Keycorp (KEY) — Q1 2023 Earnings Call Transcript

Well, good morning, and thank you for joining us for KeyCorp's First Quarter 2023 Earnings Conference Call. Joining me on the call today are Clark Khayat, our Chief Financial Officer; Don Kimble, our Vice Chairman and Chief Administrative 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 moving to slide 3. Before I comment on our quarterly results, I want to touch on three areas that I know have been top of mind for investors, namely deposits, capital, and credit quality. Key has significantly strengthened each of these areas over the last decade. We have de-risked our business and built a differentiated franchise that is well positioned for all business conditions, including the current environment. Key's relationship-based business model provides us with a strong granular deposit base and with attractive lending and fee-based opportunities. Our long-term standing strategic commitment to primacy that is serving as our client's primary bank continues to serve us well. Over 60% of our deposit balances are from consumers, wealth clients, small businesses, and escrow accounts. Over 80% of our commercial balances are core operating accounts. The diversity of our deposits extends across client type, account size, industry, and geography. Our deposits come from 3.5 million retail, small business private banking, and commercial customers with 56% covered by FDIC insurance and an additional 10% of balances that are collateralized. In the first quarter, our period-end deposits remained stable and balances from March 31 to present remain relatively unchanged. With respect to capital, Key's position remains strong with a common equity Tier 1 ratio of 9.1%. This positions us well to execute against our capital priorities, including supporting our clients. We are also aware of the heightened focus on accumulated other comprehensive income, AOCI. AOCI improved this quarter by 13%, which drove a 20 basis point improvement in our tangible common equity to tangible asset ratio. Our capital position will benefit from the expected $2 billion improvement in AOCI by 12/31/24. Credit quality remains strong, once again reflecting our proactive and intentional de-risking over the past decade. In our consumer bank, we serve a wide range of clients. Our weighted average FICO score at origination is above 770. In our commercial bank, 82% of our credit exposure is to relationship clients and 56% of our C&I portfolio is investment grade. We have built a strong originate-to-distribute model that strengthens our risk management and allows us to offer our clients a wide range of on and off-balance sheet financing options. In the first quarter, we raised $26 billion for our clients. Another area getting attention is commercial real estate. Our largest exposure is multifamily, including a growing affordable housing segment. There exists a significant shortage of available housing broadly and affordable housing specifically in the United States today. As such, affordable housing will continue to receive bipartisan government support. Importantly, we have limited exposure to high-risk areas such as office, lodging, and retail. We also have unique insights into commercial real estate through our third-party commercial loan servicing business. Not only is this a great business with over $630 billion of servicing assets, but the business provides us with unique insights into the markets, which vary greatly by asset type and geography. Each of these three areas that I've covered; deposits, capital, and credit quality provide a foundation and support the long-term earnings power of our company. With that as a backdrop, let me move to slide 4 and touch on a few quarterly highlights before I turn it over to Clark to cover the quarter in detail. This morning, we reported earnings of $275 million or $0.30 per common share. Our results included $126 million or $0.14 per share as a result of both our increase in allowance for credit losses and the expense actions we previously announced. The build in our allowance for credit losses is principally model-driven and reflective of a greater range of outcomes as we look ahead. Our strong credit quality and guidance for net charge-offs, however, remain unchanged. Our expense actions this quarter were part of a company-wide effort to improve efficiency and support reinvestment back into our business. We completed actions this quarter, which represented over 4% of our expense base or $200 million in annualized benefit. This will allow us to hold non-interest expense relatively flat in spite of persistent inflation. Our results this quarter were driven by year-over-year growth in both our consumer and commercial businesses. In our consumer business, we grew new households at a pace supporting our Investor Day target. Our commercial businesses also continued to add and expand relationships. Recent market disruption has provided us with further opportunity to acquire clients and opportunistically add high-quality bankers to the platform. Net interest income declined from the fourth quarter, reflecting higher interest-bearing deposit costs and a shift in funding mix. Net interest income was also negatively impacted by our received fixed rate swaps, which are used to hedge our floating rate portfolio. Swaps and treasuries reduced net interest income by $317 million this quarter and lowered our net interest margin by 72 basis points. Given the short duration of our swaps and treasuries and the meaningful repricing opportunity, we will see significant benefit to our net interest income beginning late this year and extending into 2024 and beyond. We have continued to take actions to lock in the net interest income benefit going forward. Clark will cover our interest rate positioning in detail during his presentation. Our fee-based businesses in the first quarter showed several areas of strength, but overall reflected expected weakness in capital markets. Although the market remains challenging, we did experience a record first quarter in our M&A advisory business. While we do not anticipate a significant pickup in our capital markets business in the first half of the year, we continue to expect deal activity to pick up sometime in the second half. As I pointed out on the prior slide, credit quality remained strong this quarter, with net charge-offs as a percentage of average loans of 15 basis points. Our credit losses remain near historic lows and we remain confident in the way we have positioned our portfolio consistent with our moderate risk profile. Despite the market disruption, we have not lost focus on driving our targeted scaled strategy and investing in points of differentiation. In our Wealth business, for example, which currently has $54 billion in assets under management, we are bringing the power and capabilities of our private bank to better serve mass affluent clients through our retail channel. Our Laurel Road business is expanding to serve the distinct needs of healthcare professionals through hospital system partnerships. In our commercial businesses, we are empowering our relationship managers with a comprehensive suite of tools to enhance productivity and to better support our clients. I remain confident in Key's long-term outlook for our business. We have durable relationship-based businesses that will continue to serve our clients, our prospects, and deliver value to our shareholders. Lastly, I would like to thank our 18,000 employees for what they do each and every day to serve our clients. With that, I'll turn it over to Clark to provide more details on the results of the quarter and our 2023 outlook. Clark?

