KEY - NYSE

Good morning and welcome to KeyCorp’s Second Quarter 2024 Earnings Conference Call. As a reminder this conference is being recorded. I would now like to turn the conference over to the Head of Investor Relations Brian Mauney. Please go ahead.

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 or D-Fest, 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 begin 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. Clark?

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 3% decline in non-interest income while expenses decline more meaningfully by 6% or 4% excluding FDIC assessment impacts. Credit costs were stable and included roughly $10 million bill 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-faring 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 sequential. 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 and 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. Turning 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 [ph] 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 2. In the top loft, 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 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 loft, 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 the 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. Operator?

Thank you. [Operator Instructions]. One moment please for the first question. And we go to the line of Ebrahim Poonawala with Bank of America. Please go ahead.

Hey, good morning.

Good morning Ebrahim.

So just maybe, Clark, just starting out with NII, a huge focus for the stock. Looking at the Slide 14, it seems like the $120 million is locked in no matter what. So fourth quarter NII, 1 or 2 and then the upside from there is driven by how some of the second part of that works out. So give us a sense of the downside risk on NII, if loan growth ends up being weaker or negative in the back half and implications, I guess, more so for 2025 versus 2024. Just talk through us in terms of -- you've given a good concern on the Fed rate. I'm just wondering what weaker loan growth would imply and the scenario where we get to the 2.5 NIM versus the 2.4?

Yes. Okay. Thanks, Ebrahim. And maybe I'll just kind of reground everybody in the whole thing, and then I'll get to your question because I'm sure this is not -- you're not unique in the NII question for the fourth quarter. So first of all, I think we've been really consistent or tried to be that a lot of this pull-through will happen in the second half of 2024, which we would expect will materialize as you see on the slide, and you noted. So we've talked a lot about the structural roll-off in swaps and treasury. So just a reminder, $5.5 billion of treasury is maturing in the second half at an average yield of about 47 basis points. $3.2 [ph] billion of swaps at about 60 basis points and then $2 billion of securities repricing at roughly low to mid-2% yield. So just that's the piece on the left that you referred to. There's another $10 million to $15 million in day count and fees. So again, we feel fairly good about that pulling through. We do expect deposit costs to continue to rise. So let's assume one cut coming in December. We guided to a mid-50s beta if there's no cuts. So a little bit of drift up. If there's one cut in December, that won't be impacted materially. We will see some benefit on betas if there's a cut in September, but we will also see the impact, obviously, of loan yields coming down, and that will happen in advance, not just because the loans reprice immediately, but SOFR will reflect that, as you know, a little bit before that cut. So there's a little bit of negative drag in 2024 if there's a first cut in September. As you commented, right, loan balances will be the variable. So we've been a little weaker in the quarter than planned. As Chris said, our pipelines are strengthening materially. I think that's a function of ongoing engagement with our teams, with clients, and prospects. As you said, middle market is up 50% plus on the pipeline side. So we do expect and are starting to see some traction in the back half. I think if there's a little bit lighter loan growth than what we guided to, we'll still be okay getting there. And if it's materially lower, then that's a different conversation. What the real implication is, I think, and probably where your question is going is, what does that mean for 2025 and the size of the balance sheet and the loan book going there. So look, I do think we all expect rate cuts to come, although I'm certainly not very good at predicting the economy, so I won't try to do that. But should we get some rate cuts, we do think that will create more client activity. We're already, as we talked about in pipeline and engagement dialogue seeing client interest in that. I think that means even if we start on a lower exit rate on loans, we will see good strong growth going into 2025 on loans. In the 12 years I've been at Key other than the last 12 months, we've been a leader on commercial loan growth, and I don't see anything today that would cause me to believe that will be different going forward. But I do think it's valuable maybe to add a couple pieces of content on 2025 that we really haven't covered. We've been laser-focused on 2024 swaps and treasury. So let me just add something that we've included in the appendix on Slide 20, which just gives you some sense of maybe some repricing opportunity in 2025 as well. And that is about $20 billion of additional asset repricing that comes next year. Those yields are low 3%, and that comprised of $5.2 billion of swaps coming off at $180 million. So some more swap pickup, not as meaningful as what we're seeing today, but not unmeaningful at those levels. Another $11 billion plus of fixed rate loan repricing that are coming off at 4.15 and then $4.2 billion of fixed rate securities that are about $275 million. So definite opportunity there. You'll also get the full year move and impact of the fourth quarter treasuries that will come off the books and swaps and then as rate cuts come in, we'll have the full year 2025 to deploy that beta into our consumer book. So I do think there are headwinds or tailwinds for us, sorry, as we get into 2025. And I think we have confidence we'll be able to grow loans and add clients on the commercial side as well.

