Keycorp (KEY) — Q4 2022 Earnings Call Transcript

Well, thank you for joining us for KeyCorp's fourth quarter 2022 earnings conference call. Joining me on the call today are Don Kimble, our Chief Financial Officer; Clark Khayat, our Chief Strategy Officer. Upon Don's planned retirement, Clark will assume the CFO role and also Mark Midkiff, our Chief Risk Officer. On slide two, 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'm now moving to slide three. This morning, we reported earnings of $356 million or $0.38 per common share. Our results included $265 million of provision for credit losses, which exceeded net charge-offs by $224 million or $0.20 a share. The additional provision builds our allowance for credit losses, adjusting our credit models to reflect a more cautious economic outlook. Our results reflect continued growth in both our consumer and commercial businesses. In our consumer business, we have added new households with younger clients being our fastest-growing segment. Our commercial business also has continued to add and expand relationships. In 2022, we raised a record level of capital for our clients. Net interest income was up 2% from the third quarter, reflecting continued relationship-based loan growth supported by stable deposits. Deposit costs continued to move higher with a step-up in deposit rates late in the quarter. At the end of the fourth quarter, nearly 60% of our deposits were in low-cost retail and escrow balances. In our commercial businesses, over 80% of our deposits are from core operating accounts. Our average loan balances increased 3% from the prior quarter as we continue to add relationships and offer the best execution with both on- and off-balance sheet solutions. We continue to benefit from investments we have made in our business, including the health care sector. In 2022, we continued to grow relationships with significant health care providers and expanded our Laurel Road business. Despite the student loan payment holiday, we originated over $1.5 billion of Laurel Road loans last year and increased our member households by over 30%. Additionally, we expanded our offering to nurses, added new products and capabilities and completed the acquisition of GradFin. Since acquisition, GradFin has held nearly 30,000 individual consultations for refinance and public service loan forgiveness. These consultations are with prequalified credential prospects, all new to Key. Our fee-based businesses in the fourth quarter reflect the continued slowdown in capital markets activity and the impact of changes to our NSF/OD fee structure. Investment banking and debt placement fees were up $18 million from the prior quarter, but down meaningfully from the year-ago period, reflecting broader capital markets trends. The new issue equity market is virtually nonexistent and the M&A market continues to be engaged in price discovery. Our pipelines remain solid, particularly in M&A. However, the pull-through rates continue to be adversely impacted by market uncertainty. We have also continued to see more activity moving on to our balance sheet. In 2022, we raised a record $136 billion of capital for our clients, of which 23% was retained on our balance sheet well above our long-term average of 18%. Credit quality remained strong this quarter with net charge-offs as a percentage of average loans of 14 basis points. Nonperforming loans declined again this quarter and delinquencies, criticized and classified loans all remained near historically low levels. We will continue to support our clients while maintaining our moderate risk profile, which positions 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, including a 5% increase in our common stock dividend in the fourth quarter. Before I turn the call over to Don, I want to share some thoughts on our outlook and priorities for 2023 and beyond. First, we will continue to execute on our differentiated business model and strategy. We will focus on expanding our presence in our fastest-growing markets and targeted industry verticals. As we demonstrated again in 2022, we are uniquely positioned to support clients through various market conditions. Secondly, we will continue to benefit from our balance sheet and interest rate positioning. We have been very deliberate and intentional in the manner in which we have managed our interest rate risk with a longer-term perspective. Although our positioning is providing less current benefit, we have significant upside over the next two years as swaps and short-term treasuries mature and reprice. If we were to reprice our existing short-term treasuries and swaps at today's interest rates, we would have an annualized net interest income benefit of $1.1 billion. Thirdly, we will maintain our strong credit quality. We've spent the last decade de-risking our portfolio, positioning the Company to outperform through the business cycle. Despite our strong credit metrics, we built our loan loss reserve this quarter, which using our 2023 net charge-off outlook now represents almost five years of coverage. To put this in perspective, our reserve is now above our CECL Day One level while nonperforming loans and delinquencies are roughly half of our pre-pandemic levels. Finally, we will continue to create capacity to make targeted investments in our business by reducing expenses. Although expense management has been an ongoing area of focus, we will be accelerating our cost takeout plans early in 2023. We will pursue cost opportunities across our company, including areas where we can leverage technology, automation, and process improvement to reduce redundancy, improve efficiency, and enhance effectiveness. Our 2023 targets represent a cost reduction of approximately 4% relative to our full year 2022 level. The acceleration of our expense reduction plans will benefit us in two ways. First, we cannot grow if we are not investing. This will give us the capacity to continue to drive our targeted scale strategy, investing in points of differentiation. With the benefit of our cost reduction plans, we expect to hold expenses relatively stable this year compared to our full year 2022 results, which would be a significant accomplishment given inflationary pressures and our commitment to continue to invest in our future. I am confident in our long-term outlook and our ability to create value for all of our stakeholders. With that, I'll turn it over to Don to provide more details on the results for the quarter and our 2023 outlook.

