KeyCorp (KEY) 2012 Q3 法說會逐字稿

Good morning and welcome to KeyCorp's third quarter 2012 earnings conference call.

Today's call is being recorded.

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

Please go ahead.

Thank you, operator.

Good morning and welcome to KeyCorp's third quarter 2012 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 leaders of Key Corporate Bank and Key Community Bank, Chris Gorman and Bill Taylor.

And also joining us for the Q&A discussion are our Treasurer, Joe Vayda, and our Chief Risk Officer, Bill Hartmann.

Slide 2 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.

Slide 3 provides some highlights on our third quarter.

Our results underscore the Company's sustained drive to increase revenue, reduce costs, and grow the franchise.

We recorded net income from continuing operations attributable to common shareholders of $214 million or $0.23 per common share this morning.

Revenue for the quarter benefited from a 6% improvement in net interest income driven by 17 basis point increase in net interest margin and continued loan growth.

CNI loans rose for the sixth consecutive quarter and we surpassed our commitment to lend $5 billion to small businesses with up to $20 million in revenue two years ahead of schedule in this quarter.

Home equity loans reached their highest level in recent years in part due to our successful borrowing campaign we have launched.

On the cost side, we are on pace to reach our targeted annual expense reduction of $150 million to $200 million by December 2013.

These efficiency initiatives will lower Key's cost structure to align with the current operating environment and should improve the Company's competitive position in this market.

During the quarter, we took steps to enhance our franchise, our product offerings, and our profitability.

We re-entered the credit card business by acquiring a $725 million Key branded credit card portfolio made up of our own clients and by beginning to self-issue cards.

The acquisition provides us with an opportunity to solidify our payments platform while realizing attractive financial benefits.

To strengthen our share of two attractive markets in western New York, we acquired 37 branch in Buffalo and Rochester from which we expect to grow current customer relationships and build new ones.

Our underlying credit quality continues to improve, and in this quarter we did make provisions to account for our acquisitions and to meet updated regulatory guidance.

Jeff will cover these items in his remarks.

The final few items on this slide highlight our continuing commitment to discipline capital management.

In addition to leveraging our strong capital position through recent acquisitions, we've continued to return capital to our shareholders by repurchasing common stock and through dividends.

Turning to slide 4, I'm sure everyone on the call today is aware of the challenges facing our industry.

We have endured a protracted period of slow economic growth and historically low interest rates, and we believe these conditions are likely to continue.

That said, we have taken steps to position Key for growth and improve profitability.

We are focused on revenue growth, improving efficiency, and disciplined capital management.

Our results this quarter are evidence of our progress.

First, we are increasing revenue.

Organically, our relationship model is generating results from new customers and expanding relationships with existing clients who are using more of our services.

We've seen our lending businesses grow and our market share expand.

And, as I mentioned, we continue to invest in our businesses.

This quarter included our branch acquisition and re-entering the credit card business, both provide new revenue streams and opportunities to grow our client base.

In addition, we are able to deploy the additional balance sheet liquidity from our branch acquisition into higher yielding credit card access and into the redemption of the trust preferred security.

Next, we believe one of our most effective levers comes from lowering our expense base and creating a more variable cost structure on the one hand and delivering a high quality client experience on the other.

As we said earlier, we made progress this quarter on our efficiency initiative, and we remain focused on reaching our efficiency ratio target of 60% to 65%, all this while remaining committed to our relationship model.

Finally, we see our capital position as a competitive advantage.

How we manage our capital will continue to be one of the most important decisions we make for this franchise over the next several years.

Overall, our third quarter results were another step forward for our Company as we continue to make progress on our targets for success.

Now, let me turn our call over to Jeff for some further comments on our results.

Jeff.

Thank you, Beth.

Slide 6 provides a summary of the Company's third quarter 2012 results from continuing operations.

As we reported this morning, the Company earned a net profit from continuing operations of $0.23 per common share for the third quarter compared to $0.23 for the second quarter of this year and $0.24 for the third quarter of 2011.

There were a number of moving parts this quarter that Beth touched on in her remarks that impacted our results.

First, we completed the acquisition of the branches in western New York; second, we redeemed $707 million of trust preferred securities; third, we re-acquired our Key branded credit card portfolio; fourth, we terminated two additional leverage leases and fifth, we implemented new regulatory guidance on how we were handling certain credits involved in Chapter 7 bankruptcies.

I'll cover how these events impacted our results in more detail on the following slides.

Turning to slide 7, average total loans for the third quarter were up $1.249 billion or 2.5% unannualized compared to the second quarter of this year.

Included in this amount was the impact of the loans acquired with the Western New York branches of $223 million and our Key branded credit card portfolio of $473 million.

In addition to the acquired loans, we also continued to experience growth in our CNI and home equity loans.

Our period ending loan balances were higher than average loan balances by $724 million which should bode well for growth in our fourth quarter average total loan balances.

And our exit portfolio declined $375 million third quarter.

The reduction in the exit portfolio was both from normal amortization and the early termination of leverage leases.

On a period-end basis, our exit portfolios from continuing operations represented less than 6% of total loans at September 30, 2012.

