KeyCorp (KEY) 2018 Q3 法說會逐字稿

Ladies and gentlemen, good morning, and welcome to KeyCorp's Third Quarter 2018 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 2018 Earnings Conference Call.

In the room with me is Don Kimble, our Chief Financial Officer; Chris Gorman, President of Banking; and Mark Midkiff, 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. We reported solid results this quarter, with earnings per share of $0.45, up 2% from last quarter and almost 30% from the year ago period.

Our results drove improvement in our cash efficiency ratio, which was 58.7%, and our return of average common tangible equity was 16.8%, both up over 300 basis points from the year ago period.

Revenue was up 3% from last year, driven by broad-based growth across our company.

With positive trends in our Community Bank and Corporate Bank.

Our growth reflects the success of our business model, competitive positioning in the market, and investments we continue to make across the franchise.

Average loans grew 2% from the prior year and were down slightly from the prior quarter.

The decline in average balances were impacted by a lower starting point coming into the quarter.

Importantly, we saw a stronger commercial loan growth as we move through the quarter, which is reflected in our period-end balances, which were up 1% from the prior quarter.

We expect to see further growth in the fourth quarter, which Don will cover in his comments.

Underlying trends in our fee-based businesses remained strong.

Investment banking and debt placement fees grew compared to the prior quarter and year ago period, reaching a new record for the trailing 12 months.

Driving this quarter's results were strong advisory and loan syndication as well as continued benefit from our acquisition of Cain Brothers.

We have to continue to be disciplined with our expense management.

This quarter, expenses were relatively stable after adjusting for merger-related charges in the year ago period and from notable items last quarter.

And we accomplish this despite the added cost from Cain Brothers acquisition and other investments that we continue to make in our business.

We remain committed to further efficiency improvement and reaching our targeted range of 54% to 56%.

Final 2 sections on this slide highlight our strong position in terms of both risk management and capital.

Credit quality remains a strength, with net charge-offs to loans of 25 -- 27 basis points.

We believe that maintaining our moderate risk profile will serve us well as we move through different parts of this cycle.

Our approach to capital has remained consistent and focused on maintaining a strong capital position, while returning a large portion of our earnings to our shareholders through dividends and share repurchases.

Consistent with our 2018 Capital Plan, our Board of Directors increased our common stock dividend by 42% to $0.17 per share in the third quarter.

We also repurchased $542 million of common shares.

Key's Common Equity Tier 1 ratio ended the quarter at 9.9%.

Overall, it was another good quarter for Key, with broad-based growth across our franchise.

We continued to be disciplined with expenses, while investing for growth and maintaining our credit underwriting standards.

This resulted in strong bottom line performance, which drove further improvement in both efficiency and returns.

And we are positioned to build on our momentum as we move through the end of the year.

As Don will discuss in his remarks, we expect to continue to deliver positive operating leverage in the fourth quarter, driven by linked quarter revenue growth and relatively stable expenses, which will result in our sixth consecutive year of positive operating leverage.

Despite the recent sell-off in bank stocks, we remain positive about our long-term outlook and the steps we have taken to position the company to perform through the business cycle.

Before I turn the call over to Don, I wanted to mention our upcoming Investor Day that we are hosting on October 30.

The purpose of the event is to expand more on our business model, strategies and positioning and to showcase our strong leadership team.

If you are an analyst or an institutional investor and have not yet received an invitation, please contact our Investor Relations team.

We are also making the event available to all of our important stakeholders through a live webcast that can be accessed through the IR webpage.

With that, let me hand the call over to Don.

Thanks, Beth.

And I'm on Slide 5. And as Beth said earlier, we recorded third quarter net income from continuing operations of $0.45 per common share.

Our results compared to $0.32 per share in the year ago period and $0.44 in the second quarter.

I will cover many of the remaining items on this slide in the rest of the presentation, so I'm now turning to Page 6.

Total average loans of $88.5 billion were up 2% from the year -- prior year and down slightly from the prior quarter.

Average balances were impacted by a lower starting point coming into the quarter and a continuation of low utilization levels and elevated pay downs.

Importantly, we saw an increased new business activity and positive momentum as we move through the quarter, which was reflected in our period-end linked quarter growth of 1% and commercial growth of almost 2%.

Clients remain optimistic and confident, their businesses are performing well, increasing profits and generating sufficient cash to fund their business needs, resulting in lower loan demand that we would've expected earlier in this year.

Despite this, our pipelines are strong and activity is up.

As a result, we expect loan balances to be up in the fourth quarter on a low single-digit percentage basis.

Continuing on the Slide 7. Average deposits totaled $106 billion for the third quarter of 2018, up $1.6 billion or 2% on annualized compared to the second quarter.

The cost of our total deposits were up 10 basis points from the second quarter, reflecting the recent rate increases as well as the continued migration of our portfolio into higher-yielding products.

Our deposit beta for the current quarter was 52%, resulting in a cumulative beta of 29%, which we expect to migrate higher overtime.

On a linked quarter basis, deposit growth was primarily driven by retail and commercial relationships as well as short term and seasonal deposit inflows.

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

Turning to Slide 8. Taxable equivalent net interest income was $993 million for the third quarter of 2018, and the net interest margin was 3.18%.

