Beth Elaine Mooney - KeyCorp Donald R. Kimble - KeyCorp William L. Hartmann - KeyCorp.

John Pancari - Evercore ISI Ryan M. Nash - Goldman Sachs & Co. Steven Alexopoulos - JPMorgan Securities LLC Erika P. Najarian - Bank of America Merrill Lynch Ken Zerbe - Morgan Stanley & Co. LLC David Eads - UBS Securities LLC Gerard Cassidy - RBC Capital Markets LLC Bob H. Ramsey - FBR Capital Markets & Co. R.

Scott Siefers - Sandler O'Neill & Partners LP Matthew Hart Burnell - Wells Fargo Securities LLC Bill Carcache - Nomura Securities International, Inc. Geoffrey Elliott - Autonomous Research LLP Mike Mayo - CLSA Americas LLC Ken Usdin - Jefferies LLC Terry J. McEvoy - Stephens, Inc. Matthew Derek O'Connor - Deutsche Bank Securities, Inc. Peter J.

Winter - Wedbush Securities, Inc..

Good morning, and welcome to KeyCorp's third quarter 2016 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 2016 earnings conference call. Joining me for today's presentation is Don Kimble, our Chief Financial Officer, and available for our Q&A portion of the call, is 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. Third quarter was pivotal for our company in terms of both financial results and executing our strategy.

We successfully closed our acquisition of First Niagara adding over $35 billion in assets, 300 new branches, and 1 million new customers to Key. And while a lot of time and resources have been devoted to making sure our acquisition and conversion went smoothly, we've also stayed focused on maintaining the momentum in our core businesses.

Importantly, both our Community Bank and Corporate Bank delivered strong results this quarter and Don will cover our outlook in his remarks. But let me just say, we remain confident in meeting our commitments, including the achieving the financial targets for our acquisition. I am now moving to slide 4.

Before I provide highlights of our quarter, I do want to share that throughout our presentation we've provided important details and transparency for Key's standalone operations and the impact of our acquisition.

As we move forward, we will be reporting consolidated results with Key and First Niagara combined, but this quarter, we thought it would be useful to provide additional detail. Slide 4 provides some highlights for standalone Key and the strong performance we saw this quarter.

Our Community Bank and Corporate Bank are performing well and we're realizing benefits from the investments we have made in recent years. As shown in our recent earnings release, we reported EPS of $0.16, and it is $0.30 excluding the impact of merger-related charges. First Niagara operations were relatively neutral to our EPS this quarter.

Compared to the year-ago period, standalone Key delivered positive operating leverage and we are well positioned as we move forward as a combined company having generated positive operating leverage for 9 of the past 11 quarters on a standalone basis.

Revenue grew 6% from the prior year, as we benefited from another quarter of solid loan and deposit growth and an 8% increase in non-interest income. Standouts for the quarter include a record level of investment banking and debt placement fees along with double-digit growth in cards and payments income.

Expenses continue to be well managed and reflected higher performance-based compensation this quarter along with an increased FDIC assessment. Not on the slide, but worth noting, we had another solid quarter in terms of credit quality with our net charge-off ratio remaining below our targeted range.

And although this slide focuses on Key's standalone results, the performance of First Niagara since our acquisition announcement has exceeded our initial projections and we remain very excited about the opportunity to grow this new part of our company. Moving now to slide 5.

As I said, this has been a pivotal time for our company and I'm extremely proud of the dedication and hard work of our teams from both Key and First Niagara. During the last three months we completed our regulatory approval process and closed our acquisition.

We also completed the divestiture of 18 branches on September 9 and we executed our client outreach plan which were comprehensive in scale and scope. We mailed out 4 million pieces of mail to our new customers and our bankers have personally touched tens of thousands of clients in every business to welcome them to the new KeyBank. I am now on slide 6.

Over Columbus Day weekend, we completed the branch and client conversion, which included moving data and account information for over 1 million new clients on to the Key platform. We converted over 300 branches, which re-opened as Key and consolidated 70 former First Niagara branches.

An additional 36 Key branches are targeted for consolidation in the fourth quarter. The conversion went well. Our detailed plans were well executed and we were open for business across our franchise as planned on Tuesday morning.

Our 3 million customers, including the 1 million from First Niagara, could bank with Key throughout our 1300 branches, 1500 ATMs and across our digital channels, from consumer online banking to our sophisticated treasury management portal. For our new customers, the systems converted as planned.

Their account information was transferred, and products and services like credit cards, debit cards and bill pay capabilities all remained fully functional. During the conversion, as issues surfaced that impacted a very small percentage of our client base, our teams worked hard to quickly resolve them and make it right for our customers.

Our planning and hard work over the past 12 months paid off and execution was solid. Although we are still in early stages, the overall feedback from legacy First Niagara customers has been positive. Turning to slide 7. As I said, we continue to be confident in our ability to deliver on our financial targets.

More specifically, I want to affirm our prior commitments that we have a high degree of confidence in achieving our cost savings target of $400 million. As I've said before, our internal target is higher and has remained consistent.

We expect to achieve our full run rate savings by the back half of 2017, which means it will be fully reflected in our 2018 results. Most of the outsource technology and operations, which are a significant part of the overall cost savings, should be terminated by early next year, with associated savings realized by that time.

Benefits from occupancy, the remaining 36 branch consolidations, and corporate functions will be realized throughout 2017.

As we look forward, we continue to believe that Key and First Niagara are a powerful combination that accelerates our performance beyond what either company could have otherwise achieved, improving our cash efficiency ratio by 300 basis points and our return on tangible common equity by 200 basis points.

And not included in our targets, but something that continues to provide real opportunity, is the $300 million in revenue synergies that we have identified.