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, 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.

Next, we go to Scott Siefers with Piper Sandler. Please go ahead.

Good morning guys, thanks for taking the questions. So Clark, appreciate that sort of walk through on the NII. I still have sort of an NII related question. Maybe when you look at sort of the deposits that -- so the deposit base looks like it's going to come in better than you had anticipated previously. Can you maybe walk through what kinds of deposits you're going and what -- sort of what the spread looks like on those, so I think there's probably some question if we dial back the loan growth expectation, but we're still getting funds in that will go into something, just sort of what that spread looks like in your view?

Yes. So -- thanks, Scott, for the question. So one, I'd say, look, we're always -- we're always trying to grow operating accounts and checking accounts. So we're going to -- we'll do that kind of regardless of what we think is happening on the asset side of the balance sheet. We did mention we added a little bit of CDs intentionally just to get ahead of what we think are some tightening liquidity expectations. And if we don't see loan growth for whatever reason, and again, we don't expect that, we do have some funding optimization, whether it's continuing to drive down the brokered CDs or our FHLB advances. So we think we'll have some opportunity to do that. We have built the cash position. So at the end of the quarter, we were kind of in the $15 billion range. So that gives you some indication of where that cash is sitting at the moment. But I would say just on deposits, maybe highlight a couple of things on where we see the back half going. One, I think positively in the commercial book, we continue to have very active dialogue with clients about their accounts, we've talked a lot about hybrids, for example. That continues to be a really good product for our clients and for Key, and we've actually moved pretty meaningfully the percentage of clients that we would deem as sort of index or index like. So as we have dialogue as they talked about rates, we've been able to move them to a more index-like product or structure with obviously anticipation of down rates. So we think that will benefit us when cuts start to come. And we're continuing to shorten the CD maturities, rates have stayed higher, so we haven't been as active driving those prices down, but we have been pulling in the maturities, and we do have a decent amount coming due here in the fourth quarter that we'll be able to reprice to the extent rates do come down. So that's kind of a long view on that, and we'd expect -- we've been pretty clear conservatively on down betas. If there's one cut, if there's a second cut we'll obviously have more opportunity to deploy that in the fourth quarter, but we still think we'll probably lag a little bit, but that will be a tailwind for 2025.

Perfect. Okay, thank you Clark. And then a little bit of a ticky-tack question on the swaps commentary on Slide 13. So you cite the $950 million annualized opportunity, which was -- that's down a little from $975 million last quarter. So I've gotten a couple of questions, does that represent a reduction in expectations or is it that we've just already absorbed that difference and the $950 million is what's still remaining in the future?

That should be a function of just where rates are as we do the calculation, but I can -- we can follow up and give you the detail on that. If the forward curve has come down a little bit, that would impact that.

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

Next, we go to Ken Usdin with Jefferies. Please go ahead.

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 kind of sharing with you kind of what's going on out there in the marketplace because I think loan demand is pretty tepid across the board. And here's what -- as we're talking to clients, I think these are the unknowns that are keeping people from borrowing in general. One is just concern about the economy, what's the trajectory. The next is rates and it's two things. One, obviously, the cost of capital has gone up significantly as Fed funds rose from 25 to 525 bps, but on top of that, we've just had a lot of volatility in the 10-year. And so today, it's around 4.2%. I actually think we'll have higher for longer and I think once that settles in, people will borrow. But as I talk to clients, if they think that it's going to go down and they think rates are going to go down and go down precipitously, they're less inclined to make a move. Also, there's kind of a 12 to 18-month lead time around most big CAPEX and property, plant, and equipment projects. And people have kind of been putting those on hold. I think the election, I think that also is just another variable out there. A lot of these closely held businesses as they think about things like tax policy and the ability to take accelerated depreciation, so I think all of those are in the mix. The next thing that I think also impacts it is there's no question that the rate of inflation is coming down. And so people that were first during the pandemic motivated to kind of go long inventory because of the supply issues. And then they were motivated to go long inventory because of inflation, that's kind of wearing off. So what we actually saw was a contraction in our utilization rate by 1 percentage point. Going to your question about kind of what we keep on the balance sheet and what we place -- in the quarter just ended, we raised $23 billion for the benefit of our customers, and we kept 16% of it on our balance sheet. And typically, throughout our history, we typically would have 20%. 16% is up a bit from last quarter. So that kind of gives you sort of a flavor of what's going on. There is -- I sat down with all of our senior credit officers yesterday, and we are seeing in the marketplace some degradation in terms of structure. And as people compete for the loans that are out there, we clearly are not going to reach for structure at all. We don't feel like we need to do that. But that is an element, but it's not the lion's share of what's going on. On the positive side, we're starting to see transactional finance starting to come into the pipeline. For example, in our real estate business, 30% of the pipeline right now is transactional, which is a big change. So maybe hopefully, that's helpful, Ken, in terms of how we're thinking about it and what's going on out in the marketplace.

