KeyCorp (KEY) 2013 Q4 法說會逐字稿

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

This call is being recorded.

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

Please go ahead ma'am.

Thank you, operator.

And good morning and welcome to KeyCorp's fourth-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 our Key Corporate Bank and Key Community Bank, Chris Gorman and Bill Taylor; also joining us for the Q&A discussion are our Chief Risk Officer, Bill Hartmann, and our Treasurer, Joe Vayda.

On 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. I will start with some comments on the year and then turn it over to Don who will discuss our quarterly results.

2013 was a good year for our Company.

We acquired and expanded relationships in our targeted client segments, invested in our businesses, improved efficiency, and returned peer-leading capital to our shareholders, and all of this was reflected in the performance of our stock last year.

On the left-hand side of the slide are three focus areas that we identified at the beginning of the year: optimizing and growing revenue, improving efficiency, and effectively managing capital.

We made meaningful progress in each of these areas.

First, I'll begin with revenue.

Despite the continued low interest rate environment and slow economic recovery, core revenue trends remained relatively stable in 2013.

Excluding the gain from the redemption of our trust preferred securities in 2012, revenue was up 1% for the year.

Importantly, we grew both consumer and commercial loans with total average balances up 5% in 2013.

The primary driver was commercial, financial, and agricultural loans, which were up 12% for the year and continued to outpace the industry growth rate.

Net interest income was up 3% from the prior year and we had positive momentum in a number of our fee-based businesses.

One example is investment banking and debt placement fees, which grew for the fifth consecutive year.

We also benefited from the investments we had been making in our businesses.

For example, cards and payments income was up 20% from 2012, reflecting the successful acquisition of our Key branded credit card portfolio.

And mortgage servicing revenue more than doubled from 2012 as we built scale from our acquisition of a servicing portfolio in special servicing business.

The second focus area was efficiency.

In June of 2012, we committed to reduce annual expenses by $150 million to $200 million by the first quarter of 2014.

In the third quarter of last year we reported that we had exceeded the high end of this range one quarter ahead of our original goal.

Through the end of the year we implemented $241 million in annualized savings.

Our actions included reducing and realigning our staff, consolidating branch locations as we optimized our distribution channels, and in total we consolidated 81 locations or approximately 8% of our franchise since the launch of our [efficiency] initiative.

And just as important, the achievement of our cost savings is the cultural change that has taken place within our Company.

Efficiency and positive operating leverage are becoming part of the fabric of Key.

Leaders and employees throughout Key are focused every day on continuing to perform against these important objectives.

We are committed to maintaining this type of discipline going forward without the need for named programs in the future.

And finally, capital management.

We remain disciplined in managing our peer-leading capital.

Adhering to our capital priorities, we continue to invest organically, increase our dividend by 10%, and repurchased $474 million in common shares during 2013.

The result was a payout ratio of 76% for the year, which we believe places us among the top companies in our peer group while maintaining some of the strongest capital levels in the industry.

Overall, it was a very meaningful year for Key, including the successful execution of a number of strategic imperatives.

We continue to invest in our business to drive organic growth as well as adding commercial mortgage servicing and fully integrating our credit card and payment platform.

We continue to sharpen our strategic focus by divesting parts of business that did not fit, such as Victory Capital Management, and we met the commitments we made through our efficiency initiative to reduce expenses and lower our efficiency ratio.

I am proud of our team and I am proud of our performance.

In 2014, we will sustain our momentum and drive performance by continuing to focus on three priorities.

The first is driving positive operating leverage by acquiring and expanding client relationships, investing in our businesses, and continuing to improve efficiency and productivity.

The next is maintaining a moderate risk profile and a balanced approach to risk and reward.

And the final priority is remaining disciplined in the way we manage capital and executing on our stated capital priorities.

Now I'll turn it over to Don who will comment on our fourth-quarter results and outlook for 2014.

Don?

Thanks Beth.

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

This morning we reported net income from continuing operations of $0.26 per common share for the fourth quarter.

This compared to $0.25 for the third quarter of 2013.

Our results include charges related to our previously announced efficiency initiative and pension settlement of $0.02 in the fourth quarter, compared to $0.03 for the third quarter.

I'll cover many of these results in my remarks, so now turn to slide 6. Loan growth has remained a very positive story and reflects our distinctive business model and more targeted approach.

Average total loans for the fourth quarter were up $337 million, or an annualized 3% compared to the third quarter of 2013, and up $1.7 billion or 3% compared to a year-ago quarter.

Our growth was driven primarily by commercial, financial, and agricultural loans across Key's business segments.

Much of the activity occurred toward the end of the quarter, resulting in larger increases in period end than average loan balances.

In the fourth quarter period-end balances grew 2% from the prior quarter or 6% annualized, which outpaced the industry growth.

And in the fourth quarter, total commitments were up while utilization was relatively stable.

Our outlook for loan growth in 2014 remains consistent with our prior guidance of mid-single digit full-year growth driven by CF&A.

A change in pace in the economic recovery could impact client demand and loan growth relative to our current expectations.

Continuing on to slide 7. On the liability side of the balance sheet, average deposits, excluding foreign branch balances, were up $2.4 billion from the third quarter, and up $4.7 billion from one year ago.

Deposit growth from both the prior quarter and the year-ago quarter was primarily due to the higher escrow balances from commercial mortgage servicing, and continued client inflows, particularly in business and public sector clients.

This growth in deposits resulted in similar increases in our short-term investment portfolio, which increased $2.8 billion from the quarter.

This increased liquidity was the reason for the reason for the 10 point basis point reduction in our net interest margin.

Over the past year our mix of deposits have significantly changed with CDs declining and low-cost transaction accounts increasing 11%.

