Beth Mooney – Chairman & CEO Don Kimble – CFO Bill Hartmann – Chief Risk Officer Chris Gorman – President, Corporate Bank EJ Burke – Co-President, Community Bank.

Marty Mosby – Vining Sparks Gerard Cassidy – RBC Capital Markets Ken Usdin – Jefferies & Company Erika Najarian – Bank of America Scott Siefers – Sandler O'Neill & Partners Keith Murray – ISI Group Ken Zerbe – Morgan Stanley Bob Ramsey – FBR & Co.

Nancy Bush – NAB Research Geoffrey Elliott – Autonomous Mike Mayo – CLSA Limited Sameer Gokhale – Janney Capital Markets Ming Zhao – SIG.

Good morning and welcome to KeyCorp's second-quarter 2014 earnings conference call. This call is being recorded. At this time I would like to turn the conference over to Beth Mooney, Chairman and CEO. Please go ahead..

Thank you, operator. Good morning and welcome to KeyCorp's second-quarter 2014 earnings conference call. Joining me for today's presentation is Don Kimball, our Chief Financial Officer.

Available for the Q&A portion of the call are Chris Gorman, President of our Corporate Bank; EJ Burke, Co-President 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. Turning now to slide 3. This was a good quarter for Key with solid financial results that reflect the successful execution of our strategy and continued progress on our commitment to one, drive positive operating leverage.

Second, to maintain strong risk management practices. Third, to remain disciplined in the way we manage our capital. Our positive operating leverage from the prior year, reflects the work we have done to capitalize on the strength of our business model and improve efficiency by both growing revenue and reducing expenses.

Compared to the year-ago period, pre-provision net revenue was up 13%. Positive revenue trends for both the prior year and previous quarter reflect solid loan growth, driven by our commercial, financial, and agricultural loans. CF&A loans were up $3 billion or 13% from the second quarter of last year.

We have been pleased with the quality of our new loan originations, but we continue to see loan yields impacted by the competitive pricing environment. Non interest income benefited from the strength in our investment banking and debt placement fees, which were up 18% from both the prior year and the prior quarter.

Coupled with our solid loan growth, these results reaffirm the strength of our business model and our success in growing market share. Expenses were down $22 million, or 3% from the prior year, and in line with our guidance.

Our second-quarter results reflect normal seasonal trends and the acceleration of charges related to our continuous improvement effort. We remain committed to further improvement on expenses and efficiency, and Don will discuss more on our path forward in his remarks.

Our strong risk management practices resulted in another quarter of very good credit-quality trends. Net charge offs to average loans were 22 basis points, well below our targeted range. Nonperforming assets declined 41% from the year-ago period. Our NPA ratio is down to 74 basis points.

Importantly, we continue to originate new business that has better overall risk rating than our existing portfolio. While the environment remains competitive, we are remaining disciplined with structure and staying true to our relationship strategy. Capital management also remains one of our top priorities.

In the second quarter, we began executing on our 2014 capital plan by repurchasing $108 million in common shares and increasing our quarterly dividend by 18% to $0.065 per common share. These actions put us on a path to remain among the highest in our peer group for total shareholder payout, the second consecutive year.

Over the past few years, we have also used our capital to drive opportunistic growth through acquisitions of commercial mortgage servicing, credit card, and branches. Today, we announced another strategically important investment, which is highlighted on the next slide. Moving now to slide 4.

Pacific Crest Securities is a leading technology-focused investment bank and capital markets firm. This acquisition underscores our commitment to be a leading corporate and investment bank serving middle-market companies. The comprehensive platform aligns with our industry expertise and gives us another important industry vertical.

Adding technology expertise accelerates our momentum and will provide us the opportunity to add and expand client relationships. Clients will benefit from our broad capabilities as well as the expertise we will now bring to the market around technology trend that are intersecting and impacting our other industry verticals.

We anticipate the transaction will close in the third quarter of this year, subject to standard regulatory approvals. I am very excited about this acquisition and pleased with our overall financial results for the quarter.

We have good momentum in our core businesses and our strategy and business model continue to provide a competitive advantage in the marketplace. Now, I will turn it over to Don, who will comment further on our second-quarter results.

Don?.

Thanks, Beth. Slide 5 provides highlights from the Company's second-quarter 2014 results. This morning we reported net income from continuing operations of $0.27 per common share for the second quarter, compared to $0.21 for the second quarter of 2013 and $0.26 from the first quarter of this year.

I will cover many of this in my remarks, so I will now turn slide 7. Average total loan growth remained solid in the second quarter, with balances up $2.9 billion, or 6% compared to a year-ago quarter, and up $0.9 billion, or an un-annualized 2% compared to the first quarter.

Our growth was once again driven primarily by commercial, financial and agricultural loans, which was broad-based across Key's business lending segments. Average commercial, financial and agricultural loans were up $3 billion or 13% compared to the prior year and up $1.1 billion or 4% un-annualized from the first quarter.

In the second quarter, total commitments were up with utilization rates relatively stable. As Beth mentioned, the lending environment continues to be competitive. By remaining disciplined with our relationship focus, the quality and structure of our new business has held strong.