These results compared to taxable equivalent net interest income of $962 million and a net interest margin of 3.15% for the third quarter of 2017.

And $987 million and 3.19% in the second quarter of last year.

Purchase accounting accretion contributed $26 million or 9 basis points to our third quarter results.

This compares with $28 million, also, 9 basis points in the second quarter and $48 million or 16 basis points in the third quarter of 2017.

Excluding purchase accounting accretion, net interest income was up $53 million or 6% from the third quarter of 2017.

The increase was largely driven by higher interest rates and earning asset growth.

Net interest income increased $8 million or 1% from the prior quarter, excluding purchase accounting accretion, benefiting from higher interest rates and day count, partially offset by lower loan fees.

This quarter's margin was negatively impacted by higher levels of liquidity as our cash position increased almost $1 billion from last quarter.

The higher level of liquidity reduced our margin by 2 basis points.

Also during the quarter, the average 1-month LIBOR will only increased 14 basis points compared to the 25 basis point increase in the Fed funds rate.

If the 1-month LIBOR had increased by 25 basis points, our net interest income would have been $5.5 million higher, and the margin would've been 3.20%.

Moving on to Slide 9. Key's noninterest income was $609 million for the third quarter of 2018 compared to $592 million for the year ago quarter and down from $660 million in the prior period.

Growth from the year ago period was primarily driven by a $25 million increase in investment banking and debt placement fees, with strengthening advisory fees, including the benefit of the acquisition of Cain Brothers as well as organic growth.

Operating lease and other leasing gains increased as well related to higher volume and lease residual losses in the year ago period.

Compared to the prior quarter, the decline is largely due to the $78 million net gain on our insurance sale, which was recognized in other income last quarter.

Trust and investment services income also declined, primarily reflecting the sale of Key insurance and benefit services.

Partially offsetting these declines is a $41 million increase in operating lease income due to a lease residual loss in the second quarter of 2018.

Investment banking and debt placement fees also increased a record trailing 12-month level of $664 million.

Turning to Slide 10.

Key's noninterest expense was $964 million for the third quarter 2018 compared to $992 million in the third quarter of 2017 and $993 million in the prior quarter, down 3% from both periods.

The third quarter of 2017 included $36 million of merger-related charges.

Excluding these charges, the slight expense growth from the year ago period was largely related to acquisitions and investments over the year, including Cain Brothers.

This growth offset the realization of cost savings and efficiencies across the entire franchise.

Compared to the second quarter, the decrease in expenses was largely driven by a $33 million decline in personnel expense.

This was driven in part by lower severance and incentive compensation expense related to the efficiency-related charges last quarter.

Importantly, as we move towards the end of 2018 and into next year, we're committed to continuous improvement in our efficiency efforts across the franchise.

Moving on to Slide 11.

Our credit quality remains strong.

Net charge-offs were $60 million or 27 basis points for the average total loans in the third quarter, which continues to be below our target range.

The provision for credit losses was $62 million for the quarter.

Nonperforming loans were up this quarter as a result of a few of the credits, with no concentration by industry or type.

NPL represented 72 basis points of period-end loans.

Other leading indicators such as credit size loans and delinquencies, all showed improvement this quarter.

At June 30, 2018, our total reserve for loan losses represented 99 basis points of period-end loans and 138% coverage of our nonperforming loans.

I'm turning to Slide 12.

Capital also remained the strength of the company, with a Common Equity Tier 1 ratio at the end of the third quarter of 9.9%.

As Beth mentioned earlier, in line with our 2018 Capital Plan, we increased our common share dividend by 42% this quarter from $0.12 a share to $0.17 a share.

We also continued to repurchase shares, which totaled $542 million this quarter.

Slide 13 includes our outlook for the fourth quarter 2018 relative to the third quarter results, as we build our momentum through the end of the year.

We expect positive operating leverage, driven by revenue growth and relatively stable expenses.

We expect average loan balances to increase by a low single-digit percentage in the range of 1% to 2% from the third quarter level of $88.5 billion.

Deposits are expected to remain relatively stable with the third quarter.

Net interest income is expected to be up in the low single-digit range from the third quarter, again, approximately 1% to 2%.

And this reflects the benefit of the September rate increase.

We also expect one more rate increase in December, which will have minimal impact in the fourth quarter.

We would expect our margin to increase 1 to 2 basis points, assuming our liquidity position remains at the relatively same level.

We anticipate that noninterest income will be up in the mid-single-digit range from the $609 million reported in the third quarter.

Growth is expected from many of the fee-income areas, especially investment banking and debt placement fees.

And as I mentioned, we continue to expect noninterest expense to be relatively stable with the third quarter amount of $964 million.

We had previously assumed a benefit from a reduction in the FDIC assessment during the fourth quarter, which is no longer included in our outlook for next quarter.

We'd also previously communicated that we would be approaching the high end of our efficiency ratio target by the end of the year, continue to expect our efficiency ratio to improve in the fourth quarter from the third quarter level.

But the absence of the FDIC benefit and the lower loan balances will impact the pace of our progress in the fourth quarter.

As Beth communicated, we remain committed to our target efficiency ratio of 54% to 56%.

And we'd expect to be within this range in the second half of 2019.

