KeyCorp (KEY) 2014 Q1 法說會逐字稿

Good morning and welcome to KeyCorp's first-quarter 2014 earnings conference call.

This call is being recorded.

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

Please go ahead, ma'am.

Thank you, operator.

Good morning and welcome to KeyCorp's first-quarter 2014 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 Chris Gorman, President of our Corporate Bank; and Bill Hartmann, our Chief Risk Officer.

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 today.

Turning now to slide 3. This was a good quarter for Key with solid financial results.

We delivered on our commitments to generate positive operating leverage, to maintain strong risk management practices, and to remain disciplined in the way we managed capital.

Our positive operating leverage from the prior year reflects the work we have done to improve efficiency, with initiatives targeted for both revenue and expense.

And this becomes even more critical given the slow recovery and revenue headwinds that continue to impact our industry.

Key's revenue in the first quarter was relatively stable with the prior year, and down modestly from the prior quarter, reflecting normal seasonal trends and lower activity levels.

Revenue benefited from solid loan growth which continued to outpace the industry.

Loan growth was driven by our commercial, financial and agricultural loans, which were up $1.2 billion or 5% unannualized from the prior quarter.

We have been pleased with the quality of our new loan originations, but we continue to see loan yields reflecting the competitive pricing environment.

Non-interest income benefited from areas where we have been investing, including credit card and payments and commercial mortgage servicing.

We have also made significant progress on expenses which were down $19 million or 3% from the prior-year end, prior-year quarter, and down $50 million or 7% from the fourth quarter.

Our cash efficiency ratio was 65%, which was within our targeted range.

We remain committed to further efficiency improvement, and Don will discuss our path forward in his remarks.

Our strong risk management practices and a more favorable environment resulted in another quarter of positive credit quality trends.

Net charge-offs declined to 15 basis points, aided by strong recoveries as well as our improving credit quality, and we are well below our targeted range.

Additionally, non-performing assets declined 33% from the year-ago period.

And capital management remains a priority.

We were pleased to receive a non-objection from the Federal Reserve on our 2014 capital plan.

This will allow us to repurchase up to $542 million in common shares, and, subject to Board approval, increase our quarterly common share dividend 18% to $0.065 per share.

Using Street estimates, our total shareholder payout would be in the 84% range, among the highest in our peer group for the second consecutive year.

Additionally, we completed our 2013 CCAR capital plan with common share repurchases of $141 million in the first quarter.

I'm now turning to slide 4. During the first quarter we made a number of leadership changes to leverage our alignment, accelerate momentum, and to drive growth.

Last week we announced that Dennis Devine and EJ Burke will be Co-Presidents of our Community Bank.

Dennis will focus on retail banking and small business clients, and EJ will be responsible for our commercial and business banking as well as our private bank.

Based on their experience and proven leadership, we feel they are a perfect fit for these new roles.

Since joining Key in 2012 Dennis has made significant progress in sharpening our consumer and small business strategy, while also realigning resources to sustainably improve productivity and performance.

His new leadership role in the Community Bank reflects the importance of consumer and small business banking to the overall success of Key, and our intent to drive this business forward.

EJ is a 14-year veteran of Key.

His strong leadership, successful transformation of our real estate business, and other broad accomplishments in the Corporate Bank will help drive our commercial business and private banking segments, while further deepening the collaboration of these Community Bank areas with our Corporate Bank, an important component of our unique business model.

Both Dennis and EJ will join our executive leadership team and report directly to me.

We also made a change in our commercial payments business, moving Clark Khayat, who is our former Head of Strategy and Corporate Development, to lead this critical area.

Clark and his team will be focused on growing this business and maximizing the return from our recent investment, which includes the launch of purchase and prepaid cards earlier this year.

In addition to the new payment products, we have continued to invest in and build out our online and mobile capability.

This past quarter we expanded our online account opening tool to include more products and services.

And our user base is growing.

Downloads of our mobile application have increased over 70% from the prior year, and online penetration continues to increase.

We also made progress on other strategic initiatives, including improving sales productivity and strengthening our business mix through targeted investments, as well as exiting businesses that are not a strategic fit.

In the Community Bank, we are strengthening our sales management process and have seen a lift in our sales productivity, which will remain a major focus for Dennis and EJ.

In the Corporate Bank, we continue to see growth in new and expanded client relationships.

In the first quarter, we also announced that we would be exiting our international leasing operation which had limited scale and connectivity to our other businesses.

This is consistent with our commitment to allocate our capital to businesses that fit our strategy and generate appropriate risk-adjusted returns.

I'm very excited about all the changes we made in the quarter.

They accelerate our momentum and enhance our efficiency.

And overall, it was a good start to the year in terms of both financial results and our strategic initiatives, as well as the leadership changes we announced.

Despite the environmental challenges, we have good momentum.

And I'm confident we will continue to improve our performance.

Now, I'll turn it over to Don, who will comment on our first-quarter results.

Don?

Thanks, Beth.

Slide 6 provides highlights from the Company's first-quarter 2014 results.