By leveraging our products and capabilities in areas like payments, treasury management, and commercial mortgage banking, we have the opportunity to better serve First Niagara's client base, and we've already seen some early wins and our confidence continues to grow in achieving our revenue plans.

Let me conclude my remarks by recognizing the hard work and dedication of our teams over the past year. I'm incredibly proud that we were able to successfully close and integrate our acquisition while at the same time, accelerate our momentum that's been reflected in our Community Bank and Corporate Bank performance.

And as we move forward as one company, I'm even more excited for the opportunities we have to accelerate our performance, drive growth, and create long-term value for our clients, communities, employees, and most importantly, our shareholders. Now I turn the call over to Don to provide more detail on our quarterly results.

Don?.

Thanks, Beth, and I'm on slide 9. Third quarter net income from continuing operations was $0.30 per common share, after excluding $0.14 of merger-related charges. This compares to $0.26 per share in the year-ago period and $0.27 in the second quarter, which excluded $0.04 of merger-related charges.

As Beth mentioned, after adjusting for the impact of First Niagara and merger charges, we generated positive operating leverage relative to the year-ago quarter. On a standalone basis, Key's revenues were up 6% from the prior year, and up 5% from the second quarter. The EPS impact of First Niagara was relatively neutral to our third quarter results.

Results not only reflect the impact of First Niagara's operations for two months, but also the estimated purchase accounting adjustments and the impact from our divestiture of 18 branches on September 9. I'll cover many of these items on this slide in the rest of my presentation, so I'm now turning to slide 10.

Average loan balances were up $18 billion, or 31% compared to the year ago quarter, and up $17 billion or 27% from the second quarter. First Niagara contributed $15 billion alone to the third quarter results on an average basis, or $23 billion on a period-end basis.

Excluding the impact of First Niagara, average loans grew 5% year-over-year driven by commercial, financial, and agricultural loans up 11%. We've seen double digit year-over-year growth in 18 of the past 20 quarters for CF&A loans, reflecting our investments in senior bankers, and we've also maintained our moderate risk profile.

Average loans were up $1 billion, or 2% unannualized from the second quarter, excluding the impact of First Niagara, driven primarily by growth in commercial loans. Our estimated fair value adjustment on acquired First Niagara loans was 2.8%, or $686 million.

Importantly, this adjustment is an estimate and we expect to see additional refinement in the fourth quarter of this year as we work to finalize our purchase accounting. Also during the quarter, our branch divestiture resulted in a reduction of $439 million in loans. Continuing on the slide 11.

Average deposits, excluding deposits in foreign office, totaled $95 billion for the third quarter of 2016, an increase of $25 billion compared to the year-ago period and $21 billion compared to the second quarter. First Niagara contributed $19 billion of deposits to the third quarter results on an average basis, or $27 billion on a period-end basis.

In our Appendix materials, you will see that we recorded an estimated $356 million of core deposit intangible asset associated with the acquisition.

Excluding First Niagara, the 9% year-over-year increase in deposit balances primarily reflects core growth in our retail banking franchise, and higher escrow deposits from our commercial mortgage servicing business.

Compared to the second quarter of 2016, our average deposit growth of 3% excluding First Niagara reflects higher escrow balances from our commercial mortgage servicing business, core deposit growth in retail banking franchise, and inflows from our commercial clients.

During the quarter, the branch divestiture resulted in a reduction of $1.6 billion in deposits. Slide 12 shows our investment portfolio and highlights changes that occurred over the quarter.

Average total investment securities were $24 billion for the third quarter, which was up $5 billion from both the third quarter of last year and the second quarter of this year.

Growth compared to the prior year and the prior quarter reflects the acquisition of First Niagara's portfolio, which added $4.7 billion on an average balance basis, and $9 billion on a period-end basis.

During the quarter, we completed planned sales and the repositioning of First Niagara's portfolio to more closely align with Key's portfolio and investment philosophy. Proceeds from the portfolio sales were primarily used to pay down FHLB advances.

The average yield on investment portfolio decreased 13 basis points from the prior year and 12 basis points from the prior quarter, which reflects the impact of First Niagara portfolio and the continued pressure from lower reinvestment yields. Turning to slide 13, taxable equivalent net interest income was $788 million for the third quarter 2016.

The net interest margin was 2.85%. These results compared to taxable equivalent net interest income of $598 million and a net interest margin of 2.87% for the third quarter of 2015. First Niagara contributed $175 million to third quarter net interest income. Included in this figure is $19 million from purchase accounting accretion.

The purchase accounting accretion on the loans for the third quarter was estimated, which did not reflect any loan prepayments. In the fourth quarter, we will finalize the purchase accounting marks, which we expect will result in an increase in net interest income. Reported results for the quarter also include $6 million of merger-related charges.

Excluding First Niagara, and the merger-related charges, net interest income increased 4% from the prior year and 2% from the prior quarter, with both increases driven primarily by higher earning asset balances. The third quarter net interest margin of 2.85% was 9 basis points higher than the prior quarter.

Purchase accounting contributed 6 basis points of the growth, with all other items providing a benefit of 3 basis points on a combined basis. Slide 14 shows a summary of non-interest income, which accounted for 41% of our total revenue.

Non-interest income in the third quarter was $549 million, up $79 million or 17% from the prior year and up $76 million or 16% from the prior quarter. Our results this quarter included $53 million from First Niagara, which reflected two months worth of impact.

Additionally, within non-interest income, we incurred $12 million of merger-related charges, including losses realized from the repositioning of the investment portfolio. Excluding the impact of the acquisition and the merger-related charges, non-interest income was up 8% from the prior year and up 7% from the prior quarter.

