Ken A. Zerbe - Morgan Stanley, Research Division
All right. Welcome, everyone. Thanks for coming. Our next presentation is KeyCorp. We have Beth Mooney, Chairman, Chief Executive Officer from Key. And with that, I'd just kick right over to Beth.
Beth E. Mooney
Thank you, Ken. We appreciate the opportunity to be a part of your conference again this year. And joining me on stage, as well as with Ken, obviously, is -- I'm joined by Chris Gorman, who is the present of our Corporate Bank, as well as our new Chief Financial Officer, Don Kimble, who many of you know. Don officially joined us 1 week ago but he brings 25 years of experience in the financial services industry. And I have to say, we're extremely proud to have him on our team. And also in the audience today is Vern Patterson, the Head of our Investor Relations.
Turning to Slide 2 is our forward-looking disclosure statement and our non-GAAP financial measures. It will cover our presentation today, as well as the Q&A session of our remarks.
But I'd like to start on Slide 3, if I may. Over the past several years, we've made significant progress in repositioning our businesses, de-risking our company and pursuing a strategy that not only differentiates us in the market price, but also enables us to grow and increase shareholder value. Specifically, we've done several things. We've become a core-funded company. We significantly improved our credit quality, and we sharpened our focus around targeted client segments, including industry verticals within our Corporate Bank, which you'll hear more about from Chris Gorman when he gives his remarks.
We also have a clear focus on acquiring new clients and expanding existing relationships. And we've seen the inflection point in our loan portfolios growth, as well as growth in our fee-based businesses. We've made investments in our geographic footprint, payment product offering and our human capital. The result has been improved profitability and a stronger growth trajectory.
As we focus forward, we are committed to operating and capital efficiency. This includes improving our efficiency ratio by growing revenue and reducing and variabilizing our cost structure. And I'm going to comment more on that shortly, and I have a slide in our presentation that will cover our efficiency initiative. And we're going to continue to be strong stewards of our capital and focus on maintaining our revenue momentum through executing on our relationship-based strategy.
Moving now to Slide 4, in addition to the execution of our strategies, we also actively manage our portfolio of businesses. In some cases, like payments, online and mobile, we are making investments to ensure that we can fulfill client needs with great products and in the channels that they want to use them. For example, we recently rolled out our new mobile deposit remote capture product, and we are currently developing more enhanced mobile commercial card capabilities. We're also looking for ways to serve our existing clients and acquire new ones. As you know, in 2012, we reentered the credit card business as a self-issuer by acquiring a portfolio of current and former KeyBanc clients. And in the spirit of operating efficiently, we did this by entering a third-party arrangement for back-office processing to drive more favorable client economics. We believe that owning the client creates the opportunity for upside. In fact, new card production is up 92% in the first quarter compared to the prior year.
Last year, we also acquired 37 branches in Western New York, and that acquisition continues to go well as we are exceeding all of our client and employee metrics at this time. And sometimes, evaluating our portfolio of businesses means it's time to exit as we did with our recently announced sale of Victory Capital Management. This is a business that, over the last several years, has repositioned itself to become an advisor-driven institutional money manager. As such, there is very little connection to the rest of Key and to our relationship strategy.
Given the prospect of continuing to make needed investments in that platform, we determined that it wasn't the best use of our capital and that we're better owners for the businesses than Key. We expect this transaction to close in the third quarter.
And our business also need constant fine-tuning. For example, we take a hard look at our physical network, given the low interest rate environment and the accelerating change in customer presences and customer behavior. And as previously announced, we will be consolidating, relocating or closing approximately 5% of our branch network, as well as rationalizing our ATM network and enhancing our alternative channels.
And lastly, we've continued to build out a commercial real estate business. We recently announced our acquisition of commercial mortgage servicing business from Bank of America and Berkadia. These moves position us to be the third largest servicer of commercial and multifamily loans and the fifth largest special servicer of CMBS in the United States.