Thanks, Chris, and good morning. I'm now on slide six. For the first quarter, net income from continuing operations was $0.30 per common share, down $0.08 from the prior quarter and down $0.15 from last year, driven in part by two notable items. We incurred $64 million of restructuring expense or $0.06 per share, which included $36 million of severance and other related costs and $28 million of corporate real estate-related rationalization and other contract terminations or renegotiations. Our results also included $94 million of additional provision expense in excess of charge-offs or $0.08 per share as we continue to build our reserves, reflecting a more cautious economic outlook and view on home prices. Turning to slide seven. Average loans for the quarter were $119.8 billion, up 16% from the year-ago period and up 2% from the prior quarter, as we continue to support relationship clients. Commercial loans increased 15% from the year-ago quarter. Relative to the same period, consumer loans increased 16%, reflecting growth in consumer mortgage. Compared with the fourth quarter of 2022, commercial loans grew 3%. Our commercial growth continues to reflect the strength in our targeted industry verticals and support for our relationship clients. Continuing on to slide eight. Average deposits totaled $143.4 billion for the first quarter of 2023, down 5% from the year-ago period and down $2.3 billion or 2% compared to the prior quarter. Year-over-year, we saw declines in retail deposits, driven by elevated spending due to inflation, normalization from pandemic levels, and changing client behavior due to higher rates. Commercial balances, which included $6 billion of brokered deposits remained relatively flat. The decrease in deposits from the prior quarter reflects a continuation of these same trends. Interest-bearing deposit costs increased 62 basis points from the prior quarter and our cumulative deposit beta was 29% since the Fed began raising interest rates in March 2022. Our outlook for 2023 now assumes a cumulative deposit beta peaking in the low 40s. Turning to slide 9. We wanted to provide incremental detail on the granularity and composition of our $143 billion deposit portfolio. At the end of the first quarter, approximately 54% of our deposits came from consumer, wealth, and small business clients. An incremental 6% of deposits are from low-cost, stable escrow balances. The remaining approximately 40% of our deposits come from our large corporate and middle market commercial clients. Over 80% of commercial segment deposit balances are from core operating accounts. Of our total deposits, 56% are covered by FDIC insurance, while an additional 10% are collateralized. We maintain access to enough liquidity to cover over 150% of uninsured and uncollateralized deposits. The quality of our deposit base derives from the strength of our relationship-based strategy, which has benefited Key both from a balanced stability and cost perspective. At period end, our loan-to-deposit ratio was 84%. Now moving to slide 10. Taxable equivalent net interest income was $1.1 billion for the first quarter compared with $1 billion in the year-ago quarter and $1.2 billion in the prior quarter. Our net interest margin was 2.47% for the first quarter compared to 2.46% for the same period last year and 2.73% for the prior quarter. Year-over-year, net interest income and the net interest margin benefited from higher earning asset balances and higher interest rates, partly offset by higher interest-bearing deposit costs and a shift in funding mix. Relative to Q4, our net interest margin was negatively impacted by 22 basis points related to higher interest-bearing deposit costs and 22 basis points from a change in funding mix and liquidity and loan fees, partly offset by 18 basis points related to higher interest rates and earning asset growth. As Chris noted earlier, our swap portfolio and short-dated treasuries reduced net interest margin by 72 basis points in the quarter. Additionally, the net interest income was lower, reflecting two fewer days in the quarter. Turning to slide 11. As previously mentioned, Key stands to benefit significantly from the maturity of our short-dated swap book in treasuries. This opportunity is consistent with the $1 billion of upside we've been talking about over the last few quarters. While we recently offered more detail on the swaps and treasuries by quarter and interest rate, we thought it would be valuable to include a view on the realization of that potential value in both timing and amount. The chart on slide 11 shows this with the forward curve. We do not include – we do include the value should short-term rates remain at current levels in a higher prolong scenario as well. We have also gotten questions about how we plan to lock in this value. As we've shared, we've taken a measured but opportunistic approach to adding hedges to address this potential. The analysis on slide 11 reflects the additional hedging activity we've undertaken beginning in Q4 and since. The point here is to provide one more level of depth to clarify the timing and magnitude of this opportunity. As this demonstrates, we continue to see significant future value in NII as these swaps and treasuries mature. Moving to slide 12. Non-interest income was $688 million in the first quarter of 2023 compared to $676 million for the year-ago period and $671 million in the fourth quarter. The decline in non-interest income from the year-ago period reflects a $24 million decline in service charges on deposit accounts due to changes in our NSF/OD fee structure that we previously discussed and implemented in September and lower account analysis fees related to interest rates. Additionally, investment banking and debt placement fees declined $18 million, reflecting lower syndication fees, partly offset by an increase in advisory fees, while corporate services income declined $15 million, reflecting lower loan fees and market-related adjustments in the prior period. The decline in non-interest income from the fourth quarter reflects a $27 million decline in investment banking and debt placement, driven by lower advisory and syndication fees. Recall that Q1 is historically the low point for investment banking activity in the year. Other income decreased by $20 million driven