KeyCorp (KEY) 2010 Q3 法說會逐字稿

Good morning and welcome to KeyCorp's 2010 third quarter earnings conference call.

This call is being recorded.

At this time I would like to turn the call over to the Chairman and Chief Executive Officer, Mr.

Henry Meyer.

Mr.

Meyer, please go ahead, sir.

Thank you, operator.

Good morning, and welcome to our earnings conference call.

Joining me for today's presentation is our CFO, Jeff Weeden, and available for the Q&A portion of our call are our leaders of Community Banking and National Banking, Beth Mooney and Chris Gorman, and our Treasurer, Joe Vayda.

Slide two is our forward-looking disclosure statement.

It covers our presentation materials and comments as well as the question and answer segment of our call today.

Now if you turn to slide three.

This morning we announced third quarter net income from continuing operations of $163 million, or $0.19 per common share.

Our positive earnings for the last two quarters resulted in a return to profitability for our year-to-date results, with net income from continuing operations for the nine month period of $121 million, or $0.14 per common share.

Key's third quarter earnings improvement compared to the second quarter was due to higher preprovision net revenue and a lower provision for loan losses.

The growth in preprovision net revenue was the result of a higher net interest margin, well-controlled expenses, and improvements in several fee-based businesses.

Credit quality continued to improve across the majority of the loan portfolios in both Community Banking and National Banking, reflecting the work that has been done to lower our risk profile and proactively address credit issues.

Our positive credit trends included net charge-offs, which were down for the third consecutive quarter, and non-performing loans, which have declined for the last four quarters.

Our balance sheet continues to reflect strong capital liquidity and reserve levels.

Our estimated Tier 1 common equity ratio at September 30 was 8.59%, and our Tier 1 risk-based capital ratio was 14.26%.

Key's loan loss allowance at the end of the third quarter was approximately $2 billion, which represented 3.81% of total loans, and 143% coverage of non-performing loans.

Both of these ratios should maintain our position near the top of our peer group.

As many of you who have followed our Company know, our management team has moved aggressively over the last 18 months to significantly fortify our capital and reserves, lower our risk profile, and improve liquidity and funding, with the single-minded purpose of emerging from this challenging economic period strong and well-positioned to compete and win in the marketplace.

I believe the trends that we have reported today in our preprovision net revenue demonstrate the progress that is being made.

Our strong capital and liquidity positions also enable the Company to support the borrowing needs of our clients when the economy expands.

The Company originated approximately $8.1 billion in new or renewed lending commitments to consumers and businesses during the quarter, and approximately $21 billion year-to-date through September 30.

The final item on our strategic update slide, investing in our core relationship businesses, has been a consistent theme for Key.

Having a strong balance sheet as solid foundation, we're continuing to position the Company to take advantage of the gradually improving economy.

In Community Banking, our largest investment is in our 14 state branch network.

We opened 34 new branches in the first nine months of 2010, and expect to open an additional five branches during the fourth quarter.

And we have plans to open another 35 to 40 branches in 2011.

The profitability of our new branches continues to be in line with our expectations.

We have also continued to modernize our existing branches and align staffing with the needs of the segments and the communities that we serve.

One of the segments that continues to be an area of focus is business banking, where we have designated 225 branches as business intensive, which are staffed to serve our small business clients.

We are also a significant participant in the SBA Small Business Loan program.

In retail banking, we're focused on deepening our existing relationships and new client acquisition.

During the first nine months of this year, we have experienced solid growth in our net new DDA accounts, and have generated a record level of revenue in our branch-based investment group.

We are also pleased to receive additional recognition for Key's online capabilities in the September edition of Bank Monitor, which ranked us second among the 16 largest US banks for our online account application features.

The investments in our new and modernized branches, along with the enhancements to the online banking, position us to grow as the economy strengthens.

Our improvement in the National Banking group is largely driven by improving credit trends, and the work we have done to reduce our risk profile.

We have also made significant progress in sharpening our focus on targeted client segments, and investing in the right people and our non-capital intensive businesses.

Year-to-date, KeyBanc Capital Markets has participated in 41 equity transactions that generated over $40 million in fees.

According to industry league tables, we have been one of the top regional banks in IPOs and follow-on deals this year, and have played a very active role in the REIT space.

We have also seen improvement in M&A Advisory business since the third quarter of 2009, as more liquidity has returned to the market.

Key has consistently ranked as a top advisor for middle market M&A transactions.

And we continue to emphasize areas of National Banking that have synergy with our client segments in the Community Bank, such as equipment leasing, and certain products offered through KeyBanc Capital Markets.

Before I turn the call over to Jeff, I want to recognize the important contributions of our employees across Key, who have remained focused on serving our clients through what has been an extremely challenging period.

Our leadership team makes a point to visit a number of our district markets each year, and we just returned from a visit to Portland and Seattle, key growth markets, where we are making significant investments for our future.

I personally came away from these visits energized and confident about the changes Beth and her team are implementing in our Community Banking model.

We are attracting new clients, zeroing in on service and delivery, and building the Key brand.

In markets where there has been disruption among competitors, there is additional opportunity, and again, the perseverance of our front line bankers during this period has been extraordinary.

As I mentioned earlier, with the significant strategic actions we've completed and implemented over the last 18 months in our capital structure, risk management, expense control, and business investment, our confidence in our fundamental strategy builds.

