Thank you for joining us for our next fireside chat with KeyCorp. They need little introduction with Clark here to my immediate left, but as you know, headquartered in Cleveland, Ohio, with about $187 billion in assets, 961 branches, put up an ROTCE in the most recent period of about 15.5%, and with me today is their Chief Financial Officer, Clark Khayat, and Clark became the CFO in 2023, right after this conference, actually, and he's been with the company since 2012, running different commercial lines of businesses such as payments and treasury functions, and thank you, Clark, for joining us today.
Happy to be here.
I know it's still earlier in the year, but with all the changes going on in the macro environment, especially with last night's news with the tariffs, can you see how, or talk to us how you guys are positioned for this kind of turbulent, I don't want to call it turbulent, but changing times?
Sure, so you guys have a good ability to anchor this conference off something. This year it would be the tariff news, so look, I think our view would be all signs still point to a pretty durable economy that feels constructive. This morning's reaction notwithstanding, our view and our hope is that this gets digested along with some of the other moves and we find some equilibrium and some stability and it ends up being a constructive year. That's obviously not a definite, but it would still be our kind of majority view that this is going to be a pretty solid constructive year.
Have any of your corporate or commercial customers in the last four weeks or so, has there been any real definitive pullbacks or changes, or can you tell? Is it just too early to really tell?
Yeah, maybe two things that we've seen or heard. One would be pull forward of inventory. And I think we're seeing that kind of broadly. That'll show up in some loan balances that we would expect to stick, but people buying inventory ahead of some of these moves. And then I think the other view would be lots of deep conversations, lots of positioning, but let's see what's going to happen. So I feel like for the last couple of quarters, we've been talking about uncertainty of the election, then you get the election, and then you feel like, okay, things are going to improve. Now we're back into again a little period of uncertainty. And so that's just always going to drive a little bit of hesitation. And we're seeing a little bit more of that right now.
Yep. I think your inventory comment is interesting because in Friday's H.8 data, I don't know if you've been noticing, but the C&I loans are clearly moving up, and it probably ties into your commentary there. The other, as we look at the banks into 2025, aside from this now new uncertainty, one of the real positive trends is the changes coming from regulation with all the new heads coming in, especially on Basel III Endgame and of course CCAR and the stress test. What's your color? What are you guys hearing and seeing, and how do you feel about the direction it's moving in?
Yeah, look, I think the direction feels constructive and positive. We're always going to be supportive of the balance of safety and soundness with allowing banks to support clients and communities. That's, I think, an important place to be and find that intersection. I think the rhetoric always leads the reality. So it's going to take a little bit of time for this to distill down to field supervision and everyday activity. That's still kind of a hangover from where we've been. But I do think generally speaking, things look like they're headed in a productive way. I think if you talk Basel III, not sure exactly how that's going to look and when, but generally speaking, we feel like we're well positioned for that. The RWA moves in the originally proposed rule, we were prepared for and actually got some benefit out of.
So I don't know that we're too concerned about that. And obviously with last year's activity, the capital and marked capital pieces feel very strong. As it comes to liquidity, I think those rules are likely here to stay, and we are well positioned for that again, given some of the steps we've taken over the last year or so. And then lastly, TLAC and long-term debt, I don't really know again where that's going to shake out. It does feel like there'll be at least some tailoring, but even if it was fully baked, it would be $2-$3 billion of additional borrowing for us, so not a huge lift. So I think across the board from those standpoints, we feel like we're well positioned for whatever direction we go in. And any sort of alteration from where we've been, I think is just to the positive.
Yeah, correct. Yeah. There is even some talk we're hearing that the LTD or the TLAC may actually go away, which would be a positive, no doubt about it. Maybe when we talk about the full year outlook, when you think back to what your guide was in January, 20% growth in net interest income, which is very strong. Some folks thought maybe it could have been higher. So maybe how are you feeling about that at this point? Again, we're two months into the year, of course, but any color there?
Hard to make everyone happy. Look, we feel really good about the 20%, as we've said, very confident. I think that confidence comes from the structural nature of that. So we've talked about whether it's the two repositionings of the portfolio we did, whether it's the swaps finally gone, whether it's another $15 billion of fixed rate securities and swaps repricing this year. There's a bunch of things that accrue to our benefit that are going to drive that. The reason we haven't moved too much off of that is, again, we're trying not to mark to market every month, and if you go back to when we did our planning, five-year and 10-year rates were at a level. They improved when we went to earnings. They're back or below where we were when we did the planning.