And at this time, I'm going to ask Chris Gorman to further discuss these enhancements to our commercial real estate platform, as well as how he is actively managing the Corporate Bank and share with you how our unique value proposition translates into real opportunities for Key and for its clients. Chris?
Christopher Marrott Gorman
Thanks. Our recently announced acquisition of Bank of America's commercial mortgage servicing business is a good example of constantly making a series of changes to a business in order to position the business for success. As a result of both the Berkadia partnership, which we completed a year ago, and pro forma for the successful completion of the Bank of America acquisition, the competitive profile of our third-party commercial loan servicing business has changed dramatically. If you look at it from a number of loans perspective, we've gone a year ago from 11,000 to 19,000 on a pro forma basis. The principal outstanding balance has gone from just around $100 billion to an excess of $200 billion. And from a deposit perspective, we've increased from $1.3 billion to what will be more than $4 billion. Additionally, and importantly, on a pro forma basis, we'll be named the special servicer on $47 billion of CMBS commercial loans. And that's really important as we think about multifamily and we think about the next cycle, that will position us very well to work through that as special servicer, so that will be a good piece of business. Let's move on, if we could, to Slide 5.
We really like our model and we like our competitive position. We really like what we've built. We believe, as I'll discuss in a minute, what we built can be better leveraged by continuing to hire people, and I'm going to talk about that in a minute. The Key elements of our strategic positioning are as follows. We have a middle-market focus. We have a complete commitment to the industry model. And we have a full product suite so we can do on-balance sheet loans. We obviously have all the Treasury products that you would imagine us to have in the traditional bank products, but we also coupled that with deep industry expertise and capital markets capability.
This is very important right now when basically all the markets are flashing green. If you think about, for example, the real estate business, we would make a decision, what's in the best interest of our client? Do we put it on balance sheet? Fannie? Freddie, CMBS? So there's a whole bunch -- it gives us a whole bunch of options in which to serve our clients.
Another -- a couple attributes that are newer to the benefit -- new to our benefit in the marketplace, size. Size, our size is small is a huge advantage when you're running a relationship-based business that has a lot of complexity to it and a lot of products. And lastly, but related to all of these matters is our cultural willingness to collaborate. So as we think about this, how does this play out in the marketplace?
Depending on the opportunity, we have really 3 broad categories of competitors. You have the large integrated banks that have the capabilities, but frankly, are not structured to holistically attack the middle-market. It's just not how they are structured. That's not really worthy of focus and then you have the 7,000 community banks, frankly, do not enjoy our industry focus or our transactional capabilities that we have built really over what is now the last decade or so. And then lastly, you have the boutiques and boutiques, obviously, don't have the balance sheet or the traditional banking products to which I just spoke.
So for some of the compete with us and the reason we to think we have an edge out there in the marketplace is take our middle-market focus, you add industry expertise, you add the capital markets capabilities, and then you delivery it by having local relationship people on the ground, we think all of that translates into a competitive advantage for us.
Moving on to Slide 6, if I could. While our business is uniquely positioned to serve targeted middle-market clients in our focused industry segments, we feel that it's under leverage, as I mentioned, a moment ago. Our opportunity is to continue to grow by adding proven senior bankers with existing relationships in order to leverage the model and take share. Since the beginning of 2010, we have successfully hired more than 100 senior bankers with existing relationships on to the platform.
A few interesting statistics. The 100 bankers, who have been on the platform for now between 1 and 39 months, have generated $270 million in revenue and $1.5 billion in loans. In the first quarter of this year, that same cohort generated more than 1/3 of the $78 million of debt placement and investment banking fees that we reported for the first quarter.
The people we've added cite several reasons for their abilities to be quickly impactful on our platform. First, they like the middle-market focus, coupled with industry and transactional expertise. They also like our broad product set. I mentioned it before, the ability to use our balance sheet to have traditional banking products, but also on a market like we're facing today to help people access debt and equity markets both public and private. And lastly, they like our size and the relative stability of our platform. With our model proven and significant opportunity ahead of us in each of our 6 industry verticals, we will continue to actively recruit talent to leverage our business.
