Keycorp (KEY) — Q2 2024 Earnings Call Transcript

Thank you, operator, and good morning, everyone. I’d like to thank you for joining KeyCorp’s second quarter 2024 earnings conference call. I’m here with Chris Gorman, our Chairman and Chief Executive Officer; and Clark Khayat, our Chief Financial Officer. As usual, we will reference our earnings presentation slides, which can be found in the Investor Relations section of the key.com website. In the back of the presentation, you will find our statement on forward-looking disclosures and certain financial measures, including non-GAAP measures. This covers our earnings materials as well as remarks made on this morning’s call. Actual results may differ materially from forward-looking statements and those statements speak only as of today, July 18, 2024, and will not be updated. With that, I will turn it over to Chris.

Thank you, Brian. I'm on Slide 2. This morning, we reported earnings of $237 million or $0.25 per share, which is down $0.02 from the year-ago quarter, but up $0.05 sequentially. On a quarter-over-quarter basis, revenue was essentially flat as we offset the expected pullback in investment banking fees from a record first quarter with growth across the balance of the franchise. Expenses remained well-controlled, and credit costs were stable. Importantly, we continued to deliver on our clearly defined path to enhanced profitability as we detailed a little over a year ago. Net interest income grew from what we continue to believe will be this cycle's low in the first quarter, and we remained confident in our ability to deliver on our NII commitments for both the full year 2024, as well as the fourth quarter exit rate. Deposit value creation continues to be a positive story for Key. This quarter deposits grew by 1% sequentially, while the pace of increase in deposit costs continued to decelerate. Additionally, non-interest bearing deposits stabilized at 20% of total deposits. We were also pleased to see client deposits up 5% year-over-year. Consumer relationship households are up 3.3% annualized year-to-date. Finally, we continue to be very disciplined with respect to pricing. Our cumulative deposit data stands at 53% since the Fed began raising interest rates. With respect to non-interest income, we have made continued progress against our most important strategic initiatives. In our wealth management business, targeting massive fluid prospects, production volumes hit another record in the second quarter as we added 5.6 thousand households and over $600 million of household assets to the platform. Since launching this business in March of last year, we have added over 31,000 households and about $2.9 billion of new household assets to Key. Within our existing customer base, we believe we have a great opportunity, over 1 million Key retail households have investable assets of over $250,000 and only about 10% are existing customers in our investment business. Overall, as a company, our assets under management have now reached $57.6 billion. In commercial payments, we continue to see strength in our commercial deposits with 9% growth year-over-year and a relatively flat beta since year-end. Cash management fees are growing at approximately 10%. Our Primacy focus has made this a core competency for us. We continue to see momentum as our clients are more focused than ever on working capital solutions and driving efficiency in their own businesses. Additionally, our focus on verticals like healthcare, real estate, and technology create meaningful deposit opportunities and our embedded banking strategy was well-timed given the growth we're seeing in that market. In investment banking, as we have previously communicated, our second quarter fees were below those of the first quarter. Our positive outlook for the business, however, remains unchanged. Our pipelines are higher today than last quarter, year-end, and year-ago levels. Our M&A pipeline remains near record levels and the near-term outlook for other investment banking fee revenue streams have improved. At this point, we expect a stronger second half of the year consistent with our prior guidance. Our national third-party commercial loan servicing business also continues to perform well. This is a counter-cyclical business that also gives us unique insight into the commercial real estate market. We continue to feel very good about our growth prospects for this business. Lastly, on loans, broadly loan demand remains tepid, and the pricing environment remains competitive. It has also taken some time after our focus on improving our liquidity and capital ratios last year to get our machine fully up to speed. Despite recent volume trends, we are optimistic we will start to see stabilization and potentially some growth in the back half of the year. Our pipelines are building. In the middle market, our pipelines are over 50% higher than last quarter. And in our institutional business, engagements broadly are picking up as well. Turning to capital. This quarter, our Common Equity Tier 1 ratio improved by roughly another 20 basis points to 10.5%. Our marked CET1 intangible capital ratios also improved. As reported a few weeks ago, we have received the results of the Fed's stress test, which implied a preliminary stress capital buffer for Key of 3.1%, which is up 50 basis points from the SCV we received in 2022. I'll make just a few comments. First, even under this preliminary buffer, we have plenty of excess capital. Our 10.5% CET1 ratio compares to what would be a new 7.6% implied minimum. So the results continue to illustrate our strong capital position. Secondly, we, like others in our industry, don't have insight into the Fed's models. The Fed's modeled loan losses for Key, particularly for our commercial real estate and first-lien mortgage portfolios, are inconsistent with our internally run stress tests. We look forward to a continued constructive dialogue with our regulators on this topic. Looking forward, I am excited about what lies ahead for Key. We have been discussing our net interest income pivot for each of the last several quarters. The pivot is now upon us. NII headwinds that we have experienced will now become NII tailwinds as we go forward. Concurrently, I'm also encouraged by the business momentum we continue to see across the franchise. We demonstrated momentum in wealth management and commercial payments this past quarter, and we are driving meaningful client deposit growth across the entire franchise. Lastly, investment banking and loan pipelines are up meaningfully from prior periods. With that, I'll turn the call over to Clark to provide more details on our financial results.

