KeyCorp (KEY) 2011 Q2 法說會逐字稿

Good morning and welcome to KeyCorp's 2011 Second Quarter Earnings Results Conference Call.

Today's call is being recorded.

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

Beth Mooney.

Ms.

Mooney, please go ahead.

Thank you operator.

Good morning and welcome to KeyCorp's Second Quarter 2011 Earnings Conference Call.

Joining me for today's presentation is Jeff Weeden, our Chief Financial Officer.

And available for the Q&A portion of the call are the leaders of Key Corporate Bank and Key Community Bank, Chris Gorman and Bill Koehler.

Also joining us for the Q&A discussion are our Chief Risk Officer Chuck Hyle, 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 would, turn to slide three.

This morning we announced second quarter net income from continuing operations attributable to common shareholders of $243 million or $0.26 per common share.

These results are above the amounts reported in the first quarter of this year and the year ago period.

Our improved performance reflected continued improvement in credit quality, good expense control and the successful execution of our business plan.

Key's favorable credit quality trends have benefited from the improvement in the economy, and the aggressive actions that were taken to exit higher risk lending activities and our early recognition and resolution of problem credit.

This has resulted in Key's net charge-offs declining to their lowest level since the first quarter of 2008.

And nonperforming assets have now declined for seven consecutive quarters.

Another area of focus has been expense management, and our second quarter showed continued progress.

We have benefited from the success of our Keyvolution initiative and other efforts to streamline our operations.

Going forward, we expect that we will continue to identify additional expense saving opportunities, as this is a critical factor in producing value for our shareholders in a slower growth environment.

We are also leveraging our strong capital, balance sheet and liquidity position by continuing to focus on meeting our clients' borrowing needs.

Key originated approximately $9.5 billion in new or renewed loans and commitments during the second quarter, as compared to $6.9 billion of new or renewed loans and commitments during the first quarter of 2011.

We were especially pleased by the growth in our C&I loan portfolio which was up 3.7% from the previous quarter.

The increase was driven by activity in the industrial and REIT sectors, as well as increases in middle-market lending in all three of our geographic regions.

Based on what we're hearing from our corporate clients, as well as lower runoff from our exit portfolios, we expect to reach an inflection point in total loans during the second half of this year and we will be poised again for growth.

We have also been working on strategies to mitigate the impact from the implementation of the new regulation on debit card interchange fees.

As we previously reported, we estimate the new limits on allowable interchange fees which will become effective on October 1 will reduce our annual revenue by approximately $50 million to $60 million before the implementation of our mitigation strategies.

These strategies will include both revenue enhancement as well as expense save opportunities.

They are focused on not only retaining but expanding our engaged client relationships, increasingly offering clients choices aligned with their needs and preferences as well as a strong focus on our cost structure for our consumer payments business.

And the final item on this slide focuses in on capital management.

Key ended the second quarter in a strong position with our Tier 1 common equity ratio at 11.01% and our Tier 1 risk-based capital at 13.76%.

These levels should place us in the top quartile of our peer group and position us for a successful transition to Basel III.

Our strong capital position provides us with the flexibility to make investments in our relationship businesses, look for opportunities to build market share and meet our clients' needs for credit and financial services as the economy [improves].

Additionally, our Board also approved a quarterly dividend increase to $0.03 per common share for the second quarter of 2011.

On slide four, we show the progress that we are continuing to make on our long-term goals.

On a number of these measures, we're currently within our targeted range including being core funded, maintaining a high-quality and diverse revenue mix, and the successful completion of our Keyvolution initiative.

And we are continuing to make progress on the other measures such as returning to a moderate risk profile and bringing asset quality within our targeted range.

And at the bottom of this slide you can see that our return on assets for the second quarter was 1.23%, which was also within our targeted range.

We continue to believe that as provision expense normalizes and we execute on our client insight relationship strategy, our results will be within our targeted range for a return on average assets.

And before I turn the call over to Jeff, let me conclude by saying that we view our second-quarter results as another step forward for our Company.

Despite the uneven pace of the recovery, we are gaining traction in both the Community Bank and the Corporate Bank.

And we have the right business model which positions us to compete and win in the marketplace.

By executing on our strategies, we can organically grow the franchise by being nimble and opportunistic in our markets and targeted client segments while maintaining our disciplined capital management.

Now I will turn the call over to Jeff for a review of our financial results.

Jeff?

Thank you Beth.

Slide five provides a summary of the Company's second quarter 2011 results from continuing operations.

As Beth commented on earlier, for the second quarter the Company earned a net profit of $0.26 per common share compared to $0.21 for the first quarter of this year and $0.06 for the same period one year ago.

Over the next several slides we will review in more detail our results for the second quarter.

Turning to slide six, average total loans declined $858 million during the second quarter compared to the first quarter of this year.

This was a slower decline than we had been experiencing in prior quarters, and supports our belief that we are nearing an inflection point in the total loan portfolio where it will begin showing growth.

In fact, commercial, financial and agricultural loans showed its first quarterly growth in average balances since 2008, increasing $611 million or 3.7% unannualized from the prior quarter.