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

This compared to $0.26 for the fourth quarter of last year and $0.21 from the prior first quarter.

I'll cover many of these results in my remarks so let's now turn to slide 7. Loan growth has remained a positive story for Key.

Reflecting our distinctive business model and more targeted approach, growth has again exceeded industry averages.

Average total loans for the first quarter were up $1.1 billion, or an annualized 9% compared to the fourth quarter of 2013, and up $2.1 billion or 4% compared to a year-ago quarter.

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

Average commercial, financial and agricultural loans were up $1.2 billion or 5% unannualized from the fourth quarter 2013, and up $2.0 billion or 9% compared to the prior year.

Period end loans grew by 2% from the prior quarter.

And in the first quarter total commitments were up and we saw a slight uptick in utilization rates.

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

Continuing to slide 8. On the liability side of the balance sheet average deposits were up $2.7 billion from one year ago, and down $2.1 billion from the fourth quarter.

Deposit growth of $2.7 billion from prior year was largely driven by higher balances from commercial and public clients, as well as increases related to the commercial mortgage servicing acquisition.

Compared to the prior quarter, deposits were down primarily due to expected reduction in the commercial mortgage servicing escrow balances from elevated levels in the fourth quarter, related to our mortgage servicing acquisition.

As a result of the continued focus on improving deposit mix, year-over-year interest-bearing liability costs declined from 70 to 54 basis points.

Turning to slide 9, taxable equivalent net interest income was $569 million for the first quarter compared to $589 million in both the fourth and first quarters of 2013.

Our net interest margin was 3.00%, which was down 1 basis point from the prior quarter.

The decline in net interest income and net interest margin was attributable to the impact of lower asset yields and loan fees, which were partially offset by the maturity of higher-rate CDs and a more favorable mix of lower-cost deposits.

For the full year of 2014 we expect net interest income to be relatively stable with reported levels in 2013, with the potential for downward pressure due to the competitive environment.

We continue to expect to maintain modest asset sensitivity.

As we have highlighted of before, we have the flexibility to manage and quickly adjust our rate risk position.

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

Slide 10 shows a summary of our non-interest income which accounts for approximately 43% of our total revenue.

Non-interest income in the first quarter was $435 million, up 2% or $10 million from the first quarter of last year, and down 4% or $18 million from the fourth quarter.

The year-over-year increase was due to higher investment banking and debt placement fees, principal investing gains, and the benefit from our recent investments in payments and commercial mortgage servicing.

The increase was partially offset by lower fixed income sales and trading income, and the impact on deposit service charges from the change in posting order for client transactions, which began in November of last year.

The decline from the fourth quarter was related to lower commercial mortgage special servicing fees, as well as the normal seasonal decline in corporate-owned life insurance.

We also had a full quarter impact of the change in the client transaction posting order combined with normal seasonal trends.

Special servicing fees which are generated in the commercial real estate workouts are included in our mortgage servicing fees line item.

They are episodic and can vary materially from quarter to quarter.

Turning to slide 11, non-interest expense in the first quarter was $662 million, including $10 million in charges related to our efficiency improvement efforts.

Expenses were down $19 million or 3% from the prior year, and $50 million or 7% from the fourth quarter.

Expenses this quarter reflect benefits from our efficiency initiative as well as normal seasonality in areas such as marketing.

We also had lower expenses related to incentives and occupancy.

Looking ahead, our typical second quarter includes annual merit increases and increase in marketing related to our spring home equity home advertising campaign, and potentially higher incentives tied to production.

In total we would expect expenses to be approximately $20 million higher in the second quarter.

Expense management remains a critical part of our drive to maintain positive operating leverage.

As Beth commented earlier, we are at the upper end of our targeted cash efficiency ratio range of 60% to 65%.

On the next two slides I'll cover our expense and efficiency ratio outlook.

Moving to slide 12, we revised our full-year outlook to reflect the improvement in our expense levels in the first quarter.

Our expectation is the full-year 2014 expenses will be down in the low to mid single-digit range from the last year.

We expect to continue to generate cost savings through our continuous improvement process, which will enable us to make investments and offset normal expense growth.

Should the operating environment become more challenging we are prepared to take additional action through further reduction in expense, as well as the timing of investments, in order to continue to drive positive operating leverage.

This brings me to the next slide.

Slide 13 is our path to achieve the lower end of our cash efficiency ratio target of 60% to 65%.

We expect to realize further improvement from business growth, both organic and through strategic investments, as well as additional reductions in our expense levels.

We will continue to seek opportunities to both enhance revenue and reduce costs.

Importantly, this assumes no benefit from higher interest rates.

If rates move in line with the forward curve, we would expect this to move our efficiency ratio below our targeted range.

Longer term, we remain committed to making progress toward an amount below our current targeted range.

For more detail on our action plans by line of business to drive productivity and efficiency improvements I would point you to slide 19 in the appendix of today's presentation.

Turning to slide 14 our net charge-offs declined to $20 million or 15 basis points of average total loans in the first quarter, which continues to be below our targeted range.

