, noninterest income decreased $233 million, primarily driven by lower investment banking and debt placement fees coming off the record level in the fourth quarter of last year. Market-related adjustments negatively impacted the quarter-over-quarter variance by $55 million as last quarter included market-related gains and this quarter experienced losses. I'm now on Slide 10. Total noninterest expense for the quarter was $1.07 billion compared to $1.07 billion last year and $1.17 billion in the prior quarter. Compared to the year ago quarter, our expenses reflect lower production-related incentive compensation offset by higher salaries, including the impact of our direct investments into the businesses. On the non-personnel side, our other expense category reflects lower prepaid card-related expenses offset by higher travel and entertainment expenses and FDIC assessments. Now moving to Slide 11. Overall, credit quality continues to perform well. For the first quarter, net charge-offs remained low and were $33 million or 13 basis points of average loans. Nonperforming loans, delinquency and criticized classified levels all remained relatively stable. Based on this performance, the quantitative level of our allowance remained flat with last quarter. However, we did add a qualitative adjustment to our allowance to reflect the economic uncertainty given the current events with Russia and Ukraine as well as potential impact of higher rates. The qualitative adjustment is driven by the impact from changes in the overall economy and their potential impact on our customers. As a result, our provision expense exceeded our net charge-offs by about $50 million. We have no direct exposure to Russia or Ukraine. Now on to Slide 12. We ended the first quarter with a common equity Tier 1 ratio of 9.4%, within our targeted range of 9% to 9.5%. This provides us with sufficient capacity to continue to support our customers and their borrowing needs and return capital to our shareholders. Importantly, we continue to return capital to our shareholders in accordance with our capital priorities. On Slide 13 is our full year 2022 outlook. The guidance is relative to our full year 2021 results and ranges are shown at the bottom of the slide. Importantly, using the midpoints of our guidance range I would support Chris' comments about delivering another year of positive operating leverage in 2022. Average loans will be up mid-single digits on a reported basis, excluding PPP and the impact of the sale of our indirect auto loan business, average loans would be up mid-teens. We expect average deposits to be up low-single digits. Net interest income is expected to be up high-single digits, reflecting growth in average loan balances and higher interest rates, offset by lower fees from PPP forgiveness. Our guidance is based on the forward curve with 8 additional expected rate increases. This would assume a Fed funds rate of 2.25% by the end of 2022. On a reported basis, noninterest income will be down mid-single digits, reflecting the lower prepaid card revenue related to our support of government programs and our first quarter actual results. We expect noninterest expense to be down low-single digits; once again, adjusting for the expected reduction in expenses related to prepaid cards, expenses will be relatively stable. For the year, we expect net charge-offs to be in the range of 15 to 25 basis points. Given our strong credit trends, we would expect loss rates to remain below the targeted range early in the year and move to modestly higher levels later in the year. And our guidance for the GAAP tax rate is approximately 19%. Finally, shown at the bottom of the slide are our long-term targets which remain unchanged. We expect to continue to make progress on these targets by maintaining our moderate risk profile and improving our productivity and efficiency, which will drive returns. Overall, it was a solid quarter, and we remain confident in our ability to grow and deliver on our commitments to all of our stakeholders. With that, I will now turn the call back over to the operator for instructions on the Q&A portion of the call. Operator?

I wanted to ask about the loan outlook. It was a nice surprise to see that increase in loans. So it's a two-part question. Can you discuss the growth dynamics between commercial and consumer? Also, regarding consumer loans, I would have expected some pressure on residential mortgages due to higher rates at Laurel Road, especially with the extension of the student debt moratorium.

We experienced growth on both the consumer and commercial sides. In our residential mortgage business, it's essential to remember that it's relationship-based and relatively new, having started in 2016, so it has a promising outlook. As Don mentioned, we had a productive quarter, and our application backlog is strong as we head into the next quarter. We're optimistic about this. Our strategy has focused heavily on purchase loans, which now make up over half our business, providing more stability. While we do expect a decrease in absolute terms across the mortgage sector, we anticipate gaining market share. Regarding Laurel Road, we have a solid niche and plan to expand it to include 4 million nurses in addition to the 1.1 million doctors and dentists in the U.S., which should drive growth. On the commercial side, we benefited from a 200 basis point increase in utilization, particularly in capital-intensive sectors like affordable housing and renewable energy, where we hold a strong position. Additionally, from our capital raised, the transition from 18% to 23% on balance sheet during market dislocation translates into approximately $1.2 billion of additional benefits. Furthermore, we began the year with 8% more bankers than last year, which supports our growth efforts.