Our outlook for loan growth for 2014 remains consistent with our prior guidance of mid single-digit, full-year growth driven by CF&A. Continue on to slide 8. On the liability side of the balance sheet, average deposits were up $1.6 billion from a year ago and up $0.8 billion from the first quarter.

Deposit growth of 2% from the prior year and 1% for the prior quarter was largely driven by inflows from commercial clients as well as increases related to our commercial mortgage servicing business.

As a result of continued focus on improving deposit mix, year-over-year interest-bearing liability cost declined from 62 basis points to 52 basis points. Turning to slide 9.

Taxable equivalent net interest income was $579 million for the second quarter compared to $586 million in the second quarter of 2013 and $569 million in the first quarter of this year. Our net interest margin was 2.98%, which was down 2 basis points from the prior quarter.

Results in second quarter reflect the impact of a leveraged lease early termination, which reduced net interest income by $2 million and our margin by 1 basis point.

The reported decline in net interest income and the net interest margin from the prior year was attributable to the competitive environment, lower asset yields, and loan fees as well as a leveraged lease early termination.

These items were partially offset by loan growth, maturity of higher rate CDs and a more favorable mix of our lower-cost deposits. Compared to the first quarter of this year, net interest income was up $10 million, primarily due to the continued loan growth and the benefit of the day count and an improvement in funding costs.

For the full-year 2014, we expect net interest income to be relatively stable with reported level in 2013 with potential for downward pressure do to the competitive environment. We also expect to maintain our modest asset sensitivity position. As we have highlighted before, we have the flexibility to manage and quickly adjust our rate-risk position.

The duration and characteristics of Key's loan investment portfolios continue to position us to realize more benefit from a rise in the shorter end of the yield cover. Slide 10 shows a summary of non interest income, which accounts for approximately 44% of our total revenue.

Non interest income in the second quarter was $455 million, up $26 million or 6% from the second quarter of last year and up $20 million or 5% from the first quarter of 2014.

The year-over-year increase was due to stronger investment banking and debt placement fees as well as principal investing and a $17 million gain from the leveraged lease termination that I mentioned earlier.

Improvement in the first quarter was primarily related to the stronger investment banking and debt placement fees which were up $15 million as well as the leveraged lease termination gain. We also saw increases in normal seasonal trends in areas like deposit service charges, and cards and payments income.

As Beth mentioned, strength in the investment banking and debt placement fee helps illustrate the benefits of our business model, which allow us to capitalize on revenue opportunities whether they are through execution in the capital markets when conditions are favorable or by offering on-balance fee alternatives. Turn to slide 11.

Non interest expense for the second quarter was $689 million down $22 million from a year-ago period and up $27 million from the first quarter. Second-quarter expenses included $24 million in charges related to the efficiency initiatives, which added 2.3% to our efficiency ratio.

Expense levels reflect normal seasonality in the area such as marketing and personnel, as well as elevated efficiency charges due to the acceleration of our continuous improvement efforts.

Specific actions this quarter included closing 18 branches, a 20% reduction in the headcount in our fixed income trading business and the exit of our international leasing business. In the second half of the year, we would expect expense levels to remain relatively stable with the second quarter in the $680 million to $690 million range.

Quarterly results may be impacted by the timing of expense savings and efficiency charges and the pace of investments and merger-related charges related to Pacific Crest. Moving on to slide 12. Our year to date, we have recognized $34 million and efficiency related charges.

We would anticipate additional charges in the second half of the year at a level more comparable to what we experienced in the first quarter. This will likely bring efficiency charges for the full year to the upper end of our range of 1% to 2% of 2013 expenses.

Importantly, our guidance for the second half of the year is consistent with our previous outlook for 2014 expenses, which is down in the low to mid single-digit percentage range from the prior year.

We remain committed to continuing to generate cost savings through our continuous improvement efforts, which will enable us to make investments and offset normal expense growth. Slide 13 is our path to achieve the lower end of our cash efficiency ratio target of 60% to 65% over the next two to three year period.

We expect the improvement to come from growing our business both organically and through strategic investments as well as from additional expense reductions. Importantly, this assumes no benefit from higher interest rates. If rates move in line with the forward curve, we would expect this to move our efficiency ratio below our targeted range.

Turning to slide 14. Net charge-offs were $30 million, or 22 basis points, on average loans in the second quarter, which continues to be below our targeted range. In the second quarter, net charge-offs benefited from improvement in total gross charge-offs, which were down 24% from the prior year and down 2% from the prior quarter.

Commercial loan charge-offs continued to be a good story with recoveries exceeding charge-offs by $3 million in the second quarter. The breakdown of asset quality by loan portfolio is shown on slide 22 of the appendix. At June 30, our reserve for loan losses represented 1.46% of period end loans and 206% coverage of our nonperforming loans.

Importantly, as Beth mentioned, the quality of the new business volume has consistently been better than that of our existing portfolio. We expect net charge-offs to remain below the target range of 40 to 60 basis points for the remainder of the year and for the loan loss provision to approximate the level of net charge-offs. Turning the slide 15.