In the first quarter, net charge-offs benefit from total recoveries which were up 28% or $8 million from the prior quarter.

Additionally, gross charge-offs were down 14% or $9 million.

Due to the strong recoveries in the quarter, commercial loan recoveries actually exceeded gross charge-offs by $8 million.

The breakdown of asset quality by loan portfolio is shown on slide 22 in the appendix.

At March 31, 2014, our reserve for loan losses represented 1.50% of period-end loans, and 186% coverage of our non-performing loans.

We expect net charge-offs to remain below our targeted range of 40 to 60 basis points for the remainder of the year, and for our loan loss provision to approximate the level of net charge-offs.

Turning to slide 15.

Our tangible common equity ratio and our estimated Tier 1 common equity ratio both remained strong at March 31 at 10.14% and 11.22%, respectively.

As Beth mentioned, we completed our 2013 capital plan by repurchasing $141 million or 10.6 million common shares in the first quarter.

We also received no objection from the Federal Reserve in March for our 2014 capital plan, which included a new common share repurchase program of up to $542 million to be executed over the next four quarters.

The plan also included an 18% increase in our common share dividend to $0.065 cents per share, which is subject to Board approval.

Importantly, our capital plans reflect our commitment to remaining disciplined in managing our strong capital position.

Our Tier 1 common ratio has remained above 11% and we have paid out a peer-leading amount of capital to shareholders.

Looking ahead, our 2014 estimated CCAR payout ratio is 84%, and is again among the highest of our peers.

Moving to slide 16, this is a summary of our 2014 outlook and expectations and is 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 benefit from the full-year low single-digit growth in non-interest income compared to the prior year.

Due to the progress made in the first quarter, we now anticipate expenses will be down low to mid single digits on a full-year basis.

This guidance reflects the impact of the 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 below our targeted range of 40 to 60 basis for the remainder of the year.

And, finally, capital management will remain a priority, including increasing our dividend as well as continuing to execute our share repurchase authorization.

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

Operator?

(Operator Instructions) Matt O'Connor from Deutsche Bank.

Hi, good morning.

This is Rob Placet from Matt's team.

First question, as it relates to your net interest income guidance, I take it to imply that there should be growth off the 1Q level.

Versus the 1Q level how should we think about net interest income and also the net interest margin?

Great.

As far as our guidance, you're right, it would have to include increases from the first quarter.

First quarter is low seasonally because of the day count, and that costs us about $8 million linked quarter from the previous fourth quarter results.

And so we would see a pickup there.

We do expect strong loan growth to continue.

We've talked about mid single-digit growth going forward.

And our guidance would assume with that loan growth and with the same levels of liquidity going forward, that margin would be relatively stable for the rest of the year.

So, those are all critical parts of the assumptions in order to get the guidance that we're providing.

Okay, great.

And then second question, similar question for fee income.

The guidance implies some growth off the 1Q level, so what are your thoughts on which categories would drive growth through the rest of the year?

Again, we would expect to see seasonal changes for a lot of the areas, including stronger activity levels.

The first-quarter activity levels were down in many critical areas including service charge income and credit card and debit card activities.

So, we would expect to see some pickup there.

But we're also seeing some very strong pipelines in our investment banking and debt placement fees.

Chris, would you want to add any color to that?

Sure, Don.

Rob, this is Chris.

We feel pretty good about our backlogs in investment banking and debt placement fees.

The other thing that's interesting about our backlogs is it's more heavily skewed right now to M&A.

And with M&A, there tends to be a multiplier effect because often we're involved in other activities in addition to just providing advisory.

So, we look for that number to continue to have some forward momentum.

The other area that we're very optimistic about, and it's very early days, is our payments, our enterprise commercial payments.

We launched both our purchase card and our prepaid card just in the first quarter of this year.

And with respect to our purchase card, we are ahead of our targets in terms of client capture.

And with respect to prepaid, we've been pleasantly surprised at the amount of activity out there for significant pieces of business.

Now, I would warn you that those significant pieces of business are complex.

They take a long time, there's a long sell cycle.

But we feel good about both the backlog with respect to investment banking and debt placement fees, and our backlog with respect to enterprise commercial payments.

Okay.

Thank you.

Erika Najarian from Bank of America.

Good morning.

My first question is a follow-up to a comment that you made, Don, during the prepared remarks.

You mentioned that if rates moved up, as implied by the forward curve, then the efficiency ratio could be below 60% to 65%.

And I just wanted to make sure I understood that correctly.

So, if we saw a steepening in the yield curve but the short end is still anchored where it is, that's enough to break the 60% level?

Erika, the forward curve through 2016 would show some movement up at the lower end of the curve, as well.

So, that was the baseline for that assumption -- that actually our net interest income would increase between a flat rate environment and the forward curve by about $200 million in 2016 from that type of a difference in the rate environment.

And that would reduce our efficiency ratio by about 3 percentage points.

Got it.

Just on the guidance on NII, flat to 2013, does that include any movements to continue to build liquidity with regard to the LCR?

And a better question to ask is where are you on the LCR?