Continuing to slide 8, on the liability slide of the balance sheet, our trend of improving deposit mix continued into the third quarter where we experienced an increase in average balances of non-timed deposits of approximately $2.6 billion or 5.2% unannualized.

Contributing to this increase was the addition of $1.6 billion of mostly consumer deposits associated with our acquisition of branches in Western New York.

You can also see here where deposit funding costs have significantly declined over the past year.

This, along with debt maturities and the redemption of trust preferred securities, is driving down the cost of interest-bearing liabilities.

As we stated last quarter, maturities of higher costing CDs and debt would benefit the net interest margin in the second half of the current year.

During the fourth quarter we have approximately $540 million of CDs at an average cost of 4.9% maturity.

These maturities, along with getting the full benefit of our third quarter maturities, will continue to lower our funding costs in the fourth quarter and help offset pressure on the asset yields in this low rate environment.

Turning to slide 9. For the third quarter of 2012, the Company's net interest margin was 3.23% compared to 3.06% for the second quarter, a 17 basis point expansion.

Taxable equivalent net interest income was $578 million for the third quarter, up 6.3% from the $544 million we reported in the second quarter primarily as a result of improvement in funding costs and earning asset mix.

We also had two leverage leases terminate during the quarter which negatively impacted net interest income and the net interest margin for the third quarter by $13 million and 7 basis points respectively.

This was the same impact we experienced last quarter in the second quarter on net interest income and the net interest margin.

On the positive front, we realize $5 million of accretion associated with our credit card purchase which added approximately 3 basis points to the margin.

Based on continued improvement in our funding costs, a change in asset mix driven by higher loan balances and lower investment security balances, and excluding any potential impact from early termination of leverage leases, we anticipate the net interest margin for the fourth quarter to be in the low 3.3% area.

On the non-interest income front, fee income was positively impacted from a $39 million of gains we realized on the early termination of certain leverage leases.

This was $26 million net of the impact to the net interest margin.

As well, we also incurred -- experienced a $54 million gain from the redemption of trust preferred securities during the quarter.

Gains on loan sales continued to be strong driven by commercial mortgage origination activity in our real estate capital line of business, and our pipeline in this business remains solid headed into the fourth quarter.

Turning to slide 10, non-interest expense for third quarter of 2012 remains well controlled at $734 million, up $20 million from the second quarter.

Included in our expense for the third quarter was approximately $16 million in costs related to our acquisition of branches in Western New York, including $8 million of merger integration costs and $2 million of amortization of intangibles.

In addition, expenses associated with our credit card portfolio acquisition were $10 million and included amortization of the purchase credit card receivable premium of approximately $6 million.

As we announced last quarter, we are targeting $150 million to $200 million of expense reductions by the end of next year.

We are making progress with implementing initiatives, including closing certain branches, consolidating operations, and adjusting staff levels to meet customer demand.

We remain on track to deliver approximately $30 million to $50 million of our targeted savings by the end of this year with efforts continuing throughout 2013.

We will also continue making investments for future growth.

Our efforts are not all about cost cutting, but they are about improving profitability and ensuring we meet the ever changing regulatory demands facing our industry and Key.

Turning to slide 11.

Credit quality metrics and provision for third quarter were impacted by a number of items.

Net charge offs for the third quarter were $109 million or 86 basis points of average loans.

Included in this were $45 million of additional charge offs we recognized as a result of updated regulatory guidance related to consumer loans discharged through bankruptcy.

This $45 million represented approximately 35 basis points of net charge offs to average loans for the quarter.

In addition, the change in guidance also resulted in adding $38 million to our nonperforming loan totals at September 30, 2012.

Going forward, we do not expect this change in recognition to have a meaningful impact on our net charge off or nonperforming loan additions.

During the third quarter, we also incurred provision expense of $32 million associated with our credit card portfolio and branch acquisitions, and established an allowance for loan and lease losses of $29 million at September 30, 2012, associated with these particular portfolios.

We expect provision expense for these portfolios will be significantly less in the fourth quarter.

At September 30, our reserve for loan losses represented 1.73% of period-end loans and 136% coverage of nonperforming loans.

On page 19 in the appendix, we provide our long-term trend of past due and criticized loans both of which continued to show improvement through September 30 of this year.

We remain on track with our asset quality trends of achieving our long-term targeted goal for net charge offs in the 40 to 50 basis point range of average loans.

And, finally, turning to slide 12.

Our tangible common equity ratio and estimated Tier 1 common equity ratio both remain strong at September 30, 2012, at 10.4% and 11.4% respectively.

We have also updated our estimated Basel III Tier 1 common ratio as of September 30, 2012, based on the fed's notice of proposed rule making on a fully implemented basis at 10.5%.

And during the third quarter we repurchased $9.6 million of our common shares at an average cost of $8.36 per share, and we will continue to execute on our share repurchase authorization during the fourth quarter of this year.

That concludes our remarks.

And now we will turn the call back over to the operator to provide instructions for the Q&A segment of our call.

Operator.

Thank you.

(Operator Instructions)

We will take our first question from Steven Alexopoulos with JPMorgan.

