KeyCorp (KEY) 2014 Q4 法說會逐字稿

Good morning, and welcome to the KeyCorp's fourth 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 fourth 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; EJ Burke and Dennis Devine, Co-Presidents of our Community Bank; and Bill Hartman, 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.

I'm now turning to slide 3. I'll provide some overview comments on the fourth quarter and the year, and then I'll turn it over to Don to discuss our financial results and our outlook for 2015.

Fourth quarter was a strong finish to the year.

At the conclusion of our third quarter, we indicated that our fourth-quarter performance would better reflect the earnings power of our Company.

And I'm pleased to report that in the fourth quarter, our results improved significantly, and we met or exceeded the guidance we provided.

And as we communicated, our results over the last two quarters were reflective of the variability in our business model, especially in some of our fee income categories, like investment banking and debt placement, where we saw some activity move from the third quarter into the fourth quarter.

And as a result, we finished the year with record performance.

We also generated positive operating leverage, relative to both the third quarter and the year-ago period.

Earnings per share were up 8% from last year, as we continued to grow organically by acquiring and expanding targeted relationships, which led to solid growth in both loans and deposits.

Core expenses were well controlled, as we are realizing the benefits of our initiatives and our continuous improvement efforts.

Our cash efficiency ratio was down 300 basis points from the year-ago quarter, and it is a continued priority for us to identify additional efficiency and productivity opportunities as we go into 2015.

Asset quality also improved over the year, as we continued to originate good quality relationship business, while staying disciplined with structure.

And consistent with our capital management priorities, we repurchased $128 million of common stock in the fourth quarter.

Slide 4 is a summary of our full year 2014 results.

We delivered on our commitments to our shareholders by generating positive operating leverage, and by remaining disciplined with both risk and our strong capital position.

Average loans were up 5% from the prior year, driven by strong growth in commercial, financial and agricultural loans of 11%, which also helped create a record year in investment banking and debt placement fees.

Expenses were well controlled, down 2% from the prior year, or 3% excluding the 2014 acquisition of Pacific Crest Securities.

And asset quality improved, with net charge-offs of 20 basis points for the year, which is well below our targeted range.

And during the year, we continued to invest in our businesses to accelerate growth.

In addition to Pacific Crest, we added bankers across our franchise, expanded our payment capabilities, and enhanced technology in areas such as mobile, online and cyber security.

We also exited non-strategic assets that were not consistent with our relationship strategy, such as international leasing.

And we made a number of leadership changes to drive focus and execution, including in our Community Bank.

In 2014, we were able to reward shareholders by returning a peer-leading 82% of our net income through both dividends and share repurchases.

Overall, it was a strong finish to what was a good year for our Company.

We are well positioned with momentum and confidence in our business model and our team, and I'm excited about the opportunities we have ahead.

Now, I'll turn the call over to Don to discuss the details of our fourth-quarter results and our outlook for 2015.

With that, let me turn it over to Don.

Thanks, Beth.

I'm on slide 6. This morning, we reported net income from continuing operations of $0.28 per common share for the fourth quarter.

This compared to $0.26 for the year-ago quarter, and $0.23 for the third quarter.

I'll cover many of these items on this slide throughout my presentation, so let's now turn to slide 7.

Average total loan growth continued in the fourth quarter, with balances up $3 billion, or 5% compared to a year-ago quarter, and up $745 million from the third quarter.

Our year-over-year growth was once again primarily driven by commercial, financial and agricultural loans, and was broad-based across Key's business lending segments.

Average commercial, financial and agricultural loans were up $3 billion, or 12% compared to the prior year, and were up $732 million, or 3%, un-annualized from the third quarter.

Importantly, we're remaining disciplined with our relationship focus, as well as the it quality and structure of our new business.

Continuing on to slide 8. On the liability side of the balance sheet, average deposits were up $1.3 billion from one year ago, and up $1.4 billion from the third quarter.

Deposit growth of 2% from both the prior year and prior quarter was largely driven by inflows from commercial clients, as well as increases related to our commercial mortgage servicing business.

And the cost of total deposits decreased to 15 basis points, from 20 basis points one year ago, reflecting our more favorable deposit mix.

Turning to slide 9, taxable equivalent net interest income was $588 million for the fourth quarter, compared to $589 million in the fourth quarter of 2013, and $581 million in the third quarter of this year.

Our net interest margin was 2.94%, which was down 2 basis points from the prior quarter.

The margin was impacted by higher levels of excess liquidity, driven by commercial deposit growth and lower earning asset yields.

Compared to the third quarter of this year, net interest income was up $7 million, primarily due to asset growth, higher loan fees and lower funding costs.

We expect to maintain our modest asset sensitivity, 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 non-interest income, which accounts for 45% of our total revenue.

Non-interest income in the fourth quarter was $490 million, up 8% from the prior year, and up 18% from the prior quarter, primarily due to the strength in core business activity.

We also benefited from the recent investments like the acquisition of Pacific Crest and the addition of client facing FTE.

As Beth mentioned, this was both a record quarter and a record year for investment banking and debt placement fees, which finished the year with $126 million in the fourth quarter.

As we indicated on our third-quarter call, there is variability in this business from quarter to quarter, but we had a strong pipeline in September, and that carried through to the fourth quarter.

We also saw growth in many other fee-based businesses, including trust and investment services and corporate services, which had strength in derivatives and non-loan fees.

Consistent with our comments last quarter, we also saw a normal seasonal lift in Corporate Owned Life Insurance and a stronger quarter from principal investing gains.