As a result year-over-year deposit costs declined from 31 basis points to 20 basis points.

Turning to slide 8, our taxable equivalent net interest income was $589 million for the fourth quarter, compared to $584 million for the third quarter and $607 million for the fourth quarter one year ago.

Results in both the fourth and third quarters of 2013 reflect the impact of the early termination of leverage leases.

These transactions reduced net interest income by $8 million in the third quarter and by $3 million in the fourth quarter.

For the fourth quarter our net interest margin was 3.01%, which was down 10 basis points from the prior quarter.

This was in line with the guidance we provided in December which reflected higher levels of liquidity from escrow balances primarily related to the acquisition of the mortgage servicing business from the Bank of America in Berkadia.

The higher level of liquidity was reflected in the $2.8 billion increase in the short-term investments.

This increased liquidity level reduced our net interest margin by 11 basis points.

In 2014 we expect our net interest income to be relatively stable with reported level in 2013.

We would also expect to maintain modest asset sensitivity.

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

In the duration, the characteristics of Key's loan and investment portfolios continue to position us to realize more benefits from a rise in the shorter end of the yield curve.

Slide 9 shows a summary of our non-interest income, accounts for approximately 43% of our total revenue.

Non-interest income in the fourth quarter was $453 million, down $6 million from the third quarter but above the $439 million in the fourth quarter of last year.

As I mentioned previously, we had leverage lease terminations in both the fourth and third quarters of 2013, which provided a benefit of $4 million in the fourth quarter and $23 million in the third quarter.

Excluding the impact of leverage leases, non-interest income would be up 3% from the prior quarter.

As Beth highlighted we are also benefiting from investment in many of our core businesses.

For example, cards and payment income is up 5% compared to the same period one year ago, and up 20% from full year compared to 2012.

This is reflective of our focus on and commitment to providing clients with the full suite of payment products.

Turning to slide 10, our non-interest expense for the fourth quarter was $712 million, including $24 million in charges related to our efficiency initiative and pension settlement.

Adjusted for the efficiency and pension settlement charges, expenses were down 4% from the prior year.

This level was above our guidance for the quarter due to the higher-than-expected charges related to our efficiency initiative, as well as higher than expected technology costs, operational losses, and expenses related to the share price performance in our compensation plans.

Importantly, we expect expense levels to come down meaningfully in the first quarter, reflecting the full run rate of our expense savings.

During the quarter we closed 16 more branches, reaching a total of 81 or approximately 8% of our franchise since the launch of our efficiency initiative.

As Beth commented earlier, our efficiency initiative reached $241 million in annual expense savings.

Going forward the savings from our continuous improvement efforts will be embedded within our expense run rate and we believe will help drive our efficiency ratio lower.

We have made a lot of progress but there is still a lot more that we can do to improve productivity.

Turning to slide 11.

Our net charge-offs declined to $37 million or 27 basis points of average total loans in the fourth quarter.

This continues to be below our targeted range and is the lowest level since the first quarter of 2007.

Total commercial loan net charges this quarter remained low at 2 basis points of average loans, and gross charge-offs improved by $12 million or 15% from the prior quarter.

The break down of the asset quality by loan portfolio is shown on slide 17 in the appendix.

At December 31, 2013, our reserves for loan losses represented 1.56% of period-end loans and 167% coverage of our non-performing loans.

We expect charge-offs to remain at or below the targeted range in 2014, and for loan loss provision to approximate the level of net charge-offs.

Turning to slide 12, our tangible common equity ratio and our estimated Tier 1 common equity ratio both remain strong at December 31 at 9.8% and 11.23% respectively.

Our current estimate of Tier 1 common equity as calculated under the final rule was 10.6%, which exceeds the fully phased-in minimum requirement.

As Beth mentioned we repurchased $474 million in common shares in 2013, including $99 million in the fourth quarter.

We have approximately $90 million of net share repurchase authorization remaining under our 2013 capital plan, which runs through March of this year.

We submitted our 2014 capital plan to the Federal Reserve earlier this month, and plan on announcing our results in March following the Federal Reserve's release of their analysis and findings.

Moving on to slide 13.

This is a summary of our outlook and expectations for 2014, consistent with my comments today.

As I stated earlier, we expect average loans to continue to grow year over year in the mid-single-digit range, and our net interest income to remain relatively stable with our reported level in 2013.

Revenue should also benefit from the full-year low-single digit growth in non-interest income compared to the prior year.

We anticipate expenses will be down low-single digits on a full-year basis.

This guidance reflects the impact of implemented expense savings, planned investments, as well as future costs associated with implementing additional cost savings initiatives.

Credit quality should remain a good story with net charge-offs at or below the lower end of our targeted range of 40 to 60 basis points.

Our GAAP effective tax rate should be in the 26% to 28% range this year, excluding the impact of any additional lease terminations.

And finally, capital management will remain a priority, including continuing to execute on our remaining share repurchase authorization.

With that I will close and turn the call back over to the operator for instructions on the Q&A portion of the call.

Operator?

Thank you.

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

(Operator Instructions)

Let's begin with Erika Najarian with Bank of America Merrill Lynch.

Yes.

Good morning.

Good morning.

I just wanted to -- my first question is clarity on the expense guidance for 2013.

I was wondering whether or not the base under which we should take the single-digit decline would be the GAAP base or the adjusted base excluding the efficiency charges?

The guidance should reflect the actual reported expense base of $2.820 billion.

We would expect to see a low-single digit kind of reduction from that level for the full year of 2014.

Keep in mind, though, that guidance also does reflect the impact of investments as well as other costs expected to be incurred in connection with further expense reductions.

Got it.

And my follow-up question is on the net interest income guidance.

