KeyCorp (KEY) 2018 Q4 法說會逐字稿

Good morning, and welcome to KeyCorp's Fourth Quarter 2018 Earnings Conference Call.

As a reminder, this conference is being recorded.

I'd 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 Fourth 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.

Now I am moving to Slide 3. As you have seen with our headlines this morning, Key reported strong results for the fourth quarter and this finishes what has been a very successful year for our company as we continue to grow, invest for the future and deliver on our financial commitment.

For the fourth quarter, we reported GAAP earnings per share of $0.45.

Our EPS results included $0.03 from a pension settlement charge and costs associated with our efficiency initiative, which we refer to as notable items in our materials.

Adjusting for the $0.03 of notable items, it brings our core earnings per share to $0.48 for the quarter.

To provide a consistent view of our financial trends and prior period comparisons, my remarks this morning will focus on the adjusted core numbers, which exclude notable items in all periods.

Our strong fourth quarter builds on the momentum we continue to see across our company.

Highlights for the quarter included solid revenue growth, well-managed expenses, strong credit quality with a meaningful decline in nonperforming loans and further improvement in criticized and classified loans.

Improved efficiency and return measures with both up almost 400 basis points from the year ago quarter and disciplined capital management, which includes returning significant amounts to our shareholders through dividends and share repurchases.

Don will spend more time on the fourth quarter detail, so I will focus most of my comments on our full year performance.

2018 was our sixth consecutive year of positive operating leverage.

A return on average tangible common equity increased each quarter during the year, reaching 17.5% in the fourth quarter.

For the year, we reached a record level of revenue of $6.4 billion, reflecting continued growth in loans and deposits as well as achieving all-time highs in several of our fee-based businesses, including investment banking and debt placement fees.

The growth in both spread and fee income reflects the breadth and depth of our business model and our ability to acquire and expand relationships with our targeted clients.

Expenses remained well controlled as we drove efficiencies across our company, while continuing to make investments in areas where we have targeted scale and reach.

Yesterday, we announced an exciting new opportunity to build-out our digital consumer lending platform with the acquisition of Laurel Road, which I will discuss later in my remarks.

Over the past year, we improved our cash efficiency ratio by over 300 basis points, and we remain on a path to achieve our $200 million of cost savings target in 2019, which represents approximately 5% of our total expenses.

We expect to reach our targeted cash efficiency ratio range of 54% to 56% by the second half of 2019.

Our credit quality has remained strong with net charge-offs to average loans remaining below our over-the-cycle range of 40 to 60 basis points throughout the year and 27 basis points for the fourth quarter.

Our nonperforming loans declined by over $100 million from the prior quarter and represented 61 basis points of period-end loans.

The linked quarter improvement was consistent with our prior comment that the increase in our third quarter NPL level was temporary and was not indicative of a trend.

Other credit metrics, including criticized and classified loans, which we look to as leading indicators, improved again during the fourth quarter.

As noted at our recent Investor Day, during my time as CEO, we have dramatically enhanced our risk practices and improved our risk profile.

We continue to remain consistent and disciplined in our credit underwriting and portfolio management, and we are committed to outperform through the business cycle.

We believe that our steadfast commitment to maintaining our moderate risk profile will continue to serve us well.

In terms of capital management, we have consistently delivered on our stated priorities of supporting organic growth, growing dividends and prudently using share repurchases.

And consistent with our 2018 Capital Plan, we increased our common stock dividend by 62% in 2018 and our dividend yield now stands at over 4%.

We also repurchased over $1.1 billion of common shares throughout the year.

Key's Common Equity Tier 1 ratio ended the quarter at 9.92%.

Again, it was a strong finish to the year.

We had broad-based growth across our franchise with record annual revenue and well-managed expenses that drove meaningful improvement in both efficiency and returns.

And we maintained our moderate risk profile and continue to return capital to our shareholders.

Now let me turn to the announcement that we made yesterday, and I am now moving to Slide 4. From a transactional standpoint, we have acquired the digital lending business from Laurel Road Bank.

This business operates under the name Laurel Road and is a leading digital-first consumer lending platform focused on student lending refinancing, primarily targeted at advanced degree medical professionals.

To be more specific, approximately 70% of the clients are doctors and dentists, with another 20% being lawyers and MBAs.

And the overall demographics of this target client base is extremely attractive, an average age of 33, average FICOs of 760 and income of approximately $185,000.

Strategically, this is a strong complement to Key's approach of building targeted scale against specific client segments.

Moreover, it closely aligns to our enterprise healthcare focus.

And while this distinctive platform is on the path to having scale in a business with student lending, it's also a concept we shared at our Investor Day.

The Laurel Road team has been proactively expanding its product set to build broad-based relationships with these targeted clients and prospects.

In the last year alone, the team has developed and launched personal unsecured loans, mortgage and deposits, all delivered digitally on their industry-leading platform.

In October, we also shared our views on the power of strategic partnerships to execute our strategy.

Laurel Road believes this as well and has constructed a network of over 150 affinity partners with whom they are the preferred provider to these targeted client segments.

The winning formula for clients, partners and Laurel Road matches our model and our clients the way we at Key approach this business.

Over the past several years, we have spent significant time developing a distinctive partner capability.

In that process, we have interacted with many different FinTech teams and other potential partners.

And to date, we have not yet found a business model or a management team with whom we are this closely aligned, which was a critical factor in our desire to engage in this transaction as well as the alignment with our relationship strategy targeted in an attractive and complementary client segment.

And with that, let me turn the call over to Don.

Thank you, Beth, and I'm now on Slide 6. As Beth said, we reported fourth quarter net income from continuing operations of $0.45 per common share.

