KeyCorp (KEY) 2002 Q3 法說會逐字稿

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Good day, everyone, welcome to KeyCorp's third quarter earning release conference call.

This call is being recorded.

Tilt, I would like to turn the call over to the Chairman and Chief Executive Officer, Mr. Henry Meyer, please go ahead, sir.

Thank you, operator.

Good morning, ladies and gentlemen, welcome to KeyCorp's third quarter earnings conference call.

We appreciate you taking some time on what we snow a busy day to be a part of our discussion.

As you will see on slide two, we show our standard forward-looking disclosure statement that covers both our presentation and the Q & A that follows.

If you will now turn to slide three, let me start out by saying that our third quarter earnings were solid and within the range of guidance that we have previously provided.

Our results, along with the rest of our peer group, clearly continue to be impacted by the weak economy, especially if terms of loan growth and especially in the case of key, our market sensitive businesses.

As we talk to our customers and look at the trends that we see in our market, it would appear unlikely that things will change much through the remainder of this year.

I'm pleased to report a number of positive developments in the third quarter that not only allow us to manage through this period of slower growth, but also position us very well for the future.

First on the list is the completion of our management restructuring with the hiring of Jeff Wheaton as our new CFO.

Chef brings over 20 years of experience in the financial services industry, serving in a number of senior management roles, including CFO and CEO.

He will play a significant role, not only with Wall Street, but also in partnering with our lines of business and line of business leaders to drive performance.

I can tell you that as I sit here today with Jeff Weeden, who is new, but with Lee Irving and Kevin Blakely, it looks like our team is one of the strongest and ready to take advantage of this upturn when it comes around.

Second and I'm sure you have noticed, we announced the acquisition of union bank shares, a small bank in Denver, Colorado, but a bank that will strengthen our market share position and it follies strategy that laid out before we did the deal, which is that we are looking for fill-in opportunities, especially if areas were our franchise is already operating.

We will also continue -- we also continue to deliver on our commitments to downsize our auto business and exit loans in our runoff portfolio.

Since we announced these initiatives, over 3 billion of these low-spread -- been taken offer of our -- loans have been taken off of our balance sheet.

We will discuss later, our net interest margin continues to hold up better than many of our pierce and we would attribute part of our success to this runoff strategy.

And finally, last month, our board approved management's recommendation to begin expenses stock options in 2003.

Given our commitment to provide greater transparency and disclosure to our investors, we simply felt that this was the right thing to do.

This will impact next year's earnings by about 4 cents and ultimately when all of the programs are phased in it will be about a 6-cent per year deduction.

Now let had he turn the call over to Jeff Weedon for some overview comment on our financial results.

Jeff, welcome and the floor is yours.

Thank you, Henry.

First let me say I'm very pleased to be a part of key and the management team that Henry has put together.

I realize that these are challenging times for our industry, however, I'm excited to join a company the caliber of key that is re-energized with some new leadership that is open to change and focused on day care the right things for its shareholders.

I am impressed with the progress the company has made in reducing its cost structure and refocusing on relationship management I believe these chances will help the company create operating leverage when the economy improves.

In my new role here at Key, I look forward to partnering with a line of business leaders as we seek ways to improve the company's overall operating performance.

I also plan to maintain an open and active dialogue with the investment community.

I have asked Verne Patterson to put together our call-in calendar for the next several quarters, so we will be making the rounds with analyst and investors.

We would also extend an invitation to you to visit our teams here in Cleveland.

Now turning to slide four. in for the third quarter, key reported 57 cents per share.

Lee Irving, our chief accounting officer will go into more detail on the quarterly results shortly, but first I will comment on some of the trends we saw in the quarter.

Our net interest margin improved one basis point to 3.99%.

This was the company's third consecutive quarterly improvement in the net interest margin.

This slight margin improvement, however, was offset by lower earning assets, resulting from soft commercial loan demand and our strategic decision to exit certain low-return businesses.

Expenses continue to be a positive and were down compared to both the second quarter and the year-ago period.

Adjusting for the amortization of goodwill, expenses were still down compared to one year ago.

In the third quarter, we reduced our share count by repurchasing 1 million shares -- those brief comments, let me turn the call over to Lee for additional details on the quarter.

Okay, thanks, Jeff.

I start my commentary on slide five and discuss net interest income and the margin.

Net interest income continued its year-long improvement, reaching $722 million in the third quarter.

It got there by means of a good margin performance, as you have been told, the margin rose a basis point to 3.99%.

That is the highest it has been since 1998, which was well prior to the sale of our credit card portfolio.

Two of the factors in the margin rise are sizable growth and demand deposits and our continued deliberate runoff of assets generating lower spreads.

Average DDA balances increased by over 5% or almost a half billion dollars in the third quarter.