Got it. Very helpful. And then just another question, just I understand under you lowered the outlook on fee income. It seems to imply that most of the pain is felt in the first quarter, and you're looking for, based on the guidance, just a pretty strong rebound in the second quarter and for the rest of the year. Could you just provide a little bit more color and maybe some guidance to what you're looking for in the second quarter?

Sure. Well, we never provide specific guidance on the second quarter, but just as it relates to our investment banking fees, our pipelines are actually up. Now the realization of those pipelines, obviously, is somewhat market dependent. But your assumption is correct. Weaker first quarter than we would have expected and the rest of the year generally in line. Don?

The other thing that I'd like to highlight there, too, Peter, is that within that other income category, we did have losses of about $25 million this quarter compared to gains in previous two quarters whether it was year-over-year or quarter-to-quarter, and we wouldn't expect those to continue. And then we're also expecting to see continued growth in a few of our categories we've talked about before with the wealth management, asset management, investment services and cards and payments-related revenues as well, and we think will be nice additions to that growth for the second quarter through the fourth quarter of this year.

I wanted to focus on the size of the balance sheet. You mentioned seasonality in deposits, but can you provide your outlook on deposits? I believe you and Chris have indicated that some consumer deposits might leave the bank. What is your perspective on consumer deposits? Additionally, how should we consider the size of the balance sheet? I also noticed some repayment on the debt side, and I would appreciate any insights on that as well.

Sure. As far as the deposits, we have about $150 billion of deposits for the first quarter. With our guidance being up low single digits for deposits compared to the previous year, that would imply deposits remain around that same general range. What we're seeing is nice household growth in our retail business, and we expect that to continue. We're also seeing growth in our core operating accounts on the commercial side, where 83% of our commercial deposits are our core operating account balances, and so that's very important for us. And so we expect that to continue to grow. Where we saw seasonality this quarter is that some of our state and government-related deposits and also some of our escrow deposits are at seasonal highs in the fourth quarter, and we do see those come down a little bit in the first quarter. And then we would see pressure for some of the excess balances outside those core operating accounts going forward, which would be offset by the other growth that we would expect to see by growing the households and new commercial customers. As far as the rest of the balance sheet, our long-term debt did decline a little bit. I would say that we'll be probably seeing a few issuances here over the next few quarters and probably especially in that Tier 2 category as we're focused on continuing to support that capital with the balance sheet growth that we are seeing. So we think we're in good shape as far as the deposits, pleased with the trajectory we have, and I'm more pleased with the customer growth we're seeing there as well.

So fair to assume you expect earning assets to grow from here from what we saw in 1Q.

We would expect some growth in earning assets. That's correct with the loan growth assumptions and seeing some modest growth on the liability side, correct.

Got it. And just one quick question on the investment banking debt fees. I appreciate that the loan growth picked up as a function of the tougher capital markets backdrop. Talk to us, if you can, just about the expense leverage in that business if it were to remain weaker for a prolonged period of time. Is there any specific expense offset to that, that we should think about?

Yes, we have discussed previously the correlation of approximately 30% between investment banking fees and capital markets revenues, specifically linked to incentive compensation. This was evident in our quarterly results, where our incentive compensation decreased compared to both the previous quarter and the same period last year due to overall production levels. There is a variable aspect to our business in this regard. As Chris pointed out, we have been increasing our senior banker count and believe there are growth opportunities ahead. We still anticipate growth, but if the economic outlook changes, we may scale back our investments if we don't see immediate opportunities or returns.

Not to beat a dead horse on the IB, debt placement fees, but this is where I wanted to start. So if we look at this quarter, your launch point is basically the same as where it was last year. I think a lot of us were surprised even at the Investor Day that the message was you thought you could grow that over where we were in 2021. Maybe can you dial us in, Don, like, what are you expecting for full year '22 for that line item?