Turning to slide 11.

Our non-interest expense for the fourth quarter was $704 million, down $8 million from a year-ago period, and stable with the third quarter.

Reported expense included $8 million in efficiency charges, and a $3 million pension settlement charge.

Combined, these two items added approximately 100 basis points to our efficiency ratio.

If you adjust for Pacific Crest, the efficiency charges and pension settlement, our core expenses decreased to $676 million from $688 million in the year-ago period.

This quarter, our cash efficiency ratio was 64%.

While this level reflects our hard work and improvement over the last few years, the efficiency ratio remains an important measure for us, and we expect to continue to make progress in 2015 from our level in 2014.

We remain committed to continuing to generate cost savings through our continuous improvement efforts, which will enable us to make investments and offset normal expense growth.

Turning to slide 12.

Net charge-offs were $32 million, or 22 basis points, on average total loans in the fourth quarter, which continues to be below our targeted range.

At December 31, our reserve for loan losses represented 1.38% of period end loans, and 190% coverage of our non-performing loans.

Importantly, the quality of our new business volume has consistently been better than that of our existing portfolio.

Turning to slide 13.

Our tangible common equity ratio and an estimated Tier 1 common equity ratio both remain strong at December 31, at 9.88% and 11.18% respectively.

As Beth mentioned, we repurchased $496 million in common shares in 2014, including $128 million, or 9.7 million common shares, in the fourth quarter.

We have approximately $187 million of gross repurchase authorization remaining under our 2014 capital plan, which runs through March of this year.

We submitted our 2015 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.

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

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

Moving on to slide 14.

As Beth mentioned, on our third quarter call, we indicated the fourth quarter would be more reflective of our earnings power of the Company, and that we would meet our full-year guidance.

With our fourth-quarter results, we delivered on our commitments, and achieved our previously communicated guidance.

In 2015, we expect to drive positive operating leverage, and continue to improve our performance.

Average loans should grow in the mid single digit range, as we benefit from the strength in our commercial businesses.

We anticipate net interest income growth in the low to mid single digit percentage range, compared to 2014.

This does include the benefit from higher rates, as we are currently modeling short-term rates to increase 50 basis points late in the year.

Without the benefit of the higher rates, we would anticipate net interest income to be up in the low single digit range.

Our net interest margins should remain relatively stable, and based on interest rates, may increase later in the year.

Non-interest income is expected to be up in the mid single digit percentage range for the year, which would include the full-year impact of Pacific Crest Securities.

Keep in mind, revenue activity tends to be seasonally lower in the first quarter compared to the fourth quarter, and areas such as investment banking and debt placement, as well as seasonally lower (technical difficulty) Corporate Owned Life Insurance income.

We also anticipate returning to a more normal run rate for principal investing gains.

Full-year reported expenses should be relatively stable with 2014, which includes a full year of expenses related to Pacific Crest, offset by lower efficiency and pension charges.

Credit quality should remain a good story, with net charge-offs below our targeted range of 40 to 60 basis points.

We also expect provision to approximate net charge-offs.

And finally, we expect to continue to execute our share repurchase authorization consistent with our capital plan.

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

Operator?

Thank you.

(Operator Instructions)

And with that, we'll go to Matt O'Connor with Deutsche Bank.

Please go ahead.

Good morning.

Good morning.

Good morning.

Good to see the expenses come in where you thought, despite better fees.

As we think about next year, we're seeing some other banks talk about upward pressure on expenses, and you're holding the line on the expenses while you're still expecting some revenue growth.

So I guess the question is, the continuous improvement that you're doing, just elaborate a bit more on where some of the gross savings are coming from?

And then, where some of the investment or offsets are?

Great, Matt, and this is Don.

And as far as where we see the savings, in 2014, for example, we consolidated 34 branches throughout our franchise, or a little bit more than 3% of the total branches, which resulted in savings of just less than $9 million a year.

Other things we did last year included reducing the headcount levels in our fixed income trading platform.

That was reduced by over 20%.

We exited our international leasing operation.

We finished a telecommunications network transformation, which had a result of $20 million in run rate savings for the year.

And more importantly, what we're doing from a cultural perspective is focused on continuous improvement.

And that's through using tools like Lean Six Sigma, which were kicked off in 2014, and we expect to see ongoing benefits for that in 2015.

And so going forward, I think you're going to see some of the same continue, that we would expect to see branch consolidations in that 2% to 3% level.

We've also talked about other occupancy costs, but we're reducing 15% of our non-branch square footage.

So a lot of the corporate office space that we have is being reduced throughout the year.

And again, just focusing on that end-to-end process management, making sure the people are helping to drive ongoing improvements in our productivity and efficiency.

As far as some of the investments, this last year, we've added over 25 new senior bankers within the Corporate Bank.

And I think you're seeing the benefit from that, and our year-over-year growth in our investment banking and debt placement fees.

And so we're making investments there.

We've been making other investments in products and services like payments.

And like many others, we've been making investments in our risk management, compliance and other modeling capabilities.

Over the last two years, the staffing for compliance and modeling is up over 50%, and we expect to see that increase again going forward.

And so we are bearing those kind of costs, but we expect to be able to achieve the kind of synergies and efficiencies from that focus on continuous improvement to help fund those costs going forward.

Okay.

Great.

Thanks for all that color.

And then just separately, on page 18 of your appendix, you've got a slide on oil and gas exposure, which is relatively modest to the size of the Company.

But just any early signs of pressure there?

Or maybe in areas that benefit from energy?