Thanks, Chris. I'm now on slide five. For the fourth quarter, net income from continuing operations was $0.38 per common share, down $0.17 from the prior quarter and down $0.26 from last year. Our results included $0.20 per share of additional loan loss provision in excess of net charge-offs as we continue to build our reserves, reflecting a more cautious economic outlook. For the full year, we delivered positive operating leverage marking the ninth time in the last 10 years. This is a testament to our differentiated and resilient business model and our ongoing focus on disciplined expense management despite the inflationary environment. Turning to slide six. Average loans for the quarter were $117.7 billion or up 18% from the year-ago period and up 3% from the prior quarter as we continue to add and deepen client relationships across our franchise. Commercial loans increased 17% from the year-ago quarter, driven by growth in commercial and industrial loans and commercial real estate balances. Relative to the year-ago period, consumer loans increased 22%, reflecting growth in consumer mortgage and Laurel Road. Compared with the third quarter of 2022, commercial loans grew 3% and consumer loans were up 2%. Our commercial growth continues to reflect the strength in our targeted industry verticals and higher line utilization. Our consumer business continues to benefit from residential real estate originations, which were just under $1 billion for the fourth quarter. Approximately one-third of our originations came from targeted health care professionals. Continuing on to slide seven. Average deposits totaled $145.7 billion for the fourth quarter of 2022, down 4% from the year-ago period and up $1.4 billion or 1% compared to the prior quarter. Year-over-year, we saw declines in non-operating commercial deposit balances and retail deposits. The increase in deposit balances from the prior quarter reflects higher commercial deposits due to seasonality and our focus on maintaining our relationship business. Consumer balances declined in the quarter, driven by inflationary spending and the movement of interest-rate-sensitive balances. Interest-bearing deposit costs increased 49 basis points from the prior quarter and our cumulative deposit beta was 19% since the Fed began raising interest rates in March of 2022. We continue to view our strong deposit base as a competitive strength with approximately 60% of our balances in core consumer and escrow deposits. In addition, over 80% of our commercial deposits were from core operating accounts. Turning to slide eight. Taxable equivalent net interest income was $1.2 billion for the fourth quarter compared to $1.0 billion in the year-ago period and $1.2 billion in the prior quarter. Our net interest margin was 2.73% for the fourth quarter compared to 2.44% in the same period last year and 2.74% for the prior quarter. Year-over-year, net interest income and net interest margin benefited from higher earning asset balances and higher interest rates. Quarter-over-quarter, net interest income and the net interest margin were negatively impacted by higher interest-bearing deposit costs and a change in the funding mix. Later in the quarter, we experienced changing market conditions and customer behavior. Market rates increased more than we expected and the migration from noninterest-bearing to interest-bearing commercial deposits picked up. This resulted in a higher deposit beta, lower-than-expected net interest income and net interest margin. Our outlook for 2023 has our cumulative deposit beta peaking in the mid to high 20% range, well below our historic levels. Included in the appendix is additional information on our future net interest income opportunities and asset liability position. Based on our feedback from our shareholders, we have also included detail on the maturities of our interest rate swaps and short-term treasury securities. As Chris mentioned in his remarks, we have been very intentional in the way we manage interest rate risk with a long-term perspective. Although our position has provided less near-term benefit, we have significant upside over the next two years as our swaps and short-term treasuries mature and reprice. We expect this to drive both our net interest income and our net interest margin higher over the next few years. We believe this is a true differentiator. Moving to slide nine. Noninterest income was $671 million for the fourth quarter of 2022 compared to $909 million for the year-ago period and $683 million in the third quarter. The decline in noninterest income from the fourth quarter of 2022 reflects a $151 million decline in investment banking and debt placement fees, along with a $35 million reduction in other income, primarily from market-related gains in the year-ago period. Additionally, service charges on deposits were $19 million lower due to changes in our NSF/OD fee structure that we implemented in September as well as lower consumer mortgage income down $16 million. Partially offsetting