Thanks, Chris, and thank you everyone for joining us today. I am now on Slide 4. For the second quarter, as Chris mentioned, we reported earnings per share of $0.25 up $0.05 per share versus the first quarter or $0.03 per share adjusting for last quarter’s FDIC's special assessment. Sequentially, revenue was essentially flat, down half of 1%, as a 1.5% increase in net interest income was offset by a 3% decline in non-interest income while expenses declined more meaningfully by 6% or 4% excluding FDIC assessment impacts. Credit costs were stable and included roughly $10 million build to our allowance for credit losses this quarter. On a year-over-year basis, EPS declined driven by a tough net interest income comparison, but as we have shared previously, we expect NII will start to become a real tailwind next quarter and in the back half of the year. Non-interest income grew 3% while expenses were flat. Moving to the balance sheet on Slide 5. Average loans declined about 2% sequentially to $109 billion and ended the quarter at about $107 billion. The decline reflects tepid client demand, a 1% decline in C&I utilization rates, our disciplined approach as to what we choose to put on our balance sheet, and the intentional runoff of low-yielding consumer loans as they pay down a mature. As Chris mentioned, we continue to have active dialogue with clients and prospects and our loan pipelines are building nicely, which gives us optimism that balances will stabilize or begin to improve from June 30th levels. On Slide 6, average deposits increased nearly 1% sequentially to $144 billion, reflecting growth across consumer and commercial deposits. Client deposits were up 5% year-over-year as broker deposits have come down by roughly $5.8 billion from year-ago loans. Both total and interest-bearing profit deposits increased by 8 basis points during the quarter, a slower rate of increase compared to the first quarter as short-term rates have remained high. 3 basis points of the increases is due to the intentional addition of roughly $1.6 billion of term deposits reflecting a more conservative approach as we prepare for anticipated changes in liquidity rules. Non-interest bearing deposits stabilized at 20% of total deposits, and when adjusted for non-interest bearing deposits in our hybrid accounts, this percentage remained flat linked quarter at 24%. Our cumulative interest-bearing deposit beta was 53% since the Fed began raising interest rates. Our deposit rates remained stable across the franchise with ongoing testing by product and market. Given higher rates through the year, we have not seen as much opportunity to reduce deposit rates. However, we've continued to attract client deposits without having to lead the market on rates nor have we been paying the cash premiums that many of our competitors are offering to attract new operating accounts. Moving to net interest income and the margin on Slide 7. Tax equivalent net interest income was $899 million, up $13 million from the prior quarter. The benefit from fixed rate asset repricing, mostly from swaps and short-dated U.S. treasuries was partly offset by higher funding costs, lower loan balances, and impact from roughly $1.25 billion of forward starting swaps that became effective this quarter. You will recall that we put these swaps in place in 2023 at a then prevailing forward rate of 3.4% as we were managing the roll-off of the 2024 swaps. Net interest margin increased by 2 basis points to 2.04%. In addition to the NII drivers just mentioned, the previously mentioned liquidity build this quarter impacted NIM by about 2 basis points. Cash assets increased by roughly $3.5 billion sequentially. We continue to believe that our NIM bottomed in the third quarter of 2023 and the NII bottomed in the first quarter of 2024. Turning to Slide 8, non-interest income was $627 million, up 3% year-over-year. Compared to the prior year, the increase was primarily driven by trust and investment services, commercial mortgage servicing fees, and investment banking cases. This offset a 21% decline in corporate services income, which has reverted to a more normalized level at 2022 and the first half of 2023 benefited from elevated LIBOR-SOFR related transition activity. Commercial mortgage servicing fees rose 22% year-over-year, reflecting growth in servicing and active special servicing balances. At June 30th, we serviced about $680 billion of assets on behalf of third-party clients, including about $230 billion of special servicing, $7 billion of which was in active special servicing. Trust and Investment service fees grew 10% year-over-year as assets under management grew 7% to $57.6 billion. We saw positive net new flows in the quarter, and as Chris mentioned, sales production set another record in the quarter. Our investment banking fees were consistent with our prior guidance for the quarter. Across products, higher M&A and debt origination activity offset lower syndication and commercial mortgage activity. On Slide 9, second quarter non-interest expenses were $1.08 billion, flat year-over-year and down 4% sequentially, excluding FDIC special assessments. This quarter, we incurred an additional $5 million FDIC charge on top of last quarter's $29 million adjustment. On a year-over-year basis, personnel expenses were up due to key higher stock price, offset by lower marketing and business services and