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 with AOCI number, if at all, relative to your 10-3 [ph] 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 feel good about our capital position. Obviously, since the beginning -- since the initial proposal of the BASEL III Endgame, clearly, when the reproposal comes out it will be pushed out and it will be less severe. We had said initially that we had a clear path to get to where we wanted to get to on both a CET1 and a marked CET1, and that really hasn't changed. The other thing that I've said in the past is, I think as all these rules are applied, and there's a lot of question marks because we've got the long-term debt proposal, we've got the BASEL III Endgame. I think when you put it all together, I'm not -- I won't be surprised if most people are where we are right now where you have kind of a mid-70s sort of loan-to-deposit ratio. But that remains to be seen because we are yet to know we'll have to see how it plays out on a couple of these rules.

Okay, got it. Thank you Chris.

Thank you Ken.

Our next question is from Erika Najarian with UBS. Please go ahead.

Hi, good morning. First question just on Slide 14, so it's pretty clear that 899 plus let's call it 125 you've got $1.24 billion in theory quote in the bag for 4Q 2024. And I'm wondering of those green bars, Chris and Clark in terms of improved funding mix and loan growth and we just heard Chris talk about how perhaps the macro environment is not that great for loan growth, could you walk us through sort of the probability of those green bars staying green. Obviously, the last two will have everything to do with the rate curve, right, so -- and you gave us pretty good guardrails in terms of how to think about deposit costs. But tell us a little bit more about how you plan to achieve the improved funding mix and the loan growth to be net positive to that number?

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, where we would expect to get loan growth are in areas where we've always been able to get a lot of loan growth, things like renewables that are -- where we're a market leader and those are project financings where we were not aggressive last year. And now we are things like affordable similarly and also sort of the health care area where there's just a lot of consolidation.

Got it. And my second question is a follow-up to Ken's question about capital. I think what struck me on Slide 11 is, I'm not sure how different the forward rate versus flat rate scenario are in terms of treasuries that don't decline by that much. But how time versus rate, although granted you only have 25 basis point difference in terms of the belly of the curve here. It is really what's going to heal the AOCI. And obviously, the stress test is a -- was a bit of a negative surprise. As Clark said, you guys have always been a premier grower in commercial. And if macro comes back, you would think that Key is in a position to outperform peers. So that and, I guess, how much is this adjusted AOCI impacting, if at all, your growth plans, it seems to be impacting your multiple and how investors think about you, but perhaps sort of square that for your investor rate in terms of how your RMs are going to market versus the sort of -- the difference between adjusted and reported? And Clark, just a quick confirmation that should we assume 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 at all on RRMs out competing in the marketplace. That's just not a variable for them at all. And to your point, under different -- under the two different rate scenarios we talked about, the difference is only $200 million. So it is a function of time, but it doesn't impact how we run the business day in and day out.

Yes. And I would just add to that, right. We do have consumer loans that continue to come down, and that gives us both liquidity in capital to redeploy into commercial there. So to Chris' point, right, that's not something we're viewing as a limiter in the field. As far as the balance sheet through the rest of the year, I think relatively flat is a good place to start. As I said to your -- in response to your optimization question, that can move around a little bit, but I wouldn't expect it to be meaningfully large moves on 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 mean -- and I appreciate your consistency on that particular item, Erika. It's -- look, it's something we spend a lot of time looking at and understanding which I think a lot of us did. We obviously had some peers do some things by the way, in places where we had already made moves. So auto in particular, where we had exited back in 2021. There are some opportunities for us to do that but frankly, we don't see a huge value in getting that additional CET1 at the moment. If something were to change, we know how to execute the transaction like that. We have a couple of portfolios that are likely prime candidates for that. But it's not clear to me at this moment that that's a lever that we need to pull to drive improved capital.

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

Got it, thank you so much.