And how should we think about earning asset growth as it relates to the loan growth guidance that you gave?

Great question.

As far as our LCR, we have already started to take some actions, as you might imagine, given our size of our investment portfolio, that we have a very strong liquidity position.

We have been shifting that a little bit more to Ginnie Mae securities.

So, as of the end of the first quarter, we had 27% of our portfolio in Ginnie Maes.

And that was up significantly from where it has been historically.

Through the end of the year we would see continued payments coming off the investment portfolio being reinvested in Ginnie Maes.

And we should have a little more than a third of our total portfolio in that level one type of liquidity asset by the end of the year.

If we hit that, and also if we see some changes as it relates to the municipal deposit rules that are currently in the current draft, we should be in good shape for the LCR, and should not have to change our overall balance sheet.

Great.

Thank you for taking my questions.

Steven Alexopoulos from JPMorgan.

Good morning, everyone.

On the expense guidance line, which is 12, at the low end of the expense savings range of 4% to 6%, then the high end of the operating investment range which is 3% to 5%, expense levels really wouldn't improve.

I'm just curious, is there at least a minimum level of expense reduction you're committed to for 2014?

What we are committed to is driving positive operating leverage.

And with this current environment that we have for lower revenue growth, we're pulling a little harder on the expense side.

So I don't know that there is any absolute minimum or maximum there but I think that the path that we showed in the first quarter is probably consistent with what we have to focus on throughout the rest of the year, unless we see things change dramatically.

And maybe just a follow-up, Comerica also had good commercial loan growth in the first quarter but for them it was primarily shared national credits.

Could you break out for us how much mix contributed to 1Q loan growth?

Thanks.

Steve, it's Chris.

Let me start by giving a broad overview.

Of all the capital we raise, only 15% actually goes on our balance sheet.

And of the deals that we're involved with, in 70% of the instances we're the lead.

I don't have the exact number in front of me but I think you should assume, whether it's leverage, SNC deals or anything else that the 70% percentage would hold.

And with that, Steve, I would just underscore that I think it is important to note, we have talked in the past, that we do clients, we are the originator, they are our relationships.

And we do not have a desk that buys paper or participates unless it is a relationship of ours.

Okay, that 70% lead is helpful.

Thank you.

Gerard Cassidy from RBC.

Thank you.

Good morning.

Beth, you've done a very good job since you've come onboard in meeting your targets for success, especially in the expense side.

And the question is, your target for the cash efficiency ratio of 60% to 65%, and we just heard Don say that in a rising rate environment you could get down close to the 60%, but when you look at some of your competitors, whether it's BB&T or PNC, these companies are all getting into the 50%s.

There are some that are already there, like US Bancorp and M&T.

Is there a possibility or probability that you're going to take a look at this ratio and actually lower the target as we go forward?

Or is it just your infrastructure keeps it so you can't really get below 60%?

Gerard, thank you.

That is a good question.

And let me compare and contrast what I think is some important differences.

As we closed out last year, 2013, the average efficiency ratio for our peer group was 65%.

So some piece of what Key has successfully done is closed the gap to the peer group through the successful completion of our Fit For Growth initiative.

So, as we start this year, we are now in line with competitors.

And in that average obviously there are different business models.

And I think that's something that worthy of just a little discussion because some of the competitors that you would outline have larger payments and credit card businesses, or potentially some high-yielding consumer misses.

Our strategy as we have outlined it is to be largely a commercial bank with distinctive corporate bank capabilities.

And as you've watched our growth, it has been in commercial lending, investment banking and debt placement fees.

Those are a different business mix and different business model.

They carry a higher efficiency rate.

And if you look at our loan mix -- again, heavily skewed toward commercial lending which is highly variable -- again, that would have a different revenue component than high-yielding consumer assets.

So, some piece of as you look across a peer group, I think you have to look at business model, business mix, and where the growth is and what the Company's strategy is.

So, I think it's important that we did close the gap to our peers with Fit For Growth and the efforts we've undertaken.

I think it's important to note we say it is a journey and we are committed to further progress within our range.

And let us just say that anything we can do to accelerate or enhance our performance, we will do.

And then I think it is inherent that at a 65% average for the industry, this revenue environment of low interest rates is clearly pressuring the efficiency and productivity of our industry in general.

So, I would tell you that I think I'm pleased with our progress but never satisfied.

And that we will continue to show progress in the range.

And interest rates of modest amount, as Don outlined in his answer, will gives us a benefit to get into the 50%s.

Thank you.

Speaking of peer groups, you guys are a leader when it comes to credit.

Obviously credit improvement has been very good.

And then your capital levels are very strong.

As you identified, you're at the top of the list of returning capital to shareholders.

The question is, you have so much excess capital.

Maybe it's debatable on how much, but I think most people would suggest you have excess capital.

When do you think you'll be comfortable going to the Fed during the CCAR process, asking for more than 100% of earnings, to give back to shareholders so that the capital ratios don't continue to grow?

Granted, I know the primary goal is to grow the balance sheet but the growth isn't fast enough yet for the industry.

