Beth Mooney - Chairman, Chief Executive Officer Don Kimble - Chief Financial Officer Chris Gorman - President, Corporate Banking E.J. Burke - Co-President, Community Banking Dennis Devine - Co-President, Community Banking Bill Hartmann - Chief Risk Officer.

Steven Alexopoulos - JP Morgan Scott Siefers - Sandler O’Neill John Pancari - Evercore ISI Bill Carcache - Nomura Ken Zerbe - Morgan Stanley Bob Ramsey - FBR Geoffrey Elliott - Autonomous Research Sameer Gokhale - Janney Capital Markets Erika Najarian - Bank of America Merrill Lynch David Eads - UBS Gerard Cassidy - RBC David Durst - Guggenheim Securities Terry McEvoy - Stephens.

Good morning and welcome to the KeyCorp’s Third Quarter 2015 Earnings Conference Call. This call is being recorded. At this time, I’d like to turn the conference over to Beth Mooney, Chairman and CEO. Please go ahead, ma’am..

Thank you, operator. Good morning and welcome to KeyCorp’s third quarter 2015 earnings conference call. Joining me for today’s presentation is Don Kimble, our Chief Financial Officer; and available for the Q&A portion of the call is Chris Gorman, President of our Corporate Bank; E.J.

Burke, and Dennis Devine, Co-Presidents of our Community Bank; and Bill Hartmann, our Chief Risk Officer. Slide 2 is our statement on forward-looking disclosure and non-GAAP financial measures. It covers our presentation materials and comments as well as the question-and-answer segment of our call. I’m now turning to Slide 3.

We had another good quarter with earnings per share of $0.26, which was up $0.03 versus the year ago period. The $0.26 per share compares to $0.27 in the second quarter, which did not include the $19 million or $0.01 per share of cost related to the pension charge that was incurred in the quarter.

We generated positive operating leverage relative to the same quarter last year, driven by a 7% increase in revenue, along with well-managed expenses. Revenue reflects growth in new and expanded relationships across our company, which drive both net interest income as well as our fee-based businesses.

We had another solid quarter of loan growth, with average balances up 6% from the prior year, driven by a 15% increase in commercial, financial, and agricultural loans. Loan balances increased in both the Community Bank and the Corporate Bank.

On the fee side, we saw positive momentum in our core businesses, including investment banking and debt placement fees, corporate services income, and cards and payments. Results relative to the prior quarter reflect higher net interest income and lower investment banking and debt placement revenue.

Investment banking and debt placement fees are variable in nature and were solid this quarter, however, lower than our record second quarter results. Expenses, excluding the pension settlement charge, were also lower than the previous quarter.

Credit quality continues to be strong, with a net charge-off ratio of 27 basis points, well below our targeted range. Nonperforming loans and nonperforming assets moved lower in the quarter. We continue to execute on our relationship strategy and to be disciplined with credit structure and terms.

Capital remains a strength of our company with a common equity Tier 1 ratio of 10.5%. In the third quarter, we repurchased $123 million of common stock. Overall, we are pleased with the quarter and believe that we are positioned for a good finish to the year.

Our results continue to demonstrate the successful execution of our business model, which has allowed us to continue to add and expand client relationships and to grow revenue. Now, I’ll turn the call over to Don to discuss the details of our third quarter.

Don?.

Thanks, and I’m on Slide 5. As Beth said, we had a good quarter with net income from continuing operations of $0.26 per common share, up $0.03 from a year-ago period and at the same level as last quarter after adjusting for the pension settlement charge. Our cash efficiency ratio for the quarter was 66.9% or 65.2% adjusting for the pension expense.

Not on this slide, but worth noting, our pre-provision net revenue is up over 17% from last year and up 8% year to date. This improvement reflects our success in growing our business, while staying focused on expenses. I’ll cover the other line items in the rest of my presentation, so I’m now turning to Slide 6.

We saw solid loan growth this quarter with average loan balances up $3.5 billion or 6% compared to the year-ago quarter and up $1.3 billion from the second quarter. Our year-over-year growth was once again driven primarily by commercial, financial, and agricultural loans, and was broad-based across Key’s business lending segments.

Average CF&A loans were up $3.9 billion or 15% compared to the prior year, and were up $1.4 billion or 5% unannualized from the second quarter.

Continuing on to Slide 7, on the liability side of the balance sheet, average deposits excluding deposits in foreign office totaled $70 billion for the third quarter, an increase of $2.2 billion compared to the year ago quarter.

The increase came from higher balances from our commercial mortgage servicing business and inflows from commercial and consumer clients. These increases were partially offset by a decline in certificates of deposit. Compared to the second quarter of 2015, average deposits excluding deposits in foreign office decreased by $278 million.

The decrease was driven by an expected decline in short term non-interest-bearing deposit balances from commercial clients as well as lowered certificates of deposit balances. This decline was partially offset by increases in NOW and money market deposit accounts.