I remain confident in Key's future and our ability to serve our clients and make progress towards our long-term financial targets.

Now I'll turn the call over to Jeff Weeden, for a review of our financial results.

Jeff?

Thank you, Henry.

Slide four provides a summary of Key's third quarter financial results from continuing operations.

Unless otherwise noted, our comments today will be with regard to Key's continuing operations.

As Henry mentioned in his comments, for the third quarter, the Company earned a net profit of $0.19 per common share.

This was the result of lower provision for loan losses as both charge-offs and non-performing loans decreased from the second quarter levels.

In addition, the Company showed improved preprovision net revenue as a result of higher revenue and well-controlled expenses.

The third quarter profit compares to a profit of $0.06 per common share for the second quarter of this year.

While not noted on this slide, the Company's book value and tangible book value increased again during the third quarter to $9.54, and $8.46 per share, respectively, up from $9.19 and $8.10 per share at June 30th, 2010.

On slide five are Key's long-term targets for success we introduced earlier this year.

On the next several slides, I will comment on our progress towards achieving these targets.

Turning to slide six, one of our objectives is to be a core funded institution with a targeted loan to deposit ratio of 90 to 100%.

As of September 30th, 2010, our loan to deposit ratio was within this targeted range at 92%.

During the third quarter, the Company experienced a $2.4 billion decrease in average total loan balances compared to the second quarter of 2010.

As we have been commenting on for several quarters, the decline in average balances continues to reflect soft demand for credit, and our continued progress on our exit portfolios as we reduce risk in the Company.

We would also note that we are somewhat encouraged by the stabilization we are seeing in the middle market, C&I portfolio, specifically in the Great Lakes and northeast regions, as businesses begin to make investments that upgrade their production capabilities or are thinking about acquiring other companies.

And we also experienced growth in our core leasing portfolio.

However, at this time, this activity is not expected to be sufficient to offset continued paydowns in the remaining books of business over the next several quarters.

Looking at our average deposits for the third quarter, we experienced continued improvement in the mix of our deposits, as higher costing CDs matured and were repriced at current market rates or moved to other deposit categories or other investment alternatives.

During the third quarter, we experienced an $800 million increase in the combined average balances of demand deposits, NOW, money market deposit accounts, and regular savings accounts, compared to the second quarter of this year.

And these balances are up $3.8 billion from the same period one year ago.

As we have been discussing for the past few quarters, we continue to experience runoff in our CD book, which declined $3.5 billion as higher yielding certificates of deposits mature and clients look for other alternatives for investing in this low rate environment.

The decline in CD balances will slow in future quarters as scheduled maturities are smaller going forward.

Turning to slide seven.

Our asset quality statistics continued to improve.

As Henry mentioned in his comments, net charge-offs were down again this quarter to $357 million or 2.69% of average loans.

This is still high compared to our long-term target of 40 to 50 basis points, but a significant improvement over prior quarters.

Non-performing loans were also down again this quarter, to $1.4 billion or 2.67% of total loans at September 30th, 2010.

And are now down by more than 40% from their peak one year ago.

We saw market liquidity strengthen in the latter half of the third quarter and used this as an opportunity to continue to move our non-performing assets.

We were also encouraged by the fact that we were able to move these assets close to where they were carried, the assets on the books, net of our reserves, or they were marked in the case of other real estate owned or other non-performing assets.

As a result of the improvement we experienced in credit quality during the third quarter, the reserve for loan losses declined to $1.957 billion, or 3.81% of total loans, and represented 143% coverage of non-performing loans at September 30th, 2010.

We currently expect to experience continued improvement in the level of net charge-offs and non-performing loans.

As a result, we expect our provision for loan losses to be less than the amount of net charge-offs for the fourth quarter of 2010.

Turning to slide eight, for the third quarter, the Company's taxable equivalent net interest income was $647 million, compared to $623 million for the second quarter of this year.

The net interest margin expanded 18 basis points to 3.35% for the third quarter compared to the second quarter of this year.

For the third quarter, earning asset yields remained relatively stable, declining one basis point to 4.39%, while the yield on interest bearing liabilities declined 24 basis points to 1.46%, compared to the second quarter of 2010.

Benefiting the margin for the third quarter was the redeployment of short-term liquidity into securities available for sale portfolio, the repricing of maturing CDs, and an improved mix of deposits on the liability side of the balance sheet.

The pace of maturities of higher costing CDs, which benefited the margin the most in the third quarter slows in the fourth quarter of this year to $800 million, and slows further in 2011 to a range of $300 million to $500 million per quarter.

Given the current mix of our assets and liabilities and the repricing characteristics, we expect the net interest margin to remain relatively stable in the mid 3.30% range for the fourth quarter of 2010.

Turning to slide nine.

Our other revenue objective is focused on growing non-interest income and maintaining it above 40% of total revenues.

For the third quarter of 2010, total non-interest income was $486 million, and represented almost 43% of Key's total revenue.

During the third quarter, we were very pleased with the strong performance we experienced in investment banking revenues.

As shown on page 20 of today's earnings release, investment banking and Capital Markets revenues were up $11 million for the quarter, and letter of credit and loan fees increased $19 million compared to the second quarter of 2010.

As discussed over the past two quarters, the implementation of Regulation E on July 1 for new clients and on August 15th for our existing clients resulted in a decline in deposit service charges of $5 million from the second quarter level, which was in line with our expectations.