by Visa litigation assessment and market-related adjustments. Additionally, corporate services income decreased by $13 million, reflecting lower derivative volumes. Moving on to slide 13. Total non-interest expense for the quarter was $1.18 billion, up $106 million from the year-ago period and up $20 million from the last quarter, inclusive of $64 million of restructuring charges related to actions we completed this quarter to take out $200 million in annualized costs. As we shared on the Q4 call, we took these steps proactively to support investment in our business in the face of continued inflation. Compared with the year-ago quarter and in addition to restructuring charges, personnel expense increased, reflecting an increase in salaries and headcount, partly offset by lower incentive compensation. Compared to the prior quarter, and in addition to restructuring, business services and professional fees declined $15 million in marketing expense declined $10 million. Additionally, other expense increased in the first quarter by $9 million reflecting an increase in the base FDIC assessment rate. Moving now to slide 14. Overall, credit quality remains strong. For the first quarter, net charge-offs were $45 million or 15 basis points of average loans, which remain near historically low levels. Our provision for credit losses was $139 million for the first quarter, which, as we pointed out, exceeded net charge-offs by $94 million. 30 to 89-day delinquencies to period-end loans were down one basis point to 14 basis points, while 90-plus day delinquencies remain stable. The excess provision increases our allowance for credit losses, reflecting a more cautious model-driven assumption. Despite the increase in the allowance, our outlook for net charge-offs in 2023 of 25 to 30 basis points remains unchanged and well below our through-the-cycle levels of 40 to 60 basis points. Moving to slide 15. With regard to commercial real estate in particular, Key's exposure is well controlled and credit quality remains strong. Over the past decade, we meanfully repositioned our commercial real estate book by sharply reducing our exposure to construction and homebuilders and reducing the level of commercial real estate loans in our book. We focus on relationship lending with select owners and operators. Our improved risk profile has been demonstrated in Key's most recent stress test results where projected losses in our commercial real estate book stands at 8.2% compared to 11.5% for peers. Now on to slide 16. Our liquidity position is strong, our period-end cash balances at the Federal Reserve stood at $8 million, and we maintain flexibility with significant levels of unused borrowing capacity from additional sources. We would expect to maintain higher cash balances until the market stabilizes. Our levels of additional available liquidity have not changed materially since the end of the quarter. On to slide 17. We ended the first 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 relationship customers and their needs. We completed $38 million of open market share repurchases in the first quarter related to our employee compensation plan. Given market conditions, we do not expect to engage in material share repurchases in the near-term. We will continue to focus our capital in supporting relationship client activity and paying dividends. Over the last six weeks, there's been significant discussion of AOCI and its potential inclusion in CET1 capital levels for Category 4 banks. We've historically chosen to put most of our portfolio purchases and available for sale. And given the recent market rise in rates, we saw significant increases in the negative mark. As time passes and if rates come down, we've seen our AOCI mark decrease by 13% and from $6.3 billion at 12/31 to $5.5 billion at 3/31. We share on Slide 16, the expected reduction in the AOCI mark from 3/31 to the end of this year and the end of 2024. Over that time frame, the AOCI mark declined by approximately 40%. And while this analysis assumes the forward curve, it's important to note that 90% of the value is for maturities and cash flows that are not rate dependent. Although we have no unique insight into the path of potential regulatory changes, as we've seen historically when bank capital regulations have changed, they carry with them comment periods in a reasonable phase-in time frame. Our view is that for any new requirements, our reduction in AOCI mark and more significantly, our earnings would allow us to organically accrete capital to required levels over the necessary period. Slide 18 updates our full year 2023 outlook. The guidance is relative to our full year 2022 results. We expect average loans to grow between 6% and 9%. Importantly, most of this growth has already occurred relative to 2022, so we don't expect material loan balance growth. We'll continue to support relationship clients by recycling capital throughout the year. We expect average deposits to be flat to down 2%. Net interest income is now expected to decline by 1% to 3% driven by higher interest-bearing deposit costs and a continued shift in funding mix. Our guidance is based on the forward curve, assuming a Fed funds rate peaking at 5.1% in the third 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. Non-interest income guidance is unchanged. We continue to expect it 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 in the first half. Our non-interest expense outlook is also unchanged. We expect it to be relatively stable, driven in part by the actions we took last quarter to accelerate cost savings, which includes the impact of the $64 million in restructuring charge. For the year, we continue to expect credit quality to remain strong and net charge-offs to be in the 25 to 30 basis point range, well below our over-the-cycle range of 40 to 60 basis points. Our guidance for our GAAP tax rate is now 20% to 21%. We feel confident in the foundation of our business, the relationship-driven value of our deposit book, the durability of our balance franchise, and our improved risk profile. Despite near-term headwinds, we continue to be focused on execution in 2023 and the strong long-term earnings power of our company. With that, I'll now turn the call back to the operator for instructions on the Q&A portion of the call.