Another opportunity we have is to do a better job of leveraging the entire bank. If you think about our Corporate Bank being a mid-market business, there's a real opportunity to leverage the Community Bank. Our Corporate Bank's business model is one based upon industry focus as opposed to geography. Our go-to-market strategy enables us to compete across the country very effectively, every single day.
Another advantage that we have though at Key is this intersection and collaboration with the Community Bank. Let me spend a couple of minutes talking about how this plays out in the marketplace. For example, if you take a midsized privately held specialty chemical company in say Upstate New York, first of all, our industry knowledge and execution capabilities our book valued by the prospect and serve as a window differentiation vis-à-vis most of our competitors.
Secondly, we, obviously -- or another point of distinction is that we, Key, are known to these folks. We're in their community. We're on the same civic boards that they are. If there's a good chance of their senior people are clients of our private banks or our retail bank, so there's a real opportunity as we look of this to focus on this intersection. This intersection of companies between $25 million and $1.5 billion that we currently have about 20% penetration. We think there's about 10,000 targets. And we think where these 2, the community bank and the corporate bank intersect, there's a huge opportunity. We're going to continue to attack. We're going to, first of all, to continue to uncover new prospects because as you dig around in these private companies, you find new ones all the time and we'll continue to attack the opportunity as well.
And then lastly, if I could direct your attention to Slide 8. As I mentioned, we're getting better and better at proactively targeting middle-market companies that we can be relevant to and that's really the key thing. It's the proactively new who we want to do business with and who you can be relevant to. The combination of our unique model and the strategic targeting of our companies has enabled us to significantly grow our clients. And when you significantly grow your clients, a byproduct of that is loans growing, fees growing and other services growing.
Now a lot of people ask me, what do we hear from our client base? And it's a question I'm hearing a lot these days. And as you may expect, our business clients remain cautious. For all the reasons, everyone in this room is well aware. As a result of that, our loan growth trajectory has softened modestly in both April and May. But our pipelines, however, remain solid, and we should continue to drive loan growth in our fee-based business throughout the balance of the year.
With that, I'd like to turn the presentation back over to Beth, who will speak to the changes we're making in our Community Bank, which will enable Key to capture the opportunity to bring new commercial clients, their owners and employees on to our platform. Beth?
Beth E. Mooney
Thanks, Chris. And I'm going to pick up again on Slide 9. For the remainder of time I have here today, what I'd like to do is discuss some of the significant changes that we just did to reposition our Community Bank, and then give you an update on our efficiency initiatives and capital.
As we look at the headwinds facing our industry, it included such things as the slow growth economy, many of the new regulations and the rapidly changing client preferences and expectations, it became clear to us that we needed to do some things differently. So within the Community Bank and within KeyCorp, we challenged ourselves to determine what changes were needed to become more efficient, more profitable and to invest more in differentiating technology and convenience. All with the goal of realigning what we do and the way we do it to both reduce cost and to grow revenue and help us drive the profitability of our Community Bank.
On slide 10, this lists what we considered to be the guiding principle for the changes we felt we needed to make. First and foremost is always proximity to the client; second is the importance of local decision-making; third was the opportunity to enhance efficiency and productivity; and finally, as Chris discussed, how do we continue to deepen the integration of the corporate bank and deliver to that clients set that we see so much opportunity with. Again, as the guiding principle, one of the things we said is we want to maintain the integrity of our Community Bank model, which at the core is our relationship strategy. Built on strong local leadership, quick decision-making and integrated delivery of resources and capabilities to our clients.
Slide 11 shows our resulting go-to-market structure. Here's what's different. We move from 21 districts to 9 geographic regions. We created one totally integrated consumer and small business segment that is responsible for all strategic, implementation, sales and investment decisions, bringing greater standardization and consistency in our efficiency initiatives across our footprint.
