KeyCorp (KEY) 2017 Q3 法說會逐字稿

Good morning, and welcome to the KeyCorp's Third Quarter 2017 Earnings Conference Call.

As a reminder, this conference is being recorded.

I would now like to turn the conference over to the Chairman and CEO, Beth Mooney.

Please go ahead.

Thank you, operator.

Good morning, and welcome to KeyCorp's Third Quarter 2017 Earnings Conference Call.

In the room with me are Don Kimble, our Chief Financial Officer; Chris Gorman, President of Banking; 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.

I'm now moving to Slide 3. This morning, we announced third quarter earnings of $0.32 per share or an adjusted $0.35 per share, excluding merger-related charges and other notable items.

My comments this morning will focus on the adjusted results, which are comparable to prior periods.

This was our seventh consecutive quarter of year-over-year positive operating leverage, and our return on average tangible common equity was just over 13%, which is consistent with our long-term target of 13% to 15%.

Our results this quarter included a number of moving parts, most notably a large commercial loan recovery that impacted our provision and was largely offset from lease residual losses in noninterest income.

Don will walk you through the line items in his remarks.

We were pleased that net interest income, excluding purchase accounting accretion, was up $20 million -- $27 million from last quarter, with the core net interest margin increasing by 2 basis points.

Average loans grew 0.4% linked quarter, driven by commercial and industrial loans, which were up 2% unannualized.

Our business model and middle-market focus enabled us to continue to add clients and take share, which resulted in growth in both C&I loan balances and Key.

Our total average loan growth this quarter reflects higher paydowns, especially in September, and relatively stable trends in our consumer portfolio.

Commercial real estate balances were impacted by clients continuing to take advantage of attractive capital markets alternative, which helped contribute to our strong investment banking and debt placement fees.

We also remain disciplined with new deals and have reduced construction loans and project financing, which is counter to some of the market trends.

We expect loan growth to be stronger in the fourth quarter based on seasonal trends and strong pipelines.

And for the full year, we expect average loan growth of around 3%, excluding the impact of First Niagara.

That's lower than we originally expected at the beginning of the year but reflective of the environment and consistent with our moderate risk profile.

Other positives for the quarter included strong fee-based income across our businesses.

As I mentioned earlier, investment banking and debt placement fees continue to grow, and we are well positioned as we head into the final quarter of the year, which historically is one of our strongest periods.

Cards and payments had a record quarter, up 7% from the prior quarter, reflecting the investments we have made in the businesses, our recent merchant services acquisition and some of our early successes with First Niagara clients.

Most of the other fee categories showed good growth, both year-over-year and linked quarter.

Our cash efficiency ratio remained under 60%, and we believe we can move that lower with or without the benefit from higher interest rates.

Expenses remain well managed with our quarterly results reflecting our recent acquisition of HelloWallet and merchant services as well as some seasonal trends.

Credit quality remained strong, with a net charge-off ratio of 15 basis points, which, as I said before, included a large C&I loan recovery.

We've also remained disciplined in managing our strong capital position, including returning a significant portion to our shareholders.

Over the past 5 years, we have repurchased over $2 billion in common shares, and our compounded annual growth rate for the dividend has been 14%.

In the third quarter, we repurchased $277 million in common shares and paid a dividend of $0.095 per share.

Overall, it was a solid quarter, which reflects our success in executing on our strategic priorities, growing our business and delivering on our commitments.

As we look ahead, we expect to complete the First Niagara cost savings by early 2018 and remain confident in achieving our targeted revenue synergies.

We continue to see organic growth and momentum across our company, and we have made investments in our people, products and capabilities to support our relationship strategy and drive future growth.

And most recently, early in the fourth quarter, we completed the acquisition of Cain Brothers, a leading health care-focused merger and acquisition investment bank.

The move will significantly expand our existing health care verticals and further enhances our ability to serve our clients with distinctive expertise and capabilities.

I will now turn the call over to Don to provide some additional color on the quarter.

Don?

Thanks, Beth.

I'm now on Slide 5.

We reported third quarter net income from continuing operations of $0.32 per common share.

This compares to $0.16 per share in the year ago period and $0.36 in the second quarter.

Our results this quarter included a $0.03 impact from merger-related charges and an adjustment to the merchant services gain.

Excluding merger-related charges and notable items, earnings per common share was $0.35, up 17% compared to the prior year and up 3% on a linked-quarter basis.

As Beth mentioned earlier, excluding notable items, our cash efficiency ratio remained below 60%.

We had a return on tangible common equity of over 13%.

I would also like to highlight a number of quarter-specific items that impacted our results.

First, we had a large C&I recovery, which reduced our net charge-offs and resulted in a lower loan loss provision.

In noninterest income, we also recognized impairment losses on some equipment leases, most of which mature in 2018 and later as we thought it was prudent to reflect current market conditions.

These 2 items were essentially offsetting and, as such, did not impact our core earnings for the quarter of $0.35 per share.

Also, professional fees were elevated due to several short-term initiatives.

And while our recent acquisitions of HelloWallet and merchant services will be accretive over time, they added $8 million of expense in the third quarter.