Also during the quarter we experienced an increase in total commercial, financial and agricultural loan commitments and a slight increase in utilization rates by our clients.

In our non-exit consumer portfolio we saw balances stabilize during the second quarter.

And in our exit portfolio, runoff slowed to $312 million.

At June 30, 2011 our exit loan portfolio was down to $4.7 billion and is expected to continue moving lower by approximately $250 million to $325 million per quarter for the next couple of quarters -- much slower than the rate we experienced earlier in the cycle.

Average commercial real estate balances for mortgage and construction loans declined by a little more than $1 billion during the quarter as market liquidity continued to remain good for these assets.

We anticipate that the decline in the commercial real estate balances will slow considerably during the third quarter and stabilize or potentially grow by the fourth quarter of this year.

While our clients remain somewhat cautious compared to prior recoveries, our lending pipelines are solid and we are actively supporting our clients' borrowing needs.

Moving to slide seven, on the deposit side of the balance sheet we continued to experience an improvement in the mix of our average deposit balances during the second quarter, as compared to both the first quarter of this year and the same quarter of last year as higher costing CDs matured and were re-priced to current market rates or moved to other deposit categories or other investment alternatives.

As shown in the highlights section on this slide, we have approximately $12.1 billion of CDs outstanding at the end of the quarter.

Of this balance, $4.3 billion will mature over the next two quarters and $5.1 billion mature in 2012.

The average rates paid on the maturities for 2011 and 2012 are 1.51% and 2.69%.

This compares to our average cost of CDs renewed during the first half of 2011 of 32 basis points.

The loan to deposit ratio shown for the quarter is based on period end balances and was impacted by a large deposit towards the end of the quarter.

On an average balance basis, our loan to deposit ratio was approximately 90% during the second quarter.

Turning to slide eight, we continued to experience an improvement in our asset quality statistics again this quarter.

Net charge-offs declined to $134 million or 1.11% of average loan balances for the second quarter and nonperforming assets are down to under $1 billion at June 30, 2011.

This is the first time since December 31, 2007.

With respect to nonperforming assets, during the second quarter we continued to liquidate nonperforming loans held for sale and Other Real Estate Owned.

As shown on page 24 of our earnings release, NPLs held for sale and Other Real Estate Owned balances declined to $42 million and $52 million at June 30, 2011; decreases of $44 million and $45 million respectively from March 31, 2011.

In total, nonperforming assets are down more than $1.1 billion from the same period one year ago.

We were also successful in liquidating Other Real Estate Owned at net gains resulting in a $3 million credit to ORE expense for the second quarter, further supporting the carrying values that we have assigned to our nonperforming assets.

At June 30, 2011 nonperforming loans were carried at 64% of their contractual amount owed, and nonperforming assets in total were carried at approximately 60%.

For the second half of the year we continue to anticipate lower levels of nonperforming loans and net charge-offs, and for the provision for loan losses to remain below the level of net charge-offs.

Turning to slide nine, for the second quarter of 2011 the Company's taxable equivalent net interest income was $570 million.

And the net interest margin was 3.19%, down from $604 million and 3.25% for the first quarter of 2011.

The decline in the net interest income was in line with our previous guidance calling for a decline in average earning assets resulting from the repayment of TARP and the movement of escrow deposit balances late in the first quarter.

Average earning assets declined approximately $3.2 billion and the net interest margin contracted six basis points during the second quarter compared to the first quarter of this year.

Our expectation is for the net interest margin to remain under some pressure given the outlook for interest rates and our asset sensitive position.

Further, we are anticipating little change in the average earning assets in the coming quarter.

In total, noninterest income was relatively unchanged from the second quarter compared to the first quarter and represented approximately 44% of total revenues for the Company.

While total noninterest revenue didn't change materially between the first quarter and the second quarters, there was movement in certain line items.

For example, principal investing revenue declined $18 million and other revenue increased $24 million.

Of the change in other revenue, $11 million is explained from improvement in commercial mortgage servicing revenue and $9 million is from the change in fair value of certain hedged instruments.

During the first quarter of this year we incurred additional amortization on certain mortgage servicing assets when we transferred the escrow deposits in March to another depository institution.

And during the second quarter, we received additional income from special servicing we performed in our commercial mortgage servicing area.

Turning to slide 10, for the second quarter of 2011 total noninterest expense declined to $680 million from $701 million in the first quarter of 2011, and from $769 million for the same period one year ago.

During the second quarter personnel expense increased $9 million compared to the first quarter of 2011 primarily as a result of higher stock-based compensation.

During the first quarter we recorded a reduction in stock-based compensation due to forfeiture of performance-based restricted stock.

The second quarter returned to a more normal run rate for this particular expense item.

Nonpersonnel expense declined $30 million during the second quarter as a result of lower FDIC insurance, a credit to other real estate expense resulting from gains on sales of property, and a credit to the provision for unfunded commitments as we continued to see an improvement in credit quality.

Criticized assets decreased again this quarter, falling 12.3% from the prior quarter.

Included on slide 20 in the appendix of today's materials is a quarterly trend in delinquencies as well as the change in criticized asset levels.

Through the second quarter of 2011 we have implemented $320 million of annualized expense savings, putting us within our goal of $300 million to $375 million set more than two years ago.