Net charge-offs and provision expense are expected to remain relatively stable with the third quarter.

And we expect our GAAP tax rate to be in the range of 16% of 17%, up slightly from the third quarter level.

As Beth said, this was a solid quarter with continued growth across our franchise.

We are benefiting from the results of our efforts to improve the efficiency and returns, and look forward to continuing to deliver on the commitments we have made.

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

Operator?

(Operator Instructions) First with the line of Scott Siefers with Sandler O'Neill.

Don, I appreciate the color on the margin guidance in the next quarter, up only 2 basis points.

I guess, I was a little surprised that the core wasn't -- was not this quarter.

I guess, maybe if you could provide a little more color on the main puts and takes you see affecting the margin rate.

And then sort of how your rate sensitivity kind of plays off from here?

Great.

And you are right.

I think the margin was lower than what we would have expected as far as the percentage compared to -- coming into the quarter.

So for the third quarter, there are really 2 items that negatively impacted us this quarter.

One was the liquidity levels.

And as I mentioned, our cash position was up $900 million to $1 billion for the quarter, which cost us about 2 basis points in our margin, didn't have much of an impact on net interest income, but did negatively impact the overall margin.

And the second piece was, and I mentioned this earlier, was that the 1-month LIBOR only went up 14 basis points this quarter.

And so, normally, you would expect to see that moving parallel to the Fed funds rate.

And if it would have, that would've added another 2 basis points to the margin or roughly $5.5 million.

And so as we look to the fourth quarter, we do expect to see more of a rate increase benefit like we would've expected this quarter.

And so probably in the couple of basis points being driven from that and very little pressure coming from the purchase accounting accretion.

And also keep in mind that our investment portfolio puts out about $1 billion, $2 billion of cash flows each quarter.

And the reinvestment rate there is about 1.2% to 1.3% higher for those cash flows for the new go-to yields compared to what's running off the portfolio as well.

And so that will also be helpful going into the fourth quarter.

Okay, that's perfect.

Maybe just as a quick follow-up on that.

So LIBOR, I guess, we can sort of watch where that has moved, so we know what the couple basis points impact would be.

And I think you had suggested -- so liquidity levels, the guidance assumes they sort of stayed the same.

What would be the main deltas that would change the liquidity levels?

I mean, I imagine the pace of loan growth and demand would be a factor.

But what would materially alter those levels?

The only other impact that you didn't say, it really was deposit flows.

And this quarter, we did have some growth in some temporary deposits along with core growth.

And so if that deposit growth outpaces loan growth, we see a build up in our liquidity position.

And not expecting that, but as we said that we expect loan growth up 1% to 2% from third quarter and deposits relatively stable on an average basis.

Perfect.

And then just final one, really ticky-tack here.

You got into a 16% to 17% GAAP tax rate in the fourth quarter, will that sustain into next year?

Or will it revert back up to a more recently typical level?

Yes, the 16% to 17% continues to expect a level of tax credits from some leasing activities.

And at this point in time, we think that's a reasonable assumption.

We'll provide more guidance on our outlook in January for '19.

Next, we'll go to the line of Peter Winter with Wedbush Securities.

I wanted to ask about loan growth.

You talked about the C&I.

But if I look at some of the other loan portfolios, we saw a moderation or an improvement from prior quarters, particularly commercial real estate.

I'm just wondering some of these other portfolios besides C&I, are you close to an inflection point and could see growth next year?

As far as commercial real estate, I would say that we don't see that as an area of strong growth for us.

But we like our business model there and risk profile.

We did see some balance lift here in the third quarter from some relationships that we had in progress.

But wouldn't sight as being a leading area for growth.

The other area that we did see some growth this past quarter was our indirect auto, and we would expect to see some continued growth there as we're continuing to originate through our existing Midwest franchise that was legacy Key.

So that should show some growth for us.

But -- and so a good percentage of the growth should continue to come from C&I growth for us.

And that's where we have our strength, and that's where we're seeing good pipeline for us as well.

On the C&I side, are you starting to see with that growth in the period, maybe pay downs slow?

And would you expect that to continue going forward?

Our pay downs really have been elevated compared to historical levels.

I don't know that they've slowed down much.

Utilization rates are still relatively stable for the third quarter from what they were in the second quarter.

The good thing is our activity levels picked up as far as new origination volumes late in the quarter, and that's where we saw the growth.

And that's what gives us optimism going into next quarter as we're seeing those activity levels pick up, and that's been helpful.

Our next question is from Matt O'Connor with Deutsche Bank.

I just wanted to ask about several fee categories that were weaker than I would've thought.

The service charges, corporate service income, cards and payments.

And you mentioned revenue recognition change, which I think impacted it on a year-over-year basis.

But maybe just discuss a little bit why those 3 buckets were weaker?

And then your outlook on those 3, which a couple of them were pretty big drivers for you.

Service charges you mentioned, there was a couple of items.

There were adjustments, including some revenue recognition true up there as well.

We would expect growth in that line item for those in the fourth quarter to more normalize for us for the quarter.

So it was artificially low this quarter for some of the adjustments there.

Corporate services income really was down mainly because of derivative incomes coming down this quarter.

But we just saw a little less demand from our customer base for that category.

And it has been an area of growth for us historically.