We saw continued growth and momentum in a number of our core fee-based businesses, reflecting investments we have made over the past few years. As Beth mentioned, investment banking and debt placement fees had a record quarter.

We saw strength across our platform, including commercial mortgage banking, equity capital markets and M&A advisory fees, reflecting the strength of the Key relationship model. And while not a material growth driver, trading income did increase, but it is included elsewhere on the income statement.

Cards and payments income also contributed to our strong results with double-digit growth, excluding the impact of the acquisition, compared to both the year ago and prior quarters and service charges on deposit accounts continue to move higher, as our number of customers and related activities grow.

During the third quarter, operating lease income and other leasing gains reflected $12 million of lease residual losses. Turning to slide 15. As you can see on this is slide, reported non-interest expense of $1.1 billion includes $189 million of merger charges and $140 million of expense related to two months of First Niagara operations.

Excluding these costs, non-interest expense was $753 million for the quarter. We provided a detailed breakout of our merger-related charges in the Appendix of our materials. Compared to the third quarter of last year, and after adjusting for the impact of First Niagara and merger related charges, non-interest expense was up $29 million or 4%.

Linked quarter expenses, also adjusted for the acquisition, were up $47 million or 7%. Those comparisons reflect higher performance-based compensation and an increased FDIC assessment. Expenses related to the First Niagara operations were lower than previous guidance provided.

This improvement reflects some acceleration of merger cost savings and lower than expected core deposit intangible amortization. Turning to slide 16. Overall net charge-offs were $44 million or 23 basis points of the average total loans in the third quarter, which continues to be below our targeted range.

Third quarter provision for credit losses was $59 million, an increase of $14 million from the year-ago period and $7 million from the linked quarter.

Impact from First Niagara resulted in $18 million of provision expense for the third quarter, $12 million of which related to the purchase credit card portfolio, which was initially recorded at a premium.

Non-performing loans and non-performing assets both increased relative to year-ago period in the prior quarter, reflecting $150 million in non-performing loans and $167 million of non-performing assets from the First Niagara acquisition.

At September 30, 2016 our total reserves for loan losses represented 1.01% of period-end loans and 120% coverage of our non-performing loans, and reflects the acquisition of First Niagara portfolios at fair value.

And turning to slide 17, our Common Equity Tier 1 ratio at the end of the third quarter was 9.55%, which reflects the impact of First Niagara. With the completion of the acquisition, we did resume our common share repurchase program and repurchased $65 million in common shares during the quarter.

Disciplined capital management will remain a priority for us. Moving on to slide 18, this quarter, we have provided you with our outlook and expectations for the fourth quarter on a combined company basis. Importantly, our 2016 full year outlook for standalone Key remains consistent with what we had provided earlier in the year.

We expect average loans to benefit from a full quarter impact of First Niagara and continued core portfolio loan growth driven by strength in our commercial businesses. Net interest income is also expected to benefit from one additional month of the impact of First Niagara, along with normal growth in NII.

Further, as we noted earlier, we anticipate having an adjustment to purchase account accretion in the fourth quarter resulting in an increase to net interest income.

Non-interest income will also reflect one additional month benefit from the acquisition and we expect investment banking and debt placement fees for the full year of 2016 to be equal to or slightly higher than our full year 2015 results.

In addition to a full quarter impact of non-interest expense from First Niagara, we're also anticipating elevated merger-related charges to continue in the fourth quarter. To-date, we've recognized about half of our expected $550 million in merger charges.

We continue to expect net charge-offs to be relatively stable with our third quarter reported results and below our targeted range of 40 basis points to 60 basis points. Provision is expected to slightly exceed our level of net charge-offs.

As Beth said, we remain committed to meeting or exceeding the financial targets we have laid out for the acquisition. We continue to expect to exceed our $400 million of cost savings targets by the back of half of 2017, which would then be reflected in our full-year 2018 run rate.

With the conversion complete, we expect to show meaningful progress toward our cost savings target as we realized savings from the consolidated branches, third party and technology cost, and redundancies across the franchise. With that, I'll close and turn the call back over to the operator for the instructions on the Q&A portion of our call.

Operator?.

And our first question comes from the line of John Pancari from Evercore. Please go ahead..

Good morning..

Good morning, John..

Good morning..

Just wanted to see if you can elaborate a little bit on the timing of the cost saves. I know you indicated that you expect it to be fully realized by the year-end 2017, and Beth, I know you also alluded to where the bulk of the realization would be. Just trying to get an idea of the timings through the year.

Is it fair to assume that over half of the cost saves could be in the run rate before mid-year because that does impact where we're coming out for full-year 2017 and 2018 projections? Thanks..

This is Don, and I would start off by saying that if you take a look at the run rate of expenses for First Niagara that's included in our third quarter results, it shows an average monthly run rate of about $70 million a month. That compares with the run rate before acquisition of over $80 million.

And so, I would say that in the current run rate, we were already reflecting about a $100 million of that $400 million targeted level. As we've said before that fourth quarter won't show a meaningful increase as far as the level of cost saves.

We would expect to see many of those occur in the first half of next year with the realization of the systems conversions, the branch consolidations that many of which will occur here in the fourth quarter, and some of the other steps that will start to be realized in the first half of next year.

And so, I would say by the end of the first half, we would be well past the 50% of attainment of that value from the cost savings..

Okay. All right, thanks. And then separately, I know you had indicated that in your prepared comments that the First Niagara deal is performing better than expected since the close of the transaction.

Can you elaborate on what you're referring to in that? Is it mainly around the timing or the account attrition or cost saves? Could you just give us some more detail?.