Could you give us a sense on where Key is positioned with the LCR proposals as you understand it?

And if you do need to continue to build liquidity from here, whether or not that's already fully embedded in your net interest income outlook for the year.

Great.

As far as the LCR as currently drafted, we haven't provided what our estimated calculation would be.

There are a couple pieces of that proposal that do cause some challenges for us.

One is the treatment of collateralized deposits, which we -- an unintended consequence of the current draft, and also some of the handling associated with agency securities that, once the rules are finalized, and we believe that there should be some positive hopefully changes from that, of those issues, we should be in good standing without any significant changes to the overall balance sheet.

Okay.

Thank you.

Thank you.

And we'll go next to Ryan Nash at Goldman Sachs.

Great.

Good morning, guys.

Hi, Ryan.

Good morning.

Just on the efficiency guidance of the 60% to 65%, I use the midpoint of each piece of your guidance and I think it implies an adjusted efficiency ratio around 65%.

I know, Beth, you've talked about getting to the middle-end of that range without higher rates.

Is it fair to say that this can be achieved over the next 4 to 6 quarters, or is this more likely to take a multi-year process?

I'll start with that answer and then I'll let Don add some color.

As we go into 2014, I think everybody can see the effect of pressures on loans and interest rates.

So as we look at it, we look to the growth in our balance sheets that we have seen in loans and deposits, growth in the businesses where you have seen us invest in cards and mortgage servicing.

So our goal is to clearly talk about positive operating leverage, where our revenue will exceed our expense growth, and embedded in that is continued expenses and an opportunity for further reductions and the opportunity to pace our investments and make sure that we are pairing them indeed with the revenue that we expect.

It supports our strategy.

I think the Company definitely has the right focus, and I believe you will see progress within the range in 2014.

And with that I'd let Don add his comments.

I think you are absolutely right, Beth.

We are very focused on driving positive operating leverage.

With that we do believe that will translate to improvements in our efficiency ratio.

I wouldn't want to suggest that it's going to be from the same pace that we saw from the second quarter of 2012.

We were at 69% to the current quarter, we're at about 65%.

But we do believe that it will be a measured improvement on a year-over-year basis.

Got it.

And then just a follow-up question on your mid-single digit loan growth guidance.

A couple pieces to the question.

I think you highlighted CF&A as an area that you expect to see growth.

But given the improvement we've seen in CRE and construction, what are your expectations for those portfolios?

Can we continue to -- can we see those picking up at an accelerating pace?

And then just also related to overall loan growth, you noted that there was an acceleration towards the end of the quarter.

Is any of that seasonal?

Are you seeing corporates paying that down early in the year?

And just one last piece of the question.

You noted that your economic outlook is muted.

Can you just give us somewhat of an outlook in terms of what you are actually expecting for a broader macro picture?

Ryan, let me start -- this is Chris Gorman.

Let me start with the CRE question.

And then, Beth, I will ask you then to come back on our view from the macro perspective.

As it relates to CRE, Ryan, we do think we can continue to grow that portfolio.

Our real estate business is an interesting one in that only about 15% of the capital we raise do we put on the balance sheet.

Having said that, as we look at our jumping off point for 2014, we had a lot of growth in the fourth quarter of CRE.

So we have a very good jumping off point.

And the business has a fair amount of momentum.

With that I would caveat it.

We are watching certain multi-family markets very carefully and we're tightening our screens.

Having said that, we believe we can continue to grow our CRE business and the pipeline looks strong.

As it is relates to kind of our macro view.

Ryan, I would just tell you that clearly our guidance is reflective of the momentum of our view of interest rates, our view of the economy as we go into 2014.

I think as you will see kind of across the board, as you look at the conference calls, the banks, as well as just the general tone in the market, 2014 is a year that is beginning with more economic strength and optimism than we have seen in past years.

So the tone, the market performance of last year, the fact that there was a beginning of tapering in December, that we have a budget deal, we have always talked about our clients as being cautious or cautiously optimistic, but we have also said that our commercial middle market and corporate clients are well positioned, they are profitable, they have good balance sheets, they are carrying high liquidity.

We saw signs last year of consumers showing recovery, particularly as housing prices began to firm up.

So could this play out to be an opportunity in 2014 I think is a big question that we will all be watching as the year goes on, is if these things do indeed translate into greater confidence in business and consumer -- consumers will we see increased activity from what we are projecting?

I would tell you that it is too soon to see if that would cause any changes.

I think our guidance is solid.

I think it's reflective of what (inaudible) we can deliver.

But I will also tell you that our business model is well positioned for the economy improved demand increase as the year unfolds, we feel very well -- very good about how we have positioned ourselves in the market.

Ryan, you had one other sub question there as far as the year end growth.

I would suggest that it was led by commercial real estate, as Chris has alluded it, and also equipment finance.

So this wasn't some of the typical window dressing you might see from some commercial borrowers at the end of the year.

This was core business that we believe will start as a good launching point for us in 2014.

Great, guys, thank you for taking my questions.

Thank you.

We will go next to Josh Levin at Citi.

Good morning.

You have closed some branches over the past year or so.

And I was wondering, what's the process you're using to evaluate potential future branch closings?

Josh, this is Bill Koehler here.

It is the same process we used for the 81 others.

We take a look at individual branch productivity, as well as, we call it branch share, which is looking at the broader impact of the way all our clients, middle market clients, business banking clients, and consumers engage in that branch and the revenue that is derived from it.

And as we look at the footprint and the productivity of the branches we have, we do see opportunities as we move forward to continue to optimize our branch network.

We do think we are at a position where we can optimize our network in what would be a more normal pace that you would typically see from any retail company.

And part of it is dependent on the pace at which we can generate more revenue from the investments in our digital channels.