So, when do you think, or what do you need to see that you're comfortable saying -- okay, we can go for over 100%?

Gerard, this is Beth again.

One of the things I think is important that we have built a consistent track record with our shareholders about how they can, within the CCAR process -- which, as you know, governs capital -- that Key has been a consistent as well as a peer-leading returner of capital.

We have always talked about our capital levels as a strength over time, because how we invest, how we return and how we deploy that capital will be important to shareholder value creation.

So, we are the highest in our ability to return capital for the second year in a row with increase in share repurchases and common dividends.

But it is ultimately a regulatory-driven process.

So, at the end of the day, we will continue to be thoughtful about how we approach that.

And if you gauge us against our bank peers, I think we fared well in this year's process.

And it is important to us that we continue to give that track record and consistency of capital management as part of our business plan.

Thank you.

I appreciate it.

Jennifer Demba from SunTrust Robinson Humphrey.

Thanks.

Just wondering if you could give us some more details about the composition of your C&I growth this quarter, it was very strong, and how much of it may have been participations or syndications.

Sure, Jennifer.

It's Chris.

Let me first start by saying it was broad-based.

So, really, we have three legs to the stool.

One is our KeyBanc Capital Markets platform that goes to market based on industry verticals.

And some of the industry verticals where we had a lot of growth there would be areas like industrial, areas like energy.

We also had nice growth in our real estate business.

And our real estate business is really focused on two principal areas.

One are what we call owners of real estate, which is principally multi-family, and also mid-cap REITs, both public and private.

We had nice growth there.

And then our leasing business, which is really a specialty business in that they focus a lot on technology, a lot on medical equipment, they, too, had nice growth.

So again, we have these niches where we're very focused, very thoughtful about how we're going to the market.

And we enjoyed broad-based growth.

With respect to what is purchased paper, what we're the lead on, one of the things we really like about our model is, as I just mentioned, we lead 70% of the deals that we're involved with.

So, in those instances we are syndicating those deals.

We are a net seller of those.

And, of course, our broad model, only 15% of what we raise actually goes on the balance sheet.

So these are -- it's a very focused area in terms of figuring out where we can be relevant.

Just as an aside, we had our strategic drill-down with our real estate team just 48 hours ago.

In our strategic drill-downs, the teams come in and the RMs walk through each of their top five prospects.

And what we're finding is, in spite of the fact that there's competition out there, because of our differentiated model in real estate and in our other areas, we're able to continue to capture clients.

In the first quarter, we captured 119 new clients.

So, that's really how the model is built.

It continues to work.

We also got a little bit of a benefit -- I think Don mentioned that we had a slight uptick Company-wide in utilization.

In the Corporate Bank I would say the utilization uptick was even a little bit more than slight.

And the other thing we're benefiting from is just we're constantly reallocating capital.

And that's a process that began really in 2010.

But as we sit here in 2014, we have a lot fewer relationships that we're actually exiting.

So, if you look at the confluence of all those things, it's a pretty good foundation for C&I growth.

Jennifer, this is Beth.

I would just add another thing that I think is interesting as I look at it across the Company.

That a lot of the growth is concentrated as you go up in size of the Company.

And as you see the upper end of the middle market perform, they are more likely to be incurring leverage to acquire companies because we see a trend towards people looking more to growth through strategic acquisitions and organic investments.

We've seen some sign of borrowing to do share repurchase, as companies think their own currency is a good investment.

And at the smaller end of the market, while we see growth, it is not as strong as it is among our upper end, middle market and corporate clients.

That's exactly right, Beth.

And the other thing we're seeing is, you wouldn't expect this, but the competition is more intense with the smaller companies.

So what we're doing is really focusing throughout Key on some of the larger ones.

Thanks so much.

Bob Ramsey, FBR Capital Markets.

Good morning and thanks for taking the call.

I was just curious, I know you all said that your net interest income guidance incorporates a relatively stable margin from where we are today.

And of course this quarter, without the benefit of the mix shift out of shorter-term liquid assets into loans, your margin would have contracted, I don't know, 6 or 7 basis points.

I'm just curious what gives you confidence NIM will be stable from here, particularly as you do shift a little bit into LCR assets through the year.

Good question.

A couple things that happened this past quarter that we wouldn't expect to have continued drag going forward.

One is that we had an adjustment to offset some of that liquidity because of the issuance of our long-term debt.

And so that added about $1 billion on an average basis from the fourth quarter to the first quarter.

And that reflected the issuances we did, including Parent Company to position us for our CCAR plan.

Second was in the first quarter our loan fees were a lot lower than what we would have expected.

It was a little over $5 million weaker than first quarter of last year.

And that had additional pressure on the margin.

And we would expect that, while there still may be some challenge there, we wouldn't see the incremental drop off there that we did this past quarter.

Bob, the one thing I would add that we always watch, because I think we saw an example of it in the fourth quarter, is levels of liquidity that cannot necessarily be anticipated, is what I'd call always the wild card of pressure.

And in the fourth quarter it was specifically some of the flows from our commercial mortgage servicing business which has been a nice source of income for us, as well as stable deposits.