Adjusting for 2 notable items, a pension settlement charge and costs related to our efficiency initiative, primarily severance, earnings per share was $0.48.

Our adjusted results compared to the $0.36 per share in the year ago period and $0.45 in the third quarter.

The severance cost this quarter, which totaled $24 million, was due to early actions taken to achieve over $200 million cost savings target and reach our cash efficiency ratio goal of 54% to 56% by the second half of 2019.

I will cover many of the remaining items on this slide in the rest of my presentation, so I'm now turning to Slide 7. Total average loans of $89 billion were up 4% from the fourth quarter of last year, driven by growth in commercial and industrial loans, which were up 9%.

Linked quarter growth in average balances was primarily from commercial and industrial loans as well as commercial real estate.

Importantly, our growth continues to be driven by building and expanding core middle-market relationships in our targeted areas.

Our business model positions us to offer our clients a wide range of financing alternatives, both on and off balance sheet.

In 2018, approximately 16% of the total capital we raised for our clients went on to Key's balance sheet.

Our C&I lending continues to be broad-based, done through our footprint as well as our targeted industry verticals.

Commercial real estate, where we saw some balance sheet growth this quarter, is primarily an originate-to-distribute model that drives fee income and strong returns, while providing flexibility and managing portfolio risk.

In the fourth quarter, we placed $5 billion of commercial mortgage loans in the market and a total of over $13 billion for the full year 2018.

In 2019, we expect to continue to grow loan balances as we support our relationship clients.

The tone and sentiment with our clients remains positive and our pipelines remain solid.

That said, we remain committed to our moderate risk profile and we will continue to walk away from business that does not meet our risk parameters.

Continuing on to Slide 8. Average deposits totaled $108 billion for the fourth quarter of 2018, up $2.3 billion or 2% unannualized compared to the third quarter and up 4% from the same period 1 year prior.

The cost of our total deposits was up 11 basis points from the third quarter, reflecting higher interest rates as well as the continued migration of our portfolio into higher-yielding products.

Growing deposits and being core funded remain foundational to the way that we run our business.

We experienced strong deposit growth this quarter, both consumer and commercial, by consciously using market rates in a very targeted way to retain and deepen existing relationships with our best clients.

As important, we are not acquiring new rate-sensitive deposits only business.

As expected, our deposit betas continue to move higher.

The incremental beta in the fourth quarter was 60%, bringing our cumulative beta to 33%.

On a linked quarter basis, deposit growth was primarily driven by the penetration of our existing 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 61% of our total deposit mix.

Turning to Slide 9. Taxable equivalent net interest income was just over $1 billion for the fourth quarter of 2018 and net interest margin was 3.16%.

These results compared to taxable equivalent net interest income of $952 million and net interest margin of 3.09% for the fourth quarter of 2017 and $993 million and 3.18% in the third quarter.

Purchase accounting accretion contributed $23 million or 7 basis points to our fourth quarter results.

This compares with $26 million or 9 basis points in the third quarter and $38 million or 12 basis points in the fourth quarter of 2017.

Excluding purchase accounting accretion, net interest income was up $71 million or 8% from the fourth quarter of 2017.

The increase was largely driven by our earning asset growth and our positioning to benefit from higher interest rates.

Net interest income excluding purchase accounting accretion increased $18 million or 2% from the prior quarter, benefiting from earning asset growth and higher loan fees, partially offset by higher deposit betas.

The net interest margin was negatively impacted by deposit growth exceeding loan growth for the quarter and the excess funds were deployed into the investment portfolio.

Moving on to Slide 10.

Key's noninterest income was $645 million for the fourth quarter 2018 compared to $656 million for the year ago quarter and $609 million from the prior period.

The comparison from a year ago period reflects our record results for investment banking and debt placement fees in the fourth quarter of 2017 and the sale of our insurance business in the second quarter of 2018.

We continue to see positive momentum in many of our fee-based businesses with linked quarter increases in trust and investment services, investment banking and debt placement fees and corporate services.

As Beth said, investment banking and debt placement fees achieved a new record level in 2018 as we continued to experience strong growth across our capital markets platform.

In the fourth quarter, our results benefited from strength in our commercial mortgage and M&A advisory.

Corporate services income increased as well, reflecting higher derivatives and trading income and trust and investment services income grew, largely due to stronger brokerage commissions.

Turning to Slide 11.

Fourth quarter noninterest expense was $1.012 billion or $971 million, excluding notable items consisting of a $17 million pension settlement charge and $24 million of efficiency-related expenses.

This compared with $1.098 billion in the fourth quarter of 2017, which included $85 million of notable items and $964 million in the prior quarter.

The table on the bottom left side of this slide breaks out the notable items incurred in both the current and year ago periods.

Compared to the prior quarter, noninterest expense increased $48 million on a reported basis or $7 million excluding notable items.

The $7 million increase reflects higher business services and professional fees and higher other expense, partially offset by the elimination of the quarterly FDIC surcharge.

Business services and professional fees reflect a number of corporate initiatives related to CECL, our payments business and technology enhancements.

Over half of the increase in other expense related to the pension settlement.

Other expense in the fourth quarter also included higher operational losses, insurance reserves and additional investments in our payments business along with other seasonally elevated expenses.

As Beth said, we remain committed to our $200 million cost savings target this year and reducing reported expenses by low single-digit range.

We expect to reach our cash efficiency ratio target of 54% to 56% by the second half of the year.

Moving on to Slide 12.

Our credit quality remains strong, and we continue to be consistent and disciplined in our underwriting.

Net charge-offs were $60 million or 27 basis points of average total loans in the fourth quarter, which continues to be below our -- over the cycle range of 40 to 60 basis points.

The provision for credit losses was $59 million for the quarter.

As expected, nonperforming loans were down this quarter with NPLs declining by $103 million from the prior quarter and now represent 61 basis points of period-end loans.

Other leading indicators such as criticized loans and delinquencies all showed improvement this quarter.

Turning to Slide 13.

Capital also remains a strength of our company, with a Common Equity Tier 1 ratio at the end of the fourth quarter of 9.92%.

As Beth mentioned earlier, we have remained true to our capital priorities, including returning a significant amount to our shareholders.

Our quarterly common dividend -- our quarterly common share dividend increased by 62% over the past year from $0.105 to $0.17 per share.

And we continue to repurchase common shares, which totaled $278 million this quarter and over $1.1 billion for the full year 2018.

On Slide 14, we've provided our outlook for 2019.

This builds on our performance in 2018 and reflects our expectation for another year of strong positive operating leverage and continued momentum across our company.

Average loan balances were expected to increase to the $90 billion to $91 billion range, once again, driven by our commercial businesses.

Average deposits should continue to grow, reaching the $108 billion to $109 billion range.

Net interest income should be in the $4.0 billion to $4.1 billion range and our outlook assumes no interest rate increases in 2019.

We expect that noninterest income will be in the range of $2.5 billion to $2.6 billion with growth in most of our core fee-based businesses.

We also look for another year of growth in our investment banking and debt placement business.

Additionally, we expect noninterest expense to be down low single digits from the reported 2018 level in the range of $3.85 billion to $3.95 billion.

This range includes the realization of the $200 million in run rate cost savings and reaching our targeted cash efficiency ratio of 54% to 56% in the second half of the year.

Keep in mind, the outlook includes the impact of our Laurel Road acquisition, which adds approximately $50 million to the range.

We see nothing on the horizon that changes our expectations on credit quality, with net charge-offs and provision expense remaining below our targeted range of 40 to 60 basis points.

Our loan loss provision should slightly exceed our level of net charge-offs to provide for loan growth.

And our GAAP tax rate should increase slightly to the range of 18% to 19%.

Our guidance also assumes some variability over the course of the year.

First quarter will reflect an expected decline related to seasonality, including a lower day count and customary step down in capital markets activity from strong fourth quarter levels.

Additionally, first quarter carries an increase in employee benefit costs, which will elevate personnel expense by about $30 million.

Our guidance also includes the impact from Laurel Road acquisition that Beth discussed.

Laurel Road, as mentioned earlier, will add less than $50 million to both income and expense in 2019 and will be dilutive by approximately $0.02 for the year and accretive thereafter.

The near-term dilution reflects a change from their gain on sale model to our plans to place these attractive loans on our balance sheet.

With the expected midyear closing and the gradual buildup of our loan balances in the second half, it will also have a very modest impact on our full year loan growth.

While adding slightly to our efficiency ratio in the first year, it does not change our commitment to reach our cash efficiency ratio target of 54% to 56% in the second half of 2019.

Overall, 2019 should be another good year for Key, building on our momentum with strong operating leverage, focused risk management and continuing EPS growth.

On the bottom of this slide are our long-term targets.

We are already operating within the range of 3 of the 4 measures and believe we will reach our efficiency ratio during the year.

That said, we have significant upside remaining to improve returns and deliver value to our shareholders.

I remain confident in our ability to continue to move toward the top tier of our peer group and believe over time the market will recognize our progress and improved results.

I'll now turn the presentation back over to Beth.

Thanks, Don.

And before moving to the Q&A, I will make a few closing comments.

Despite the volatility that was experienced late in the year, I am pleased with our results and the momentum we have and share Don's confidence in our outlook.

Over the past several years, we have made incredible progress across our company, and we have delivered a step change in our financial performance.

And we are now approaching peer-leading levels of return, while remaining disciplined with risk and capital.

In the fourth quarter, we increased our return on tangible common equity target to 16% to 19%.

And as Don pointed out, we remain on a path to achieve our long-term target.

Our stock valuation, however, does not reflect our stronger performance, competitive positioning and improved risk profile.

We continue to believe that Key offers a compelling investment opportunity, given our track record and focus on sound, profitable growth, supported by a dividend yield of over 4%.

I remain optimistic about Key's future, and I'm proud of the momentum and accomplishments of our team in 2018.

And as we look forward, we are well positioned to grow revenue, to control and reduce expenses, manage risk, drive further efficiency improvements and ultimately, drive higher returns for our shareholders.

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

Operator?

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

Don, a quick question just on the cost outlook.

A lot of moving parts this year.

You guys typically have, I guess, more seasonality in the quarterly cost base, just to begin with, given the investment banking component and we're layering in the acquisition, but then you have the cost.

So I was just hoping you could maybe give a little more color on how you would expect the quarterly base to kind of traject or flow throughout the year?

In other words, is there a quarter like the 2Q that represents the high watermark and then we start to come down or would the fourth quarter be the low watermark for the year in that we get the run rate cost savings?

And how do you see that all panning out?

Great.

And like you said, there are a number of moving parts there.

One, we did highlight the first quarter.

We do expect to see a tick up in expenses, reflecting the $30 million of higher benefit cost.

Now that would be offset slightly by the impact that we expect investment banking debt placement fees be lower in the first quarter compared to the fourth quarter, which tends to be high point, but those 2 items will impact the first quarter.

As far as our continuous improvement, our efficiency improvements we're making, we should see some small amounts come through in the first quarter, start to build in the second quarter and really for the second half of next year majority of those $200 million in run rate should be reflected in our expense levels.

And so we would expect to see the improvements come through there.

Laurel Road, we talked about having an acquisition in midyear of '19 and that really is what drives that roughly $50 million in expenses and so you would see that in the second half of the year.

So that would minimize some of the bottom line reduction as far as expenses that we will be achieving on the expense savings, but still, in my mind, show probably the low point in expenses being in the third quarter and fourth quarter being up a little bit just to reflect the seasonality we typically see on our capital markets-related revenues typically be stronger.

But again, I think those all combined still get us to that 54% to 56% efficiency ratio range in the second half of the year.

Okay.

That's perfect.

And then just quick question on the margin outlook.

So you had a little liquidity build that you discussed.

In the slide presentation, you note that some of the deposit inflows were kind of short term or -- and/or seasonal.

So one, how does that all play out?

I imagine, some of that securities portfolio then comes down if the deposits are indeed seasonal, but would that allow the margin may be to see a little lift here in the near term as an offset?

We would say that our margin outlook for '19 would be relatively stable with what we were seeing for '18.

And I think '18, we were 3.17% for the full year and 3.16% for the fourth quarter.

And so they're both pretty tight already, but we do think that there could be a little bit of an improvement in the overall liquidity position.

But right now, our guidance would suggest that deposit growth would about equal loan growth.

And so we don't see a significant change in the overall liquidity position, and we're not also including any assumed rate increases for '19.

And so we wouldn't see a lot of lift from that either.

Next, we'll go to Peter Winter with Wedbush.

I was just wondering, when I look at the loan growth in the fourth quarter, it was more broad-based than what we've seen in the past, which were more reliant on C&I.

I'm just wondering if you can give us some color behind the change.

And do you think that's sustainable going forward?

I think if you're looking at average balances, Peter, you would see a growth in commercial real estate.

And what you would have seen is some of the $1 billion of the portfolio in the third quarter going into the fourth quarter for some of the loan sales we typically have.

And we've talked about -- for the quarter, we sold about $5 billion worth of commercial real estate balances.

And on Slide -- Page 21 of the earnings press release, you can see, for the quarter, our total loan sales were $5.5 billion and that's quite a statement given the challenge in the markets and what we are able to accomplish for our customers.

And so it was more of a timing issue for that commercial real estate balance, but we continue to see some growth in consumer categories, mainly the indirect auto and our expectation is as we integrate with Laurel Road, we'll start to see some other components of loan growth there as well in later '19 also.

And just to follow up, can you talk about maybe some potential flexibility you might have to fund loan growth?

The loan-to-deposit ratio has been steady.

I'm just wondering if you would let that kind of trend upward or maybe use securities and excess liquidity to may be fund some of the loan growth and putting some less pressure on deposit costs?

Good question.

I would say that we are very focused on having our balance sheet core funded.

And we're doing that through growth in our deposits with our existing customers.

And so we're not out there trying to get wholesale deposits that -- in more of a digital channel base, so we're growing those with our existing customers and adding to those relationships, deepening those relationships on the deposit side and we'll continue to do that.

And our outlook, as I mentioned, would suggest that loan growth and deposit growth are going to be about equal for next year and we like it that way.

Now my preference longer term is to have a little bit higher loan-to-deposit ratio and have less liquidity on the balance sheet.

But near term, we're not seeing that in our outlook.

Our next question is from John Pancari with Evercore ISI.

On the loan growth, just looking at the commercial trends end of period versus average, it doesn't appear that you saw a lot of benefit at all from the capital markets seizing up in December.

Some of the other regionals have seen some benefit from that.

Did you -- can you just talk about it if you saw that at all, if that could impact the outlook at all?

John, it's Chris.

We actually did not get the benefit of that impact.

As we look across our book, our clients are doing very well.

Some of our clients, actually, at the end of the year pay down part of their loans.

And as Don mentioned, we had a really, really strong quarter as we moved $5.5 billion of financings off our balance sheet.

So we did not see a pickup in loan balances based on what was going on in the capital markets.

Okay.

All right.

That's helpful.

And then just to confirm one thing on the expense side.

I'm pretty sure I know the answer, but the midpoint of your expense guidance of about -- for 2019 of about $3.9 billion, that's up a bit from the midpoint of what you implied of your range that you gave coming out of your Investor Day of about $3.85 billion.

And that change is mainly the Laurel Road -- incorporating the Laurel Road, is that correct?

100% of the gap.

Yes.

So Laurel Road adds about $50 million to our expense base outlook for 2019.

On an annual basis?

It's for the full year impact of '19.

If you looked at Laurel Road for an entire year, it will be north of that $50 million number.

Got it.

But your cash efficiency ratio range remains intact because you're also dialing in the revenue impact from Laurel Road.

Correct?

Correct.

That's Correct.

And what is that -- how much is the revenue?

Well, what we've said is that we expect Laurel Road to be about $0.02 dilutive.

And so for that $50 million in revenue -- excuse me, in expenses, it would imply about $20 million revenue number for the year.

And the reason for that gap is we're converting it from a sale model -- a loan sale model to a retaining type of model.

Got it.

Okay.

And then lastly on the credit side, your charge-off guidance still well below the 40 to 60 through cycle basis point range for charge-offs.

Can you give us a little more color?

I mean, how long do you think it will trend below that when you look at the portfolio?

And why not get more specific at this point in this cycle in terms of your charge-off guidance?

I would say that as we look at our portfolio today that it's still very, very good, very solid.

And in this last quarter, we talked about our nonperforming loans being down, our criticized and classified loans were down $300 million to $400 million as well.

And so we're seeing continued improvement in the trends there.

And so we don't see anything that would change significantly from where we're at now.

I'd say as far as looking down the road, multiple years, Mark, do you have any insights or thoughts you'd add to that?

I only would add that we're obviously at a very low level and continue to be at a low level as we kind of move into '19.

Yes.

And we're just not seeing early indicators that would suggest that's going to change anytime soon.

So I'd be reluctant to put a time line out there.

And next we'll go to Ken Zerbe with Morgan Stanley.

I guess, just kind of follow-up on the Laurel Road acquisition.

I just want to make sure I fully understand this.

So they're no longer doing gain on sales, so everything that they originate presumably -- I mean, let's say, 100% student lending, that goes onto your balance sheet?

And that, I guess, new balance sheet growth drives this $20 million this year of revenues?

And then does it just continue to layer on as you grow that and kind of what size or target balances would you expect over the next year or 2 or 3?

To put things in perspective there a little bit that Laurel Road originated about $1.2 billion in total loans this past year.

And I would say that the credit quality and the nature of those loans, and more importantly, the nature of those relationships, we think, are consistent with our targeted customer base and we're very excited about that.

And it goes beyond the student loans as well that they've already implemented a mortgage-lending capability and they've looked at other products they can add to that offering as well.

And so it really is more of a relationship strategy for us than just a student loan origination.

So we do believe that we'll continue to have the opportunity to put those on balance sheet, and we'll see that annuity continue to build as that portfolio continues to mature and develop over the next couple of years.

Got you.

Okay.

And do -- would you anticipate continuing any part of the gain on the sale model or...

I think that's an option for us.

And I would say that where we see that there's a good quality relationship, we'll probably retain it.

But one thing that we talk about is their ability to originate mortgage loans.

And if it's a conforming mortgage loan that we will probably sell that in a secondary market like we do with our existing portfolio.

So I think that's more of our approach going forward.

Got you.

And in terms of the yields that you would get on these new originations, like how do they compare versus your current portfolio yields and where are they at generally?

I would say, generally, they're a little stronger than some of our consumer loan yields today, and I think it provides a nice upside for us.

Got you.

Okay.

And then just really last question.

In terms of the tax rate, looks like it jumped up about -- sorry, for your guidance, it looks like it's about 2 percentage points higher than where it was this year.

Any reason for that?

I would say that the primary driver there is an outlook for lower tax credits from some of the business models we've deployed in the past.

And so it's just slower rate of that.

And also with the higher level of earnings, the incremental earnings growth is really taxed at the marginal rate and that helps drive that tax rate up as well.

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

I guess I thought -- I would have thought the expense outlook, at least the high end, might have been a little bit lower.

It's just we look at it versus this year, it implies relatively flat cost.

I know you've got the acquisition that adds $50 million, but you also have about $70 million of one timers this year that you called out, so -- it just seems like if you kind of adjust all those things, the high end of your expense outlook is for relatively flat cost and I can appreciate that some of the initiatives are faded in -- or phased in kind of throughout the year, but just from Investor Day, it seemed like there was real effort to shrink the cost base on a full year basis.

There clearly is that effort in outlook.

And we'll go back and look at the math on that, but my math would have shown that even on the high end, we've been down about 1% and at the low end, we would be down about 3%.

So we think that's right in the ZIP Code of what we talked at Investor Day, but we'll go back and confirm that, Matt.

Okay.

And then just a swing factor of that $100 million.

Is it just on -- depending on what revenues are?

Or do you have a scenario where you're at the high end of your revenue range and the low end of the expense range if you can realize all your cost savings?

I would say the primary driver of movement within that range is tied to the revenue growth and what we're seeing from movement in the markets and also from our core business model.

So what we've talked about in the past is that we can adjust that expense based on what we're seeing as far as the economic outlook and what we see as the revenue growth.

And part of that expense base does assume reinvestment back in the business and that's one of the levers that we can pull as to slow that investment if we don't see the kind of upside from benefits from those investments.

Next, we'll go to Steven Alexopoulos with JPMorgan.

To start on deposits.

If we look at the $108 billion to $109 billion guidance for deposits, Don, what's the underlying assumption for noninterest-bearing deposits in that guidance?

The assumption there is we will continue to see some slight reduction in those balances throughout the next year and that's primarily on the commercial side where we continue to see those customers migrating more of their deposit mix over to the interest bearing as opposed to noninterest bearing.

I think this year we saw 1% to 2% kind of decline, and I would say something along those lines will probably be consistent with our outlook for next year.

Okay.

That's helpful.

And then when we look at the expense guidance, are there any additional efficiency-related charges such as severance included in this guidance or is this operating guidance?

This is operating guidance, but we wouldn't expect those efficiency charges to be significant for next year.

We would probably see something continue about the same level of the notable items we have this quarter throughout the first half of next year.

Okay.

And then finally, so you guys have been cutting expenses, obviously, for many years.

How much longer do you think you can run with expenses in this flat-to-down pattern, right?

Once we get past the $200 million, is there any wood left to chop or do expenses start drifting higher at that point?

You must have been talking of some of our line managers who try to push back on some of the targets, but I would say that, generally, many of these savings are really taking a look at how we can make our existing processes and workflows more efficient and going from the customer back -- to the back office and seeing how we can either use technology to help achieve those or just process redesign.

And this $200 million, we'll pull out a chunk of those, but we still believe there's still ammunition left to use for that.

And the other thing is that even though this $200 million does include some acceleration as far as some of the branch consolidations, just because of the changes in our consumer behaviors, we still think that they'll be on -- continue to apply some efficiencies from rightsizing that branch distribution as well.

Okay.

And then looking for 2020 guidance, but it sounds like even beyond the second half, there's still a road for you guys to keep pretty significant downward pressure on expenses.

Is that right?

We can manage those, so we can continue to generate nice positive operating leverage in the future.

You're right.

And Steve, we talk about it and have talked about it publically as -- on a journey of continuous improvement.

And as you think about how we're aligned, have we go to market, technology, digitization of the enterprise, process improvement, all these are things that will be continually part of our focus.

This is not a one and done.

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

I'm sorry to reask Matt's question another way.

I'm just trying to figure out why the stock got down when the market opened.

So in terms of your outlook, it seems like consensus is at the lower end of your net interest income range, at the midpoint of your fee income range and at the low end of your expense range.

And I guess, I just wanted to confirm that that's fair.

And is there any move up in the -- in the range on expenses will have to do with better revenues?

I would say that as far as our outlook, one thing that the consensus would not have reflected was Laurel Road.

And we talked about there'd be a slight dilution from that of $0.02 a share.

And our expense guidance -- again, the range is more tied to what we would see from a revenue perspective.

And so if revenues are up, we would expect to probably be at the higher end of the range, given some of the cost to support that.

Got it.

And regarding Laurel Road, I think, if you get the question, is really now the time to layer in consumer risk on your balance sheet, given that we're late cycle?

Beth, you write off some of the statistics in terms of income and FICO that were quite compelling.

I'm wondering sort of what additional layers in terms of underwriting do you plan to -- do to enhance the process that Laurel Road has today, especially as you're going to go to a retention model rather than originating sale?

I would offer -- this is Mark Midkiff.

I would just offer that we do think that what we've seen that the underwriting is very sound and very complementary.

But obviously, we'll be under our lens and our -- in our buy box.

And I think that we'll be very focused around relationship where we get just better overall credit performance than when you're working at a transactional level.

So that will be an enhancement.

And of course, we've looked at this on a stress basis and feel very comfortable overall relative to our risk appetite as well.

It's just kind of a normal ongoing outlook for losses in that business.

Got it.

And just one more question, if I can.

Beth, you noted strong dividend growth of 62%.

Given where your stock price is trading relative to your return potential, I'm wondering if your CCAR ask for 2018 -- sorry, 2019 would perhaps be more focused on buyback than dividend growth?

Erika, obviously, we are in the early days of starting to look at CCAR 2019, and we have always been talking over the last couple of years of supporting dividend growth.

And this year, we were approaching that 40% dividend target payout ratio, but we will definitely look at the mix and make sure that whatever we choose for this year's capital returns that we are really optimizing our use of capital for our shareholders and that would be a consideration.

Got it.

And one more, if I can.

As we think about first quarter trust and investment management income fees rather, Don, I'm wondering there's like a 9% step down in AUM.

I'm wondering what the step down would be in the first quarter to reflect that step down in AUM?

We could see some very modest pressure on that line item for first quarter, but that's generally in line with where we're showing the fourth quarter levels.

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

Could you give us some thoughts on the investment banking and debt placement line?

How do you think that could evolve across a range of scenarios?

One where we kind of stay in tough markets like we encountered in December and then another where we get something more akin to what we've experienced over the last few years?

This is Chris Gorman speaking.

So that's a line that we're really proud of the fact that we've been able to consistently grow over the last decade.

Obviously, it's market dependent.

As we see the markets right now and as the markets are currently functioning, we believe we will continue to grow that business in 2019 as well.

That's a business that we grew.

We grew the top line this year 8% in a down market.

If you go back to 2015, we've grown that line 46%.

So it's a business that is based on client relationships.

It's based on serving clients.

It's based on serving many of the same clients many times.

So we feel good about where we're positioned with respect to our investment banking and debt placement line.

The interesting thing, if the markets seize up a bit, that's when it could get more interesting for us in terms of opportunities to put things on the balance sheet and serve our clients.

As Don mentioned in his comments, we only put about 16% of the capital we raised last year on our balance sheet.

And I would just add that part of what I have always felt is a strength of our platform and some piece of how we look at our outlook against investment banking and debt placement fees, all market sensitive fees, obviously, is the breadth and depth of our platform.

Again, we have a broad range of capabilities and we are not dependent on a certain area of the markets.

And given that it's relationship-based mid-market, we do have the option to balance sheet, but we also can do a variety of things across advisory fees for M&A.

We've loan syndication, debt placement, equity raises, sponsors, we do in our commercial mortgage business.

We have such a breath in that platform that we really do have confidence that it can generally produce those kinds of results.

And then if I could squeeze in a quick one on Laurel Road.

I guess, there's quite a few banks who've got similar sorts of business.

Citizens has got something, First Republic has got something.

So far, there isn't a bank that I think is active in that space.

What is it that makes Laurel Road different from those other platforms out there that are high level, it kind of feels like their customer base is the same 33-year-old doctor or dentist with good FICO?

We anticipated that we might have an opportunity to speak more holistically about the strategic fit as well as the strength of this platform and why we found it attractive.

So I have asked Clark Khayat who is in the room and really spearheaded this transaction for us and spoke to this at our Investor Day.

And I'm going to ask Clark to share that we are very excited and think this is a highly selective, not only demographic, but related to a phase in differentiated platform.

And with that, I'm going to identify that Clark is in the room and ask him to take that question.

Thanks, Beth.

So I guess, I'd answer it in a couple of ways.

One, as we talked about in October, we hit on a couple themes, 2 of which were distinctive platforms, the other was targeted scale.

So on the distinctive platform front, this is a very compelling end-to-end digital platform.

So contrary to many others, it's not just the digital entry point.

It is legitimately end-to-end, highly efficient, highly customer oriented.

And just as a side note, they enjoy NPS scores on the consumer side that are high 60s, low 70s, which are numbers that frankly most banks just do not enjoy.

And that is a function of the process and flow and experience they've built on this end-to-end platform.

So we do think that is quite distinctive relative to others.

You noted the customer focus and we've talked targeted scale by identifying client segments with whom we want to do business.

This one we do think is different than most, even though others may reflect those sort of demographics.

And I think a fair bit of this is driven by a very extensive partner network they've built that positions them as sort of partners with these trade associations, member entities, other groups to talk directly to those end users in a way that we think is quite distinctive to the way a broad mass market business might work.

So there's more to that, but I think, to your question, those 2 points, in particular, I think were the most compelling to us and give us confidence that we not only like this customer base, but that we have the opportunity to continue to grow it intelligently, leverage the partnership network they've built.

And then as Beth noted, they have begun to build an extension of products for these clients based largely on the clients asking for them.

So the opportunity to not only be a compelling single product provider, but then to build sustainable, durable and long-term relationships that are more broad-based across product sets with this attractive client base is another thing that's very consistent with our relationship strategy.

So we just think that complement to the way Key thinks about its businesses and the way Laurel Road has built this platform.

We just haven't seen ones that are as consistent and compelling as this for us.

Our next question is from Saul Martinez with UBS.

Look, I hate to beat a dead horse with the expenses, but I think the communication on the guidance is really important.

So Don, the -- when you say low single-digit decline, I assume you're basing that off the GAAP reported number of $3,975 million.

Is that correct?

That's correct, yes.

Okay.

So during the course of the year, you called out about $75 million of noncore items.

You have next year about $36 million by my calculations or $35 million, something like that of FDIC expense charges that are not going to be there.

So those 2 things alone get you to about $110 million.

Obviously, you have the Laurel Road of $50 million.

But net-net, it looks like, on an operating basis, the core number is closer to like $3.9 billion, $3.91 billion, which kind of suggests that your guidance isn't really -- doesn't imply any reduction in expenses, so -- if you use the midpoint of the range.

So I guess, my question is, what am I missing in terms of the moving parts?

Because -- like I said, if you kind of make these investments, it doesn't seem like there's any real reduction on a nominal dollar basis on an operating basis?

The $3.975 billion for the full year and back out the onetime charges and then add to that the $50 million for Laurel Road.

That gives you $3,925 million.

I'd say that the midpoint of our range will be about 2% below that.

So I think that we are showing reductions in the noninterest expense.

And as we highlighted at the Investor Day that, that one -- the low single-digit decline also reflected the benefit of the FDIC special assessment reduction, so...

Okay.

Just -- I mean, it just doesn't seem like it's all that impressive, the midpoint versus kind of the core number, but fine.

I guess, just second question, the -- just to change gears a little bit.

Obviously, a lot of attention in the market on leverage loans and can you just remind us how much you have your exposures here?

How you manage risk?

How you've managed your exposures either -- both as a lender and any indirect exposures you may have through other -- through CLOs or BDCs or anything like that?

Sure.

This is Chris.

Let me address kind of how we approach the leveraged finance business.

First of all, we are focused exclusively on the industries in which we play.

So we know exactly who we want to do business with.

In terms of that portfolio, it's about 1.8% of our assets and it's a portfolio that has a lot of visibility and a lot of velocity.

We feel really good about that portfolio based on all the metrics and frankly, all the time we spend looking at it.

So it's a portfolio that has been flat literally since before we grew our asset base by 40% when we bought First Niagara.

Mark, would you add anything?

And I would just add, it is client based.

It surely faces our capital markets business.

We manage it to be a fixed amount.

We do not allow it to grow.

We recycle capital within that.

Mark will talk about some of the credit attributes, but it is therefore, a, client relationships where we are leading activities and -- on behalf of our capital markets and we manage it very rigorously.

And it is a very small portfolio relative to our balance sheet.

Yes.

And it's, I would only add, consistent in terms of fundings.

It hasn't moved around a lot.

We haven't changed market.

It is relationship-based, as Chris said.

And then as Beth said, recycle capital, but also very consistent in terms of leverage terms.

Debt to EBITDA leverage has been very consistent and stable for a long time.

And we've said that portfolio is $2 billion or less at any given time.

Next question is from Terry McEvoy with Stephens.

A question on Laurel Road.

If that business does a $1.2 billion of originations like it did last year and all of it's held on the balance sheet, does it swing from 2% dilutive to something accretive at that point?

Or maybe asked another way, what's the breakeven size in terms of balance sheet size for that business to contribute to the bottom line?

What we've said, I think, is just with the assumption that if we acquire at midyear that we'd only have a half year's worth of production next year.

And we would expect it to be accretive in 2020 and beyond.

So it's a fairly short window as far as the dilution impact to the acquisition.

And then how does Laurel Road potentially change your tech spending budget, which, I think, from your Investor Day, was $700 million, $800 million?

Were you investing in the student platform?

And is that platform scalable or something with their technology that can be utilized at Key to offset some of the tech spending expected this year?

Yes.

Part of the $50 million in expenses that we're assuming as far as the increase is really continuing to have Laurel Road maintaining the same kind of pace of investment they've been making from the digital platform.

And we'll continue to include that in our assumptions going forward.

And we'll go to David Long with Raymond James.

Maybe my first question for Chris.

Just the discussions that you're having with your larger corporate customers related to using Key's balance sheet versus the capital markets, has there been a change in tone in those conversations over the last few months?