Turning to slide 10.

We are continuing to make good progress on our Keyvolution savings and through the third quarter, we have implemented $224 million of annualized savings towards our goal of $300 million to $375 million by the end of 2012.

For the third quarter, total non-interest expense was $736 million, down $33 million from the second quarter of 2010, primarily as a result of lower personnel expense and a decline in other real estate expense.

Personnel expense declined as a result of a $12 million credit to the pension expense in the third quarter, compared to a $6 million of expense in the second quarter.

We do not expect to record any pension expense in the fourth quarter of 2010.

OREO expense declined to $4 million from $22 million in the second quarter of this year, and from a highly elevated $51 million for the same period one year ago.

During the third quarter, we were successful in selling $63 million of ORE at prices approximating their net carrying values.

As a result, ORE expense declined significantly.

At this point in the cycle, more of the property we are taking possession of has cash flows associated with it and typically has become easier to sell as liquidity has returned to the market for income producing property.

However, we do expect to see volatility in the amount of ORE expense in future quarters, depending upon market conditions.

Slide 11 shows our preprovision net revenue and return on average assets.

With the improvement in the net interest margin and good expense control reviewed on the previous slide, pre-provision net revenue improved by $51 million in the third quarter to $397 million.

In addition, coupled with improved credit costs, our return on average assets increased to 0.93% for the third quarter of 2010, a significant improvement over where the Company was operating just a few quarters ago.

And finally, turning to slide 12, all of our capital ratios continued to improve during the third quarter, compared to the prior quarter.

At September 30th, 2010, our tangible common equity to tangible asset ratio was 8.0%.

Our Tier 1 common equity ratio was 8.59%, and our Tier 1 risk-based capital ratio was 14.26%.

We believe our capital position is strong, and positions us well for the potential implementation of Basel-III and the eventual repayment of the TARP preferred capital in the future.

That concludes our remarks, and now we'll turn the call back over to the operator to provide instructions for the Q&A portion of our call.

Operator?

A brief reminder.

The question-and-answer session will be conducted electronically today.

(Operator Instructions).

We will take as many questions as time permits.

There may be many callers holding to ask a question at one time.

We appreciate your patience.

We'll begin with Matt O'Connor with Deutsche Bank.

Hey, guys.

Good morning, Matt.

If I could just follow up on some of the loan comments that you made, I think you said some of the positive signs in middle market and leasing would not be enough to offset paydowns for the next several quarters.

I think you're assuming or implying that loans will continue to decline for two, three, four quarters.

Am I hearing that properly?

That is correct, Matt.

Okay.

Just remind us, I think your commercial mix might be a little different than some others.

I think there might be large corporate.

When we look at industry-wide commercial loans, they seem to be ticking up ever so slightly.

Can you just remind us how your mix might be a little bit different and why we're still seeing declines in that portfolio overall.

The first thing I'd like to point to, we added a slide in the appendix of today's section, slide 15, and in there we try to do a reconciliation or a roll-forward of the loan activity and as you can see on that particular slide, the decline -- the majority of the decline that we experienced in our loan portfolio outside of the exit portfolios coming down by about $400 million, gross charge-offs were around $400 million, and then the rest of the decrease was around $1.1 billion.

Of that, about $800 million of that $1.1 billion really came from our commercial real estate book.

We're going to continue to see commercial real estate loans continue to pay down here.

There's improved I think liquidity we're seeing in the marketplace and certainly on the multi-family is doing very well in today's marketplace.

But I think Beth and Chris would probably be willing to comment here on the middle market and the leasing books and the large corporate.

Yes, Matt.

This is Beth Mooney.

We are definitely starting to see stability in the middle market loan book.

We have obviously seen that client base delever over the last seven to eight quarters but as you look into the trends from the first to the second to third quarter, we had the lowest level of decline in this quarter that we've seen through the cycle and we are actually starting to see, as Jeff mentioned in his comments, particularly in our Great Lakes and northeastern regions, signs of increased new business activity and modest glimmers of loan growth.

However, on net, you still see pressures in the Western markets.

They were late into the cycle.

But we do see some pickup in business activity and clearly signs of stability in the middle market book as well as in the core leasing portfolio, which intersects with a lot of that same client base, renewed activity.

Yes, Matt.

It's Chris Gorman.

As you look at what's going on in the national bank, basically the rate of decline has flattened.

But as Jeff alluded to, there's a pretty significant mix shift and that we talked last time that leasing we thought would come out pretty early because we're very involved in technology leasing.

We have seen that.

So the leasing book has stabilized and now is growing a small amount.

As you look at the C&I book, the rate of decline was halved quarter-over-quarter on a linked basis and conversely we had a pretty significant step up in real estate as we strategically derisked the balance sheet.

And obviously there's a lot of liquidity, both in the mortgage market which we benefited from as a player in the mortgage business, but also just liquidity in the market in general as we take our real estate book down by strategy.

Then I guess the good news of all this is the capital ratios, specifically the regulatory capital is building quite quickly because you're making money on an operating basis, you've got the reserve drawdown and the balance sheet continues to shrink.

I look at the big increase in capital and probably more to come implying that it might make sense to wait to try and repay TARP a little bit so you can show higher capital ratios two or three quarters out.

How should I think about that?

Well, that's clearly a way of thinking about it, Matt.