these declines was an increase in corporate services income up $13 million due to higher derivatives income. Relative to the prior quarter, noninterest income declined $12 million. Service charge on deposit accounts accounted for the majority of the decline, down $21 million, once again reflecting our new NSF/OD fee terms. Additionally, corporate services income decreased $7 million, driven primarily from an evaluation adjustment benefit in the prior quarter. Investment banking fees increased $18 million. I'm now on to slide 10. Total noninterest expense for the quarter was $1.16 billion, down $14 million in the year-ago period and up $50 million from last quarter. Our expenses reflect our ongoing investments in digital, analytics and our teammates. Compared to the year-ago quarter, we saw declines across most non-personnel line items, including business services and professional fees and operating lease expense. Personnel expense remained flat compared to the year-ago period, reflecting higher salaries and employee benefits, offset by lower incentive and stock-based compensation. Compared to the prior quarter, noninterest expense is up $50 million. Higher non-personnel costs drove most of the increase. Other expense increased $17 million, reflecting a pension settlement charge in the fourth quarter. Also, professional fees were higher in the quarter, some of which were temporary in nature. Personnel expense also increased, reflecting lower deferred costs from slower loan originations. Moving onto slide 11. Overall credit quality remains strong. For the fourth quarter, net charge-offs were $41 million or 14 basis points on average loans, which remain near historical low levels. Nonperforming loans were $387 million this quarter or 32 basis points of period-end loans, a decline of $3 million from the prior quarter. Our provision for credit losses was $265 million for the fourth quarter, which exceeded net charge-offs by $224 million. The excess provision increases our allowance for credit losses, reflecting a more cautious model-driven assumption set. For our CECL modeling, we start with the Moody's consensus scenario. This quarter, the consensus estimates reflected a marked slowdown in the economy and meaningful reductions in home prices, both of which impacted our allowance levels. Despite the increases in the allowance, our outlook for net charge-offs in 2023 of 25 basis points to 30 basis points remains well below our through-the-cycle loss levels of 40 basis points to 60 basis points. Now onto slide 12. We ended the fourth quarter with a common equity Tier 1 ratio of 9.1%, 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 to return capital to our shareholders. We will continue to manage our capital consistent with our capital priorities of: first, supporting organic growth in our business; second, paying dividends. In the fourth quarter, our Board of Directors approved a 5% increase, which now places our dividend at $0.205 per common share per quarter, and finally, repurchasing shares. Our current share repurchase authorization of $790 million is in place through the third quarter of 2023. We did not complete any share repurchases in the fourth quarter. On slide 13 is our full year 2023 outlook. The guidance is relative to our full year 2022 results. Importantly, using the midpoints of our guidance ranges would result in another year of positive operating leverage in 2023. We expect average loans will be up between 6% and 9% and average deposits will be flat to down 2%. Net interest income is expected to be up between 6% and 9% reflecting growth in average loan balances and higher interest rates. Our guidance is based on the forward curve, assuming a Fed funds rate peaking at 5% in the first quarter and starting to decline in the fourth quarter. These interest rate assumptions, along with our expectations for customer behavior and the competitive pricing environment are very fluid and will continue to impact our outlook prospectively. Noninterest income is expected to be down 1% to 3%, reflecting the implementation of our new NSF/OD fee structure last year and continued challenging capital markets activity, at least for the first half of the year. We expect noninterest expense to be relatively stable with the benefit of the cost takeout opportunities Chris described in his remarks, along with ongoing investments that we will make in our business. For the year, we expect credit quality to remain strong and net charge-offs will be in the 25 basis point to 30 basis point range, well below the through-the-cycle range of 40 basis points to 60 basis points. Our guidance for our GAAP tax rate is approximately 19% to 20%. Finally, shown at the bottom of our 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 a very good finish to another successful year for Key. We remain confident in our ability to grow and deliver on each of our long-term targets. With that, I'll now turn the call back over to the operator for instructions on the Q&A portion of the call.