Good morning, everyone.

I wanted to start this morning Huntington and their earnings release.

They said they saw a broad-based change in customer sentiment late in the quarter talking about uncertainty over the economy, issues like fiscal cliff.

Are you guys seeing this shift in your customers as well?

Do you expect this to impact growth over the near term?

Sure, Steve.

It's Chris Gorman here.

We are.

I was just out with our leasing folks, which I think is a pretty good forward look and clearly we have seen a slow down in terms of, for example, equipment purchases.

I think the fiscal cliff, the election, I think all these things play into it, but right now we have -- back logs are strong.

I do think there is a fair amount of hesitancy out there in the market place in the business community.

And this is Bill Koehler.

Sorry, Steve.

I would agree that as we look at middle market and even in our business banking, smaller businesses we would see the same amount of cautiousness, I guess, as we go forward.

Okay.

That's helpful.

Just a followup.

Following the news of QE3 and we're seeing MBS yields come down, we're seeing quite a few banks get even more aggressive on deposit repricing.

We're seeing money market products that we saw where floors go even further, as you guys look at your deposit repricing strategy, are you putting even more aggressive reductions in there, particularly as all these high-cost CDs roll off?

Thanks.

Steve, this is Bill again.

We have not been any more aggressive.

We believe our relationship strategy helps us attract good customers at deposit levels, at pricing levels that make sense, and we have maintained a very consistent pricing strategy in the market.

Okay.

Thanks for taking my questions.

We'll take our next question from Steve Scinicariello with UBS.

Good morning, everyone.

A couple quick ones for you.

Just as you guys look to continue to improve the payments platform, I know you brought in the Key branded customers, $725 million of receivables, I'm just kind of curious, what kind of revenue opportunities you see in potential for growth in that portfolio that you might have going forward, if you could give some color on that?

Thanks.

This is Bill again.

Thanks for the question.

We feel very good about our credit card acquisition because it broadens our product offering in a way that is very consistent with the way clients are choosing to behave in the market.

And we can also fold it into our relationship rewards platform.

So, whereas prior to the acquisition we had a debit credit card strategy and that was impacted by [Durbin], here we can offer a more -- a broader product offering that gives our clients more choices and early days everything is moving according to plan.

And, Steve, I would just add that, as Jeff mentioned in his comments, that it did create a more favorable asset mix on our balance sheet as well as strong economics from the use of those credit cards.

This was part of our [Durbin] [engagement] strategy and when you couple that with the realignment and the more efficient platforms we have done underneath on the cost structure, this is a big step forward for us as we replace some of the impacts of the governmental price controls.

Definitely.

And so we should expect that and those balances to keep growing as we look ahead then, right?

This is Bill again.

Early days.

We are pleased with results we're seeing.

Good.

And then just my last question.

Just in terms of some of the franchise improvement and optimization that you guys referenced in the beginning of the call, just kind of curious in terms of the timing of maybe some of the pruning of some areas or, like you said, consolidating or open Tim eyeing some of these things, what's kind of the pace we should expect as we look ahead?

Steve, this is Beth.

We will keep you updated as we go through.

We did indicate that we have made progress on what we had targeted of $30 million to $50 million of our total goal this year and I think we announced that we have closed 16 branches in the third quarter and we have another 3 scheduled for closure in the fourth quarter.

We have consolidated some of our back rooms, we have worked to reduce our staffing levels, and we continue to look at our procurement and vendor relationships.

So, as we go into the end of the year we feel good about the $30 million to $50 million that will be coming through in our 2013 run rate and have plans and implementation strategies and line of sight to the 150 to 200 by the end of 2013.

Steve, this is Jeff Weeden.

Just to give you a little bit more in terms of some proof points on it also.

If you remember, last quarter we talked about some of the things we had entered into specifically in our real estate capital line of business.

You can see that starting to really show up if you look at the line of business reporting, and it's on page 28 of the earnings release this morning.

You'll see the FTE count is down in that particular area and deposits are up.

So, we said it was a combination of what we were also going to be able do on the cost side, but also looking at what we had to do on the revenue side.

So, it's a combination.

When we talk about it, it's not just about cost.

It's also about revenue enhancements and improvement and improving the overall profitability.

So, the numbers are coming through in various lines of business and we're making reinvestments also just as we talked about in card or the branches in Western New York.

Excellent.

Thanks so much, guys.

We'll take our next question from Marty Mosby with Guggenheim.

Good morning.

Beth, I wanted to ask, you had mentioned that one of the most strategic paths, which given the excess capital that you have is the deployment of that excess capital.

Can you give us some prioritization and a sense of how you really want to take that capital and put it to work, and also give us kind of a third dimension of time in the sense of how fast do you want to get it back, or will you hold some back for some strategic use down the road?

Marty, thank you.

We have talked about our capital priorities and said that obviously our level of capital we believe is a competitive strength in the coming years.

And as we've talked about our priorities, clearly our first two priorities -- our first priority is to support our own organic growth of our business model and you have heard in this quarter we utilized some of our capital for the purchase of branch acquisition and the credit card portfolio.