I'll cover many of the remaining items on this slide and the rest of my presentation, so I'm now turning to Slide 6.

Total average loan balances of $87 billion were up $9 billion or 12% compared to the year ago quarter and up $312 million or 0.4% unannualized from the second quarter.

Compared to the year ago period, average loan growth primarily reflects the impact of the First Niagara acquisition as well as ongoing business activity with commercial and industrial loans continuing to be a driver.

Sequential quarter growth and average balances was driven by commercial and industrial loans, which were up 2% unannualized as we continued to take share in the areas we have targeted.

Our C&I portfolio grew despite higher levels of loan paydowns.

Commercial real estate loans declined this quarter due to payoffs toward the end of the quarter and planned reduction of certain acquired loans.

Home equity loans also continued to experience elevated levels of paydowns, which exceeded our loan originations.

During the month of September, loan paydowns increased, resulting in a decline in the period-end balances of $450 million during the month.

We would typically see growth during September.

Given the paydowns in the last month of the quarter as well as our pipelines and expected activity, we've updated our guidance and now expect fourth quarter average balances in the range of $87 billion to $87.5 billion.

Continuing to Slide 7. Average deposits totaled $103 billion for the third quarter 2017, an increase of $8 billion or 9% compared to the year ago period and up $326 million or 0.3% unannualized compared to the second quarter.

The cost of total deposits was up 2 basis points from the second quarter, driven by contractual rate increases on commercial deposits and a change in the overall deposit mix.

Our beta of 17% in the third quarter continues to remain below historic levels as we are maintaining pricing discipline in our markets.

Compared to the prior year, third quarter average deposit growth was driven by First Niagara as well as core retail and commercial deposit balances.

On a linked-quarter basis, the change in deposit balances was primarily driven by noninterest-bearing deposits from commercial deposit inflows and short-term escrow balances.

Growth in CDs also helped to offset our managed exit of certain public sector deposits.

We continue to have a strong core deposit base with consumer deposits accounting for 60% of the total deposit mix.

Turning to Slide 8. Taxable-equivalent net interest income was $962 million for the third quarter of 2017 and net interest margin was 3.15%.

Purchase accounting accretion contributed $48 million or 16 basis points to the third quarter results.

This compares with $58 million or 19 basis points in the second quarter.

The third quarter decline of $10 million from the second quarter level was primarily driven by a $7 million lower benefit resulting from prepayments.

The second quarter also benefited from an additional $42 million due to the finalization of purchase accounting.

Looking ahead, we continue to expect to benefit from the accretions to trend down into the range of approximately $40 million in the fourth quarter of this year and further reducing by approximately 10% per quarter in 2018.

Excluding purchase accounting accretion, net interest income increased $145 million from the prior year, largely driven by the impact of First Niagara and higher-earning asset yields and balances.

Growth of $26 million -- $27 million from the prior quarter resulted from higher-earning asset yields, which was partially offset by higher funding costs and lower loan fees.

Excluding the impact of purchase accounting accretion, our net interest margin was 2.99% for the third quarter, up 2 basis points on a linked-quarter basis as we saw a net benefit from the higher interest rates.

For the fourth quarter, we expect our core net interest margin, excluding purchase accounting accretion, to be relatively stable.

Loan yields in the fourth quarter are expected to be stable while deposit cost will continue to increase.

We do anticipate the benefit from our investment portfolio as yields on the new purchases are expected to be approximately 50 to 60 basis points higher than maturities.

Moving on to Slide 9. Noninterest income in the third quarter was $592 million.

During the quarter, notable items included an adjustment to our merchant services gain of $5 million.

Excluding these notable items, noninterest income was $597 million, up $36 million from the prior year and up $5 million from the prior quarter.

Growth from the prior year reflects the impact of First Niagara acquisition as well as broad-based organic growth, which helped offset lower investment banking and debt placement fees relative to our record third quarter level last year.

We continue to be on pace for another year of growth in investment banking and debt placement fees, reflecting the success we've had in growing this business.

Compared to the second quarter, the increase in noninterest income largely reflects continued growth in our fee businesses, including another strong quarter in investment banking and debt placement fees and cards and payments income, which, as Beth mentioned, reached a record level as we continued to benefit from the investments we are making, including the recent merchant services acquisition.

Momentum in our business was offset by leases -- by lease residual losses of $13 million during the quarter.

As I said earlier, these equipment leases have maturities that primarily extend in the next couple of years.

However, we thought it was prudent to recognize a loss to reflect the current market conditions.

Last quarter, as is typical -- typically more common, we had gains in this line item.

Absent the third quarter lease residual losses, our cash efficiency ratio in the third quarter would have improved to 59.2%.

Turning to Slide 10.

Reported noninterest expense for the third quarter was $992 million, which includes $36 million of merger-related charges.

Compared to the third quarter of last year and after adjusting for merger-related charges, noninterest expense was up $63 million.

Growth primarily reflects the full quarter impact of First Niagara acquisition as well as ongoing business investments and the recent acquisitions like HelloWallet and merchant services.