Well, Steve, what we are seeing is strength in the pipelines. The pipelines are up year-over-year. We're seeing activities still going forward. As far as the first quarter, on March 1, we were thinking in IB&D fees would have been about $40 million higher than where they actually came in at. And so we saw a number of transactions basically pushed and so we're seeing some of those close here in the second quarter. But our outlook would essentially be that based on the pipeline, we're going to see it recover to where we would have expected going into the year for the second through fourth quarter. But I don't want to make a commitment that's going to be up year-over-year. Some of that is based on the market volatility that we're seeing and seeing what's going to happen from this point forward. But we are expecting to see a significant pickup from the first quarter levels for the rest of the year.

Okay. I mean do you think you could hold it flat Don where you were last year? Is that a stretch goal at this point?

Steve, I think what we've got here really is showing strong growth in our revenue outlook. The fee income category we're showing moved down as far as our outlook for this year, which implies basically the January 1 guidance adjusted for the actual results in the first quarter. So that's not assuming that we make the recovery of that shortfall in the first quarter, but we think we will show strong growth from here and excited about the pipelines and the prospects from this point forward.

Okay. That's helpful. And then I wanted to follow up on Ebrahim's question on deposits. I was actually surprised you kept the deposit guidance. I mean what we're hearing from other banks is that businesses are finally starting to use deposits to invest in their business, and we know the Fed is now about to embark on QT. And this is probably even more important than NIM when we think about NII for 2022. Could you drill down further why you're not expecting deposit balances to fall as this liquidity comes out of the system overall?

Steve, we focused extensively on our commercial deposits when we had significant liquidity. As Don noted, 83% of our commercial deposits are operating accounts, which provides a solid foundation. It's important to recognize that commercial deposits will likely experience a higher beta compared to consumer deposits, and we will monitor how this develops. However, we are confident in our assumptions regarding betas and the overall composition of our commercial deposits.

Okay. But Chris, while I understand that 83% of the deposits are operating accounts, don't you think that when examining the account level, those operating accounts appear to be inflated compared to a year or two ago? I believe there is a risk that operating account balances might decrease as the Fed continues with quantitative tightening.

I do think there's a risk, particularly if interest rates start moving up at 50 basis points at a crack. Actually, on our balance sheet, the more elevated deposits are really on the consumer side at this point.

And if I could squeeze one more in. Don, the NII guidance, is that the current forward curve, is that what you're assuming?

That's correct. It's up 8 additional rate moves or a 25 basis point increase. There might be some 50 basis point hikes expected, resulting in a Fed funds rate of 2.25% by the end of the year.

I have a question regarding expenses. It seems like you expect capital markets revenue to be somewhat lower for the full year despite the recovery, and you've lowered your overall non-interest income guidance, which is also reflected in the first quarter. However, you maintained your expense range for the year. Does this indicate improved loan production, or is it just based on the range itself?

Yes. There is some of the range there. I would say that keep in mind, too, the impact for the first quarter wasn't all IB&D fees. Some of it was the market valuation adjustments. And there really isn't any IC attached to that. We don't pay on those revenues to any of our business units. And so there isn't that correlation. So only a portion of that was the timing within the IB&D fees. And so if you look at our outlook for expenses going forward, there is an increase assumed there for the second through fourth quarter compared to the first quarter levels, and that's reflective of the increased revenue that we're expecting throughout the capital markets areas.

And John, the only thing I would add to that is we will continue to invest in our business. And so that, too, we're obviously always taking expenses out, but at the same point, we're making investments.

Got it. Okay. And then on the loan growth side, the increased loan growth guidance up to the mid-teens level now. Could you just possibly unpack that a bit in terms of how do you think that growth could break down by C&I, CRE, which also saw some pretty good growth and consumer?

Yes. The growth in CRE is primarily driven by the affordable housing projects we're seeing. We're experiencing growth in that area. Looking at prospective growth, it reflects the trends we've observed over the last three quarters, where we've consistently grown our average loans by about 4% quarter-over-quarter, translating to an annualized growth rate of about 16%. In the latter half of last year, our focus was more on consumer lending. This quarter, we benefited from commercial lending as utilization rates increased by 200 basis points, also resulting in a 4% growth. Moving forward, we expect this growth dynamic to remain stable, with both commercial and consumer lending showing approximately 4% growth rates, resulting in mid-single-digit to mid-double-digit growth when adjusted for PPP and indirect auto loans.