From there, we prioritized dividends and second from there we need to repurchase of our shares underneath the CCAR process at these attractive rates that our stock is trading in the market.

And as you correctly pointed out that, fourth, you would always retain some level of capital to create flexibility for strategic opportunities to enhance the franchise and grow the business over time.

Just one more question about this credit card acquisition.

We're seeing this happen more often within the super regional bank group where in the past we had so much loan growth we were crowding out some of our assets.

Now that we have all the deposit funding, we're kind of looking back and pulling some of those assets back on the balance sheet.

But if you also look at in a sense of the debit card pressure that we have for the regulatory change and on the flip side you have the heed lock product that's under so much capital pressure, those things just kind of push us right back into this credit card business.

And then lastly, how about the operations of bringing the portfolio back on the balance sheet?

Are there any challenges there?

Thanks.

Marty, I'll take a first pass at that and then I'll let Bill or Jeff add if they have some additional thoughts.

In terms of bringing the credit card balances back on, one of the big drivers I think for all the regional banks has also been the ability and the cost infrastructure to actually service those cards is dramatically different than it was ten years ago when many of us exited the business and it fits more fully with relationship strategies verses the days when it was more of a mono line product.

So, we see it as attractive client relationship coning that client experience as well as attractive client economics.

So, we view it as a good augment to our payment platform as well as our client experience and have plenty of room within our balance sheet for good relationship loans to include equity and card.

I don't think we have any further comments.

So, operator, we'll take the next question.

Thanks, Marty.

We'll go next to Erika Penala with Bank of America Merrill Lynch.

Good morning.

My first question, I just wanted to make sure I understood your guidance correctly for expenses.

If we run rate the $734 million that we saw this quarter, I get $2.9 billion.

And then I take off the one -- the mid point of your guidance and get to 2.76 run rate for next year.

Can you -- is that, A, the right way to think about it and, B, could you keep it that flat to that level?

In other words, is the expense program or the expense savings that you mention net of any sort of core investments that you'll make into next year?

This is Jeff Weeden.

We're going to continue to make investments and I think we talked about that earlier and I made that in my prepared remarks, too is that we will continue down this path.

There is a lot of things all of us do in the banking industry to meet all the updated regulatory requirements.

And as we're going through and improving the overall efficiency and effectiveness, we're continuing also to invest in our businesses.

And so I think you're seeing top line revenue growth also is what we're driving for.

So, we're targeting a 60% to 65% efficiency ratio.

That's one of our targeted items.

Now, to get there we have to have expense reduction and also revenue growth.

And one of the things that we are keenly focused on is reducing costs when we can reduce costs.

So, we haven't given a specific target for the absolute run rate of expenses for 2013 at this particular juncture.

What we have talked about is reducing our costs from where we were.

You have to add in, which is why we try to show some of the waterfall effect here when we talk about it, add in what we're making reinvestments on and what those reinvestments are for going forward.

Erika, Jeff referenced the waterfall and that is on page 10 of our slide deck and I think it will help you understand some of the dynamics of the $734million for this quarter.

Okay.

Yes.

I appreciate the guidance that you gave for the fourth quarter on the margin.

Looking at the average balance sheet, I appreciate the commentary on deposit costs, but it still looks like there could be some wood to chop on the wholesale funding side.

Could you give us a sense of what the opportunities could be in terms of either the maturities of debt or maybe calling some debt to help support the margin in 2013?

Okay.

So, -- this is Jeff Weeden.

What we have provided guidance on again was for the fourth quarter.

We'll update our guidance for 2013.

We continue to have maturities of CDs here.

We talked about the $540 million in the fourth quarter.

We'll have additional maturities in 2013, but they go down dramatically.

So, while we've been running close to the -- we had $1 billion in the third quarter.

We have $500 million here in the fourth quarter.

They start to drop into the $200 million to $250 million per quarter going forward.

So, entire 2013 time period, basically the higher costing CDs are about $1 billion.

I think when we look at our debt we have additional debt maturities next year, but they're not that significant at this particular point in time.

And in 2013 we have $750 million that matures in the May time period next year.

So, there is not a lot of additional debt maturities.

And I think the other thing that we're constantly looking at is what do we need to have for a level of debt that's outstanding also to support just long-term liquidity of the balance sheet.

So, these are all the different things that we're looking at.

We'll provide additional guidance as we get into next year.

We think we're well positioned at this point in time.

The credit card portfolio is only on for partial quarter in the third quarter.

We'll have the full quarter benefit.

You'll see that in the average balances of what we talked about, I think it's about $773 million.

The ending balances, if you look at the average balances, they were basically in that $470 million range, so significantly different.

We'll get about a $300 million pick-up there in terms of balances at a much higher yield.

Got it.

Okay.

Thank you for taking my questions.

And we'll go next to Mike Mayo with CLFA.

Good morning.

The card acquisition and branch acquisition, that must have added to expenses in excess of the one-time charge.

What was that number?

Okay.

So, what we have on an ongoing basis, on slide 10 in our deck we tried to point this out.

The $16 million that we incurred in the branch acquisition, Mike, of that we had $8 million of one-time expenses and we also had $2 million of amortization of the core deposit intangible that was embedded in that.