Our tangible common equity ratio and estimated Tier 1 common equity ratio both remain strong at June 30 at 10.15% and 11.33% respectively. As Beth mentioned, we repurchased $108 million or 7.8 million common shares in the second quarter. We also increased our quarterly common share dividend by 18% to $0.065 per share.

Importantly, our capital plans reflect our commitment to remaining disciplined in managing our strong capital position. Our Tier 1 common ratio remained above 11%, while we have paid out a peer leading amount of capital to our shareholders. Moving on to slide 16. This summary of our 2014 outlook and expectations is consistent with my comments today.

As I stated earlier, we expect average loans to continue to grow year over year in the mid single-digit range and our net interest income to remain relatively stable with our reported level in 2013. Revenue should benefit from the full-year, low signal-digit growth and non interest income compared to the prior year.

We continue to anticipate expenses will be down low- to mid-single digits on a full-year basis. This guidance reflects the impact of implemented expense savings, planned investments, as well as future costs associated with implementing additional cost-saving initiatives.

Credit quality should remain a good story with net charge-offs below our targeted range of 40 to 60 basis points for the remainder of year. Finally, capital management will remain a priority including continuing to execute on our share repurchase authorization.

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) One moment for our first question. And we’ll go to the line of Marty Mosby with Vining Sparks. Please go ahead. .

Beth, I wanted to first ask you a little bit about the acquisition.

Was this able to use some of your excess capital? Can you deploy cash into these types of acquisitions? How do you think about this going forward?.

Yes, Marty. This is a cash acquisition for us and it is an opportunity for us to build out a differentiated platform and consistent with our desire to expand our industry verticals, so it will be cash.

It is not a material transaction in terms of its size, but we think it's significantly proceeds its size for what it's going to do for us within our Corporate banking platform..

Do you see these types of acquisitions – because through the cash side you can use a little bit of that excess capital that's trapped on the balance sheet.

Do you see some other opportunities going forward to be able to look to use some of your excess capital?.

Marty, we have always said that one of the opportunities we will have through time is how we can deploy some capital, not only to support organic growth, but you've seen us over the last couple years deploy capital for commercial mortgage servicing, we brought back in our credit card portfolio.

So yes, some piece of the advantage, I believe, that we have is the levels of our capital will both support inorganic growth, organic growth, as well as, clearly, a high priority, which is return of capital to our shareholders in the form of dividends and share repurchases..

Thanks. Don, on the efficiency ratio, you broke out this time the adjustment for what you have in charges each quarter. You've kind of showed what was interesting is why it's been a downward trend. There's also been some seasonality with fourth quarter and typically second quarter is a little bit higher.

But you broke that trend this quarter with, once you take the charge out, the actual efficiency ratio, operating wise, went down from first to second quarter. It seems like expenses came in a little better than what I expected.

I just was curious if there were a little bit more traction in the efficiency gains this quarter than what we've seen in the past?.

We continue to move for additional efficiency gains and they could be lumpy at times as far as their benefit. I think you highlighted some key points there that despite the fact that we had some increases in our marketing costs lean quarter and some other items like that that our core efficiency ratio did show improvement.

That's something we're striving for over the long haul..

Lastly, you mentioned just a statement you have that you said a couple of times that the incremental loan growth is of higher quality than your existing portfolio.

I think that foreshadows better asset quality trends as we go forward, but why is it so much better than what you would've had in the past? What makes it different with what you're seeing in the market today than what you've been able to build over time?.

Marty, this is Bill Hartmann. One of the things that we've seen is the focus that we have had in the last couple of years on our relationship strategy has really focused us on who we want to do business with. If you take a look at the portfolio that we had, we continue to see de-risking occurring in that portfolio.

Part of that is driven by the improvement in the new business that's going in and part of it by the improvement in the existing portfolio..

Bill, would you think that would lower your targeted charge-off rate at some point, if that continues?.

We know that right now it is changing, it is lowering our probability of default..

Right. Okay. Thank you.

Thank you. We’ll go to the line of Gerard Cassidy with RBC. Please go ahead. .

Can you guys share with us how long it took when KeyCorp bought McDonald's and Company, how long it took to fully integrate it where you guys were comfortable that it was working very effectively?.

Sure, Gerard. This is Chris Gorman. Just a little bit of history for the group. McDonald was acquired by Key in 1998, and the businesses were really run independently until 2003 when we put about 17 businesses together to form our Corporate and Investment bank.

Admittedly, Gerard, it took probably two or three years before we really started to get the rhythm of being very targeted, as Bill Hartmann just mentioned, in who we want to do business with. And really getting focused in our industry verticals, which as you know, is how we go to market and how we've been successful.

Clearly, anytime you acquire a group of people, and in this instance where acquiring 170 people that are very very good at what they do in technology, there's obviously integration challenges. I'm really pleased, though, in this instance this was not an auction by any stretch of the imagination.

This is a negotiated deal that we've been working on since September of last year. So A, we've done it before and B, we've been working on this particular transaction and how we’re going to go to market, obviously, for the better part of a year now. That just gives you a little bit of history..

Thank you.

Obviously, in this type of business the people part of it is extremely important, how do you expect to keep the key players at Pacific Crest with you? Second, when you look back to the McDonald deal, are there many people left from the original McDonald transaction that were key people back then that may or may not be here today?.