professional fees. Sequentially, the decline was driven by lower incentive compensation and employee benefits from FICA seasonality in the first quarter. Moving to Slide 10, credit quality remains solid. Net charge-offs were $91 million or 34 basis points of average loans and delinquencies ticked up only a few basis points. Non-performing loans increased 8% sequentially and remained low at 66 basis points of period-end loans at June 30th. As expected, the pace of increase in criticized loans slowed markedly to 6% in 2Q, following our deep dive in the first quarter. We expect that to continue to moderate and flatten out by the end of the year, assuming no material macro deterioration. Moving to Slide 11, we continue to build our capital position with CET1 up 20 basis points in the second quarter to 10.5%. Our March CET1 ratio, which includes unrealized AFS and pension losses improved to 7.3%, and our tangible common equity ratio increased to 5.2%. The increases reflect work we've done over the past year to build capital and reduce our exposure to higher rates. We have reduced our DD01 by 20% over the past 12 months, and at June 30th, our balance sheet was effectively interest rate neutral over a 12-month run. Despite higher rates, our AOCI improved by about $170 million to negative $5.1 billion at quarter end, including $4.3 billion related to AFS. On the right side of this slide, we've extended our AOCI projections through 2026. As we've been doing, we showed two scenarios; the forward curve as of June 30th, which assumes fixed cuts through 2026, and another scenario where rates are held at June 30th levels throughout the forecasted time horizon. With the forward curve, we would expect AOCI to improve by $1.9 billion or 39% by year-end 2026. If current rates remain in place, we would still expect $1.7 billion of improvement given the maturities cash flow in time. Slide 12 provides our outlook for 2024 relative to 2023. Our P&L guidance remains unchanged across all major line items. We have updated our loan guidance to reflect the lack of demand we referenced. We now expect average loans to be down 7% to 8% in 2024 and for the year-end 2024 loans to be down 4% to 5% compared to the year end of 2023. This implies fourth quarter loan balances are flat to up $1 billion from June 30th levels. We also positively revised our average deposit guidance to relatively stable from flat to down 2%, with client deposit growth in the low single-digit range. We continue to believe we can hit our full year 2024 and fourth quarter exit rate net interest income commitments, even if loan volumes end up slightly short of our revised target. On Slide 13, we update the net interest income opportunity from swaps and short-dated treasuries maturing. The cumulative opportunity stood at about $950 million using the June 30th forward curve loan change from last quarter. As of the end of the second quarter, we've realized approximately 50% of this opportunity, which is shown on the left side in the gray bars. This leaves about $480 million annualized NII opportunity left, which we expect to capture over the next three quarters with the most meaningful benefits expected to occur in the fourth quarter and first quarter of 2025. Moving to Slide 14. We've laid out for you the path of how we intend to get from the $899 million of reported net interest income in the second quarter to a $1 billion plus number by the end of the year under a couple of potential rate scenarios. In short, we believe we have about $130 million of tailwinds from lower fixed rate assets and swaps running off and from higher challenges. The rest largely nets out and includes what we believe are relatively conservative assumptions around modest loan growth, deposit costs, funding mix, and near-term negative NII impact from a Fed rate cut or two. In the top left, we've laid out the drivers of the growth, assuming the Fed cuts once in December. In this scenario, we expect about $80 million benefit from swaps in U.S. treasuries. We also expect growth from the redeployment of lower-yielding assets, more specifically, approximately $2 billion of other security cash flows in the back half of the year and about $1.5 billion of maturing consumer loans. Day count and some pickup in loan fees drive the other $10 million to $15 million. In the bottom left, we performed the same exercise but this time, assuming the Fed cuts by 25 basis points in September and again in December. While we still believe we can comfortably achieve our full year NII target rate in this scenario, we do become a little tighter on fourth quarter exit rate, although we still think we'll hit that guide. Keep in mind, while two rate cuts this year would have a near-term impact on NII as it takes time to deploy deposit beta, we would expect to recapture that effect in 2025. We would also likely drive improved balance sheet dynamics as we would see benefit from approximately $7 billion of forward starting to receive fixed swaps that come off in the first half of 2025 as we position ourselves to be modestly liability sensitive next year. In addition, rate cuts would most likely provide benefits beyond NII, higher client transaction activity, more demand for credit, and improvements to capital so we would welcome this trade-off. With that, I'll now turn the call back to the operator for instructions for the Q&A portion of our call.