We're trying to do the right thing in paying TARP back with our shareholders in mind and we are also very conscious of some of the implications of early versus late.

So we're taking all of those things into consideration as we look at the appropriate time.

But no matter when that time is, it's getting closer every day.

Okay.

All right.

Thank you very much.

We'll take our next question from Craig Siegenthaler with Credit Suisse.

Thanks, good morning everyone.

Craig Siegenthaler, Credit Suisse.

Good morning, Craig.

Good morning, Craig.

Just on the timing of the deposit reprice here, can you remind us when the $2.8 billion of high cost deposit CDs repriced in 3Q and also when the $0.8 billion will reprice in 4Q, just the timing of it?

Craig, this is Jeff Weeden.

The timing, remember, go back to the second quarter, a lot of the deposit repricing happened late in the second quarter of that particular grouping of deposits and the $2.8 billion in the third quarter was more heavily weighted to the July and August time period.

So we're seeing a slowdown now.

And as we get into the fourth quarter, the $800 million is going to be more evenly spread at this particular point in time just like we get into 2011, it starts to slow down fairly significantly.

Got it.

And then just second question.

Can you help us with the remaining kind of timing and prospect for the $270 million of decel DTA, how do you expect to realize this and is there any kind of ceiling on how much you expect to generate back into capital over the next year?

Well, I think, Craig, you probably saw that the DTA decreased in the third quarter from the level in the second quarter and there is a combination of events that draw that down.

One is profitability, obviously, as critical, and then the other part is that the reserve for loan losses which is a very large portion of the deferred tax asset component continues to come down.

So being profitable and being profitable on a preprovision, less net charge-offs basis as well as bringing the reserve on down is an -- improves that particular recognition of that asset.

But it should be noted that as we go through the rest of this year as well as 2011, that that particular asset will continue to decrease and should eventually get down to zero.

Great.

Thanks for taking my questions.

We'll take our next question from Betsy Graseck with Morgan Stanley.

Good morning.

Good morning.

Couple questions.

One's just on the DTA.

You noted that declined in the quarter.

I just wanted to get some color, I would expect that had to do with reserve shrinkage but maybe you could just he elaborate on kind of the drivers and how rapidly I should anticipate that is shrinking in the next couple quarters?

Betsy, this is Jeff Weeden again.

I think part of the answer was on the last question, and that is as you see reserves coming down, so we have a combination of events here.

Charge-offs are coming down.

Charge-offs now are less than our preprovision net revenue.

We see that trend continue, obviously that's generating taxable income at that particular point as well as having the reserve itself come down.

So if you think about the reserve itself coming down and if that generated at the statutory rates for every dollar, $0.375 coming off of that, that in and of itself creates less of a deferred tax asset.

Profitability on the other hand improves that.

So as we look forward, the utilization of any net operating loss carry forward that existed at the end of the year start to also get absorbed so these are all positive things that contribute to it and that's why we believe that over the course of the next five quarters, that deferred -- the disallowed portion of the deferred tax asset will actually be gone.

Right.

Okay.

Do you have any NOLs within the DTA or is it all timing difference?

An NOL is a timing difference.

Right, Okay.

So it's -- the entire thing is available to go away, as you indicated, over five quarters?

That is correct.

And then on the investment portfolio on slide 16 of the appendix you put some details here.

Yes.

Could you just give us a sense, you indicated until loan demand returns, excess liquidity goes into the investment portfolio.

How do you think about the net new investment into the securities portfolio in terms of duration?

Well, looking at that slide 16 that you referenced, we've actually put the duration that we expect to invest in and that we have been investing in and it's basically between two and-a-half to three and-a-half years.

We buy new, so we don't buy premium bonds.

We haven't bought premium bonds.

We've gone out basically in the first 10 days of each month.

We determine what our cash flow is going to be for the current month, make the appropriate investments at that particular point in time.

Obviously the yield on those in today's market has come down fairly significantly.

So new investments are going in basically for this month would be about 2.3%.

Okay.

And as you indicate, two and-a-half years or so in duration.

Is there any -- how do you think about under Basel III constructs, AFS volatility goes into your Reg caps, does that influence how you're thinking about the reinvestment.

It will.

But the Basel III implementation takes place over a period of years and so we will look at how we're going to restructure or do things differently going forward, obviously.

It does have an impact.

It will change I think the way we invest.

We may have--obviously, one of the things we have to look at, we may have more held to maturity.

The Company will look at all different types of structures here to ensure that we don't create a lot of volatility.

I think that's an excellent point and certainly one that we are looking at very closely here at the Company.

Last from me.

Do you think that you will be required to adopt Basel III at this stage?

Well, I think all companies are going to be required to go to the new Basel III capital standards and the question I guess that you maybe are getting at, do we think that we will have to adopt all the counter party credit risk and the operational risk capital implications.

We currently are a Basel I bank.

We did not opt in to Basel II.

So, we do not expect that that will be the case that we will end up having to have those particular components in the capital computations, but that remains to be seen.

Okay, All right.

And so that's part of the reason why your RWAs under Basel III are unlikely to change that much?

Change very, very little.

We have small trading portfolios, very small amount.

And as a result, no systemic risk buffer?

Well, we're going to end up with if we were to do a pro forma basis on the OCI that we have right now, we would estimate that our Tier 1 common ratio could approach the 9% level.

So it actually would go up.

Right.

Okay.

Thank you.