But there is some variability to that based on customer activity.

And then as far as the cards and payments related revenues, we do have some items in the second quarter that were more purchases, accounts and the equipment that would have had that level be a little bit stronger.

It is an area of growth for us.

We do expect the fourth quarter to be up.

And we expect that to be an area of growth for us going forward into 2019 as well.

Okay, that's helpful.

And then just stepping back kind of bigger picture.

Revenue overall, I thought it was soft this quarter.

Some of it seems like it's temporary.

And obviously, you've addressed it in the pieces with loans and fees.

But just kind of big picture, like, do you think this was a quarter where things just kind of went against you from a revenue perspective?

Or do you think the revenue outlook is going to be a little bit weaker than you would've thought?

And then maybe you should be focused on tightening the costs a little bit more?

I would say that loan balances are coming in lower than what we would've expected for the third quarter.

And that really was the surprise that we had at the end of the second quarter, which continued for us, which was the lower levels of utilization.

And the impacts were some higher pay downs.

And so as we would've come into this year, we would've expected the loan growth to pick up in the second half of the year, and we haven't seen that.

And so that is a surprise for us based on what our expectations would've been coming into the year.

As far as the fee income categories, when we look at the activity and the volumes and the customer activity around these areas, we're seeing positive trends.

And so our guidance for the fourth quarter says that fee income should be up mid-single digits on a linked quarter basis.

So I think we're going to see some of that momentum come into the fourth quarter.

And I think it helps set the table for us going forward.

But the follow-on point that you made, Matt, is something we only do manage to.

And if the revenue growth isn't there, then we do believe it's important that we do manage our expenses more tightly.

And that's something that we'll continue to look at and make sure that we're doing what we need to do to make sure that we live up to our commitments.

And Matt, this is Beth.

We're obviously in the 2019 planning cycle.

And it is very much a focus as we have both Don and I reiterated the commitment to the 54% to 56% efficiency ratio target.

And that we plan to be operating within that by the back half of 2019.

We are making sure we are constructively balancing, both our outlook for revenue as well as appropriate expense levels investments in order to achieve that.

Our next question is from Ken Zerbe with Morgan Stanley.

I was hoping you can just elaborate just a little bit more on the higher nonperforming loans that you saw in the quarter.

I think it was up $100 million.

I know you said there wasn't any concentration, but was it a couple of loans?

Was it a lot of loans?

Trying to figure out.

It really was just a few unrelated loans.

And then they weren't concentrated in any industry or geography at all.

So don't view that as a trend for anything from a credit-quality perspective.

As I mentioned before, [indiscernible] were down, delinquencies were down.

And so other trends would reinforce that credit quality continues to remain strong.

Got it.

Okay.

And then in terms of loan growth, I guess, you -- in the fourth quarter, I know you were surprised that we're not seeing the rebound in second half loan growth, so more broadly speaking.

But what could derail the growth in fourth quarter?

Because I think -- and I guess, I'm kind of -- we're all probably a little bit worried that you expected to go up.

But like, are we going to be surprised again to the negative when fourth quarter ends?

So Ken, it's Chris, good morning.

As we look at it, the reason we have confidence as we go into the fourth quarter is we've got a -- we have a strong backlog, we have a much better starting point.

We also have a business that typically in the fourth quarter is particularly strong.

For example, we have a significant M&A backlog that often pulls through financing.

The other thing that we have is our leasing business, Ken, generates about 33% of their annual volume in the fourth quarter.

And they're very focused on technology and health care equipment.

So those are pretty good flows, and we have pretty good visibility on that.

In terms of what could derail it, one, if we have dislocation in the markets and we can't get transactions complete, that's always a risk in our business.

The other thing is that people continue to not borrow under their lines but use their cash flow to buy inventory out of cash, to invest in PP&E out of cash.

And then the other thing, of course, that is always unique to our business model is we only put about 20% of the capital we raise on the balance sheet.

So if, by chance, there are huge opportunities for us to better serve our clients by taking them to other markets, that too can have an impact on our loans.

But the flip side of that would be it improves our fees.

Next question is from Ken Usdin with Jefferies.

Just following up on the NII outlook and commentary.

Don, can you just dig in a little bit more to what you're seeing in terms of this customer behavior on the different sides of the business from a repricing perspective?

Obviously, you guys, like everyone else, are seeing the rate of increase move up on 13 basis points to deposit cost this quarter.

But you can kind of -- can you give us a little color on segments in terms of any changes in terms of consumer versus commercial and how the behavior is starting to act, if any different?

The -- this last quarter, we did see the deposit betas move up for both consumer and commercial.

But consumer was in the mid-40s, and the commercial segment was about 70%.

So we did see both of those move up.

And that continues to be a strong demand coming from both sides as far as looking for additional products that have higher rates and yields.

And we're seeing that being offered to the customers across the board, whether it's the community banks up through the largest banks in the U.S. or providing some rates that are higher for some of those commercial deposits.

And so as we look forward to our deposit betas, we would think that for the fourth quarter, we're still going to be in the mid-50s as far as deposit betas.

So maybe up just a touch from where we were in the third quarter.

But over time, we'll continue to see the cumulative 29% beta inch up as the consumer behaviors continue to seek higher deposit cost of products.