Next, we go to Gerard Cassidy with RBC. Please go ahead.

Hi Chris, hi Clark. Chris, I know this is not really quantifiable, but obviously, you've been at this for quite some time. But I took interest in your comments about your pipelines and how strong they are. Can you give us some confidence on -- there's pipelines and there's pipelines. How confident are you that these are real that they could pull through as you look at it over the next 12 months?

Yes, well, we -- as you can imagine, we have a pretty detailed review of our pipelines for just the reason that you mentioned. And I look at pipelines, it's a combination of probability, time to time, times fee. We spent a lot of time looking at them. Will some fall away, I'm sure they will. Will some things appear that will be relatively short dated that we will close expeditiously. That will happen as well. But we sweat the details on these pipelines. Where we haven't been as tight, has been on some of the loan pipelines just because those that have a few more variables and people sometimes those deals get done away from you. But with respect to our investment banking pipelines, we're in good stead. Now if we have if we have a huge downturn and all of a sudden, the market has changed significantly, obviously, those pipelines can go away. But we feel good about the pipelines.

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 riskier 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?

Yes, so today we are putting forward starters on in 2025 for the purpose of getting a little bit liability sensitive going forward, and we're putting those on kind of in the 4% range. So obviously, that depends on how forward starting and how long they are, but that compares to the 180 quite favorably, obviously. And even the 278 that sits out there in 2026. So definite benefit there. On the fixed rate consumer loans at 415, those are probably, well, one, the student loan market just isn't there for a variety of reasons, rates and sort of give an overhang and the forgiveness in the holiday from the government. But if you were going to put on kind of the jumbo mortgage market, that's probably in the 6.5% to 7% range, but that isn’t incredibly vibrant at the moment either. But those would be the kind of comparison points. And then on your -- yes, if you did C&I, you'd be at 7%. So that would be the way we'd probably think about that replacement rate. And then on the securities, that $274 today is coming on kind of 5.5 to 5.75-ish range.

Very good, thank you Clark.

Next, we have a question from John Pancari with Evercore. Please go ahead.

Good morning. Clark, as you are looking at the impact of the swap and treasury maturities and the benefit to NII, I know a heavy focus on the 4Q exit rate of the NIM and what it means. And clearly, that has a pretty positive impact on 2025 and I believe from a revenue perspective, you could be looking at double-digit revenue growth and mid-teens or so on NII next year in terms of growth, just given that dynamic what type of -- how should we think about how much of that benefit really fall to the bottom line. Operating leverage for next year, it looks like it could be anywhere in the ballpark of 800 to 900 basis points positive operating leverage based on how consensus is thinking about it, if you're looking at 2% expense growth rate. So is it that wide a positive operating leverage that you'll allow to materialize and allow this to follow the bottom line or do you think that we could be looking at something less than that?

Hey John, it's Chris. We -- I don't disagree with your assumptions. But obviously, we're not yet coming out with sort of what our view is of 2025.

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 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 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.

Next, we go to Manan Gosalia with Morgan Stanley. Please go ahead.

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.

Got it, thank you.

Next, we go to Steve Alexopoulos with J.P. Morgan. Please go ahead.

Hey, good morning everyone. I want to start -- Clark, thank you for all the detailed disclosures on NII, and we've obviously beat that horse on this call quite a bit. But just assuming that we get two cuts this year, just say, September and December, what's your bias in terms of where you'll likely be in terms of 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. Okay, thanks. And for my follow-up question, I want to go back and ask John's question a little bit different on expenses. I know you're not going to give 2025 outlook at this point. But if you do achieve the expense outlook this year, I think it's basically three years in a row where you haven't had any real expense growth. And I guess what we're curious of there's lots of ways to achieve that. One of them is just deferring expenses and projects until the environment is better. And is that the key just help us understand that -- is there a catch-up in expenses coming because you've been deferring and you have an expense growth for multiple years or should the next year as the revenue environment gets better, just looks like a more normal expense year for the company?

So Steve, the answer is, as we look forward, it will be a more normal expense year for the company as we continue to come out of the position that we're in. We have been investing though and the reason we've been able to invest is we took $400 million of expenses out last year just for the purpose of being able to invest in people and in technology and in the businesses that we're trying to grow like our private client business, our payments business, our investment banking business. So expenses will go up in 2025, as you see the pull-through of the earnings that we're talking about, but we have not starved the business. We've continued to invest in our migration to the cloud. We've continued to spend $800 million a year in our tech area. So -- but in order to be able to continue to invest in the business, I think you can imagine that expenses will go up in 2025. But it's not because of deferred expenses. It's just because business continues to grow.