And how are you monitoring that differently now, say, versus three months ago?

Yes, Matt, this is Beth.

Given the attention on this topic, we did add slide 18 in the appendix, and hope that will be helpful color and context for folks, as they look at the quarter, as well as our portfolio.

And I would say the headlines are that it is a long-standing area where we have history and expertise.

And as you said, it is a small portfolio for us.

It's only 2% of our outstandings.

We are mainly in the E&P or upstream end of the market.

We would say we have a quality client book.

They're well-reserved and well-protected, with minimal oil field services exposure.

So as a small portfolio, it is not a big concern to us, and we will continue to monitor it.

And I think the slide in the appendix has helped, giving good understanding of what we see.

And we also mentioned in that slide that we have reflected it in our reserves and our allowance at the end of the fourth quarter, given current prices.

And where it will benefit is, I think we're all saying that this certainly will be a boon to consumers, their capacity to spend, their confidence.

And on average, while there will be some stutter steps in the economy, I think this will be a net positive, to have lower oil prices for our economy in 2015.

Okay.

Thank you very much.

Thanks, Matt.

Our next question is from Steven Alexopoulos with JPMorgan.

Please go ahead.

Good morning, everyone.

Good morning.

Don, maybe to start and follow up in on your expense comments, when I look at the 2015 guidance, which is relatively stable versus what you guys promised and then ultimately delivered in 2014, which was a slight reduction in expenses, what's really the difference in 2015?

Because it seems that you still have ample room to cut expenses, but you're not guiding that.

You're going to follow through with that this year.

So what's changed in 2014 versus 2015?

The biggest impact there, Steven, is the full-year impact of Pacific Crest, and so we do have increases there.

But we've also talked about making investments to grow revenues.

And we've done that within the Corporate Bank this past year, and we're looking for other areas to make those similar investments.

And what we're focused on is driving positive operating leverage.

And in addition to the flat expenses, we're showing our guidance to reflect an expected increase in both net interest income and fee income, and we think that's a direct benefit from the investments we're making.

Don, what would be helpful to us, as we assess the progress you're making on the efficiency front, could you break out for us, what was the expense and revenue contribution from Pacific Crest in the most recent quarter?

And what do you expect that incremental build on both of those to be in 2015?

Yes, that -- what I would say is, on the slide on expenses, we do break out the Pacific Crest impact, which is about $17 million for the quarter.

It was about a breakeven for us.

And so going forward, we're going to see more and more of the Pacific Crest operation being integrated with our overall capital markets.

And so it's going to be tougher to really single that out, and especially as we look at integrating some of the back office and operations activities.

Okay.

I'll look that up.

And I know you're guiding to the same amount of loan growth for 2015 as you did last year.

Do you see double-digit C&I growth as sustainable in 2015?

What we're seeing is, our commercial growth should still be a strength for us.

That we're seeing some growth in our retail bank for consumer lending, but that's being offset by the exit portfolio wind-down.

And so we could see other components of the commercial category also providing some growth for us.

But I think in aggregate, it all translates to a mid single digit kind of growth expectation, which is consistent with 2014.

Okay.

And just a final question.

The exposure you outline on energy, relatively small, we shouldn't expect any impact from that on your capital [ASP] for this year?

Is that correct?

That's correct.

Okay.

Thanks for all the color.

Our next question us from Ken Usdin with Jefferies.

Please go ahead.

Thanks.

Good morning.

Don, I noticed that the period end balance sheet was significantly larger than the average for the fourth quarter.

And it looks like there was a really nice surge in non-interest bearing deposits.

So just wondering if you can flush out the sources of that deposit growth, if we're onto a meaningfully different trajectory for average earning assets?

And what are some of the moving parts there?

I'll go ahead and have Chris take care of the loan question, and then I'll go ahead and fill in some background on the deposits.

So Chris?

Sure, I'd be happy to.

Good morning, Ken.

Just to remind everybody, our business model is one where a relatively small amount, in the case of 2014, about 19% of the $54.4 billion that we raised actually ended up and stayed on our balance sheet.

So within any period, and within any category, there's just a lot of variability.

So first of all, that's one thing always to keep in mind, with respect to our business.

As we think about our ability to grow the loan side of it, we've been pretty successful in taking share.

We had 599 new clients in 2014.

And we actually think that as we think about it, Ken, our model resonates with our targeted clients and prospects.

So while it seems aggressive, we think we can continue to grow our loan portfolio.

But we really do so not necessarily going after loans, but really seeking clients that we think would fit into our business model.

And then as far as the deposits at period end, that we had some fairly large increases from some of our governmental customers that we had at the end of the year, which were short-term in nature.

So we do not expect that to be an indication of the start point for us for deposit growth, that we would expect, going forward, that our loan growth will exceed our deposit growth.

And so that will help drive a greater efficiency on our overall balance sheet.

Okay.

And then my follow up, then, Don, also just on securities buildup and long-term debt funding, where you had done a lot of that pre-funding for LCR, and we've seen that in the securities book.

Can you talk about where you are there?

And how much issuance you might continue to do versus securities build?

Good question.

And throughout the month of December, we were in the mid-80s, as far as our LCR ratio.

Keep in mind that we have to be at the 90% level by the first quarter of 2016.

And we think that we can continue to get there through some minor adjustments, going forward.

That we've shifted our investment portfolio to about 42% being comprised of Ginnie Mae securities, which is very helpful.

And we'll continue to see some cash flows go in that category, which will allow us to, over the next year, continue to push that ratio up.