I will start with the first part and then I'll address the second part. With respect to the first part, Gerard, we had a very specific list of people as we got to know the company that we thought it was imperative that we had their hearts and minds and that they believed in the shared vision going forward.

In fact, each of those people, each and every one of those folks, have executed, as a condition of us entering into this agreement, a retention agreement, so that's a good start. What really will drive this, though, is the notion of a shared vision. One, we know we can plug this industry vertical, i.e.

technology, into our business, but the real opportunity, the real long-term opportunity, is what we call convergence. That is the way technology is now infused across all business and particularly the six industry verticals that we operate in. That's what I think people both here and at Pacific Crest are really excited about.

With respect to McDonald investments, as you know, we sold the retail piece and we sold that fairly early. With respect to the people that were on the banking platform, many of those people are still here today.

I was obviously part of that, Randy Paine, who is going to be responsible for driving this integration, was on that platform, as was the Chief Operating Officer of the broker dealer, Doug Preiser. So, there are a lot of people, actually, in this building today that came over as part of the McDonald acquisition way back in 1998..

Great.

Lastly, Don, do your results for the current quarter reflect the shared national accredited exam results? I know some of the lead banks out of New York were given their results, so do the reserves or the reclassification of any loans that may have occurred because of the shared national credit exam, are those reflected in your credit quality statistics this quarter?.

This is Bill Hartman again. Yes, it does..

Thank you..

(Operator Instructions) One moment for the next question. Thank you. And our next question comes from the line of Ken Usdin with Jefferies. Please go ahead. .

I was wondering if you could just elaborate a little bit more on the commercial lending environment? You'd had a couple of really strong quarters and then just looking at the commercial financial agricultural owning up $100 million this quarter.

Understanding that you're being selective and that it's competitive out there, but can you give us a flavor for what you guys are seeing throughout your verticals in customer base? Is this at all really leaving some growth on the table, or is there some slowdown that we've seen recently that wouldn't have shown, necessarily, in the industry data versus what you guys are doing?.

Ken, this is Chris. Let me take a pass at that, if I could. First of all, and I will speak just for the Corporate bank and then I'll turn it over to EJ Burke, who will give you some insight into what's going on in the Community bank. From a Corporate bank perspective, we continue to see good loan growth. If you look year-over-year, we are up 14.5%.

On a linked-quarter basis where up 4.3%. Candidly, we see the momentum continuing. Now, because of our model, because were able to toggle between being a principal and being an agent, you will see fluctuations because we only put about 15% of the capital we raise on our balance sheet.

We think, look, it's a challenging market out there in a variety of ways. Is there pricing pressure? Yes, there's some. Is there some pressure on structure? There is. What we're really finding is with our targeted approach, Ken, the deals that we're going after that we want to put on our balance sheet, we're putting on her balance sheet.

The clients that we go after, and we don't really chase loans or any other product per se, what we really go after are clients. We're able to capture those clients. While it's always competitive and it's always a challenging environment, we feel pretty good about how the business looks going forward..

Ken, this is EJ Burke. I would say that our pipelines have been growing. In the second quarter we did see the same level of competition that we've seen throughout the year. In our lower-end size client, we're competing against smaller community banks where it appears that there is a lot more competition around structure.

Like Chris said, we're being selective. We're being very disciplined around our relationship strategy, and we're very comfortable with the pace of growth that we have in that business. .

Ken, this is Don. I may have misspoken on the call, but our growth in CF&A lending at one quarter is $1 billion and year-over-year is $3 billion. So, I want to make sure that that growth rate is actually at a faster pace this quarter than what we've seen in the previous couple quarters..

Okay. I was just looking at the period end up 100% on page 23 on period-end basis. Second question, Don, can you just also talk a little bit about where you guys stand now on LCR compliance? It didn't look like you really built much more on the security's book.

Is that pretty much done, and do you have any anticipation that you'd have to either continue to expand your liquidity base through either sub debt or other non-deposit funding from here?.

Ken, we're still waiting for the final rules to come through, but if they come through in the line with our expectations, most of our effort is really shifting the mix of that investment portfolio away from agencies to Ginnie Maes. As of the end of the second quarter, we had about 31% of our portfolio in Ginnie Maes.

We'll continue to take the cash flows from the portfolio and reinvest it that way, and that will take us north of a third of our portfolio by the end of the year, in that category of which we believe should position us well for LCR compliance..

Okay. Very good. Thanks, Don..

Thank you..

Thank you. We’ll go to the line of Erika Najarian with Bank of America. Please go ahead..

In terms of the actual impact for Pacific Crest for full-year 2015 in the income statement, could you give us a sense of what that could be?.

Erika, this is Don. As we've mentioned before, it won't be a material acquisition from a pure P&L perspective. We would say that over the last 12 months revenues have been in the $80 million range. Just to give you a perspective of the size..

Got it. I will follow up off-line, thank you..

Thank you. We’ll go to the line of Scott Siefers with Sandler O'Neill. Please go ahead. .