We don't want to be tied too much to all this volatility. And again, we feel really good about where we're going. I think to the extent the economy is as constructive as people feel like it could be, I think we've got some upside. But as we just talked about, there's a fair amount of now uncertainty that I don't think has been as prevalent. And to the extent it goes in a different direction, then I think that puts some pressure across the board. But all in all, we feel really good about where we are, and we'll continue to update, but everything is tracking very comfortably with those people.
If you had to paint an interest rate scenario that is ideal for Key the way you are today, is it the short end sticking around four and we get a positive slope? Or if you had your ideal environment, what would it be?
Yeah, I think longer term, everybody wants something that is probably a little bit lower on the front end and upward sloping. In the near term, cuts to the front end tend to put pressure when your loans reprice right away and you've got a little bit of deposit lag. I think we've managed that pretty well. We're relatively neutral to rate. So I think we're very well positioned for almost any rate environment that could happen. There's probably some extremes that we can talk about. But again, upward sloping curve is always ideal from a shape standpoint, but obviously the absolute level of rates matters. So I do think to the extent we see the five-year and 10-year where they are kind of right around here, that could drive some activity as long as it's not a function of people thinking the economy is going downhill.
So there's got to be kind of good constructive belief in the economy and then kind of rates at the right level.
Okay. Speaking of deposits, your deposit costs in the fourth quarter dropped 21 basis points sequentially, which obviously is very impressive. Non-interest bearing now is about 23% of total deposits, including the hybrid accounts. How is the deposit pricing trending so far in the quarter, and what are your deposit beta expectations for this coming year?
Yeah, as we've said, as we go through the year, we'd expect to be around 50. We ended in the fourth quarter, we were 40 +. We probably in December around 45. We're probably a tick higher than that in the first quarter. The reason we're not a lot higher is two things. One, seasonal deposits are always lower in the first quarter. We've seen that again. I think in my time at Key, that historically has been kind of down 1%-3%. We'll see it closer to the 1% end than the 3% end. So I think we're doing well there. But that obviously puts a little bit of pressure. And then the rate expectation is fewer cuts, which means probably less ability to drive pricing down. That said, we have continued to be proactive in managing the book.
We'll expect to see a few billion dollars per month in the first half come out of CDs and MMDA promos. So we clearly have some opportunity. So all in all, I'd say deposit balances and pricing have gone very well. We expect it to continue to be good. I mean, there's again some edge cases where it could get challenging, but right now, again, we'd expect betas throughout the year to kind of be close to 50 or around 50. And balances, I think from a first quarter low, will continue to build as they generally do. And we don't see anything there that would cause us to think differently.
Yep. It's interesting with the non-interest bearing deposits that you folks have relative to total deposits. It's been a number of years where we've had such a higher front end of the curve where those non-interest bearing deposits are really quite golden, and do you see any ability of, I mean, they're quite high already as a percentage of total going higher, or is this where they kind of settle out at?
That's a good question. I think if rates were to come down, you could see a little bit of build there. The other place where I think we've had a lot of success, and you noted the kind of additional non-interest bearing component of the hybrids, that piece for us has been a really great tool. And one of the things our payments team does really well is engage and expand those relationships in those hybrid accounts, which translates to moving those dollars from interest bearing to non-interest bearing. And we've continued. I think in the fourth quarter, we created another maybe $500 million of non-interest bearing through the expansion of treasury services. So we'll continue to do that. That's a really proactive, great way to increase retention, improve the relationship, get more non-interest bearing deposits.
The broad consumer book, again, is going to just be acquisition of checking accounts and then absolute level of rates. So a little bit less proactive on that other than can you acquire new clients.
Yep. Well, when we were just chatting about interest rates, you talked about some extremes, but when you look at the full year on the net interest income guide, what's the biggest risk of that number not materializing? Is it an extreme move in rates one way or the other?
Yeah, I think that's exactly it. So I think a hard move on the front end in either direction.
Oh, either direction. Okay.
I mean, look, the down. You're just going to have the loans repriced right away and just take some time. So that'll put some pressure on it. The up then, I guess, is going to depend on loan volumes, which then drive deposit needs, which then drive deposit pricing and beta competition. But I think those moves would have to be hard and quick for us to feel enough pain to get really outside of that guide. And I don't see anything causing that other than kind of an event we're not thinking about right now, which is always possible. I mean, there can be a geopolitical thing that happens or an economic real recessionary activity. So that brings with it a whole host of other issues. But other than a really hard short-term move up or down, I think we're relatively well positioned.