Nothing material, as far as change, going forward.

Okay.

Just one little follow-up on that point.

And do you expect that you'll run with a buffer to the trajectory?

Or just once -- or just track to the 90, 100 of -- over time.

Yes, we do believe that we will have some buffer, just because you don't want to have any exposure for being under that number.

But I think that buffer will be modest.

Right.

Okay.

Thanks a lot, Don.

Thank you.

And next go to Bill Carcache with Nomura.

Please go ahead.

Thank you.

Good morning.

I had a follow-up question on deposits.

Don, you mentioned that there was an impact from some governmental clients in the quarter.

I believe that you guys had previously said that you were de-emphasizing municipal deposits, because you viewed them as punitive from an LCR perspective.

Can you update us on how you're thinking about those deposits currently, in light of the most recent LCR revisions?

And then how all that fits in with the growth that you saw from those governmental clients this quarter?

As far as our focus on the collateralized government deposits, we have seen those balances come down in the fourth quarter, and especially in some of the time deposit categories.

We will continue to support our strong customers, and those that have those relationships that have an expanded type of product relationship with us.

But we will expect those collateralized municipal deposits to come down.

The growth that we saw really was at the end of the calendar year, just for a few days prior to the end of the calendar year, and stayed with us for early part of January.

And it was very temporary in nature, as far as that buildup at the December 31 balance.

Okay.

So you're looking across the relationship.

And it sounds like -- so I guess along those lines, separately, can you elaborate a little bit on how you guys consider the overall profitability of a customer relationship?

And how that influences your lending decisions?

And if you could describe how that process maybe has evolved over the last couple of years, as we've -- as competition has intensified.

Sure, Bill.

This is Chris Gorman.

Let -- first, I'll talk about our public sector, public finance, but let me start more broadly.

We have a requirement that we get to a 20% rate of return with our clients.

Obviously, where a lot of debt is priced right now, that it's required that we have a wholesome relationship in order to hit our return hurdles.

Every single six months, we sit down and we go account by account on what the game plan is, what the returns are, what we have targeted, what we have achieved.

And so it's a very, very disciplined approach, once the clients are actually on our platform.

But I think even more importantly is the process that we use in terms of targeting our clients, figuring out who we can be relevant to.

And in our instance, we're looking for people in certain sectors that are middle market companies that we think need and value what we can provide, which we think is differentiated.

So as it relates, for example, to public sector, public finance, we are only focused on certain entities, certain agencies where we have a relationship that, as Don mentioned, is broader than a -- just a deposit.

Just as, on the corporate side, we're focused on companies where the relationship is much broader than just a loan.

What I'd like to do now is ask EJ to comment from a Community Bank perspective, because they take a similar discipline.

That's right, Chris.

We approach our client targeting in a very consistent fashion with the Corporate Bank.

I would say that in the Community Bank, we tend to compete against smaller banks.

And in that type of arena, our broad product capability, especially in payments, has helped us to price competitively.

Because we can look over -- typically, we look at a three-year time horizon to say, what kind of revenue are we going to earn over that period of time?

And how many products can we add?

And where the answer is positive, we can be very competitive.

Where a client says, I want to just use your balance sheet, but another bank is going to be my provider, we will move on to the next client.

That's excellent.

Very helpful.

Thank you very much.

Thank you.

Thank you.

And we go to Bob Ramsey with FBR.

Please go ahead.

Hey, good morning, everyone.

Good morning.

[Obviously], a very strong quarter for investment banking fees, and great to see the balance and fee income generally.

Just wondering if you could talk a little about the investment banking pipeline heading into this next quarter?

And what is incorporated in growth in 2015 versus 2014?

And your total fee income guidance on the banking line?

Bob, this is Chris.

I'll start and talk a little bit about the investment banking piece of it.

When I look at it, I really look at, what are the fundamentals of the business over a period of time?

And as I look at those, I think we've expanded our capabilities.

We've expanded our sectors like technology, consumer.

We just mentioned public sector.

And I think the level of discussions, and the strategic nature of the discussions that we're having, are better than they've ever been.

Having said that, obviously, there is a great amount of volatility in when these fees actually come to fruition.

So I don't really think about it on a quarter to quarter basis, but I do look at it over a period of time.

And if you go back to 2010, we were at about a $200 million run rate.

Now we're at about a $400 million run rate.

If you look at our trailing 12 number, currently, it's about 13% greater than our trailing 12 number was a year ago.

And I think we can continue that kind of a trajectory in this business, based on the people that Don mentioned we've been able to bring onto the platform and the clients we've been able to convert.

So while I like our trajectory, I think the long-term trajectory will continue.

There, of course, will be variations on a quarter to quarter basis.

As it relates specifically to the pipeline, with the exception of one particular area, we are above where we were in our pipelines last year.

So I feel good about our pipelines.

But as always, we -- first of all, we have to execute.

And secondly, we have to have the continued cooperation of these markets.

Okay.

Great.

That's helpful.

I guess also, while I'm on fee income, corporate services seemed particularly strong this quarter.

Just any commentary around what drove that line item?

We had some stronger derivative income, along with some non-yield loan fees occur.

We also had a slight re-class from other income up into corporate services this past quarter.

And so all three of those contributed to the growth.

Okay.

That's helpful.

And then I was just wondering, I know you talked about how much you've got left in your existing CCAR capital plan.

I just want to be clear, I guess it's your intent to fully complete that in the first quarter here before you guys reload?

That would be our intent, to complete it.

Because you use it or lose it, so that would be our expectation.