We feel good about some of the progress we're making there but there is more work to be done.

Okay.

My second question is about capital.

We don't yet know what your minimum regulatory capital requirement will be, but it's pretty clear that you have excess capital.

How should investors think about that excess capital?

Does it ultimately get distributed to shareholders?

Should we assume at some point, not in 2014, but at some point your payout ratio exceeds 100%, or is that excess capital now a permanent part of your capitalization?

Josh, I'll paint some color on our capital priorities and then I'll let Don add some of his thoughts.

I think we have been pretty clear all along on our capital priorities and been consistent that we are fortunate to have a strong capital base that supports our ability to invest and grow our Company organically, that we are committed to our dividend, we're committed to share repurchase, and that with that strong capital we feel like we have a competitive advantage to opportunistically grow our Company, that that does indeed create future opportunities for us to continue to invest and grow.

In terms of, as you said, there is (inaudible) capital ratios left.

We continue to participate, obviously, in the annual CCAR process.

We believe we are well positioned as a Company, strong foundation of which to go into the CCAR process and are looking to build a consistent track record with our shareholders for how we manage, divest, and deploy our capital.

At this point in time I'll let Don talk about the relative level of capital.

But I think it's premature to indicate a capital level because the rules aren't final in that regard.

I agree.

I think Josh, as far as our capital levels, I think it's going to be more dictated based on the results of the stress test prospectively than it will be on any type of reasonable buffer.

But even with that, we do believe that we have very strong levels of capital and more than what our business model would suggest that we would need to have to maintain a very profitable strong balance sheet.

And we he do have the current constraints as far as the capital planning process and I would not want to project when those rules or guidelines might change.

I will tell you, as Beth stated, that our priorities are to support organic growth, to continue to have a strong common dividend to return shareholder -- equity to the shareholders in the form of share buyback and to make it available for any other strategic opportunities, but that we are going to be prudent in how we manage that capital prospectively.

Thank you very much.

And we'll go next to Steven Alexopoulos at JPMorgan.

Good morning, everyone.

Good morning.

On the expenses, on last quarter's earnings call you guys guided to -- I think expenses were $680 million to $700 million, including one-time items in the quarter.

And one timers came out at it was $2 million above the upper end of the $15 million to $20 million range.

But total expenses are $12 million above the upper end of the range and that was only a few months ago.

Can you walk us through what drove expenses coming in so much higher than the upper end of guidance?

Sure, I think you started some of the walk forward there, Steven.

But essentially the one-time costs were $24 million, which was the expense initiative and the pension settlement cost of $24 million.

And so that was a roughly $4 million higher than our guidance.

We also had expenses associated with operating loss.

We also had some higher technology costs than were expected, and we also had some increased costs associated with compensation plans that have a component tied to our share price.

And the three of those areas cost us around $12 million.

And so if you would adjust for those areas, that I think the core expense base for the current quarter is just shy of the $680 million range, which would put us within that guidance range that we would have projected at the end of the third quarter.

So we acknowledge that it was higher.

We would suggest that the nature of those expenses that caused it to be higher would be more one time in nature or non-recurring, which gives us some confidence in our expense guidance going into 2014.

Don, maybe I could follow up on that guidance?

The way I'm looking at basing it off of a base that includes one-time items doesn't give us really much transparency at all into how you are planning to manage expenses in the new year.

You look at core expense levels, right, which I think was $2.7 billion for the year.

So we know you need to make investments next year.

Can you offset those and at least hold core expenses flat for the year?

Well our expense guidance was down low-single digits, and we've defined low-single digits as less than 5%.

So if you take that $2.8 billion reported expense base and reduce it by the more in that range, I think it would imply a fairly flat to maybe slightly down expenses from that core level that you had cited.

So we have committed to the $241 million in expense savings that has been implemented.

We would expect to see and realize the full benefit of that in the first quarter of 2014 prospectively, and our guidance does include the additional investments we are planning on making along with an estimate of what we think will be one-time costs associated with further expense reductions that we have planned going into 2014.

Great.

I appreciate the follow-up color.

Thanks.

Thank you.

We'll take our next question from Matt O'Connor at Deutsche Bank.

Hi.

Good morning this is Rob Placet for Matt today.

How are you guys doing?

Good morning.

As it relates to your fee income guidance of low-single digit growth versus 2013.

I guess first, what categories do you expect to drive growth in 2014, and will it be a continuation of what you've seen in 2013?

And then, secondly, if we look at the implied full-year 2014 fee income number, just comparing that to the 4Q annualized level, how should we think about kind of growth versus the 4Q annualized level?

Right.

Yes.

As far as the guidance for 2014, a couple of areas that we think will be strong contributors to us in the 2014 results for fee income growth.

One is investment banking and debt placement fees.

We are expecting that to outpace the rest of the fee income categories.

And the second would be in cards and payments related income.

We made some investments there and we really launched our proprietary card here in the late third, early fourth quarter.

And so we're expecting to see lots of benefit from those two areas.

If you take a look at the fourth quarter of $453 million, there are some items in there that are more seasonal in nature, including our Corporate owned life insurance income.

We tend to have a pickup in the fourth quarter there and some of the other categories will show some normal seasonal trends, too.

For instance, in the first quarter, with the day count being two days smaller or less, that it does create some pressure on some of the fee income categories in the first quarter compared to the full-year run rate.

Okay.

Great.

And then just as it relates to your net interest income guidance for 2014 of flat year over year, I guess what does this imply for the net interest margin?

And can you just talk about kind of the trajectory of the NIM kind of as we go through 2014?

And then maybe your ability to deploy some of the liquidity build you see in 4Q?

Good question.