Turning to Slide 8, taxable-equivalent net interest income was $598 million for the third quarter of 2015 and the net interest margin was 2.87%. These results compared to taxable-equivalent net interest income of $581 million and a net interest margin of 2.96% for the third quarter of last year.

The increase in net interest income reflects higher earning asset balances, moderated by lower earning asset yields, which also drove the decline in net interest margin. Compared to the second quarter of 2015, taxable-equivalent net interest income increased by $7 million and the net interest margin was essentially unchanged.

The increase in net interest income and the relatively stable net interest margin were primarily attributable to improvement in earning asset mix, partly offset by a slightly lower earning asset yield and loan fees. One additional day in the third quarter also contributed to the increase in net interest income.

Our outlook for the fourth quarter is net interest margin to remain relatively stable with the third quarter level. Slide 9 shows a summary of non-interest income, which accounted for 44% of our total revenue.

Non-interest income in the third quarter was $470 million, up $53 million or 13% from the prior year and down $18 million or 4% from the prior quarter. The increase from the prior year was attributable to the strength in Key’s core fee-based businesses which included a full quarter impact of the September 2014 acquisition of Pacific Crest Securities.

The improvement in our core businesses from the prior year included $21 million of higher investment banking debt placement fees, an increase of $15 million in corporate services income, and $9 million of higher trust and investment services income. Cards and payments income was also up due to higher credit card and merchant fees.

Compared to last quarter, non-interest income declined by $18 million due to the decline in investment banking debt placement fees related to our record second quarter levels. We expect to meet our full year guidance of mid-single digit growth in non-interest income.

The largest contributor this year has been the investment banking and debt placement fees. Fourth quarter is historically a strong quarter for this business and once again based on the current pipelines and market conditions, we expect a strong finish to the year.

Turning to Slide 10, non-interest expense for the third quarter was $724 million, up $18 million from the year ago period and up $13 million from the second quarter.

Personnel costs increased $21 million year over year, reflecting our investment in senior bankers across the company, higher performance based compensation related to our strong capital markets businesses, and a full quarter impact of the September 2014 acquisition of Pacific Crest Securities.

Non-personal expenses remain relatively stable as lower occupancy costs offset an increase in business services and professional fees. Compared to the second quarter, non-interest expense increased by $13 million.

This increase included a $19 million pension settlement charge, $7 million increase in salaries reflecting the increased number of business days, offset by $6 million of lower occupancy cost and $6 million of lower incentive and stock compensation related to the lower capital markets revenues. Our expense guidance for the year remains unchanged.

Reflecting our current quarter pension charge, we would expect to come in towards the higher end of a relatively stable range which is defined as plus or minus 2%. For the fourth quarter, I would expect expenses to be roughly in line with the third quarter excluding the pension charge.

Turning to Slide 11, net charge-offs were $41 million or 27 basis points of average total loans in the third quarter, which continues to be well below our target range.

In the third quarter provision for credit losses of $45 million, slightly above the level of net charge-offs, which reflects the current trends in our portfolio in our continued loan growth. Non-performing loans and non-performing assets were both down relative to the prior quarter and year ago period and criticized loans have been relatively stable.

At September 30, our reserve for loan losses represented 1.31% of period end loans and a 198% coverage of our non-performing loans. Turning to Slide 12, our common equity Tier 1 ratio was strong at September 30 at 10.51%. As Beth mentioned, we repurchased $123 million in common shares in the third quarter as part of our 2015 capital plan.

Importantly, our capital plans reflect our commitment to remaining disciplined and managing our strong capital position. Moving on to Slide 13, we expect to be within our guidance ranges we have provided for 2015. Average loans should grow in the mid single digit range as we benefit from the strength in our commercial businesses.

We expect full-year net interest income growth in the low single digit range which does not anticipate any increase in interest rates. Non-interest income should be in line with our outlook for mid-single digit growth. Non-interest expense will likely be toward the higher end of our guidance range reflecting the pension settlement charge this quarter.

Credit quality should remain a good story with net charge-offs below our targeted range of 40 basis points to 60 basis points. We also expect provision to approximate net charge-offs. And finally, we expect to continue to execute on our share repurchase authorization consistent with our capital plan.

With that, I’ll close and turn the call back over to the operator for instructions for the Q&A portion of our call.

Operator?.

[Operator Instructions] First, we go to the line of Steven Alexopoulos with JP Morgan..

Looking at the $725 million of approved buybacks in the 2015 capital plan, if I annualize what you guys have done over the last two quarters, it looks like you’re buying back at a level that’s about $100 million less than what you could be buying back, if you look at the full cycle.

So Don, are we expecting a ramp in buybacks in the coming quarters or is there something else going on here that we should be paying attention to?.