Yes.

And then high level -- I'm sure you don't want to be too precise.

But thinking about capital plans for next year, you paid out 82% of earnings this year, your capital ratios are every bit as strong as they were a year ago, and you all continue to build capital.

Would it be your hope to return a little bit more than that in the coming year?

Bob, this is Beth.

And as we indicated, we have submitted our 2015 capital plan.

I think we have always indicated that we believe we are well positioned, both in terms of our capital base, as well as the inherent risk in our businesses, as well as our balance sheet.

So we think we're well positioned for this CCAR cycle.

We've been successful, in the last several years, to be a peer leading returner of capital.

And we look forward to being consistent, and an advocate for our shareholders in that regard, and being able to announce our results in March.

All right.

Sounds good, Beth.

Look forward to it.

Thank you, everyone.

Thank you.

Our next question is from Erika Najarian from Bank of America Merrill Lynch.

Please go ahead.

Good morning.

I just had one follow-up question.

Beth and Don, I really appreciate how you laid out your outlook and expectations for the year.

And I guess as a follow-up to Steve's question, is the message to us that even if -- even without the benefit of higher rates, that Key is targeting positive operating leverage for 2015?

That's absolutely the case, yes, that we would expect revenues to grow not only in aggregate, but both net interest income and fee income to grow, and expense to be relatively stable.

So we would show positive operating leverage in both scenarios.

Great.

Thank you.

Thank you.

Thank you.

And we'll go to Gerard Cassidy with RBC.

Please go ahead.

Thank you.

Good morning, guys.

Good morning.

Question for you.

When -- you've given us the targets and you've met some -- on slide 16 of the handout.

And clearly, you've reached some of these targets.

Can you paint us a scenario where you'll get your net interest margin to over 3.5%, from the standpoint of an interest rate environment?

What do you think you would need to see for that target to be reached or exceeded?

Couple things.

I know higher rates, but if you could be a little more precise.

A couple things.

One is that I think that we'd have to see rates up at least 300 basis points from where they are today, and continue to see our balance sheet become more efficient.

We've talked about loan growth exceeding deposit growth, and we think that's a component of us being able to achieve that 350 guidance.

And with the rates being 300, Don, would that also include a steepening or maintenance of the steepness in the current curve?

Or is it more just the front end of the curve that you're focused on?

It would require some continuation of the steepness of the curve.

We're most impacted from the three- to five-year end of the curve and shorter.

And so as long as we see the steepness through that, I think that would help drive that kind of an absolute increase in the overall net interest margin.

And then coming back on capital, clearly, you guys are very well, if not over-capitalized, by many measures.

You've obviously focused on returning that to shareholders.

Can you share with us your thoughts on acquisitions or mergers?

Obviously, there was a big one announced today.

Do you guys consider that?

Or is it more just, let's return it to shareholders for the time being, and not really focus on doing M&A?

Gerard, this is Beth.

I think, as we've talked about our capital relative to our business plans and strategies over the last couple of years, we have had a consistent hierarchy of how we see utilizing our capital and returning and deploying it.

First and foremost, to support the organic growth of the Company, which we feel our capital base clearly adequately supports.

Second includes dividends and share repurchases.

And then we said it's important to have capital available for strategic opportunities.

And in recent years, we said, obviously, there's nothing in our business model we don't have that we need to be successful.

And you've seen us do some puts and takes, in terms of adding businesses and exiting things that are non-strategic.

But we clearly have adequate capital to be opportunistic, should something present itself that makes sense for our companies, accretive to our shareholders, and is additive to our business plan.

It has been a relatively quiet acquisition era, with more what I call one-off idiosyncratic type transactions.

But in the coming years, it's hard to predict what would transpire.

But I think what's more important is to know that we are committed to having the agility, as well as the capital, to do the right things by our shareholders.

And then finally, on returning of capital, we recognize the regulators are not very supportive of banks giving back more than 100% of earnings just yet.

But should that change possibly in the 2016 CCAR?

Philosophically, are you guys comfortable with, if there aren't any other opportunities to use that capital, of giving back more than your -- potentially could earn in 2016, especially if your Tier 1 common ratio stays at the levels it's at now?

I think that would depend on a lot of things, as far as what we're seeing from an economic environment, what we see as far as our organic growth.

Part of our challenges is that if we look back throughout 2014, we had an 82% return on earnings, as far as our dividends and share buybacks, and our capital ratios remained relatively flat.

And so that was just because the economy did not allow us to grow the balance sheet at a faster pace, and so we were able to maintain our capital ratios.

We believe our capital ratios are higher than where they need to be long-term.

And so one way to get there might be higher distributions in the future.

But that's all speculative, as far as what kind of a change would we see in the overall regulatory environment, going forward.

Agreed.

Okay.

Thank you very much.

Our next question's from Matt Burnell with Wells Fargo Securities.

Please go ahead.

Good morning, everyone.

Just a question on the level of pension and efficiency charges.

I think those totaled, on a combined basis, about $80 million in 2014.

I think in the past, you've suggested that maybe a $30 million level for those combined expenses would be a reasonable starting point for 2015.

Just curious if you've had any changes in your thinking on that?

Generally in that range, and depending upon -- you look at the pension settlement charges, those occur from two factors.

One with rates being very low, and also the high level of headcount reductions we've had throughout the year.

Our headcount is down almost 1,000 people year over year.

And so that is a direct impact of that, as well.

And so if that were to occur again next year, the $30 million to $50 million range wouldn't be bad.