Hey, good morning.

Good morning Ebrahim.

So, starting with net interest income, which is a major focus for the stock, it appears that the $120 million is secured regardless of circumstances. For the fourth quarter, we expect NII to be around 1 or 2, and any potential upside will depend on how certain factors play out. Could you provide insights on the downside risk for NII, particularly if loan growth turns out to be weaker or even negative in the latter half of the year, and how that might affect 2025 more than 2024? Please discuss your thoughts on this, especially considering the concerns you've raised about the Federal Reserve rate. I'm interested in understanding what weaker loan growth might indicate and how we could achieve a net interest margin of 2.5 compared to 2.4.

Thank you, Ebrahim. I'll provide some context before answering your question. You're not alone in your inquiry about net interest income for the fourth quarter. We've been consistent in our belief that much of the growth will occur in the second half of 2024, as shown on the slide you noted. Specifically, we anticipate $5.5 billion of treasury maturing in the second half, with an average yield of approximately 47 basis points, alongside $3.2 billion of swaps at about 60 basis points and $2 billion of securities repricing at roughly low to mid-2% yield. This refers to the initial piece you mentioned. Additionally, we expect another $10 million to $15 million from day count and fees, which adds further confidence to our projections. Deposit costs are expected to keep rising. Assuming we see one rate cut in December, our guidance indicates a mid-50s beta if there are no cuts, suggesting a gradual increase. Even if there's a cut in September, the impact on betas would not be significant. We anticipate some decline in loan yields, as these will not only be affected by immediate loan repricing but also by SOFR adjustments preceding the cuts. Therefore, if there's a September cut, it may bring some negative impact in 2024. As you noted, loan balances are a crucial variable. We experienced weaker performance in this quarter than anticipated. However, as Chris mentioned, our pipelines are improving significantly, a result of our ongoing engagement with clients and prospects. We’ve seen over a 50% increase in the middle market pipeline. We expect to gain traction in the latter half of the year. If the loan growth is slightly below our guidance, we should still manage well, but significantly lower growth would necessitate a different discussion. The main concern relates to 2025 and how the balance sheet and loan book will look. We anticipate rate cuts, which are likely to stimulate client activity, and we’re already observing interest based on our current engagement. Even if we start with a lower loan exit rate, we expect strong growth in loans moving into 2025. In my twelve years at Key, except for the last year, we've been leaders in commercial loan growth, and I see no reason this will change. To add more insight into 2025, we have focused on swaps and treasury for 2024, but there are also repricing opportunities ahead. The appendix on Slide 20 shows approximately $20 billion in additional asset repricing next year, with yields in the low 3% range. This includes $5.2 billion of swaps that will provide $180 million. Moreover, over $11 billion of fixed-rate loans will reprice at 4.15%, and $4.2 billion in fixed-rate securities is expected to yield around $275 million. We will also consider the full-year impact of the fourth quarter treasury roll-offs, alongside swaps, as we initiate rate cuts, allowing us to apply this beta into our consumer lending. Overall, I believe we will face both challenges and opportunities as we approach 2025, and I am confident in our ability to grow loans and attract commercial clients.

That's good color, thanks Clark for walking through. The other question just on Slide 10, you look at NPLs and criticized picking up sequentially. We are seeing a lot of banks talk more about losses coming from C&I. Remind us in terms of your outlook on sort of what you're seeing from your customers on C&I, any specific areas where you're seeing credit degradation that could lead to just higher NPLs going forward and charge-offs? Thank you.

So Ebrahim, it's Chris. Look, a couple of things, one, the normal migration from criticized to nonperformers, it's playing out exactly as we would have expected it to. Stepping back for just a second, our C&I book, 53% of it is investment grade, 70% is secured. And so most of them have very low utilization in terms of borrowing. So we start from a pretty good place. Your question is a good one though, as to where sort of the action is. And let me tell you where we're seeing some people impacted by the higher for longer scenario. Consumer goods, some business services, some equipment businesses. On the other side of the equation, we're starting to see actually healing in the health care sector. So think about seniors housing, think about facilities-based health care we're seeing that kind of going in the other direction. The other thing that we always look at is what's the mix of downgrades to upgrades and downgrades still exceed upgrades, but that ratio is starting to close. So that's kind of how we're thinking about it. Obviously, C&I is a very broad category in general. But that's kind of sort of how we're thinking about it.

And the only other thing, Ebrahim, I just follow on from the financial standpoint, we built the reserve very strongly over the last 12 months. We came in, I think, solidly in net charge-offs and provision in the quarter. We do expect some normalization. So we'd expect net charge-offs to pick up in the back half. That's, I think, fairly consistent with where we've been. We're comfortable on our 30 to 40 basis point range. I did say last month, we probably tend to the higher end of that, but that's really a denominator issue on loans versus more charge-offs than expected.

Thank you for taking my questions.

Good morning everyone, thank you for the questions. Clark, I appreciate your overview on the net interest income. I have another question related to that. It seems like the deposit base is expected to perform better than you initially thought. Could you explain the types of deposits you are acquiring and the associated spreads? There are some concerns about potentially reducing loan growth expectations, but we're still bringing in funds that will be allocated somewhere. What is your perspective on the spread in this context?

Thank you for the question, Scott. We're always focused on growing our operating and checking accounts, and that effort will continue regardless of what happens with asset growth. We have intentionally added some CDs to prepare for expected tightening in liquidity. If loan growth does not materialize as anticipated, we have strategies for optimizing funding, such as lowering brokered CDs or utilizing our FHLB advances. We believe there are opportunities to manage our funding effectively. At the end of the quarter, our cash position was around $15 billion, indicating where our liquidity currently stands. Looking ahead, I want to highlight a couple of positive trends in our commercial book. We are engaging actively with clients about their accounts, and hybrids have proven to be a beneficial product for both our clients and Key. We have seen a significant shift in the percentage of clients moving toward index-like products in response to discussions about rates, positioning us well for when rate cuts occur. We are also shortening CD maturities, as rates remain high, which has limited our ability to reduce prices, but we're bringing in maturities that are due in the fourth quarter, allowing us to reprice them if rates go down. We've been conservative in our projections for down betas, and while any potential rate cuts may provide us with more opportunities to deploy funding in the fourth quarter, we anticipate that we might lag slightly. However, we expect this will provide positive momentum into 2025.