The one thing that’s not clear from that is, is that each year in the first quarter we have shares that are issued in connection with employee benefit plans, and that allow us to buyback additional shares. And so we have a heightened level of share buybacks in that first quarter of each year.

And keep in mind that the $725 million will represent five quarters as opposed to just the four quarters..

And if I can ask one unrelated follow-up Don, you guys are obviously an asset sensitive bank.

If the Fed does not move rates this year and it looks like low for longer is here to stay, would you guys take action to reduce asset sensitivity, convert some potential earnings into real earning, or do you just maintain this position no matter how long the Fed sits at zero?.

We take a look at that frequently throughout the year and try to reassess what’s the appropriate position for us. In the past and we’ve called this wrong, we continue to expect that interest rates would be going up, say 12 months down the road, and we haven’t seen that yet.

And so we’ll continue to reassess and we have the flexibility to manage that overall rate risk position fairly quickly with the change in interest rate swap position..

Our next question is from Scott Siefers with Sandler O’Neill..

Don, just a couple of quick questions on expenses. First, I want be make sure I’m clear on the fourth quarter guidance. So are we done with the pension settlement charges for the year or will there be more in the fourth quarter? And then sort of a follow-on on cost broadly is, it’s going to come in within your range, but towards the higher end.

I wonder if you could just talk about the nuance of that, is some of the pressure if we were to ex out the pension noise, is that coming from the investment banking revenue base, just coming in stronger than you might have expected it at the beginning of the year? In other words, what’s behind the overall expense level in your mind?.

As far as the pension charge, last year in the fourth quarter, we had about a $3 million charge related to the pension settlement, and so we would expect a nominal level again here in the fourth quarter, but that should not be nearly the size of the $19 million we experienced this quarter.

As far as our guidance range, we have said it's been relatively stable. And so, if you back out the pension charge, we’re up about 1% year over year, which I think is relatively stable. And to your point, we have seen some pretty strong investment banking fees, and our expense model is fairly variable to reflect the impact of those revenues.

With the pension charge and with an outlook for the fourth quarter to be consistent with the third quarter level, we still think that we’re going to be in that plus or minus 2%, even though it'd be toward the higher end of that range..

If I could switch gears really quick and maybe if Chris is on the line, if he could just speak in a bit more of a detail on the investment banking pipeline, it sounds like you guys are still pretty pleased, even in spite the strength you’ve had year to date, just wondered if you can just give a little more color behind it.

And then maybe to the extent that you can sort of square expectations for a strong finish for the year with just some of the broader dislocation we are seeing in the capital markets?.

Sure, Scott. I’d be happy to. So as we look at our pipelines, we would characterize our pipelines as being strong.

The other thing that is interesting is our pipelines, although we don't report by segment, our pipelines in our M&A business are up and as we talked about before, those revenues have a tendency to pull through other revenues, so that's another reason that we feel good about our pipeline.

The other thing that we’ve said before about our business model that I think is really important is when there is a little bit of dislocation in the market, we feel like that's a great opportunity for us because there are certain shops that are focused on one product, the ability to go to one market.

And as we think about serving our clients and we can look broadly across markets, we think when there is a little dislocation and everything isn't flashy and green, that's a nice opportunity for us to really come in and serve our clients..

Our next question is from John Pancari with Evercore ISI..

On the loan growth, on the C&I side, just wanted to see if you can give us a little bit more granularity on the drivers, because it was exceptionally strong this quarter and then also just how do you think about that going into fourth quarter and into 2016 to stay at that pace?.

So a couple of things. We spend a lot of time looking at where the growth is coming from. Interestingly, as we look back in the corporate bank, it’s a $3 billion of growth that we’ve had year over year, about 80% of that has come from new clients.

So our model is resonating, we’re out there, we captured on a year to date basis a significant number of new clients, specifically 587 new clients, and as we look at our model, that’s where most of the growth is coming from.

The other thing that’s interesting about our model is in spite of the fact that we’re getting a lot of the loan growth only in, in this quarter, only about 13% of the total capital that we raised actually went on to our balance sheet. So we feel a couple of things.

One, we’re doing a good job in terms of growing share and secondly, we have the ability to be selective and to go to the right market in terms of growing our balance sheet..

On the Community Bank side, we have achieved a lot of loan growth simply because we have more bankers than we did at this point last year. We have made a significant investment in commercial bankers, putting more feet on the street and we’re starting to see dividends coming from those investments..

E.J., that’s very good and in both the corporate and community bank, we’ve increased our senior bankers by over 10% and I think we’ve had a little more than 60 people across the company in this area and it’s been an area of focus and we have seen very good returns on those new hires as well..

And then lastly, on the expense side again, I appreciate the guidance that you have given there in terms of growth, but help us just think about how we can look at the efficiency ratio? In the [66%] range here, I know you have provided a low 60%s expectation previously, where can we get to in this lower for longer rate environment and how long can it take to see it reach the low 60%s range?.