But as some of those CMBS portfolios unwind at different times you can get liquidity flows that could pressure margin.

So, liquidity is always something that's hard to predict that we will always identify if that's an issue in any quarter.

Okay.

Great.

Thank you guys.

Ken Usdin from Jefferies.

We saw some pretty big swings obviously related to the escrow accounts.

Just how should we think about that going forward?

And was there some seasonality in there?

Or you how should we think about those balances going forward?

Ken, it's Chris.

That was actually part of the BofA portfolio that we purchased and we completely anticipated that.

And what happened is there were some planned payoffs.

And when they're of large CMBS loans, and what happens is the escrow flows through both principal and a bunch of other payments.

So there were about $18 billion that flowed through in and out in a short period of time in the fourth quarter.

It probably will not be to that extent going forward.

But it is a lumpy business and you will have flows, escrow flows, through it.

As we think about that business, we think about the stable servicing business having about doubled from pre BofA portfolio acquisition.

It used to run about $7 million per quarter.

Now we think it will run about $15 million per quarter.

But there will be from time to time large escrow swings.

By the way, the core deposit base actually increased both in the quarter and year over year.

Okay.

Great.

Thanks.

(Operator Instructions) Keith Murray from ISI.

Thank you.

Good morning.

Just thinking about your ROA target, the 1% to 1.25%, you're in the middle of that range now, only about 12 bps from the high end.

When we think about the efficiency improvements you have out there, the loan growth outlook, I know credit obviously is performing better than normal, but do you think at a certain point in time your franchise might be able to do above that 1.25%?

And is that a target you might want to revisit?

That will be a target that we hopefully will be revisiting at some point in time.

To your point, with the efficiency improvements, with expansion of the margin as rates would go up, that we think there would be opportunity to reassess.

I think you hit on the right variables now which is that offsetting some of those headwinds really is coming from our credit cost being so low.

With provision expense of $6 million and charge-offs of $20 million, while we'd like to say that's our new normal I don't think that's something we can count on long term.

Fair enough.

And then just curious, on the tax rate.

It came up a little bit this quarter.

What should we think about using going forward?

It did.

And we've stated that we think our tax rate will be between the 26% and 28%.

And we were toward the higher end of that this past quarter.

So that range still holds.

Okay.

And then, just finally, Beth, you've talked about improving asset productivity.

People in our types of seats we don't get to see all the internal things.

What type of metrics should we be looking at over time?

Should we look at things like PP&R per employee?

Just give some guidance on what you think is something to note.

Keith, I'll take some thoughts on that and then I will ask Don if he has any additional comments.

One is obviously, a high-line metric that you should watch is the level of growth, because one of the things we've talked about in terms of asset efficiency is the mix between loans and investments on our balance sheet, and becoming a more productive balance sheet.

And then as we look at it, it should be against our targeted client segments, which we've identified our strengths in commercial lending, corporate banking, as well as we've now entered some consumer products with the successful conversion of credit card, although that also really is an attractive fee income base for us for the transactional capabilities in there.

And then we are looking at new clients as well as expanded clients, and making sure that as we do lend into these clients that we are getting good cross-sell and appropriate returns.

Don, what else would you add to that?

I think you've hit an important point for us, and that's something that we need to see how we can address to provide a little bit more of a foreshadowing of those improvements in productivity.

I think when you mentioned PP&R to headcount and also revenue to headcount, I think those would be good variables.

But it's something we should look internally to see if there's other ways or measures that we can provide that will at least provide a little bit more insight.

Okay, thank you.

Sameer Gokhale from Janney Capital.

Thank you.

Good morning.

I had a couple of questions here.

The first one was just looking at your non-interest income, the chart on page 10, with cards and payments at about, it looks like 9% of the mix, and I think you had mentioned you had some new management to run the business and to grow it.

So, could you give me a sense for how much you expect that piece to increase as a percentage of the overall pie, say, over the next 12 to 24 months?

It's relatively small now but certainly payment seems to be a big focus area of interest.

So, just curious if you could give me a sense for the growth expectations as a mix percentage relative to the overall non-interest income.

There's really three components that are included in that line item.

One is debit card revenues.

Second is credit card fee revenues.

And third is more commercial payments revenues.

We are investing in each of those three areas.

And we would expect that growth to outpace the rest of the bank and expect that to be an area of outperformance for us.

But keep in mind that these are not programs that we're designing to be national in footprint, especially for the credit card and ATM.

It really is our debit card.

It's more based to serve our retail customer base.

And we feel there is great opportunity to increase the penetration there but not something that we're going to be becoming a national player.

Understood.

That's helpful.

And then, also, I think in the commentary there was some reference to some complexity associated with the prepaid card.

I'm not sure I understood what that was referencing, if you wouldn't mind clarifying that.

Sure.

This is Chris.

I just mentioned that the large prepaid opportunities are complex transactions.

Sometimes they're with -- the issuers are government entities.

And I mentioned that there's a long lead time.

I see.

Okay.

