KeyCorp (KEY) 2013 Q2 法說會逐字稿

Good morning and welcome to the KeyCorp's second quarter 2013 earnings conference call.

This call is being recorded.

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

Please go ahead, ma'am.

Thank you, operator.

Good morning and welcome to KeyCorp's second quarter 2013 earnings conference call.

Joining me for today's presentation is Don Kimble, 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, Bill Hartmann, and our Treasurer, Joe Vayda.

Slide 2 is our statement on forward-looking disclosure and non-GAAP financial measures.

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

Turning now to slide 3, our results in the second quarter reflect the clear progress we have made in implementing our growth initiatives, improving our cost structure and executing on our capital priorities.

Year over year, revenue grew for the fifth consecutive quarter with current period results benefiting from our branch and credit card portfolio acquisitions, loan growth and lower funding costs.

Revenue trends, compared to the first quarter, were relatively stable with flat loan balances but stronger fee income from commercial clients who are taking advantage of favorable capital market conditions.

Because of our distinctive model, we were able to capture the economics from these transactions while doing what was right for our clients.

During the second quarter, we also continued to invest to drive future revenue growth.

We acquired a commercial servicing portfolio and added to our special servicing business.

This allows us to leverage our existing platform and meaningfully changes the competitive profile of our commercial loan servicing business positioning us as the third largest servicer of commercial and multifamily loans and the fifth largest special servicer of CMBS in the United States.

The first phase of the transaction closed as expected at the end of June.

We've also continued to invest in our online and mobile offerings.

In the second quarter we launched new remote deposit capabilities for both our commercial and consumer clients which add value and convenience consistent with changing client preferences.

Reducing our cost structure and improving efficiency also remained among our top priorities.

On the launch of our expense initiative one year ago we have achieved annual run rate savings of $171 million, a substantial portion of the $200 million target we committed to reach by December of this year.

Importantly, reaching our target will be a significant milestone but not an end point.

We are already identifying new opportunities to both grow revenue and reduce and variablize our expenses.

And as we previously communicated, we expected this quarter to be the high point in terms of charges associated with our efficiency plans.

Consistent with our guidance, we incurred charges of $37 million with a large portion related to the realignment of our Community Bank and the consolidation of 33 branches.

In the second half of the year we have another 14 branches identified for closure which will bring our total to approximately 7% of our total branch network.

As a result, non-interest expense was down $45 million from the prior year excluding the charges for our efficiency initiative as well as costs related to our recent acquisitions of credit card in the Western New York branches.

And as Don will discuss, our cash efficiency ratio, adjusted for the efficiencies charges, was 65.4% this quarter, just above the upper end of our near-term goal of 60% to 65%.

And finally, we continued to manage our capital consistent with our stated priority.

During the second quarter our board approved a 10% increase in our common share dividend and we executed on our share repurchase program by buying back $112 million in common shares.

This is consistent with our 2013 CCAR submission which places us among the highest in our peer group for estimated payout ratio.

And as we look forward, capital management will remain a clear priority.

Along with improving our operating leverage we are both executing on our revenue initiatives and improving our cost structure.

Now let me turn the presentation over to Don for some details on our second quarter results.

Don?

Thank you, Beth.

Slide 5 provides highlights from the Company's second quarter 2013 results.

This morning we reported net income from continuing operations of $0.21 per common share for the second quarter compared to $0.21 for the first quarter of 2013 and $0.23 for the second quarter of 2012.

And importantly, as Beth pointed out, we incurred $37 million, or $0.03 per share, of cost associated with our efficiency initiative this quarter.

I'll cover many of these results my remarks, so I will now turn to slide 6.

Average total loans for the second quarter were up $70 million, or an annualized 1%, compared with the first quarter 2013, and up $3.3 billion, or 7% compared to a year ago quarter.

Loan growth continues to be impacted by cautious client behavior, a competitive environment and as Beth mentioned the attractiveness of capital market alternatives which we are well-positioned to deliver to our clients.

Our outlook for loan growth remains positive and consistent with our prior guidance of mid single-digit growth for the year driven by CFNA.

Continuing to slide 7, on the liability inside of the balance sheet average deposits, excluding foreign branched balances, were up $1.7 billion for the first quarter and up $4.6 billion from one year ago.

Deposit growth for the first quarter was primarily due to an increase in demand and interest-bearing commercial deposits including higher balances from some of Key's larger clients.

Compared to the prior year, deposit growth also benefited from Key's acquisition of branches in Western New York.

Over the past year our mix of deposits has significantly changed with CDs declining and lower cost transaction accounts increasing 13%.

As a result year over year deposit cost declined from 47 to 26 basis points.

Turning to slide 8, our taxable equivalent at interest income was $586 million for the second quarter, compared to $589 million for the first quarter and $544 million for the second quarter one year ago.

Compared to the second quarter of last year, net interest income increased $42 million, or 8%, due to growth in average earning assets which included our recent acquisitions and an improvement in funding costs.

I would also point out in the second quarter of 2012 Key's results reflected the impact of the early termination of leverage leases.