Good morning, guys. Yes. I think my first one is following on Ken's The difference between average loan growth at end of period was pretty considerable. Was there any large payoff or large payoff, Don, that impacted that? Just because the end-of-period balances were much lower here.

It certainly doesn't sound like there's anything that impacts your outlook for the full year but just am curious why there's such a big delta between the average and end of period this quarter?.

Yes, Scott. As far as the impact, we had a couple of things that did impact the period-end balances. If you look at our exit portfolio, it was down $325 million, point to point, and that included the impact of the leveraged lease transaction that we mentioned before, which was over $100 million as far as the balances.

Chris also referenced earlier that we can see some timing differences from point to point as far as deals that would close and the use of our balance sheet versus access of other markets for our customers. That had an impact.

As you also articulated that even with that change in the position that we still are reiterating, our outlook as far as mid single-digit growth year-over-year in loan growth..

Okay, perfect that make sense. I appreciate it. Just one kind of ticky-tack question. The tax rate was a little lower this quarter. I know in the past when you have leveraged lease transactions they've had an impact on the tax rate.

Did that do anything this quarter? Just the basic question is, was there anything in the tax rate and what would be your expectation for the remainder of the year?.

Yes, the leveraged lease transaction did have an impact on the tax rate. On a normal basis, we would expect that rate to be in the 26% 28% range, so that clearly had a benefit this quarter..

Okay. That's perfect. Thanks a lot, Don..

Thanks, Scott. .

Thank you. We’ll go to the line of Keith Murray with ISI. Please go ahead. .

Curious, given your exposure on the commercial bank side and how strong you are there, it doesn't make sense the strength that we've seen in C&I lending in what's continued to be a slow GDP backdrop and not a lot of CapEx.

What do you see the clients building up the credit usage for? Just curious what you're seeing?.

Keith, it's Chris. To your point, we have not seen a lot of plant expansion. What we have seen is a lot of strategic discussions. Business is a dynamic thing. If you look at – I think everyone was a little disappointed with the growth rates in the first quarter, in terms of GDP.

But like we are doing with our announcement of Pacific Crest, many of our clients are looking to grow strategically. If you look our M&A business, our fees are up, year over year, about 134%. I just looked at the deals that we had approved through our commitment committee. Those are up 29%.

So, you have a situation where people are sitting on a lot of cash. There's not a lot of growth to be had and so people are looking to grow strategically. A couple other areas were think we’re seeing a little bit of pickup. Yesterday, in talking to our leader in our leasing business, we're seeing a pickup in terms of medical equipment.

During the Affordable Healthcare Act and some of the uncertainty around that, that actually went down a little bit. Now, we are seeing investment by large hospitals.

The other thing that I think we’re seeing a little bit of is, for the first time in a long time, people are starting to see a little bit of inflation in some of the raw material inputs that they need to run their business. Of course, that encourages people, a little bit, to go out and get some inventory..

Keith, one other area, while you asked on the loan side specifically, I know Chris has talked about, with our platform investment banking and debt placement fees being up, they are participating in those strategic discussions, and some of the benefit you see is coming through in that strong growth.

Investment banking is in our M&A advisory book as well.

EJ, would you like to give some color on middle market?.

Yes, Beth. Part of what Chris mentioned around strategic acquisitions, that can be a double-edged sword for us. We've seen some of our private companies be sold, which means that we get paid down. Then alternatively, some of our other clients have been buying other companies, so that has definitely had an impact on our portfolio.

I would say, though, in the second quarter, we did start to see some borrowing for expansion. First time in a while..

Thanks very much.

(indiscernible) with the Hassle-Free checking account you guys came out with?.

I'm sorry, Keith, you cut off there, because we did not hear the entire question.

Could you repeat it, please?.

I'm sorry.

Just asking on the Hassle-Free checking account that you guys came out with, what's the philosophy behind that and the return profile you think about that over the long term?.

Keith, I'll go ahead and take that one. Hassle-Free is a new account offering for us that we put into the market and supported, obviously, with our increased marketing spend, was to promote that launch as well as what is always our spring home equity borrowing season. It is designed for ease. It is designed for convenience.

It is designed to help create utilization of lower-cost channels and alternative channels, such as online and mobile. It has been met with good market receptance. We're only six weeks or so into the launch, but have had a meaningful increase in overall traffic, number of new accounts, and it is both an attractor of new clients.

But it is also an opportunity, as we get them in, to profile and cross sell. I would tell you we are very encouraged by early results, and it is, like I said, still early days, but it has been a very positive market positioning and market reaction for us..

Thank you..

Thank you. We’ll go to the line of Ken Zerbe with Morgan Stanley. Please go ahead. .

Just a quick question on the leveraged lease termination, I think you mentioned it had a $2 million impact on NII and a little bit on NIM.

Does that have any carryover impact in the third quarter given the timing of the termination?.

This is Don. It really doesn't have much of an impact in the third quarter. Most of it was really just the gain realized this quarter and some slight impact future quarters, but not significant..

Okay. Thanks. Then, just one other question. In terms of the RISO ratio, I hear what you're saying that charge-offs are going to remain below your normalized guidance, but when you think about the reserves at 1.46% right now, of loans.