So, about $6 million were the ongoing costs.

If you look at the card portfolio --

Before you leave branches, so just the cost of running branches goes up $6 million due to the acquisition?

Cost of -- roughly, yes.

In other words, other than the one time, the permanent step-up in expenses due to the branch acquisition would be $6 million?

Approximately, yes.

Okay.

Good.

Thanks.

And then if you look at the card portfolio, we have the ongoing cost associated with processing of the cards and we also have embedded in that are the purchase credit card receivable amortization.

In the third quarter, that number was $6 million.

It will increase in the fourth quarter as we have an entire quarter.

So, it will go up approximately $2 million.

So, on a quarterly basis the $6 million will go to approximately $8 million going forward.

And then we have just our normal processing costs that go along with that particular card portfolio in addition to other services.

So, all I'm trying to get to is if you hadn't done these acquisitions, how much would your expenses have gone up?

If we hadn't done these acquisitions, compared to the prior quarter expenses would have been down.

Down how much?

Approximately $6 million.

Okay.

So, core expenses then are down $6 million and doing the same logic, if you hadn't done either of these acquisitions, what would have happened to the margin?

Well, it's very dynamic, Mike.

I think as you look at it we use the deposit funding here to really offset the maturities that we had in terms of the $707 million worth of trust preferreds.

We also had additional debt maturities of about $650 million during the third quarter that were outside of the calls.

And then on top of that, the investment in terms of the card portfolio.

So, it was really used to help fund that particular investment along with just lower levels of investment securities.

So, the balance sheet changed on the asset side as well as the liability side.

However you want to look at it, but the margin was up 17 basis points.

If you hadn't done these deals in your estimate, it would have been up 10, 5, flat, down?

Well, in our analysis that we talked about, it probably would have been up about 10 basis points without it.

And the loan growth, what would loan growth have been without these acquisitions?

Loan growth, we still would have had very strong loan growth on the CNI book.

And so we've really given the break out of the overall loan growth without it.

I think we were up about 1.1% excluding the acquisitions, but that's because a lot of this -- that's on average balance basis, Mike.

Right.

Okay.

And NII if you hadn't done the deals?

Net interest income if we hadn't done the deals, I guess I don't have that number right off the top of my head, Mike.

We'll have to do the math on that.

Okay.

My big question is I recall -- or maybe if you can just talk about the history of KeyCorp and the credit card business because you have to appreciate over the last two decades KeyCorp has expanded its product line many times only to contract.

I recall 1997 KeyCorp sold off some credit cards and what I just don't understand is how KeyCorp has the capabilities and the portfolio to compete with the likes of JPMorgan, American Express, and Capital One and others that have made huge investments in brand loyalty and partnership.

So, KeyCorp getting back in the credit card business, I'm sorry, it's a little bit deja vu.

And I'm just wondering if that makes sense.

Clearly, you thought about this long and hard.

And what can you say to reassure those of us who have been around for a while and seen a few of these cycles?

Mike, this is Beth.

I'll go ahead and take that.

I do think the credit card industry and the ability for regional banks to compete in the credit card space as a relationship product is very different than it was ten years ago.

I made reference to that in an earlier answer that I provided.

We look at this as an augment to our relationship strategy.

This product offering will be embedded in our relationship awards, which is our primary account offering right now for our mass affluent client base, and the underlying cost structure, as Jeff said, we can outsource the processing of that so it's a unvariable expense for us so that we have created a nice profitable spread by reentering.

So, this is not a business line that we intend to re-embark as a growth strategy for client acquisition or a lead product.

We see it as a complement to our existing portfolios.

Many other regional banks have also gone back into this and we can own and control the client experiences.

We've offered cards, but through a white label relationship.

So, this client base also has, on August 1 when we announced this transaction, has substantial deposits and investments with us, and loans.

So, this is a well seasoned and mature set of clients that we acquired.

And then last followup.

I ran over to our credit card analyst and I said what you were doing and he said that the key to the credit card business today is what makes them sticky, the most sticky, is the rewards that you offer as opposed to it being KeyCorp, the offer you present to them.

So, how is your credit card offer going to be strong enough to be sticky so that the other credit card players with enormous gale don't pull them away?

I'm going to let Bill Koehler augment that but, as I said, we are embedding this into our relationship rewards program that we have with our client base.

We have already got a very strong relationship rewards.

And a year ago when Durbin was enacted, one of the things Key did that was differentiating in the market space was we reaffirmed and re-launched our awards.

And this was a product gap and we obviously, as we looked at our Durbin mitigation strategies, re-acquiring that card portfolio, putting it in our existing relationship reward product to make it more robust, gets the attractive client economics, the attractive usage economics as well as being able to process it on a variable cost basis was a significant part of our strategy to mitigate Durbin.

All right thank you.

Thanks, Mike.

(Operator Instructions)

We'll go next to Matt O'Connor with Deutsche Bank.

Good morning.

The CNI growth was quite strong this quarter.

Frankly, we're seeing slow downs for most other banks.

And I'm just wondering what is driving that?

You mentioned some of your real estate lines of business within the broader CNI bucket.