I'll take another crack at that as well. If you look at the growth of the experience from the time of the acquisition to the time of closing, it was in excess of what we would have expected.

They showed growth in customers and households, they showed growth in deposit balances and loan balances and so they were able to continue to grow that franchise, despite the fact that this merger was going on.

And then you combine that with the expense saves that we realized here in the third quarter that would have been earlier than what we would have expected as well. And so it feels like and it shows that they're exceeding on all fronts..

Okay. Thanks, Don..

Thank you..

Our next question comes from the line of Ryan Nash from Goldman Sachs. Please go ahead..

Hey, thanks for the color on the cost saves. Maybe just following up a little bit on John's question, Beth, you talked about your internal targets being higher than your external targets and you sound like you're getting increased confidence now that you've had a few more months to look at it.

Can you give us a sense of what you think the incremental cost savings could be and will those be beyond the 2017 period or do you expect those to be phased in concurrently with the rest of the cost savings?.

Yes, Ryan. This is Beth, and then if appropriate, Don may have some more color. Yes, we do have confidence that, as we said, our internal targets have exceeded the $400 million in the path of (24:04) those.

However, at this time, I would say since we're still early days of making sure we realized the $400 million that we outlined in the amount and the timing that we have suggested, we will defer until we get into 2017 and before we outline what those additional possibilities of the timing will be.

But I will tell you that we do see a path for outperforming what would have been our initial projections of $400 million that we committed to a year ago..

I would agree, Beth. And we've talked about the realization of that $400 million coming primarily in the first half of next year and as we wrap up 2017 we would expect to see the full benefit of that run rate in our 2018 outlook..

Got it. Maybe I could just ask one other question.

The 200 basis points ROTCE uplift, is that a fully phased in run rate in 2018? And how do we think about the base for that? Is that current tangible book value, is that pro forma for 2018? Can you just remind us what you were using for legacy Key as part of your expectations?.

Yeah. We were operating around a 10% return on tangible common equity before the transaction. I would say in the third quarter, adjusted for the merger related charges, our return on tangible common would have been about 11%. And if you would just add on top of that, the additional benefit from the expense savings, we would be in that 12% to 13%.

So it would be equal to or exceeding that 200 basis point improvement we talked about..

Got it. Thanks for taking my question..

Thank you..

Our next question comes from the line of Steven Alexopoulos from JPMorgan. Please go ahead..

Hey, good morning..

Steven, you changed your name there?.

Yeah, on every call it appears. Don, thanks for all the transparency related to the First Niagara impacts, really helpful this quarter.

I just want to make sure I understand, did you say that there are a $100 million of cost saves now in the run rate this quarter?.

What I've shown to calculate that was basically the run rate of expenses for First Niagara was a $70 million a month. So if you take the 140 divided by the two months that are reported and compare that with the $80 million a month they were running at before the acquisition.

So that gives us about $100 million of cost savings realized on a run rate basis..

Okay, that's helpful. And Don, I know you're running parallel on the systems with First Niagara.

What's the target date right now where you are expecting to turn off their systems and get the $160 million of cost saves from the vendor contracts?.

Many of those should be shut off after the end of this calendar year. There will be a few that still linger over into 2017, but the vast majority of the benefit there should be in early half of 2017 benefit for those contract terminations..

Okay, got it. And could I ask you on the margin, obviously, a lot of moving pieces for this quarter.

Can you help us think through the trajectory for NIM in the fourth quarter?.

Take a look at our NIM in the third quarter. For the month of September, we had a margin of right around 2.90% and I would use that as a baseline for the fourth quarter. But keep in mind, we talked about the fourth quarter will include some additional net interest income related to our purchase accounting accretion.

And so, it should be a little stronger than that 2.90%..

Okay. If I could squeeze one more in, Don. would you be able to (27:30) think about a tax rate going forward? Thanks..

Sure. We've had some early comments about the low tax rate for the quarter and if you take a look at our reported earnings and back out the related merger charges and assume a 35% tax rate on those merger charges, the effective tax rate for the current quarter was 22.4% for core operations.

On a year-to-date basis, that's 24.4%, and so we benefited in the third quarter from some higher credits associated with some equipment leasing activities. We also had a slight charge in the second quarter.

And so we would expect those credits to continue and so we would expect our tax rate for the full year to be in that 24% to 25% range, so it would be very consistent with our year-to-date effective tax rate..

Okay, perfect. Thanks for all of the color..

Thank you..

Next, we have from the line of Erika Najarian from Bank of America. Please go ahead..

Hi, good morning. I echo Steve's sentiments on the clarity of the First Niagara impact. My question is as we look forward to 2017, how should we think about the $753 million legacy KeyCorp expense base. The year-over-year growth rate is about 4%.

Is that the kind of growth rate we should think about for 2017 or should we really think about it in context of the 65% efficiency ratio legacy?.

I would say first, Erika that the $753 million reflects the performance based compensation associated with a record high quarter for investment banking debt placement fees of $156 million. So we did have higher levels of expenses than what we would expect to be our normal run rate.

And so we would expect the core to come down based on not being able to sustain that level of investment banking debt placement fees. Core Key is currently operating on a 65% efficiency ratio. And so I think that is a good benchmark for legacy Key.

But, again, as we start to realize the cost savings from the combined organization that we should see that efficiency ratio drop meaningfully..

And also, as we think about next year, how should we think about average balance sheet growth in context of some of the assets that may be rolling off from First Niagara that you don't think is as core to you today? And if I could just slip one more here in, in terms of your comments on purchase accounting, are you expecting just a refinement in that will have one more month of purchase accounting accretion or is that $686 million potentially going higher? Thanks..