Our other 3 business lines in each region, which would be middle-market, business banking and private banking, will report to a regional executive, and that region will be focused on driving relationships with targeted clients and prospects and creating deeper collaboration with our corporate bank. The collaboration with the Corporate Bank aligns well with our private bank capabilities, especially with executives and owners of business.
Moving now to Slide 12. We think the result is a more empowered sales force, focused on revenue generation, with a more efficient streamline cost structure from removing layers that can complicate serving our clients. It also brings more consistency and rigor around the sales management process, as well as resource allocation and investment, and to be more nimble and responsive to the rapidly changing environment around convenience and channel preferences.
Turning now to Slide 13. This slide should be familiar to many of you at this time. It details our plans to achieve $200 million in annualized cost savings in 2013 for full run rate in 2014. And I remain confident that we are going to deliver on this commitment. And it's a critical step in achieving our near-term goal of a 60% to 65% efficiency ratio by the first quarter of 2014.
We've divided our efforts into 5 major categories and have shown what we expect to realize in each category in providing some examples of the types of actions we're taking. Today, with my conversation I just had about the changes in the Community Bank, I'd like to direct your attention to the center of the slide, and under the categories of Branch Rationalization and Sales Management and Structure. Here's where you will see the work and the result of the transformation we did in our Community Bank that I just discussed. And a significant portion of the work we are doing to reposition our franchise is occurring now.
During the second quarter, a time in which we are consolidating 33 branches and approximately 200 ATM terminals, as well as announcing our realigned and refined Community Bank structure, the cost savings associated with that work that we are doing in this quarter are yet reflected on this slide, which shows our progress through the first quarter.
And we're going to continue to look at our go-to-market structure and streamline it, so that decision makers are empowered in our clients, as well as ensuring that our sales teams are freed up to spend more time with customers and prospects. We're also making progress by negotiating better contracts and more efficiently managing our vendors and other sourcing in places where it makes more sense for others to do the work instead of ourselves. And I think our partnership with Berkadia is a good example of that.
And during the remainder of the year, we will continue to incur severance and other costs related to our efficiency initiative. And by the fourth quarter, we expect our quarterly expense run rate to be in the range of $680 million to $700 million.
And throughout our presentation today, as noted on Slide 4, we highlighted our efforts to improve both sides of the efficiency acquisition, growing revenue and achieving cost savings. Our initiatives have put us on a path for delivering results with a long-term plan for greater revenue growth, efficiency, productivity and value for our shareholders. And I want to reiterate that we remain committed to achieving an efficiency ratio of 60% to 65% by the first quarter of 2014. It's important to know that we will not stop there. Our targets are not an endpoint, but it is an important milestone. Continuous improvement is firmly embedded within our company, and we are already identifying new revenue and expense opportunities that can continue to improve our performance.
Turning now to Slide 15. We continue to have a strong capital position and how we deploy, invest and return that capital will be some of the most important decisions that we're going to make in the coming years. And to that end, our capital priorities have remained consistent. We're focused on organic growth, dividends, share repurchases and opportunistic growth. And in March this year, the Federal Reserve notified us that it had no objection to the capital plan we had submitted, as part of a comprehensive capital analysis and review process. This allowed us to move forward with the new share repurchase program of up to $426 million, which is a 24% increase over our share repurchase program last year and a 10% increase in our common share dividend, which our board approved last month.
And it's important to note that based on our 2013 C-car submission and using consensus estimates, Key has the highest total payout ratio among its peers, underscoring both our strong capital position and the importance we have placed on returning capital to our shareholders.
And in that vein, we are also recently notified by the Federal Reserve that they had no objection to our request for additional share repurchase equivalent to the after-tax net realized gain on the cash portion of the sale of Victory Capital Management, which is estimated to be approximately $100 million to $125 million.