Significant progress has been made in reducing the expenses of the Company over the past ten quarters, and we will continue to seek additional cost savings in this challenging revenue environment.

However, we will not be reporting specifically on Keyvolution going forward as we view the philosophy of Keyvolution as part of our normal operating rhythm.

Instead, we will continue to manage our expenses and focusing on delivering solutions to our clients that they value.

Slide eleven shows our pretax pre-provision net revenue and return on average assets.

As expected, pre-provision net revenue declined from the first quarter and is relatively unchanged from the same period one year ago.

Also shown on this slide is our return on average assets for the second quarter of 2011 and the trends over the past five quarters.

The return on average assets for the second quarter was 1.23%.

Our return on average assets for the second quarter benefited from provision expense remaining low due to improving credit quality and well-managed expenses.

We continue to believe, as provision expense normalizes and we execute on our client insight relationship strategy, our results will be within our targeted range for a return on average assets of 1% to 1.25%.

And finally turning to slide 12, our tangible common equity ratio and estimated Tier 1 common ratio both increased during the second quarter to 9.67% and 11.01% respectively at June 30, 2011.

In addition, book value and tangible book value per share increased this quarter to $9.88 and $8.90 per share at June 30, 2011.

With strong capital, reserves, favorable migration of credit quality, and an expense management culture in place, we are well positioned to focus on executing our business plans to grow and deepen our client base and deliver shareholder value.

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

Craig Siegenthaler, Credit Suisse.

First I was just wondering if you could help us dissect the decline in the loan yields.

If you take a look at the 20 basis point decline in the C&I yield from 1Q, what was the rough contribution from rates, competition and then maybe some unusual items like swaps [runoff]?

Okay, this is Jeff Weeden.

The decline -- the 20 basis point decline that we experienced in the C&I loan yields in the first quarter, there is a couple of important points to make.

One, swaps contributed about 8 basis points of that decline.

So, as swaps rolled off, that cost us about 8 basis points.

But we also went out and looked at the impact.

We have a large degree of our loan portfolio that is variable rate and is priced off of one-month LIBOR as well as three-month LIBOR.

So if you look at the average rate on LIBOR between the first quarter and the second quarter, one-month LIBOR was down about 6 basis points and three-month LIBOR was down about 4.5 to 5 basis points.

So that also contributed probably about 3 to 4 basis points in that particular area.

And then we did see -- just as new spreads coming on are a little bit tighter, so that also had an impact.

So the balance was really a tightening of the spreads, but there's a lot of it that is explained by swaps and just the change in LIBOR.

And then when we think about what you have seen so far in July in terms of competition, and if we assume kind of let's say a flattish LIBOR, flat interest rates in Q3 versus that 8 basis points of competition you saw in the second quarter, how are we trending thus far in the third quarter?

It's Chris Gorman here.

I think the pressure continues.

I think that as we look at both structure and pricing, I would assume it would kind of go down another 5 basis points as people are looking for assets.

The interesting thing that we see is -- we see it from both sides.

We have a very big syndication business that we originate paper for our clients and distribute.

So we see it on that side of it and we also have a very big commercial loan mortgage business.

So we feel like we have a pretty good insight to where the market is, and clearly structure is getting more aggressive, as is pricing.

And then on the CD runoff, $4.3 billion is running off in the third and fourth quarter.

Can you help us with the timing?

Because I know it is very important if it is beginning, middle or kind of end of quarter for this $4.3 billion.

This is Jeff again.

What we have specifically in the third -- there is about $2.4 billion that will roll off in the third quarter.

It's going to be about a 1.46% yield.

I think you have to look at -- there's a lot of that, of course, that will be in there that will be 7-day, 30-day, etc.

that -- just the normal runoff that continues to happen each and every quarter.

The bigger runoffs really happen in 2012 when we get into the higher costing -- some -- really the more higher-cost CDs out in the second and the third quarter.

The third quarter has got the largest block.

So there is about $1 billion in the third quarter of 2012 with an average rate of around 5%.

Got it.

All right, great.

Thanks for taking my questions.

Ken Zerbe, Morgan Stanley.

Thanks.

I guess my first question is just on capital.

Obviously your Tier 1 common has grown by what -- I think it was like 27 basis points this quarter.

You're building capital, which is great.

How do you -- maybe you -- could you just review your capital priorities, specifically as they relate to buybacks and potential acquisitions?

Yes, this is Beth Mooney.

Clearly you are right.

We're in the era of generating new capital.

And we have said that disciplined capital management will be one of our priorities.

In 2011 when we submitted our plan to our regulators under the capital submission, our priority at that time was the repayment of TARP in a shareholder friendly manner, as well as the increase of our dividend to $0.03.

Going forward, as we look at how we manage our capital, both for a return to shareholders as well as supporting our business, increasing our dividend is important over time.

Share repurchase relative to our book value is clearly attractive.

And then it is important that we support our organic growth, as well as we've said in the past we would look at potential opportunities to enhance our geographic footprint but that we would be disciplined and that we would make sure that it created franchise and shareholder value.

But those would be the primary goals of any capital management policy at this time.