Linked-quarter expenses, adjusted for merger-related charges and other notable items, were up $21 million.

Third quarter expense levels mostly reflect the recent HelloWallet and merchant services acquisitions, which added $8 million as well as seasonal trends in marketing and personnel, which collectively added $10 million.

We also had $3 million of business services and professional fees related to short-term initiatives that we would not expect to continue going forward.

Excluding these items, expenses were down on a linked-quarter basis.

We are also on track to realize the remaining $50 million of merger-related savings by early 2018.

Looking forward, the Cain Brothers acquisition will add approximately $20 million to fourth quarter expense and revenue levels.

Turning to Slide 11.

Net charge-offs were $32 million or 15 basis points of average total loans in the third quarter, which continues to be below our targeted range.

Third quarter provision for credit losses was $51 million.

As I mentioned earlier, we had a large C&I recovery during the quarter, which benefited our net charge-offs and provision by $20 million.

Aside from the recovery, our portfolio continues to perform well and charge-offs remain below our targeted range.

Nonperforming loans were relatively stable, up $10 million or about 2% from the prior quarter and represented 60 basis points of period-end loans.

At September 30, 2017, our total reserves for loan losses represented 1.02% of period-end loans and 170% coverage of our nonperforming loans.

This quarter, we've broken out the allowance for our acquired loan portfolio.

As you can see on this slide, this allowance has grown as we built provision to coincide with the turnover in the acquired loan portfolio and the associated wind-down of the loan (inaudible).

Turning to Slide 12.

Our Common Equity Tier 1 ratio at the end of the third quarter was 10.26%.

Capital levels in the third quarter benefited from a change in our methodology related to risk weightings for multipurpose facilities, specifically commitments that can also be used for letters of credit.

As Beth mentioned, we repurchased $277 million of common shares during the quarter.

Slide 13 provides you with our outlook and expectations.

We remain committed to generating positive operating leverage.

However, guidance remains the same with the exception of loans, reflecting the results through the third quarter.

As I mentioned earlier, we now expect fourth quarter average loans to be in the range of $87 billion to $87.5 billion.

Again, the remaining guidance for the full year has remained unchanged.

We continue to expect average deposit balances for the year to be in the range of $102.5 billion to $103 billion.

And net interest income is still expected to be in the range of $3.8 billion to $3.9 billion.

Our outlook continues to assume no additional benefit from rate increases this year and that betas will remain low -- well below their historic levels.

As I mentioned earlier, purchase accounting accretion will trend down over time, reaching approximately $40 million in the fourth quarter.

Quarterly impact should then decline at a rate of approximately 10% per quarter in 2018.

We continue to anticipate that noninterest income will be in the range of $2.35 billion to $2.45 billion, and noninterest expense should be in the range of $3.7 billion to $3.8 billion.

Included within this range is approximately $20 million in added expense from Cain Brothers, which closed early in the fourth quarter.

In addition, expenses related to HelloWallet and merchant services acquisition as well.

We expect merger-related charges, which are not included in our guidance, to continue to trend lower.

In 2017, net charge-offs should continue to be below our targeted range of 40 to 60 basis points and provision should slightly exceed our level of net charge-offs to provide for loan growth.

Our GAAP tax rate is expected to be in the 26% to 28% range for the year, and we remain committed to our long-term financial targets stated at the bottom of the slide, including: continuing to generate positive operating leverage, operating at cash efficiency ratio less than 60%, maintaining our moderate risk profile and producing a return on tangible common equity of 13% to 15%.

I'll now turn the call back over to the operator for instructions in the Q&A portion of the call.

Operator?

(Operator Instructions) First on the line is Matt O'Connor with Deutsche Bank.

I wanted to circle back to the cash efficiency ratio target.

You were just below 60% this quarter on an adjusted basis, and that's in line with the year-to-date.

As we think beyond the fourth quarter and you've got a couple of these deals that obviously are a drag on the efficiency ratio, you still got the $50 million saves coming in, any early thoughts on what to expect in 2018?

Matt, we would expect to continue to drive the efficiency ratio down from here.

You -- as you highlighted, the most recent transactions are not helpful in that case, but that we do believe that there are opportunities between the additional expense savings that we have remaining of $50 million from First Niagara, which we expect to realize early in 2018, the additional revenue synergies that we'll be achieving from that acquisition and just the organic growth, where we continue to drive positive operating leverage, to help drive the efficiency ratio down in 2018.

And then just quickly on the purchase accounting accretion, I guess.

So take the $40 million for the fourth quarter and shrink that 10% per quarter for next year, and I guess you got the kind of, call it, $120 million to $125 million range for the full year?

That makes sense in that range, yes.

Next, we'll go to Scott Siefers with Sandler O'Neill.

First one is just sort of a ticky tack one on that PAA.

I think the expectation before had been for a close to like $48 million per quarter for a while.

So it seems like a fairly large change in the expectation.

I'm just curious, what drove the change in thinking there?

Yes.

I think as far as the future expectation, we expected that purchase accounting accretion would continue to wind down year after year and continue to get to the point where 5, 4 years from now, it would not be adding any benefit at all.