And then just on a different note, I know you've talked a lot about expenses.

One of the things I was curious about, you clearly laid out your expectations for charge-offs in your guidance.

And I was curious about how we should think about the interplay between higher charge-offs or, if you will, normalized charge-offs relative to workout-related costs.

From an expense standpoint it seems like the two are related and if charge-offs normalize then you should see an increase in those type of loan workout costs.

So, how should we think about that?

Or do you feel that incrementally, even if you get to that 40 basis points number, there's not much of an incremental lift in those types of expenses?

This is Bill Hartmann.

I think if you take a look at what is actually driving the level of net charge-offs that we have right now -- and Don alluded to this when he discussed the level of recoveries and the gross charge-off level -- we have benefited from some strong recoveries in the latest quarter.

As those recoveries abate, the cost of actually running your workout organization declines.

And we've had a fairly dramatic decline in the cost of our workout organization.

So, we think that by normalizing it actually is a reduction in recoveries, as well as continued improvement in the gross charge-off levels.

So another way of thinking about it is you don't expect any upward pressure from recovery-related expense, workout-related costs going forward.

No, in fact, probably the opposite continues.

Okay.

Great.

Thank you.

Mike Mayo from CLSA.

My question relates to slide 13.

And I'll ask my question by way of an analogy.

If I played golf yesterday and shot 89, and I got a new driver, new lessons and a new caddie, and then I promised to break 90 in three years, you would say that I'm sandbagging a little bit.

And, so, what I see here is you guys shot 64.9% in the first quarter with your efficiency ratio.

You're committed to growing revenues faster than expenses.

And by 2017 you say you'll shoot under 65%.

So is this target rigorous enough?

And I would note, I have a separate peer group here.

We all have our peer groups.

But I have peers at 60%.

And I'd also point out, as you know, I've pointed out before, two decades ago -- and it's the two decade anniversary of KeyCorp as of March 1 -- the efficiency ratio was 58%.

So, Beth, as you at the head, efficiency's improved, cap returns improved, the share price has improved.

You've outperformed peer but it just seems like looking out over the next two to three years this efficiency target doesn't go far enough.

Mike, I appreciate it.

And we will take our golf lessons and invest in new golf clubs.

And wait for the weather to warm up, one thing that hasn't come up in our call.

I would tell you that it is important that we felt it was a good thing for us to do to be responsive to the question to what sorts of things move us within the range.

And at this point in time we are not moving the range from 60% to 65% but we are showing the path to our ability to reduce within the range.

It is also important to note that the business growth is net of investment because I think it is important as you list the things that we have accomplished it is because we are also investing in our franchise, that it's important that we grow this business in smart and appropriate ways.

And then as I look at our revenue mix, about 60% of our income does come from our loan book, which is a highly variable loan book, not high-yielding consumer assets as I mentioned earlier on Gerard's question.

So, some piece of it is embedded in our revenue component that we will drive growth through our business activity.

Interest rates will benefit our particular mix of business when the short end gets a little relief.

And it is on us and part of the reason we identified Fit For Growth to know that near term, in a pressured revenue environment, we must continue to work the expense side of the equation to create that progress without a benefit from interest rate.

So, what we're trying to show is we are committed to a path to the low end of the range without any external help from the environment.

And we will consistently improve.

And as I said earlier, we will be disciplined but constructively and patient, as well.

The only thing I'd add there Mike, as well, is that, as Beth highlighted, it's taken us down to the lower end of the 60% range.

With interest rates we'll be in the 50%s.

Keep in mind, too, that back in 1994 Key had a margin of over 4%, and we're right at 3% now.

And that won't improve without interest rates going up.

And, so, that does impact that efficiency ratio, as well, in addition to the additional costs we're incurring associated with regulatory burdens today compared to 1994.

Just to follow up, as you say, some of that margin might not come back since you're more commercial oriented today.

What I'm looking for is some recognition that the efficiency is somehow related to structural issues, especially after two decades.

It would be nice to see ROE or at least ROA by state.

Maybe we have ROA by state somewhere, I couldn't find it, or maybe you could disclose that.

But it just seems to me, out of all your states, there might be a few that you could consider for divesting.

Any thought process about more structural changes at KeyCorp?

Mike, this is Beth.

Some piece of the discussion around our geographic footprint is against the broader business model where we are really also focused heavily on our commercial clients and the ability to integrate our Corporate Bank.

So, while our geographic presence and physical branches are across those states, in every market we also have additional business banking, commercial, private banking and corporate banking opportunities.

So, the mix of our revenue is very fulsome in our various geographies.

And in a digital image-enabled world, the cost of maintaining a branch network is not a driver of our structural inefficiency.

So I think as I look at the priorities I would set against our geographies is to drive more revenue from those physical presence.

And they are profitable.

All right.

Thank you.

Nancy Bush, NAB Research, LLC.

Good morning.

I'm going to ask the opposite question from Mike.

You've certainly done a great deal with the Company, Beth.

I think we're happy to see that loan growth is finally starting to ramp up.

As one questioner said, you've got plenty of capital.