These transactions reduced net interest income by $10 million but provided a gain of $31 million in non-interest income, resulting in a net pretax gain of $21 million.

For the second quarter the Company's net interest margin was 3.13% compared to 3.24% in the first quarter and 3.06% in the second quarter of last year.

As you can see on this slide the decline in net interest margin from the prior quarter was primarily due to lower earning asset yields and higher than expected levels of liquidity resulting from softer than anticipated loan demand and higher levels of deposits.

The higher level of deposits and its resulting impact on liquidity and investment securities was the primary difference from our prior guidance as it reduced our margin by approximately 5 basis points.

The net interest margin also was impacted by the termination and maturity of $4.4 billion of interest rate swaps that were not replaced as we continue to increase our overall asset sensitivity.

Importantly, the use of interest rate swaps provides us with the flexibility to manage and quickly adjust our rate risk position.

While Key was a little off with other asset sensitive banks generally benefit from a rise in both short-term and long-term rates, the duration and characteristics of Key's loan portfolio, and also investment portfolio, position us to realize more benefit from a rise in the shorter end of the curve.

Recognizing that asset yields remain under pressure and given our higher levels of liquidity, we expect that net interest margin to experience modest pressure in the range of 1 to 3 basis points in third quarter in the second half of the year.

We anticipate for the balance of 2013 loan growth will exceed deposit growth which should result in a relatively stable net interest income.

Slide 9 shows a summary of non-interest income, which accounts for approximately 42% of total revenue.

Non-interest income in the second quarter was $429 million, up from $425 million in the first quarter but below the $457 million in the second quarter of last year.

Adjusting for the $31 million gain from the leverage lease terminations in the second quarter of 2012, non-interest income would be slightly higher than in the prior year.

Additionally, principal investing gains were down year over year.

Many of our core fee income categories have shown strength through the second quarter.

Investment banking and debt placement fees continue to grow and are up 46% on a rolling four quarter average basis as we continue to do more business with our commercial clients and win market share.

And cards and payment income is up 35% compared to the same period one year ago, reflecting our investment in and our focus on payment products including our reentry into the credit card market during the third quarter of last year.

Turning to slide 10, our non-interest expense for the second quarter (inaudible) $711 million.

The increase was expected and driven by several factors.

Importantly, as I mentioned earlier, expenses for the quarter included $37 million in charges related to our efficiency initiative.

Compared with the same period last year, expenses increased $18 million.

Including the current period expense along with the charges for our efficiency initiative of $37 million, were costs of approximately $26 million associated with our two acquisitions completed in the third quarter of last year.

Excluding these two items, expenses for the quarter were $45 million lower than the prior year.

Overall, we are seeing the benefits from our expense initiative come through to the bottom line.

As Beth commented on earlier, we have captured approximately $171 million in annualized savings as of June 30.

During the quarter, we closed 33 more branches and aggressively continued with other efficiency initiative implementation plans.

We also incurred additional expense from marketing associated with our spring home equity campaign and for contract programming as we continue to implement new technologies.

We continue to expect that expenses will decline to the $680 million to $700 million range by the fourth quarter this year.

Included in this forecast are efficiency initiative charges of approximately $20 million.

Slide 11; our net charge-off declined to $45 million, or 34 basis points of average total loans in the second quarter.

Overall gross charge-offs declined and recoveries remained strong.

Total commercial loan charge-offs remained low at 5 basis points of average loans.

A breakdown of asset quality by loan portfolio is shown on slide 18 in the appendix.

We anticipate that net charge-offs will remain at or below the lower end of our targeted range for the balance of the current year and for provision expense to be near this same level.

At June 30, 2013 our reserve for loan losses represented 1.65% of period-end loans and 134% coverage of nonperforming loans.

And turning to slide 12 our tangible common equity ratio and our estimated tier 1 common equity ratio both remain strong as of the end of the quarter at 9.96% and 11.2% -- 11.25% respectively.

Earlier this month regulators approved the final rule for implementing the Basal III regulatory capital standards.

The mandatory compliance date for Key begins in January of 2015 with transitional provisions extending to January of 2019.

Our current estimate of tier 1 common equity as calculated under the final rule was 10.8% which exceeds the fully phased in minimum requirement.

As Beth mentioned, during the second quarter we also repurchased $112 million, or 10.8 million shares of common stock.

And the board increased our common dividend 10% or $0.055 cents per share.

We also expect the Victory divestiture to close during the third quarter.

The after tax realized gain, which was originally estimated to be $145 million to $155 million, is now expected to be in the range of $100 million to $115 million.

We anticipate the cash portion of the gain to be between $75 million and $90 million.

The difference between the original estimate is due to higher than expected client attrition that has taken place during the consent process, which is difficult to predict.

Key has received no objection from the Federal Reserve to use a cash portion of the gain for common share repurchases.

The remaining amount of the gain is expected to be considered in our 2014 CCAR submission.

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

Operator?

A brief reminder, the question-and-answer session will be conducted electronically today.

(Operator Instructions)

We will take as many questions as time permits.

(Operator Instructions)

We appreciate your patience.