I'd say that the current quarter came in lower than our expectation as far as that $48 million number because the purchase accounting benefit from the prepayments came in lower than what we would have expected.

And so that's the only difference from that perspective, and just our outlook will continue to reflect that as our new start point.

Okay.

And then, Donald, when you had given the margin guidance.

I think you said core, including the PAAs, would be stable.

Was that the reported margin you expect to be stable in the fourth quarter or the core and the way we would think about it without the PAA?

What we said in the script was the core without the PAA.

But even with the PAA, that'd still be in that same general range because when we say stable, we say plus or minus a couple basis points, and then we would expect the purchase accounting to have that kind of an offsetting impact.

Okay, perfect.

I think I just misheard that.

Apologies.

And then final question.

Just on the -- you've got some puts and takes in the loan growth.

And then it looks like that sort of the ongoing growth is pretty strong, particularly in the commercial portfolio, but then we've got these kind of unexpected paydowns.

And I know it can be difficult, but to what extent do you have visibility into the paydowns?

Or more -- I guess more to the point, to what extent have you incorporated such phenomena continuing into the updated guidance?

We -- in our updated guidance, we have assumed that the prepayments or paydowns would be higher than typical, and that's why we're showing loan growth getting us to $87 billion to $87.5 billion for the fourth quarter.

As far as our insights, we were a little surprised by the level of paydowns we saw in September.

So I wish our crystal ball was a little clearer than what it is right now, but I would say that, that came in higher than expectations.

And so we're -- our updated guidance would reflect that we would see some continuation of some of those higher levels of paydowns.

Next, we'll go to Ken Zerbe with Morgan Stanley.

Great.

I guess first question.

Just in terms of the expenses -- or the expense guidance, I just want to make sure I'm using kind of the right numbers here to get to your $3.7 billion to $3.8 billion of total expenses.

If I put in sort of similar numbers this quarter into fourth quarter, I get at the very high end of that range.

Is that how you're thinking about it?

Or is there -- because I did see those items that you mentioned, the HelloWallet, merchant, et cetera.

Should be back out all those $20-or-whatever million dollars in fourth quarter so the number would be $20-or-something million lower than where it is now?

Any clarity would be helpful.

Good comment.

As far as our outlook, we're not backing out any of the impact from HelloWallet or the impact of Cain Brothers.

So those are included in the numbers.

So you're right, if you would add in a similar number for this quarter and add in the impact of Cain Brothers, we would be at the higher end of that guidance range.

I would say that an outlook for the fourth quarter would assume that the core expense levels, absent Cain Brothers, would probably be a little bit below the third quarter level.

But when you add in Cain Brothers, it would be higher than the third quarter level of $956 million.

Got it.

Understood.

And then just a quick question.

In terms of -- going back to the loan balances.

I get that you're expecting the prepayments or the payoffs to continue at this level.

But if I just look at like CRE on an average basis down 1.5%, construction is down a lot more, if the past due continue at this point, like at what point can you actually drive growth in those particular lines?

I would say, one, is that we've been counting on and continuing to show growth in our C&I book.

I would say that CRE and our construction portfolio did show declines this quarter.

We would not expect that, that level of decline to continue, but we would expect to see more of an ongoing stable look to that portfolio in the future, but we have seen some declines, especially in the construction portfolio and would expect to see that continue to trend down a little bit.

Next question is from Erika Najarian with Bank of America Merrill Lynch.

I fully appreciate the guidance on the efficiency ratio.

But as you both know, the conversation with investors sometimes always focuses a lot on dollar expenses.

So on the back of Ken's comments, as we think about some of the core growth that you expect for next year relative to the cost savings from First Niagara, Don, how do you expect that the quarterly trend line on absolute expenses to go sort of in the first half of next year versus second half?

And we'll provide more clarity at the end of first quarter call as far as the '18 outlook, but I would say generally that we would see the remaining $50 million realized in that first part of 2018.

Also, think about as our revenue synergies would be realized, we've said that, that would be $300 million over the next 2 to 3 years.

We'll also have expense added to the tune of about $100 million to support that $300 million in growth.

And so we would see that kind of proportionate throughout the next few years to grow to that level of additional revenue levels.

I would expect the core expenses, absent those kind of trends and adjusted for these recent acquisitions, would be relatively stable.

What we've tried to do is continuing to drive the positive operating leverage by achieving cost savings to help offset some of the expense increases and allow those investments to drive the revenue growth, which generates the positive operating leverage.

Got it.

And this next question is for Beth.

Beth, as you recall, there was a lot of consternation in last quarter's call about some comments that may have been misconstrued on your part about your strategy.

And I'm wondering if you could -- would baffle this big audience in front of you.

You could give us a sense of how you're thinking about capital management for 2018 and 2019 for Key, and I'm asking that purposely in an open-ended way.

All right, yes, and I appreciate the opportunity to be clear on the point.

As we look at capital management for '18 and beyond, I think our priorities are very clear.

First and foremost, our ability to use our capital to support our organic growth is our top priority.