But maybe a little more detail in terms of what's driving that.

Is it chunky?

Is it broad-based?

I think you said the pipeline at the end of the quarter looked pretty good, so a little more flavor going forward as well, please.

Matt, it's Chris.

I think what's driving it is our strategy enables us to really take share.

For example, in the corporate bank in terms of new clients this year we have 450 new clients that have generated around $63 million or so of revenue.

And so, while there are some challenges in the market place, and I think there is a lot of concerns out there, we do see ourselves continuing to take share.

The other thing that I would remind you of, of course, is that our business model, 54% of our revenues are non-interest income, so that gives us, we think, a lever that's a little differentiated from some of our competitors as well.

And I would add -- Matt, this is Bill.

I would add on the smaller end what we've seen throughout the year is a general trend of smaller companies getting stronger and having an opportunity to strengthen their balance sheet, strengthen their business, and although it's smaller dollars in terms of its impact on the whole, we have seen our loan volumes in business banking migrate up and our pipe lines remain consistent as a result.

Matt, this is Bill Hartmann.

Just maybe to add a little bit to what Chris and Bill have said.

We've actually seen pretty good growth across the geographies and across our major segments of business.

This is the result of a lot of effort that went into identifying who the customers were that we wanted do business with and then decking bankers against those clients and understanding what our appetite for risk was, and then just going out and executing.

So, it's a concerted strategy against a defined customer base.

Was there anything in particular that happened this quarter where again it just seems like you had an acceleration of growth verses deceleration for others?

And sometimes these initiatives and efforts take a while to bear fruit, but did they just kind of all come together at once or there's always some puts and takes and this quarter it kind of all went in the same direction?

Matt, it's Chris again.

There's always -- it's always a little bit lumpy here in the corporate bank.

On a quarter-over-quarter basis we were up about 1.9%, that would compare to say 11% over the last year.

So, there was really nothing particular in this quarter that was any huge piece of business, but what we do see is Bill Hartmann mentioned the notion of being very targeted in certain industries and knowing exactly who we want do business with.

We've been at this pretty hard for a couple years now and we are getting our shots with our targeted customers.

And so that's what was driving it.

And, Matt, as we looked at the quarter, one of the things we did say in our second quarter call is that we went in to the third quarter with solid and strong pipelines and some piece of what we talked about was what was going to be the [pulsory] rate because it really was based in client and business sentiment.

And so to your question is this episodic or is it the trend, I think it was the pulse of a strong pipeline into the second quarter, broad based geographically from a client base and reflects our targeted relationship strategy and, as we said, we are taking shares.

There is a lot of new client acquisition that is, on average, better credit quality and has more revenue associated with it in many ways than our average loans in our current books.

Okay.

Thank you very much.

And we'll go next to Craig Siegenthaler with Credit Suisse.

Thanks.

Good morning, everyone.

Can you provide us some perspective on capital deployment here.

Just looking how high your capital levels are versus peers and regulatory ratios and that's not really that new.

I'm wondering if you can provide us any perspective on how capital deployment could potentially change into next year or in the future kind of given your conversation with regulators?

Craig, this is Beth.

As you know, we are at the front end of the 2013 CCAR process and really have not yet received the guidance from the Federal Reserve on scenarios they want to use.

And so we like the other banks who can comment on any near-term capital actions.

It will be subject to our CCAR submission this year and clearly we enter that with a strong level of capital, and we're pleased this year that we were able to pass through dividends increase as well as share repurchase program for this year.

Okay.

And then maybe turning over to reserve balances.

On a dollar basis it looks like they have stopped falling here.

Your loan growth is positive.

That's one driver.

I'm wondering if there's any regulatory pressure on the other side?

How should we think about reserve-to-loan ratios because on that base, it's still declined by a little bit, but should we expect a decline further potentially under 1-5?

Well, I think what we have to look at is -- this is Jeff Weeden.

Each and every quarter Bill Hartmann's area and the risk management area go through and build up the overall arching research.

So, it's going to depend upon the credit migration and overall quality, the size of the portfolio and it has to be built up in that particular regard.

So, we said earlier this year that we expected to see charge-offs continue to come down.

Now, in the third quarter here we had the regulatory adjustment that took place that was an industry-wide event.

That added to our provision and charge-off about $45 million in the third quarter.

We don't expect that to continue into the fourth quarter.

So, our long-term target of 40 to 50 basis points remains intact.

And we said that provisioned expense would migrate towards our long-term targeted rate of net charge-offs.

So, in terms of reserve, I can't tell you.

It may come down a little bit.

It may go up a little bit.

It's going to depend upon how we build it up each and every quarter.

This is Bill Hartmann.

There's obviously been some press out there about specifically I think the OCC who has been talking about the level of reserves.

If you read, what they're really saying is they want to make sure that firms are diligent in the way that they document the level of reserves.

And so we obviously have talked with them about the level of our reserves and we are comfortable that we are showing the right level of reserves.

At this point, do you think reserves are more relevant relative to NPA's or forward charge-off expectations?

You were already saying.

It's probably more indicative of former charge-off expectations.