Good morning.

Good morning, John.

I know you mentioned that you observed an increase in deposit rates late in the fourth quarter. Could you provide more details on which products were affected and the extent of this increase? Additionally, you indicated that there was higher-than-expected pressure on deposit costs, not just an increase but a greater amount of pressure than anticipated. I'm trying to understand what areas caught you by surprise and what you think contributed to this unexpected situation regarding deposit pressures and rates. Thank you.

Sure can, John. And as far as late in the quarter and late November, December, we started to see a different migration pattern regarding some of the deposits and the rates. We saw market conditions start to pick up regarding rates and many products. Our expectation coming into the quarter was continuing to drift up some of the money market rates on deposits, but the customers were migrating more towards time deposits which had a higher incremental cost than what our assumptions were regarding money market deposit accounts. We also saw a shift away from noninterest-bearing accounts at a faster pace than what we would have expected late in the quarter. And so both of those had an impact of driving net interest income down for the current quarter compared to what we would have expected even coming into the end of the quarter and is also reflected in our outlook going forward. And Clark, I don't know if you want to offer up any thoughts as far as trends going forward regarding the deposit rates and betas and what have you?

Sure. Thanks, Don. A little bit more just to get to your question, John, a little more pressure on the commercial side than the consumer side, which would not be unexpected. We did see, as Don mentioned, a rotation out of noninterest-bearing to interest-bearing. And we saw the ending balance of noninterest-bearing around 29% and that's a little bit of seasonality, and we've seen that come back. That's a ratio kind of in the high-20s that we would expect through the year, and that's a little bit better than where we've been historically, which would have been sort of mid-20s. In terms of products and rates, as Don said, CDs came through. We'd expect the betas for the year to be mid to high 20s, as Don said in his prepared remarks. And again, a little bit more movement to CDs than money markets than we expected, but we've factored that in, and again, that sort of stable, high-20s noninterest-bearing ratio for the year.

John, it's Chris. It's interesting. Customer behavior is really hard to model. We wouldn't have expected that the cumulative beta for the first three quarters would have ever been as low as 9%. And as we got to the end of the year, it really accelerated. A lot of it was on the commercial side. A lot of it were excess deposits in places like our private banking area. So, it's been interesting. This has been the steepest rate of increases in the Fed's history. And I think some of the conventional curves are sort of out the window.

Okay. Thanks. Chris, that helps. And then I know you mentioned the need for investment and you're focusing on ratcheting up investments in certain areas. So I want to see if you can give us additional color on what changed there in terms of areas that you're investing in that necessitated the greater pullback in costs elsewhere? Thanks.

Yes. It’s a continuation of the investments we’ve been making. The point I was making is that we will continue to invest even as we reduce costs. At Investor Day a year ago, we mentioned our goal to increase our consumer base by 20% by 2025, particularly in our growth markets. We’re seeing significant success with younger customers and will keep focusing on both products and marketing in this area. We also discussed hiring more bankers, aiming for a 25% increase in our banker population by 2025. Last year, we slowed down our hiring in the latter half due to an overheated market and anticipated economic downturn. We believe the upcoming environment will be favorable for recruiting and onboarding new talent. Lastly, regarding Laurel Road, we committed to growing our membership from 50,000 to 250,000. This year we achieved a 30% growth and made substantial investments, including expanding offerings for nurses, acquiring GradFin, leading in public service loan forgiveness, and entering the income-based forgiveness sector. These are not new investments but rather ongoing commitments in critical areas of our business, including migrating to the cloud and enhancing our digital capabilities.

Okay, Chris. That helps clarify that. I appreciate it. And that's it for me, and best of luck to you, Don.

Thank you so much.

Hey, good morning. Can you give us some more color on the reserve build this quarter? To your point, your NCO guide for '23 is well below your long-term targets. So, I guess, what changed in the macro environment that necessitated the reserve build? And I guess, is this you being a lot more conservative? And should we expect the reserve ratio to stabilize from here or could there be factors that drive that reserve ratio higher?

Thank you for your question, Manan. You're correct that we have strong credit metrics, but we still decided to build the reserve. Looking at the broader economic situation, we believe the economy is slowing down. We see an increased likelihood of a recession from the third to the fourth quarter of last year. Our main scenario predicts a mild recession. There are three primary factors affecting the CECL reserve: the macroeconomic outlook I just mentioned, loan growth—which we are experiencing—and specific portfolio risks, which are not influencing our reserve build. To give you a clearer picture, we've observed GDP declining from approximately 1.3% to 0.4% and unemployment rising from a projected peak of 4.1% to about 5%. Moreover, regarding the home price index, we initially estimated a 1.3% increase in the third quarter, but our fourth-quarter model indicates a decline of 4.6%, marking a notable shift of 5.9%. In terms of our portfolio, we hold $21 billion in mortgages, making up about 18% of our loan book, with average FICO scores around 761. Notably, 40% of our mortgages have scores of 800 or above, which reassures us about that segment. However, as we utilize our forward-looking CECL models, the macroeconomic factors significantly affect our reserve build. I hope this clarifies your question.

Yes. That's really helpful. Thanks so much for the color. And then, if you could just round that out with how you're thinking about the NIM and just managing the NIM as you go through 2023. Earlier on, you were in the camp of the Fed keeping rates higher for longer. Has that changed? And has that changed how you're managing putting on any additional swaps or hedges on the books?