Great question and you are right that we've seen the efficiency ratio holding there around 65% for the last few quarters. I would say that's really reflecting a couple of things.

One is that this year’s earnings stream is much more core in nature, we haven't had as much in the way of principal investing gains and leverage lease termination gains like we had last year. And so this year's growth is coming from new customer acquisition and customer related fee income.

Second, as we talked before, we are making a number of investments and so we are cutting cost to be able to afford the new investments. And one of the areas we just mentioned with the addition of 60 new senior bankers throughout the franchise and those investments are fairly immature.

And so as they mature, we will start to see that translate to efficiency ratio improvement over time. Keep in mind too that's just one measure for us. If you look at our positive operating leverage we've achieved for the first nine months of this year, it's a 2% positive operating leverage. So our revenue growth exceeds our expense growth by 2%.

If I just look at our peer banks, which is 12 banks through June 30, we don't have one bank that has higher than a positive operating leverage of 2%. And so we think that we are doing a good job of managing the bottom line from that perspective and growing our core.

We still think over the next couple of years we can drive that efficiency ratio from the 65% level down in the lower 60%s. And hopefully if rates do ever come through, that can help us go back down into the 50%s as well.

But I think what you're going to need to see is more maturity of some of the investments we are making and have that translate to improvements in the overall efficiency going forward..

So you can get to the low 60%s, barring anything out of the Fed?.

That's correct..

And next we’ll go to Bill Carcache with Nomura..

Don, can you put the – I wanted to revisit the pension settlement charges again.

Could you put in context for us how much more there is to go in terms of future charges to future periods?.

Essentially what happens here is that based on the accounting rules that we have a threshold established based on the interest rate component of our pension expense. And so with rates being so low, that hurdle for this year was $32 million of lump-sum distribution. And as soon as we go over that, it triggers a settlement loss.

And so if rates remain at this low level for a long period of time, there is risk that we can continue to see that in the third or fourth quarter of subsequent years. But at this point in time, it's difficult for us to predict when that would occur and how..

Looking at your 10-K at the end of last year, it looked like the pension plan was under funded by about $250 million.

Does that suggest you'd, in theory, have $250 million in charges if the plan participants elected to receive their benefits in a lump-sum? Is that effectively how that works? And it's not being done all up front now so it's happening slowly over time.

I'm just trying to think through of trying to just isolate what the magnitude of the impact could be?.

You're right, there is exposure there, but what will have to happen is each of those participants would have to retire and then each of them will have to have a lump-sum distribution, otherwise you could see that $250 million being recognized over a 30 plus year time period.

So difficult to predict exactly what people will select and the timing of that recognition..

I would just add that it is, as Don accurately point out, a function of the interest rate environment. If you also look at our STE line, this charge has been triggered for the last couple of years related to our significant repositioning of our workforce which we have brought down over the last several years.

And we have, as you've heard, we've been adding to client facing and senior bankers, but overall we've been bringing down our headcount. So that remixing and reduction in headcount is also triggering the opportunity for people to make those elections as they exit. So it really takes both of them to happen in order for us to incur a charge..

If I may, finally, one question on funding, Don, your loan growth, as you've discussed, looks quite solid and nothing seems to be getting in the way of that from what we can see this quarter. We did see that your loan growth outpaced your deposit growth and that's also consistent with what we started to see at the HA level.

So an initial look at your loan to deposit ratio suggests that you guys have some room for that to continue while still remaining core funded. But we now also have to think about LCR when we think about that loan to deposit ratio.

Can you discuss, A, how you think about the remaining core funded in the context of the loan to deposit ratio and how LCR fits in, and, B, discuss whether the fact that loan growth is now outpacing deposit growth is having an impact on how you're managing the business?.

As far as our loan growth exceeding deposit growth, we've been talking about that for a period of time because we expect that to be an area that help us see a little bit more stable net interest margin and you are right that we are still below where we would target as far as our loan to deposit ratio long term.

And so I think that is an area that we can continue to manage up. If you look at the LCR and at the end of the third quarter, we were north of 100%. So our requirement is to be at 90% plus range in the first quarter of next year. So we think that we are well positioned from that perspective.

And I also like to note that in the third quarter we did see some of the more short-term focused deposits leave the bank and that will put some additional pressure on a linked quarter basis as far as the deposits being down slightly compared to the second quarter..

Our next question is from Ken Zerbe with Morgan Stanley..

First question just on provision expense. I totally get the charge-offs are going to stay below your guidance and there's a lot of room underneath that 40 basis points to 60 basis points. But when I look at provision expenses, ticked up, I think, six quarters in a row. Still very, very low, so I'm not implying any credit problems.

But when we think about the go-forward over the next year, given the loan growth, given the reserve ratios trended basically remains pretty low and continues to decline, are we at a point where we should expect going from say a 27 base point charge-off and hence a similar provision to something up closer to the 40 basis points to 60 basis points? I'm just trying to get a sense, does provision continue to tick up from here?.