Got it. Yep. Yep. It was similar when you think about hard moves like during the pandemic when they dropped so dramatically at the very beginning. The net interest margin coming out in the fourth quarter of 2024 was 2.41%. You've been talking about achieving a 270 net interest margin or better as we go out. If we do have higher for longer on rates, how does that margin play out as we get into the end of the year?
So again, if it's on the margin, it's not going to have a huge impact. It's going to be slightly beneficial. So we're pretty neutral with maybe a little lean to asset sensitivity right now. But I would call it neutral for the sake of this discussion. So it's not going to have a big impact. I mean, slight moves on the front end of the curve, again, I think are marginally good or bad, but manageable. And then the reinvestment rates or the borrowing capacity that happens based on where the five and 10-year are. Again, unless they're moving dramatically, again, there's some advantage or some not. If it's all structurally higher in the near term, I think reinvestment rates get better, but you're probably going to see loan demand come down. So there's some trade-off there.
I think for our business and maybe for the economy generally, we'd like rates to be a little bit lower. We'd like a little bit more economic activity to happen. I think that just benefits the business more broadly.
Yep. Got it. And moving now, obviously net interest income is very important for your organization, but turning to fees. When you guys were talking about the upside this year in the Fourth Quarter Earnings Call, you were talking about a 5% upside to fees in 2025. Can you walk us through the puts and takes of what you're seeing in achieving that number?
Yeah. So we said again, kind of 5+ because we think there's something on top of that. But I'd say in the areas we talk a lot about, so investment banking, wealth, payments, we feel really good about where we're positioned. We're adding people in those areas. We're building capability. And we'd expect those to be mid- to high-single-digit growers. So really solid, very consistent. We'd also, if you look at the other income line, that was noisy last year with the repositionings. In addition to repositionings, we traded some Treasuries at some times earlier in the quarters. If you take all of that out, I think you really will see that come back. And I'd guide to like a $15 million a quarter kind of number, which I think is obviously beneficial year over year.
The counter to that will be from a pure growth percentage, our commercial mortgage servicing business, which is really important to us, a great business, had a record year last year, is going to be kind of flattish. So you won't see the percentage growth there. And it's a meaningful business. Still really strong, but we would expect special servicing to come down after a really record year. And then operating lease expense because of a change we made two years ago that wouldn't have mattered in March of 2023, where we changed accounting treatment and we now kind of, we don't take all the credit upfront. We take it as it occurs. That number will come down pretty significantly in the year. And it'll be offset almost dollar for dollar on expense. So net net, it doesn't really impact PPNR. But from a fee standpoint, that's actually declining.
So I think there's a lot of movement underneath, but the places that we really are focused are, I think, set to perform well.
You're unique in this question because of your commercial mortgage servicing. You just touched on special servicing. Can you share with us, because as you pointed out, it grew very rapidly last year as the commercial real estate markets suffered, particularly office? What are your guys seeing now, the guys in special servicing? What are they telling you about what they're seeing in the commercial real estate markets?
Yeah. So the thing that's really declined in the last two years has been retail in special servicing. So that used to be the leader post-pandemic, as you would think. Still relatively high, but it's stabilized to come down. Office obviously spiked, and that's going to work its way over time. I think it'll continue to be a challenge. We see it in the survey.
Is it more in the so-called gateway cities of Nashville or Austin or Fort Lauderdale versus Buffalo, New York?
Buffalo and Cleveland are always the example. Maybe there's a benefit of being there.
I'm going to say Cleveland when I'm with M&T tomorrow.
Yeah, yeah. Clearly, the Southeast is just a supply and demand issue. So tends to be great demographics, but a little bit of oversupply. And I think some a little bit more stress there than you're seeing in other markets. And as we've talked about, we got out of some gateway cities probably too early. But in a view to be conservative on where we're lending, we did move out of those. And I think, again, lower rates will help work that through. But if we do see some inflation and any uptick in unemployment, given some of the swirl that we're hearing, I think that will create some more pressure.
Key has obviously differentiated itself with its investment banking business. And over the years, you and Chris have hired investment bankers. And you talked about that on the fourth quarter call about hiring more investment bankers for 2025 and into 2026. Can you talk to us, how is that progressing? Where are you guys seeing that move?
Yeah. So we tend to go in and out of that market based on how hot it is and where we think we have opportunity. We step back in in 2024. I think we had a fair bit of success. We've got a really strong pipeline in terms of potential additions. We're focused largely in our seven industry verticals or sub-verticals, building out some of the sub-verticals there. And I think we've had some real success in the last few quarters adding high-quality bankers. And it's always a function of, are they going to be in a place where we have interest supporting, and are they going to be able to do more with the platform? So often it's somebody coming from a boutique or a single kind of double product thing, and now they have a full menu.