And that's contemplated as part of our guidance.

Okay.

Thank you.

And then just finally from me, on page 26, it looks like you saw some higher non-performing loan balances, specifically in commercial, but also in home equity.

Is there anything to read into that?

Or is that just, given that we're at such low levels, we're going to begin to see volatility in those numbers, not just consistent declines.

Matt, hi, this is Bill Hartman.

You're absolutely right.

The numbers are low, and any movement is almost expected at this point, where things will just bump around.

And they'll go up a little, down a little.

We're into about three quarters of fairly stable performance right now, with the rate of improvement not as great anymore.

So your observation is correct.

Okay.

Thanks very much.

We'll go to Mike Mayo with CLSA.

Please go ahead.

Hi.

In looking at efficiency, it seems like a bad news/good news story, and I'd love some more color.

I guess in my bad news list, first, it seems like you might have missed your old efficiency target.

On page 14 of the release, it says you had a 66% cash efficiency ratio for 2014, and your prior target, I thought, was 60% to 65%.

Second, your long-term target implies by 2017, you'll get to an efficiency ratio that would still be 200 basis points worse than where it was almost a quarter of a century ago when you first had the merger.

And third, it seems like you have some of the savings already, like the fixed income headcount reduction is done, and you've already exited some businesses.

So that's my bad news column.

My good news column is, 64% efficiency ratio in the fourth quarter.

It's not clear how sustainable that is, but that's an improvement.

Second, I guess you do have some things left.

It would be nice to hear more about that.

You said branches, 2% to 3% reduction per year.

How many more years?

And what do you have left in Six Sigma?

And then third, the investment bank seems to be an extra lever.

And it's interesting.

It seems like your smaller investment bank is having better results than a lot of the large investment -- or the largest investment banks out there.

So Beth and Don, can you help reconcile my bad news/good news thoughts, when it comes to efficiency?

Mike, you get the prize for the longest question of the day.

So we'll give it our shot, and try to be direct here.

So as far as our full year 66% efficiency ratio, you're right, it's higher than our previous near term guidance range of 60% to 65%.

I'd say that going into 2014, we saw that revenues were going to be weaker than what we had expected, so we took additional steps to accelerate some of the cost savings.

That resulted in restructuring/pension charges of $80 million, which were $50 million higher than our plan.

And so absent those -- that increase, we would have been within that range, despite the fact that revenues were flat.

And so that was clearly an issue for us, from that perspective.

Good news, you're right that the current quarter is 64%.

It was benefited by the strength in the revenues, and also our continued discipline as far as managing those costs.

And we are very focused on driving those.

As far as the branch rationalization that -- we do believe that we have a period of time here where we will have the ability to reduce 2% to 3% of the branches for a few years.

That just the way that our customers are using those branches, that they have a different definition, and becoming more of a sales office than they are just a service center.

And so we think that is an opportunity for us.

And in the past year, we were able to save run rate a little less than $9 million a year from that type of consolidation effort.

We had also talked about the occupancy cost in other areas, our non-branch related space.

And we've been reshuffling a lot of that space this last year.

We should start to see some of the benefit, especially later in 2015, because that's when we'll see the benefit of those lease terminations come through.

And we expect to see a 15% reduction in our non-branch space over the next year and a half.

And that will translate to about a $12 million a year run rate savings for us.

As far as Lean Six Sigma and our continuous improvement focus, I'd say that we're early stages there, that we really have just started to kick off those programs and we're getting more and more traction.

That the benefit that we're projecting from that in 2015 is stronger than what we had in 2014.

And we think that will continue to gain hold and become more ingrained as part of the culture, which will help drive that going forward for us.

Okay.

One follow-up, then.

The specific follow-up, the 15% reduction in occupancy, you guys said it was 17% when Beth presented in September.

Does that -- is that a lower number?

Or did you achieve some of those savings?

As it relates to Lean Six Sigma, can you quantify any aspect of that, or is that cultural?

And then my big picture question for Beth.

I know we've been down this road before.

But again, just comparing the efficiency ratio of some of your peers, not to mention the 1994 level, versus where you are today -- and I understand you're changing the culture, and you've made strides.

But is there something a little bit more structural?

Would you consider more business exits?

Thanks.

As far as the occupancy for the non-branch space, it's reflective of the changes we've already made, that we have not reduced our [projection], as far as the savings there.

So it's just what we have prospectively left out of that 16% or 17% that we would have shared in September.

Then, as far as Lean Six Sigma, that I would say that the economic benefit from those Lean Six Sigma reviews that we implemented in 2014 was $25 million.

Our projection for 2015 is $40 million for those efforts.

And that's not all the cost savings.

It's just for those specific initiatives that are tied to that use of the Lean Six Sigma tool.

Mike, this is Beth.

And to the second part of your question is, we have made progress in 2014, and we are committed to continuing that progress in our efficiency goals and our productivity in 2015.

This was a year, and you have seen across the industry, a number of people have noted, that progress was difficult in this continued low interest rate environment, as well as slow economic growth.

So we did, as Don indicated, make some decisions early in the year that brought through some higher restructuring charges, to make sure we continue to do the things that keep us on the path to be sub-60, which is our commitment.

We are on that path.

We are committed to it.

And as I look at us relative to peers, each and every institution has their own unique business model, and there are attributes of ours that are different than some of our peers.

And specifically, we have talked about being predominantly a commercial bank, with a distinctive corporate bank model, which, as you indicated, has indicated significantly to our performance in the form of investment banking and debt placement fees, and is a lever.