And if I close on Slide 16, I want to emphasize why I remain positive about the outlook for Key and believe that while we always have work to do, we're on the right path to achieve our long-term targets. We've made a substantial changes in our organization over the past few years, and we are now focused on efficiently managing our franchise and delivering what we believe to be a differentiated client experience. And if we do that well, we will continue to increase our client base, grow our balance sheet, improve revenue and profitability and deliver shareholder value. More specifically, we plan to improve our operating leverage by increasing both revenue, as well as reducing and realigning our cost structure. And as I mentioned earlier, we are on our way to achieving our near-term efficiency targets. And we'll continue to work closely with our board and our regulators to manage our capital, consistent with our capital priorities.
And if I begin my third year as the CEO of Key, I couldn't be prouder of the progress we've made and look forward to the opportunities that we have ahead. And with that, I thank you for your time, and I'll be happy to take any questions. And Ken, I believe you're going to come back to the podium and kick us off. Thank you.
Ken A. Zerbe - Morgan Stanley, Research Division
Like I see, interactive polling. So why don't we just jump into that really quick?
So first question, basically what do you want management to focus on? What do you want to hear more of? So it's either existing organic growth opportunities, more expense cuts, ways to sell non-core businesses or things that you can do to strengthen the franchise, including acquisitions or tuck-ins or any product?
All right. So it looks like the main answer is ways to grow organically. Perfect.
So let's just go to the next question. Why would you buy Key today? What's the most attractive about the stock? So stock and distribution, expense cuts, it's geography or footprint, that someday we'll be acquirer in the bank space? Or you can say all other, which is you'd rather own other banks, or you don't like banks at all? I have to fill in some alternatives in there.
Okay. So it's pretty evenly split between capital distribution, expense cuts and other preferences.
So third question? All right. Last one, what are the key risks to either earnings of the stock price that you're most concerned about with Key? So it's lack of loan or revenue growth? Insufficient expense cuts or at least, a too high efficiency ratio, deals, valuation or no meaningful concerns?
Well, I don't know how to say to that one.
Let's move on. Let's open up for Q&A.
Ken A. Zerbe - Morgan Stanley, Research Division
Any questions? All right. Maybe I'll just ask one, easy one, obviously, you've been into 2 rounds of expense cuts. The first, I'm going say probably going to work as well as we'd hope. The second one seems lot better than we originally hoped, going into it. After this round, do you anticipate further need for I guess more aggressive expenses cuts to reach your ratio or your efficiency ratio target? Or just pretty all that need to be done?
Beth E. Mooney
Ken, I would tell you that we did a year ago, in our second quarter call, in July, announce this targeted than the range of $150 million to $200 million in expense cuts that we have now zeroed on -- zeroed in will be $200 million. But I think part of what we've been very conscious and careful about talking about is building a culture of continuous improvement. I think if you look across many industry, how do you continually enhance your efficiency, your productivity and your cost base is a way of doing business. So to say we have yet another programmatic, large-scale dollar announcement isn't the way I'm thinking about it. But I do see how do we continuously variabilize our cost, decide who has best performed the work, what is -- how we differentiate and run our business, to get which we can do more cost effectively. And that, that is a mindset of as we talk about Key, that we will talk about going forward. So I continue to see will push the curve, as well as bringing more and more ideas for expense and efficiency. But the other piece of that is demand, and the reason we chose to talk about it in the form of an efficiency ratio is how do we also grow the business? What can we do to continue to generate revenue, to acquire client and continue to leverage our business model? And if you go back to that slide where you said, do you want to pay attention to revenue? Or do you want talking about more expense cuts? Revenue got more votes than expense, but they were both by far the strongest, which says to me back to an efficiency ratio, a demand we need to do both and expense discipline is just going to be part of how we run the company.
Ken A. Zerbe - Morgan Stanley, Research Division
Great. And for those on the webcast, the pop-up, the biggest risks were lack of total loanrevenue growth and insufficient expense cuts, to a lesser extent.
With that, we want to thank KeyCorp for coming to our conference, and thanks, everyone. So thank you.
Beth E. Mooney
Thank you for your time today.
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