The ability to continue the dividend increases that have been outlined in our capital submission and we'd expect to continue as we submit next year's CCAR, as we talked about, migrating our dividend payout more to a -- [40%] to 50% range is a priority.

And then to continue to repurchase our share to the extent they are attractive for our shareholders and the return of capital to our shareholders.

From there, strategically, our priorities would not be M&A.

That is not a priority.

And yet, on that front, we do not yet feel like we are fully complete realizing the value of First Niagara for our shareholders.

So first and foremost, we believe it's incredibly important that we complete the job there and make sure that our shareholders realize the full benefit.

And then to the extent we have done investments in people, products and capabilities, those are things that we continue to look to enhance our relationship strategy as well as our capabilities for our customers.

Cain Brothers would be a recent example of that.

And within the second quarter, HelloWallet and the -- purchasing our merchant services business would be examples of other areas where we feel like investment support our strategies and enhance our growth.

Our next question is from Peter Winter with Wedbush Securities.

If I could just follow up on Erika's question about the expense.

That -- if that $100 million in expense is added to support the revenue synergies, would you expect the revenue synergies to come through in 2018 and be above that?

Or is there some type of delay?

I would say, as far as our revenue synergies, it's a total of $300 million a year, and that's building proportionately throughout '18 and '19 and into 2020 a little bit.

And we would expect the incremental expenses to be proportionate to that revenue realization.

So we don't think there'll be any further early build-out of those expenses.

And so we would expect to see that net benefit continue to build throughout the next 2- to 3-year time period.

Okay.

And just a quick follow-up.

You added $19 million to the reserves this quarter, which it looks like it mostly went in for the acquired loans.

Is that a new pace that we should expect going forward?

Yes, the $19 million included both the allowance and the reserve for unfunded loan commitments.

The $22 million for the newly acquired loans was a little bit higher this quarter.

I don't know that I would signal that's a new pace for us as far as having provision exceed charge-offs by $20 million, but we do expect to continue to build that allowance at about 1 point -- or 1 basis point per quarter.

So you will see some increased provision to account for that.

Next, we'll go to Saul Martinez with UBS.

Appreciate the commentary on the revenue synergies and the benefits you get there, but can you just talk a little bit more about how that's progressing?

And it does seem like it is something that does take time for you to penetrate and really extract value from those clients.

But can you talk a little bit about what you're doing there and how you see that $200 million net run rate playing out and starting to filter through the results over time?

It's Chris Gorman.

It's really a few areas where we're principally focused.

And those areas are, and I'm going to come back to residential mortgage in a minute, is residential mortgage payments.

Beth made a couple of comments about the trajectory of our payments business, where we have a pretty broad portfolio that we're doing a pretty good job penetrating.

Next is private banking.

If you look at the legacy First Niagara footprint, there is a lot of wealth in that footprint, and our Key private banking business can do a good job, we think, of penetrating that.

Next, we've got a lot of activity in the commercial banking capital markets area.

It's kind of fun for me as I'm out in the market calling with people.

You really can't differentiate kind of the way we're going to market in the new areas and the legacy areas.

So I think we're making really a lot of progress there.

And then lastly and importantly, I mentioned residential mortgage.

That's a business that First Niagara had.

That's a business that we, Key, didn't have and that we're building.

And we think it's a significant opportunity.

If we just get our fair share of the 3 million clients we have that are taking out residential mortgages, we think that can be a pretty significant growth business.

And on that point, we've added -- if you look at our MLO count just in the last quarter, we've added 20% to that sales force.

So that gives you maybe a little bit of the flavor of kind of where we're focused.

That's helpful.

And in terms of when we actually start to -- it starts to show up in the results, is this -- this sounds like it's a long-term process.

You guys have talked about it being a multiyear kind of framework, and there's a lot of blocking and tackling, obviously.

But is this a 2018?

Is this a 2019 story?

How should we think about what you just said in terms of it actually filtering through in the results and in top line momentum?

I would think that you'll start to see that build in 2018.

As Chris said, we've been building out that residential mortgage business, and we'll start to see the benefits there.

And we've already started to see some of the benefits start to show some sprouts as far as the payments business and the capital markets-related activities.

And so those will continue to build those annuity streams for us going forward and start to pick up in '18.

That's helpful.

If I could change gears a little bit on -- and ask about capital.

Your CET1 is now above 10%.

I think you -- correct me if I'm wrong.

You guys have talked about, I guess, 9%, 9.5% is an optimal CET1 ratio.

Any updated thoughts on capital?

It seems like you have a lot of room to rationalize capital.

And if you could just comment also, in relation to that, how any changes in the SIFI threshold would think about -- would influence your thinking there.

Sure.

And you're right that we've talked about our long-term target for that CET1 to be in that 9% to 9.5% range.

In the past year's CCAR submission reflected the impact of our acquisition, which has some -- a punitive impact to it as far as how the math works.

And so our expectation is, is that we should, as Beth highlighted, be able to continue to step up that dividend and have share repurchases to help manage that capital level down toward that 9% to 9.5% targeted range.

And so we're optimistic that we can take those steps here in the next CCAR submission.