Steven Alexopoulos.

Good morning everyone

Good morning

I'm curious on the expenses with the $171 million of the cost saves already in the run rate at the midpoint of the year.

Is this a function of getting to the $200 million in targeted cost saves more quickly?

Because I thought originally you were saying more this was going to come in the back half of the year.

Or is it a function of the opportunity for cost saves potentially being above $200 million?

Steve, this is Don.

And as far as our cost save projection you are right, $171 million is probably earlier than what we would've initially expected.

We are very focused on delivering against our plan.

I think that it's important to note that even once we achieve this, this is more of a milestone as opposed to the end game.

And we do believe that once we implement our initiative to achieve the $200 million, we will continue to be looking for additional opportunities to improve the overall efficiency of the Company.

Okay.

Just one separate question.

On the sale of Victory, Don, could you review again why is the gain now estimated $40 million to $45 million lower?

And then could you just review again the timing of when you expect to buy back the stock related to the cash portion of the gain?

Sure.

The reason for the lower amount of the gain is that throughout any sale of an asset manager there is a consent process that occurs.

And during that time period the customers have the ability to consent to the transfer or not.

We have seen greater attrition from that process than what we would've expected which is resulting in a lower gain for us.

Our expectation is the transaction will close here in the third quarter and that we can initiate share repurchases once the transaction's closed equivalent to the cash portion of the gain.

So the buyback's in 3Q for this?

That would be our expectation as far as timing, yes.

Okay.

Thanks for taking my questions.

Thank you

Thanks Steve

Bob Ramsey, FBR

Good morning.

I just maybe wanted to follow up a little bit on the buyback to be sure I'm thinking about it the right way.

If you all have approval for $426 million plus the $75 million to $90 million from Victory, less the $112 million you did this quarter, rough math tells me you've got about $390 million left over the next three quarters.

We think about that -- one, is that right and then two should we think about that equally distributed over the next three quarters or will you do the Victory piece sooner since you'll have that gain in the third quarter?

A couple of minor tweaks.

One is that the $112 million did include some share repurchases associated with some employee benefit plans.

And so the net number for the current quarter was about $103 million.

And so that would be the portion that would be tied up against the $426 million of total purchases.

Generally it is fairly consistent throughout the four quarters.

The timing of the Victory purchase would probably be more accelerated than spread out throughout the rest of the year.

Okay.

Great, that's helpful.

And then just a couple follow-up questions on the guidance you gave.

I think you said provisions should be near the same levels on the back half of the year.

I was just curious if that's the same level as this quarter or the same level as the first half of the year?

Good clarification question that our guidance would be more equivalent to the charge-off levels.

So that we would not be anticipating changes in provision being significantly different than charge-offs.

Okay.

I got you.

And then also I think you gave expense guidance but I missed, it was $670 million to I think you said $690 million including efficiency charges, but I couldn't quite catch that number.

The number was $680 million to $700 million including about $20 million of one-time charges.

Okay perfect.

Thank you guys

Thank you

Erika Penala, Merrill Lynch

Good morning.

I just wanted to ask Steven's question another way on the expense side.

As we look out to 2014 do we think of the run rate -- quarterly run rate for next year sort of at $680 million to $700 million range minus the $20 million of efficiency charges?

And if so, if that's the right base, are you growing core expenses from there or is the message that maybe additional savings will offset any investments back into the business?

Erika, this is Don and as far as the Outlook into 2014 we really haven't provided guidance out into that range yet.

But I would suggest that we are to continue to focus on efficiency improvements beyond achievement of the $200 million.

We would expect to be able to utilize some of those savings for further investments in the business to drive growth.

And so as we start to wrap up our outlook for next year will provide more guidance on that.

And Erika -- Erika, this is Beth Mooney.

I would just add that as we have -- are obviously closing in on that $200 million target which we have done at a quicker pace than I think we would have anticipated a year ago with a lot of focus and energy by our team.

We've been intentional in talking about efficiency ratio because I think that's important that you recognize that we are focused on what we can do to both drive revenue as well as lower our cost and variablize our cost base income, also focus on operating leverage through these investments and strategic things we do within our businesses.

Got it.

And just a question on slide 8, given that this has been a big topic among the -- in the investor community.

The 2.5% increase in annual NII, I'm in a 200 basis point rate simulation.

Is that a parallel increase across the curve or is that just a short end?

And also could you give us a sense of what you are assuming in terms of spread compression and deposit runoff in that scenario?

As far as the assumption it's 200 basis point increase over the 12-month period on a consistent basis across the curve as opposed to one and/or the other.

And as far as deposit compression we do have assumptions as far as the level of participation in our deposit rates going up in this rate environment.

I would suggest that we believe that the market will probably underperform that, meaning that the rates will probably go up on the deposit slide slower than what we generally think our models would include.

And on the spread side, on the loan side -- given your comments on deposit do you think that spread tightening up could follow an increase in benchmark rates and also slow?

Our model would assume at this point in time keeping spreads in a general same range is what we're seeing today.

Which is probably about 25 basis points lower than what we were seeing a year ago.