Thank you, Clark. I have a technical question regarding the swaps commentary on Slide 13. You mentioned the $950 million annualized opportunity, which is down from $975 million last quarter. I have received a few inquiries about whether this indicates a reduction in expectations or if we have simply already accounted for that difference and the $950 million represents what remains for the future.

That will depend on the current interest rates during the calculation, but I can provide more details on that later. If the forward curve has decreased slightly, it would influence that outcome.

Okay, perfect. Alright, good, thank you for taking the questions.

Hey guys, good morning. Just a follow-up on just the loans in the context of the whole balance sheet. So I'm just wondering if you can give us a little bit more color on just how much of the loan growth versus what we see in HA when we see your peers, is this you guys just being more conservative and can you talk a little bit about like how much did you keep of your originated, did that change, and where specifically when you mentioned earlier, Clark, the pipeline, like what areas do you see those pipelines coming in, is it more just a straight up commercial? Thanks.

Sure, Ken, it's Chris. Let me start by sharing what's happening in the marketplace because I think loan demand is quite soft overall. As we talk to clients, several unknowns are causing hesitation in borrowing. One concern is about the economy and its future direction. Another issue is interest rates. The cost of capital has risen significantly as Fed funds increased from 25 to 525 basis points, combined with considerable volatility in the 10-year rates, which are currently around 4.2%. I believe we will experience higher rates for a longer period, and once this stabilizes, it may encourage borrowing. However, many clients are reluctant to act if they expect rates to drop sharply. Furthermore, there’s typically a 12 to 18-month lead time for significant capital expenditures and equipment projects, which many are currently postponing. The upcoming election adds another layer of uncertainty, especially for closely held businesses considering factors such as tax policy and accelerated depreciation. Additionally, while inflation is decreasing, the motivations for stocking up on inventory during the pandemic have faded, leading to a 1 percentage point drop in our utilization rate. Regarding your question about our balance sheet, in the last quarter, we raised $23 billion for our customers and retained 16% of that on our balance sheet. Historically, we would maintain about 20%, so 16% is slightly up from last quarter. I also met with our senior credit officers recently, and we’ve noticed some deterioration in loan structures competing for what’s available, but we’re not inclined to reach for more favorable structures. However, this is just one aspect of the situation, not the primary issue. On a positive note, we are beginning to see transactional finance come into the pipeline; for instance, 30% of our real estate pipeline is now transactional, which is a significant change. I hope this provides a better understanding of our perspective and the current marketplace dynamics.

Great, thank you for that color. And the second question is just when we think about just the entirety of the balance sheet, your RWAs have come down a lot over the last year. So CET1 is growing. CET1, even with AOCI, we can see in Slide 24, up to 7.3%. The stress test went a little bit tougher. So just how important is managing to that AOCI number, if at all, relative to your 10-3 regular way and just how you're thinking about just managing your capital position vis-a-vis the loan book and RWA growth? Thanks.

Ken, we are confident in our capital position. Since the initial proposal of the BASEL III Endgame, it has become clear that when the reproposal is released, it will be less severe and pushed out. We previously indicated that we have a clear path to achieve our goals for both CET1 and marked CET1, and that remains unchanged. Additionally, I have mentioned that as these rules are implemented, there are still many uncertainties, especially with the long-term debt proposal and the BASEL III Endgame. When considering everything, I would not be surprised if many institutions find themselves in a similar position to ours, with a loan-to-deposit ratio in the mid-70s range. However, we still need to see how these rules will actually unfold.

Okay, got it. Thank you Chris.

Thank you Ken.

Hi, good morning. My first question is about Slide 14. It seems that with 899 plus around 125, you could have approximately $1.24 billion secured for the fourth quarter of 2024. Regarding the green bars, Chris and Clark, given that the macro environment may not be favorable for loan growth, could you explain the likelihood of those green bars remaining positive? The last two will certainly depend on the rate curve, and you provided good guidance on deposit costs. Could you elaborate on your strategy to improve the funding mix and achieve loan growth that positively impacts that figure?

Sure. So let me handle the first one, Erika. So look, on improved funding mix, we're still sitting on something on the order of kind of $7 billion of FHLB advances. So we have some opportunity to continue to bring that down. We brought broker down close to $6 billion over the last year, but still some opportunity to manage that as well. And then on the margin, we can kind of calibrate where we think overall deposit costs will be based on the size of the balance sheet and the loan book. So we do think we have some opportunity to do that and a little bit of leverage here in the back half of the year on maturities around things like CDs and MMDAs. So we're looking at that very dynamically. We're watching our loan pipelines as they materialize, and we feel like we should be able to pivot one way or the other based on how much traction we're getting on loans.

And Erika, we expect to see loan growth in areas where we have traditionally experienced significant growth, such as renewables, where we are a market leader and had not been aggressive last year but are now. We also see opportunities in affordable housing and the healthcare sector, which is currently undergoing considerable consolidation.