We'll take our next question from Scott Siefers with Sandler O'Neill.

Good morning, guys.

I guess a couple questions.

First on the OREO piece.

One, do you have the dollar amount of -- actually not OREO, but just do you have the dollar amount of restructured loans that are not in NPAs?

I don't have that right off the top of my head here.

I think in terms of -- it's not a very significant amount.

As you can see that we have approximately $228 million.

Yes.

In the restructured book at this point in time.

It's not a material amount, though.

Okay.

And then Jeff, you had given some color on the OREO costs and why they were down, despite the balances going up.

You mentioned those will likely be volatile going forward.

Do you have kind of a sense for what a more appropriate run rate is or is it just volatile, just kind of where it's going to be.

It really is volatile.

It depends on obviously the property that's in other real estate and I think if we look at what we had originally in the other real estate categories, going back a year ago or more, it was involving a lot more of what I call for sale real estate in the sense of residential type property.

Today we're talking about more in the income producing property.

So we sold $63 million in the current quarter.

We had good volume, good activity.

We've actually -- if you look at the reconciliation that's on page 25 of the press release, we even had valuation adjustments that we took in the current quarter of approximately $7 million that ran through and yet the overall ORE expense including all the rest of the costs associated with it including taxes and maintenance, et cetera, netted down to $4 million.

So we're actually moving some of this property at this particular point in time at gains.

Now, that's the part that I can't predict in the future as to what will happen there because all real estate obviously is local.

We were very successful in moving property in the current quarter, though.

Okay.

And then I guess one last question.

I was hoping you could just flush out a little more how you're thinking about the overall balance sheet size.

I guess between the combination of the $5.8 billion exit portfolio and then the $6.5 billion of discontinued ops, it's about $12.5 billion of I guess just kind of stuff you guys don't do anymore or don't intend to do anymore.

So I mean, why wouldn't -- I guess what I'm getting at is why wouldn't the balance sheet contraction potentially be a multiple year phenomenon from here on out?

How are those issues likely to play out as we look forward?

Well, I think if you look at the $6.5 billion that you referred to in discontinued operations, that's a student loan book.

That has a much longer duration on it so it's going to be around for a long time.

If you look at the $5.8 billion, it is actually come down fairly rapidly here over the past six quarters.

And so if we look at that particular book, a lot of the stuff that's going to pay off relatively quickly has done so.

When we get into the commercial lease financing, there's $1.1 billion of that particular book that are the LILOs and SILOs and those are going to be around for a number of years.

They may have maturities that go out into the 2020.

On the Marine book, which is about $2.3 billion at the end of the current quarter, that also is a much longer duration.

Now, that's more predictable as far as the cash flows coming off of it and it will continue to probably work its way down from $100 million to $150 million in any given quarter.

And we may get additional acceleration of that if unemployment goes down and the economy picks up somewhat as people want to trade up a different boat.

So I think if we look at the overall balance sheet, yes, it will come down some here but it's more going to be driven on the liability side.

So to the extent that we are continuing to take in deposits, we will find a place obviously to put those particular funds and invest them.

This is Henry.

Let's not ignore the growth opportunities too.

Our leasing portfolio showed a little bit of life in the third quarter, Beth talked a little bit about business banking and middle market.

We got some great news and publicity in our Cleveland marketplace where we regained the number one position in this market.

All of those are factors that over a few years, as you know you sort of framed it, yes, we're going to have runoff but we're going to have new opportunities too.

Okay.

That's helpful.

Thank you very much.

We'll take our next question from Gerard Cassidy of RBC Capital Markets.

Good morning, Henry.

Good morning, Jeff.

Good morning, Gerard.

In terms of the loan loss provision, could you guys envision that provision dropping to zero if your credit improvement continues on the pace that you're seeing?

Well, I think we go through the loan loss reserve and the provision calculation each and every quarter.

It's challenging to determine exactly where that would end up.

Certainly if things continued to improve and continued to accelerate on the improvement and we're not calling for that, but I'm just saying if that were to happen on a hypothetical basis, yes, you could get down to almost a zero provision but that's not what we are currently expecting.

Right.

Right.

We all recall of course the pressure all you banks were under in 2003, 2004 from the accountants of the securities exchange commission about having too much in reserves and in were even negative provisions people took.

In fact, Bank of New York had a negative provision this quarter.

I know this might be putting the cart before the horse, but do you ever think about that type of thinking?

Could you guys be under pressure, believe it or not, a year from now going into 2012 maybe about having too much in reserves?

Well, I think it's a hypothetical situation.

There's too many things that you have to project out into the future, Gerard, to actually make that call today.

I think it would be a nice problem to have and I would look forward to seeing credit costs melt away in the future to be in that position.

But at this point in time, I think it's a little premature for us to make that call.

Okay.

And Henry, regarding your comments about TARP, what are some of the considerations that you're looking at when you mentioned the near term maybe benefits for shareholders of paying off TARP?

It seems like right now if anyone wants to pay off TARP over the next 90 days or so or maybe even 120, they're going to have to raise common equity to do it where as possibly if people wait until a year from now when your capital ratios are much, much stronger, people may not have to raise common equity to pay it off, and it would be less dilutive to shareholders.

Can you share with us some of the pros and cons of doing it sooner versus later.

I think everyone understands the math.

To the degree our currency is higher in price, we'll have to issue fewer shares for a given amount of capital that has been heretofore required.