I would have suggested that we would have seen more utilization of our excess liquidity earlier in the year throughout 2013 and we continue to see it build.

Our guidance is on net interest income and not necessarily on the margin because of that, because we would expect to see higher levels of liquidity continuing in the first part of 2013, which would imply initially maintaining a margin that's fairly close to the current level because those excess liquidity levels would continue.

On a normal basis throughout 2014, we would expect to see the lower rate environment still have a 1 to 2 basis point negative impact on a quarter basis and that will put pressure on the margin that would be offset by some of the benefit of utilization of that excess liquidity throughout the year.

Okay.

Thanks.

We'll go next to Craig Siegenthaler at Credit Suisse.

Thanks.

Good morning.

Good morning.

So, first, I just wanted to hit on expenses one more time here.

I'm wondering, Don, maybe if you could provide some additional detail behind what specifically drove the operating loss, and also the IT trend in the fourth-quarter results?

Yes.

As far as the operating loss, it was an individual issue that would be non-recurring.

It was less than $4 million.

So it wasn't a large dollar amount, but it did result in a negative variance and we did recognize that later in the quarter.

As far as the IT costs, we had a lot less capitalized IT and more expensed IT in the current quarter based on the nature of some of the projects.

And that worked out to be about a $4 million negative variance there, as well.

So those are the two primary areas associated with that variance.

Okay.

And then just on commercial real estate, you had a really nice momentum here in the fourth quarter on both the loan generation and also the fee income side.

Can you update us in terms of what you have seen in the last few months, and also how the joint venture with Berkadia has played into it?

And also what are you seeing on the construction front, and also the permanent financing segment?

Because it seems like some banks have talked about competition easing a little bit on the back part.

So, Craig, Chris, so what we're seeing from a competitive landscape is really not a big change.

We compete really in all the segments between on balance sheet, CMBS, Fannie, Freddie, FHA with the institutional market, which is primarily insurance companies.

So we don't see a huge change in the competitive landscape.

What we do see, and I think I alluded to it earlier is, we see markets where there has been a lot of building, specifically in multifamily, specifically in certain markets.

Having said that, there are plenty of opportunities outside of those markets, and even in those markets we see opportunities with our really great customers and people that we require them to put in more equity.

So we feel good about the real estate market.

But it's been -- probably the bright spot has been multi-family.

And as you look at the cap rates, it manifests itself in that multi-family cap rates right now are somewhere between 5.5% and 7.5%.

And they didn't really change after the 10-year went up 110 basis points.

All right.

Great, guys.

Go ahead, please.

I am sorry.

You go ahead.

As it relates to our third-party commercial loan servicing business, we continue to have a lot of momentum in that business.

The CMBS market this year was about an $80 billion market, up from around $60 billion.

But what's really interesting for that business is, we're now at a point where a lot of the CMBS that we service are maturing.

And so that gives us an opportunity to garner more servicing.

It also gives us a unique opportunity to look into those and see what pieces and parts we might want to finance.

And then the last piece, and it actually impacted us positively in the fourth quarter, is the special servicing business that we have really grown and then picked up two additional pieces.

We are named special servicer now on about $50 billion, up from kind of mid-teens just a couple of years ago.

And that's a counter cyclical business.

You're basically the work out agent, and by definition you are not a lender into that deal.

So that's an area that really hasn't kicked in yet.

But when the market gets softer, as it inevitably will, that will be an opportunity for us.

And just one follow-up.

As those loans mature within the servicing portfolio, when do you think your servicing portfolio will actually start to drive stronger commercial real estate loan growth?

Will it be in 2014 or is it more in 2015 and later event?

As you look at the refinancing cliff, I would say that there will be some in 2014.

But 2015, it should accelerate in 2015.

Great, guys.

Thanks for taking my questions.

Thank you.

Thanks.

(Operator Instructions)

Mike Mayo at CLSA.

Can you reassure more on efficiency?

And I guess there is three parts to my question.

And I guess there has been about five or six questions on efficiency.

Your stock is down 4% in the opening minutes.

With all the questions on expenses and efficiency, I'm guessing it has to do with that.

But first the 2014 guidance for positive operating leverage, but having the efficiency chart is included in the base for 2013, I think that's probably the biggest concern.

On slide 10 you show the efficiency ratio without those charges.

Then when you guide forward, you include those back in.

So just any more comfort on 2014?

I guess you said flat to down.

But I am not sure what else you could do that would be helpful.

The second part of that would be the efficiency target.

At the annual meeting, Beth, you said 60% to 65% is not an ending point, and the target range, 60% to 65%, is still worse than where the Company was 20 years ago.

And I guess the third point what this is leading to is just more details, and Don, I appreciate you saying a lot more to improve efficiency, but we don't have any numbers.

So anything else you can give us.

I guess, are you going to stop reporting the $241 million annualized savings?

Do you have new number?

Branch closings?

FTE?

Which business areas?

The 65% is still a really lousy efficiency ratio.

Beth, you have made tremendous progress over the past couple years, not to take anything away from that.

But just as stocks go up, they can go back down if that progress is stalled, as it looks like it's been stalled in the fourth quarter.

Thanks.

All right.

Mike, there were many parts to that question.

If I could, I will address the target and then I think you had some very specific questions on certain slides and certain numbers that I am going to ask Don to fill in.

And I would reiterate that 60% to 65% is not the end of where we see the path for Key as we become a more efficient Company.

As we look at 2014, we are reaffirming 60% to 65% as the goal.

The range for 2014, that's driven by a couple of factors.

I alluded to one of them earlier, which is the continued low interest rate environment.

The pressure everyone is seeing on their net interest income as a result.

Strong balance sheet growth isn't necessarily translating into topline revenue growth in this particular environment.