Ken, I’ll take a first crack at that and then ask Bill Hartmann to chip in as well. If you look at the charge-offs, the change over the last four quarters really has been in the level of recovery, the actual gross charge-offs are pretty flat over the last five or six quarters. And so we haven't seen much change from that.

The recoveries are down primarily in the commercial category and that just reflects that we haven't been replenishing the inventory, which is good as far as problem assets [indiscernible] and therefore don't have the higher level of recoveries. And so we think that we are getting closer to more of a stable level of recovery.

But to your point, we are still well below that 40 basis point to 60 basis point range, we would expect to continue to be under that for a period of time that we have seen some increases in charge-offs reflecting the lower level of recoveries.

So Bill, anything else you would add to that?.

The one thing I would add to that is if you look at what could be leading indicators of where we think things are going, our level of non-performing loans has been pretty stable. We've been signaling that we are entering a period of stability where the improvements that we've seen in previous quarters were going to begin to level out.

And again, the numbers are pretty small, so quarter to quarter, we might see a small increase or decrease in some of these levels.

And again, we had signaled that we thought that provisions and net charge-offs should be about equal to each other as we enter this period of stability and any change in provision may be more driven by loan growth which is what we saw in this quarter..

And then the other question I just had in terms of loan growth, obviously C&I is incredibly strong and if I heard right a lot of it's because you're hiring bankers. But when you look at something like say Fifth Third or Huntington and compare to where you guys stand, it appears that you are taking share in C&I.

What's to stop Huntington or Fifth Third or any of your other competitors from going out and just hiring a bunch of bankers, as well? What are the pitfalls of this strategy that they may be avoiding or you find value in?.

We think that our business model is unique. And we are focused on seven sectors, we are focused on the middle market. For example, we have 46 research analysts covering 777 companies and while clearly our model can be replicated, it's not just as easy as hiring a few bankers because you need the product experts and you need the industry experts.

And so because of that we feel like we have a bit of a competitive advantage in the marketplace..

And I might just add from a middle market community bank perspective, we compete against those banks everyday for talent.

One of the things that really attracts bankers to Key is the relationship we have with our corporate bank and the ability to bring an industry expert to a client meeting to talk about their industry as opposed to competing solely on price or on credit terms.

So our recruiting efforts are oftentimes aided by Chris’ folks talking about how they can help them win new business..

The one thing that I would add that we also always talk about is when you look at the growth in our loans to our commercial clients and as you look at it also with our investment banking and debt placement fee, you can see a high correlation that that's where the business model comes to light, it's both what we can put on our balance sheet, how we attract clients and actually lend into them, but also through our broad product suite which Chris think is unique and differentiated are able to drive M&A fees, debt placement fees, equity fees and a variety of robust fees coming out our payments capabilities.

So it's really a very holistic approach and loans are a significant part, but also I think indicative of the broader model that we are able to bring across the continuum of commercial and middle market clients..

Our next question is from Bob Ramsey with FBR..

I may have missed it, but I know you talked about fourth quarter expectations around margin and expenses.

Did you say where you think fee income will be relative to this quarter, beyond the full-year number, but just fourth quarter?.

What we just said is our full year number would be within our guidance range of mid single digit growth. So that would imply that it’s going to be in that 4% to 6% range on a full year basis..

And then could you maybe talk about a couple of the lines, predominantly principal investing, I think, is still running below where you have talked historically about run rate levels. I know it can be a volatile quarter to quarter, but curious bigger picture how you think about that.

And then maybe the operating lease decline this quarter, maybe what's driving that and how we should think about that line going forward?.

As far as principal investing gains, with market conditions overall and with the size of the portfolio shrinking, I’d say that $11 million that we have in the current quarter and for the past couple of quarters is probably appropriate run rate going forward. And so you will see some volatility there, but generally I think that’s a decent outlook.

The operating lease income line item is down this quarter and that reflects a couple of things. One, we had about $4 million loss in the current quarter and we had a slight gain in the previous quarter.

And so that really created the change on a period over period, but I’d say that the current level is probably a little low given the impact of that loss..

And then corporate services obviously strong, I know you highlighted some of the derivative income and loan commitment fees.

Is that just building from the hiring that you guys have done and the growth in the commercial bank or is there anything unusually strong and lumpy this quarter?.

Because of the fact that we are in the transaction business, you will from time to time see lumpiness, particularly with respect to commitment fees, but underlying the entire line item and this cuts across both the corporate bank and E.J.’s business in the community bank as well, we have seen elevated levels in both foreign exchange and derivatives.

So yes, there is some lumpiness, but the underlying trend line is also positive..

And next we go to Geoffrey Elliott with Autonomous Research..

I wondered if you could give us a quick update on your thinking about deploying capital through M&A and whether that might be something you'd be open to over the coming quarters and years..