Got it. My second question is a follow-up to Ken's inquiry about capital. What stood out to me on Slide 11 is the difference between the forward rate and flat rate scenarios in terms of treasuries, which do not show much decline. However, the relationship between time and rate, even with only a 25 basis point difference in the belly of the curve, is crucial for healing the AOCI. The stress test was somewhat of a disappointing surprise. As Clark mentioned, you have consistently been a leading grower in commercial. If the macro environment improves, it stands to reason that Key would be positioned to outperform its peers. Additionally, I'm curious about how much the adjusted AOCI is affecting your growth plans. It seems to be influencing your multiple and investor perceptions. Could you clarify how your relationship managers are approaching the market concerning the difference between adjusted and reported figures? Lastly, Clark, can you confirm if we should expect a flat balance sheet from the 170.6 through the end of the year? Thank you.

I'll start with the first part of that. Our AOCI position has no impact on RRMs competing in the marketplace. That's not a factor for them at all. To your point, under the two different rate scenarios we discussed, the difference is only $200 million. So it is a matter of timing, but it doesn't affect how we operate the business on a day-to-day basis.

Yes, I would like to add that our consumer loans are continuing to decrease, providing us with both liquidity and capital to reinvest in commercial operations. So, in line with Chris' point, we do not see this as a constraint in the field. Regarding the balance sheet for the remainder of the year, I think starting with a relatively flat position is appropriate. As I mentioned in response to your question about optimization, there may be some fluctuations, but I do not anticipate any significant changes in earning assets.

So just to confirm, it feels like obviously, the go-to-market strategy you were very firm, Chris, if that's not impacted. In terms of managing the balance sheet for these wins should we expect any RWA mitigation or credit risk transfers or do you feel like that's very much a 2023 story at this point?

Yes, I appreciate your consistency on that particular item, Erika. It's something we spend a lot of time analyzing. We obviously observed some peers making moves in areas where we had already taken action, particularly in the auto sector, which we exited in 2021. There might be opportunities for us to do something similar, but honestly, we don't see significant value in acquiring additional CET1 at the moment. If circumstances change, we know how to execute such transactions. We have a few portfolios that could be suitable candidates for that, but right now, it’s not clear to me that this is a strategy we need to pursue to enhance capital.

Obviously, the better you think your portfolio is, the more expensive the transaction is.

Got it, thank you so much.

Hi Chris, hi Clark. Chris, I realize this may be hard to quantify, but you've been in this field for a while. I'm interested in your comments about the strength of your pipelines. How confident are you that these pipelines are legitimate and can deliver results over the next 12 months?

Yes, we have a thorough review of our pipelines for the reasons you mentioned. I view pipelines as a mix of probability and time to fee, and we dedicate a lot of time to examining them. Some will likely drop off, while others may emerge quickly that we can finalize quickly. We pay close attention to these pipelines. However, we haven't been as precise with some of the loan pipelines due to the additional variables involved, and occasionally those deals can fall through. In terms of our investment banking pipelines, we are in a solid position. Of course, if there's a significant downturn and the market changes dramatically, those pipelines could diminish, but overall, we feel positive about them.

Very good. And then as a follow-up on the credit, your Slide 10, I think you guys mentioned that there seems to be some improvement in the health care area and in the C&I, I think you said it might have been durable consumer. The question on the C&I portfolio, obviously, you guys have been very strong in capital markets for a number of years. And part of that, I presume you work with your sponsors, the private equity guys and in earning the fees from those folks, they tend to also use your balance sheet. Is there any evidence that on the private equity side or the loans to non-depository financials that category. And I know it includes insurance companies and less risky borrowers, but is there any evidence that there's any credit concerns in that category of loans?

No, there's not. And you asked specifically about loans to the private equity community. Obviously, those are in the category of leverage loans, and we are literally in this kind of rate increase. We're underwriting those literally every quarter. Are there some issues, has there been some migration, absolutely. But we're not concerned about that universe of borrowers.

And Gerard, that portfolio that would drive kind of that financial concentration we've been in that 20-ish years. I think maybe there's one loss in that time frame, like literally one credit. It's super clean, great returns, and it is actually the portfolio that we entered into that forward flow agreement with Blackstone, and that was entirely to manage the credit risk concentration, not for any concerns about the quality of that portfolio.

Got it. And Clark, while I have you, just a quick technical question on that Slide 20 where you gave us the 2025 refinancing dollar amounts. And the coupon on what you're receiving, what's the increase, for example, the 180 on the weighted average rate received if that was to convert today, what would it convert to same thing with the fixed rate loans?

Today, we are planning to introduce starters in 2025 to be more sensitive to liabilities moving forward, and these will likely be in the 4% range. This is a favorable comparison to the 180, and even the 278 that is set for 2026. There is a clear benefit there. As for fixed-rate consumer loans at 415, the student loan market is not performing well due to various reasons including rates and government forgiveness programs. If we were to consider the jumbo mortgage market, it would likely be in the 6.5% to 7% range, but that market is not very active at the moment. Those would be the relevant comparison points. If you were to look at Commercial and Industrial (C&I) loans, they would be around 7%. That would likely be our approach to the replacement rate. Regarding securities, the current $274 is in the range of 5.5% to 5.75%.

