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KeyCorp (NYSE:KEY)

Goldman Sachs Financial Services Conference

December 10, 2013 13:10 AM ET

Executives

Beth Mooney - Chairman & CEO

Don Kimble - CFO

Analysts

Operator

Unidentified Analyst

Up next with KeyCorp joining us for the 3rd time since becoming CEO is Beth Mooney. Under Beth’s leadership Key has focused its efforts on controlling cost, completing it's second expense plan over the past three years and shedding non-core businesses and additionally it has successfully reinvested in it's corporate bank driving outside fee income and loan growth for the past 10 quarters. All of this has resulted in the 52% rise in the stock year-to-date making Key the best performing regional bank in the S&P 500. With that joining us is Beth Mooney, Chairman and CEO. Also joining her is Don Kimble, CFO and Vern Patterson from Investor Relation. So with that let me turn it over to Beth.

Beth Mooney

Thank you Ryan for that kind introduction and we’re delighted to be back again for this year’s Goldman Sachs conference. Let me go ahead and get started on our forward-looking disclosure statement that can be found on slide 2 of our presentation. It will cover not only our presentation today but all portions of our Q&A as well. If I could I’m going to go ahead and start on slide 3, last year as Ryan said this is our third conference since I was made CEO. I stood up here and talk about three things that I thought would drive our success in the coming year for the year of 2013. The first thing that we talked about was our need to optimize and grow revenue. Second we talk a lot about improving our efficiency and efficiency ratio and third was effectively managing our capital. I think we made significant progress in each of these areas and we’re pleased that our accomplishments have translated into measureable results.

In addition we believe that through the focused execution of our strategies Key we will continue to make demonstrable progress in each of those areas and one of the ways we measure success is our relationship strategy and that is our ability to expand and acquire client relationships and in our commercial business particularly we are having becoming more and more important to our targeted clients and we’re very getting rewarded for our seamless delivery of our capabilities, our advice, our insights and they reward us when something significant or strategic happens we are often in a leadership role on those transactions.

As a result we have seen strong growth in our commercial loans and in our investment banking and debt placement fee. As you can see on the slide CF&N loans are up 11% year-over-year and then another sign of our strength of our commercial franchise is that our investment banking and debt placement fees are up 29% on a rolling four quarter average from the prior year. So we have also grown our consumer and our commercial payments business and that’s demonstrated by nearly a 60% increase in new card issuance over the last year. We believe that the move in the self-issuance and control of the product has enabled us to drive meaningful growth and with a low double digit penetration of credit card within our client base we know that there is significant room to grow as we ramp up and deliver this new capability to our clients. We have also made great strides in improving efficiency. In June 2012 we announced that we would achieve $150 million to $200 million in cost savings and in the third quarter of this year we reported that we had exceeded the high end of that range and we had done it one quarter ahead of our original goal. Through our efforts on both revenue and expense we have reduced our efficiency ratio from 69% at the launch of the initiative to 64% in the last quarter.

But I’m also pleased that the cultural change that has taken place at our company. Efficiency and positive operating leverage are becoming part of the fabric at Key. Leaders and employees throughout the organization are focused every day on continuing to perform against these important objectives and we have also been disciplined in managing our peer leading capital position. Adhering to our capital priorities we continue to invest organically, we increased our dividend by 10% and we have repurchased $375 million of common shares through the third quarter. The result is a payout ratio of approximately 79% for the first nine months of the year placing us at the top of our peer group. Turning now to slide 4, by staying true to our relationship approach and executing on our business strategy we have enabled to drive pre-provision net revenue growth and peer leading shareholder returns this year.

On a year-to-date basis our core PPNR is up 6% from the prior year, and consistent with my comments on the prior slide you can see that Key has the highest payout amongst CCAR and capital banks. And while the bank market has, while the market has clearly recognized our progress they share with us stock being up over 50% through November. We still had meaningful opportunity to improve our financial performance and close the valuation gap with our peers which you can see on the right hand side of this slide and know that our management team and employees are focused on continuing to deliver solid results that will over time continue to improve the value of Key.