I'm not sure we can get all the way out to--I'm not sure we want to get all the way out to a point in time where our capital would demand that we don't have to raise any because during that period we have some restrictions and those restrictions in terms of M&A and the like could also affect the longer term value to our shareholders and I think that the capital levels we're hoping that the regulators realize that the number should become down as companies are generating their own internal capital.

So those are the factors that we're looking at.

On the other hand, as it relates to shareholder returns, 5% nondeductible dividend is not cheap anymore.

So it isn't just let's wait.

Some of it is what's the right opportunity, what's the right time, what's the cost of some equity, hopefully less than a high number, and those are all the mathematical numbers.

Sure.

And could you -- other question I had was I think you mentioned something about some of the bank branches now are business intensive.

Can you share with us what you guys are trying to do with those branches?

Yes, Gerard.

This is Beth Mooney.

It was a project that we started two years ago where we reviewed our franchise for intensity of small businesses in a three to five mile radius around our different branches and then realigned our staffing models and the competency of the people that we put in those branches to make their calling -- outward calling skills, their basic business acumen and their familiarity with our small business product set to be differentiated in their ability to serve those markets and this has been going on now for two years.

We've seen a nice lift from those activities and just this week the JD Power survey came out for Customer Service in small business and Key was named--ranked number three of all the banks that were rated by JD Power for their small business satisfaction.

So when I look at our focus, our increased efforts around SBA, this very targeted segmenting where we have business intensive areas around our branches coupled with our service initiatives, I think it's paying dividends for us.

And we've also just recently made some organizational changes in Beth's Community Bank where small business SBA is a segment so we're really trying to put a lot of focus in that area.

And just one last question.

Jeff, on the pension expense that you mentioned, could you give us some color -- I know you touched on it -- on why there was a credit in this quarter and why is it going to zero in the fourth quarter?

Well, we went through with the actuaries the assumptions that are being used on the plan and as you recall we basically -- we froze the plan a year ago.

So we don't have any additional earnings credits, salary credits, et cetera, going into that particular cost.

As we went through and looked at the changes in the demographics associated with the plan participants that are in there that will continue to get credited a future earnings credit on that and did the evaluation the update with the actuaries, it resulted in basically coming to a zero pension expense for the year.

We had already recognized in the first two quarters $12 million of expense.

So the third quarter was a reversal of that $12 million in essence, the credit coming through and then there's no additional expense anticipated now for the fourth quarter, based on that updated valuation.

Thank you.

Ladies and gentlemen, we ask that you limit yourself to one question and one follow-up question to ensure we give all participants a chance to ask their question.

We'll take our next question from Matt Burnell of Wells Fargo Securities.

Good morning.

First of all, just wanted to get a little more color from you in terms of the non-performing asset or nonperforming loan in-flows in the quarter versus the second quarter.

Well, on the non-performing, we provided a little bit of additional information obviously on the dollar amount of the in-flows of page 25.

Relatively stable as far as the dollar amount of in-flow coming in to it.

But I think what we're seeing now too coming in on the in-flows specifically from the commercial real estate is going to have more income producing type property that's going in there and then that's getting resolved a little bit faster as we go through the cycle as liquidity is returned to the marketplace.

Okay.

And Jeff, maybe another question for you.

In terms of the Keyvolution savings, it looked like they were up about $25 million on an annualized run rate from the second quarter and to get to your target of about $375 million, that implies on average about $25 million -- if we assume that same run rate, that implies about another five or six quarters to get to your target.

Can you give us a little more color as to how you're thinking about the timing of reaching that $375 million target?

Yes.

In terms of the timing of it, it's going to extend on out into 2012.

We have a number of initiatives that are longer cycle so they're going to involve the -- they're going to involve both in terms of technology investments that we're continuing to make and overall process changes that are taking place in the Company.

So we've got some shorter term benefits that we've been recognizing.

We had some additional implementation and benefits in the third quarter.

And then as you look out, it's not necessarily going to happen in even $25 million chunks in any given quarter.

We could have that type of level again.

We could have more, we could have less.

Because if you look back between the difference between the first quarter and the second quarter was a much smaller overall improvement.

But it sounds like you're going to reach that number potentially well ahead of your fiscal year end 2012 target; correct?

That is a --We will be within that range by fiscal year 2012.

But we won't be at the upper end of that range until later on.

Okay.

Good.

Thank you very much.

We'll take our next question from Terry McEvoy with Oppenheimer.

Thanks, good morning.

Just a question back on the expenses.

I know Gerard asked about the salaries in the fourth quarter.

Just looking at total expenses for the fourth quarter, could you provide any sort of guidance or range, given the nice decline we saw in the third quarter?

Yes.

I think earlier this year we provided a range of basically 750 to 800.

We've been pretty consistent in that -- that 750, more in the 765, 775 range.

Again, I think with the $12 million pension credit coming through in the current quarter, and ORE expenses which are more difficult because they can be somewhat volatile to project going forward here, we would expect to be somewhere in the 750 range at this particular point in the cycle.

Okay.

Then just a second question.

It was nice to see the CRE charge-offs come down so much.

Is that a sustainable number?

Was there any large recoveries within the -- I'm looking at slide 20 there.

Well, as you look at the overall improvement in what we experienced, I don't know if it's -- looking at slide 20 of the deck itself, is that what you're referring to?