Well, sure. As far as how we're managing it right now, our assumption set is basically that we would just continue at this point in time to replace the roll-off of swaps that we have that we're continuing to evaluate that. I think the challenge that we all have is just with this inverted yield curve is when do you pull the trigger to start to lock in some of that rollover risk and outlook. And so, right now, we've not embedded any of that into our base assumptions, but it's something that we'll continue to have as optionality to take care of that in the future.

Great. Thanks so much.

Thank you.

Hey, good morning.

Good morning.

Good morning, Ebrahim.

I guess just wanted to follow up on credit. So you talked about the consumer book and the FICOs. When we look at the commercial book, both on the C&I, CRE, just talk to us about the idiosyncratic risks, I mean, the leverage lending book you provide on slide 15 is relatively small. But when we think about the impact from higher rates, cooling demand and you talked about mild recession as your base case. Like where within the CRE and the C&I portfolios do you expect delinquencies to start moving higher? And where is the lost content?

Thank you for your question, Ebrahim. You've highlighted an important area where we focus our attention, particularly on leverage. Leverage finance represents about 2.5% of our total loan portfolio and is centered on our seven industry verticals, showing a high turnover rate. You're correct to note that during a mild recession, with declining EBITDA, we need to monitor this closely. We feel positive about this portfolio, as nothing concerning has emerged, but we are continually modeling it. Additionally, real estate is another area of significant focus. We have completely overhauled our real estate operations to not only include real estate loans but also to distribute a substantial amount of risk. This sets us apart from many competitors in the market. We are particularly concentrating on certain asset classes, especially multifamily housing, with an emphasis on affordable housing. So far, we're seeing good trends in rent stability. The portfolios that require careful attention are the B and C class office spaces in central business districts, of which we currently have $250 million in exposure. We're monitoring this, as these buildings contain multiple tenants, and any businesses implementing cost-cutting measures could pose risks. Moreover, we have around $1 billion in retail exposure, which we are also keeping a close watch on. This outlines our current perspective, and we are consistently modeling these portfolios to assess the differences between borrowing rates and debt rollover.

Okay. Got it. And I think in there you mentioned that you're actively de-risking some of these loans. What's the market for that in terms of being able to get out of some of these credits without having to take a big mark-to-market or credit charge?

There hasn't been much movement yet. I believe people are still engaged in price discovery within the M&A environment. For example, regarding B and C class office properties, many individuals are facing impaired equity. However, I think that people will need to endure some additional challenges before reaching a consensus on how to restructure and attract new equity.

Got it. And just one question, Don, on NII. Do you think the mid to high-20s beta is conservative enough? I'm just wondering, in a world of 5% plus Fed funds QT like a lot of banks are kind of nudging their expectations a bit higher. Like do you think that sets you up for more downside risk over the next few quarters? Just give us a sense of your comfort level with that beta guidance?

I'll go ahead and offer up some thoughts and I ask Clark to go ahead and chime in as well. But I would say that keep in mind that, as Chris mentioned earlier on, we really were kind of best-in-class for the first few quarters of this rate increase cycle that our cumulative deposit beta is at 19%. Most of the peers I'm seeing are closer to the 30% already. We did do a thorough scrub as to where we see rates going. And I think what you're seeing and why we have confidence in our deposit beta assumptions is the fact that we have shifted our priority and focus over to more primacy, both on the commercial and consumer side. And we think that will continue to pay dividends for us as far as keeping our overall deposit cost down. Clark, anything you would add there?

Yes. The other point I would add is just that it's less for us about new deposit acquisition. We're always going to acquire deposits from new clients and new relationships. But a lot of what we're looking at this year is managing clients from product to product and that just allows us a little bit more flexibility on pricing.

Ebrahim, I agree with everything that Don and Clark mentioned. However, I want to emphasize that we are in uncharted territory. While we are pleased with the progress of our deposit betas, we must not focus solely on winning the deposit beta battle at the expense of the overall deposit strategy. It is crucial that we prioritize serving our clients and retaining them at Key.

Makes sense. All right. Thank you very much.

Thank you.

Hey, good morning, everyone.

Good morning, Steve.

Good morning.

I wanted to start on the loan outlook. If I look at where period end and average loans ended 2022, it appears that you're not looking for much loan growth in 2023 on a period end basis. Can you confirm that and maybe give some color on why such a sluggish outlook? I don't know if you're tightening the credit box or whatnot?