Good morning.

Good morning, Ebrahim. How are you?

So starting with deposits, we've seen an increase from a mid- to high 20s beta to the 30s, and now it's in the low 40s. Chris Clark, can you share your thoughts on why this low 40s beta is appropriate considering the possibility that the Fed may not raise rates again? What gives you confidence in this number and what analysis supports that assumption?

Certainly. We will discuss that analysis shortly. However, we were initially surprised by how low the betas were, and recently, we have been taken aback by the steepness of the curve. Your question is valid. Before I hand it over to Clark, let me provide some context about our deposit base. Our total cost of deposits is 99 basis points, and our cost of interest-bearing deposits is 1.36. As previously mentioned, our cumulative beta is 29, and we now anticipate that betas will peak in the low 40s. I want to highlight the composition of our deposit base; we are more focused on commercial than retail deposits. These deposits are primarily from businesses that we have supported through various cycles, including the PPP program. Over 80% of these accounts are operational accounts. When discussing insured and uninsured deposits, it's important to note that if you're managing a business with $200 million to $400 million and holding your operating account with us, those deposits are not likely to leave since they are essential for daily operations. I felt it was necessary to provide this context because we always analyze deposits by category. Now, returning to your question, Clark will provide the detailed reasoning behind our estimate of low 40s and our confidence in that projection.

I would start with our balances, which we feel very good about in comparison to where they have been, the market we’re in, and our competitors. It begins with our balances, and then moves to pricing. As we've mentioned previously, our focus has been more on retaining deposits rather than acquiring new ones, which is reflected in our beta to date. Since the last quarter of the previous year, as we've observed market developments, we have gained a clearer understanding of customer interactions. The commercial betas have largely materialized, and we've seen those increase. Many of them, as we've discussed, are indexed, and there's been extensive engagement with commercial clients. Consumers tend to be slower to change, but at this point, we feel we understand their behavior better, including the types of accounts they prefer and how competitors are responding. Considering the low 40s figure, which is up from the high 30s, we are confident that we can implement beta across our retail franchise and in targeted customer segments to not only retain but also potentially gain deposits going forward.