Where do you see that stabilizing? The questions also stems around some banks may be getting a little more pressure to stabilize the reserves as opposed to continue releasing.

Are you at the point where you feel that you're at a stable level, or is there more downside to the reserve side – ratios?.

Ken, this is Bill Hartmann. We spend a significant amount of time each quarter evaluating the portfolio and what we think the expected losses are out of that portfolio in establishing the appropriate reserve levels.

As we close out each quarter, just like we did this quarter, we think that it's set at the appropriate level, but we'll continue to evaluate that going forward..

Understood. I understand how it's always at the appropriate level.

My question is, when you envision, given the higher-quality loans that you're putting on, where that ends up being? Or more specifically are you seeing or hearing any pressure from the regulators or other sources that may want that not to decline from here?.

The conversations that we have with the regulators are very similar to what I described. They're not telling us that we should increase or decrease. What they are making sure is that were intelligent in the way we go about evaluating the appropriate level of our reserves..

Alright. Thank you..

Thank you. We’ll go to the line of Bob Ramsey with FBR. Please go ahead. .

Hey. Good morning. Just a couple quick questions on fee income. Obviously, a strong quarter for fee income and investment banking and principal investment income in particular. It sounds, from your commentary around investment banking, as if trends in that business are good.

Is this is a good run rate for this quarter, or do you think you pull back a little bit to more like where you've been running?.

Bob, it's Chris. As you know well, in this business there'll always be a fair amount of fluctuation quarter-to-quarter. As you go back, historically, typically, we, for example, ramp up in the fourth quarter.

Rather than give any guidance on what should be a run rate, what I will share with you is, across the board, our pipelines are stronger today than they were one year ago. Obviously, when these deals hit, if they hit, obviously, there's a fair amount of variability..

Okay. That's fair.

The principal investment income, how should we think about that line?.

Historically we've said that was a mid-teen type of number, but I'd say over the last four quarter, the average for that line item has been $22 million. Even though it was high this quarter, it was not that much higher than what we've been experienced over recent quarters..

Great. Then, the operating lease income line, I know you guys highlighted the $17 million termination gain this quarter. Is the right way to think about that line is take out that one-time gain and then that's in the ballpark or in the business is, assuming no further gains? I know you guys have had several recently..

Bob, on that line item we also had an additional $5 million negative adjustment to some lease residual values. So I don't think you'd want to pull out the entire $17 million based on that..

Okay. That's good to know. Great. I think those are my questions, thank you..

And we’ll go the line of Nancy Bush with NAB Research. Please go ahead. .

In your call, I've heard the competitive environment referenced more times than I have in some of the others. That's historically consistent with what we've seen in the Midwest in terms of competition.

Would you just look back at the competitive environment in past cycles, is it better than, worse than, whatever, this time around?.

Nancy, it's Chris. Let me speak from a corporate banking side. I certainly think that what we're seeing right now is consistent with where we are in the cycle. I don't think from either a structure or a pricing perspective we're seeing a lot of aberrations.

Specifically, as we go to market based on industry verticals, obviously, that spans geography and what we see is healthy competition. But as I mentioned, we find that with our targeted prospects and clients, we are able to garner new clients. We're able to win business, so we don't see it as particularly challenging vis-à-vis other cycles.

The one thing I would say, and EJ Burke can probably comment more and Beth can comment more on this, I think as you get to smaller companies, I think the competitive dynamic is a little bit different..

Nancy, I would just add that I think one thing that we've all talked about over the last year, and I know we've commented on our calls, that the competitive intensity in some way seems to intensify as you go down in size of asset and market company, because the field of competitors broadens out from community banks, regional banks, large banks, non-bank competitors.

That is an area where we see, actually, a high competitive intensity. You mentioned the Midwest. I would tell you it's not geographic per se. I think it is a function of how many competitors are in a market and there's just a broader set for the middle market in small business lending..

If I could ask a part B to that question, it would be in the area of deposit competition.

We haven't seen so much of that in this cycle, but as rates go up, what you anticipate? Is Hassle-Free checking one of the products that you're preparing for that era, or is there a different reason for that?.

Nancy, you're right as far as the deposits have not been as much of an issue, that most banks have a lower loan-to-deposit ratio today than what they historically have had. It probably hasn't been that bigger as a pricing. If you look at the last rate cycle of 2004 to 2006, the change in our deposit rates correlated about 55% of LIBOR.

So, we did see a beta of about 55%. We would expect going forward it would probably be somewhere in that range.

And there are probably other components that we would expect to see, including some migration from some of the non-interest-bearing deposits into interest-bearing and probably some deployment of some of the excess funds that are being parked on balance sheets.

Generally, we wouldn't think that would be a significant impact to our overall deposit position. .

Nancy, I would just add that our mix of deposits has changed dramatically and to the better over the last couple of years where we have really brought in core relationship deposits of both our commercial and consumer businesses.

As Don mentioned, some of those companies are carrying higher levels of liquidity that they may draw down some as the rate cycle changes, but I think they will forever hold more liquidity than they did in the past.

Indeed, Hassle-Free is yet another product to bring in core transactional relationship consumer accounts, which further solidifies the quality mix of our deposits..