Got it, okay.

And second question just on the mix of earning assets.

You had some average deposit growth this quarter, and you mentioned the loans weren't quite there.

What's your philosophy right now in terms of securities portfolio?

Where do you want -- do you want to be putting incremental cash there?

And what you're seeing in terms of front-book versus back-book yields?

Sure.

On the investment portfolio, we've been maintaining that really stable.

It's just shy of $30 billion.

And it's been there for a number of quarters.

And longer term, we do believe that our loan growth will be outpacing our deposit growth.

And so we do believe that there will be an opportunity to continue to maintain that level of investment securities and not have to shift that mix overall.

Now the good thing is on the investment portfolio.

As I mentioned, we've got about $1.2 billion of cash flow a quarter off the investment portfolio.

The yield on that cash flow is 2.15% to 2.2%.

And the new purchase volumes are coming in at 3.4% to 3.5%.

So we do see a nice lift there, which helps offset some of the drift in the deposit base and also any purchase accounting accretion changes.

Next, we'll go to John Pancari with Evercore ISI.

Back to the nonperformer discussion.

Could you give -- can you give us a little bit more specific detail around that?

Like, what was the number of credits?

What were the sizes?

And also what were the industries?

I know you mentioned they're not concentrated.

But what were the exact industries?

I would say that it's 5 or less, as far as the total credits.

So it is a very few.

And I would say that the industry types are very diverse.

And Mark, if you could add just a general sense there?

Yes, just broadly, I mean, from equipment to the real estate category.

So it's broad.

Okay.

And any of them loans to financial institutions?

They are not.

No.

Or leverage loans?

No, they're not.

Okay, all right.

And then related to that, the loan loss reserve is around 99 basis points now.

Although, I know it's higher when you exclude the marked -- acquired portfolios.

But how are you feeling about that longer term here?

Where do you think the appropriate longer-term loan loss reserve level is?

Particularly in a context where we are in this cycle and that we've got a little bit of noise that's now resurfacing in the nonaccruals?

Well, one, I don't want to have the nonaccrual relate to future potential problems there.

I don't think that's a trend that we would want to extend from here.

Two, you're right.

If you would take a look at the purchase accounting credit mark on the loan portfolio and add that to our total reserves, it's in the [1 15] to [1 16] level.

And so I think that will be an appropriate assessment as to where that would trend overtime as those purchase loans do mature and are replaced with new originations.

I think the other thing that we need to keep in mind, though, too, is that the nature of this portfolio has changed significantly from where it was before the crisis.

And so it's a much cleaner portfolio, much less risk profile to it.

And so we think that it would be appropriate range as far as the overall allowance being in that 1 15 to 1 16 range, yet to be determined as far as the impact of season.

We'll have that come through in 2020.

And so that will set a new level.

And I think we'll be well south of that 1 15 level before CECL was implemented.

So we can provide more color at that time.

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

The first question I wanted to ask is you have obviously addressed loan growth in many different ways.

I am wondering, especially from you, Chris, if you can give us a little bit more sense of how competitive the nonbanks are with your business and give us a sense of structure versus rate competition?

And also, I hear you loud and clear on the NPL composition.

But I'm wondering what are your exposures on balance sheet to either broadly syndicated leverage lending or sponsor-backed transactions?

Sure.

Good morning, Erika.

So just to kind of give you a flavor on the competitive landscape, clearly, there is competition and it manifests itself in structure and it manifests itself in pricing.

The way we approach it is we price everything on a relationship basis.

And so on the margin, 12.5 basis points does not make a huge difference for us as we go out there and holistically serve our clients.

So there is pricing pressure, but we don't find that it really degradates our returns in total.

Now as it relates to structure, there are some people that are taking duration risks, there are some people that are going out on the credit spectrum, that's not our business as we maintain our moderate risk profile.

As it relates to the nonbanks, most of their activity is around leverage finance.

So that's where you see the most activity by the nonbanks.

As it relates to our leverage finance, specifically, we have been flat in terms of our exposure to leverage finance literally since before we completed the First Niagara transaction, where we grew by 40%.

We get a lot of velocity out of that portfolio.

And so we're really pleased with where we are.

And obviously, we have the ability to distribute a lot of that paper, much of which frankly is purchased by some of the nonbanks.

Okay.

And I'll just follow up more with the exposure offline.

But I wanted to follow up to Matt's question, and I wanted not be difficult and ask this as respectfully as possible.

But during your prepared remarks, you essentially told us that your efficiency target for the year, right, in terms of getting to your range by year-end was pushed out at least 3 quarters.

And I understand the dynamic of the FDIC surcharge not going away.

But I'm wondering if you'll tell us in 2 weeks or how your thought process is about really trying to hit that efficiency ratio target even if revenue falls short?

In other words, is there a capacity for expenses to be more meaningfully controlled as the revenue environment potentially doesn't improve next year?

Because I do think that, that is probably part of why the discount on your stock persists to peers.

Erika, as far as pushing out our guidance, as far as the efficiency ratio, I think one thing that I'd like to clarify is that we've been talking about the fourth quarter where we'll be approaching the high end of our targeted range with the benefit of the FDIC assessment.