That is analyzed growth of 21%, but that is not the whole story.

Period end balances were up almost $1 billion or 11% from just June 30th.

The margin rise was enough to offset the quarter's impact of a lower level of average earning assets.

Average earning assets fell by half a billion dollars.

As Jeff indicated, loan demand has been soft.

We supplemented loan growth by purchases of securities, many of which settled near quarter end and will have a greater effect on next quarters a average earning assets than this quarter's.

Period end balances were up fire only $1 billion from those of June 30.

Our securities portfolio, including securities available for sale, even after considering the third quarter purchases is still relatively small as a percentage of earning assets, approximately 11% to 12%.

And our sensitivity rising rates remains very modest, approximately one half of one% of net interest income is at risk to a 200 basis point increase over the next 12 months.

The outlook for the fourth quarter is for a relatively stage margin.

Our fourth quarter generally features some seasonal boosts from increases in corporate DDA balances and increased corporate originations as customers are tax motivated to close deals before year's end.

Fed rate moves, of course, are a wildcard to watch.

We would expect very modest earning asset growth, due in part to the increases in our securities portfolio I just mentioned.

Turning now to slide six, noninterest income.

You see the primary drivers of the $16 million quarter to quarter decrease that we experienced.

The $432 million total and noninterest income for the quarter is our lowest quarterly amount this year, the primary drivers of the decrease were capital markets, related and probably not a surprise to anyone.

Investment banking and capital market fees were down, reflecting a lack of deal flow, trust and investment services income was down, reflecting declining market values of assets under management.

A reasonable outlook for the fourth quarter is for continued weakness in noninterest income.

Please note, while we are on the subject of noninterest income that we made a reclassification of certain brokerage commission income in the third quarter and restate restatedded all priors shown in the information.

The amount per quarter ranged from $2 1 million to $23 million since 2001 and this was purely a reclass and total noninterest income is unaffected.

Slide seven is next.

And it shows that noninterest expense declined by $6 million in the third quarter to $659 million.

Expense control is good at Key and this quarters a total is the lowest since the third quarter of 1998, even adjusting for the lack of goodwill am mortgage teuz stkphraeubgs. -- amortization.

Declines in commission pay are affected and last decline of about 400 old time equivalent employees during the quarter.

You will note here however that the one component of expense which did not decrease was marketing, which rose $3 million for the quarter as we launched the new media campaign.

Marketing, like all areas, is under strict expense control at Key but one of those areas more likely to make selective new investments.

The next slide, slide eight, recaps for you some developments in our three major business groups.

On a linked quarter basis, revenues were up in three of the four lines of business in key consumer banking, the one in which revenues were not up was indirect lending, the one in which we are deliberately down -- the auto loan portfolio and exiting the auto lease portfolio.

Net income for this group rose by 6% on a linked quarter basis, despite the decline in contribution from indirect lending.

E-consumer banking contributed 46% of the net income produced by the three groups on this page, up from 44% in the second quarter.

In KeyCorp Pratt finance, revenues rose in the second quarter and net income rose by 5%, both benefited from good growth and deposits, an area of focus in the corporate bank.

Key corporate finance contributed the knelt income produced by the three groups on this page, up from the second quarter.

Finally here, key capital partners -- of die pressed capital markets, deal flows and asset values.

On a linked quarter basis, this group showed a 7% decline in expenses but not enough to offset an 8% decline in revenues.

The result was a 12% decline in net income and as a result, key capital partners contributed only 14% of total net income produced by these three groups on this page down from 17% in the second quarter.

Now go to slide nine.

Jeff -- let's go to slide nine.

Jeff mentioned the share of the repurchase program had been activated in the third quarter.

A point we would acknowledge is the capital Raisch Joyce [ph] grown to the upper end of our internal guideline ratios and in some instances, the ratios exceed those upper guideline that has allowed us to be comfortable with limited share repurchases.

Until we see sign that is economy has turned the quarter and credit quality issues are clearly behind us, we are more inclined to conserve our capital than to use it to repurchase shares.

When economic and asset quality improvement does occur, our first preference of capital deployment would be to invest in attractive business opportunities and even while awaiting economic growth, recent experiences once again emphasize that -- matter.

Our strong capital base allows for a healthy dividend.

Having said that, we recognize our payout Raisch Joe high and expect earnings growth over time to gradually get us to a ratio closer to 40% than 50%.

Repurchases are the alternative when invester -- investing for growth is not an option.

Our focus on growing our profitable core business -- core deposit business will remain a high priority T is one of those parts of our business that increase from our marketing expenditures and just announced dial for union bank shares in Colorado is a prime example of the kind of capital deployment we would like to do more of in the future.

It is an in market acquisition of a retail relationship-oriented banking franchise.

Now it is time to focus on a sit quality.

Here to do that is Kevin Blakely.