Our trailing 12 on that business is right at $400 million now.

So as we look at it, positive operating leverage is something we've been talking about for well over a year, in addition to efficiency, as something that is driving our performance.

And as we have the corporate bank as a big contributor, it is not a low efficiency business, but it has certainly been an out-performer, both in absolute performance as well as relative performance this year, and as we look into the future.

And we do not have as large a payment business or some of the high yielding consumer assets.

When I look at the mix of our business, I think what's important is our focus on the operating leverage, our focus on our path and our commitments that we're making, and continuing to deliver on those.

All right.

Thank you.

Thank you.

And we have a question from Richard Bove with Rafferty Capital Markets.

Please go ahead.

I've been looking at page 19, I guess, of your press release.

And it indicates that funds available for shareholders actually went down by 1% in 2014 versus 2013.

And trying to relate that to the stock price, which was up about 3.6% in 2014, or well below the improvement in the market.

And if -- even with the rally going on in the stock right now, if you take a look at the stock price from, let's say, January 1 of 2013 to the present, it's down about 4%, in a market which has been relatively robust.

So I guess the question is, have you done any studies at all which indicate what the impact of repurchasing $128 million worth of stock has on the stock price?

In other words, do you have any rationale which shows that, by buying back stock, it has a positive impact on the stock price?

I'll go ahead and take the first crack at it.

This is Don.

And as far as the comment, as far as the net income available for Key, the line that you're looking at there includes our discontinued operations.

And in 2013, we had a gain on the sale of our victory capital.

And in 2014, we had a loss from the sale of our residual interest in our student loan trust.

And so if you look at just the net income available from continuing operations, we're up 8% year over year.

And so I think that's showing the strength in the overall performance for that line item.

As far as the share buyback program, that we do believe that it is additive or beneficial to our existing shareholders.

We are constrained, as far as what we can do to help manage our capital position, based on how the current rules work in this environment.

And so we believe that it is helpful.

But keep in mind that, at $128 million in the current quarter, it really doesn't move the dial a lot, as far as the market activity and flows for our stock.

So it's helpful, but I don't think it's a meaningful addition, from that perspective.

Beth?

And I would just add that -- and I appreciate the perspective on the stock performance, because obviously, it is among our goals to deliver top performance to our shareholders in terms of returns, both through our performance, as well as our capital actions.

And if you look at us on a three-year TSR, we are among the highest performers in the index.

And really driven in 2013, where we led the peer index in the group in that regard.

Many times, following a record breakout year, you tend to migrate back to more of the middle of the pack, which we did in 2014.

But again, when we look -- and I think shareholder return needs to be viewed in multi-year windows, extremely strong performance, both retroactively on a three-year basis.

We felt like 2014 was solid.

And as we said, as we go into this year, with positive momentum and confidence for what we will continue to do in terms of our ability to build value for our shareholders.

I understand that basically, there's a massive demand upon all managements in this industry to buy back shares.

What I don't understand is that in virtually no case where there's been huge buybacks of shares has there been out-performance of the stocks, vis-a-vis the market.

And I'm guessing that the reason why managements are buying back stock is not because they've studied the impact of the buybacks on stock prices, but because their investors are saying, we want you to buy back stock.

And therefore, I'd really be interested, if you ever really have studied, is there a relationship between buying back stock and an increase in the price of the shares?

Because clearly, with all these banks selling at premiums to book value, buying back stock is not what it used to be.

I would just like to add there that we do continuously look at whether or not we should be using the capital and the earnings to buy back shares.

But we do believe that it still is an attractive price for us to buy back, that we are generating earnings that exceed the need, from a capital perspective, to support our business organically.

And so we feel it's most appropriate for us to return that to our shareholders.

And based on how the current rules are structured, that we are limited as to the form that distribution can occur.

And so again, we feel that it's appropriate for us to continue to buy back shares, and feel that it's an appropriate price for us to continue to use the earnings to do so.

Thank you very much.

Thank you.

Thank you.

And we have a question from Marty Mosby with Vining Sparks.

Please go ahead.

Thank you.

Beth, I wanted to focus on, we've seen the investment banking kicking in, in a lot of the super-regional banks.

What is the real tailwind?

Or competitively, how's the landscape shifting to be able to allow for you all to take advantage of what really seems to be a very strong trend?

Marty, I will let Chris Gorman augment the answer.

But I do think it is important to note that we have a very distinctive Corporate Bank model, and it's something that we have built over years to be a very sophisticated platform.

And I think, as we look at 2014, is that it had record performance and relative out-performance versus a regional peer group.

So I'll let Chris talk a little bit about some of what the drivers are of what we think is a very distinctive part of our business model.

Sure, Beth.

So Marty, the way we see it is, there's -- although there's 7,000 banks in the United States, there's probably 18 or so, globally, that have the capability to complete integrated corporate and investment banking type work.

Most -- the predominance of those banks are focused on very large companies.

We are focused exclusively on mid-cap, middle market.

So then you -- and you also have many boutiques who are very good at what they do, and have very deep relationships, but clearly don't have the capabilities that we do.

So the opportunity for us is, first and foremost, focus.

And we focus on certain industries, and specifically on the middle market.

We think, actually, focus propels growth.

The second thing that we think we have a huge advantage is our size.

And when I say size, I mean sizes and small.

Our entire Corporate Bank only has 2,000 people in it.

And so it's pretty easy for us to maneuver, and to get things done on behalf of our clients.