Are you seeing any kind of thawing in the willingness of sellers to participate in M&A?

We would not comment obviously on any market trends, but we certainly -- as you have seen, there's not been a lot of market activity yet this year.

Understood.

And just the last question, on expenses, how much -- I understand you're basically done with Keyvolution.

But is there a way to quantify the additional expense savings you guys had mentioned about going forward?

Or is that just sort of part of the ongoing business?

And also, is the $20 million reduction in FDIC insurance expenses sustainable going forward?

Thanks.

Yes, I think in terms of the -- I will comment on the FDIC insurance first.

It appears to be sustainable simply because we have de-risked the overall Company.

So the Company has changed significantly I think in the last three years.

So we have a lot more Tier 1 capital at this particular point in time.

The quality of our investment portfolio is extremely high; so there is a great deal of liquidity and the overall wholesale funding needs or the loan to deposit ratio has improved dramatically.

So we will see.

Obviously going forward on FDIC insurance it will be significantly below where it has been for the prior quarters.

We would expect something similar to what we experienced in the second quarter of this year.

Overall expense management and expense controls, we haven't given any specific targets there.

It is really part and parcel to our culture for the organization to continue to manage expenses tightly and look for revenue opportunities.

We know that it is a challenging environment and that's just part of the culture of the organization.

All right, that is helpful.

Thank you.

Matthew O'Connor, Deutsche Bank.

Good morning.

This is Rob Placet on Matt's team.

How is everyone doing?

Very good, thank you.

Good.

Thank you.

You mentioned the NIM is expected to remain under pressure from here.

How should we think about the trajectory of the NIM going forward compared to the 3.19% in 2Q?

And just compared to your long-term target of greater than 3.5%, what do we need to see from rates in the economy for Key to achieve that?

This is Jeff Weeden again.

I think in terms of achieving the longer-term goal of above 3.5%, we're going to have to see the overall rate environment increase.

So, we certainly need an increase in short-term rates as well as on out to probably the three to five years on the yield curve, which as we all know has been very much depressed here of recent.

And the prospects of that, I would say, of going up are not real high in the near-term.

In terms of overall pressure on the margin, I think just what we talked about.

We were talking about a little bit of pressure on some of the loan yields.

And so as asset yields come down a little bit we are re-pricing deposits, which is why we provided the additional clarity I think around the CD book.

But the fundamental item there is that as yields come down on assets and we are -- asset-sensitive position that we are in right now, it is going to continue to pressure the overall net interest margin as well as how much liquidity we have.

So, liquidity has been extremely strong.

Deposits are continuing to be plentiful in the system overall, so that just has a natural depressing impact on the net interest margin.

Not necessarily net interest income.

Okay, great.

And then just switching gears looking at credit, in terms of quantifying reserve drawdown from here with reserves to loans coming down to currently 2.6%, how much should we expect the magnitude of reserve release to slow from here?

Well, we don't provide specific guidance with respect to reserve release because it is something that we go through mathematically each and every quarter.

We did provide the direction.

Our expectations would be for lower levels of nonperforming assets as well as lower levels of net charge-offs.

I think as we continue to see the economy improve, and you see the charge-off level really approaching that 1% level here in the second quarter, that the trend on reserves is going to continue to come down.

Okay, and just a quick follow-up.

Just longer-term, where do you see the reserve level normalizing?

Well, that is a difficult question to answer.

I think in terms of what we had commented on even six months ago was that, having the reserve over a cycle, it could come down to 1.5% to 2%.

I really can't give you any more specifics than that because it does depend upon the quality and the size of the overall portfolio.

Okay, appreciate the color.

Thanks.

Ken Usdin, Jefferies.

Thanks.

Good morning Jeff and Beth.

Jeff, your comments about pretax pre-provision, it's obviously settled in off of the original fourth quarter high point.

I'm just wondering if you are talking about stable earning assets and a little bit of margin pressure, fees look pretty good.

And then expenses you had a little help from provision expense, and then we get the interchange stuff in the third quarter.

I'm just wondering, are we at the point where pre/pre is flattening?

Or does that actually have to get -- is it once we get past the interchange run rating?

I'm just wondering how close we are to a flattening out on pretax pre-provision and where do you think it could range.

Well, I think last quarter we commented on a range of $300 million to $340 million as being plausible outcomes for the pre-provision net revenue.

I think you have to look at individual expense line items.

We had the gains in other real estate.

Other real estate balances are pretty low at this particular point in time, so we're not looking for a significant expense in there.

But a more normal level of expense would be somewhere around $5 million for that particular item.

And then I think in terms of the reserve for unfunded commitments, that continues to track down.

But commitments are also starting to build again.

So we're having some success in clients actually taking out new commitments, which we believe is a very healthy sign.

So the trend in that may not be down for an extended time period.

So those are kind of offsetting items, and then I think the net interest margin itself will remain under some pressure here just generally as rates have been fairly low.

So if I adjust for the expenses and build in the impact of Durbin, and then earning assets flat with a little margin pressure, it would probably mean versus this quarter's $344 million we're probably -- directionally you have to move down.

But you're saying that that range is still pretty reasonable.