Got it. Thanks for that. And just maybe a quick one, Clark, on the slide 11, the bar chart with the NII upside from swaps and treasury roll-off. Give us a sense of sensitivity if rates were 100 basis points lower next year versus today? What does that mean for that upside that you lay out there?

Yeah. So what's embedded in the chart on the page, Ebrahim, is the forward curve, which is coming off. I don't have in front of me exactly what those rates are, but they're coming down pretty significantly over that time frame. I could follow up with a little more sensitivity, but effectively, you can think about the forward curve in that 720 range as we talked about annualized. Maybe the right comparison is, if rates didn't move at all and the spot rate just sort of played out you'd get back to that $1 billion number. So you see a little bit of a sensitivity between 'higher for longer version' where the spot rate just sort of sticks versus the forward curve, which is coming down fairly significantly over the next seven quarters.

And I think in the prepared remarks, you said you were taking actions to lock that in. How are you doing that?

I believe we've discussed this before, but I’m glad to elaborate. Looking at 2023, at the start of the year, we had about $6.2 billion of received fixed swaps coming off, with $1.7 billion maturing in the first quarter at a rate of 2.62, which was the highest rate in the two-year period. The remainder, approximately $4.5 billion, will mature throughout the year, and we do not plan to replace those. This means we will let the natural asset sensitivity of our loan book take effect. Next year, another $7.5 billion in swaps will mature, and we have replaced them with a mix of forward starters at an average rate of 3.4%. This does introduce some negative carry, but by the end of the year, they are somewhat in the money. Additionally, the other half consists of floor spreads that activate at $3.40, allowing us to capture all floating rate value above that threshold until the forward curve declines. In a higher rate environment, we would benefit even more from not hitting that floor. We believe we have effectively managed the downside risk while also preserving some potential upside. The reason we haven't done more with floors or floor spreads at this stage is due to the high cost of volatility, and we are attempting to strike a balance between risk and reward in this trade.

Thanks for taking my questions.

Sure.

Good morning, everyone. Thank you for your question. Mark, considering the current margin of 247 and the target margin of around 320, I'm curious about the journey to get there. Do you have any insights on when we might hit the bottom for the margin? More specifically, when do you anticipate it will begin to rise? I understand that the treasury and swaps are focused on the end of 2023 and into 2024, but will we see a margin increase this year, or should we expect a further decline before it starts to rise again? What are your thoughts on this situation?

Yes, good question, Scott. We initially believed that Q1 would be the lowest point, but now we think that Q2 will be. After that, we expect some stabilization and improvement in the second half of the year. Part of this is due to the swap book starting to roll off, and we will see some treasuries, although they are relatively light in 2023.

Okay. That's perfect. Thank you. And then, Chris, maybe just a thought on the investment banking rebound in the second half. I mean what does that kind of look like in your mind, how powerful could it be? It's been such an odd environment. You got the VIX at a level where historically, there'd be a lot of activity now. But it certainly feels very uncertain, and I think we've all been sort of surprised by overall lack of activity. So when you sort of look out over the remaining several months of the year, what's sort of your best guess as to how a rebound might play out?

I believe we need to go through a process of price discovery. There is essentially a bid and ask situation with equities. Some deals are being priced, and we're seeing some high yield transactions completed. However, it will take time for buyers and sellers to adjust their expectations. Based on my experience, this adjustment typically takes a while, but people will eventually adapt to the new normal. I anticipate a recovery in the second half of the year. Our pipelines are down about 10% from last year, which isn't too bad considering this time last year. The pipelines remain strong. We had a solid quarter in terms of advisory work, but many of our clients are currently staying on the sidelines. There are opportunities available, but we are advising clients that now may not be the ideal time to engage in financing or transactions. However, the market will recover, and the pipeline is gradually building. Some deals may fall through, but overall, it will come back.

Yeah. Okay. Perfect. Thank you all very much.

Thank you, Scott.

Good morning.

Good morning, John.

Good morning.

I have a couple of questions about the outlook for net interest income this year. Could you share your thoughts on the shift in the non-interest-bearing deposit mix and how you see that developing? Additionally, regarding the margin progression in the second quarter, you mentioned a pullback followed by an inflection. Could you provide more detail on the expected margin compression for the second quarter? Thank you.