Kevin?

Okay, thanks, Lee.

If you will turn to slide ten, you will find information pertaining to loan charge offs.

Focus on the column on the far right, $1 85 million for the quarter losses, 84 million from the portfolio, 41 million from the consumer side and 50 million against a nonreplenishable reserve.

On slide 11, a variety of important asset quality indicators.

Again focusing on the far right column, note that nonperforming loans finish at 987 million this represents an increase over the second quarter of 30 million.

The single largest addition to nonperforming this quarter was the 33 million assisted living health care relationship.

Nonperforming loans now rent approximately 1.5% -- 7% of the overall loan portfolio, increase over last quarter of 7 basis points.

As previously mentioned, charge-offs constituted 185 million, representing.16% of loans.

The loan loss reserve declined modest likely to finish the quarter at slightly less than 1.5 billion and now represents 2.37% of loans.

The ratio of reserves to nonperforming loans finished the quarter at 151%.

Moving ton slide 12 you will find an update on the runoff portfolio we set off during the second quarter of 2001.

We continue to have great success in reduce the size of the runoff pool.

Commitments have declined to approximately 1 billion and outstandings have reduced to 662 million.

Nonreplenishable reserve, against which runoff losses and loan sales are charged constitutes 87 million and nonperformance in the pool are down to 91 million.

Which continue to feel very comfortable with the adequacy of the nonreplenishable reserve.

We believe the purpose will largely be served in next couple of quarters, although there maybe some longer maturity loans we will be looking for a net opportunity to access.

On slide 13 you will find an update and outlook nor a number of asset quality categories.

The lackluster performance of the economy, particularly in the midwest, continues to extend out any significant improve N most of these areas.

That said, at this juncture, we envision NPL to be relatively flat versus the third quarter.

Chargeoffs remain basically flat but weighted a little more toward the core portfolio.

Our internal watch list has shown little movement from second quarter to the third and lastly, we believe that our overall loin loss reserve a adequate to meet our current needs W that I will turn the meeting back over to Lee Irving.

Lee?

Okay, Kevin.

We are now on slide 14.

On slide 14, we are shown in general terms.

While we hope that by this stage of 2002, an economic recovery would be clearly under way that is has not proven yet to be the case.

Things don't appear to be getting any worse, neither are they getting any better.

Therefore, our fourth quarter is one which we expect little change from the third quarter and slide portrays that given that we don't see much change taking place in the line items of the income statement and assuming not much change in the economy or the general level of interest rates, the most reasonable expectation for fourth quart earnings per share is that it will closely resemble third quarter earnings per share of 57 cents that -- with that, operator, we will turn it over you to and ask you to give instructions for the Q & A session.

Thank you.

If would you like to pose a question, press star 1 on your touchtone phone that is star 1 to signal to ask a question.

If you are using a speakerphone, please make sure you are not muted.

If you are muted, that will block your signal.

We will take as many questions as time permit and pause a moment to give everyone chance to signal star 1.

Gentlemen, our first question comes from Steve Warden at Louis Sales.

Hi, how you doing?

Steve.

I had a couple of questions actually.

Small ones.

First of all, I wanted to find out what exactly was the DDA growth in just the consumer bank?

The DDA growth, Steve, in the consumer bank, was 7%.

That was DDA and now accounts and while the consumer bank is showing loss in deposits, it is really a mixed issue, where we are in a very thoughtful way, we are running off CDs under 100,000, which are core deposits, but they are running off at very expensive rates and our focus has been to grow the much more profitable DDA category and now account.

We are offering free checking.

I think jack has talked about this.

So, our profitable deposit accounts in the consumer bank are growing and in fact, are up 7% from a year ago, even though the total category in consumer shows down.

What about the sequential change?

Quarter-to-quarter, we are up but I don't have the exact number.

I met with Jack this morning to get these and didn't get that number, Steve.

It is up.

He told me it is up, but I didn't write down what it was up.

We can get that for you.

Our next question from Jennifer Thompson at Putnam Lovell.

Hi, good morning.

I had a question regarding your guidance.

It looks like the -- basically for the line items you talked about, revenue expenses, basically flat, the net charge off ratio basically flat, but the tax rate is looking like it is going to be increased in the fourth quarter versus the third.

And yet you think EPS will be about stable.

What is going to be the offset to that tax rate going up?

Again, I wouldn't look -- raid too much into that.

Frankly, I'm not sure that we are that good to call it exactly right on the nose.

When we give you a figure of approximately 33%, the equivalent for this quarter, somewhere between 32 and 33 and frankly, we are trying to not over promise here.

So, I would tell you that you can expect it to be approximately 33%, perhaps it will be a built beneath that, but really is not much fundamentally that ought to change the rate from one quarter to the next.

Okay.

Great.