I believe that range is still pretty reasonable.

Okay, great.

Thanks.

And then the second question I had was just -- credit quality is obviously continuing to get much better.

It did look like, if I'm reading this right, that inflows were up a little bit.

So, I'm just wondering when you look across the portfolio is everything kind of still down and to the right?

Or is there any things you could worry about from a softening of the economy perspective at all?

This is Chuck Hyle.

I think generally speaking everything is moving down and to the right.

Quarter-to-quarter everything doesn't move in a nice, easy trajectory.

Things tend to bump along a little bit.

I think our inflows this quarter were up just a tad.

But a lot of things can contribute to that.

We're negotiating in a lot of different areas.

But I think not only are inflows up a little bit, payments are also up.

Returns to accrual are also up.

There are a lot of things that go on in any given quarter, kind of an arbitrary timeframe.

But I would say the trend in all areas are moving in the right direction, some a little more slowly than others.

Clearly the business bank and the kind of consumer end of the business that didn't go up very much in terms of bad loans and so forth are coming down more slowly.

And that is probably the sector of our portfolio that is most closely tied to the economy.

As the economy bumps along, we expect the trajectory to -- the slope of that to come down a little bit more slowly.

But overall we're pleased with direction and feel quite comfortable that things are moving in the right direction.

Okay, great.

Thanks everyone.

I appreciate it.

Erika Penala, BofA Merrill Lynch.

Good morning.

Just to follow up on Ken's question, on the community bank level I did notice a spike up in the provision.

What were the dynamics that were underlying that spike?

And are you getting more worried about your core home equity debt service performance as the economic recovery stagnates?

This is Jeff Weeden.

I think what we were -- what you saw in the current quarter was that there were some reserves that were allocated around some of the business units where we saw some risk.

But I don't think it was more than just the net charge-offs.

So, in that particular book, it was just a replenishment of the net charge-offs.

I think as Chuck talked about, some of those particular books have not seen the improvement, overall improvement.

But they did not have the amount of degradation earlier and so charge-offs and provision have just kind of normalized and matched themselves in that particular book for the second quarter.

Okay.

And in terms of Beth's comment with regards to an inflection point in loan balances, Jeff you mentioned that the exit portfolio runoff is going to decline to a $250 million to $325 million range.

I was wondering if you could help us fill the blanks in terms of how much you expect for runoff -- continued runoff in CRE, what kind of growth you are expecting out of your consumer core portfolio.

And given your commentary about how the confidence is not quite where it should be, given where we are in the economic recovery, what you are expecting for C&I for the rest of the year.

I will comment on some of the other books that we have had.

The runoff portfolio we do expect to go down about $250 million to $325 million, but that is kind of normal amortization that we're going to see from that.

I think Chris Gorman can comment on the CRE book.

Both Chris and Bill Koehler can talk about kind of what they are seeing in their other portfolios.

Sure, Jeff.

I will start with the real estate book because that is the biggest piece.

We had a runoff of about 10% quarter over quarter, which was about $900 million, which is in keeping with what we anticipated.

Jeff mentioned in his comments that we expect that portfolio to stabilize in Q3 and have growth in Q4.

That is still our view.

We had pretty good visibility as to what was going out of there.

That is the biggest number.

The second portfolio would be our national leasing business.

That portfolio has in fact been stable over the past year and we feel very good about where that portfolio is going.

We have a big exposure to technology, to software and to medical equipment.

And that typically is a late year capital cycle.

So we feel good about that business.

And then lastly, our institutional and capital markets business enjoyed a 10% growth quarter over quarter which was $400 million.

We feel very good about where we are in that business going forward.

We have a very large syndication pipeline which gives us very clear visibility for continued growth in that portfolio.

So, from the corporate banking perspective, we think we in fact have reached that inflection point and are focused on getting growth in the back half of the year.

So the inflection point comment is from -- on the corporate banking pieces of the business, not on the total loan balances?

(multiple speakers) No, total loan balances is what we are talking about.

Because we're saying that the growth that we're seeing overall -- both in our commercial C&I book, as well as the fact that we have come down fairly rapidly because of the liquidity in the marketplace on CRE -- gives us this greater confidence that we're not going to see as much decline.

That's what was in our comments; as much decline in the third quarter in CRE, and may in fact see a build in that particular book.

With the strong pipelines that we have overall, we actually expect to see growth in the book in the fourth quarter.

But we are not forecasting a specific amount or anything.

But it appears that we have reached that inflection point and we would start to see growth overall in the portfolio.

And the reason we always start by talking about real estate is it really obfuscates a lot that is going on in the rest of the bank because the numbers are so significant.

And Erika, to your question, why don't we let Bill Koehler augment his view on the Community Bank, because we have noted healthy pipelines across all our businesses and stabilization in a number of portfolios.

So, Bill, why don't you share your view of the Community Bank?

As we have looked, Erika, at activity in our commercial businesses, the middle-market continues to be strong.

This will be I think the third straight quarter of strength in middle-market in terms of loan growth.

And the pipelines are still good.

We had some pull-through, so there is a little bit of downdraft in the pipelines, but that is simply related to pull-through from the previous quarter.