And of course you always have to have a degree of what might be the embedded losses and the loss confirmation period for the credits that you have on your books today.

If you look in some of the material in the appendix of the slide, there is a credit quality trend on slide 19 and that gives you an indication of where things have been going.

Got it.

Great.

Thanks for taking my questions.

And we'll go next to [Ken Houston] with Jefferies.

Hi.

Good morning.

This is actually Bryan Batory from Ken's team.

My question is on the CRE loan portfolio.

So, that's flattened out this quarter, actually showed a little bit of growth quarter over quarter.

Could you just comment on some of the trends you're seeing there?

And should this -- would you expect this to be the bottom for that portfolio and we could actually see some growth going forward?

Sure, Bryan.

It's Chris Gorman.

There's a couple things going on in that portfolio.

First of all, we talked earlier today about de-risking and making sure we're doing business with the people that we want do business with and there's still some planned and thoughtful run-off in that portfolio.

The other thing that's been going on, Bryan, is our mortgage banking business has been quite robust, and obviously that cannibalize that portfolio to some degree.

Having said all of that, we do think it's bottomed out and we do think it will grow modestly from here.

Okay.

And then, Jeff, typically do you give a pre provision net revenue outlook on where you think you could run near term?

Last quarter it was 290 to 330.

What would your near-term outlook be as we go forward?

Bryan, we're really not changing our near-term outlook at this particular point in time.

We're still going through and I think in terms of where that would be, it might be, again, 300 to 330, in that particular range.

Okay.

Thanks.

We'll go next to Gerard Cassidy with RBC.

Thank you.

Good morning.

Beth, in regards to your comments about the credit card portfolio, is there any way or can you point us to a metric that we outsiders can look at to determine the success that you're having with that portfolio where it's contributing to a higher ROE for this organization?

Gerard, I think the way we will realize the benefit of the credit card portfolio that will translate into obviously our returns is the revenue we receive from the balances, our ability to extend that into our existing client base with our relationship rewards, the transactional fees that we receive on the interchange as our clients use those, coupled with a very, like I said, variable cost base and a well performing credit profile given that it is a well seasoned portfolio.

So, it will be generally accretive to our revenue growth as well as help us with client acquisition and broader client experience.

So, we see it as a positive to the performance as you look at how we are deploying our balance sheet and building revenue.

Gerard, this is Jeff.

Near term, of course we have the amortization of the purchase credit card receivable that's going to be going through.

So, that runs through basically on a sum of the months or sum of the years digits basis, so it's more front-end loaded.

We have some of the accretable income that's coming in, it was about $5 million in the third quarter.

It will be slightly less than that in the fourth quarter.

That part of it burns down relatively quickly.

The amortization will continue on.

So, from a net P&L in the very first year or so that we have of this, it's not what I would call accretive to the overall bottom line because of that.

It's really the long-term view that we have of the portfolio.

And we've done all of our returns based on that.

And I would still -- the other thing I would say, this is Bill, Gerard, accretive to the client experience, that is the important thing to take away here.

As outsiders, because we hear this to the comments made earlier for the folks who have been following KeyCorp for a long time, we've heard strategies like this from other banks.

Could you guys -- some of our big banks have obviously the big credit card businesses and they break it separately so you can really look at how successful they are.

Any chance that you guys would break the credit card business out separately or is that going to just be engrained into the different banking lines and we won't be able to see it?

Gerard, this is Jeff.

It's going to be embedded into the various banking lines.

What we are talking about starting off here is a portfolio of about three-quarters of a billion.

We will grow that portfolio over time, but that is probably not a quote unquote significant stand-alone line of business for us.

We also have our enterprise commercial payments.

That was part of our announcement, too, in July.

So, we talked about what we are doing on the merchant side of the business.

And these are across the entire payment stream.

So, we are investing in payments within our Company.

But as far as breaking this one specific area out, that's probably not going to happen.

We do break out on the margin analysis.

You will be able to see that.

We'll break out additional line items going forward with respect to the fee revenue that comes from it.

And so you could construct some type of a P&L from probably our publicly available disclosures on it.

Have you guys given us, and I apologize if you already did it on the call, what the targets are for the size of this portfolio in 12 months and 24 months out?

No, we have not.

Okay.

And then finally on the capital side of the balance sheet you guys have a very strong Tier 1 common ratio obviously under Basel III.

Assuming that the regulations when we get the final numbers in the spring of next year hopefully, that 7% Tier 1 common ratio is the number everybody has been managed to, plus a SIFI buffer, and if we assume for a moment your SIFI buffer will be 50 basis points on top of that.

So, I'm assuming you're going to be required to carry 7.5% Tier 1 common and you're obviously well above that.

What level are you comfortable with in carrying if those are the rules, 7.5% is your bogey.

And then second, once you give us that number of your comfort level, how quickly would you move to bring that number down to that comfort level?

Gerard, I think in terms of overall capital levels, it's something that we have discussion with our Board on as to what that level ultimately will end up being.

Until we see the final rules and the NPR is just out at this point in time, it's just the comment period, I know it's supposed to end here next week.

We'll see what we ultimately end up with.