And if you could just talk a little bit about your exposure to telecom?

Sure.

I will take care of that.

Overall, which are not a huge player in the telecom industry.

We have about $250 million all okay in telecom and for the most part it is performing quite well.

We have a few credits that are in the criticized or classified category but overall it is doing very well.

We also have some additional exposure to towers, if you want to include that would be about another $180 million, but our tower exposure doing very, very well.

In fact, we only have a nominal amount of criticized and classified there.

So telecom is not a big issue for us here.

for those outstanding?

Yes.

Okay, thank you.

Our next question from Mike Holton from T Rowe Price.

I was wondering if you could talk more about the share repurchase thoughts.

I know you provided some flavor on that but as you get down to eight 023 and if you are in a position where you feel comfortable from a capital basis and environmental basis to buy stock, how should we think about it?

Should we think about it as maybe a couple million shares per quarter or could you be talking bigger things?

I guess everyone is looking at me.

I will take it is Henry, Mike.

We have always used share repurchase as a capital management tool.

We have, as you think you know, authorization significant any excess of what we are currently buying back, just rough numbers.

I think we have about 15 million more in authorized shares.

So, we are -- we will give some guidance, as we get closer there.

We are not going to jump from our current level, with which is, you know, a very modest, maybe 100,000 shares a day.

We won't make a significant jump in that because we don't think, you know, that's the right way to do it.

We have thought that at the prices we started buying, Key was undervalued, so, that was an important issue.

We also want to make sure that we are -- we are looking at ones that have been -- looking at options that have been exercised so our share count doesn't grow.

And that was the basic parameter that I wanted us to make sure this year we attacked.

So, that was about 2 1/2 to 3 million shares and we will just see where the economy is, you know?

I continue to be disappointed that our credit quality is not improving.

On the other hand, I'm not disappointed by our efforts.

Being a realist, we are not going to get out of all of our problems of the economy picks up.

But when the economy does pick up, the charge off levels that have been running well above 1% are going to drop significantly and are adequate, very adequate loan loss reserves are going to look even more adequate as accruals go down, at this point in time, we will feel better about our capital levels.

Okay, thanks, Henry.

Thank you.

Our next question from David Pringle at Folkham Global Partners.

Good morning.

Good morning.

Actually, I have got three questions.

Unless asking questions generate more questions.

You had mentioned the lease residuals in the press release.

Where does that come into the income statement?

Lease residuals, the -- losses are shown as an element of noninterest income.

Is it in other?

Yes.

Okay.

Secondly, didn't seem like you said made heck of a lot of progress in the runoff port from this quarter.

Could you talk about that a little bit please?

Sure, the -- actually the runoff portfolio is now getting down to the point where it is becoming more and more of a past graded portfolio and a lot of the assets that are left in there are higher grade loans that we really haven't had an opportunity to exit ourselves from yet because they don't -- they tend not to trip covenants, their mature Ritz a little bit longer, so it is just taking us a longer period of time to get out of a lot of those.

But the percentage of the overall portfolio that is passing versus criticized is getting higher.

So, it is just a matter of finding an opportunity to exit versus, you know, having a lot of hard-core problems on our hands.

This is Henry.

We did announce when we set up that portfolio -- that there were -- portfolio that there were investment-grade names in there that we didn't have a relationship with.

And just to add to what Kevin said, as we get -- we knew at this time that we'd have greater success in taking charges and working off the problem loans but that the good loins would stay with us more -- good loans would stay with us more than a year and in some cases based on the agreement that we had, some of those could be as long as three or four years in revolvers it is still our goal to have those runoff because there is no relationship or additional business, but the problem loans really are moving out faster because we are able to address those kinds of issues.

So I guess what you're saying is don't expect a lot of change in that over the next few quarters?

No, we will -- we are really going to try to work hard on the problem loans that remain, but we will get down to a cat tkpwoeur of loans and think -- I don't -- category of loans and I think, I don't have the sheet in front of me, but I think we were 87 million in reserves left against 91 million in nonaccruals.

You will see the nonaccrual number come down as we continue to work on the problems and then that portfolio will just be an accruing loan margin about to go portfolio, but which really think over the next two quarters, we will be very successful in working our way out of most of the problems.

So, it isn't div knit and we haven't hate plateau.

We are continuing to work, but as you did see, we had greater success in the early stages as we really address problems and trip charges and loans and moved them off of our balance sheet.

Sure.

And then finally the increase in the nonperformers, the runoff portfolio was about $63 million.

Do you have a 90-day past due number?

Yes, I do if you can give me one second, I will find it I think is around a little over 200 million. 208 million.

Yes.

Can you talk a little bit about the assisted living credit as to what came in sort of this quarter?

Sure, you mean into the nonperforming?

Please.

Okay.

It's -- the assisted living was the biggest contributor.