Very good, thank you Clark.

Good morning. Clark, as you evaluate the effects of the swap and treasury maturities and their benefits to net interest income, there is significant attention on the fourth quarter exit rate of net interest margin and its implications. This clearly has a positive influence on 2025, and from a revenue standpoint, it seems possible to anticipate double-digit revenue growth and mid-teens growth for net interest income next year due to this dynamic. How should we interpret the extent to which this benefit will translate to the bottom line? For next year, it appears there could be a positive operating leverage in the range of 800 to 900 basis points, assuming a 2% expense growth rate based on consensus expectations. Is this a sufficiently wide positive operating leverage that you will allow to materialize and benefit the bottom line, or do you think we might see something more modest?

Hey John, it's Chris. I don't disagree with your assumptions. However, we're not ready to share our perspective on 2025 yet.

Okay, alright, thanks. And then separately, on the deposit costs that I know you indicated that you expect some incremental pressure on deposit costs, and they increased this quarter, but a little bit less than the first quarter, and you cited the CDs actions on that front. Could you maybe just help us think about the incremental upside that you think is likely under maybe a forward curve assumption when you look at deposit costs from here?

When you say upside, just so I understand, you're talking about increase in rates or data.

Increase. Increase in rate, yes, sorry.

Yes, yes. Look, so we guided to kind of mid-50s. If there were no cuts, one cut will have a maybe minor impact on that. If that cut is in December, it is just not a lot of time to implement that. And the reality is, I guess, technically, if that cut occurs, the beta cycle is sort of over so the question is, is your beta on that first cut positive or negative. I think it would be in December, again, not a lot of time for impact. If we do get a cut in September as well, as I said, I think you're going to have a little bit of drift just by nature of the stickiness of the consumer book, but we think we'd have kind of a plus or minus 20 beta coming down. What that does on the overall cost, again, you get kind of into the technical definition of data cycles ending. But I think you'd see in a September cut rates start to really flatten through the back half of the year, whereas with one cut in December, they may still be up a bit.

Got it, okay, great, thanks Clark.

Good morning. I want to summarize the situation regarding investment banking fees and the strong pipeline. How are you viewing the latter half of the year? Last month, you mentioned revenues between $300 million and $350 million. Do you still feel confident about that range?

Yes, Matt, it's Chris. That is the range that we believe our revenues will be in for the second half of the year. We ended the first half of the year right around $300 million, and we've maintained our guidance at $600 million to $650 million, and that's unchanged.

Okay, and then sticking with fees, the Trust Investment Management, investment services, obviously, nice growth there, some boost from the market. But just remind us what else is going on there that might drive growth beyond what the market is giving us here? Thank you.

One of the things we mentioned in my initial comments is that we are clearly experiencing significant growth in our mass affluent business. We welcomed 30,000 new customers and added about $3 billion in total assets to Key. This is a major factor contributing to that line.

Okay, thank you very much.

Hey, good morning. I just wanted to ask on the ACL ratio. I mean the loans are coming down, you're ratcheting up results from a dollar perspective. So the ACL ratio has been going up fairly steadily. How do you think about those reserve levels and what's the right level here if the macro environment remains stable?

Sure. Well, first of all, thank you for the question. The three things that really drive that are, as you point out, loan growth, your view of the macro economy, and then idiosyncratic to the actual credits. I could see a scenario depending on how this plays out, where we evaluate what the total reserve is. But I think it's premature right now only because it's still unclear to us exactly what path the economy is going to take. But as we get more clarity, we'll continue to evaluate it.

So I guess what you're saying is until there's uncertainty, you probably keep the reserves at these levels. And then when you get a little bit more certainty, you can start to bring that down and right size that relative to your loan growth, is that fair?

Right. We've constantly been looking at it and adjusting it based on the three metrics that I just shared with you. One, our view of the macro economy; secondly, the size of the book, which obviously is going down in this instance and also just the idiosyncratic look at things like migration and what we have in terms of nonperformers and so forth.

Good morning everyone. I want to start by thanking Clark for the detailed disclosures on NII, we’ve discussed that quite extensively on this call. Assuming we see two rate cuts this year, in September and December, what is your expectation for the NII range for the year?

Look, I think with two cuts we're going to be closer to the bottom end of our range. But I would tell you just from an overall health of the business, I'd take the second cut because I think it drives more loan demand, I think it buys more capital markets activity. I think it gets people more engaged in economic investment. So I think it's a trade we certainly would make going into 2025 versus, I guess, maximizing what's in the fourth quarter.

Got it. Thanks. For my follow-up question, I'd like to rephrase John's question about expenses. I understand you won't provide guidance for 2025 at this moment. However, if you meet your expense goals this year, it would mean three consecutive years of no real expense growth. I’m curious about the various methods to achieve that. One approach could be deferring expenses and projects until conditions improve. Can you clarify if there's a potential for catch-up in expenses due to deferrals over the past few years? Should we expect next year, as the revenue environment improves, to reflect a more typical expense pattern for the company?