And so with our guidance showing revenues up in the fourth quarter and expenses being relatively stable, even without the FDIC assessment, I think that would push our efficiency ratio into the 57% range.

And if we would've had the 70 basis point benefit from FDIC.

I think that'll be pushing us close to have 56% range, which I think would be meeting our commitment as far as approaching the high end of the range.

And when we talk about in the second half of this year or next year being in that 54% to 56%, that's only to reflect in the first half of the year, and especially in the first quarter.

We have some seasonal items that cause our expenses to be elevated, and it tends to be a seasonally weak first quarter.

But your more global question, we will provide some more color on that at the our Investor Day.

And we will reaffirm that there are times when we have to push heavier on the expense side to make sure that we meet our commitments.

And so that's something we will live up to, and we'll talk in more detail about that here on the 30th.

Our next question is from Kevin Reevey with D.A. Davidson.

So Don, my question is for you related to your recent share price movement.

Can you give us some color as to what your appetite is for M&A?

And would M&A kind of be pushed to the back burner?

And how aggressive should we expect to see you on the buyback?

Sure.

A couple of things.

One on the M&A side that we've talked about as far as our focus going forward is maybe continuing to look at some very small investments and acquisitions that will be aligned in more people, products and capability, but nothing on the banking front at all.

We do not believe that's something that's necessary to deliver against our operating model and have not been focused on bank M&A.

And so that would not be a priority.

As far as our share buybacks, the pacing of those are really controlled by our Capital Plan that we submitted earlier this year.

And so as we noted before, we acquired our repurchased $542 million of stock here in this current quarter.

Our total Capital Plan for this year is $1.2 billion.

And so think about those share buybacks for the rest of the 3 quarters being fairly consistent throughout that remaining time period.

But that does allow us to accelerate the pace based on the price sensitivity and allows us to navigate within those quarters a little bit, but not much in the way of the absolute level of share buybacks.

And then related to just revenue enhancements, can you talk about any revenue enhancements that you've seen materialize related to First Niagara that you can pinpoint?

The areas that we've been talking about really are residential mortgage.

And we still see that as a top candidate for us.

The markets have not been good for us as far as the market -- the mortgage market.

But we are making investments there, and we do expect to see some nice trajectory going forward in residential mortgage.

The second area, really, has been on the payment side.

And we have seen very good traction there.

And we are seeing the Commercial Payments and commercial deposit products being offered throughout the First -- former First Niagara customer base, and we are having a lot of success and traction with that.

The third area where we have seen good activity is on the Capital Market side that we've been leveraging the capabilities that we bring to market, especially on the commercial real estate side to meet the needs of the commercial real estate customers of First Niagara, and that's had a huge success for us.

The fourth area where we continue to see some growth is in the indirect auto space, and we've taken that product and really started to sell that throughout some of the legacy key footprint where we did have commercial relationships with those auto dealerships.

And so we've seen nice growth on a year-over-year basis in indirect auto, and much of that is coming from the new markets that Key has brought in.

Then the last piece is more private banking, and we are seeing traction there.

It is a longer sales cycle, but we are making progress on that front and believe there's still opportunity for us to continue to offer up more wealth management and private banking traditional products to the high-end retail customers of First Niagara, and I'm looking for some strong success there as well.

And then lastly, your investment banking debt placement fees continue to outperform.

My question is how much better can it get?

So this is Chris.

We feel good about where the business is.

Our rep, they're having great discussions with our clients.

Our backlogs are strong.

It's market dependent.

This is a business that we've grown since 2011 at about a 16% compound annual growth rate.

We're confident that on a linked quarter, we will be up.

We're confident that, ultimately, year-over-year, we'll be up.

So we feel good about it.

And next we'll go to Mike Mayo with Wells Fargo Securities.

So I guess, I'll ask a personal question, Beth.

When is your -- when do you have mandatory retirement, if at all?

How many more years do you expect to stay?

And one reason I ask is maybe we get more interest in the October 30 Investor Day when we see the rest of the management team, and maybe the next CEO is from that group.

I'm not sure, but if you could share some insight.

Good morning, Mike.

Didn't expect that.

KeyCorp does not have a mandatory retirement policy.

And I think the goal of our Investor Day is, as I stated earlier on, is we have a really strong leadership team that, I think, you've met many of us over the years where we've really evolved our strategies and are thinking by customer segments how we're going to market and the strength of our performance.

So you will see, broadly, our leadership team to include, obviously, our 2 Vice Chairman, Don Kimble and Chris Gorman.

But deeper into our businesses, a chance to introduce our new Chief Risk Officer, more broadly, to investors and analysts as well, Mark Midkiff.

So we are looking forward to appearing as team KeyCorp and talking about the future of our business.

Well, staying on the theme of Investor Day, I guess, you'll talk about scale.

I mean, you have a lot scale against smaller banks and not as much as the largest banks.

I look forward to hearing some insights at Investor Day.

But when you look at your digital engagement with consumer customers, what percent of your customers are online?

And how much do you spend on technology every year?

Those will both be topics within Investor Day.

So we are very much teeing up this notion of how we think about scale and how we drive our business against products and businesses and client segments where we can scale, such as our discussion of what we have successfully done in our middle market commercial and corporate banking.