The next one after that -- I'm on the wrong page here.

It's -- it was largely, let's see, mixed between the large corporate portfolio, we had a credit.

We had several more structured finance credits.

In fact, the majority of the credits still coming in were out of our old structured finance portfolio that we have been working our way out of for the last two and a half years or so.

So, that probably represents the majority of where it is coming from R

You know, to be fair, I would tell ya that while it doesn't show up on our big numbers list, we continue to see middle market and our bread and butter credits are now into this fall the second year of a significant downturn, especially in the midwest.

And while the portfolio isn't getting worse in any dramatic way, we continue to see all significant segments of the portfolio, some deterioration at the low end and traditionally, we will continue to see that right into the teeth of an upturn as those credits that have been weakened by significant revenue sales drops just don't have the staying power.

So that makes up some of T is kind of a steady -- we call it a steady environment, but I would be less than honest if I didn't tell you that our core port foil seeing some pressure now given this 24 months into a slowdown.

So you have got some company, if it is any consolation.

Just quickly, I'm sorry to follow-up on an earlier question, is -- how much were the corporate DDAs up during the quarter and how much of that was just sort of what's going on with interest rates and how much of it as you guys sort of getting out and getting more DDAs from your, you know, lending?

You have both issues and, begin, when interest rates are lower, the earnings allowance for offsetting other services is lower, so DDAs have to be increased if companies are going to pay for those services with balances.

That is a part of T I don't have the exact split, but I do know that the concentrated effort that we have put on in both business banking and middle markets, to make sure that we are not a wholesaler, that there is a deposit account that goes with our lending, and even though our loans down, we have renewals that didn't have DDAs.

So, a good portion of the wholesale increase in DDAs is coming from this concentrateed initiative to make sure that a relationship it isn't just a lending of dollars a it is also the deposit relationship as well.

Thank you.

Our next question from Mike Mayo at Prudential Securities.

Good morning.

Mike?

Just one follow-up from what you just commented.

You said there is deterioration on the lower end.

Could you just give a little bit more color what you mean by that the size and where they are located?

Actually, if I could jump in for a second.

The overall portfolio is not doing too bad.

It is -- considering, as Henry said that we have been in a recession -- recessionary environment for quite some time now.

We are seeing some improve N some portfolios.

For example, in the assisted living health care portfolio, which has been a real handful for us over the last several years, actually going see the light at the end of the tunnel.

I sometimes feel like we are at the edge of the tunnel for that not quite out of it yet, but we can definitely see daylight there.

Structured finance on the other hand still continues to deteriorate a little bit, but the size of that portfolio continues to shrink overall.

We are seeing some flatness occurring in the mild market area, despite the fact that we are -- middle market area.

Despite the fact we are in the economy, the middle market has not significantly improved nor deteriorated in last quarter.

We saw slight improvement in the middle market during the third quarter.

Large corporate actually showed fairly significant turn around.

Commercial real estate showed a slight deterioration.

Overall, it is still a very solid portfolio though.

So it is kind of a mixed bag.

We are seeing some deterioration and some smaller credits and various sundry portfolios.

We are seeing some improvement in other portfolios.

At this juncture, the overall knelt performance is flat from quarter to quarter.

Okay, thanks for that detail.

But and separately, during the quarter, did you buy union bank shares, expanding in Denver.

Just what was your thought process in going in that strategic direction, that is the first deal you have had in seven years, could have bought a lot of other properties in different businesses.

You know, why now?

Why there?

A little bit more color, if you can.

Well for one thing, Union Bank had a very attractive loan-to-deposit ratio, attractive meaning many more deposits than loans.

And we are concerned here at Key about what has been a high loan-to-deposit ratio in the 140 and above range compared to some of our peers.

So that was an attractive strategic position from our perspective.

The rock skies are also continued to be a higher growth region and we do have a good foothold in the Rockies.

So that by buying in franchise smaller banks really gives us an opportunity to take costs out and get the benefits of the greater critical mass in a regional area.

So, we are not particularly -- we are not as interested in growing significantly in the midwest

Yeah, so not the midwest?

No that is not to say at all that we wouldn't do a fill-in acquisition that bolstered our micro market share, but I'm much more interested given a tie, which never happens in growing in faster, growing geographic markets, adding the number one share or number two share, the kinds of shares we have in just say Cleveland or Toledo.

That is not as helpful in terms of moving up the profitability curve as it is to move from fifth or sixth to first, second or third.

And those opportunities are more prevalent in our franchise in the northwest, where we have good locations but we aren't in the top three market positions.

So, that prioritizes but doesn't eliminate a good pricing in terms of adding franchise banking in existing market share areas.

Looked for more union bank share-type acquisitions?

Yes.

Okay.

We are looking for more union bank share type acquisitions.

All right.