Yes. And just to put it -- reiterate Chris' point there, it's just investment will be stable to up. It's just the lack of a clear takeout to fund that that will be the difference.

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

Next, we go to Mike Mayo with Wells Fargo. Please go ahead.

Hi, I think I'm missing something very basic, and that is that you have the same -- no change to the fixed asset repricing, you have less favorable loan growth guidance, yet you still have the same NII guidance, so what am I missing in my logic?

Yes, look. I mean it's -- part of it is there is a range, Mike. So where you land in the range is part of that. A lot of that, as we've talked about in the call, a lot of the increase is going to be structural to the fixed asset repricing. So the plus or minus pieces on that, I think, is largely going to be whether or not we have loan growth, but a little bit of that muted loan growth is offset by a little bit stronger deposit performance. So we hit both of those balance sheet components, one of the negative, one of the positives. And we think those are somewhat offsetting. So the amount of loan growth we see in the second half will be kind of the plus or minus on 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 had -- even though you have such strong backlogs and it seems like you have a certain degree of conviction, you still thought you should guide loan growth lower, is that correct?

We did. And one of the things -- one of the reasons we felt that way, Mike, is that our exit rate was lower than our average loan rate, which was part of our thinking there.

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?

Sure. So as it relates to a depository, I don't see anything happening in the near future. I think the obstacles to completing a deal is, first of all, can you get it approved. Secondly, if you can't get it approved, how long does it take and what's left of the business after you get it approved. As I mentioned earlier, I think there's some real questions on -- everyone seems to be coalescing around the soft landing. I hope people are right. I'm not sure that, that's a fatal comply. And so I think as you're thinking about buying a business, you're buying a book, and of course, unrealized losses become realized losses. So for all those reasons, I don't see it happening in the near future. What I had mentioned in the -- on the call that you had sponsored as I said, with respect to First Niagara, we were able to keep the clients and keep the people and take 42% of the cost out of the business. And I think that's a pretty good business model in any industry. So I think that -- I think there will be consolidation. What I've shared with our team is I don't think there's going to be any consolidation until there's a lot. So I think that -- I think there will be consolidation. Where you will see us spending time is on these entrepreneurial businesses. I'm really proud of our ability to buy entrepreneurial niche businesses and integrate them into our business. That's really hard for a big company to do. And I think we've done it pretty well, and that would be things that we'd be focused on 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?

Thank you, appreciate your questions.

And next, we go to Peter Winter with D.A. Davidson. Please go ahead.

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?

Sure. One, our consumer lending, we -- as you know, Peter, we don't have a huge credit card book. It's really mortgage, home equity, personal loan, student loans. That has an enormous amount of volume in the mortgage market, the jumbo mortgage market or nonconforming market or the student loan market, which is generally what has been on balance sheet for us. We continue to support clients where we can, particularly in held-for-sale mortgages, but I would suspect as we go forward, you will see us do -- and rates come down and those businesses get a little stronger, you'll see us support those clients very actively, but probably do a little bit more of that off-balance sheet. So we'll view that a little bit more as a fee income generators as we service those clients. We will always have some room on the balance sheet to accommodate good clients as it relates to nonconforming structures as an example. But that will be probably less so than it's been in the last few 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.

Okay. And then just on a different question, just on buybacks. I know there are no plans to buy back stock this year. But Chris, I'm just wondering what are some of the parameters you're looking at to get back into the market to buy back stock?

Well, the first parameter would be to really have a firm understanding of where the BASEL III Endgame is going to be because until we know what the phase-in period is and what capital is going to be required it's -- that's just -- I think that's a very important piece of the equation. And for us, obviously, we had mentioned we've been under earning. And as our balance sheet heals that will give us an opportunity at the appropriate time to revisit that. But we've been very clear, we're not going to engage in any buybacks this year for sure because we, in fact, don't even have a plan approved by the Board. But going forward, obviously, like everybody, we'll be taking a look at it.

And then just one last, just clarification question, Clark, on Steve's question about the NII range. You mentioned with two rate cuts closer to the bottom end of the range, does that mean closer to 2% down.

Closer to 5%. So it would be the upper end...

Upper end of the down range?

Yes, we can wrestle on those semantics. But yes, closer to that closer to the 5% down.

Got it, thanks. Thanks for taking my questions.

And I'll now turn the conference back to Chris Gorman for closing remarks.

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.