And Dennis Devine will be walking through our consumer platforms and digital strategies as well as we have said that of our $700 million to $800 million a year roughly in technology operations spend, $200 million of that is against investments in digital and other capabilities for our product set.

And then we're also going to talk a little bit about how we think about fintech partnerships and investments there as well.

So a wide range of topics.

And last question, a small one.

I think I see tangible book value flat for the second quarter to the third quarter despite some good earnings.

Is anything happening with securities or OCI?

Or am I missing something?

Mike, those tangible book value was negatively impacted by OCI to the tune of about $0.08 a share.

And the other impacted -- mitigated some of the lift you would have seen in the tangible book value also was for the fact we bought back $542 million of stock.

And that's on an incremental basis dilutive to tangible book value.

One thing to keep in mind while mentioning OCI that if you look back to where our OCI has moved since the data we announced First Niagara.

We have about an $0.86 negative impact to our tangible book value per share because of OCI because of interest rates.

And if you would add that back on to our current tangible book value, we'd be in excess of the tangible book value per share that we were at of the day of announcement by about $0.16 to $0.17 a share.

So this doesn't show, given the changes in rates and the impact of OCI.

But we are making progress to recapturing that loss to tangible book value.

And next, we'll go to Saul Martinez with UBS.

Wanted to ask follow-up on the guidance for noninterest income of mid-single digits.

I'm struggling with how you get there?

And I think in your prepared remarks, you mentioned IB and debt placement fee.

But that was probably the only line item on the fee line that was the bright spot this quarter.

So mid-single digits kind of imply, I think, $30 -- $25 million, $30 million sequentially.

What am I missing?

Is there some seasonality we're not taking into account?

I guess, where do you fill that gap in terms of sequential growth?

There is clearly some seasonality.

And I would say that in addition to investment banking debt placement fee, most if not all of the individual items are expected to have some growth at third quarter to fourth quarter level.

And so that wasn't the case for this past quarter, given the seasonality.

But we do expect growth and just about every single one of those line items going into the fourth quarter.

Okay.

And are there any specific areas that are going to drive it or have more seasonality?

Or is it just pretty broad-based across all the categories?

It's broad-based.

And some of the things where you would see seasonal lift would include -- corporate own life insurance tends to be high in the fourth quarter.

The deposit service charges and cards and payments revenues tend to be higher in the fourth quarter than they are in the third quarter.

And then some of the other items we mentioned earlier such as deposit service charges were artificially low this quarter, which should see some pickup again next quarter.

And so each one of those we believe will be contributors to our outlook for growth in the fourth quarter.

Okay.

Fair enough.

And then can you remind us how much Key Insurance & Benefits impacted the revenues this quarter?

I think -- I have in my mind $60 million for full year was the run rate.

Did it all fall into the trust in investment services line?

And I think, I guess related to how much of a tailwind did you get in terms of expenses from the sale of that business?

The trust and investment services line had about $7 million of insurance-related revenues to our KIB's sale.

Much of that was more in the contingent fee revenues that we recognized in the current quarter.

So there really wasn't a lot of expense reduction going from Q2 to Q3 for KIB.

But -- and most of that was realized in the second quarter.

All right.

So $7 million this quarter and not really anything on the expense line?

That's correct.

And next, we'll go to Geoffrey Elliott with Autonomous Research.

Can you give us an update on earnings credit rate?

In the previous conference call, you talked about some increases there.

How has the movement there been playing up?

Most of the increases in our earnings credit rate have really been more tied to LIBOR.

And so we are seeing those rates continue to increase.

That does provide some incentive for some of our commercial customers to seek some interest-bearing deposits because some of their noninterest-bearing deposits are being used to offset their other charges.

And so we do see some shift coming from that.

And we also do believe that there's still an opportunity for us to grow our commercial deposits and so we think that could help minimize some of the migration trends that the earnings credit rate would normally have for that area.

And in terms of that migration out of noninterest-bearing into interest-bearing, is there anything you can do to kind of help frame that for us?

What portion of noninterest-bearing deposits do you think potentially flow out overtime?

We really haven't set that expectation.

So let us get back to you with some thoughts on that.

I don't have anything right now that will be helpful for you.

Our next question is from Marty Mosby with Vining Sparks.

Don, I want to ask you about the repositioning that you did.

Back in the appendix, you explained a lot of different moving pieces that you actually made.

In the liquidity impact, I just want to make sure that's separate from -- because there had to be some cost in the NII related to this repositioning as well.

So I just want to make sure that wasn't somehow counted in liquidity.

And do you think how much of NII or incremental charges came into the play, given the repositioning this quarter?

Good question, Marty.

The thing we didn't talk about in the appendix, we note that we actually terminated $5 billion worth of swaps that were scheduled to mature in 2019.

That enabled us to reset our asset sensitivity position back in about the 3% range because we're seeing that asset sensitivity drift down as deposit betas increased.

And so we wanted to reaffirm that.

So we actually terminated those swaps.

And so at the end of the third quarter would've been about $12 billion worth of received fixed losses as opposed to the $18 billion that we were at in the last quarter.

Again, we did that because the yield curve was fairly flat.

And also because our outlook would have had a few more rate increases than what the forward curve was implying at that time.

And we've actually seen the rate -- the rate curve move up about 15 to 20 basis points since we've terminated those swaps.