Steve, this is Don. And as far as the outlook, the period-end balances sometimes can be a little misleading. So, if you just take a look at the fourth quarter average for total loans at $117.5 billion, our midpoint of our guidance range is in the $120 million range, and all of that really is coming from commercial. With this change in our economic outlook that also influenced or determined what our allowance was, we've also pulled back on some of the loan growth outlook. You also see, Steve, that our consumer loan balances are flat throughout next year. And what our expectation is there is that we'll continue to have residential mortgage originations that we'll continue to see some of the home equity balances trade down and relatively flat on other consumer categories. And so it is very modest incremental growth from here, but we think it's appropriate given the backdrop of the economic outlook we have.

Got it. Okay. Don, that's helpful. And then, on the reserve build, if the reserve build was a change in the economic assumptions and not idiosyncratic risk, why did a specific reserve not go up materially in some of these consumer categories? I know they're smaller, but home equity, consumer direct card, I would have thought if you changed the unemployment rate, et cetera, we would have seen an increase in those as well.

One of the biggest things that Chris talked about were the larger moves were this GDP coming down and also the home price index. And so what you would have seen is the residential real estate-backed credits having a larger increase than some of the others. You also factor in the position that our delinquency levels in our criticized and classified levels are still very benign. And I think that's why you're not seeing some of those other higher risk categories showing increased reserves because we're not seeing the migration of those portfolios at this point in time.

Got it. Okay. Thanks. If I could squeeze one more in. Just looking at the NII guidance up 6% to 9%. I know you said mid to high 20% range for deposit beta, but what is the assumption? Is it mid or high that's underlying this guidance range? And what are you assuming the mix of noninterest-bearing is by the end of '23? Thanks.

Yes, Steve, it's Clark. The deposit beta is expected to be in the mid to high 20% range for the year, around the 27 to 28% area, while the noninterest-bearing percentage is projected to be roughly in the high 20% range, about 29%.

Okay. So, staying pretty flat. Okay, great. Thanks for taking my questions.

And just was a little bit lower for seasonality, 32% in the fourth, on average.

Got it. Thanks a lot.

Hi, guys.

Good morning, Gerard.

Don, I think you mentioned in your remarks that there weren't any share repurchases completed in the fourth quarter. Maybe Chris or Don what's the outlook for stock buybacks? I may have missed your comments if you gave it, but what's the outlook for stock repurchases in 2023?

Gerard, we're not assuming that there's going to be any meaningful stock repurchases. As we look at our balance sheet and supporting our clients and we look at our second priority, which is paying our dividend, I just don't see us out there repurchasing a lot of shares based on our current modeling.

Very good. You mentioned the deposit betas and the deposit mix for the quarter. It's clear that your competitors have expressed similar observations, but Key's margin remained essentially flat while others increased. I've noticed in your average balance sheet included in the press release that both your short-term and long-term borrowings have risen, and they are significantly more costly than deposit funding. Can you elaborate on how you are utilizing those borrowings and why they have increased?

Gerard, as far as the funding, what we've seen is that the loan growth throughout the second half of the year especially exceeded deposit growth. And so we were using FHLB and some other issuances to help address the funding needs. I would say that our loan growth outlook and our deposit outlook wouldn't suggest the continuation at the same pace as far as building that other funding sources. And so we wouldn't expect to see that same type of growth rate going forward. But near term, we're fine with that. But I would say, traditionally, we would look at a loan-to-deposit ratio in the 90% to 95% range and we're still well below that. And so, we've got plenty of capacity to continue to leverage that funding source as needed.

Very good. And Don good luck in your future endeavors. Thank you.

Thanks, Gerard. I appreciate it.

Good morning, everybody. Thank you for taking the call. Don, with regard to the $1.1 billion of NII repricing benefits to which you guys alluded I was wondering if you could just sort of walk through the trajectory of when and how those kick in? I mean I see the repricing numbers in the appendix, which is very helpful. But just would be curious to hear kind of more vocally how you think about it, maybe put it another way or I wonder if there's an easy frame of reference. What would first quarter '23 NII look like versus, say, fourth quarter '23 or first quarter '24? Not looking for specific numbers, but is there an easy way to say, hey, we sort of trough here and then start to accelerate meaningfully off of here? And if there's a time frame around that, something like that?

Good. And I will offer a couple of quick comments, but turn it over to Clark because Clark is to be the one that's here to deal with that going forward. And I won't be around. So, will go ahead and pass the baton from that perspective. One thing I want to highlight, though, Scott, is as we take a look, for example, you mentioned in the first quarter of '23. Keep in mind, there are some things that impact the first quarter relative to the fourth quarter that are more seasonal. Day count-related issues cost about $20 million from where the fourth quarter is to the first quarter. We also typically see fee income drop from the fourth quarter to first quarter, given some of the refinance activity on the loan side. And so, we would see the first quarter traditionally being the low point for both our net interest income and net interest margin and would expect to see growth from there. And Clark has been spending a lot of time taking a look at strategies as far as the swaps and treasury. So Clark, why don't you take it from there as far as other insights?