Don, if I could just ask one more. Do you have what your new money loan yields are for your new loan production that you're putting on? I don't know if you have to break that out by bucket. I'm just curious because I know you made a point to mention that you're seeing a loan growth opportunity to actively put liquidity to work in higher-yielding areas?

Yes. The liquidity to work in higher-yielding areas is in the loan growth. And what we're seeing on the commercial side is spreads are still a little tighter today than what they were a year ago. But we're seeing a decent pickup there compared to what we're yielding on cash or the short-term investments we have in the portfolio. As far as Laurel Road, we target a price spread to the cost of funds for that type of asset duration of about 200 to 225 basis points. And so if that were a fixed rate loan and an average life of four years, you would have something in the 4% type of handle for the yield there. And with the residential mortgages, we're seeing a nice mix of ARMs and 15-year product. We do have some 30-year of jumbos, but those are declining, and those will be consistent with what you would see in the jumbo rate market going forward. So that's just a little bit of flavor as far as the spreads.

Chris and Don, can you guys elaborate on the positive operating leverage outlook you're talking about, it's going to continue to be positive. But if the world changes from where we are today, what are some of the levers that you guys have on the shelf to be able to use to make sure that you do achieve your positive operating leverage goals?

Sure. So the first thing is we have several businesses that are really variable cost businesses. So Gerard, that's a huge advantage. That is why you see our expenses on a linked quarter basis, they're down $100 million linked quarter. The other levers that we have is we're always focused on continuous improvement. And every place we can, and this is not new, we've been talking about this for some time, we are replacing clumsy handoffs with software. Front, middle and back office. And those continue to provide benefits. Other areas where we focus last year, for example, we had some kind of onetime things we contributed, for example, to our foundation in a large way. So we had some onetime things last year. And then the other thing that I think is a huge opportunity for us on the expense side is just real estate. I mean the world has changed dramatically since pre-pandemic. And we, like a lot of people as leases come up, I think we've used the number of 25% of our non-branch, non-ops real estate. I think it's probably even higher than that. So those are a few things that we have going for us, levers that we can and will pull if required.

Very good. And then Don, it looked like from the average balance sheet, you have about $45 billion or so in available-for-sale securities. Can you share with us your thinking on, are they all going to remain in that category? I know you don't have to take any AOCI marks through your CET1 ratio since you're not an advanced approach bank. But can you just share with us what you're thinking on whether some should be moved into held to maturity? And then what was the AOCI mark in the quarter, if you have that?

Regarding the $45 billion in available-for-sale securities, approximately $9.5 billion of that investment is in short-term treasuries, which we acquired throughout last year and have a lifespan of 2 to 3 years, so we expect that to decrease over time. Additionally, over $2 billion is tied to securities from the indirect auto securitization transaction, which we will also see reduce gradually. Most of the growth in this category compared to last year stemmed from these two areas, while the rest remained largely stable. We are continuously assessing whether to make new purchases in held-to-maturity as opposed to available-for-sale securities. However, from an economic standpoint, there isn't much difference for us in terms of where these assets are positioned. There is, however, an accounting impact, which we noted with AOCI increasing by over $2 billion from the previous quarter, influenced by both the valuation of the investment portfolio and the swap book. Compared to our peers, we hold a larger percentage of assets in these categories, which reflects the overall impact on our balance sheet. Our loan portfolio consists of about 70% floating-rate loans and 30% fixed-rate loans, in contrast to most competitors who typically balance at 50-50. Notably, while our loans do not get marked to market, the investment securities and swaps do, which results in some disproportionate effects for us.

And Don, just on the duration, you said that the new investments are coming in around 2, maybe 3 years, if I heard you correctly. And what's the overall duration of the portfolio?

I apologize, Gerard. The short-term treasuries had a yield with a maturity of 2 to 3 years. The overall duration of the portfolio is now close to 5 years. We typically buy CMO structures in that range, and we also purchase some 15-year pass-throughs, which are around the same duration. Looking at the yield on those new purchases moving forward, it is currently in the 3% to 3.5% range. This will be an improvement compared to the 2% yield that we are experiencing from the runoff of the existing portfolio.