Sure. From non-interest-bearing, we've seen that come down 29% to 26, 27, we would think that, that would make its way to the mid-20s. But I will say there's one caveat in there, and that is we have been using the I believe we've talked about this, but we've been using what we refer to as a hybrid account with many of our commercial clients where we're taking non-interest-bearing deposits and some of their excess balances and keeping them together in one interest-bearing account. So we've moved balances out of non-interest-bearing into those accounts. They would reflect on the balance sheet as a decline in non-interest-bearing, but it allows us to maintain those balances in a technically interest-bearing account, but at very attractive rates. So again, we can break that out over time. But I would say the non-interest-bearing decline probably isn't quite as stark as it would appear on its face. As it relates to net interest income, second quarter, we'd expect that to be down kind of 4% to 5% in Q2 with NIM, NIM coming down in part because we're carrying a little bit excess liquidity post the early March period, and we would see that come down we think maybe another 6 to 8 basis points. And then as I responded to and Scott's question, kind of stabilize and start to come back up in the second half of the year.

Got it. Okay. All right. That's helpful. And you care to venture a projection in terms of the magnitude of the inflection in the back half of the next?

Not at the moment. We haven't provided that yet, but you would see our guidance for the year indicating a slight decline in NIM. However, we will need to perform better in the second half than we currently anticipate.

Got you. Okay. Thank you. And then just separately on regulation. I want to see if you can maybe provide some comments around how you're thinking about the most likely areas of regulation where you expect some measures out of the regulators or around inclusion of AOCI, potentially TLAC, FDIC, stress capital buffer risk. Maybe if you could just comment on that Chris, I'm interested in your comments on that as well.

I'd be happy to comment on that. To the premise of your question, there's no question that we'll be experiencing. We're going to have to carry more capital, and there'll be more regulation. I personally think TLAC is going to be part of that or some debt security that looks like TLAC. I also think that we'll probably have to carry more capital. We, as you can imagine, have run all kinds of scenarios. We feel comfortable that based on the burn down of our based on the earnings power of the company. And based on timing, i.e., there would be some comment period and some phase-in period. We feel like no matter under all the scenarios that we've looked at we feel confident that Key can be in a position to meet both the regulatory and the capital requirements going forward.

Great. Thank you.

Thank you, John.

Yes. Hi, good morning. If I could ask the NII protection question another way. Clark, the loan beta of your commercial portfolio was something like 52% in the second half of 2022 and about 65% this quarter. As we think about the protection for down short rates, and I think a lot of investors are expecting down short rates in 2023. Should we interpret your protection as a lower sensitivity to each 25 basis points of cuts that we've seen to the upside?

Sorry, can you ask that one more Erika? I just want to make sure I'm understanding the question.

Yes. Yes. So, I wanted to understand slide 11 in a different way, right? So, the protection on your commercial portfolio and locking in the upside. So, we saw the sensitivity to higher short rates in terms of the carry through to your yield at about the low 50s in the second half of last year and in the mid-60s this quarter, right? The way investors are interpreting protection to the downside is a lower sensitivity as the Fed cuts, right? And so should we expect the key commercial yields have a lower sensitivity to cut on the way down than it did to increases in rates on the way up?

I mean, yes, if you think about the incorporation of the swaps, right? So, the swaps are there for exactly that purpose and they would reduce the sensitivity on the way down, that's the intent of those instruments.

Okay. And what you're showing us on slide 11 is essentially the assumption that your current swap book as it rolls off gets replaced with a higher received fixed rate?

Yes, there are two components to consider. In our view, I have not observed any predictions where rates drop below the swap rates. Therefore, we will allow that to flow through our natural loan rates and yields for 2023. For 2024, we have successfully replaced the swap book with forward starters at a higher average rate of 3.40%, and the floor spreads have a kick-in rate of 3.40%. If rates remain high, we will benefit from the value on the floor spreads while managing the negative carry on the forward starters. If the forward curve develops as expected, both will be beneficial at some point in 2024.

Understood. I apologize for combining everything into the third question. As investors evaluate whether bank stocks are genuinely undervalued, they are considering a 2024 EPS as a low point. Regarding your current commercial yield, there are a couple of challenges. The first challenge is the lower fixed rate you receive on your notional amounts. Conversely, the yield will likely be better safeguarded if the Fed makes cuts. Am I correct in interpreting the message about downside NII protection in relation to your commercial portfolio?

Yes. I think you said that well.

Hi, good morning. Just a follow-up on the swaps. So maybe just to ask it a different way. So in the back end number from the 10-K, of the reported impact from swaps in the fourth quarter was minus $162 million, do you have the number of what that negative impact was in the first quarter? And can you help us understand what it will look like when we see the new disclosure for the roll-forward next four quarters? Thanks.

You're talking just swaps specifically, Ken?