As we said before, we have articulated our capital priorities and have said our capital position is the strength of this company. So we’re pleased to continue to be among the peer leading return of capital to our shareholders.

And as you’ve seen over the last couple of years, we have also used the opportunity to enhance our business model and our strategy as we expanded our product offerings such as acquiring our credit cards last year, we are on the one year mark of our acquisition of Pacific Crest Securities and we’ve done some things over time to enhance our distribution.

So as we look at it, we would look at opportunities that are consistent with our model, things that would add to our client base and would be good for our shareholders. And I think the things we have done in recent years have met that standard..

And then just to follow up on that, there has been a couple of bank deals that have been a little bit larger in size that have got approval over the last few weeks – City National and Hudson City, do you think the environment for bank M&A is starting to change at all?.

It is good to see that some transactions have been announced and approved and the market has cleared those. So I think it is an indication that there is more confidence or perhaps certainty. I think that’s good for the markets, I think it’s good for buyers and sellers alike..

Our next question is from Sameer Gokhale with Janney Capital Markets..

I wanted to follow up on something that Ken had asked about earlier. Beth, you talked a little bit about your loan growth and how that's somewhat tied into investment banking-related work that you do, so there's some cross-selling going on there. And you clearly have strong commercial loan growth.

But when I look at the yields on your loan portfolio, clearly there's some downward pressure there. And I know you talked about pricing these things holistically.

But can you give us a sense for how much cross-selling is going on between your lending clients and your banking clients? And given your very strong growth, is there pressure because you want to drive efficiency improvements to keep ramping up that loan portfolio or should you be slowing that growth down so that maybe you can maintain some pricing discipline there? So can you just talk about that a little bit because there seems to be some moving parts? And again, that yield pressure we would have thought at some point would've stabilized, but it hasn't yet, so some color would be helpful..

Let me just step back for a moment, we don’t really look at it as separate. In other words, we don’t look at a loan product, a fee product, but what we’re really doing in a very holistic way is and a very targeted way is pursuing client relationships. And when we pursue those, we get the benefit of both fees and loan growth.

And if you look for example in the corporate bank, our non-interest income this quarter is about 51%. We like that mix of kind of half and half. We think it’s a competitive advantage to have a balance sheet, but we really think it’s our job to identify clients and serve them in any way that we possibly can.

And as I mentioned earlier, the preponderance of the time that involves us accessing capital elsewhere. In terms of the actual pricing on loans, we have seen a slowdown in the rate of decline. So if a year ago, the year over year rate of decline for similar loan was down maybe 25 basis points, maybe this year it’s down maybe half of that.

But with our business model, we’re able to generate very, very good returns for our shareholders and not take excessive risk in terms of growing core. So we don’t look at them as one or the other, we focus on client relationships and the outcome of those could be loans, could be fees or any derivation thereof..

The only thing I would add to that or two points, one is that if you look at the new loan originations, they have a better credit quality than the existing portfolio. And so we would expect to have a little bit lower yield if their credit quality is better.

And so that’s helpful for our overall credit picture, but it has a little bit of additional pressure on the margin. And then second, I would say that linked quarter, we did see our loan fees come down a little bit which cost us a couple of basis points there as well.

And so not necessarily reflective of the aggregate pricing for the portfolio, but from time to time we do see some variance there as well..

And then on the efficiency ratio guidance and the reported numbers it seems like, to the extent that you dial up on your fee-based revenues in any given quarter because you have higher investment banking activity that puts maybe some upward pressure on your efficiency ratio.

But at the same time I would imagine that that's probably a higher ROE earnings stream. So how do you think about balancing the two out because ultimately isn't it about ROEs as opposed to just the efficiency ratio? And then just on a separate note, if you can just talk about some of your investments on the digital front, where you stand on those.

If you could size for us how much you expect to spend over the next, say, 12 to 18 months that also would be helpful..

You’re absolutely right. One of the things we focus on quite a bit is just what kind of return on capital are we generating from our customers and whether that’s in the community bank or the corporate bank. Our fee businesses clearly have a stronger ROE for us and so that’s something that we’re very excited about.

And if you look at for just an example the corporate bank, the return on capital in that business has been hovering around a 30% type of level. So clearly north of 20% and so that clearly is in an area that we want to see growth going forward.

And so sometimes that comes in areas where it’s a higher efficiency ratio and we’re fine with that as long as we can get the return on capital and get the return for our shareholder, which we think is exceeding the cost to deliver that. So again, that is accretive. As far as digital, we continue to make a lot of investments there.

If you look at our technology deployment, I would say that’s somewhere between 15% and 20% of that budget on an annual basis, is facing off against our digital investment and it’s enhancing our customer experience and providing more opportunities for those customers to engage and open new accounts with us.

Dennis, anything else you want to add there from a digital side?.