Chris, I just wanted to ask you this directly because the stock is indicating down premarket. A lot of analysts have asked you this in different ways already. But should core fee income like investment banking, should the pipeline not materialize as much as it's indicating. Is your commitment to positive operating leverage strong enough that you will adjust expenses in order to achieve that even if the core fee income outlook gets worse?

That's correct. We're committed to having positive operating leverage. And as I was just sharing with Gerard, we have a lot of levers that we can pull, including we could cease to make some of the investments we're making. We don't see that as the base case, but that's obviously an option that we have.

Got it. And my second question is for Don. Don, a few follow-ups on how we should think about the balance sheet as we think about a rising rate environment. Number one, to Ebrahim's question on earning asset growth, should we assume that earning asset growth should be about equivalent to that 2% deposit growth that you are forecasting for the year? Second, cash end of period looks like it's now under $4 billion. Have we reached the bottom in terms of absolute cash levels? And third, I'm wondering if you could give us an update on the value of each 25 basis points to the NIM. And I'm guessing that obviously, the value would be greater in the first 100 versus next 100 given deposit betas?

It's a loaded question there. I'll try to take care of those, Erika, in order here. But as far as the average balance sheet growth year-over-year, I think that low-single digits or about 2% growth is appropriate. I would say that the incremental growth from here probably is lower than that, that would be implying that our deposit balances are relatively stable, and we will have some growth in some of our debt but not a lot. As far as the cash position that what we've talked about before is that cash plus that short-term treasury position is really a view of our excess liquidity. And so that was about $20 billion at year-end, and it's about $12 billion on a combined basis here at the end of the first quarter. We do see that cash position coming down from that $3.8 billion. We typically run that in the $1 billion to $2 billion range. And so we would expect to see that come down, but not dramatically from where it is today. And then as far as the impact for net interest income for a 25 basis point increase in rates across the board, it would be upper $50 million range as far as the NII impact. As far as the NIM impact, I'd have to go back and work through the math on that, but it would be based on that same upper $50 million range. We are forecasting that over the next early rate increases, deposit betas will be low. And as we mentioned in the speaker notes that second quarter, we would expect deposit betas to be in the upper single-digit range and then transitioning into the 30% range in the second half of the year. So we would expect to start to see that deposit beta pick up, as you would see rates go up that 100 basis point plus range compared to where we started the year.

I have a third question to add. Don, your peers are estimating a 25% growth for the next 25% to 30%. That seems to be in line with expectations. Do you think a 30% forecast is conservative, or does it seem appropriate based on your observations? I found it impressive that 83% of your commercial deposits are operating.

I would say that compared to where we were before, that 30% is a strong number and is reflective of what we are expecting for that commercial performance given that strong operating account level and many of our commercial deposits are contractually set as far as how they reprice based on changes in rates. We do think there could be some upside. We think it's a reasonable forecast given the pace of rate increases and what we're starting to hear or speculate as far as the market change overall.

You shouldn't overlook the bigger picture. You can validate these figures. Returning to the base case, for the first quarter, there's an operating leverage of minus 3%. Your 2022 guidance using the midpoints shows an increase of 4%. This implies that you're looking to make a comeback, similar to the Cleveland Cavaliers in the 2016 NBA Finals. If you fail to do so, you won't meet those expectations, and I’m uncertain if you have a standout player like LeBron. In straightforward terms, how do you move from a decrease of 3 percentage points to an increase of 4% by the year’s end?

A couple of things on that, Mike. First quarter, we would have expected to see some decline in our operating leverage compared to the year-ago first quarter that we knew that we had some gains in the first quarter of last year in that other income category. And so we thought we would see some pressure there. So our initial outlook would have suggested a positive operating leverage without the changes that we just made. And to your point, Mike, we are forecasting a better PPNR and therefore, better operating leverage number for us with this outlook, including the rate changes in our balance sheet growth than what we had before. So we think that's a real positive. And I think that to your point and what Chris had answered before, I think some of the strength in the model and why we have confidence in our ability to achieve that positive operating leverage, is many of our growth categories are highly variable. And so if the growth doesn't come through, we'll see the cost come down because it doesn't come through there. And so, we feel confident in our ability and I think we've got 17,000 LeBrons running around here trying to deliver our business and have success. So we're optimistic about where we're going forward.

Okay. And I did the math right. So you're basically guiding for up 2% revenues and 2% down expenses.