To your point, as far as the SIFI designation and what type of benefit that might have, but -- last year, we started to see a little bit of relaxing of some of the payout levels.

And before, we had constraints as far as payouts couldn't exceed 100% of total earnings.

And so we think that if that SIFI designation would change, that could even loosen those restrictions even further.

But our objective is continue to have a strong level of capital, and we believe in that 9% to 9.5% range, that, that would position us very well prospective.

Our next question is from Gerard Cassidy with RBC.

Don, can you share with us -- in looking at your earning asset yields, particularly in the commercial loan portfolio, I see that they dropped from about 4.34% in the second quarter of '17 to 4 11%.

In particular, the construction loans really dropped as well as commercial real estate.

What are you guys seeing in that market for the yields to come down like that?

Gerard, unfortunately, what you're seeing there really is some noise related to that purchase accounting true-up that we had in the second quarter.

And so that was about $42 million, most of which hit those categories that you had talked about.

And so if you would adjust for that, our commercial loan yields were up 15 basis points linked quarter, which reflects the impact of the increased LIBOR for the quarter.

And so it -- we're seeing on a core basis, it just makes it more difficult for you all to see it on a reported basis.

And do you guys find that the underwriting standards are being maintained in those lines of businesses?

Or are you seeing some changes there by chance?

Gerard, it's Chris.

So as you think about -- specifically since your question was about real estate, what you're seeing is sort of what you would expect at this point in the cycle.

So I don't think the underwriting standards are changing dramatically.

I will say, though, with the capital markets being as wide open as they are, what you're seeing is that our customers have a lot more opportunity to look at taking 10-year -- no recourse, 10-year paper.

And I'm thinking of Fannie, Freddie, FHA, HUD, the life companies.

CMBS market has been open.

So clearly, there are opportunities for our customers.

But in terms of what people are putting on their balance sheet, we haven't seen a huge change.

Very good.

And then, Chris, speaking of just real estate, the investment banking and debt placement fee line, obviously $141 million is a good number.

Can you break it out between the debt placement fees and pure investment banking?

And then second, as part of that, and did you -- were you able to capture any business from the First Niagara customers in the quarter?

So in terms of a breakout, Gerard, we've never provided a breakout by product with respect to that number.

So that number that -- has a trailing 12 run rate of about $550 million.

That's obviously -- it's a big business for us.

We've grown it each of the last several years.

We anticipate continuing to grow it this year.

As it relates specifically to some penetration into First Niagara, we have had some successes, which is -- which really gives us, frankly, a lot of comfort.

One of the areas of success is in commercial mortgage.

So far, we placed about $300 million of commercial mortgages, things that were on our books that, first and foremost, serve the client better because it's a better deal for the client.

We make a fee, we derisk our balance sheet.

So that's one area.

We've also had some wins in terms of things like straight-up financial advisory-type work, which is pretty early to already have been engaged and complete those.

So we feel pretty good about that trajectory.

Next, we'll go to Kevin Reevey with D. A. Davidson.

I was wondering if -- maybe, Don, I know the auto loan book is a small percentage of your overall loans but a key focus of investors' attention.

If you can kind of give us some color as to how the credit in that book performed this quarter versus last quarter.

I would say the credit continues to be very strong there and no deterioration in that portfolio, but keep in mind that we focus on issuing super prime paper.

So it's a 760 FICO score on average.

And so we're very pleased with the performance, and we believe that we continue to be positioned well for that business.

And then, Don, I just wanted to kind of understand the moving parts on your earlier discussion on the NIM.

You had mentioned something about the investment securities rolling off, and you -- did you say you expect to see 50 to 60 basis points increase in yields?

Should that -- so that should offset some of the run-off in the loan accretion as well as the increased deposit costs?

I just want to kind of understand the moving parts.

Sure.

As far as the investment portfolio, we have about $1.4 billion of cash flows a quarter coming off that portfolio.

And what we've said is for the fourth quarter, we would expect to see about a 50 basis point pickup on that $1.4 billion compared to the -- a run-off of that portion of the portfolio.

And so that will be an add, and that's how we get back to that guidance as far as a relatively stable core NIM for the quarter.

Next, we'll go to Marty Mosby with Vining Sparks.

There's 2 things that really were kind of off-track in a sense of kind of kept you from doing a little bit better this quarter.

And one of those was, like you said, the PAA.

As you had all these paydowns in September, those paydowns should have really led to higher purchase accounting accretion.

So what was the disconnect?

I mean, do you -- I think you have mentioned earlier kind of off the cuff that you were surprised that it didn't work.

When you looked at it, what was the reason that it didn't work this quarter?

I would say that the paydowns that we saw throughout the quarter that put pressure on our loan portfolio didn't necessarily correspond to the same type of benefit that we would have seen for some categories that had a higher purchase accounting discount recorded at the time of the acquisition.

And so those higher credit discount portfolios didn't attrite as much this quarter as what they had in previous quarters.

And so it was really more of a mix of those paydowns as opposed to the absolute level of paydowns that caused that balance to come down at a slower pace.

That makes sense.