Thank you.

Our next question from Jason Goldberg at Lehman Brothers.

Thank you, good morning.

Good morning, Jason.

Morning.

Similar to what you did for the telecom, I was hoping for an outline your exposures for the auto industry?

For the auto industry?

Well, I can't tell you, but I can quote specific numbers, although our overall exposure Bob centered here in our midwest part of the franchise.

I believe that overall, we have about -- about $3 billion in middle market type credits I in the midwest and would say that a good portion of that say 50% or more may be associated with the auto industry or its ancillary supplier-type businesses.

So far, they seem to be holding their own.

Yes, we do have some issues in the industry, but all in all, I can say that it is certainly not a catastrophe by any stretch of the imagination.

Okay.

Then in an unrelated question in terms of just you guys adding secures I over the last couple of quarters, should we expect that to continue until loan demand picks back up or is there is a limit to how much you want to put on the balance sheet?

This is Henry.

I think that the only significant increases have really been in the last quarter and it is clear any response to loan demand being very soft.

We are trying to make sure that we have got the earning assets to support the noninterest and interest income -- interest income that we want, but I wouldn't categorize it as significant purchases in terms of where our portfolio is and we have been buying short and intermediate -- so that we are not playing a yield curve game here of going long.

We are trying to have securities laddered so that they roll off when loan demand comes back, so, that's generally the philosophy that we have been trying to --

Jason, we are coming off of a very low base.

If you think the increases are large because proportionately they may be larger than in other companies, I would argue that it is coming from a very low base.

We are somewhere between 11 and 12% of earning assets and investment portfolio and think that is low for our group.

It is.

Okay, thank you.

Next question will come from Jefferson Davis, FTN securities.

Good morning, how are you all?

Good morning.

A couple of questions.

First, if I missed I apologized I joined late.

Any impact of the recent snuck exam results on charge offs for NPA levels?

I would say that nothing more than the normal.

We have a few downgrades, we have a few upgrades that has all been incorporated into our results.

You know, it -- I would say that most banks, you know, each quarter make changes to their SNICKS and we are no different.

It was no big deem for us.

Okay.

Energy portfolio, how large is the energy portfolio--?

Not very large.

We don't focus on energy.

Any adjustments to the private equity portfolio that might account for the reduction in the capital markets line?

In fact that portion of our business had a smaller decrease in the third quarter in the third quarter than the second.

I think the net all in was $1 million loss in the third quarter compared to as 2 million loss in the second quarter.

So inconsequential.

Okay, Lee, thanks.

And then lastly, general comments on what you guys are seeing on the home equity side, national home equity lending earnings, about a million late quarter.

Are we getting to the position where we are building balances, we are going to begin to see a little more lift in the earnings contribution there?

Yes, the answer to that is a definite yes.

When we made the decision two years ago to start putting the home equity, the champion loans in particular on our balance sheet, we knew that the crossover point would be 18 to 24 months out.

We really crossed over in 2002.

We won't have huge profitability in 2002 but we will have profitability and that profitability will grow at a much higher percentage than the balance sheet grows that will continue into 2003.

So that is one of the bright spots in terms of the lines crossing, the lines being if I canned costs that used to be covered by the gain on sale.

And then when we stopped that, we were running at a loss, which will be minor league profitable in 2002 and much more profitable in 2003.

Okay, so Henry is right now run rate 6 million a quarter is that something that moves say closer to 15 by the middle of next year?

Well, you know, I'm not going to give you a number, if you move up.

Okay.

Fair enough, thanks much.

Next question from Scott Syphers, Sam Letter O'Neil.

Just hoping given the way the investment banking line has bounced around, now just from a macro level, things haven't turned out as one would hope, just if you can give us any anecdotal commentary what the pipeline looks like and just any commentary you can give us with regard to-- contribution from that line item?

Well this is Henry, Scott.

We had a very good first six months.

We were very pleased with deal flow and the pipeline.

That has weakened as we have gone into the third quarter.

We are back looking at expenses with the banking group.

Anecdotally, I can tell you that the key word for McDonald and Key is alignment.

And I honestly believe that our alignment with commercial banking and investment banking has been done better than anybody else.

I think, you know, the landscape is littered with investment banking, banking deals that have not worked and I'm really convinced ours is working, it's just that in this marketplace it is very hard for know make that empirical case with data.

But I think that the groups are work together better.

One of the more recent moves that I made was to move investment banking under Tom Bunn so that commercial banking and investment banking report to the same executive.

So, I think we are doing a lot of things right and I think, I know when the market picks up, we have engagements, but those engagements don't pay until deals get done and this is a very tough market for us to see deals getting done in.