Yes.

Yes, $215 million in the first quarter.

Okay. That's $215. And then so last quarter's next four quarters roll forward from the K was $655 million after tax. Do you have an idea of what the new roll-forward will be when we see that in the 10-Q?

Not at this point, but we can follow up and let you know that.

Okay. And then the last question is you mentioned the $750 million and the $1 billion and that you're not going to be replacing now. Can you maybe just flesh that out a little bit in terms of like the any change to that strategy around protection and how you'll be replacing going forward to get that incremental forward benefit from the roll-off versus what you're putting on?

Yes. I will continue to clarify. The $6.2 billion in fixed swaps received in 2023 are set to mature, with $1.7 billion maturing in the first quarter. We do not plan to replace these swaps to safeguard the loan book from a received fixed swap perspective this year. There's an additional $7.5 billion that will mature through 2024, and we have taken measures to effectively replace a portion of that, approximately $7 billion in total, with half of it being forward start received fixes averaging at a rate of 3.40. This essentially replaces the existing rate of 2.4 and raises it to 3.40. The other half consists of floor spreads that coincidentally have an attachment point around 3.40 as well. This setup provides protection against potential decreases in rates, which the forward curve suggests at this time, ensuring that about $7 billion will yield 3.40 or higher as the other swaps expire.

Got it. And I know that was asked so I apologize for re-asking.

That's okay. I think maybe not doing it as clearly as possible. So I appreciate the follow-up.

Hi. This has been a challenging quarter for you. It seems that you fell short of expectations in areas such as net interest income, net interest margin, fees, provisions, and expenses. You have revised your net interest income guidance downward from an increase of 1% to 4% this year to a decline of 1% to 3%. You also mentioned that net interest income is expected to decrease in the next quarter. Given these challenges, are you looking to reduce expenses further? Are you being more cautious, or are you simply facing the reality of higher funding costs and moving forward? Additionally, while you haven't changed your loan guidance, it doesn't appear that you are taking a more cautious approach there. Essentially, I want to understand if the situation is as dire as it appears, or if there are any positive aspects to consider. Could your resilience lead to gaining market share, even though that isn’t reflected in your guidance?

Yeah. So thank you for the question. Let me just, kind of, broadly talk about the quarter. Mike, there's no question it was a challenging quarter for us, but we continue to do the things that we need to do to build the franchise. And so what are those things? You mentioned expenses. We put a hiring freeze in place in November, and we took out $200 million or 4% of our expense base just in the quarter we just completed. So that's one of the things we do. We've talked a lot today about how we're managing our balance sheet. We have taken significant actions and we have the luxury of taking the actions because they're short duration, both on our swaps and on our investments to put us in a position where we can benefit from the rise in interest rates. So we've done that. And then the other thing we continue to do, as you know, is we continue to strategically invest in our business and focus on targeted scale. So my perspective is, yes, this is a challenging quarter. Yes, we have to get through this NII drag, but we have a clear path to do so. And that's what we as a team are in the business of focusing on.

And Mike, I'd just add two things. On the expenses, they're up because of the charge, $64 million. If you took that out, we'd be in good shape. And I think if you annualize that number, we're right in line with our guidance of relatively stable year-over-year. And again, that's in the face of some inflationary headwinds. I think on the provision, you heard in our charge-offs, we didn't change our guidance, which may beg the question of why did you build your provision? And frankly, we're doing what we think CECL was intended to do, which was when macroeconomic conditions change, you build the reserve. So we're applying that standard, and that would be the reconciliation between two quarters of build and no change in the charge-off guidance.

Given that extra caution, you kept your loan growth the same at 6% to 9%. So I'm trying to reconcile your more caution with your provisions with no change in your loan guidance, whereas others have brought down their loan guidance as they tighten things up.

Yes, Mike. We are currently at the low end of our guidance for the year. Moving forward, we will be focusing on recycling capital. It's clear that the cost of raw materials has increased significantly. We will not alter our lending standards, but we will adjust our pricing accordingly. We are fortunate to have strong relationships that compensate us well, allowing us to effectively serve those clients. However, as we've discussed before, lending to a stand-alone business requires careful consideration of cost recovery. Therefore, when the cost of capital rises, the pricing and other terms for those customers will need to increase as well.

Yes. Just to be clear, the 6% to 9% year-over-year loan growth really was evident at the end of 2022. It reflects the growth that occurred in 2022.