So it's proved out to be a fortunate transaction for us.

At the same time we did that, we did enter into some floors to help protect the downside.

But the total cost of those floors was only $330,000.

So it was a very nominal cost to us.

And to your point, as far as the impact for the current quarter, the losses on those swaps are getting amortized over the remaining life of those swaps.

So there was a very little negative impact to us in the current quarter, about $1 million.

And we would think that'll be more than offset with positive benefits coming forward in the fourth quarter and beyond.

So we like how it positioned us, and we think it streamlines the overall asset sensitivity position for us.

And then if you look at the -- just roll forward of the portfolio, $1.2 billion per quarter, the maturation of your swap book of $1.6 billion and over 100 basis points that you're picking up, that in of itself every quarter should generate, I'm estimating, somewhere between $5 million and $7 million of incremental NII every quarter just from rolling those yields back up to current market rates.

Is that about right for the impact?

It sounds generally about the right range.

And that really is allowing us to keep our margin relatively stable, even when rates don't go up.

And so that helps to offset the deposit drift and also the purchase accounting accretion reductions.

And then, as we mentioned before, with the rate increases, we think that the margin should be up 1 or 2 basis points into those quarters.

So that was part of our outlook for the fourth quarter.

And then lastly on the nonperforming increase, you didn't really see delinquencies and you didn't really see criticized move up.

Again, if you look back down into appendix and see some of the details.

I was just curious, can you give us some flavor because you really were adamant in the sense that the increase in nonperformers doesn't really lend to increase losses going forward.

So what is kind of the characterization enforced them to be classified as nonperforming?

And why are you so comfortable that, that's not going to lead to?

I mean, what's the characteristic of those loans that makes you feel like that didn't make your net charge-offs go up meaningfully in the next year?

A couple of things.

One is that some of those credits were actually noncurrent throughout the second quarter.

And so you wouldn't have seen the delinquency spike from that.

And so it didn't have an impact from that perspective going into the third quarter.

Second, as we put those credits in the nonperforming, we do assess them as to what type of loss content is there.

And so we do maintain specific reserves against those credits.

And we'll write them down as appropriate.

And so we believe that they are maintained at the appropriate level.

And why we don't believe there is additional loss content there.

And the third is as far as the timing, it really was just part of the overall workout of those individual credits.

And each one of them had unique circumstances and issues.

Some of which were -- some transactions were expected to happen in the third quarter and even gotten delayed.

And so it resulted in us taking those nonaccrual status until those transactions are completed.

So then there would be a relatively short workout period if there is just an expected event in the future -- near future that was going to happen, just didn't happen in this particular quarter?

I think that's a good assessment.

Yes.

And we'll go to Gerard Cassidy with RBC.

Don, touching upon future risks.

Clearly, the industry and new folks, even though I know you've talked a little bit about a small pickup in credit issues.

But generally speaking, credit is very strong.

And I'm trying to look for other risks for you folks and your peers.

Can you share with us what if this U.S. economy and this is not consensus, of course, but what if it overheats?

And next year at this time, the Fed has moved more aggressively, and they're talking about 3 or 4 rate increases in 2020, and even maybe a 50 basis point rate increase.

Can you share with us what could happen to the securities portfolio, the OCI mark and stuff?

Can you kind of frame that out?

Again, I know it's not consensus, probably low probability, but just to kind of give us an idea.

Good.

One, on our investment portfolio, we keep a fairly short average life and average duration.

I think it's 4.9 and 4.3 years on average.

And then so we don't have a lot of extension risk in our portfolio.

We tend to keep it more 5-year type of CMO structures or 15-year pass-through paper.

So there really isn't a lot of extension.

We could see -- if the long end of the curve moves up like you've suggested that could put some additional pressure on OCI and our tangible common equity.

I would say that we tend to be more focused on Common Equity Tier 1 and some other measures, which we really believe assess where our overall capital picture is.

And so even with some additional pressure on the OCI, I don't think it would take our tangible common equity to a level that would be of concern to us at this point.

As far as other areas, one of the reasons why we did go to a little bit more asset-sensitive position this quarter was we did believe that there was a higher likelihood that we're going to have a December rate increase and continued rate increases in '19, as the Fed has suggested in the forward curve, wasn't implying that.

So we did pick up our asset sensitivity a little bit to better position us for that potential outcome.

And then just as a follow up.

What kind of environment would you need to foreseeing the future to take the received fixed swap book down to zero?

You mentioned you've already lowered it in this quarter?

What would you have to see as a guide?

What would we have to do to take that to zero?

I'd say as a general rule that we want to continue to maintain a moderate risk profile.

And so we tend to manage our asset sensitivity within a range, and that range probably is plus or minus 5%.

And so you probably won't see us take it to zero, but as you've seen this quarter, we do have the ability and the flexibility to manage that actively.

And with the use of floors, we can protect us on the downside of it without minimizing the potential upside impact for interest rate increases.

And so we could toggle one way or the other a little bit.

But I don't want you to expect that, that could go to zero.

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

Thank you, operator.

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

If you have any follow-up questions, you can direct them to our Investor Relations team at (216) 689-4221.

That concludes our remarks, and have a good day.

Thank you.