For those of that you have followed key for a long time and know many of you have, our fourth quarter has usually been our strongest quarter from both and I think Lee mentioned this or maybe it was Kevin, from our leasing activity picks up in the fourth quarter and we used to get quite a few closings in the investment banking world in the fourth quarter, but we don't see those types of events at the level they have been in the past five years happening this year.

All right, thank you.

Next question from John McDonald, UBS Warburg.

I apologize if Lee already covered this, but did he talk about the tax rate going past the fourth quarter and if what is going to come down from the 33%?

John, I didn't speculate on what the tax rate might be for beyond the fourth quarter.

Did comment that the fourth quarter would look a lot like the third and fundamentally, the -- is really any significant reason why I would expect a major change.

We take advantage of tax planning opportunities when they arise.

And as I admitted on a prior call we not good enough to call it exactly to the tenth of a percent.

So this quarter is being between 32 and 33, I would expect could you use that in model for quarters going forward.

If there is a reason for us to give you more precise guidance than that we will do that.

Okay, thanks, Lee.

And if could I ask Kevin one more industry exposure question.

Kevin, can you junction comment on airline exposure?

Sure.

Our overall airline exposure, passenger rare airline industry is somewhere in the vicinity of $300 million.

I would say that there is a bit of criticized classified in there, but overall it is not too bad of a portfolio.

Most of the problems that we have are in the special mention area otherwise it is pass or even investment grade.

Yeah, it is an area we keep an eye on but not a big portfolio and something we wring our hand over a lot.

Thanks.

Next question from Casey Embreck at Millennium.

Thanks for taking the phone call.

A strong quarter.

I just wondered if you could give it more quarter on the margin, seems to hang in there pretty well and I was just kind of wondering if could you walk through some of the mitt trick and how you are supporting it and kind of the outlook for it going forward?

I made some comments on the margin for the third quarter and also gave you color on the outlook for the fourth.

I apologize if I missed it.

Resisting, wandering too far beyond the next quarter.

Our crystal ball is lot clearer for the next quarter.

What I did say with regard to the next quarter is that generally our fourth quarter benefits from a couple of things.

Henry mentioned equipment leasing as people try to do deals, tax motivated by the year-end, so, that helps our margin, particularly in the month of December but we also generally see a run up in corporate DDA.

Don't see any reason to think that won't continue, so, the near term, we have got a couple of factors working in our -- to keep that margin up and we also have the low margin runoff portfolio gradually winding its way off our balance sheet.

That helps too.

We admitted that the fed rate moves are a wildcard and tough to call which direction the next move would go in or so whether we should be happy or sad about it.

Okay.

Could you update us on your asset liability sensitivity?

Yeah, our asset and liability sensitivity using the traditional measure of how much of our net interest income is at risk over the next 12 months to a 200 basis point rise in rates, the answer so that is approximately one half of 1%.

In dollar terms that translate to about $14 million pretax or 2 cents a share and that is assuming that you just sit there and don't do anything about it.

Let me just re-emphasize that's -- that's what happens in a static model.

I would also point out though as rates have come down, there has been tremendous comp were Exon retail deposits.

In the last four or five fed moves down, we have not been able to take the deposit rates down a commence rattle amount.

That will work -- a commence Seurat amount that will work to our Ben fete because consumers won't get 25 of the first 25 or 50 of the first 50 as rates move up.

So the assumption on 200 basis points over the year with no action puts a half of one percent of our interest margin at risk but we will take action and there will be some offsets to that as -- and I'm not sure when you joined the conversation, but as Lee mentioned earlier, our DDAs are up spot well over average and we have initiatives.

That is going to help us.

On the other hand, and think it was Mike, but one of them mentioned that we bought some securities.

Those secure Ritz at lower margins than -- secure Ritz at lower margins -- securities are at lower margins than the 3.99 we are running at.

Take all those into consideration, ours has gone up a basis point when many have gone down and comfortable our margin can hold in this tight range and 4% for the next quarter or so

Henry, one quick follow-up.

You mentioned that the midwest economy appears to be agenda little bit.

Has that changed at all from previous -- sagging a little bit.

Has that changed from your previous continue -- do you think that is getting worse?

Are you modeling future rate cuts or anything like that?

No and I think -- I have been out quite a bit to our districts and I'm amazed at how stead debt environment is.

It is not a great environment, but -- steady the environment S it is not great environment but it is not deteriorating much at all.

Now with any company our size there are loans getting worse and there are loans getting better, but in general, I would tell that you a lot of companies are managing through a much lower level of revenue and, you know, from my perspective, because I'm glass half full kind of person, I think the operating leverage that we have introduced into key has also been introduced into a lot of middle market companies who have used this opportunity to computerize, to use more technology to take costs out and when the economy comes back, and it will, it is a question of when, and when it does, I think there is going to be lot of operating leverage and profitability in the bread and butter companies that we lend to.