Yeah, a couple of things there, Erika. As far as the growth rate, we'll provide more guidance when we get in the January earnings call to provide guidance for 2017. I would say right now, our pipelines remain strong and the core franchise is growing, and we saw growth across the Key footprint, as we said, 5% growth on a year-over-year basis.

We're also seeing growth in the First Niagara so we'll continue to work through that. We're not seeing material portfolios where we would consider them to be in exit mode as far as a First Niagara franchise. So we don't think that will dilute the growth from that perspective. But, again, we'll provide more guidance there later.

As far as the purchase accounting adjustments that – you're right, the accretion for this quarter was $19 million. We would expect to see another month of accretion in the fourth quarter.

And so, on top of that, we would also have some additional accretion impacting our earnings because we did not assume any prepayments in the third quarter and as those loans would prepay it would also accelerate recognition of some additional purchase accounting discounts.

And so, we think the benefit from the purchase accounting will exceed just a core realization of the $19 million number that we experienced in the third quarter..

So, just to be clear, the $686 million over a shorter duration then when I calculate to be about a six-year duration that you assumed for this quarter?.

Yeah, and essentially what we're required to do is assume that accretion would occur over the contractual life of the loans. And so we would assume a faster than contractual life type of assumption as far as the realization of those reflecting the impact of prepayments..

Got it, thank you..

Thank you..

Our next question comes from the line of Ken Zerbe with Morgan Stanley. Please go ahead..

Great, thanks. Good morning..

Good morning, Ken..

I guess, first question is a little more of a broader question. You guys have frequently referred to potentially saving more than the $400 million.

If you did achieve, and pick your number, say, another $100 million of expense savings, how much of that would actually fall to the bottom line?.

Well, Ken, I don't really want to set your sight for another $100 million. That would be a meaningful step up..

Hypothetical number, of course..

That would assume that we would be reducing over half of the legacy First Niagara franchise expense base. But that being said, we do believe that the cost saves will drop to bottom line. Now offsetting that, we've also talked about revenue synergies and we're starting to see some activities that are reinforcing our confidence in achieving those.

We've talked about $300 million run rate of revenue synergies and with that we would have incremental costs associated with achieving that. And so, it would realize about another $100 million or so of additional expense for that. And so, again, we do believe that those cost saves will drop to bottom line.

They won't be offset by other add-ons, but that we will have some additional costs to achieve those revenue synergies..

All right, perfect. And then just the other question I had, in terms of provision expense, can you just explain the $18 million of First Niagara and obviously the $12 million related to the credit card higher provision? I just want to make sure I understand that, I guess. I would have thought all of the loans were mark-to-market.

What am I missing in terms of why there's now a provision expense on the First Niagara loans?.

Ken, what you're missing is you're trying to apply logic to accounting rules, and that doesn't always follow case (34:00).

But, essentially, what's happened here is that, as we look at the non-PCI, non-purchased credit impaired portfolios, those loans that are recorded at a discount, you would be accreting that discount back into income over time, but you would always look at the remaining discount to see if it's adequate to cover the required reserve associated with those loans.

What's unique about those credit card portfolios is that we recorded that at a premium, and so the value of that portfolio was higher than par, and so we had no discount to compare to for the recognition of allowance associated with that credit card portfolio.

So, effectively, on day one after the acquisition, we had to record the entire allowance, or $12 million, associated with that $300 million portfolio. And so that's what triggered that, and that's why we had a higher level of provision associated with the First Niagara transaction..

All right, great.

And then, really quick one, the preferred dividend on a go-forward basis?.

The preferred dividends will increase next quarter that the First Niagara preferred declared their dividend in July, and so it didn't have an impact on the current quarter results. So, you'll see almost a doubling of the preferred dividends compared to what the current quarter was..

Doubling versus this quarter. Okay, all right, thank you..

Thank you..

Our next question comes from the line of David Eads with UBS. Please go ahead..

Hi, good morning..

Good morning..

Obviously there's been a lot of commentary about the outlook for C&I demand across the industry, and I'm just kind of curious what you guys are seeing, if you're seeing anything kind of unique related to the merger closing?.

This is Bill Hartmann, David. One of the things that Don mentioned earlier was the continued momentum that was going on at First Niagara during the time between the announcement and the merger closing.

And I think that that, from a growth standpoint, could be viewed as something that's a bit unique because in many cases, people would expect to see a business momentum drop-off.

We have experienced continued growth across our portfolio as a result of the investments that we made in bankers over time, and we continue to see benefits from that investment, certainly in the current quarter..

And, David, this is Beth. I would just add that this is an area where I believe Key has outperformed the industry.

One of the statistics we quoted early was, 18 of the last 20 quarters, we have seen double digit C&I growth in our portfolio, and I think it's important to underline that it does reflect investments in senior bankers, so growth being driven by our client-facing personnel being increased, our bankers.

Second, we have also been investing in capabilities to differentiate Key, both on our KeyBanc Capital Markets platform but also in products such as payments and treasury.

So, as I look at it, this has enabled us to compete differently and post a higher level of C&I growth than the industry has been seeing, yet maintain our risk profile and loss content. So I think this is that strategy coming through for core Key..

All right.

And obviously, you guys will give formal guidance at the end of the year, but it sounds like no real change to the near-term outlook there?.

No changes to the near term outlook, that's correct..

Yeah. And then, on the IB business, obviously a great quarter there. Can you talk a little bit about the pipeline out of the quarter, and kind of the implied level for 4Q is potentially maybe down a little bit, but still at a pretty attractive level.

Is that the narrative we should be thinking about?.

Our pipelines remain strong. And in order for us to hit our guidance, we have to have something in $120 million plus as far as the quarter for investment banking debt placement fees. So, down from the record level but still strong compared to a year ago, and reflective of what we see as new business coming on.