That's correct. In the middle of what the guidance range is.

Okay. And then just separately, I mean, Netflix was in the news because subscriber growth went down or something. And I guess if you measured your own subscriber growth, I don't know, customer growth? Is it up? And how much is it up? And how much do you measure that? Clearly, gaining wallet share with greater loan utilization. So I get that. But how much are you growing customers, say, in Laurel Road or elsewhere?

Sure, Mike. And as you know, on Investor Day, we made some commitments and we'll be reporting on those twice a year, so we'll report on it for the first time this fall. But I can tell you to use your analogy, we are growing subscribers in our retail business, which is really household relationships. We clearly are growing subscribers as it relates to Laurel Road. It was a record quarter, both in terms of funded volume and number of new households. And the other equivalent that obviously, we'll be talking about is just the number of bankers that we have out on the street that then translates into subscribers as they're out calling on people.

How many new households did Laurel Road add this past quarter or year-over-year, if you can share that information?

We're not disclosing it until September. And then, Mike, what we'll do is we'll roll forward. I can tell you that it's up, and then we'll actually report on it twice a year, we'll report in September.

I was looking at Slide 18 on the ALCO position, and I know you previously discussed this with Gerard in relation to the quarter. I wanted to understand how the modifications you've made in the ALCO book are likely to affect NII for the remainder of this year and into next year, as well as the AOCI. It seems you have taken steps to address AOCI risk in the second quarter. I'm asking because we are all aware that the 10-year has backed up since March 31. Some clarification on this would be helpful.

Certainly. We've seen a slight decrease in our asset sensitivity, which is attributed to various positions we established throughout the quarter. A key aspect for us that enhances our balance sheet and overall earnings is the approximately $6 billion of CMBS agency securities in our portfolio. We initiated a forward starting swap for those securities, converting them to a floating rate. In the first quarter, we unwound about $3.5 billion of these swaps, and we plan to unwind another $2.5 billion in the second quarter. These unwinds effectively convert the floating component to fixed, resulting in an additional 75 basis points in yields on that $6 billion through the remaining life of the securities. We believe this will provide a beneficial boost for us moving forward. Our overall swap position has remained stable for the core cash flow swaps used for asset-liability management, and we will continue to evaluate that. We're also looking at how to manage that position in light of recent rate changes since the end of the quarter, which has allowed us to take advantage of opportunities with some of these forward starting swaps. We expect to see positive impacts on our position as we proceed.

Okay. So based on the backup and long end that we've had since March 31, how much less impact would you say you'd be exposed to if this rate is what prints on June 30 relative to what we experienced in 1Q.

Betsy, I don't have the exact numbers at this moment, but we can discuss that and provide the information later. However, I believe that our position on rates and our outlook for net interest income moving forward will remain consistent with what we had as of March 31, despite current rates and the curve today.

Okay. And then just other question I had is on funding the loan growth that you're looking for in the rest of this year. It seems like in this quarter, there was a partial funding from deposits, partial funding from cash. And I'm just wondering if I'm thinking about the rest of the year, given that you're looking for deposit growth to slow and really, as you mentioned earlier, be flat here from here on. How are you thinking about funding that loan growth? Is it drawing down more on cash? Or is it more drawing down on securities or just the cash flow from the securities book, would be helpful.

Sure that you hit on all the levers that we're looking at, essentially that we would see that cash position come down a little bit from where it is. I would say that the bond portfolio puts out about $1.8 billion to $2 billion a quarter of cash flow just from maturities. And as I mentioned earlier in the call, we would expect to have some debt issuances through the second and fourth quarters of this year to help reset that. And so all of those combined will be used to help fund some of that future growth and are reflected in our forecast.

Don, just one more follow-up on the balance sheet. So your 4.4% rate sensitivity, the forward starting swaps, I guess, do we know how much is still yet to start? And how much would those forward starting change that 4.4% sensitivity, if at all?

Well, the forward starting that we didn't close out by the end of the first quarter was $2.8 billion. And then the other component, I think we've got about an additional $1.5 billion that are forward starting that will start later in the year that are already reflected in that but will be fully phased in by the end of the year.