Correct.

And we did see overall improvement.

I think nonperformers in some of the categories were relatively stable.

Others declined quite nicely.

We saw multi-family nonperformers came down very significantly.

The expectation obviously that we provided in the prepared comments regarding where we see the direction of net charge-offs is still an overall decrease for the organization.

I think if you go to the press release itself, and you look at slide 23, you'll notice on that, that we did have a recovery but that was in the C&I book, not so much in the CRE book.

So charge-offs themselves actually showed a nice decline for the quarter.

Thank you.

We'll take our next question from Paul Miller of FBR Capital Markets.

Yes, thank you very much.

I was wondering if you could add some more color to some of the loan detail?

You said you sold the loans at the marks.

I was wondering, I don't think you've given this detail but have you disclosed what those marks are to date?

Yes.

And we actually have disclosed that in prior quarters where we generally carry our loans held for sale and our non-performing credits.

Non-performing loans are held at about $0.67 on the dollar.

If you look at -- in terms of non-performing loans held for sale are basically carried at about $0.60.

So we're carrying a lot of the credits at around $0.60.

ORE we have marked down to $0.51 on the dollar.

When I say on the dollar, I'm talking about what the original face value of that particular credit was.

And we've been able to move the credits and some of the credits that were in the held for sale category at the end of the quarter have already been sold because at the end of the third quarter, they were basically -- the trade had taken place a lot of these on the non-performing side as T plus 30 as far as the closing goes.

And then the -- I forgot the other -- you talk about like income producing -- I'm sorry, on the loan, on the multi-family stuff when you talked about the loan portfolio and you're getting paydowns on the multi-family.

And just real quick, is that because Fannie and Freddie is such a big player in the market now or is multi-family doing well just because of the housing crisis?

Well, I think it's primarily related, Fannie and Freddie are still very active in the multi-family area and that's an area that has done well.

I think you'll see Class A space is in high demand on the multi-family side of the equation still.

Okay.

Thank you very much.

We'll take our next question from Jeff Davis of Guggenheim Partners.

Good morning.

Good morning.

Question for Beth.

Beth, Huntington has introduced the, I guess, their 24 hour grace period in terms of NSFs and maybe a broader effort to move market share and giving up some fee income in the short run.

Have you seen any impact on it and your thoughts on maybe -- on that sort of strategy for Key?

Yes, thank you, Jeff, that's a good question, because we are obviously working very closely not only with the regulatory changes but trying to make sure that we review the full range of consumer options and trends given financial regulatory reform.

Have not seen any particular impact from that Huntington change but I think you know that we introduced a new account for consumers called Key coverage that provides them grace periods, minimum limits, certain number free per day for a $10 fee per month.

We have also done a variety of things around how we have implemented Reg E to work with our clients to make sure they map to accounts and services that fit their needs as well as making it a component of financial literacy and we are watching all these various trends and making sure that we are doing the things that meet the segment and client needs and are responsive to the environment.

And a follow-up.

I think Henry touched a little bit on potential for acquisitions in the context of maybe paying back TARP and that decision process.

If you had your druthers on your footprint, where would you do some fill-in acquisitions.

Well, there are certainly opportunities.

Because, as we have talked in the past, there are -- we have many markets where we have less than what we call optimal amount of share which is 10% in-market.

While I think you would look at fill-ins anywhere where it made sense, strengthened your market position and you could benefit from that combination, but when you look at market demographics over a long period of time, I would tell you the demographics, growth characteristics as well as our share characteristics in our Western markets would be incredibly attractive to us and as you look at where we're investing our branch expansion dollars, many of those are concentrated in our Seattle and Portland markets and Colorado markets.

Would you expect to see more opportunities to acquire, say, in the west than in the Midwest?

I think that's one of those that as we talk -- all of us talk about the inevitable industry consolidation that I think as that plays out I think the watch word for us as well as other institutions is you need to be nimble and opportunistic and evaluate what becomes available.

Thank You.

We'll take our next question from Carole Berger with Soleil.

Hi, I was just curious as to your discussions with the regulators on TARP.

I sort of listened to you talk about how fast your capital is going to build because of the return to profitability and the use of the DTA and yet given how expensive they are, it seems to me that you would really want to pay them back as soon as practicable without issuing new common.

When you talk to your regulators, is there -- do they give you any credit for the fact that you are now earning and you will be at those targets within X amount of time?

Well, Carol, I would like to pay back TARP without issuing any common also.

Unfortunately, that has not been the practice of the regulators to date.

And we're constantly talking to them and as I said earlier, that is one of the factors that we're trying to evaluate as we work with them to try to find a solution that is shareholder-friendly as well.

So there's been really no change in their attitude in terms of, you know, either meet your capital ratios or you don't?

Well, I haven't seen any banks that have -- especially S cap banks that have paid TARP back without issuing some capital.

But I think that they aren't necessarily set on just one number and it's a dialogue that continues.

Okay.

And secondarily, I'm curious as the to who the buyers are on the commercial real estate?

I mean, are you really seeing new investment pools come into this marketplace?

Yes, this is Chris Gorman speaking, Carol.

We are.

We have set up a group that is raising a lot of private capital, our joint venture group.

We're seeing new entrants coming into the market, institutional capital.

The other thing that is going on out there is the mortgage banking business is just exploding and that would be Fannie, Freddie, FHA, as we look at our backlogs, for example, our backlogs are up 84% over the same time last year.