So maybe the better borrowers were able to do that versus the credit impaired borrowers.

The other thing that I was looking at is, while your investment banking and debt placement moved up sequentially and was at a higher level, it still was down from last year.

And I was just curious if you thought that possibly any of the disruptions that we saw across the country with hurricanes and everything else that was going on, that, that somehow possibly delayed some of the transactions just because of the business disruptions that were going on out there at the back end of the quarter.

Marty, it's Chris.

We don't specifically think that the hurricanes and some of the other disruptions had a material impact.

A lot of these transactions have a pretty long lead time, and exactly when they happened is a whole confluence of things.

But I don't think the weather per se had an impact on the timing of these deals.

Having said that, we do feel good about where the pipeline is.

And Marty, I would add that if you look at 2016, of the first half of the year, the markets were depressed and not functioning well.

So our levels of investment banking and debt placement fees were not consistent with the level of performance we would have expected.

And the third quarter last year was the quarter where you really saw the markets open up and a lot of the pipeline flowed through.

So third quarter last year was actually a record year and reflects what was pent-up demand coming out of the slow first half.

The next question is from John Pancari with Evercore ISI.

On the loan demand side, I just want to talk about the front end a little bit.

I know you've been talking about in terms of loan growth, the impact of the paydowns and everything.

But in terms of the front end, Beth, you sounded a little bit more constructive in your commentary around the pipeline.

And so I wanted to give you -- I wonder if you can give us a little more color around where you're seeing the strengthening of pipeline and also a little bit around line utilization.

Sure, John.

It's Chris Gorman.

Couple things.

As we look forward into the fourth quarter, the pipelines are strong, and there's a few things really working in our advantage there.

The first is that we have a leasing business that typically is a fourth quarter business.

The second thing is just our business flows continue to be good.

Even areas like real estate, where we didn't grow loans, we're clearly growing the business.

So we have really good flows.

As it relates specifically to utilization, pretty flat.

So if you go back a year or you go back a quarter, right around the -- it's -- the utilization has been flat.

So that is potential upside if people feel the impetus to sort of go long on inventory, which heretofore we haven't seen.

Okay.

And then in terms of the borrower sentiment, are you still seeing a -- the number of borrowers apprehensive to draw down on lines amid the uncertainty in Washington?

No, I think sentiment has remained sort of as it's been.

I would describe it as cautiously optimistic.

We're out talking to our clients all the time, but one of the interesting things that we've seen in places as diverse as, say, Elkhart, Indiana and Boise, Idaho is all of a sudden, it seems like unskilled labor is a little bit tight.

It seems like the cost of building materials is starting to increase.

So I would hold those out as sort of a little bit of a sort of green shoots as you think about people getting back to being a little bit more aggressive.

But what we're seeing in general is sort of a continuation of what we've seen, which is that our clients are doing well but they're cautiously optimistic.

And John, I would add that there is dialogue that relates around fiscal policy, particularly related to tax reform.

And I do think that there is some tendency at this point in the year to wait to see what that uncertainty translates into.

And with a more constructive tax environment, I do think there is some level of demand that might come forth.

Okay.

And then on the comp expense, the 3% or 2.5%, pick up there on a linked-quarter basis, how much of that was IB related or related to the performance from the investment bank?

And then what other drivers impacted that?

Sure.

As far as the investment bank, we tend to see about a 30% correlation between the revenue changes and the comp expense related to the investment banking and debt placement fees.

And so that's been fairly consistent over the last couple of years.

One of the drivers this quarter as far as total personnel cost is, is that do we see seasonal increases in our health care and medical costs?

And that also drives an increase on a linked-quarter basis of around $5 million or so.

Okay.

And then one more for me.

The Cain $20 million in revenue and expense that you expect in the fourth quarter, how does that trend further out?

Does the expense level pare back a bit?

Or how are you thinking about the profitability of the acquired business?

Yes, we do see a strong contribution coming from Cain.

I would say that expenses do come down a little bit, and we see a lot of revenue synergy opportunities for us as well as they're a great fit with our overall banking franchise.

Anything you'll add to that, Chris?

No, I would say that as an enterprise, we have about $10 billion of exposure in places like hospitals, seniors' housing, skills -- skilled nursing.

Cain is an organization that we had been keenly interested in for some time.

So we're adding about 100 people, 25 senior bankers that have very, very good relationships that tie in really well with the business that we've built.

Sort of the first test we always have when we're looking at any acquisition like this is, can we integrate it into our core business?

And as you think about the offerings that we have in terms of debt, payments, equity, we think Cain will be a great fit.

Our next question is from Mike Mayo with Wells Fargo Securities.

There are a lot of ins and outs here.

Where is your guidance by line item a little bit worse?

And where is it better?

And as you look ahead, I think you said you expect better efficiency next year, but there's some other ins and outs I might have missed.

As far as our guidance or outlook, the one piece that we did change was the loans.

And so we do see those at a lower level for the fourth quarter than we previously expected, and it came out a little light on the third quarter compared to our expectations.

And so that's the primary driver.

As a result of that, we're seeing a little less net interest income, but we've still kept that in the overall guidance range that we had established at the beginning of the year.