Clearly, we have more Tier 1 common than we believe that is necessary and that we would like to deploy that.

However, it's a deployment that takes place between the Board, management, and the regulators as to how that will be ultimately repatriated into the future or utilized.

Thank you.

We'll take our next question from Mike Turner with Compass Point.

Hi.

Good morning.

On your about $17 billion securities portfolio, what is sort of the plan for that?

It seems to be continuing to run off.

I know a lot of the proceeds are being used to repay [trups] and CDs, and then also what are the reinvestment rates and remind me what duration on that is?

This is Jeff Weeden.

The portfolio at the end of the quarter was actually between available for sales and health to maturity portfolios were down to about $16.1 billion.

And so we're getting close to kind of the floor level of maintaining a portfolio right around that particular size just for overall liquidity management as we talked about pledging, et cetera, what we will use that portfolio for.

In terms of the duration it's around, I believe, 2.1 or 2.2 years at this particular point in time.

We provided disclosure for it.

I guess I could go directly to that particular slide which is slide 15; 2.3 years is the average life and in terms of what reinvestment rates are and what rates are going off at.

So, the overall yield on the portfolio combined is about 2.78%.

I think if you look at what comes off currently, it's fair to say it's coming off at around 3%.

And new reinvestment yields at this particular point in time on the product that we structure in the market place is about 1.4% to 1.5%.

Okay.

Thanks.

Then just a follow up on expenses.

Of the $30 million to $50 million you expect to realize by the end of this year, how much have you already booked through the third quarter?

We haven't disclosed how much we booked already through the third quarter.

I think though if you look at some of the things that we have changed in terms of our shifting of FTE count around.

So, we've actually taken FTEs out of certain areas of the Company.

We've consolidated some of our operations.

You can see that if you look at some of the specific line of business information that I was pointing to on page 28 of the press release.

Those items have already taken place.

We have continued to work on overall occupancy costs.

We are continuing to invest though, too, in occupancy.

If you look at the third quarter, we added the 37 branch in Western New York.

Those costs are on, yet occupancy costs remain relatively stable for us.

So, we're taking costs out.

We're making reinvestments.

It's a dynamic process we are going through.

We'll provide additional information as we get into the fourth quarter earnings call.

Okay.

Thank you very much.

We'll take our last question from Andrew Marquardt with Evercore Partners.

Good morning, guys.

Just a couple clarification questions.

In terms of asset quality and credit costs, could you just clarify that this quarter you had $109 million of provision but that sounds like it included the $45 million from the change in regulatory reporting requirements, and then also some reserve build from the card and branch acquisitions of 32.

So, if we adjust for those, should we think about kind of the more normal kind of core run rate of provision being in the mid to low 30s?

Am I thinking about that right?

In terms of basis point or in terms of dollars?

Dollars.

Dollars.

So, if you were to look at the third quarter, that's how you would have looked at the third quarter.

It would have been in kind of that low to mid $30 million range.

That's correct.

And longer term we've said that it will migrate closer in terms of basis points now in terms of to the 40 to 50 basis point range of charge-offs is where we're headed.

Okay.

So, coming off -- but the base should be kind of we're in that kind of mid to low $30's million and maybe migrating a little bit higher on a provision ratio basis.

Is that fair?

That's where we were for the third quarter.

Again, we don't provide that specific type of a guidance with respect to the level of provision because it becomes more problematic as you just look at overall credit quality trends which are continuing to show improvement.

And, again, I don't want to get in front of ourselves until we actually close the fourth quarter on out.

And slide 11 I think gives some good color and context on that, Andrew.

Thanks, Beth.

And then lastly on the margin and also obviously the other drivers on [pre-pre], the margin obviously is going to hold up for another quarter or so.

But then it becomes maybe tougher in terms of less levers, in terms of liability as you've noted next year, but is it possible given the other initiatives to improve your pre-pre from the kind of low 300's this quarter next year given still all the head winds that you and everyone are facing?

So, we provide a guidance for the fourth quarter at this particular point in time.

We'll update that guidance as we get into the January time period when we do our fourth quarter earnings call.

I think it's fair to say that we have in heading into the fourth quarter we feel very good about the direction of the overall margin.

So, in the low 330 area.

I think as you look further on out and we start talking about all of 2013, '14, if the rate environment stays exactly where it is today, assets are going to be pressured, liabilities will continue to re-price, but there's less levers that we're talking about there.

I think in terms of longer term, the margins for the industry and for us will be pressured as we go further out the spectrum.

And then on pre-pre you had said 300 to 330 was your goal.

Can you remind us what the time frame is for that?

That's what we're operating in today.

I mean, we're above that for the third quarter, but we had the trust preferred gains out there.

That was for the fourth quarter.

Got it.

Okay.

Thanks, guys.

And there are no other questions at this time.

I'd like to turn the conference back to our speakers for any closing remarks.

Thank you, operator.

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

And if you have any follow-on questions, you can direct them to our investor relations team, Vern Patterson or Kelly Lammers, and their number is (216)689-3133.

And that will conclude our remarks for today.

Thank you.

Thank you, everyone.

That does conclude today's conference.

We thank you for your participation.