One other indicator there really is taking a look at our loans held for sale, and you can see a nice pop-up in the commercial mortgage loans held for sale ,to about $1 billion level. And so that's just one indicator, as far as the strength of the pipeline..

Great, thanks for the color..

Thank you..

Next we have from the line of Gerard Cassidy with RBC. Please go ahead..

Hi, Beth. Hi, Don..

Good morning..

Good morning..

Don, can you share with us, talking about the accounting for the provision on the loans that came over, could you also talk about the non-performing assets or non-performing loans, I should say, that came over from First Niagara, because once again, normally those are mark-to-market? What caused those loans to come over as non-performing loans?.

Sure. And as far as the accounting treatment, we took a look at the $23 billion portfolio and divided it into two primary pieces. One is purchased credit impaired, which was just shy of $1 billion, and the other piece is the non-purchase credit impaired.

For the purchased credit impaired $1 billion portfolio, they're primarily commercial loans, and those are loans where we don't think they are going to be able to live up to the commitments required in the loan agreements and they're included in that category, and they're marked net of reserves and net of interest rate mark.

And so they don't bring over any allowance associated with that, and that interest rate mark will be accretive back into income over time. Because they are recognized as purchase credit impaired, they're excluded from the non-performing assets and non-performing loans.

Now, the rest of the $22 billion in loan portfolio, we did also record a mark on that portfolio, and it includes both credit and interest rate. We did not have any additional allowance related to that. But since it's not purchase credit impaired, we did carry over the status as far as the non-performing loans and non-performing assets.

And so that's why we show $150 million coming over in NPLs from the First Niagara acquisition, because many of those loans included in that non-purchase credit impaired are reviewed on a portfolio basis, as opposed to an individual loan basis.

And so, on a portfolio basis, we believe that the portfolio will be able to perform in line with expectations..

Would that imply they are mostly consumer loans then in the non-impaired, versus the other portfolio being the commercial loans?.

Well, there are commercial loans that are not PCI impaired, and so – also in the commercial portfolios, some business banking loans that are looked at on a portfolio basis as opposed to an individual loan basis. And so, it's a mixture of both, Gerard, but I would say that most of the consumer loans are in the non-purchase credit impaired category..

Okay, good. Thank you. And then second question, obviously, you guys had a blockbuster investment banking quarter. Traditionally, or historically, if I recall, you typically sell most of the production that you produce in a quarter.

Was that the case this quarter or did you retain more than normal? How did that work?.

I would say our sales levels would be consistent with what we had experienced in the past. And I think we've talked about for the capital raise that we would retain somewhere in the realm of 20% level and I don't know that's changed dramatically for the current quarter..

Thank you. I appreciate it..

Thank you..

And next, we go to the line of Bob Ramsey with FBR. Please go ahead..

Hey, good afternoon or good morning, I should say.

The 5 million shares issued under the employee comp plan, can you just remind me sort of what the triggers are around that issue that's related to share price or business line performance, sort of what drove that this quarter?.

The bulk of those shares issued related to the First Niagara acquisition and so as we issued new unrestricted shares or others in connection with employee change of control contracts as we structured some of those agreements is how those shares were issued for the most part.

And so they would have been granted as of or around the August 1st time line when the acquisition was finalized..

Okay, perfect, thanks. And then just last question on the card provision, which you explained.

Is that entirely a one-time sort of catch-up, true up, or are there any lingering sort of impacts to be aware of in future periods?.

As it relates to the card, that's a one-time impact. And so, going forward, we just have normal provision to cover charge-offs and loan growth in that portfolio. Keep in mind that down the road we will have to make sure that we're adding provision for new loan growth, and so we will have provision to cover that loan growth.

And also, as the accretion of that discount occurs for the non-purchased credit card impaired, we will start to replenish the reserves associated with some of those portfolios over time as well..

Got it. Thank you..

Thank you..

Next, we go to the line of Scott Siefers with Sandler O'Neill. Please go ahead..

Good morning, guys..

Hey, Scott..

Good morning..

I think most of my questions have been answered, but maybe just one on sort of the margin and rate sensitivity. I think, if I heard correctly, you're pretty much done with restructuring the FNFG securities portfolio.

Just curious if you can give little color on how the combined company's rate sensitivity compares to what Key looked like standalone before the deal?.

Yeah. No, you're absolutely right that the restructuring of the First Niagara portfolio is done. It was done really quickly in the quarter and so we really experienced the impact in those two months from having the change in that mix of the investment portfolio.

As far as the – and I'm sorry the second part of the question?.

Combined sensitivity?.

Combined....

Combined sensitivity. I'm sorry. If you look at combined sensitivity, we're about 2% asset sensitive. And so as we redid the portfolio from First Niagara and combined that with our overall balance sheet, it kept it fairly consistent with where we were before so we didn't see a real change there. And so, we're pleased with our position overall.

We'll continue to reassess that but right now we're about 2% asset sensitive..

That's perfect. Thank you very much..

Thank you..

Our next question comes from the line of Matt Burnell with Wells Fargo Securities. Please go ahead..

Good morning. Thanks for taking my question. Maybe just a little housekeeping here. The buyback was about $65 million. That's a little bit less than 20% of what you mentioned in June you were planning to repurchase over the four-quarter capital planning cycle.

How should we think about buybacks over the next three quarters? Would they be – should we consider that instead of a pro-rated level or is there any sense of doing it sooner rather than later?.

One. We didn't start buying back any shares until after the merger was completed. So, whether there was some timing to that. But, more importantly, our employee stock issuance typically occurs, for the most part, in the first quarter of each calendar year.