Sure. Just to try to address your question directly, Scott. I think really, the majority of the value is going to come in '24. If you think about what's coming off in swaps and treasuries in '23 that number is about $7 billion to $7.5 billion. It's more like $15 billion and '24 billion. So think about that kind of two-thirds, one-third almost ratio. I'd say, of the number we've shared, which is, again, just to remind you, kind of taking all $29 billion of swaps and $9 billion of treasuries and spot pricing them, again, I think you'd see about a third of that benefit in the '23 exit run rate. So, the beginnings of some steepness in that NIM and then more of that pulling through in '24 as you'd see again, the majority of that maybe two-thirds or three-quarters of that value starting to come through by the end of '24.

Thank you. I'm a bit surprised that the estimate has held steady at $1.1 billion compared to the $1.2 billion you mentioned last quarter, especially considering the changes in the curve's behavior. What factors would significantly impact that number? Is a figure above $1 billion a solid estimate regardless of how things trend?

Yes. I'd say the biggest impact there is the movement in the two-year end of the curve. And what we saw was the longer end rates moved a lot more significantly than two-year point.

Okay. All right. Perfect. Thank you all very much. And Don best wishes.

Thanks so much.

Hey, good morning, Mike.

Hey, you guys see financing to a wholesale company from both the lending side and the capital market side. And one topic during this earnings season is the capital market conditions are a lot tougher whereas the lending conditions are not that much tougher. So when do you think these will converge? In other words, the pricing in capital markets is much more difficult than the pricing in the lending markets? Are you seeing any firming up or not?

So, the answer is that it depends on the customer segment. Fifty percent of our loans go to investment-grade customers, and adjustments in that area happen quickly. There are various factors at play, such as whether people are hedging or using swaps, with many parties involved. The real issue lies in the quality middle-market companies, where financing tends to come from one bank or one fund. We have not observed the expected adjustments in that segment.

Okay. Do you expect that to change coming up? And just your general outlook on capital markets, that's a nice tailwind at times recently set a headwind.

Sure. I believe that ultimately, adjustments will happen, but it takes time—whether we're discussing bank debt entering the middle market or major strategic acquisitions. From my experience, it takes over a year for expectations to realign. We're currently about six months into this process. I anticipate that the first half of the year will be difficult in capital markets, as people are still recalling the valuations from six, eight, or nine months ago. However, it's important to note that buyers are fully aware of the new pricing. I expect a convergence of these perspectives, but it will be challenging in the early part of the year. The significant backlog we have will begin to clear as we progress through price discovery in the second half of the year.

All right. Thank you.

Thank you, Mike.

Hey. Good morning and Don best wishes as well from me. I just have to come back and just super clarify, Don, the 27%, 28% beta for cumulative, that is interest-bearing that compares to the 19% through three quarters?

Absolutely, yes.

Many of our peers are discussing mid-30s and even low-40s in their earnings calls. Can you provide more detail on the pricing assumptions and the specific products and businesses that contribute to your greater confidence relative to your peers? Thank you.

Sure. Ken, it's Clark. So, I'll pick that up. Again, for us, what we saw in the fourth quarter and what we're looking at in '23 is much less about new to Key deposits where those kind of new business rates are much higher and necessarily have to be higher to bring them in versus motion in the book of noninterest-bearing, interest-bearing or from different accounts to different accounts where we can manage that transition a little more comfortably. And given that what we're avoiding, we think, in large part, is the significant marginal cost of funds that the new price or new offer dollar requires in repricing the larger book.

The only other thing I would add, Ken, is that right now, we're at 19% cumulative. I think most of our peers are close to 30%. And so by them going to 40%, it's the same thing as us going to high-20s. So the incremental change from this point forward is probably fairly consistent. It's just that we're at a better starting point than peers.

Yes, that makes sense. However, it seems that in order to reach that point, your incremental interest-bearing deposit costs need to have betas lower than 33% in the fourth quarter to align with that.

As far as a cumulative, probably not because you'd only got a 50 basis-point increase going forward as far as rates in 2023, but we can go back and reverse engineer the math, but I think it still lines up.

Okay. Just one quick one. Laurel Road origination outlook, can you give us your updated thoughts there? Thanks guys.