Thank you..

And we’ll go to the line of Geoffrey Elliott with Autonomous. Please go ahead. .

On the diluted share count, that's increased over the quarter despite the buyback.

Could you explain what was happening there, please?.

Sure. We have a convertible preferred security on our balance sheet. Once we hit an EPS level of $0.27 a share, the accounting rules change from taking your net income less the dividends to average shares to actually reflect that preferred as being converted. So, it actually has about 20 million shares to our base.

Then, you basically don't deduct the preferred dividend in your EPS calculation. No significant impact in overall EPS, but it does show a little bit different geography as far share count..

And the trigger is using that $0.27 of EPS?.

That's correct..

Then just to follow up, there was the discontinued operations, the charge there, and then there was, I think, $6 million negative that dropped out in non controlling interest.

On both of those could you explain what was happening in a bit more detail?.

As far as the discontinued operations that this quarter we reassessed the valuation of the student loan securitization assets that we have on our balance sheet. What we essentially had as of the end of the first quarter was a net asset value of about $86 million.

With more recent information that we have seen as far as valuations on recent transactions, especially in the private student loan category, resulted in us taking an adjustment to that valuation. That's what you've seen come through the discontinued operations line item this quarter.

As far as the non-controlling interest that there really wasn't anything of significance in that $6 million adjustment..

So, not something you've seen in the last few quarters but nothing in particular you can call out?.

Nothing that would be worthy of calling out or saying that would be an expectation of continuing going forward, just a minor adjustments..

Okay. Thanks very much..

(Operator Instructions) We’ll go to the line of Mike Mayo with CLSA. Please go ahead..

Hi.

You said Pacific Crest had 12 month revenues of $80 million, so that would, base on the second quarter, boost your Investment banking capital market find by about 1/5th?.

Well, it would show through in a couple categories. It would be in the Investment banking debt placement. It would also come through the asset management and brokerage services. So it would also come through that trust and investment services income, which includes the brokerage revenue..

Okay. Then, just to follow up before my main question, you said that the average credit rating that's coming in in new business is better than what you have on your books. I know you already had a question on that topic, but it just seems a little unusual.

I mean, new loans are that much better? Can you quantify the amount that they're better based on your internal risk categories or some other quantitative factor?.

Mike, this is Bill Hartmann. If you take a look at the fact that we have a portfolio that over the last several years has been improving in quality.

And you can see the metrics that flow through from quarter-to-quarter on things like nonperforming loan statistics, criticize classified statistics and the rest, and you've seen the reduction in the net charge-offs, you're seeing that improvement in the base portfolio.

The new business is based on our relationship strategy, and so we are out and bringing new business in that is one, with the better customers on our balance sheet already and we add additional business with those customers, or new customers to Key that are part of the targeted strategies that EJ and Chris have.

So, that natural mix has been occurring. The difference, the delta between those two statistics has been narrowing. Obviously, the portfolio that we have has been improving, and so the impact of the high-quality new business is not as great as it was a year ago..

Mike, just one other thing on the mix. For example, in our real estate book, if you look back three years we would have a whole lot of construction and less REIT exposure, and what we've done is it's been a direct shift away from construction to REITs, for example in real estate. That would be an example of the mix shift part of that strategy..

That's helpful and that's good in contrast to one other item I see in the slides. To tell you the truth, I thought it was a typo at first. You'll find that's my sarcastic way of saying, I cannot believe that your efficiency target is 60% to 65% 2 years to 3 years out.

So that, if in 2017, you have a 65% expense-to-revenue ratio, that will be within the bounds that the Company is setting? I know we've talked about this a lot, Beth, but this is the first time I've seen a 2- to 3-year outlook with an efficiency range like that.

One question is has the Board approved that efficiency target that high, that far out? This is just – look, you know I've covered this Company for 20 years, but that is just abnormally complacent. I just can't believe it, as I look at that now.

I will say, I've talked to some people today and they've seen that also, and I just can't believe that target.

Can you just help me out this, because you've done a very well for shareholders the past couple of years and as I asked a couple quarters ago, is this it? Have we seen the most aggressive gains? Your thoughts about that efficiency target?.

Yes, Mike, I will go ahead address that.

We do have a slide in our deck that we have used at investor conferences and in this call trying to help frame the 2 year to 3 year path, which is how do we move within the range of 60% to 65%? It clearly shows that we are projecting that over the next several years we will come down to the low end of that range.

Additionally, as Don has mentioned a couple of times, it does not include the benefit of interest rates. So, that it is merely based on our attempts to grow our Company, appropriately manage expenses, do those investments that we believe are accretive to our platform in our business mix while offsetting normal cost pressures.

We see ourselves coming down to the low end, and if you overlaid the forward interest rate curve, not speculating one way or another, but just the forward curve, it would show us going into the high 50%s.

We are very, as you know, we have talked about it, conscious of the things we need to do to both operate our business, grow our Company, as well as continue to become a more efficient and effective Company..

Just one follow up.

Just remind us maybe the three most important priorities that should improve the efficiency ratio regardless of whether or not we are happy with the target or not?.