And we just want to make sure they can take advantage of that. And I think we've done that well. I think we put a number out, a target of kind of 10% more hires. I view that as more of a guideline than a rule. We're not going to get to 10% just for the sake of getting there. But cultural fit, right person at the right time in the right space. We're going to go add that person to the platform and continue to invest there.
Yep. Talking about investing, you mentioned hiring these investment bankers. You're also investing in wealth management and payments, of course, and you're upping your tech spend this year, so you're committed to the mid-single-digit rate of growth in expenses, so can you talk to us about where the tech spending's going? And are you getting cost savings in other areas to help offset some of the increased spending in these areas?
Yeah. So it's a great question. One, I would just start by saying I think over the last four or five years, we've done a really good job just managing expenses and maintaining discipline. So when I first got to Key, it was always like, we're going to have to run a program and maybe cut some expenses. I think we've been much more proactive about getting in front of it and managing it intelligently and strategically. I think this is no different. We're going to invest more to build out some tech platforms, mostly on customer-facing and sort of what we would call change-the-bank type platforms, and then hire or redeploy people into sales and client-facing positions. And we do that by virtue of, I mean, you'll see an uptick. We said low to single digits this year.
But part of that discipline is just finding savings every year. So doing things, is it process reengineering? Is it automation? Is it outsourcing certain services? Is it insourcing certain services in some cases? So it's just an ongoing version of good tight discipline and managing that over time so that we can invest where we have to when we have to. And again, I think what you'll see going forward, assuming no big event in the market, is we'll be kind of a 2%-3% expense grower as we continue to invest over time.
Got it. Shifting over to credit, your charge-off, net charge-off ratio in the fourth quarter was about 43 basis points. You've guided to 40-45 this year, which is quite low relative to history, of course. Where could we see some, I mean, in that number, where do you see the charge-offs materializing within your range?
Yeah. I mean, we always start with the leverage book, although we feel really good about that. Since I joined Key, the dollar amount of that leverage book is the same. And we're about twice as big. So we can do the math on percentages. But we've again managed that pretty good. And it's got a lot of turnover. So always something you have to pay attention to. And there's going to be loss in that book at some point. And you just prepare for that. Anything consumer-oriented, I think, has been tough the last few years. I think that's likely to continue. And again, some of these policies that we're seeing from the administration could make that even harder. Again, anything that sort of hits inflation or unemployment will create a little bit more stress there.
And then multifamily, again, or commercial real estate to the extent rates really spike. But I'm not so worried about that from a loss content standpoint. Our models will tell us to provision. And we will to be conservative. But I don't think that generally pulls through to loss in the same way that it does provision.
Right. When you think about leveraged lending, obviously, as you mentioned, since you've been there, it's been flat relative to the size of the organization. Is it a better organized market? I mean, are people not doing crazy things in leveraged lending yet? Or are those animal spirits about to kick in and you're going to see higher debt levels and stuff like you normally see as an economy takes off?
Yeah. I think the bank books are just pretty conservative. We call it leveraged when it gets to a certain level. I'm not sure that's what maybe the market thinks of broadly as leveraged. I do think as we started this off today, maybe the animal spirits mentality is a little bit tamped from where it was a few months ago. But I do think our leverage book is reflective of our risk appetite. We talk a lot about private credit and the threat or partnership opportunities with private credit. I think we're actually really well positioned to deal with that across a bunch of different fronts, one of which is just we'll distribute the paper to those funds. And we're happy to do that on behalf of clients and get them the best, most competitive terms.
But again, our leverage book probably hasn't grown quite as much because the market's moved in a different direction. And our risk appetite hasn't expanded to take on more credit risk there.
Speaking of the private credit side, you guys announced the joint venture with Blackstone, I think it was, about last year or prior to that. How is it going? Or is it something, and how does it differ from what you've always done, which is lay off some of the risk?
Yeah. I mean, so if I just step back and say, how do we think about private credit? Right. One is we distribute a lot of loans to that group. We always have. There's more appetite, more capital to do it. So we would expect that to continue. The second version of that is something like a Blackstone where we've got kind of a direct and bespoke partnership. The difference really than any distribution is you know what the terms are and you have committed capital and you work through that. I'd say returns on that are fine. We're coming up on, do you re-up that or not? And we'll determine whether it makes sense to keep doing that. We love the underlying business that that supports. And if you recall, we ultimately did it as a risk concentration vehicle. So we'll revisit all of those terms.