So I think our goal this year, and what you should watch and hold us accountable to, is our ability to move within the range, both by every single day our ability as we talk about positive operating leverage is to grow our businesses, to grow our revenue, to become more efficient, continue our journey of reducing our cost base.

But at the same time as you have heard us talk about some of the investments we have made are bearing fruit, specifically in the commercial mortgage servicing business, in our cards and our payments.

And we are going to continue to invest because we believe it is benefiting our business mix, the vitality of our Company and fits within our profile from a risk point of view.

So 60% to 65% is not an end, but it is the right range for 2014.

And as I said earlier, our goal is to move within that range during the year.

And then I think you had some more detailed questions that I'm going to turn over to Don.

Sure, Mike.

And as far as the expense guidance that we always want to baseline that with our reported numbers.

And so the $2.820 billion is our total expenses for 2013.

The low-single digit kind of decline year over year is translating to something that would be flattish with the core expense levels in 2013.

And absent the $117 million of one-time charges, keep in mind that our guidance for 2014 does include roughly $30 million or so of one-time cost estimates for 2014, and also it does include investments that we're making in a number of our strategic areas.

And so we believe that the guidance is appropriate.

We do believe that it does reflect ongoing expense initiatives, and we are very focused on driving positive operating leverage.

We think that this guidance does accomplish that and we think it's consistent with our overall operating plan outlook.

Just as one follow-up, Don, if you could just give some insight with your limited time in the position, some areas where you see additional efficiency benefits?

I keep harping on this issue as somebody who has covered the Company 20 years and I know it's new management and everything else.

But 65% efficiency versus a peer group average closer to 60%, yes, there should be a lot of room to improve efficiency.

Just which areas -- point us in some direction, which business lines?

Anything else that we can sink our teeth into?

Thanks.

As far as areas, what we need to continue to improve is our overall productivity across all of our segments, and each of our businesses are keenly focused on that.

We need to enhance that over time.

Just a more specific area is if you look at our occupancy cost compared to revenue and size of the organization.

It is outsized.

We have taken a number of initiatives and steps to address that.

We have talked about the reduction in the commitment to space here in our Corporate center.

And we're going to free up about 200,000 square feet and have a net savings of $4 million to $5 million a year coming from that.

Much of that doesn't kick off until 2015 as these leases expire.

But we've got similar efforts throughout our franchise that have addressed other regional headquarters' space and trying to gain additional efficiency improvements there as well.

So we are making a lot of progress.

We do have a number of areas to continue to focus on.

And we are addressing it, just like we have with some of the branch consolidation efforts as well.

So there are a long list of initiatives and areas of focus and more of that will be driven prospectively by some of the change in the culture and focus on continuous improvement throughout the Company.

And one area, Mike, that we've invested in that I have talked about more recently at one of our conferences is lean six sigma.

I think our processes, our end-to-end processes in this Company are ripe for opportunities to improve not only the efficiency of the process but the ultimate end-client experience.

And we have a list of those that we have prioritized as a team of where we're really going to look at some of our underlying processes because I think there will be opportunities and targets will be put around that that we are expecting from that group.

That is something that many other companies may have already done.

But that's a journey where I think this is a year where we're really well organized to do that work.

There continue to be opportunities within vendors and sourcing as well.

So as you look at the underlying infrastructure, what it costs to deliver at Key, there are still continuing opportunities.

Thank you.

We will go next to Bob Ramsey at FBR Capital Markets.

Thank you.

My questions have been asked.

All right.

Thanks, Bob.

And we'll move next to Steve Scinicariello at UBS.

Good morning, everyone.

I just wanted to focus on the other driver of the efficiency ratio, the revenue side of the equation.

I know you mentioned a couple of drivers on the fee income side, whether it's been mortgage servicing, the cards, and also on the investment banking side.

But just kind of curious where you might see the greatest revenue opportunities as you look out to 2014 and just kind of give us a little color on some of the key drivers there?

Sure, Steve.

It's Chris Gorman here.

Our biggest key driver is to continue to be able to take our unique business model that connects with these middle market customers and convert them to customers.

So if you look last year, we literally brought on hundreds of new customers.

We enhanced hundreds more.

We have this broad product offering.

As you look at our ability to bring new people on to our platform, we have had a lot of success in doing that.

So really as we think about revenue, we don't necessarily think about any particular product, loans, deposits, fees.

We have been fortunate enough to grow all those.

What we really focus on is in a very targeted way growing the clients that we have.

Empirically, last year we brought on 648 new clients.

We also brought on some new senior bankers.

We've talked about the fact that we are going to continue to go out and hire people and leverage the platform.

So that is what we see as our biggest driver of revenue in the past year, and frankly, going forward as we look to 2014.

And this is Bill Koehler.

In the Community Bank in particular as it relates to the consumer, I think most people would say the consumer is getting steadily stronger.

And we've seen that materialize in our home equity book.

And we've also seen some growth in our credit card portfolio from the levels when we originally bought it.

We think there is more opportunities there; as the consumer gets stronger you can envision more investment.

IM&T revenue you can certainly envision more net interest income from improving our consumer loan book.

So there are plenty of opportunities there as we go forward, too.

Perfect.

So that's the other part of the equation.

When you are talking about increasing productivity, it sounds like you have a lot of targeted opportunities both in the middle market side and on the consumer side as well then?

And this is Bill again.

I would say two things.

It's not just productivity, but we see an opportunity to leverage our model to take share.

So in both the Corporate Bank and Community Bank, we intend to hire some bankers in very targeted ways where we see opportunity to enhance our presence in either industry groups or in specific geographies.