And so we would typically see acceleration as far as some of the share buybacks during that quarter. And so you would see a skewing or heavier weighting of the share buyback for that quarter but that's consistent with what we've done in the prior years as well..

Okay. And if I can ask – just a follow up on the capital markets. You didn't mention capital markets as a potential revenue synergy within the FNFG franchise.

Can you give us a little more color as to where you think the opportunities in capital markets in the future, beyond the fourth quarter, may lie within the FNFG franchise?.

Matt, this is Beth.

I would tell you that we do see opportunities within our Corporate Bank platforms, particularly in commercial mortgage banking as an area where we see real opportunity, particularly given the book of business in First Niagara that they have within real estate, both on their balance sheet as well as more broadly some of what those clients own.

And we cited that there have already been a handful of early wins. Many of them are related to the capability that we have in commercial mortgage banking. We also see obviously very, very good opportunities against some of our core payments, treasury management, FX and derivative products.

And then, obviously within that client base, our advisory capabilities will probably also over time create opportunities. But near term and early wins, I think, will be in commercial mortgage banking..

Okay. Thank you for the color..

Thank you..

Next, we go to the line of Bill Carcache from Nomura. Please go ahead..

Thank you. Good morning, Beth and Don..

Good morning..

Beth, actually, I remember you mentioning early on that at times you need to take some criticism upfront before ultimately being congratulated and kind of referenced to this transaction. And certainly it seems as though the execution is coming through.

Along those lines, a number of your peers are engaged in programs aimed at driving returns higher, but you guys seem to have what looks to us like a more tangible opportunity before you to the extent that you continue to execute on First Niagara on the integration.

It sounded from your earlier comments, Don, that your pro forma return on tangible would go from 11% this quarter, ex-merger related charges to 12% to 13% once you run rate the $400 million in anticipated cost savings.

Did I get that right?.

You are right, yes. That's correct..

Okay.

So then there's upside to the 12% to 13% number to the extent that there's further cost savings above the $400 million baseline that you mentioned and then, as well, if you layer in the revenue synergies?.

That's correct. And we're always looking to continue to improve our returns on an organic basis and don't believe that this transaction just stops it. So that will be something we're continuing to be focused on..

And so what could that return number look like, if you start to factor in some of the revenue synergies as well?.

We'll provide some more guidance later as far as what our targets are for return on tangible common. But I would say going from a 10% to 12% to 13% range is a meaningful step up. And so we'll again provide more color on that later..

Okay..

Bill, I would underscore that the core momentum that you're seeing in Key is what I think has been the rigor that we have given to our expenses to also create capacity to invest in banker's products capabilities that have created some of the revenue momentum that we're showing.

And, again, importantly as we kind of look at it, 8 out of the last 11 quarters Key has generated positive operating leverage. So the investments show in our revenue but the discipline in our expenses to create those investments have been part of the momentum and performance that we're experiencing..

That's very helpful. Thank you.

And lastly, if I may, going forward, is it reasonable to expect that you'll adjust your CCAR ask such that CET1 stays in the 9.5% range?.

We're very comfortable with our capital ratio being in that level and so we will consider that as we look forward to the future CCARs and also we take into consideration any changes in the guidance of the NPR is finalized and additional comments we've heard are put in the rule..

Thank you..

Thank you..

As a reminder, please limit yourself to one question in the interest of time. And your next question is from the line of Geoffrey Elliott, Autonomous Research. Please go ahead..

Hi. I better keep it to one. Last quarter, you talked about $30 million of incremental intangible amortization coming from the transaction and it looks like the step up in intangible amortization this time was a lot smaller than that. It was about $6 million.

So realizing you only had two quarters and two months of FNFG in there, just wonder whether that steps up further in 4Q or whether the $30 million shakes out to – the number shakes out to be lower than the $30 million?.

Yeah, you're right. The current run rate in the third quarter was below that $30 million target. We are finalizing some of the purchase accounting adjustments and could see some adjustments to the core deposit intangible in the fourth quarter but still believe that it should be a slight opportunity from what we initially estimated..

Great, thank you..

Thank you..

Next we go to the line of Mike Mayo with CLSA. Please go ahead..

Hi. Well, it sounds like your Columbus Day weekend conversion went well, but that was the fourth quarter.

so, how is it that you got 1/4 of your targeted expense savings in only two months? And if you could just give an update on how many branch closings you have versus the ultimate total and head count reductions versus the ultimate total?.

Sure. As far as that $100 million that I had cited that there was a number of expenses associated with some of the system development work that First Niagara was doing before the announcement. And we also had some executives, former executives of First Niagara leave and some staffing leave as well, post legal day 1.

And so those were really the sources of much of that $100 million of cost savings. We would expect to continue to see some ramping up later this year. And as we said earlier, we would expect to realize majority of those cost saves in the first half of 2017 and be at a full run rate and finishing up throughout 2017..

So, I mean, in terms of head count reduction already versus your target and branch reduction that you've achieved versus a target?.

One, on the head count reduction, I would say that we haven't seen any meaningful head count reduction yet that has been helpful, but not a meaningful source of total savings.

As far as the branches, we consolidated 70 branches of First Niagara over the conversion day weekend and we would expect to have 36 branches of Key consolidate here in the fourth quarter. And so, we should be there for our targeted branch consolidations, which would represent about 25%.

The other piece that occurred here in the third quarter is in the middle of September, we did close on the divestiture of the branches required for the acquisition and that reduced our branch count by about 18..

Okay. So you just shut those 70 branches. They're gone? I mean, so they....