My question would be, do you finally have the leeway to grow in some of these markets where you don't have as much market share as you would like?

And my add-on question would be, if so, what would those markets be?

Nancy, I think that's a great question because some piece of how we are looking at the future is the interplay of digital and mobile, and how that will affect both the consumer business, but our relative positioning within markets.

And I think some piece of what might be the paradigm going forward is that I don't think any of us, as you listen to myself and my peers, who will tell you that we don't believe that market presence and branches are still a core and important part of our value proposition and how we go to market across our various geographies.

But potentially density is less important because as you think about it, there is a transformational change.

So, part of what we are doing within our strategies is upping our investments in mobile, digital, and mobile and digital advertising, as well, so that as we connect those experiences between the branch, online, mobile, digital, that we have a value proposition that we think will also enhance our market growth over and above just investing in more physical stores.

So, I think that's an exciting opportunity and that some of the old paradigms are shifting.

And then I think the emphasis that we have placed on commercial, our middle market and business continuum of companies with sales of $25 million to $1.5 billion, those squarely fit in our geographies.

And as we acquire and expand those relationships, we get private banking opportunities, we get incremental growth.

So, I think we are growing our markets with our go-to-market business model.

Thank you.

Chris Mutascio from KBW.

Thanks for taking my question.

A lot of my primary questions have been asked.

But, Don, the net charge-off ratio guidance of below zero -- 40 basis points to 60 basis points -- you're so far below that right now it's not even funny.

So, I was wondering if I could get your thoughts on the relationship between the provision expense and the net charge-off ratio as you see over the next several quarters.

Our guidance assumes that charge-offs will equal provisions.

That's our expectation going into it, but it will be adjusted based on changes in overall credit quality and outlook for losses inherent in the portfolio.

But your provision expense was lower than your charge-offs this quarter, right?

That's correct, it was.

It was $14 million lower this quarter, you're right.

And, so, going forward we start to match.

That would be our expectation, yes.

All right.

Great.

Thank you.

Steve Scinicariello from UBS.

Good morning, everyone.

I just wanted to follow up on something that I think's an important distinction that you're making between productivity improvement and efficiency improvement.

I just wanted to get a little more color about that, some of the things that you're doing to drive productivity improvement.

Because a lot of times when you say efficiency, people just assume cost cutting.

But clearly with the progress that you guys are making it's both revenue- and expense-driven.

I was just curious to hear a little bit more of the success that you're having improving productivity, how you're doing it.

And, specifically, how are you improving the cross-sell in the Corporate Bank which seems to be a really big driver of this?

I'll go ahead and take a first crack at that and then I'll turn it over to Chris as far as the Corporate Bank.

But as far as productivity, if Dennis Devine were here and answering this question as it related to retail, he'd talk about the process that we put in place over a year ago as far as enhancing our overall sales management process in the retail channel.

And we would acknowledge that our sales per person in that branch have been lower than where our peers have been.

We're taking steps to manage it with the expectations laid out on a weekly basis and measured on a daily basis to see how we can change that.

So, we're seeing significant improvements in our productivity in our branches.

And it's not about any type of rocket science.

It's making sure we have very clear expectations and holding people accountable to those expectations, and we're seeing that progress.

And so that's one area of productivity.

Chris, you want to talk about the Corporate Bank?

Sure, I'd be happy to, Don.

There's a few things that we're focused on with respect to productivity.

The first that we talk about a lot are new clients and expanded relationships.

Because we think we have a platform that we can leverage but we need to continue to add new clients and expand the relationships that we have.

And we have very specific targets around those.

We also spend a lot of time talking about the revenue per person.

For example, right now on a trailing basis the revenue per person in the Corporate Bank is $830,000.

We've set some very specific goals around those, as well.

The other thing that we're thinking about in terms of productivity is to leverage some of the investments that we've already made.

We talked earlier today about commercial payments.

We really need to leverage that.

Healthcare -- throughout Key we have about a $7 billion healthcare portfolio.

And we have a Company-wide effort to be very focused on facilities-based healthcare and how we can deliver the whole platform.

And then we've invested a lot of time.

Beth alluded to the coordination and the collaboration between the Corporate Bank and the Community Bank which is very important in how we can be distinctive going to market.

So we spend a lot of time looking at that.

Then the last two pieces are things we've talked about before in terms of generating productivity.

One is strategic, just tuck-in type acquisitions.

And I think the BofA third-party commercial loan servicing portfolio would be a great example of that.

And lastly, and most importantly -- and it's one of the things that has an impact when you start comparing our efficiency ratio -- is continuing to invest in people.

Because we think our platform is under-leveraged, we're out there hiring people that are senior people that have existing relationships.

And there admittedly is a bit of lag as you bring senior bankers onto the platform, but we've proven to ourselves they can be extremely productive.

So, those are really the four prongs of the growth strategy.

Perfect.

Thank you so much.

There are no more questions in queue.

I now turn it back over to Beth Mooney for final comments.

Thank you, operator.

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

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

Thank you and that concludes our remarks for the day.

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