And in business banking, we had a very strong quarter in business banking.

Our approvals are up across the board from small business sort of traditional business banking as well as SBA.

If you go back a couple of quarters, we would have said approvals were largely coming in the form of SBA.

And now it is much more balanced across all the subsegments of our small business activities.

On consumer, the home equity has stabilized, at least this past quarter and with having -- the loan balances declined at a much lower rate than previous quarters.

So we are seeing activity much broader across the Community Bank than we would have seen over the past few quarters from a loan demand perspective.

Thank you.

That was very clear.

And my one last question is for Beth.

I know that as you have come into your position you've been very busy executing on the business plan goals that you laid out.

But have you had time to sit down and really think about Key's strategy in a more wholesale, holistic manner, in terms of whether currently as Key stands you're in the right geographies and you're in the right businesses?

That's a good question, because as we sit here today we're in the process of finalizing our strategic plans for the coming year.

I would tell you we feel even more confident about our business plans and where the Company is positioned to compete in the marketplace.

We feel like we have built something very distinctive with our relationship-based, locally delivered Community Bank, our unique expertise capabilities and range of products and services in our Corporate Bank.

So, both sides of the bank we believe are distinctive and well-positioned to compete.

And then the segment we have been talking about that we feel like has really, really added to the robustness of our business model is the collaboration that we have built and the cross-business opportunities between the Community Bank and the Corporate Bank.

Each are seeing opportunities and revenue and client growth that they would not have without the other.

So, that alignment of our Corporate Community Bank around our targeted verticals in our markets is serving us well.

We believe that it is less than an ideal operating environment.

But we're gaining traction and we see that we're winning with our clients, which to us validates the notion that we need to execute this strategy, stay focused, start showing organic growth and couple that with our capital management.

As you said, I've been very busy over the last couple months.

But I did meet with many of our institutional shareholders.

And I have heard and understood that their expectations are for profitable growth, a continuing strengthening of our risk profile and for disciplined capital management.

And we feel like we are positioned to deliver those with these strategies and the markets we serve.

And when will you unveil this plan?

Is it in conjunction with your fourth-quarter call or perhaps during the fall conference season?

It's not a different plan.

I think it is our ongoing annual process that we have where we constantly look at our strategies and validate them.

So, as we go to various investor conferences and outline our priorities, our strategies, how we believe we are competitive and distinct, we will continue the dialogue.

And if there are changes or nuances, we will always highlight those.

I think as we have taken our stake in the ground about executing on our business plan, focusing in on organic growth and disciplined capital management for our roadmap to how we're going to maximize shareholder value, we're very focused on continuing on that path.

Thank you so much.

You're welcome.

Steven Alexopoulos, JPMorgan.

Maybe I'll start.

I want to just clarify what Chris Gorman just said.

You're saying that the $9.7 billion pre-book you expect to be stable in the third quarter, and then maybe show growth in the fourth quarter.

I'm just wondering, what is changing here?

Is the runoff slowing?

Or you just have more of an appetite to add new commercial real estate and offset this runoff here?

There's a few things going on there.

One is that we have very opportunistically delevered a lot of our clients, gone to the equity markets, gone to the commercial loan mortgage market.

So that process has really kind of run through.

The second thing that has happened is we have now successfully transitioned that book.

When we started, we had about 60% of that book that was in construction.

Today that rests at 16%.

And then at the same time, in keeping with what Beth was talking about, working very closely with the Community Bank we have really targeted these owners of real estate.

And we're getting a lot of traction; we have a lot of traction in the REIT business already.

I think we lead 17% of all the publicly traded REITs from a financing perspective.

But we're also now getting a lot of traction with these owners of real estate.

So not only are the exits diminishing, but we're getting a build in the pipeline.

Okay, that is helpful.

And I just wanted to follow up on a question on cost saves.

For Beth, given your experience on the retail side, would you consider a more aggressive branch reduction strategy to drive cost down?

And any thoughts on even selling off parts of the branch network that might be a drag on overall profitability?

Yes, I would be glad to elaborate on that.

First, in terms of our network, we have looked at the distribution of our markets.

And all are contributing and accretive to Key.

But clearly, with some of the economics in the retail and consumer segment we are still very focused on our cost structure from -- I think I mentioned in the call our cost infrastructure under our consumer payments, how we utilize various lower-cost channels to make sure that we are adding to our convenience.

And on the branch front, while we continue to invest and build branches in some of our priority markets in Seattle, Portland and Denver, we also have -- if you look at our branch growth in any given quarter, we're using this as an opportunity to consolidate, close and reposition some of our fleet.

So it is not a growth net 40; it is a growth 40.

So we're constantly looking at how we can strengthen, become more cost effective and be well-positioned to compete in our markets.

But we do have a continuing eye on these economic headwinds as well as revenue headwinds, specifically in that segment, for trying to make sure we are optimizing our cost over time.

Maybe to follow up, I know there are some banks selling branch networks out there.

To drive more efficiency in the branch network, do you think you are more likely to add to the network to get to those efficiencies or actually shrink the size of the network?

I think we always look at all options to say what is the best mix for Key in its markets and given our attributes.