The only thing I would add is you’ve seen a deliberate remixing of our distribution to our clients, so you see the branch counts coming down meaningfully over the years and while that’s in the digital taking place. So there’s no doubt that we see significant growth in the engagement of our clients from a digital perspective.

You see a real focus on the relationship strategy so that the investments we made are to bring ease, value and expertise to our clients to the digital environment, making sure that there is relevant offers to them in the digital space. You see some partnerships that we’ve announced to bring that to life as well. So that’s in the run rate.

We’ve really ramped up the investments in digital and expect to see that continue..

Our next question is from Erika Najarian with Bank of America Merrill Lynch..

Just a quick follow-up to John's question earlier, you were able to grow net interest income, or are forecasting to grow net interest income this year while your margin is still come under pressure.

As we think about next year in the scenario where the Fed doesn't raise rates, could we still expect your spread revenues to grow, assuming that the margin has stabilized from here or is that too optimistic because we would have to take down our assumptions for activity levels if the Fed is keeping rates that low for longer?.

I’ll tell you that we’ll provide more clarity as far as our 2016 outlook at the next quarter’s call. But as we’ve talked about for the next quarter and on a year over year basis, we’re still expecting to have net interest income increase in the low single digits.

So not seeing anything fundamentally that would change that dramatically, but again, we’ll provide more clarity after next quarter..

And we’ll go to David Eads with UBS..

I wanted to follow up on some of the expense dynamics you've been talking about this morning. When I look at the salaries and incentive comp line combined, the expense for the third quarter was roughly the same as the second quarter. I would've expected that to come down a little bit just due to the lower IBE revenues this quarter.

I'm wondering does that relate to some of the hiring you've done on the bankers side or maybe some incentive expenses related to the loan growth, can you just walk through the dynamics of what has caused that to stay stable?.

If you look just the salary line by itself, $7 million linked quarter, a little over half of that is because of the number of business days increased by one this quarter versus the second quarter, a little over $3.5 million of the increase there.

The rest of it really is the investments in the talent we talked about and also reflective of the current quarter is our first quarter of every year where we add our new rotational programs, whether it’s in the corporate bank or credit or other areas, we bring in a group of college graduates to the Key organization and that resulted in an increase in headcount linked quarter from that effort.

If you look at the incentives and stock-based compensation, it’s down $6 million and that really is tied to that change in our capital markets revenue.

Not only did you see a decline in the investment banking and debt placement fees, but you saw an increase in some of the corporate services income which was primarily driven by capital markets related areas as well.

And so the net change there of roughly $19 million had an impact of about $6 million decline in our overall incentive and stock based compensation expense..

And then just to confirm, you guys didn't call out any kind of meaningful – the branch count was down, I think, 17 this quarter, you guys didn't call out any meaningful restructuring or efficiency charges this quarter, correct? And is there anything baked into your outlook for 4Q on that front?.

We would continue to have some branch consolidations. We didn’t call it out, but we’ve recognized that’s more of a part of our ongoing run rate that we did have our branches come down by 17 this quarter.

I would expect to continue to have a 2% to 3% decline year over year and that would imply some additional branch consolidations in the fourth quarter..

But nothing on the expense front that we should be thinking about specifically?.

Nothing outsized from what we experienced this quarter. That’s correct..

And next we’ll go to Gerard Cassidy with RBC Capital Markets..

Don, can you share with us, I think most people would agree on the call that you folks are certainly overcapitalized. And you also are giving back some of the most amount of capital as a percentage of earnings of your peers, as you pointed out, Beth.

What do you think it's going to take for you folks or maybe the industry in CCAR to give back more than upwards to 100% of earnings? Is there any color you can give to us on what you're thinking on how do you approach that with the regulators?.

This is an ongoing question that we have not only for our investors, but also for our board and our management team. And we’re always trying to read the signals and messages that we’re hearing from DC and our regulators to see if there is more willingness or appetite to see that type of pay out increase.

We do recognize that we are highly capitalized and want to be one of the top returner of capital going forward. And so we’re looking for every indication we can get to see if that tone has changed or shifted.

Right now, we just want to make sure that we’re disciplined with it; we recognize that part of our value really comes to our shareholders in the form of dividends and/or share buyback and we want to make sure that we can continue those going forward..

And then as a follow-up to your comments about the change in the mix of earning assets this quarter which contributed to the improvement in net interest income sequentially, you brought down your liquidity as you pointed out, is there more opportunities to do that in the fourth quarter and subsequent quarters or are you at the optimal level now?.

We think there is greater opportunity for us long term. We still think our loan to deposit ratio is lower than where we would like to target long term and so we do have some additional flexibility.

I’d say that the current quarter coming down by $1 billion in the short term earning assets is probably outsized from what you would see in subsequent quarters, because it reflects some of the impact of some of those short term deposits that we expected to go out of the house over the last quarter and wouldn’t expect those same pace going forward..