And, Steve, I would just underscore, because Don mentioned it, that it is, indeed, a focus of our Management team that productivity is an opportunity, as well, and it's something studying metrics and we'll be reviewing regularly with our team to capture opportunities for a more productive sales force, as well as adding to our sales force with high-quality people who can help generate business.

Perfect.

Thank you so much.

Thank you.

And we ask that you please limit yourself to one question to allow everyone an opportunity to ask a question.

We'll go next to Alan Straus at Schroder's.

Yes.

Could you maybe give us a little insight into the one-time -- or the repositioning charges that you expect in 2014, and at the same time, what the incremental cost saves you would expect I guess we would see in 2015 from those charges?

As far as the estimated one-time cost it's for programs similar to what we have implemented this year.

And I would say generally it's about 1.5 year to maybe a 2 year payback on some of the costs.

But generally it's a fairly quick turnaround.

So what would -- could you refresh me?

Let us know what it was in -- what was it this past year, the one times that you put through?

The one time --

Not the one time.

But for the year.

The repositioning costs.

The total costs associated with the expense initiative were in the $90 million range for the current year.

On top of that we had roughly $27 million on the pension settlement.

So a total of $117 million.

And we are expecting to have about $30 million of one-time costs in 2014.

So then in 2015 the run rate should go down by at least maybe another $90 million with these cost saves?

I would suggest that the $30 million has a 1.5 year type of payback period that would imply somewhere around a $20 million type of annual expense reduction for those initiatives.

Okay.

Thanks.

Thank you.

We'll move next to Gerard Cassidy at RBC.

Thank you.

Good morning.

Good morning.

Don, can you come back to the capital questions that you have heard today?

I think you pointed out that the stress test may be the driver of what kind of capital you and your peers will have to keep on your balance sheet.

Everyone recognizes, as you did, that your Tier 1 common ratio under Basel III is very high.

If I recall correctly, the stress test is calling that all you -- all the banks have to exceed a Tier 1 common ratio of 5%.

If 5% is the bogey in the stress test, what does that equate into a regular Basel III Tier 1 common ratio based on your balance sheet today?

I think what you would see typically is a stress of about 300 basis points in most banks compared to what the capital levels would be on a starting basis versus what goes through the stress test.

And so I think that gives you one benchmark.

Thank you.

We'll move next to Jennifer Demba at SunTrust.

Thank you.

I think that's all the -- all the questions have been asked.

A follow-up on the multi-family caution.

Just curious which markets you're relatively more cautious on right now, Chris?

So, Jennifer, we are constantly screening these markets.

I think some of the markets that we really have our eye on are markets like Washington, DC, like Raleigh, like Denver, like Seattle.

Those are some of the markets we are watching cautiously.

Okay.

Thank you very much.

We'll go next to Nancy Bush at NAB Research.

Good morning.

Beth, if I could ask you, is there some part of this sort of chronically high efficiency ratio that's structural?

I mean, is there something about the configuration of the Company that leads to this, and part of that being markets where you don't have as much scale as you would like to have?

And how do you address this over the long term?

Yes, Nancy, I'd be glad to talk about that because I do think it is a question that does come some from time to time, and I would tell you it is my belief, and I think it's something we have evaluated pretty thoroughly, it is not a structural cost related to our footprint, particularly in an era of image enabled technology, digital.

There is no particular cost burden to our geographic footprint that I think is burdensome to the Company.

I think as we look at it, I think it is a matter of a couple of things.

When you look at kind of our expense ratios and then our revenue per FCE, I think some piece of it is embedded in the productivity and the revenue side of this Company.

So you heard, I think, continued and purposely talk about this as positive operating leverage as within efficiency ratio.

I think we should get more productivity out of our franchise.

I think we have benefited from our geographic dispersion with our particular business model because it plays into our verticals, it plays into our ability to be a strong middle market lender, a private banking presence.

So we talked many times what we are in a market is so much more than just whatever our branch density is.

So I do think it is a journey for Key that does every single day have us thinking about what can we do to enhance revenue, add to our capabilities, add to our sales professionals, add to our productivity, and constantly reduce our expenses.

And I think the broader structural opportunity is the one I mentioned, which is in some of our processes.

We have never gone on an end to end look.

And I think that is a bigger opportunity for us this year and something I'm really going to focus on.

If I might just ask as an add-on to that, I mean, what part will acquisitions play, and your thought process?

I would tell you that for a lot of reasons, the acquisition (inaudible) robust for the last couple of years.

As you have seen, more has happened and we've participated in one of those in terms of acquisition of branches as opposed to whole franchises.

We did the Western New York transaction from HSBC in 2012 and I will tell you that has gone very well for us.

So I think as we look at it and look at where we would invest opportunistically, I think we would always look at something that could complement a market where we already have presence.

And by building density or bringing in the right customer base, that that would be added.

I think we are looking at how can we use investments and technology, mobile, and digital to augment our franchise.

I view that as something where we have a unique opportunity, I think, to leverage that against our footprint, because I think that's going to broaden our ability to create a consumer and client experience.

And then, frankly, we have shown where we will look at specialty businesses that are very much on point and within strategy, but yet add to our business platform or our product platform.

So that's how I am thinking as acquisitions.

I look at them more broadly in terms of what can they do for our business model to grow revenue and increase our capabilities.

Thank you.

We'll move next to Terry McEvoy at Oppenheimer.

Thanks.

Don, you said the first quarter expenses would come down meaningfully.

Should we look at $680 million or $680 million as a good starting point for the first quarter?

And how should we think of the $39 million of expenses, one-time expenses in 2014?

Will that be relatively spread out?

Are there any quarters where you see those costs being elevated?

As far as our first quarter, I think our baseline for the fourth quarter is a good start point to make adjustments from.

Keep in mind that there are certain seasonal type of expense trends that do occur in the first quarter.