So I would tell you we have a very robust process as we look at our market density.

Okay, thanks.

Mike Mayo, CLSA.

My question -- first, Beth, could you elaborate a little bit more on maybe kind of the strategic differences, now that she's CEO, versus the past?

Mike, I would be glad to take that question.

One thing I've said at a variety of our investor conferences that I've participated in over the most recent months is, much of our strategy has been developed over the last one to two years within the management team here.

And part of the reason that I believe the Board was comfortable in an internal succession candidate is I was an architect of many of those pieces of our strategy.

So I feel fundamentally very solid about our Community Bank's focus to local delivery, relationship-based and service-based approach to our markets and feel like we have really validated that business model.

And it's got a lot of traction.

Under Chris Gorman's leadership, the Corporate Bank has gotten very focused about its targeted verticals, how to make sure that we have the right business mix in leasing, commercial real estate.

I think you heard him talk about a number of those areas, as well as our distinctive capabilities in our capital markets group.

The real winner, we believe, for us -- and we think we are in early innings -- will be how we are truly aligning our Corporate and Community Bank, serving a continuum of our customers with capabilities that we think are, A, distinctive for a regional bank and that, B, we don't see other competitors really trying to deliver into the middle-market, which we're defining as companies from say $25 million in revenues to just around $1 billion.

So we have lots of success where we're getting cross referrals, bringing our whole team to targeted clients.

And we see ourselves not just landing lending and treasury management, but really being poised to offer debt and capital market capabilities.

We have a number of wins across the Bank and feel like that is distinctive.

And we feel like we have adequate levers in our branch network to address some of the revenue headwinds that are specifically hitting the consumer segment and retail segments of our businesses.

So if we look at our strategy, we like where we are.

And our mantra is we need to stay the course, execute this business plan, talk about our results and our strengths and weaknesses with clarity and transparency.

And prove that this can organically grow our franchise and create value.

To assist with the transition, is Henry Meyer on board as a consultant for maybe a year or so?

If you would've seen in our proxy as well as our announcements around the April timeframe, Henry will stay on as a year in a consulting basis.

He is not an officer of the Company.

It is largely around what I would call Henry has a Rolodex that is second to none.

And as I stay very, very focused on executing our business plans and making sure we really gain the momentum and traction that we believe is on the horizon, asked him to stay with me on community, civic and some industry groups where I can leverage his knowledge, expertise and Rolodex.

And I can make sure we are head down on our business plan.

All right, thank you.

(Operator Instructions).

Brent Erensel, Portales Partners.

First of all, given the dynamics of the pretax pre-provision, what you mentioned about the inflection point with the lending, the headwind from Durbin, how do you break out of the current 1.28% ROA that you just reported?

This is Jeff Weeden.

Our stated objective is from 1% to 1.25%.

Right now it has been a little bit higher than that, or at the upper end of the range of that for the last several quarters.

That is driven by the fact that we have had overall credit improvement.

We have had some benefit associated with that.

I think in terms of really getting the pre-provision profitability of the organization going longer-term, we're going to have to see generally an increase in interest rates and then overall growth in the lending activities and other activities of our clients.

So as our clients continue to gain more confidence and business activity improves, I think that is where we will continue to see -- that is when we will see some of the overall growth.

But until that point in time, we're talking about the range on pre-provision profitability of really being between $300 million and $340 million.

And a quick follow-up, have you entertained a buyback in the current environment?

Well, with respect to buybacks -- and I think Beth has commented on this before, but whatever we do has to go through the Board.

The Board has to go through their analysis of it, and then in today's environment it has to go through a regulatory review process.

So I think in terms of our comments on that, we spoke specifically about the fact that the next time that we go in for the overall annual review, that the regulators will conduct again -- at least the 19 banks, if not more than that, that will be part and parcel to our overall plans for coming time periods.

But anything you do along those particular lines does require the non-objection of your regulators.

Matt Burnell, Wells Fargo Securities.

Good morning everybody.

I wanted to follow up a little bit, and pardon this question being a little -- being pretty detail focused.

But you mentioned that commitments have been rising on the commercial side.

I'm just curious; over the course of the past three to four months, have you seen an improvement, stability or reduction in what I would refer to as commitments to commit?

Are more customers coming to you looking for commitments now?

Or could you just characterize sort of the trend in your commercial commitments over the last few quarters?

I will comment just briefly on it, because I specifically looked at what we are seeing.

Beth commented about new and renewed commitments and her comments there earlier, I believe, were like $9.3 billion, $9.6 billion.

I don't have the exact number here to put my finger on it.

But I did look specifically at the overall trend in commitments, and what we saw in the trend in commitments, we saw it in the first quarter.

We saw going in the third month of the quarter was the strongest.

And we continued to see strength build in the second quarter for approved new commitments.

So if I were to look at each of the months -- April, May through June -- we saw building of approved commitments that got recorded.

And we have also seen a commensurate increase in the size of our pipelines over time related to that.

It's Chris.

I'm not sure that there is that much more activity out there.

I think we are winning in the marketplace.

We were just doing an analysis.

I think at the end of the year we think we'll -- 8% of our client base will be new.