So Steve, looking ahead, we anticipate a more typical expense year for the company as we move away from our current position. We have been investing, and this is possible because we eliminated $400 million in expenses last year to enable us to invest in personnel, technology, and growing sectors such as our private client business, payments, and investment banking. Consequently, expenses are expected to rise in 2025, reflecting the earnings growth we are discussing, but we have not neglected the business. We have maintained our investment in cloud migration and continue to allocate $800 million annually in our tech area. Therefore, while expenses will increase in 2025, it is not due to postponed expenses but rather the natural growth of the business.

Yes. To reiterate Chris' point, investment will remain stable or increase. The difference will come from the absence of a clear way to fund that.

Yes. Got it. Okay. That's great color. Thanks a lot.

Hi, I think I'm missing something very basic. You have no change to the fixed asset repricing, a less favorable loan growth guidance, yet you still have the same NII guidance. What am I missing in my logic?

Yes, there's a range to consider, Mike. Where we fall within that range is important. A significant portion of the increase will relate to structural fixed asset repricing. The variability in that will mostly depend on whether we experience loan growth, though some of the subdued loan growth may be balanced by stronger deposit performance. We're seeing both negative and positive impacts on our balance sheet, which we believe largely offset each other. Thus, the level of loan growth we realize in the second half will influence where we land within that range.

You said middle market pipelines are up 50% quarter-over-quarter. Is that correct, and how much is middle market of your total commercial?

The answer is the 50% quarter-over-quarter is correct and middle market would be of total commercial, probably 40%.

So even though you have strong backlogs and seem to be quite confident, you still believe you should lower your loan growth guidance, is that correct?

We did. One of the reasons we felt that way, Mike, is that our exit rate was lower than our average loan rate, which influenced our decision.

And then just a separate topic, Chris. In terms of the merger environment, I feel like the topics died down here recently, but you said that you'd be willing and able to pursue another first Niagara sort of deal. Is that still the case and under what circumstances do you think it would become more likely, would it be more likely after the election, what do you think the tone is in D.C. and what's your appetite?

I don't foresee any developments regarding a depository in the near future. The challenges in finalizing a deal include securing approval and, if approval isn’t granted, the time it takes and the state of the business post-approval. There's ongoing speculation about a soft landing, which I hope turns out to be correct, though I’m not entirely convinced it's a sure thing. When considering the acquisition of a business, you're acquiring a portfolio, and unrealized losses can quickly turn into realized losses. For these reasons, I believe that such a deal isn't likely in the immediate future. Regarding our previous call about First Niagara, we successfully retained clients and staff while reducing costs by 42%, demonstrating a strong business model. However, I think any significant consolidation will not occur until there are considerable changes in the market. Consequently, our focus will remain on entrepreneurial niche businesses, which we have successfully integrated into our operations—a challenge for larger companies. We plan to continue this approach in the near and medium term.

And then last question, investment banking, I know your mix is different. You're more loan syndications, you have mergers, but relative to the big banks, I know it's not apples-to-apples completely, but it just doesn't really compare so favorably to them, on the other hand, you said you have record backlogs in investment banking, so what areas of investment banking are you seeing the record backlogs?

Sure. I'll begin by discussing the divergence. We are focusing on specific industries. Many companies had a strong quarter in equities, but that was not the case for us, primarily because it's not a significant part of our business and equities teams often perform well in particular sectors at certain times. Our main strength lies in M&A, where we have a strong backlog, which is crucial for us given our middle-market focus. M&A also drives additional business such as loans and hedging. Furthermore, we have a commercial mortgage business that is expected to improve as interest rates decrease and stabilize. I believe both areas are essential, and as I mentioned earlier, we should anticipate an increase in activity in the second half of the year.

Got it, thank you.

Good morning. The consumer loan growth was under quite a bit of pressure in the second quarter. I'm just wondering if you could talk about the outlook on the consumer side of the lending business?

Certainly. In our consumer lending segment, we don't have a large credit card portfolio. Our focus is mainly on mortgages, home equity, personal loans, and student loans. These areas have significant volume, especially in the mortgage and jumbo mortgage markets. We continue to assist clients, especially with held-for-sale mortgages. Moving forward, as interest rates decrease and these segments become stronger, we plan to support our clients more actively, likely through off-balance sheet strategies. This means we will aim to generate fee income as we service these clients. While we will always maintain some capacity on our balance sheet for good clients with nonconforming products, our approach will likely be less accommodating than in recent years.

Would you expect just given the low yields, a similar type of decline going forward on the consumer side?

In terms of what we've seen this year?

Just relative to the second quarter?

Yes. I mean, I'd have to go back and look for sure, but you have student loans and mortgages, right. They just have structural paydowns every month. So we'll see that book continue to come down at a sort of normalized rate. I think it will accelerate as rates come down, but they have to come down quite a bit, frankly, for a lot of refi. So I think what you're seeing is probably illustrative of what you'd expect going forward. But definitely, I don't know of any unique thing that happened in the second quarter that would have driven consumer loan growth down more than expected.

Again, thank you for participating in our call today. If you have any follow-up questions, you can direct them to Brian and our Investor Relations team. This concludes our remarks. Thank you.