And so, one more follow-up. It seems like the capital markets are pricing for risk more than the lending markets. But when you have that conversation with your commercial customers and say, 'Hey, we're going to pass on this higher cost of raw materials.' Are you seeing any additional pricing power in lending markets? I mean, it just seems like loan yields should be going up more than they've already have done.

Yes. And they never go up as much as they should because, frankly, there's too much excess capacity in the banking market. But no, they haven't moved. And that's where it really pays to have a wholesome relationship like where we can drive a bunch of other revenue, but there hasn't been the adjustment yet that there should be based on the arbitrage between the capital markets and the bank market.

I guess, I sneak one last in there, if that's the case then, I mean, the cost of all materials are going up and you can't get the loan yields you desire, maybe just delever a little bit and just not have much growth, but have less risk, or I mean, how do you view that trade-off? Because just...

I think, over time, that's what you're going to see, right? We'll be using the capital markets as they open up to actually place paper for people. But in terms of putting new debt on our balance sheet, we're not going to do it unless we have a complete relationship, and we can drive a whole bunch of revenue. And that in itself will be limiting.

Got it. All right. Thank you.

Thanks, Mike.

Hey, good morning. I wanted to follow up on the cost-cutting efforts that are underway to counter inflation. Just given the events of the past few weeks, how does that change? What do you think you need to do on the investments, right? So as I think about deposit competition accelerating, are there any investments you think you need to make on either the technology or the product side in order to retain and grow deposits? And how much of that is embedded in your expense guide?

Yes. Thanks, Manan. So, right question. The good news for us is, we undertook the expense cuts, so we could make those investments, and we've got both on the consumer and commercial side, a focus on deposit and customer acquisition technology, whether it's digital capabilities in consumer, things like embedded banking, which we've talked about before, or other payments capabilities on the commercial side. So that cost cutting was in part to make room for exactly those types of investments.

But is there anything additional you need to do given the events of the past few weeks?

I mean, we'll assess that as we go forward. I think we feel well prepared to handle the deposit challenges in front of the market right now, and I think our numbers have shown that. I think more than anything, we're probably likely to be more offensive on the deposit side than we've been to date, and we feel well armed to do that.

Got it. Great. And then just on securities. I appreciate the detail on the AOCI accretion over time. I wanted to ask how do you think about the future mix and duration of the securities book just given what we've seen in the past few weeks? And just given the potential for higher regulation, would you skew the mix of your securities more shorter-dated towards treasuries. Just want to get a sense of how you're thinking about that?

Yes. It's a good question, hard to answer in a vacuum, but my sense would be you'll see higher quality portfolios, although ours is pretty high quality today, and you'll probably see shorter duration or more floaters. So it will be interesting to see if that's the way it shakes out. The broader impacts of bank security portfolios moving in that direction and how that might impact the market more broadly.

Great. Thank you.

Hey, good morning, everyone.

Good morning, Steve.

So first, on the deposit side. So your uninsured deposits are fairly high, but it does not appear that you saw a large degree of outflows, right, that many of your peers saw in the aftermath of Silicon Valley Bank. Could you comment on that? Were there notable outflows or because of the operating nature of these accounts, which you called out, Chris, was that enough of a factor where you just didn't see what many peers saw?

Just to clarify, 66% of our deposits are either insured or collateralized. We did experience some outflows, particularly among high net worth individuals and smaller businesses where the deposit and the person are closely linked. There were also a few larger excess deposits that moved out. However, the primary reason for the strong retention of our deposits is that these are operating accounts for businesses that have been clients of Key for a long time. Fortunately, there wasn't much concern during this period. We proactively reached out to our customers, and I was very pleased with how sticky our core deposit base has remained.

Okay. That's helpful. And then, Chris, on the potential for new regulation, and you said you're in a good position to organically build capital, right, in anticipation of new regulations potentially coming. Do you assume that you need to suspend buybacks for an extended period until we see new regulation in order to build that capital?

I don't plan to execute any buybacks until we have clarity on the future capital framework. Therefore, I don't expect that we'll be doing any share repurchases until we have that clarity.

Thank you for that. I have one more question regarding Cary's earlier inquiry about the hybrid account for commercial customers. It shows as non-interest-bearing, yet you're paying some interest. Could you share the balance in that account and the interest amount you're paying? Thank you.

Yes. We'll have to follow up. I don't have that specific number in front of me. But we'll follow up with you, Steve. Well, I want to thank everyone for joining us today. This concludes our first quarter call. If you have any questions, please, as always, reach out to Vern Patterson. Thank you so much. Have a good day. Goodbye.