Our next question is from David Durst with Guggenheim Securities..

One of your peers has announced they're selectively pulling out of some of their retail markets in the Midwest.

As you think about the way you're going to consolidate your branches in the future, would you consider exiting some markets as you're thinking of evolving?.

When we take a look at that, part of our challenge that we see is we’re not seeing a differentiated performance market by market. So we’re seeing improvements across the footprint and seeing better performance in all of our markets.

And our challenge really is if we exit the market, what happens is that we eliminate 100% of the revenue and a portion of the expenses, but not 100% of the expenses, because we still have an infrastructure that supports the technology, risk management and other functions that may not be quite as variable in nature.

And so we haven’t seen a benefit to our shareholders for truly exiting the markets, but our focus really is continuing to improve the performance across our footprint and we’re seeing that and it’s starting to translate to bottom line improvement from that as well. .

And then if we look at the number, the 60 hires you had, and then we look at the year-over-year productivity improvement you've been providing over the past couple years, does this suggest there's still room to improve your cross-sell ratios and that productivity ratio?.

Absolutely the case and all of my business partners here are all nodding their head across the table from me. So I think we have absolute agreement on that..

Our commitment and confident to be more productive and more efficient..

And next we’ll go to Terry McEvoy with Stephens..

Just looking at the cards and payments business, it's now 10% of fee income. I know you've been making investments in payments.

Are you seeing the full benefit of those investments? Where do you see growth coming from going forward? And can you talk about maybe penetration rates among your merchants and some of the other metrics that we can track and monitor going forward?.

There is a couple areas that we have invested in significantly that we’re really starting to see a lot of traction.

And first is the purchase card business and what we’ve done and I’m going to turn it over to Dennis in a minute, but what we’ve done is worked very, very closely with the community bank and not only in terms of penetration rates which are three or four X what they’ve been, but also the size of the clients are higher. So that’s one area.

Another area where we’ve had a lot of wins but it isn’t really reflected yet, because it takes some while to set up these programs, is we got into the prepaid business and we had some very significant wins out of our public sector area. Those don’t really come online until 2016, but it gives us confidence as we look forward.

And the other area where I think we had some success, I’m going to ask Dennis to comment on it, is on the merchant side where Dennis’ team has been very closely aligned, especially thanks to Dennis, who have been really coordinated..

The cards and payments line, to Chris’ point, you see on that line tangible payoff of the investments that we’ve been talking about. So we acquired our credit card portfolio and we now self-originate. To Chris’ point, you see that same activity in the merchant business.

You also just see core client growth occurring across the community bank, across the consumer and business banking portfolio and so with client growth comes activation and active cards.

Very proactively managed business, but you can see a portfolio of investments that are really paying off with client growth and the active evidence of our relationship strategy. Every one of these clients, every one of these products is not a standalone, but in the context of the broad relationship we’re bringing to market each day..

Just a follow-up for Chris, you're one year into Pacific Crest.

As you think about the synergies between the tech vertical and the corporate bank, do you think going forward we will see you enter maybe an eighth vertical as you continue to build out the investment bank and the corporate bank?.

We’re always looking for a new vertical.

And as we look back, I think the most important thing about Pacific Crest has been the fit from a cultural perspective, the willingness of our team at Pacific Crest to be part of the bigger platform where they can offer more things to their clients and it does give us confidence that if we could find the right niche, and again our business is all built around niches, if we could find the right niche, we would definitely look at trying to continue to leverage our platform which we think is not as leveraged as it could be..

And we have a question from Ken Usdin with Jefferies..

This is [Josh] in for Ken.

Bringing it back to investment banking, was there any slippage in closings in the third quarter that might also help on top of the pipeline and the seasonality in the fourth quarter?.

Josh, clearly the disruption in the market in the last part of the third quarter caused some of our deals and probably everybody else’s deals to be pushed out a bit. So there’s no question.

And then also as I mentioned earlier, for us, I think opens the opportunity for us to look at alternative ways to finance transactions for the benefit of our clients. So the answer to your question is yes, some things undoubtedly were pushed off..

And for the residential mortgage business build-out, how will the expense build show and when do expect revenues to start to show as well?.

As far as the expense build, we’re already starting to incur some of that because we’re really investing in the infrastructure to make sure that we do it right and so we have added to our team already and you’ll see a slow add to it over the next several quarters.

As far as truly launching it, we’re looking at sometime later in 2016 as far as really when you start to see the revenues pick up.

Anything else to add there, E.J.?.

No, Don. I think that’s correct. As we’ve talked about before, we try to calibrate on investment with our other expenses and you wouldn’t expect to see much difference in that business until the second half of 2016..

And this morning, we have no further questions in queue..

Thank you, operator. Again, we thank you for taking time from your schedule to participate in our call today. If you have any follow-up questions, you can direct them to our Investor Relations team at 216-689-4221. That concludes our remarks and thank you again..