Okay. Is this the level of asset sensitivity you are comfortable with in that 4.5% range? I know you reduced it slightly, but do you expect to either increase it or modify the complexities you're introducing on the fixed rate side to alter that in any way?

We could see that continue to trend down a little bit. We tend to be focused on about a plus or minus 3% range. And depending upon what we're seeing for our expectation for rates versus what the market would have, I think you could see that close down a little bit but not a lot from that 4.4% level.

Okay. So we're pretty much looking at like what the balance sheet should look like aside from the growth dynamics that you've talked through.

You will see the impact of the growth dynamics, correct, but not see material changes from here as far as the overall balance sheet, correct?

You had a lot of growth in commercial real estate this quarter and really over the past year or so and you mentioned it is coming from affordable housing. Maybe just remind us like what type of loans those are, just the risk dynamics of it. And if there's some sort of like government backing or encouraging or how those are appealing.

These loans typically fall within a multifamily context. The affordable aspect slightly alters the economics, but the lending parameters remain unchanged. There isn't a specific backstop, yet we have significantly reduced the risk in our real estate portfolio over the years. Currently, we have very little construction exposure. At one point, prior to the global financial crisis, our construction percentage was around 42%. Now, it stands at a high-single digit. Our portfolio is solid, backed by reliable developers, and as we've previously discussed, there is a substantial unmet need that I believe will continue to receive funding.

And then somewhat maybe related or unrelated, the corporate service income line. What is the key driver there that was very strong? Are there loan fees included, or what are the main factors contributing to that?

There were some loan fees there, but more of it, Matt, was in derivative production that we saw in the quarter and have seen over the last couple of quarters going forward on that category.

Don or I guess, Don and Chris, on Slide 12, you show the CET1 on top and the TCE on the bottom. And Don, you made a bunch of great points about the funkiness of the AOCI concept. It's very logical and very consistent with what we hear from other banks. So I want to acknowledge that. But as you think about capital this cycle, clearly CET1 is the main one. Is the TCE matter at all? Is there any level of TCE that would make that a limiting factor? Or is TCE just kind of not relevant this cycle because it's about rates, not credit?

That's a great question, Brian. I would say that our primary focus is on the Common Equity Tier 1 ratio. That's what we're managing and using, and it's central to our capital priorities, especially in supporting organic growth, maintaining a strong dividend, and utilizing share buybacks within that range. The TCE ratio has clearly been affected by the significant changes we've seen in rates. What helps us on that front is that, as I mentioned before, a third of that AOCI adjustment will be resolved in the next 2.5 years, which means we’ll see that impact diminish fairly quickly. This will assist us in determining the appropriate level of TCE. We monitor that closely and have set goals and objectives regarding it; while we aim to avoid seeing it drop below certain levels, we are still above that threshold and it hasn’t necessitated any additional adjustments to how we manage our capital or overall balance sheet.

I think most have been kind of asked and answered. But Don, maybe I'll take that one that hopefully is fairly straightforward. And just other fee income. So you had the market-related adjustments. So that led to the loss of $4 million or so versus a typical number kind of in that $50 million to $60 million range. With the losses kind of behind you, does that revert straight back up to 50% or would that necessitate some sort of recovery in that? In other words, does it split the difference with no change in market dynamics? How should that all flow through?

Typically before last year, we would have seen something in the 20s for that category. So it's more of a split the difference there, like you said, Scott, and that would be our expectation going forward.

LeBron, I mean Don. Can you discuss Chris' comments from his opening remarks about the student loan holiday? Have you looked into your customer base regarding the potential impact once the holiday ends or the deferments, and how much refinancing business there is for you to capture?

Yes, Gerard, it's Chris. We clearly think there's a backlog. We've seen it before just when people thought the holiday was ending that we've seen ramp-ups. So I'm sure there are people out there that logically have deferred. And if and when it were to end, I think there's some pent-up demand. We've seen that play out with sort of the couple deadlines that have been out there and have been extended.

And Chris, is it more for the existing customer base? Or is it just the general pool of medical school debt that's out there that you guys would try to go after?

No, we would go after the entire pool of medical school debt. So there's the medical school debt that's with the government, and there's also the refinance debt.

Thank you, operator. And again, thank you for participating in our call today. If you have any follow-up questions, you can direct them to our Investor Relations team (216) 689-4221. This concludes our remarks. Thank you so much.