We've also seen purchase accounting accretion come in a little lower than what we had previously expected.

And so we think that is -- is an area of challenge from that perspective.

The opportunities, we continue to see strong fee income growth.

And we think we're well positioned for the capital markets space to be strong again in the fourth quarter.

And we think fee income is growing at a pace that's in line to better than where we had been positioned before.

And I'd say as far as the expense guidance that the only adjustment we've made there really is to reflect Cain Brothers.

That wasn't previously in our guidance.

And even with that, we're still in the range that we had previously provided.

So I don't know that, that has changed materially as well.

And so I think it's just those 3 pieces that really have moved a little bit.

Right, got it.

And maybe this is too simplistic, but I think with KeyCorp -- with the capital markets being able to capture more the disintermediation from the traditional bank lending.

In other words, the paydown on the loans, borrowers accessing the capital markets more -- shouldn't you have seen more of those revenues there?

Well, Mike, it's Chris.

We agree that we think the model that we built is, first and foremost, well suited to our clients to be able to access whatever the most advantageous capital is.

And so to the extent that there are pockets of pretty -- the markets are wide open and there are pockets of opportunity out there, we think we're well positioned to serve our clients and continue to grow our business.

It might, in any given quarter, not be on the loans on our balance sheet line, but we can continue to grow our business.

Our next question is from Steve Moss with FBR.

It's actually Kyle Peterson on for Steve today.

I'm wondering if you guys could talk a little bit more on the capital front.

I saw you guys got the nice boost to CET1 this quarter, kind of the methodology reclassification.

Moving forward, I guess, is there a particular -- in terms of combined payout, is there a kind of a level or a [per bound] that you guys are looking at in future cycles?

Or is it more about managing that dividend payout ratio where you want and trying to get CET1 more to that 9% and 9.5% range?

I think it's more the latter there.

Now we do believe we want to see our dividend continue to step up and get into that payout range of 40% to 50%.

And then we will adjust the other capital actions, share buybacks, to help manage that capital level down to that targeted range over time.

And so that's where we think there should be a nice step-up for us in future CCAR periods to be able to reflect those.

Okay.

And then I guess a little bit more on the paydowns.

I think, if I heard commentary correctly, I'm just looking at the numbers, looks like they were tilted -- or is it fair to say they were tilted was a little more towards CRE and construction over C&I?

And is -- are those trends kind of continuing so far early in the fourth quarter?

The paydowns, you're right, probably had a disproportionate impact on the commercial real estate portion and construction.

We would expect construction to continue to wind down a little bit from the current levels.

And so we would expect that.

We also expect paydown to continue to be at an elevated level here in the fourth quarter.

But longer term, we do think that there's opportunity to show more stability.

And maybe even down the road, a little bit of growth there in the commercial real estate portion of the portfolio and that continue to see that line down.

And next, we'll go to Steven Alexopoulos with JPMorgan.

I wanted to follow up on John's earlier question.

I'm trying to better understand why you're not seeing the slowdown in C&I that many of your peers are seeing.

Are you guys are just finding your markets more resilient?

Are you doing a better job of taking market share?

And is there a particular market driving the growth?

Steve, I think as we step back and look at it, as you know, we've always been strong in C&I.

So we have a real business built around continuing to go out.

And as we look at it, it's really share capture because it's not as though we're holding any more of the credits that we're underwriting.

So we really attribute that 2% linked-quarter, unannualized growth to really -- we're fortunate enough to be out there and be able to win in the marketplace.

And one thing I'd like to add to that as well is that historically, we were relying more on the Corporate Bank as far as generating the C&I growth.

And I'd say over the last 1.5 to 2 years, we've seen the Community Bank portion of the commercial lending activity also be additive, and that's been a real help for us.

And so we have the entire organization helping to drive that as opposed to just one portion of it.

Is the growth broad based?

Or is there one market that you would point to really being key to the story here?

It's really broad based.

As Don mentioned, in our Community Bank, going to places -- last week, I was in Salt Lake, I was in Boise.

They -- we're getting really good growth across the board, and a lot of that is C&I.

And that's the business, of course, just last quarter had double-digit growth.

So it's really broad based.

And Steve, I would just add that also, part of it, if you think about it, that we've talked about last quarter and it continues into this quarter that the First Niagara bankers in the new and overlap market are starting to also contribute the first couple of quarters growth, or perhaps more focused on transitioning their relationship books.

And they are now also starting to see growth, which is gratifying.

Helpful.

Maybe one final one.

Don, sorry if I missed this, but the new purchase accounting guidance going down 10% quarter-over-quarter in 2018, I think you originally said you expected 2019 to decline around 20%.

How should we think about that?

Should we decline 20% off that new level for 2018?

Look, well, your crystal ball goes out a lot longer than mine does here, Steven.

But I would say just to continue to assume that 10% decline per quarter.

That could continue for the foreseeable future, be a good estimate at this point in time.

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

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.

Have a great day.

Ladies and gentlemen, that does conclude your conference.

Thank you for your participation.

You may now disconnect.