Mike, this is Don. I would say the three biggest areas for us is continue to get more productivity, and so we need to get more from our existing resources including greater sales activity. We've seen some notable improvements in those areas already, and so were on a good path. I'd say continue to manage our expenses more efficiently.

We're doing a lot of reviews of end-to-end type of process management and we think those will continue to have strong payback for us. As we've talked about before, Mike, I would say some of the categories of expenses that will reflect those benefits would include the personnel line item as well as occupancy. We continue to manage that down as well..

Okay.

Did the Board approve that target being three years out?.

We always, when we do our reviews with the Board, do have a 2- to 3-year view of the business trends, so we have shared this with them in our strategic reviews..

Alright. Thank you. .

Thank you. We’ll go to the line of Sameer Gokhale with Janney Capital. Please go ahead..

I had a question about hold sizes on loans.

I'm assuming those haven't changed, but if you could just confirm whether or not your hold sizes, particularly in your commercial loans, have increased? The other thing is, in addition to participating in Shared National Credits and in that program, are there any other type of balance sheet structures that you might contemplate using in order to go after bigger deal sizes and in offloading some of that loan exposure? If you could talk about that a little, that would be helpful? Thank you..

Sameer, hi, this is Bill Hartman. On the first topic of the hold sizes on the loans, we have – if you saw any change in the hold size, it would be related to the quality of the companies.

As the credit quality has improved, we have a scale like most banks do that says that for the better rated clients, you can hold more than for the lower or worse rated clients. We've seen improvement in the quality of the borrowers in our portfolio. On average, you probably saw some increase in the hold sizes in the loans that are related to that.

With regards to utilizing structures or trying to go into the market and acquire loans, just to build loans, that is actually inconsistent with the relationship strategy that we've been articulating for the last couple of years. We have a very disciplined approach to how and who we want to do business with.

I know there are some banks out there that are looking at growing by just putting structures in place or dealing with other bank syndication desks, but that's not her strategy. That's inconsistent. What is our strategy, though, it enables us to play bigger than we are, is to have the capability to distribute.

We lead 70% of the syndicated finance deals that we're involved with. We can distribute paper to the private markets, to the public markets, in our real estate business. We have a very large agency business Fannie, Freddie, FHA, which is HUD. We can go to the life companies. We can go to the CMBS market.

That, Sameer, is how we go to the marketplace, keep our risk profile at a moderate risk profile, but be able to serve our clients..

Okay. That's helpful detail.

Then on a different note, one of the things I was just curious about is as you went through the CCAR process and initially were preparing for the CCAR, I was curious if you used external consultants to build your stress testing models and the like? The reason I asked this question is because it seems like some banks that may have gone through the CCAR for the first time may not have used external consultants.

What I'm getting at is, it seems like, at least from what I understand, that maybe regulators actually favor the use of third parties because then they have more confidence in those stress testing models.

I'm curious if you agree with that view? If you actually did use third-party consultants while building your stress testing models and just to give your perspective on this issue?.

This is Bill Hartman. We did not use third parties to the build our models. We have a significant amount of modeling capability in-house, both on the building of the models and the validation of the models.

Again, our history is a bit longer than some of the banks that are just coming into this now, so I think we've been at this between SCAMP and CCAR, now, about five years. Over that period of time we have, when it comes to building models and validating models, we have quite a bit of in-house capability..

Okay, thank you. I just actually had a last question. You did talk about commercial loan growth and discussed at length, but I was just curious on slide 7, you talked about your commitments growing with the utilization relatively stable. It seems like a lot of banks have been talking about utilization actually increasing.

So is that just the optics of utilization just because your commitments have grown so whether or not that utilization is stable, but on existing commitments are seeing increased draw downs on that.

Is that the way to think about it?.

I would say that, overall, our utilization rates are fairly stable, so it hasn't seen much movement as far as the overall aggregate utilization rate. We did see a slight pick up in the first quarter compared to the fourth quarter, but relatively stability here in the second quarter..

And we’ll now go to the next and final question, Jack Micenko with SIG. Please go ahead. .

Hi. This is actually Ming on Jack's team. I just had a quick question. Going back to the Pac Crest acquisition for a second, some of their officers are in Boston, San Fran, New York, so places where Key doesn't have much of a presence.

Does this acquisition actually change your thinking on your footprint? Or, are you thinking about switching that up a little bit?.

This is Chris. Actually it doesn't change our thinking with respect to footprint because within these businesses we've always gone to market through industry verticals as opposed to geography. As it so happens, we are in most of the cities that they are in, which gives us an opportunity to work together.

Lastly, which I think is very fortuitous, Portland happens to be a very large base for Key. We like large bases because we think that teams of people learn from each other. And it just so happens they're headquartered in Portland and we think we can leverage that a bit, particularly through our Community bank..

Okay, great, Thanks. .

We have no further questions in queue. I would now like to turn the call over to our speakers for closing remarks..

Thank you, operator. We thank all of 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 Investors Relations team at 216-689-4221. That concludes our remarks for this morning, thank you..

Thank you, ladies and gentlemen. That does conclude our conference for today. Thank you for your participation and for using AT&T Teleconference. You may now disconnect..