So I don't know if it is that we're being more effective in our targeted calling, or that there is a whole lot more opportunity from a whole market perspective out there.

And I guess my follow-up focuses on slide 10 with the average FTE graph.

Obviously the Keyvolution and some other steps you have taken have reduced the average FTEs over the past couple of years.

I'm just curious from where you sit today at about 15,300, where -- what your thoughts are in terms of that number moving higher.

Or is this going to stay pretty stable for the next two to three quarters?

This is Jeff Weeden.

The overall trend will probably remain fairly stable.

We typically have seasonal tracking of when you have additional vacations, so you end up with having some seasonal temporary help that comes on in the summer months.

But we are continuing to add people in select areas where we can drive revenue, so we're making those particular investments.

Of course we have been also adding additional branches to our network, which will come with additional staffing.

But we still have other initiatives that we are executing on within Keyvolution.

As we continue to execute on those, those will also have somewhat of a dampening impact on the overall change in the FTE counts for the organization.

Okay, thank you very much.

Terry McEvoy, Oppenheimer.

Just wanted to dig deeper into Beth's response to Steve's question about just Key's M&A strategy.

It seems like in the past it has been Key would want to have 10% of the branches in each market.

We can all do that analysis and see that most of that is west of the Mississippi.

It sounds like your response today suggested that maybe Key is willing to pursue a transaction where they already have significant market share, that maybe there is a benefit of going from 20% to 30% in certain markets, particularly if there's an opportunity to cut costs.

I just want to make sure I interpreted Beth's response correctly there.

This is Beth.

How about I will clarify that?

Thank you.

If you look at the focus of our de novo build where we -- as you said, our Western markets we're not at that 10% threshold of branch share.

That is where we have concentrated our new growth opportunities in terms of de novos.

But I think we have always said in the past that our geographic distribution creates opportunities.

If there was ever consolidation opportunities within our industries, because of the diversity of our markets as well as our market share in many different places, opportunistically you would look at whether something enhances your franchise value or -- and enhanced your shareholder value.

So we have always said when it comes to potential for M&A acquisition that our geographic distribution could create opportunities across the spectrum.

But we are concentrating our new builds in the West.

Appreciate that.

Thank you.

Gerard Cassidy, RBC Capital Markets.

Thank you good morning.

Regarding the growth that you are hoping or are anticipating in the commercial real estate portfolio toward the end of the year, do you guys have any targeted levels that you want to manage the commercial real estate portfolio to, as a percentage of total loans?

And second, as part of that, is there any parts of the -- is there going to be in-footprint commercial real estate lending that you are going to see the growth, versus the out of footprint that was done during the boom times?

Chuck Hyle.

Let me take a stab at that.

We're not targeting a specific number.

We look at the total portfolio all the time.

We look for concentrations.

We look for correlations.

And I think that having brought the construction and residential commercial real estate part of our portfolio down quite dramatically, almost to nothing, the composition of our commercial real estate book is really quite different than it was a couple of years ago.

As a result, with all the construction largely out of the portfolio and moving to owners of real estate, REITs and larger players in that particular market, I think the number that we have come down to -- and it was referenced earlier -- we will probably see some increase in that part of the portfolio.

In terms of the other part of your question, we have completely deemphasized construction.

It doesn't say that we won't do the occasional transaction for a major player, but we have really deemphasized that.

And to the extent that we do, we would play closer to home in terms of footprint.

So the composition of our commercial real estate business, as Chris alluded to earlier, has changed quite dramatically.

Thank you.

The second question was on your -- on the business plan or the metrics you guys manage to on page 4 of the slides.

How often when you go to review and update this page, is it once a year in your August meeting possibly?

And as part of that, what should we expect for the provision?

You said the net charge-offs to average loans should reach about 40 to 50 basis points.

Do you guys think once your reserve gets to a level that you feel is adequate, that the provision should equal net charge-offs?

This is Jeff.

I think over time you will see that migration towards the net charge-off level.

But I think also you have to look at the overall quality of the portfolio, too.

So that will have a change in it.

It may match charge-offs or it may be greater than charge-offs in some time periods, too, depending upon the overall direction of credit and the size of the overall portfolio.

But that will probably be a good proxy once we get to whatever normal is.

And that number would really reflect our core business, rather than some of the exit businesses that we are still working our way out of, which obviously have higher charge-off numbers in them.

Okay, and just in terms of the review of all of the metrics, do you guys do it once a year or every other year?

Or how often is it looked at?

We review it on a regular basis.

Probably for change, though, it is more on the annual process when we go and update our long-term plan.

So as we go through that with the Board.

We start the process even this week, and go through it through the next two meetings with the Board as we get ready to get into 2012 and set the targets basically for '12, '13 and '14.

That does conclude today's question-and-answer session.

I would like to turn the call back over to Management for any additional or closing remarks.

Thank you operator.

And again, we thank you for taking time from your schedule to participate in our call today.

If you have any follow-up questions, you can direct them to our investor relations team -- Vern Patterson or Chris Sikora.

And their number is 216-689-4221.

And that concludes our remarks today.

Thank you.

This does conclude today's conference.

Thank you for your participation.