The other thing I would say that as really -- as we think about some of these step functions, I think the stability of our platform, over a period of time, is both attractive to the people that we bring on to the platform.

And I think it's attractive to our clients and prospects.

So that's sort of the opportunity that we see out there.

And Beth, what I also wanted to focus on was your investing in payments or cash management.

That's an area where you've been behind the curve.

Can you see you replicating the success there, as you have developed the investment banking platform that we just talked about?

Marty, we do have our commercial payments business embedded within our Corporate Bank, to align it very much to these strategies, and how our targeted clients, we can matter to them, meet their needs.

And so we have done a variety of things, as we've invested, to align our commercial payments capabilities with some of our targeted industry groups.

We have developed new product capabilities that we have deployed in purchase and prepaid.

And again, that fits well with some of our targeted verticals.

So within that, we are making sure we have a core competitive offering.

And then we're also using the strength of our Corporate Bank model, and our Community Bank model, to make sure that we find unique niches of growth and opportunity, where we can be relevant and have the opportunity to get returns and growth for it.

Thanks.

And lastly, principal investing, is that an outgrowth from having more connection with these middle market and investment banking, and other types of avenues?

Or is that something else?

What are the sources?

And does that tie into your core business?

Marty, this is Don.

And this is a piece of the business that we've had for a number of years.

It really isn't linked at the hip with our capital markets activity.

It's just an investment strategy that existed years ago, and we've been benefiting from that.

That it's more of a wind-down mode for us now.

And we think, over the next 10 years, that will continue to [attrite].

Thanks.

We have a question from Nancy Bush with NAB Research.

Please go ahead.

Good morning.

I just got off the BB&T conference call.

And they were, of course, touting the Susquehanna acquisition, and the fact they will gain entree into Cincinnati, and I think their plans are to expand further in the Midwest.

But can you just speak to the competitive conditions there?

And where we stand, in terms of pricing and structure?

And we're hearing a lot of horror stories earlier in 2014.

And if you can just tell us how we ended out the year?

Nancy, this is Beth.

I will tell you that I think this has been a year where, in virtually every conference call, I think every bank has talked about the competitive intensity in the market, particularly in the loan generation area.

So I would tell you nationally, we see a lot of intensity.

It is true that historically, the Midwest has been outsized in its competitive intensity, given the number of competitors that are here.

We find that we compete well across all those different markets.

And as we look into 2014, I think it will be -- continue to be highly competitive on pricing, on structure, on product offerings.

And I think what we have done is -- over the last couple years, if you hear us talk, is trying to sharpen our focus about where we can matter, up our execution and our ability to reach targeted clients and bring the full relationship offerings of our bank.

And translate those into meaningful gains in acquisition and expansion of client relationships.

And we feel like we have had several years of performance in that regard.

And as we said, we have confidence.

We look forward, that's a strategy that fits our bank and our markets.

Okay.

And another question for you and/or Don.

I mean liquidity, you only, in recent years, have you become what I would call a very liquid organization.

And obviously, hanging onto core deposits is a big goal for you.

As we get closer to the interest rate increase time, and I'm hoping we are getting closer, how are you -- what kind of conversations are you having with your retail clients?

And what kind of product planning are you doing to make sure that, when liquidity starts to lessen, that you hang onto the deposit base that you've got?

And grow it, hopefully.

Nancy, this is Beth.

And I believe this would be a nice opportunity for Dennis Devine of -- the Co-President of our Community Bank to talk a little bit about the value proposition.

And how we are making sure that the core funding, which we also, by the way, agree that we hope interest rates are very close to going up.

But as rates potentially move, that our core funding, and our deposit mix, as well as our client base there, has really changed substantially over the last couple years, and puts us in a very different position.

Thanks, Beth.

And thanks for the question, Nancy.

You see, in the balance sheet, the continuing decline of timed deposits.

So the CD book has really begun to roll over the years.

But a commensurate offset with the growth in our core liquid deposits, transactional deposits, as well as money market deposits within the Community Bank, certainly driven by those retail deposits and commercial deposits we talked about earlier.

The strategy of the retail organization is organized around client growth.

You've seen new products introduced this year to accomplish just that.

We have a relationship-based strategy.

So when you look at the yields that we're currently offering within the non-time book today, you see we've continued to manage that really thoughtfully around those client relationships.

And certainly, as rates begin to -- as interest rates grow in the market, we've got a core relationship book that we'll be working with, as we assess what the yield on those deposits will continue to look like.

So you'll see us grow clients.

You'll see us really thoughtfully manage the current book.

And it will be with a sense of what betas look like holistically across Key, but certainly a very deliberate understanding of, what does that look like in the money market book?

Relative to, what does that look like against each one of the transactional deposits that we have within our business?

We're in a strong position, given the decline that you've seen in timed deposits, and a strong, relationship-based liquid book within our Community Bank.

Do you feel that you'll have to, perhaps, give more of the rate rises to clients and to customers?

And more quickly than you have in the past?

Because it's -- people have been complaining, and I'm sure you're aware, of low rates for a very long time.

And my sense is that they're going to be more sensitive when they begin to hear the news that rates have begun to rise.

It's an unprecedented rate environment, so we clearly will manage that closely going forward.

We've got some good experience here, and we expect that, given the relationship nature of our clients, that we'll be able to manage that very well.

And we don't have rate shoppers (technical difficulty) today.

Okay.

Thank you.

And with no further questions, I'll turn it back to you, Ms. Mooney, for any closing comments.

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 at 216-689-4221.

And that concludes our remarks.

Please have a good rest of the day.