So you will see some variance in a few line items like employer taxes, and marketing tends to be a little lower for us.

So you will see some positives and negatives there.

And as far as the $30 million of expected one-time cost, right now we are not showing any significant volatility throughout the year, but that can change based on the timing of different announcements and plans.

Thank you.

We'll go next to Marty Mosby at Guggenheim.

I wanted to follow up or kind of talk about net interest margin and asset sensitivity.

Just curious about how asset sensitive do you think you are when rates eventually decline and you have been kind of letting swaps roll off.

So how much would you like to increase that, let's say, over the next 1 year, 1.5 years before short-term rates begin to increase?

Marty, this is Don.

And right now our estimated asset sensitivity is around a 3% position for a 200 rate environment.

We have accomplished that from, as you suggested, the runoff of some of the swaps as they matured.

That did have a negative impact in the current quarter, about 2 basis points to our margin as far as the link quarter change and our swap benefit.

We would probably continue to manage in a relatively similar range to where we are now.

I wouldn't want to suggest that we would see a lot of variability in that over the next year.

We have about $1 billion of swaps that mature throughout 2014, which allow us the opportunity to adjust that position over time.

At this point no further plans on the 2 basis points you lost this quarter, deterioration because of the swaps rolling off and not getting the benefit?

No.

No plans to make any adjustments there.

Again, I think just beyond the swaps, though, the nature of our balance sheet allows us to benefit from rates we think pretty quickly.

If you look at our investment portfolio, it tends to be a shorter duration.

It was 3.6 years as of the end of the fourth quarter, and that would allow us to benefit from increasing rates fairly quickly.

Thanks.

We'll take the next question from Andrew Marquardt at Evercore.

Good morning, guys.

Morning.

I just wanted to drill down a little bit on to fees.

Just to be clear, first off, on the guidance, is that just to be clear, it's off of a reported number, it sounds like, across the board.

Is that correct?

That's correct.

Okay.

And then for this quarter it looks like other other had some benefit in it from certain sale gains in the real estate capital group.

And also appreciate the breakdown of -- the breaking out, rather, of the mortgage servicing fees this quarter.

How should we think about those two line items on kind of a go-forward basis?

Thanks.

As far as the other other, you are right, that we did have about a $4 million link quarter improvement come from some of the gains as you referenced.

And the mortgage servicing fee income did benefit this quarter a little bit from especially servicing fees.

And those may be a little more episodic as far as their occurrence.

And so you might see a little fluctuation there.

But those types of changes were considered as part of our overall guidance for the growth year over year.

And when I look at, I guess the Corporate Bank business line segment it looked like the other other kind of gains were maybe greater than that or are there other things in there?

Maybe I'm getting too lost in the weeds here in terms of $15 million gain this quarter, fees this quarter versus last quarter $8 million drag, and a year ago $6 million drag.

Yes.

Other things --

In the fourth quarter of 2012, we really benefited from a very strong commercial real estate market both in the volume and also rates on some of the sales that we had.

So that's some of the drag that you referenced compared to the fourth quarter of 2012.

As far as other unusual items in the Corporate Bank for the fourth quarter, there really weren't other items of any size.

So that $4 million change that we talked about before really was the largest individual change within those categories.

Great.

Thank you.

Thank you.

And we'll go next to Ken Usdin at Jefferies.

This is Tom [Shearer] from Ken's team.

I just had a quick question on taxes.

The 4Q rate looked a little light.

How should we be thinking about that for 2014?

Sure.

The fourth-quarter rate didn't reflect the impact of the leverage lease transaction that was referenced as well.

What we provide as far as guidance for 2014 would be an effective rate of somewhere between 26% and 28%.

And that assumes no further leverage lease transactions.

Okay.

Great.

Thanks.

Thank you.

And we have time for one more question.

We will go next to Brian Foran at Autonomous.

Hi.

I have a seven-part question.

Just on the fees, two numbers you mentioned.

15%, I think.

15% of total CRE capital raised going off the balance sheet, securitization, debt and equity placements, et cetera, and 648, or at least that's what I wrote down, new middle market customers who you're attempting to further penetrate and cross-sell.

Can you just remind us on both of those metrics, how does that compare versus history, and any expectation for how that will look going forward?

Brian, it's Chris Gorman.

As it relates to the question you asked specifically on real estate, so it's actually the inverse of what you describe.

We raised in the real estate business a total of $44.3 billion in 2013.

Of that, in terms of commitments, $6.4 billion or slightly less than 15% went on our balance sheet.

The other 85% was placed elsewhere.

And as you look at those metrics it would compare so a total of $34.7 billion raised in 2012.

And as you look at what's on balance sheet in terms of commitments, it would be $6.4 billion up from $5.5 billion in 2012.

As it relates to our new clients, we spend a lot of time really focusing on new clients and expanded relationships.

And the reason we do that is we think that this platform we built is unique for the middle market, but we think there is an opportunity to leverage it.

So the 648 new clients really was across the entire Corporate Bank.

They generated about $108 million worth of revenue.

And what's even more interesting is our expanded relationships, those which were doing significantly more business than we did last year, 428 of those generated another $259 million in revenue.

So, as you can see, it's a pretty dynamic client base as we continue to get more and more focused and really go deep into the six verticals that we're focused on.

Does that answer your question?

That's very helpful.

Thank you for the detail.

You are welcome.

And that does conclude today's question and answer session.

At this time I would like to turn the conference back over to Miss Mooney for any closing and additional remarks.

Thank you, operator.

We thank all of you for taking time from your schedule to participate in our call today.

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

And that concludes our remarks.

Thank you and have a great day.

Again that does conclude today's conference.

Thank you for your participation.