So we have not anticipated further compression beyond that at this point.

Got it.

Thanks.

Thanks

Jennifer Demba, SunTrust Robinson.

Thank you.

Good morning.

Just wondering if you could give us some color on what your customers are -- how your customers are acting these days given you only had sort of stable loan growth on a linked quarter basis.

What's your feeling -- what are you seeing and what you're feeling on the economic improvement and the pace?

Sure, Jennifer.

This is Chris Gorman speaking.

What we're seeing on the part of our clients is they're cautious.

Their businesses are performing well.

But one of the -- I think one of the real telling points of the cautiousness is we are not seeing really a pick up in utilization, but we continue to see for example very strong deposit growth, which I think is kind of one of the things I would point to.

The cautiousness obviously relates around just some of the uncertainty, the 1% or so GDP growth that we're seeing.

So I think they're fairly cautious but at the same point I think they are all performing fairly well.

So that's what we are seeing from our clients.

Jennifer, this is Bill Koehler.

The only thing I would add to that as you can imagine in the Community Bank world we're focusing on smaller companies.

They feel a little more susceptible to change -- potential changes in Affordable Care Acts, any lingering effects from sequestration, because their businesses just aren't as broad and diversified as some of the larger corporate kinds we have.

So you can imagine that they are very careful about how they're choosing to invest right now.

Thank you very much.

Josh Levin, Citigroup.

Good morning.

Your shares have run up quite a bit and I was wondering as you think about your CCAR for the remainder of the year, does the share price appreciation affect how you think about buying back shares?

We do on an ongoing basis evaluate our share repurchase activity based on price and overall return.

But I would say at this point that we still believe it's appropriate for us to continue to purchase Key shares and are very excited about the opportunity to deploy capital that way.

Josh, this is Beth Mooney.

I would just underscore that I continue to believe even at these prices our shares are an attractive purchase and return of capital to our shareholders.

Okay and going back to the loan growth I think when we came into the year I think Key and your competitors, you all sounded pretty optimistic about loan growth picking up in the second half of the year.

But now it sounds like you and your peers they're all sort of -- you know everyone's dialing back expectations for loan growth for the second half of the year.

What's changed?

Why are your consumer -- your customers less confident now than they might've been say six months ago?

Josh, this is Chris Gorman speaking.

I think all the things I just mentioned I think clearly impact our customers.

The other thing about our business model that impacts our loan growth is we, depending on what the market is, we have competition not only from other banks that are very competitive from a perspective of price, structure, tenor, hold limits, but we also have competition from other capital sources.

For example, in our real estate business in the first half of the year we raised a total of $18 billion of capital.

But very little of that actually hit our balance sheet because we were placing that capital elsewhere, acting as agent not as principal.

Now the interesting thing that could happen is we get these changes in interest rates when you think about the steepness of the curve and you think about was going on with interest rates, some of that as we go forward some of our clients may elect the best option may be to put it on our balance sheet going forward.

So there's really a lot of puts and takes.

There's been a ton of liquidity just across all markets and when it's right and it fits our moderate risk profile we clearly are putting it on the books.

But other times we're actually looking for other people to provide other types of securities.

Thank you very much.

Josh I would only add -- this is Bill.

If you look at the economic data it's been relatively volatile.

Month-to-month, quarter-to-quarter in terms of inventory build or inventory drawdown.

If you look at rates the comments that have come out by the Fed and the impact it had -- that has on rates that only creates uncertainty in the market that our clients are reacting to and trying to figure out how to invest against.

Thank you.

Josh, we do feel good about our mid-single digit guidance for here and our loan growth.

Todd Hagerman, Stern Agee.

Good morning everybody.

Just perhaps a question for Chris and Beth.

I just want to follow-up on the commercial servicing in part, the purchases that you announced.

One is basically, given what we've seen in terms of commercial loan growth so to speak over say the past four quarters, I would've expected to see a little bit more transparency in terms of the growth in that business given your position.

And then secondly, based on the purchases at this point and the expected close, how should we think about kind of the potential revenue capture there as well as the offset in terms of expenses?

Todd, it's Chris.

Let me give you kind of an overview.

As Beth mentioned in her initial remarks this was a very important acquisition for us because it made us the number three servicer of CMBS, but it also made us the number five special servicer.

And as we think through the cycle and you think to the next real estate cycle, we initially actually thought we would be named special servicer on $47 billion.

As its turned out because there are a lot of moving pieces, we are actually named special servicer on $52.4 billion.

In terms of the conversion, it's right on target.

We converted the first 3,900 loans on June 24 and we picked up about $700 million in deposits.

So we did give some clarity on that.

We also this weekend will convert another batch of loans that will represent $300 million in deposits.

We've never given a lot of numbers around it.

One of the things I will share with you though is you can imagine with the change in interest rates if you look at the MSRs, while we like the deal initially kind of the two things that have happened to the positive is A, we're executing on time and the next -- the other thing is we have a little -- we have more in terms of special servicing.

And lastly, with the change in interest rates, obviously that has an impact on the value of the MSRs.

That's very helpful.

And then as I combine that with the sale of Victory, for example, which I know the impact is not significantly material.

But as I take a step back and think about this purchase and how significant it is, I would suspect that as you look towards the back half of the year that Beth, you would expect to be able to grow revenues year-over-year at relatively healthy pace so to speak.

Well Todd, as you've seen I think we have done a variety of things to both invest in our businesses as well as make sure we are supporting our organic growth to acquire and deepen client relationships.

This particular acquisition I do think both brings in stable funding, as Chris outlined, about $1 billion of incremental deposits.

It is a market where scale matters.

The number three servicer we think puts us in a position to be in good stead for whatever activity is out there in CMBS market in terms of new issuance as well as C income out of special servicing.

And as we look at Victory, it did not align with our relationship strategy.

We continue to think strategically that it is a good move and that Key was not the best owner for that asset and they will look forward to utilizing the gain proceeds, particularly the cash portion we expect to realize in this quarter to return that capital to our shareholders.

Great, thanks very much.

Mike Mayo, CLSA.

Hi.

The commercial servicing platform acquisition, how much did that add in the second quarter for revenues and expenses and earnings?

Mike, this is Don.

That really did not add a whole lot to the closing of that initial phase was late in June, so we would see more of the benefit from that going into the third quarter.

Can you size that a little bit?

I don't know that we've provided much detail there.

Again, it could be both in the form of deposits and also some fee income and we've not provided any additional clarity there.

Okay.

And the margin going down a couple basis points the rest of the year, what's the impact of the $3 billion of CDs that are maturing for the next two quarters.

And then you have another $3 billion next year I guess that's offset by the pressure on the asset yields?

Can you elaborate?

Sure can.

As we've said, we were down 11 basis point this quarter but five of that came from excess liquidity.

And also two basis points came from reduction of our swaps.

And so we don't believe that either one of those will be negative nearly to the same extent that we experienced this quarter.

As far as loan yields, they were down six basis points in the current quarter, about two basis points of that was related to loan fees which tend to be a little difficult to predict as far as the timing of those.

So normal core loan yields were down about four Bips and we would expect the deposit repricing to add about two basis points back to the margin as we see some of those higher cost CDs mature.

So the net of those -- the four basis point decline and the earning assets and the two basis point improvement and the cost of funds is really how we get to that 1 to 3 basis point outlook per quarter going forward.

And then my main question relates to the growth initiatives.

Don, I guess this is the first call you've been on as CFO, and it'd be great to hear about your philosophy for controlling expenses, improving efficiency.

Beth I know you said this is a milestone not a stopping point for your efficiency targets.

What's the plan ahead?

When do you guys meet, I guess you probably have budget planning meetings later this year.

Can you give us some sense of the ultimate target?

And I'll just note, I mean the expense guidance you gave for year-end on a core basis it looks like not a lot of these expenses are hitting the bottom line.

So just any color you can give.

Mike, this is Don.

And you're right, this is my first call today 8.45 today.

So still learning as we go here.

But I think the approach that we're using here is very appropriate.

That we are keenly focused on driving positive operating leverage and driving improved efficiency for the Company.

As far as how I think are going to see that improved efficiency come through it's really from four levers.

One is executing against our existing plan and making sure that we deliver that to the bottom line and then from that point forward showing a continued discipline to make sure that we remain focused on additional efficiency improvements, not necessarily having stated targets of $200 million here or $150 million there, but driving this as a part of the core cultural of the organization.

Second, we need to get more productivity from our existing resources and that's both people and also our distribution and technology.

And so that will help drive some of the efficiency for us as well.

Right now our third item is our balance sheet efficiency.

We are at 84% loan to deposit ratio.

That is a real drag on us as far as the overall efficiency ratio and margin and we need to see improvement in that going forward.

And some of that improvement will come from the additional productivity I just talked about.

And the fourth component is interest rates.

Just like every other bank in the country these low rates are painful as it relates to our margin and also our efficiency ratio.

And we think that returning to more normal rates will drive our efficiency ratio down somewhere between 300 and 400 basis points.

And so that will be a big plus.

So this isn't an end game as far as our $200 million of cost saves.

It's just the start of the foundation and the team around here is very focused on delivering it.

We have weekly meetings and it doesn't go by without each of those meetings talking about some of the initiatives that we are taking on and the success that we are as far as executing against it.

And contrary to what you said, I would believe that we are showing this drop to the bottom line.

In the second quarter we've demonstrated that we've got a $45 million improvement in expenses year-over-year backing out the impact of our acquisitions and these one-time costs.

So that on an annualized basis is $180 million and that's real money for us and we think that we will deliver existing future improvement from that as well.

All right, thank you.

Thank you

Ken Usdin, Jefferies.

Good morning.

This is Brian Pattaya from Ken's team.

I was wondering if you guys could give us a sense of just timing for how the remaining swap portfolio rolls off and what the asset sensitivity profile would look like without the swap portfolio?

Sure.

We had as of the end of the first quarter about $20 billion in interest rate swaps.

About $15 billion of that was related to our asset liability management.

That dropped by $4.4 billion this quarter.

And so as far as those that are usually -- are used to hedge our loan book it's down to about $11 billion.

The average life of that is 2.3 years and for that $11 billion to come off the balance sheet it would probably take that 2.5% asset sensitivity all the way up to about 8% would be my best guess.

So it's a meaningful impact to our asset sensitivity.

Okay great.

Just one quick one for Chris.

Can you just give us a little bit of color on what the investment banking pipeline looks like relative to last quarter and the same quarter last year?

Yes.

Brian as we look at it, the investment banking pipeline as we look year-over-year is stronger than it was at this time a year ago.

Assuming -- what's interesting about our business model is when all the markets are working perfectly it's not as -- it's harder for us than when you get some volatility as we've had in this market.

Because our business model enables us to go from one type of financing to the other.

So and then of course we go to market with senior level people talking to these middle market companies.

So our pipelines are up from a year ago and actually some of the turbulence that we've experienced in the market since the beginning of May is actually in many ways helpful to us.

Got it, thanks.

Marty Mosby, Guggenheim.

Good morning.

I wanted to ask about the asset sensitivity and the increase of the asset sensitivity about 25% from a 2% hit to a 2.5% advantage in the sense of you increasing that asset sensitivity.

Was that in line with where rates were back in the second quarter?

Do you feel like you're going to continue, like you said if the swaps were runoff that number would explode up to 8%.

Are you going to manage that at this level or are you going to kind of think about increasing asset sensitivity or do you have enough of a yield curve to start using some of that now?

Marty, this is Don and as far as the asset sensitivity on an organic basis our balance sheet will migrate to much more asset sensitive over time.

We do believe that we are going to be conservative in how we position the balance sheet.

That if you would have asked me three years ago where rates were going they were going nowhere but up and I've been wrong since then so I don't like taking big bets.

But we could see that asset sensitivity drift up a little bit.

Our expectation is over the next say 18 months we would start to see some of the short end of the curve maybe move up as well and so we'd like to be in a position to better benefit from that.

I think the one advantage that we do have is given the relative size of that swap portfolio we have the ability to shift our asset sensitivity much quicker than many of our peers.

And so we think that we have a lever there that we can pull to be much more responsive to that overall effort.

Keep in mind too that that swap book has a fairly short life and our investment portfolio is fairly short in duration as well.

It's at 3.2 years even with rates going up.

And so we intentionally managed the balance sheet so that we can capture the benefit of those rate increases fairly quickly.

And then Beth, just a follow-up question on the efficiency ratio.

If you finish out the $200 million under my estimate it would add -- improve your efficiency ratio by another 2 percentage points down to around 63%, which would put you right in the middle of your range.

So going forward I know you're still kind of talking about gauging it, but when the momentum, if you can get some revenue growth and start to see some of the other things, loan growth, coming back would you still feel like you would migrate towards the maybe lower end of that range over the next couple years?

Yes Marty, this is Beth.

As you correctly noted part of what we committed when we unveiled this a year ago was our intent was to be within a near-term target of 60% to 65% on our efficiency ratio and that we would achieve that target by the first quarter of 2014.

As the time and the intervening quarters has played out we have realized our expense savings faster than we would have thought a year ago and I think you're seeing evidence of that as we are now already at the upper end of that 60% to 65%.

As we go into next year and we finalize our plans and as Don said we are instituting this notion of continuous improvement and the cultural change in terms of how we drive not only our cost structure but our productivity.

Those are the sorts of things that will drive further improvement within that range.

So I would tell you that with revenue momentum, with productivity, with cost efficiencies, we are very much top-of-mind that 60% to 65% is a near-term target and that we believe clearly obviously we're on a path to meet our commitment of being there by the first quarter of 2014.

Gerard Cassidy, RBC.

Thank you.

Good morning.

Beth, when you look at your Tier 1 common ratio obviously it's very strong under the Basal III interpretation.

Now that we have that and you folks are not obviously in the top eight banks, what kind of Tier 1 common ratio are you comfortable running at since you're going to be required to hold seven?

Maybe there's a small SIFI buffer of 25 basis points that will be assessed to KeyCorp.

But what number do you think is a comfortable level as you go forward?

Gerard, I'm going to also let Don augment my answer here.

I will tell you that clearly at 10.8 which is our estimate if you were to phase in the Basel III rules as they've been released, we well exceed the 7% floor as well as any SIFI buffer that would be appropriate.

I think we've always talked about our capital as both currently having an opportunity to continue to return to our shareholders what is more than needed even with the phase-in of the rules.

But we would also talk in terms that we would also always want to have our own operating buffer for a variety of reasons as well.

So we are well-positioned.

I think Key is -- continues to be peer-leading in its capital levels which creates a lot of flexibility for us in the future as we go through our plans.

But I'm going to let Don talk a little bit more about his thoughts and [speak] to the ranges.

Sure, Gerard.

And I think that we do have one piece of the puzzle that has been solved for us with the new rules.

I would say that that's only one component so we really haven't stated what our objectives are as far as long term capital position publicly.

One of the other variables that does impact that is the stress test.

I think the stress test will probably result in larger buffers than what's publicly stated as part of Basel III.

And so we just need to make sure that we continue to understand what the impact is there and what level of capital that we feel comfortable operating at and beyond that.

I will tell you that we all believe that our capital position is very strong and with the position that it's in at this point that we do have the ability to continue to return levels of earnings to the shareholders that are probably in excess of our peers just because we do believe that we are operating from a position of strength at this point.

Do you guys expect to publicly disclose to us at some point what those levels will be when you take into account CCAR, though the market will know that you are very comfortable at an 8.5% number or whatever it is?

We will disclose at some point in time more guidance but I don't know -- I wouldn't want to project what the timing of that at this point.

Okay.

And then just as a follow-up to all of this, if your buyback -- obviously you've received approval from CCAR, would you guys use a special dividend as a way of accelerating the return of capital to shareholders if you felt your stock price did get too high?

My understanding, and I haven't reviewed this since I've been here, but my understanding is that the non-objection relates to a cash dividend component and then also to a share buyback.

And that the share buyback cannot be substituted for a one-time cash dividend.

No, no I agree but going forward for 2014 and 2015 you sit down and think about what you want to apply for.

Philosophically you guys think about a special dividend because I see your capital is going to be accumulating, if growth remains modest, very rapidly and would you consider that as an alternative for giving it back to shareholders?

With our 80% combined payout if you look at the total payout compared to the street consensus at the time that the CCAR was announced that should translate to us continuing to leverage our capital position.

You can see in the last quarter that we did see slight declines in some of our capital ratios.

And it would be difficult for me to speculate what might be available to us under CCAR 2014 so I'll go silent at this point.

Gerard, I would just add as you know that we don't usually [fall], there usually is more insight into what will create acceptable plans and it's really too soon to have any visibility into that.

Thank you.

Thank you

As a reminder, please limit yourself to one question.

Alan Straus, Schroder Investment Firm.

Hi, good morning guys.

I think you did a good job controlling what you can control in this environment when your customers don't want to borrow money you don't want to just make bad loans.

But could you comment on the mortgage servicing business?

Do you see any ability to get some loans out of those customers or is this really more just servicing and gaining deposits?

So Alan, it's Chris.

There's -- we have -- there is an opportunity when you service loans to convert some of those into borrowing customers.

Candidly in the past we have not been real successful in doing that.

Basically the economics stand on their own in terms of servicing rights.

What I think the more interesting opportunity is, is this whole notion of this big pool where we're named special servicer.

And as named special servicer, these will be loans that need to be restructured, Alan, where we don't have any capital, but we can be the solution to the problem without having any exposure to it.

That I think is even a better, a more interesting opportunity as we look forward.

Okay, thanks.

And those special servicing drive C income so that you get paid for the various activities.

So it is an interesting hook to continue to build special servicing rights.

And for example you could raise junior capital, et cetera.

Right.

I mean, your investment bank should be teed up, or are you hiring there on the investment bank on the special servicing side?

We haven't hired on the special servicing side per se.

But we clearly have ramped up on our real estate investment banking side over the last several years including hiring people that are experts in raising private capital.

In the real estate business it's often called JVs, but we have a whole team of people that raise non-control junior capital for developers.

So the answer is yes.

And Alan, I would just add one other thing.

As we look at these various things they create opportunity for us to leverage what we think is a very distinctive platform.

So we have the capacity to do a number of these things without necessarily having to increase headcount.

It goes back to this notion of how to think about efficiency that Don outlined that is not just efficiency and cost but it's the efficiency of your balance sheet and efficiency of your platform that we can put more throughput in it.

Okay thank you.

Brian Foran, Autonomous Research.

Good morning.

Good morning.

Don, I apologize because I'm probably going to screw up this description, but at your old -- in your old role a couple years ago there was a swap transaction where, if I understand it right, the benefit was kind of pulled forward, there was a stair step down and the life was short and didn't you end up more asset-sensitive at the end, but the benefit of the swap income kind of shortens up.

Can you just remind us when you talk about levers you can pull on swaps is that is something that's always available or was that transaction kind of unique to that point in time?

That transaction was not unique.

It was basically terminating swaps early.

And then you can go back in and enter into new swaps over a longer duration.

And so we did terminate some swaps early this quarter.

That of the $4.4 billion, I believe $2.5 billion were early terminations or thereabouts and we decided not to go back in and enter into new swaps.

And so we allow the asset sensitivity to increase as a result of that.

And by being more proactive, I think it's much easier for us to reposition our asset sensitivity by managing the overall swap book than it is for any other asset class on the balance sheet.

So for instance you can get more asset sensitive by selling out of your investment portfolio, but that will result in a gain or loss in the security and then you'll have to figure out what to do with those proceeds.

On the swaps you can terminate those and that automatically switches your balance sheet to being more asset-sensitive.

And so that's why I think that we're fortunate here in the way that Key has positioned its overall balance sheet and interest rate position to be able to leverage that swap book a little bit more disproportionately than many of our peers might be able to.

And you touched briefly on it, but do you have a strong view right now on when rates are likely to go up?

Or is it more just you felt there was no way rates were going down from where they were back in April and May?

Brian, I hope you have somebody with a better crystal ball than I do at this point because I think that we do believe that rates are going to go up at some point in time but that right now I wouldn't see that occurring in 2013 on the short end of the curve or even the first half of 2014.

And that would be my personal expectation that we will wait and see how things play out here over the next couple of quarters.

My crystal ball has been broken for a couple years now so -- (laughter).

Thanks.

Thank you

Terry McEvoy, Oppenheimer & Company.

A question for Beth.

Beyond closing branches can you talk about the realignment of the Community Bank.

Was the decision more than just finding a way to cut costs?

And any early data on customer attrition?

Does that give you more confidence or less confidence on continuing to look at the opportunity to close branches?

Terry, I'll also let Bill Koehler, the president of our Community Bank add to some of my comments.

But as it relates to branch closures based on what we have accomplished and will through the balance of the year, it will be about a 7% of branches and what we identified in these branches tend to be low profitability, low traffic count.

And as we have closed and/or consolidated, and many of them are near another branch of service, we have experienced very little attrition, well below what we would have expected when we modeled this a year ago.

¶ So it does give us confidence that in, as we rationalize both our ATM network and our branches that this can be done in a way that is helpful to our cost initiatives, our efficiency without material client impact.

And then with that I'm going to let Bill Koehler just give a couple headlines about what was done in the broader Community Bank alignment that is both going to make us more efficient, more productive and more focused.

Terry, this is Bill.

The realignment was really focused around two things.

Obviously efficiency, but more importantly putting our teams in a better position to drive revenue growth through more focused execution of better defined strategies.

So to the -- so part of that related to creating one fully integrated national consumer franchise where we could focus our teams on more consistent sales execution.

Throughout the platform we think there's an opportunity to grow revenue there.

And the second was around refining our go to market strategies and value proposition with respect to middle market business banking and private banking.

And there it's very much about identifying those clients who tend to typically be privately owned businesses, their owners, their employees, and finding ways to target our broad capabilities in a more relevant way to those clients to drive better growth.

Great.

I'll leave it there.

Thank you.

Ryan Nash, Goldman Sachs.

Just one follow-up from a question from earlier.

I guess Beth or Don, when I look at the capital position now you're at 10.8%, Tier 1 common under Basel III, and someone mentioned this morning that they think that we could see a fairly decent pick up in M&A in 2014 as we start to get a lot of the -- find a lot of the new regulations moving into place.

So I guess my question would be, given that you've shown in the past the willingness to be acquisitive do you agree with that view that we could see a pick up across the industry?

And what is your appetite to do deals given the strong capital position?

Ryan, this is Beth.

We've always said that, I think our capital priorities have been clearly stated.

That our capital is and does create advantage and opportunity for us.

It is obviously been able to record our organic growth platform because it's been able to dividend and share repurchase in order to return capital to our shareholders.

And then it also creates and has been able to assist us as we've opportunistically over the last year or so done a variety of acquisitions to augment product capabilities, add to geography and consistently create our scale and presence in the commercial servicing market.

But with that, I think this is another crystal ball question as to when M&A will actually and actively pick up.

I think as we have gone through the last couple years it has been a pretty muted market and most transactions have been for very particular reason.

We have said that with our geographic franchise as well as our very differentiated platforms that we could be opportunistic and would evaluate if things are additive to our business model, if they are additive to our client relationship philosophy and that they are good for our shareholders.

So as this too unrolls and unveils know that we would be opportunistic, but I've also always said very, very disciplined, that it has to fit our business models and be good for our shareholders.

Great.

And just in case I missed it earlier in the call, in the 1 to 3 basis points of quarterly NIM compression is there an assumption that you will be redeploying some of that higher liquidity that you talked about earlier in the call?

The assumption is modest.

What we did say in the call was is that we expected loan growth to exceed deposit growth.

And so there would be some implication there that we would see some of that liquidity being used, but that we are not reliant solely on that.

Great thanks for taking my questions.

Thank you

John Moran, Macquarie Capital.

Hey guys, thanks.

Really the last thing that I have left on the list here is just kind of circling back on the OpEx guidance.

Don, just wanted to make sure that that guidance is inclusive of any incremental cost on the commercial servicing deal?

That is.

That's correct.

Okay.

And then the $20 million in charges on the efficiency program, we would expect to see $20 million in both third quarter and fourth quarter or is that only -- are you only talking about third quarter there?

That $20 million is really more a reflection of what our fourth-quarter forecast would've shown, but it wouldn't be out of line for third quarter as well.

Perfect.

Thanks very much, guys.

Thank you

I'd like to turn it back to our speakers for any additional or closing remarks.

Thank you, operator.

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

If you have any follow-up questions you can direct them to our investor relations team, Vern Patterson or Kelly Dillon at 216-689-3133.

That concludes our remarks and thank you, operator.

This concludes today's conference.

Thank you for your participation.