So, you know, I don't see much happening at all and I think in a way that is positive, because as we clean up old problems, our portfolio will get better gradually, if you will take that upturn for us to really get back to the kinds of competitive levels that our peers have who -- competitive levels that our peers have who didn't make the mistakes we made in structured finance and other areas.

Our next question from Dave George of A.G. Edwards.

Good morning, most of my Jess been answered.

I did have one quick question on head count, which was down 2%, second to third quarter.

I was wondering if you could provide some color on this was this attrition or any informal head count reduction programs in place?

Is this a trend that you think will continue into Q4?

Just some additional comer on that would be appreciated.

Thanks.

David, I would say of the 400 or so FTE reduction from the end of June to the end of September, about three-quarters of that came about by virtue of the sale of our servicing business for 401(k) toward the end of June.

So that three quarters of the decline is attributed to that one event.

You might also expect some decline in -- from seasonality, as summer works head back to school.

So, -- workers head back to school.

I'm not sure you can expect anywhere near the decline that we did have in the third quarter.

Having said that never say never, we are constantly looking at our businesses for those that are doing well and those that are not.

Henry mentioned with investment banking pipeline, looking the way it is we are looking at expenses there you can expect us to always be in a position of paying attention to cost control as one of the reasons why the figures for that look so good this quarter.

I would also add just emphasize what Lee said, there was some seasonal and divestiture that impacted that.

My focus is to try to reinvest in growth T isn't to try to continue to cut costs.

Now, hopefully, we are going to do it intelligently, find areas we can take costs out of, but we are trying grow in the business bank area under Mike butler.

We are trying grow in some of the regions in terms of our middle market.

We are trying to add in the new McDonald financial group some private bankers and brothers,.

So, we are selectively trying to add revenue producers, not trying to gain on taking the headcount down by 500 a quarter.

That is not write want us to be.

That is helpful, thank you very much.

Next question, Steven Wharton, Loomis Sales.

Hi, just a real quick follow-up.

Can somebody provide the impact on average or period end loans this quarter from both the auto loan and lease, you know, run down and then the runoff portfolio runoff?

I can tell you what the runoff portfolio went down.

The overall outstanding went down from 724 million to 662 million.

Your other question was the auto lease portfolio is that right?

Yes, I'm trying figure out what core loan growth was, including those things weighing it down.

Steve, on average, the auto lease portfolio is down $250 million.

I don't know the point-to-point offhand.

We may be able to get that for you, but on of a range $250 million was the decline third quarter versus second.

Okay, thank you.

Next question, Jefferson Davis, FTN Securities.

A couple follow-up questions.

Lee, the -- the consumer banking group, the notation talks about an 11 million write down of premium on purchased home equity.

I know the long end of the curve is moving up here the last couple of days, maybe somewhat of a new question.

But how much of unamoratized premium is left in that portfolio?

I don't know the answer to that I can't answer that let me see the press release.

Don't make the assumption 191 million write down is what which had to come to grips with during the most recent quarter because of I recall payoff activity.

In fact this is the cumlative effect of an error caught in the third quarter that guess back close to two years.

So we had a lot of catching up to do for a rather small part of our portfolio, I can assure you we have taken steps to make sure that does not happen again.

Actually, it was caught in a system change and the new system will be taking those into account as payoffs happen.

This was a cumulative effect of pay downs, early payoffs, where we hadn't addressed that issue.

We don't expect this again.

So is another way to say it, in effect, maybe had one to one and a half cent of nonrecurring write down here, assuming there is not premium amort if rates came down or another large write down?

You might look at it that way, David but a company as big -- and complex-- ins and outs like that you do that at your peril.

I got gotcha.

One last follow-up quirks the come was made with regard to net charge offs being flat or flattish for fourth quarter, but a little bit more weighty.

The core portfolio, can you give us any more come terror and I'm going to assume that the provision will continue to match losses on the core portfolio and hence we would see a provision expense moving up next quarter also.

Yes, I would say that is a fair statement and already been vacant to the other figures that Jeff and Lee already tossed on the table there.

Okay.

We are talking about a dramatic number, five to ten.

Thank you, gentlemen.

Gentlemen, we have no other questions at this time, I will turn it back to you for any closing comments.

I want to thank everyone for their participation in today's call.

I thought we'd good dialogue, a lot more questions than normal, but again from my perspective, I think this was a very solid quarter and that key's performance, we were not, you know, digging into deep reserves to try to make things up.

We are performing at a very solid level and again, in this economy, we think that this is a level that will stay till we can see some pickup in loan demands, some return to higher noninterest income levels from our market sensitive revenue sources and I think all those things are going to happen as we go into 2003.

With that, we will say goodbye and again, thank you for your participation.

Thank you, that does conclude our conference call.

Again we appreciate your participation.

At this time, you may disconnect.

Thank you.