In the fourth quarter, they are no longer operational. That's correct. So they have shutdown and we'll be realizing the expense savings associated with those branch consolidations in the fourth quarter and then we'll have another 36 from legacy Key that will be consolidated later in the quarter as well..

All right, thank you..

Thank you..

Our next question comes from the line of Ken Usdin with Jefferies. Please go ahead..

Thanks, good morning. Don, just have a question on the balance sheet, you did the securities portfolio repositioning, as you mentioned, and you mentioned that the outlook for the book to stay relatively stable.

Can you just help us understand the mix of earnings assets going forward, and would you expect to see earning assets move forward just in line with loan growth, or would you expect also to see portfolio builds as you move forward as well, on the security side?.

The biggest driver will be the loan growth. I would say that investment portfolio should be relatively stable overall.

We'll continue to make sure we're meeting our expectations and requirements for LCR, but you could see a remixing as well because we still had, in the third quarter, a very high level of short-term earning assets, mainly the Fed account, and we would expect that to come down over time..

Okay.

And then, as far as your reinvestments at this point, you mentioned the cash flows in the slide deck, and so can you give us an update now on a pro forma basis, where are you relative to LCR? And how much – like what your go-to investment rates are versus the 1.94% I guess is what we saw on the book for the quarter?.

Yeah. As far as the LCR, on a combined basis, we're north of 120% on the LCR and so we're in good position from that perspective. On the go-to investment rates, the current quarter, we bought about $4 billion in securities, about $1 billion of that were in floaters, so agency floaters. And so it only had about a 94 basis point yield.

The remaining securities that we were purchasing during the quarter had an average yield of somewhere in the 1.8% to 1.9% range, and we're seeing that come up a little bit as rates have moved up here late in the quarter..

Okay, thanks, Don..

Thank you..

And next we go to the line of Terry McEvoy from Stephens. Please go ahead..

Hi, thanks. Good morning..

Good morning, Terry..

Could you just talk about the rollout of the residential mortgage product that came over from First Niagara? Is that out in all of the markets now? I know it's a relatively small revenue number this quarter, but going forward, do you see that growing?.

Yeah. We are now all operating on the same origination platform, and so that is a positive event. I would say that that didn't occur with legacy Key until late in the third quarter, early fourth quarter, as far as the rollout.

And so, you wouldn't have seen much lift from that, but that we would expect to start to see some of the benefits as we go into later 2016 and into 2017. And so, we've been pleased with the rollout on the First Niagara, mortgage loan officers converted over to our new origination platform as well, and feel that was a success.

Beth, anything else?.

And, Terry, I would add that, as we now have – as we talked about some of the benefits of First Niagara, one was the acceleration of standing up a mortgage platform for Key from origination through servicing.

And our plans in 2017 and forward do include us adding to our mortgage origination staff and more robustly offering mortgage across our entire Key footprint. So, that is one of the sources of the revenue synergy that we see in the transaction..

Great, thank you both..

Thank you..

Next we go to the line of Matt O'Connor from Deutsche Bank. Please go ahead..

Good morning..

Hi, Matt..

Just following up on the net interest margin percent, the 3 basis points expansion versus last quarter, ex the purchase accounting accretion, what drove that?.

Well, the purchase accounting accretion was clearly related to First Niagara. Also, First Niagara had a stronger margin than Key going into the transaction, and so that was also a benefit. I would say legacy Key was relatively stable linked quarter as far as the overall margin..

Okay.

And then just separately, the tax rate expected for this year of 24% to 25%, is that a good range to use for 2017 as well?.

It depends on the tax credits that we have available. I would say that a more appropriate range would probably be in the 25% to 27% range, as opposed to 24% to 25%..

And is there a related decline in expenses associated with the higher tax rate?.

I would say the decline in expenses is, the merger-related charges will be lower, which will have an impact on the overall tax rate, and that's why you're seeing a step up there..

Got it. Okay, thank you..

Thank you..

And next we'll go to the line of Peter Winter with Wedbush Securities. Please go ahead..

Good morning..

Hey, Peter..

Hey, good morning..

Just on the revenue enhancements.

Can you talk a little bit about maybe the timing that you see some of that coming through in 2017? And then, in addition to residential mortgage, what some of the big contributors will be?.

Sure. When we talk about the $300 million of incremental revenue synergies, we said that that would typically be in a three to five year type of time period. And so, we'll have to continue to monitor that, but that's our initial assumption going in.

In addition to the residential mortgage, one of the big areas for us is our cash management services, treasury management services for the commercial side. And as we take a look at the activity levels that we're seeing right now, we're seeing a nice increase as far as potential referrals and pipeline associated with that.

I think we've got over 200 First Niagara customers that are at least talking to us about adding additional treasury management services, and so that would be another category that we also have potential growth and a number of other products and services, some of which came from First Niagara, and some of which are for legacy Key.

Beth, anything else you'd want to add there?.

In the product capabilities, again, a robust offering for the commercial customers would also include what we put in our Corporate services income of FX and derivatives and a broad suite there. We also look at wealth management and private banking.

And within that, we have investment management and other services that I think will be a good fit again for their consumer, as well as business customers within Key..

Okay.

And just quickly, anything you'd want to comment on 2017 with regards to some of that revenue enhancement that you see?.

Really, again, I think it falls back to – we think it's a three to five year time period. So you can think about that ramping up over that time period.

So I would say that we'll provide a little bit more guidance as we get into the fourth quarter call in January, and provide more clarity as far as the timing and a level of recognition associated with those revenue synergies..

Thank you..

Thank you..

And that was our last question. I would now like to turn the conference back over to Beth Mooney for final or closing remarks. Thank you..

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. And with that, it concludes our remarks and our conference. Thank you very much and have a great day..

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect..