All right. Up next, we are happy to once again have KeyCorp joining us for the conference. Key's had a busy year, strategically raised equity to shore up its capital base, returned to sequential revenue growth, and has maintained a tight hold on costs for multiple years. As we look to 2025, it expects to achieve positive operating leverage and should position the company to improve returns. Here to tell us more of how they're going to achieve this is Chairman and CEO Chris Gorman. Today's discussion is going to be a fireside chat. Chris, welcome back.
Well, so great to be here, Ryan, and thank you for including us. We appreciate it.
Absolutely. So, you know, when I think back, Chris, you and I sat up here last year talking about Key's RWA diet to improve capital, whether NII, NIM were bottoming, capital markets were under pressure, whether Key could maintain the dividend. I remember asking that to you. A year later, obviously, things have shifted. NII's inflected, capital's in a much better place, both the strategic investment, and now the focus has shifted back to growth and profitability. So, as you reflect upon the past year, what are the things that went well? Where do you see opportunity for improvement? And what are you most focused on as we head into 2025?
Wow, there's a lot to that question, Ryan.
One question with seven minutes.
Let me just first start with what I'm just immensely proud of, of how we conducted ourselves in this year. And to your good point, we made a ton of progress on a lot of fronts. But for us, it all starts with our team. And I'm just so proud of our team and the job that our team does day in and day out, serving our clients, serving our communities, which is kind of a good starting off point. One of the things I'm immensely proud of is, in spite of everything going on, we grew our clients and grew it in a significant way. So, we always talk about targeted scale, and we always talk about relationships. We grew our consumer relationships by 3.3% organically.
And our commercial relationships were basically flat, but they're flat in light of the fact that we basically pushed out $15 billion of RWAs. And so, when you think about being really targeted, growing your customer base, that's really, really important. The other areas where we made just incredible strides, we always talk about our capital light business. We generate about 40% of our revenue from non-interest income, and we were particularly focused in three areas. One is wealth. And Ryan, specifically in wealth, we're focused on mass affluent. We think mass affluent is an underserved sector. We have 3.5 million clients, and we think a million of those clients have between $250,000 and $2 million to invest. Right. And the average client has been with us for 10 years, or I'm sorry, 20 years in the instance of consumers. And right now, our penetration rate's only 10%.
We've been focused on that for the last 18 months, and we've converted 30,000 customers that were just banking customers are now banking and investment customers. So, that's one area where I'm proud of what we did. The next area is our unique integrated corporate and investment bank for a bank our size. We are going to have the second best year we've ever had in that business. And so, that was a bright spot. And the third bright spot is always our payments business. We've always been talking about, when we talk about payments and deposits, we talk about them because they're inextricably linked. We've been investing in payments for a long, long time. We grew our customer deposits this year or will somewhere between 4% and 5%. So, those are areas that I was particularly pleased with.
Other areas that I'm really pleased with is, you know, from just an enterprise perspective, all the changes we've made around risk management of all risk stripes, including interest rate risk, how we're well positioned for how things play out. On that point, I'm also proud of the job that we did in terms of the equity raise that we announced in August, which was the Scotia deal, selling basically 14.99% of the bank at a significant premium. Obviously, only a third of that money is in, but that came in in the successful repositioning of that. So, those are kind of the things that I think have really positioned us well as we look out of 2024 and into 2025. Things that I'd like to see us do better and focus on, there's always a long list of those. I'd start with we need to execute, right?
We've talked about publicly that we can grow NII by 20%, 2024- 2025. We've got to pull all those levers and make sure that we do that. There's a bunch of different paths to get there, so I feel good about it, but we've got to do that. We also have a record backlog in M&A and some other areas. We've got to make sure we execute on those. The other thing that I want us to continue to do is really, really play offense and focus on continuing to garner new customers, new relationships, and we follow, you know, all those metrics. One of the things I've always been working on in terms of our culture, we have a great service culture at Key. I always want us to be more of a sales culture.
That's something that I continue to work on. That's kind of what's gone well, and I think we're really well positioned as we turn the page.
I mean, the answer was even more robust than the question.
The question kind of encompassed everything.
So, Chris, maybe since the last time we've heard from you, obviously, there's been a lot of change, you know, rates, political. Curious your take on what the new administration should, you know, could mean, you know, under a more business-friendly environment for Key.
First, maybe I'll step back and I'll talk kind of at a macro level what I think the new administration could mean, because I think there's going to be an opportunity, and I'm not speaking just to, I'll speak to financial services in a moment if you'd like me to, but just broadly, I think for M&A generally, it's going to be very positive. It has been a real challenge to get M&A deals approved, and that's obviously a big business for us. I think that near term is going to be, from a macro perspective, the biggest change. That can be a big catalyst for banks like Key. From a regulatory perspective, as it pertains to Key specifically, we're running the business day in and day out as though nothing is going to change. That's how we have to run it.
We always run our business assuming that everything, all the proposals will be approved as proposed in the timeline, because I think that's the prudent way to run the business. The other thing that I find when there's a change in administration throughout my career, there's a pretty long lead time before you really see a bunch of changes. But I think the biggest change, and it's not inconsequential, is just the approach to M&A deals getting through the system.
So, speaking of M&A deals, you know, when you think about your capital markets business, you said you're on pace for the second best year ever. Markets have become more optimistic about capital markets. You said you have a record backlog. Maybe just talk about what you're hearing from clients. What do you think activity looks like, not only into 2025, but in this kind of more business-friendly environment?
Sure. I'm cautiously optimistic about our capital markets business. We had given guidance that we were going to be somewhere between 600 and 650. We then said it would be at the high end of 600- 650. I think probably now a better number is like 675. So, and we've got strong backlogs. So, I feel good about our business. When I say I'm cautiously optimistic, if I kind of think about our business, I think M&A, I've already talked about how I think there's a good trajectory there. The debt markets are wide open. We've raised $90 billion in the last 12 months, only put 17% on our balance sheet. So, the debt markets are good. The IPO markets have not been that good. So, there's opportunity there.
But when I say I'm cautiously optimistic, the thing I'm thinking about, Ryan, is I do think there's a chance that inflation starts to accelerate again. And if it were to accelerate and the 10-year were to go to 5.550, something like that, I think that could have a stifling impact as we think about executing our backlog. Now, from a client perspective, and we do this client survey, this is actually pretty fascinating. And we did one just recently, 700 middle market clients. 80%, a full 80% of our 700 middle market clients that we surveyed felt either very good or good about their growth prospects. So, I think that's good. The other thing, and I'll preface what I'm going to say by I don't really believe this number, but I will give it to you.
When we interviewed our 700 customers, a full 50% said they were contemplating M&A. Now, I don't know if you're a middle market company, if you get a CIM, are you contemplating? I don't know what contemplation of M&A is.
What does that mean?
But I do think it does show that people are kind of thinking about kind of not being in the foxhole and out there doing stuff.
Maybe just building on the thoughts on activity. So, 2024 was a slow year for loan growth, given all the uncertainty, you know, RWA focus earlier in the year, then obviously the election. You know, now the markets are focused on when clients will obviously start borrowing again. So, maybe just talk about what you're hearing from clients in terms of on their own growth prospects. You talked about obviously focusing on M&A and their borrowing needs. Like, are you anticipating it's going to start to pick up?
That's a great question. I mean, companies are borrowing money. They're just not necessarily borrowing it from banks right now, and that's kind of the distinction I would make. We raised, as I mentioned, $90 billion for our customers in the trailing 12 months, and so, I think there's a couple phenomena there, and I'll sort of speak to those. The first, well, first of all, I just want to be clear on this. There's no question that private capital is a competitive thing, but I will tell you, there is a real need for bank financing that companies have. If you want to change your deal, if you want to expand your deal, if you want to open up your deal again, if you want to change the covenants, anything but taking a term loan and putting it on the shelf, I think there's a real opportunity.
Where banks aren't seeing borrowing, and we're not yet either, Ryan, is on utilization. The best thing for banks is to have your existing customer utilize the lines more, because it takes absolutely no additional effort, and you get greater outstandings. We're flat at like 31%. So, the question is, why is that? Why are we not seeing any growth? Well, the first thing is the economy has been slowing down. I mentioned I'm concerned it might re-accelerate, but the economy has been slowing down, so these companies threw off a lot of cash. That's one thing. The next thing is, in the pandemic, with the supply chain issues, people basically went long inventory. Because if you had the inventory, you could basically be well compensated for having it when your competitors didn't. The supply chains have kind of worked their way through completely.
The next thing is that it's just a lot more expensive to borrow under your revolver, right? I mean, biggest hiking cycle in 44 years. It's expensive, and then the last thing is inflation has sort of, you know, is down significantly. There was a period of time where if you had a product, you could charge whatever you want for it, and while you were sitting on it, it was going up in value, and at that point, people had basically working capital was artificially high. We've kind of worked our way through that. Does that answer your question about, I mean, there will be borrowing. One thing I would say about Key is, absent the last two years, we have always been, we always have grown H.8. We've always grown debt, our loans faster than H.8. I'm not worried about our ability to do that. It's there.
One of the challenges right now is just every other market is flashing green. The best time for us to put debt on our balance sheet is when the whole markets aren't flashing green. And, you know, our job is to serve our customers.
Gotcha. So, maybe before we dig a little bit deeper into your plans for next year and beyond, maybe just any update on your guidance. You know, you referenced capital markets is doing better. How is the fourth quarter progressing relative to your expectations across both the income statement and the balance sheet?
I have a little cheat sheet here, because my sense of it is this will be more interesting to many of you than the rest of our discussion. So, here's our, we're going to have a very solid quarter in the fourth quarter. NII growth will be in the high single digits% on a linked quarter basis. About half of that will be from the Scotia repositioning and a half of it from organic. Loan growth, as I just mentioned, will remain sluggish. Deposit balances, however, you know, continue to go up. I think I mentioned we grew our customer deposits by 4% or 5%. Deposit beta is better than anything we had modeled. So, that obviously is helpful. Fees are tracking to be a little over $700 million. And obviously, you know this, Ryan, that's up significantly versus prior periods. And that's driven by investment banking and wealth.
We have $63 billion of AUM in wealth. Expenses, as we indicated on our last earnings call, will be around $1.2 billion, and then lastly, credit metrics continue to be solid and improving, so that's kind of, that's sort of a little bit of guidance around Q4.
Sounds like things are progressing well.
Yep.
So.
I feel good about it.
Maybe just to put a finer point, you said deposit betas are doing better than modeled. We've obviously had 75 basis points of cuts, and you guys have been more upbeat in the recent months in terms of your expectations to bring it down. Maybe just talk about, you know, where you're, how you're able to grow deposits and still able to bring down rate, and where you're seeing better opportunity to optimize pricing.
Sure. So, obviously, on the consumer side, we've done a bunch of things repricing around CDs that you would expect. But what has given us the fastest sort of pickup on the down beta side is we have very good commercial, we have a very significant commercial bank, and we're canted to commercial deposits. And as a consequence, as rates were going up, and most of our commercial customers have been with us for 10 years or more, and we do a bunch of strategic things with them, we were very direct with them when it was going up. Here's where all these indices are. Here's what we're going to do with your rate. We're going to move your rate up to here. And as a consequence, when we did that, we told them, when the market rolls over, we're going to be coming back to you.
We're going to reference these same indices, and we're going to move it down just as fast, and so, I think having a very honest, great relationship and a lot of discussion with our commercial clients has really helped us outperform what we would have modeled. This has been an interesting rate cycle. I think all of us probably would have modeled that beta would have started earlier than it did, but once it started to go up, it went up sort of parabolic, and I think most of us probably have modeled lesser of a down beta than we've experienced just in the early days of the cuts.
So, Chris, maybe switching to 2025. I understand that we'll obviously get formal guidance in January. But, you know, you're just about through your budgeting process. Can you maybe just talk about this year's framework or maybe a top-down strategic and financial parameters you've told the businesses they need to follow as they come to you with their business plans?
Sure. And it's a timely question because we're grinding through all of this as we speak. The first and foremost sort of North Star for us is we're playing the long game. And, you know, in the financial services industry, you can get a lot of growth really fast, and it usually doesn't end really well. And so, we're very disciplined, as you know. So, first, playing the long game. And then the second thing is focused on client by client. Like, where are we going to grow our clients? You know, we have targeted scale. What's the size of the opportunity? What do we think we can capture in that opportunity? What is our share of wallet with these customers? Where do we have what we consider to be true relationships, and we define what relationships are? That's where it starts.
And then when we have a discussion, like, "Okay, well, where do we need to invest to be more impactful to these customers?" And so, then we start talking about things. This is all at the business level unit. Then we start talking about things like, "What's the return? What do we think this will be?" And then at the enterprise level, obviously, it's a little bit different discussion. You know, we invest, you know, year after year in things like cyber, in things like resilience, in things like regulatory. And obviously, when it comes to those, we're not spending a lot of time looking at what the return is. You know, my question is, "What's the negative return if you don't do it?" So, you know, we're going through the process now, and I feel really good about it.
We'll have more money to invest this year than we have in the past.
Got it. Sounds positive. So, Chris, you know, you completed the first round of the bond restructuring and are slated to complete another post the closing of the next round of Scotia, which we'll touch upon shortly. And given this, you know, you've talked about 20% NII growth. Obviously, a lot of things have changed since the last time we talked to you. Curves deeper, less rate cuts. But you talked about needing to execute in order to be able to drive the NII. Can you maybe just talk about some of the key components to hitting that 20% NII that it sounds like you still feel good about?
Yeah, I mean, there's a lot of moving pieces, and frankly, we have a lot of paths, and you can imagine we've got all kinds of models up that look at when we get the second tranche of the Scotia investment, what do we do with that? How do we utilize it? How do we reinvest? We talked about down beta. That's an important piece of it. Loan growth is a piece of the equation, but I feel, you know, obviously, with every time the forwards change, it moves around a little bit, but I will tell you this. If you have an upwardly sloping yield curve and you have higher for longer, in general, that's helpful, not hurtful to a variety of the scenarios, so I feel good about it. There's a bunch of different paths to get there.
You know, we're going about the business of executing on it.
So, I wanted to spend a minute talking about operating leverage. You know, you guys have talked about that you're committed to it, which, you know, given the 20% NII should position you well for it. I think one concern that I hear from investors is, again, you know, given your tailwinds to NII, you noted there's more money to invest. You know, it obviously makes it easier for positive operating leverage, but there's temptation to spend a little bit more. Maybe just talk about how you're thinking about balancing more money to invest with greater positive operating leverage and improving the overall returns of the company.
Yeah. Well, I think it's a very fair question. It would be a little bit disingenuous for me to take a victory lap about having positive operating leverage in 2025 when we're going to generate a 20% increase in NII with no additional investment. What we're focused on as a team is looking at our fee businesses, which I mentioned are about 40% of our revenues and generating positive operating leverage with respect to our fee businesses. And so, I think that's a really good discipline because we are going to be investing in people, specifically people in our wealth business, people in our investment banking business, and people in our payments business. By the way, none of those are kind of unproven. We know we can go out, we can hire the people we want, and we know when we hire the people we want that they're productive.
But I do think it's a good governor to generate positive operating leverage. And in 2020, in general, we'll be focused on positive operating leverage broadly. In 2025, Ryan, we'll be focused really on our fee-based businesses, just given the benefit of the backdrop that we talked about. And we'll be very, look, we have to be good stewards of the capital. We will be very, very disciplined in how we invest. Just because we have the opportunity to invest doesn't mean that we're going to in any way be less disciplined. You know, when we were under-earning, we took out $400 million of expenses such that we could invest. And when you have to do that, you're pretty disciplined, and we'll continue to be disciplined.
Maybe to just put a finer point on it, so what do you think that means for overall investment spend and overall expense growth next year, and maybe since, you know, it's been a while since you talked about the actual investment philosophy, it's clear that you just articulated some things that you're investing in, payments, you know, investment banking. Maybe just give us an update on how you evaluate and prioritize these opportunities.
Yeah. Well, as I just mentioned, I mean, we've been investing continually. So, it's not as though we weren't investing and now we are investing. We've invested continually. In fact, on that point, I'm really proud of this. We basically have gone through and replaced all of our core systems. We have two systems right now that we haven't replaced. One is ACH, which we'll replace in 2025, and the last one is Hogan. Having led our last largest acquisition, I have no desire to replace Hogan until I think there's something that's actually better than Hogan that's been sort of pressure tested out there, so that's in the future. Right now, Ryan, we have one system for consumer loans. We have one system for commercial loans. And we have one system for mortgage and trust, which is unusual.
Additionally, we've moved all of our systems to the hybrid cloud. And we have about half of our applications in the cloud. Not that this is important from an economic perspective, but we just announced that we're getting out of our last owned data center, which I've wanted to do for some time. So, my point is we've been investing for some time. As we go forward, we'll increase our expenses by sort of low to mid-single digits. And it will be people. And then on technology, if in the past we've spent, say, $800 million a year, we'll probably spend $900 million a year. And the incremental expense will be focused on change-the-bank things, whether it's the 20 proof of concepts that we're doing around AI or a variety of things to make it easier for our teammates and easier for our customers to do business with us.
So, Chris, you guys successfully executed on the first tranche of the Scotia investment. The next tranche of investment, I believe, is slated for approval in 2025. Any updated thoughts either on the timing or how the process is going and how they've been as a partner thus far?
So, we haven't really partnered much with Scotia to date because we actually have to get it approved by the Fed before we spend a lot of time working together. I think there's incredible opportunities. I think, you know, we've talked about some of them before, and I still, I think those are every bit as prevalent as I did when we first announced it. So, in terms of the second piece of the restructuring, obviously, it'll be contingent on getting approval by the Federal Reserve Board. As you can imagine, we have all kinds of models up and running. I think we did a pretty good job when we raised the first third and did the first half of our restructuring.
We'll, you know, based on market conditions and what's out there and what's there to be done, we're in a position where we can do none of it, all of it, or some permutation. We're looking forward to it.
Maybe to build on the last question and not to put the cart before the horse, but assuming the final tranche of Scotiabank investment gets approved, you'll be sitting on a decent amount of excess capital. Just sort of a two-part question of, you know, first, how are we thinking about your capital priorities into next year, and when can we begin to see Key returning incremental capital to shareholders?
Sure. So, the premise of your question is a good one. As we model things out, we think by the end of 2025, we'll have 12% CET1. And we think marked CET1, obviously, there's a bunch of variables in this, would be between, say, 9% and 9.5%. So, there's no question that the earnings power of our business, plus the capital, that we'll have a lot of capital. Our priorities are really unchanged. It's first to serve our customers, secondly, to pay the dividend, and third, both organic and inorganic investments in our business. And that can take the form of hiring groups of people. It can take the form of buying some niche business that I modestly think we're pretty good at buying these entrepreneurial businesses.
And then to the last part of your question, you know, when can, and I think, one, I think there's going to be, I think the economy is picking up. I think there's going to be a ton of opportunity to deploy capital. We are not currently really contemplating any kind of share repurchases in terms of additional capital. And the reason for that is, one, we haven't even closed the Scotia deal. Secondly, we don't know what the Basel III Endgame is. And third, I think there's going to be, I think we're on the precipice of having a fair amount of business activity. So, you put all those things together, if in fact we end up carrying more capital than we need for a short period of time, of all the things I'm worried about, that's not a huge worry of mine.
You know, I think, you know, listening to some of the discussions thus far this morning, I think there's generally a view, although nobody seems to think it'll be them, that M&A will pick up over the next period of time. You know, where does Key fit into any strategic activity do you think once this starts out? But obviously, I know that improving the profitability of the company has been a much greater focus than going out and doing strategic activity. Just curious how that fits in for you.
Yeah. Well, to the last part of your question, I mean, we have to prove to all of our investors that we're good stewards of the capital, and we absolutely have to get a currency that you could transact with. The way I see this playing out, I don't think that there is going to be consolidation in our industry. I don't see it. I can tell you for Key, it's not in the immediate future, and I don't think it's going to be for the industry. I think if you look at everything that the DOJ has said, everything that the OCC has said, everything that the FDIC has said, and the fact that unrealized losses become realized losses upon buying something, there is going to be consolidation. I don't think it's going to be immediate, Ryan.
But I can tell you from Key's perspective, we have a great opportunity right in front of us, you know, over the near term. And we're going to go about the business of executing that, get our currency to where it needs to be, and be in a position down the road, whenever that is, to be part of as the ecosystem starts to move around.
You referenced in your prior response just you've had a lot of success buying niche businesses. You know, as you think about, you know, your investment priorities, your fee capabilities, do you see any opportunities or areas where you're thinking about adding inorganically to enhance your product offering?
So, not necessarily our product offering. I mean, it's not, we feel like we have all the products that we need, but there are opportunities to, you know, and we look at them all the time, you know, small groups of people. I find that if you end up, and whether you buy these small entrepreneurial kind of boutique businesses, or you hire people in groups, or you invest in people, when you have a platform like ours that you can plug them into, they can be really, really productive, and those are some of the best deals we've ever done because not only are they more productive serving their existing customers, they make us more productive because they sometimes bring some skills and some game to our platform, so.
So, I wanted to shift gears and talk a little bit about credit, a couple of different kinds of credit. You know, we saw charge-offs pick up in the last quarter as we saw a couple of charge-offs kind of pull through, although criticized were down, NPAs were stable. I think you commented that the NPL and criticizes are peaking out or should decline from current levels. Any initial thoughts about how you're thinking about credit into next year? Anything in particular that you're watching more closely? Are you feeling better about credit now that it feels like you have a better view on the economy?
I'm feeling better. I feel good about our credit book. I really do. I mean, I think we're always very, very critical, and the reason, and you know this, Ryan, because we've talked about this, you know, standalone credit can't return its cost of capital. And so, as a consequence, we are always very, very critical on how we rate stuff and how we grade things. I feel very good about credit across the board. I mean, whether it's charge-offs, non-performers, criticized, classified, the trends are all good. I always look at sort of upgrades to downgrades at this point in the cycle because I think it's important, and we're now in the fourth quarter of improvement in the ratio of downgrades to upgrades, and we're at a point now where you're almost at parity between upgrades and downgrades.
So, that gives you sort of a little bit of insight into our book.
And my other question on credit. So, you mentioned earlier on that companies are borrowing. They're just not borrowing from banks. They're borrowing from private credit. So, a sort of two-part question. One, I know they have a partnership with Blackstone. Any color on how that is progressing? And as you think about the environment we're hopefully moving into more business activity, do you foresee private credit being an impediment to your ability to grow loans into 2025?
So, you know, we're an interesting organization because we have partnerships, as you mentioned, with private credit providers. Private credit providers are customers of ours because we've distributed in the last 12 months $90 billion worth of capital. And then we also, in certain areas, compete with them. Private credit has been around forever. If you think about going back to the days of GE and CIT, I mean, this was 40, 50 years ago. So, private credit has been around for a long time. There's no question that the investor base for private credit has expanded. And there's no question that the asset classes have expanded. But I don't, you know, as I mentioned earlier, there's a real need for banks in the ecosystem because we can do a lot of other things other than have a piece of credit and put it on the shelf, so to speak.
Is private credit a factor in the marketplace? Yes. But they're a factor just like I mentioned, there's 4,400 banks.
Yeah.
There's, you know, there's a lot of competitors out there. We, you know, we embrace them all.
So, maybe in the last minute here, Chris, one question to answer to kind of pull it all together. Your slides still talk about a 16%-19% return. I realize that you said you'll adjust it once we know all the final rules, which, as you just referenced, are not there. But we have a decent sense whether they're not going to happen or they may be watered down. So, you're running, you know, low double digits on returns today, you know, even when you factor in AOCI. So, maybe the right number is mid-teens. But what gets your returns back to where they need to be? And how long do you think it takes to get there?
So, I don't disagree with your observation that you think mid-teens is sort of in the strike zone because I think it will be. And you can imagine we've modeled out a bunch of different scenarios. What gets it there? Well, first, we have to; we've got to execute. This 20% pickup in NII is obviously huge. We candidly need to get some loan growth. We also need to perform from a down beta perspective, which I think kind of checking all those boxes. And then the last thing that people don't really talk about when they talk about return on tangible common equity is you can't lose money. The biggest thing that destroys tangible common equity is more than anything is to have credit losses. And so, I feel really good kind of across all those. And, you know, 16%-19%, is that a bit dated?
It is. Will it come down? It will come down, but our target that is. But it's not going to come down in a significant way. We can make really, with our business model as we execute, we can make really good returns.
Great. Well, we are out of time. So, please join me in thanking Chris.