The third version is we have a direct lending fund on balance sheet. So we partnered with a third party. They put in equity. We put in a little bit of equity. We provide the senior debt. And that allows us to provide a product to clients if they want a direct platform. And then obviously we lend directly. So we think across the board, we're pretty competitive in interacting with private credit. But there's clearly a lot of dollars and a lot of appetite. And I don't think it's going anywhere. So we're just trying to understand where we best play there and not necessarily change our risk appetite and our underwriting standards to reflect there.
Sure. Yeah, no doubt. Maybe we could talk about the first quarter and how it's progressing for you guys. If you want to give us an update. I know we're about two months, obviously, into the first quarter and how loan growth is tracking and other metrics that you guys monitor, the investment banking activity, etc.
Yeah. So balance sheet-wise, as we said, we kind of saw a little bit of stability and a slight growth in commercial in the fourth quarter. C&I, that's continued to date, so call it maybe + $1 billion so far. Some of that could be the inventory kind of buy ahead, that's offset a little bit by CRE, which is pay down or refi out, and then the expected runoff in consumer, and just as a reminder, the consumer book or the mortgage book running down is accretive because those are coming off at low 3%, 3%, and you can replace them either managed liquidity or replace them with higher yielding loans or securities, so that's all good, sort of as we expected, and from a deposit standpoint, as I said, down maybe 1% +, which we view as typical seasonality, but we feel really good about that.
So first quarter overall, NII kind of at where we expected, maybe a little stronger. We think it'll come in about $1.1 billion or so. So we feel good about that. And again, completely in line with where we think the year goes. Fees, we think in aggregate kind of mid-600 range. And again, good strength across the board. Investment banking in the first quarter, call it ± $150 million. Two tough comps, right? Coming off a fourth quarter that was maybe our third best quarter ever at $220 million and coming off a year ago quarter, which was our first best first quarter ever at $171 million or so. So it's not going to compare to those, but it's going to be a very solid first quarter. And if you recall, we're a back half of the year capital markets business.
So last year, just under $300 million in the first half, close to $400 million in the second half. So I don't know if it'll be exactly shake out that way, but the number feels right on line. We don't have any concern today about the full year guide. Again, subject to where the market uncertainty goes. And then expenses, year over year, pretty flat. We're going to be down significantly from the fourth quarter, as we talked about. And when you put it all together, PP&R is going to be up $50-$60 million from the fourth quarter. So we felt like fourth quarter was strong. We had PP&R coming in quite a bit stronger. And we feel very good about where that starts. Charge-offs and provision. Charge-offs, again, I think will be pretty close to fourth quarter. Dollar-wise, flat to maybe a slight release.
Again, depending on where the last month of the quarter shakes out, but I wouldn't expect big moves there on provision. All in all, it's shaping up very well so far.
Good. And we only have a few seconds here. But coming back to provisions and reserves, do you think because of CECL now that you and your peers are just better reserved going into whatever, I mean, more uncertainty in the future, just pre-January of 2020?
I mean, in theory, we should be because it's lifetime versus.
Just on capital and with the potential softening of the rules with the regulators, how are you guys viewing your capital levels? Obviously, they're very strong since the investment from Scotiabank. How are you guys looking at that going forward?
Yeah. So look, I think we're going to be a marked capital world going forward. Right now, we're kind of mid- to high nines. Feel really good about that. I think that's probably in the zip code of where we go long term. So we're kind of there. We're going to build capital more organically based on earnings trajectory. So again, we're going to do what we've always done. We're going to support clients organically. And I would include in that organic build sort of niche tuck-in acquisitions that build capability or open client paths because I think we've demonstrated we can do that well. And it does feel like just an extension of the business. Dividend, I think, is where it is until further notice. So I wouldn't be looking to raise that. And then the last bucket is, do we do share repurchase?
We're talking to our board right now about reinstating an authorization. So I'd expect to see that this year. If loan demand doesn't materialize at all, we can look at more repositionings. If we had to do that, we could. There's places we could go. We don't necessarily want to do that. We'd rather support clients. And then there's obviously inorganic activity that may or may not materialize. I don't see that materializing this year. So I'm not spending a ton of time thinking about that. And then the reality is I'm okay right now given uncertainty to have a little bit more capital. So I feel great about that. And it's a nice problem to have. And we will actively take advantage of it. But I think we have a lot of paths and a lot of opportunities.
Great. Clark, thank you for your insights and transparency. Please join me in a round of applause thanking Clark.