So there's frankly a lot of capital.

Some from banks, but some from other players coming in as well.

Thank you.

We'll take our next question from Chris Mutascio with Stifel Nicolaus.

That's Chris Mutascio.

Thanks for taking my call.

Jeff, I was going to take the provision question in kind of a little bit different route.

While your third quarter net charge-offs are high relative to your goal and I do appreciate the color on showing the performance relative to goals.

Your actual provision expense ratio is not much higher than the charge-off ratio you're trying to get to.

I think your provision expense is about 70 bips of average loans.

Your charge-off goal was about 50 bips or so.

So, it seems to me that while charge-offs are high, the actual losses clearly aren't going to the income statement anymore.

Are we just about at a normalized levels for provision expenses going forward?

Well, I think if you look at what the provision was for the third quarter, as we try to project out into the future, obviously provision is a combination of the credit quality and the current volume of activity that's going into the portfolio.

The reserve itself is there to handle the previous loans that are recorded in the projected losses, and the losses on that particular book.

So we are as far as getting the overall level of provision has come down quite nicely here for us in the last year.

But as we look forward, there's still going to be some provision expense that we're going to be recognizing.

But we are getting closer as you've identified here to that more of a normalized level.

Okay.

Thank you very much.

We'll take our next question from David Konrad from KBW.

Have another balance sheet question.

I guess the answer is a function of the change in liquidity.

But the securities portfolio does continue to grow pretty meaningfully.

I think another 7% or so this quarter.

And we move from around 10% of earning assets last summer to now we're up to about 26% of earning assets.

So I guess two quick questions.

One, I mean, how should we think about this growth rate going forward?

And then have you seen any changes in your asset liability position because of this mix shift?

Well, I'll talk about the asset liability mix position.

In the asset liability side, in the past we used to put on a lot of receipts that pay variable interest rate swaps.

As we put more on balance sheet duration, we've reduced our off-balance sheet duration.

So interest rate swaps have continued to come down to manage the overall interest rate position of the Company.

I would state, though, in the past we would always try to operate with a liability sensitive position.

At these particular rates and how long we've been at these low rates, we remain asset sensitive as of the end of the third quarter in the 3% range.

So I think the function of the overall investment portfolio is going to be largely dependent upon the level of funding that we end up with in the organization.

As I said earlier, it's kind of dependent upon the flow of overall deposit related activities and loan related activities.

We have that stored liquidity in the investment portfolio to meet future loan demand.

We do expect future loan demand in the organization.

We will continue to price our deposits also down as we have been doing during the past year here and we should get some continued benefit from that.

But the overall size of the investment portfolio may not change materially from where it is.

So if you look at the average balance versus the ending balance at this particular point in the cycle, there's not a lot of difference in that available for sale portfolio as of the end of third quarter.

Okay.

Thank you.

Very helpful.

We'll take our last question from Steven Alexopoulos with JPMorgan.

Hey, good morning everyone.

Good morning.

Just wanted to follow up on the comments that you're getting closer to a normal provision level.

I'm just trying to understand what was it about the current quarter that required such a low relative provision relative to other quarters.

Did you reach a point where you're not provided any existing nonperformers as much.

I think if you look at the overall level of non-performing assets, non-performing loans dropped $330 million, so if you look at our coverage ratio, our coverage ratio of nonperformers at this particular point in time is up into the 143%.

If you look at where we have the assets recorded, in other words, we've already taken on our total non-performing loan book, we've already taken charge-offs against that of probably close to $690 million to $700 million just against the nonperforming loan component.

They've already been charged down.

We've done a lot of the heavy work at this point in time, plus we're getting further along into the cycle.

So we're very aggressive early on in the process and really working a lot of these nonperformers out.

If you go back to the second quarter of 2008, that's when we had our big sale of our residential commercial real estate at that particular point in time.

And so we started recognizing losses there.

We started moving the assets at that particular pont in time.

So as we move forward here into the balance, throughout 2010 and into 2011, we're still expecting to have provision expense.

So I know there were some hypothetical things that we were talking about as to what we thought that would be.

But again, as you get closer and closer here through the cycle and we have targeted a 40 basis point to 50 basis point range of net charge-offs that we're targeting, that is predicated on the fact that we have made so many changes in the composition of our loan portfolio.

We've continued to derisk it over the past I'd say three years, not just the past two years.

Really, the past three years we've continued to derisk this company with respect to those particular portfolios.

Okay.

Thank you.

Maybe just one follow-up question.

Could you talk about what you saw in terms of classified loan balances through the quarter?

Maybe the trend in upgrades versus down grades?

Well, the trend has been considerate sized and classified have continued to trend down so we've made very good progress throughout the entire year and upgrades versus down grades, the ratio continues to improve in that particular regard also.

Could you share how much classified loans possibly changed by?

No.

Okay.

Was worth a shot.

Thanks.

They don't let us.

We have no further questions on our roster at this time.

I'd like to turn the conference back over to Henry Meyer for closing remarks.

I just want to thank you all for taking time from your schedule to participate in our call today.

If you have any follow-up questions, you can direct them to our Investor Relations team, Vern Patterson or Chris Sikora at 216-689-4221.

That concludes our remarks.

Hope everyone has a great Friday and a good weekend.

Thank you.

That concludes today's conference.

Thank you for your participation.