Sure, Ken. So Laurel Road, obviously, from a straight origination outlook, has been challenged. It's been challenged really by three things. One is the federal loan student payment holiday, that's a challenge. I think that's been extended several times. The next is just the rising interest rates, which are a challenge. And the third challenge that we've had there is all the discussion around student loan debt forgiveness, obviously, I think has some borrowers wanting to stay on the sidelines to preserve optionality. Having said all of that, I was impressed that we were able to originate last year, $1.5 billion of refinance loans. But even a bigger picture, Ken, is we are trying to create a national digital affinity bank. So first of all, those originations will come back, and they'll come back when there's clarity around all the issues I just talked about. And there's a bunch of raw material being priced right now that you'll be able to refinance advantageously. But in the meantime, what we've done is build this national digital affinity bank that has a full suite of products for doctors, a whole suite of products for nurses. We're getting a 30% cross-sell on the business that we do. So, there's no question that originations have been challenged, and they'll continue to be challenged in the very near term. But what we're trying to do there is a lot broader. This GradFin business that we bought is really interesting because they're a leader in public service loan forgiveness and where you're going to see a lot of discussion going forward is around this income-based repayments. And we're kind of uniquely qualified to be in their advising on that. Any time we advise people, obviously, we'll bring them on as full customers. So, does that answer your question?

It does. Thank you, Chris.

Sure, Ken.

Good morning. Sorry if I missed it, but what part of the yield curve are we most concerned about as we think about your fixed rate assets rolling? And I realize there might be a variety of kind of parts because from the short term from the longer term. But as we think about, I think that $1.1 billion, you said, what part of the yield curves should we watch, which obviously longer rates coming in, but shorter rates staying high?

Yes. Matt, as far as the $1.1 billion, it's really a two to three year into the curve, and that's where we would be looking to extend those swaps when we're in a position to do that. And so it is in that portion of the yield curve. Beyond that, we also have a little over $1 billion a quarter and roll over our bond portfolio. And we tend to look at somewhere around the five-year end of the curve there. We tend to do more CMO structures and shorter pass-through like 15-year-type pass-through assets as far as our normal investment strategy there.

Okay. All right. Perfect. Thank you.

Thank you.

Good morning. Chris, I heard the comments on the capital markets in the second half of the year. I was just wondering if you could give some more color about the moving parts to the fee income in '23 for being down 1% to 3%.

Sure. So, there's a few areas where we will get pickup and then there's a few areas where we've got some headwinds. The areas where we'll get pickup is in our investment banking area. We'll get some pickup in cards and payments. We'll get some pickup in trust. Don, do you want to cover the other puts and takes?

Sure. The largest decline for us will be in the deposit service charges category. We mentioned that this quarter was the first full quarter of the implementation of NSF/OD fee. There's about another $70 million impact in '23 compared to '22 for that. And our outlook right now also would suggest that we think that our corporate services income will be down year-over-year just because we've had such a strong program this year as far as derivatives, interest rate swaps and what have you for customers. And we think that with less rate volatility, we'll see less opportunity there for that category. That's the blended impact as to how we get to that down 1% to 3%.

Got it. And then the loan-to-deposit ratio is now at 85%. Is there a certain level that you don't want to go above? And secondly, I'm assuming that you're going to continue to let securities cash flows and use those to kind of help support loan growth?

We typically target between 90% and 95%. It's been a long time since we reached that level, but we believe our balance sheet remains very efficient and that there is still access to the capital markets for that national funding source, which supports that. The second part of the question was, I apologize, Peter, could you remind me?

Sure. Just using securities cash flows.

I apologize. What we've talked about a lot is that we've got that $9 billion of short-term treasuries that start to mature later in '23 and throughout '24. That can be a very good source of liquidity for us. And we're really indifferent whether that replaces funding or whether we roll that over into new securities. But if you look at the rest of the portfolio, it's about $40 billion and we think that's a good core size. We can let run-off there, fund some of the liquidity needs on a short-term basis, but that's longer term, we think that that's probably a good relative size for the portfolio given our overall liquidity management position.

Peter, I would also like to highlight that in the fourth quarter, we allocated 24% of the $33 billion in capital we raised to our balance sheet, compared to a historical average of 18%. Given the current dislocation in capital markets, we were able to structure our assets in a way that we prefer for our balance sheet. As the capital markets stabilize, we expect this percentage to revert closer to the historical 18%. This is an important short-term observation for the next six months.

Got it. Thanks and Don best of luck and it's been a pleasure working with you over these years.

Right back at you, Peter. Thanks so much.

Well, thank you, operator, and thank you for participating in our conference call. If you have any follow-up questions, you can direct them to our Investor Relations team at 216-689-4221. And I just want to thank everybody for your interest in Key. And on that note, we will hang up. Thank you.