No.

David, there really haven't been.

I mean, we're out talking to our clients and our prospects.

We're constantly figuring out what is the optimal approach for them to take.

And those discussions really haven't changed markedly in the last several months.

Obviously, there were periods of time in December where markets were dislocated and people were putting off deals, but the strategic discussions that we're having with our clients are ongoing and they're constructive.

Got it.

And then, Don, not to beat a dead horse again on the expenses, but the guidance that you've given with the efficiency -- the cash efficiency ratio target, is that based on an operating or core basis, not on a GAAP basis?

Is that accurate?

We would say that for the second half of the year that we shouldn't have a lot of notable items, so our expectation is that they should be one and the same for the second half of the year as far as the efficiency ratio.

Next question is from Mike Mayo with Wells Fargo.

So help me with my thinking, almost to your contrast.

So most of the largest banks are expanding digital consumer banking outside of their footprint, right?

Citigroup, JPMorgan, Bank of America, PNC, U.S. Bancorp.

And just remind us where you are in expanding with digital banking outside your footprint?

And on the other hand, now you have Laurel Road, which is leading with consumer lending, looking to go from a single product to multiple product relationships.

So on one hand you have gathering deposits out of footprint by a lot of your competitors and now you're going to be trying to leverage lending outside of your footprint perhaps to get more deposits or -- just help me with that thinking.

Mike, it's Clark.

So as Don said earlier and I think this is the most critical point to hit, we are really focused on being core funded.

So we are not looking to use this platform or frankly any other platform at this time to drive out of footprint deposits for the sake of deposits.

So we would, as you noted, sort of use the Laurel Road platform out of footprint to drive consumer relationships and lending and where it makes sense, continue to expand that relationship with the deposit, but we want the deposit in a case where we have a broader relationship with that client, so -- but we continue to think about supporting client relationships with deposits.

We did that, we think, very effectively in the fourth quarter.

And as we move forward, whether it's in footprint or out of footprint and we do have lots of commercial clients outside of the footprint today -- the branch footprint.

We would continue to look to raise deposits as long as those clients have broader relationships.

And then, I guess, Don or Beth, what is the impact that you're seeing in your markets from the other large banks expanding into your MSAs with digital banking?

I guess, you're not really seeing anything yet, but there is that threat you'll see more competition, say, over the next 5 years.

So are you worried about that?

Are you preparing for that?

Are you looking to strike back with more efforts of your own?

Well, clearly, we are developing our own digital banking capability for our own clients.

So this is not where we would gap relative to the offerings that we see of other banks coming into the market who come in on a digital-only platform and we would certainly have every product and capability for our own clients in addition to a branch network in addition to our brand that we have in our markets.

So we feel well positioned, and we will continue to invest in our digital capabilities, this being, Laurel Road as an example of where we do believe it accelerates our platforms both from a lending as well as the potential for deposit taking.

And that we do believe, in the near term, we see adequate core funding in our markets to support our strategies.

And we compete very well because we certainly have the capabilities, we certainly have the ability to more broadly serve those clients and so we do not feel gapped in our capabilities.

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

So Beth, the follow-up on the last question related to mobile and digital.

What kind of adoption rates that you're seeing with your existing client base?

I know you guys have made a lot of investments in that area.

Kevin, I don't have those numbers off the top of my head, so I'll apologize for that.

But I do know that we have had very strong adoption and transactionally as everyone has reported years ago what happens in a branch versus what happens mobile and digitally, those lines crossed and there is no going back.

It is clearly a customer preference to be able to transact their business.

And you may recall, several years ago, with First Niagara, in advance of that integration, we deployed all new customer portals across every -- from commercial to consumer to our private banking clients a new digital platform that enables that, and it is a very, very robust platform.

Additionally, we have our financial wellness, which is a digital-led experience as well that we have consciously made sure interacts with our branch experience.

But that platform was a digital -- and you may recall several years ago, we purchased HelloWallet to really help facilitate that.

So we have looked at this as how do we create not only the ability to transact in a mobile and digital world, but also how can you have relationship attributes including advice and planning through our HelloWallet.

So it is an area where we are canting and following and making sure we support our customers' preferences in that regard.

We've even expanded it into business banking.

So as we think about digital, as we think about digital origination, as we think about wellness, we've taken the technology and the capabilities and expanded that obviously into our business banking arena as well.

And then, with that said, how are you thinking about looking at your branch network and rationalizing your brick-and-mortar footprint?

So this is Chris.

Last year, we took out 38 branches.

I think this year, 2009 (sic) [2019], you can expect us to really ramp up in that regard.

We feel like we're pretty good at it as we went through First Niagara and we rationalized the fleet.

We think with the technology, with the digital capabilities that we have, we have the capability to keep our clients and thin out some of the branches and you'll see us actually step that up this year over last year.

And then one last question related to the government shutdown.

Are you seeing any of the effects of that in your local markets at all?

At this point in time, we are not seeing the impacts broadly in our markets, but we have done a variety of measures to be able to make sure that we can both reactively and proactively support customers of ours who are impacted directly by the partial government shutdown.

And we have targeted programs for a special assistance for those who have various types of loans with us.

We are aggressively waiving fees and have introduced a loan product with a very low rate to help create liquidity for those who may be impacted by a disruption in their income.

So we are making sure that we too are in the banking landscape to be responsible to help support the employees that are impacted by the partial shutdown.

But from a loan perspective, from disruptions in markets more broadly, we are not yet seeing that.

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

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

And 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.

Thank you, and have a good day.

Ladies and gentlemen, that does conclude the conference for today.

Thank you for your participation.

You may now disconnect.