Moving now to slide 5, as we look ahead we’re committed to improving returns by combining three critical areas of focus driving positive operating leverage, effectively managing risks and remaining disciplined with capital management. First is positive operating leverage which is to us is executing on our business strategies and initiatives to both grow revenue and manage expenses. We will continue to invest where it makes sense and do client facing roles and enhanced capabilities to better serve current clients and attract new ones. And at the same time strengthening our continuous improvement culture.

Second is effectively managing our risk. At Key risk management starts with a focused strategy well executed. Our discipline and commitment is to stay true to that strategy and to rigorously manage risk and reward. We believe that when we focus on targeted segments and industry sectors where we have knowledge, presence and expertise we win more often precisely because of that differentiated position. As important as winning that business our distinctive knowledge means that we have greater insight into clients and market and that enhances our ability to manage risk And finally remaining disciplined with capital management. Our capital priorities service the foundation to our approach to managing, deploying, investing and returning capital in a way that maximizes the shareholder value.

I’m now turning to slide 6 and the first of our three commitments is to drive positive operating leverage. And over the past year the hard work of our team has enabled us to deliver on our efficiency initiative and we are committed to remaining vigilant on expenses going forward as well, but we need to be equally dedicated in our focus on growing revenue and driving higher productivity across all areas of Key. We must pull those levers revenue and expense continuously to achieve our operating leverage objective. For example in our retail banking business we are still mining our infrastructure while making targeted investments to support our clients and to grow revenue. Through the third quarter of 2013 we have consolidated approximately 6% of our branch network and at the same time we have also invested in areas such as credit cards self-issuance and digital channel capability to drive client activity and revenue. We’re also enhancing our products and our capabilities, as an example we’re currently in the process of launching prepaid and purchase card solutions for our commercial client which furthers our ability to acquire and expand client relationship and finally we are improving our sales and service productivity across the company by investing in client-facing banker and support resources, Key is able to be more impactful with clients and prospects.

At the end of the day this is a people business and getting the right banker in front of the right opportunity at the right time is how we help ensure our sales and service productivity. Turning now to slide 7, as I said earlier, we believe that a focused strategy rigorously executed is the best way to manage risk. That is why we're committed to building relationships with targeted clients. And the good news is that our targeted clients and prospects increasingly value the advice, capabilities and service we provide.

They like doing business with Key and over time they have increased the amount of business they do with us. As a result Key has been able to grow CF&A loans 30% and home equity and other consumer loans 13% in aggregate over the past three years. And the quality of our new business is strong as our new loan origination are better from a credit perspective than our overall loan portfolio. Our focused and specific industries and geography means that we know these areas and we know these companies and that translates into strong risk management.

In addition, we have demonstrated an ability to exit relationships and client types that did not meet our risk return criteria, example, the various we have strategically exited include small ticket vendor finance, indirect consumer lending and commercial real estate construction lending. That risk discipline is visible in the bar chart on the right hand side. Our exit in commercial real estate portfolios have declined by a combined 49% as a result of remixing our business.

Yet in our commercial real estate business where we have reduced our loan portfolio by 41% we've repositioned ourselves to focus on owners and developers of real estate which more closely aligns with our relationship strategy and a great example of what we did in that business is first to be more targeted in our lending and we have in addition developed and expanded our commercial mortgage banking and our commercial real estate servicing as a result of that kind of focus and with discipline we have significantly reduced our balance sheet, yet maintained and improve the overall business across lending and fee revenues.

Adhering to our risk appetite and tolerances also enabled us to resolve credit issue early in the cycle and we have experienced consistently lower net charge off rates versus our peers over the last 12 quarters. It is our commitment to maintain a moderate risk profile with more consistent loss experience through the cycle. That will be the testament to the effectiveness of our strategy and our risk discipline.

Moving now to slide 8. We also remain committed to being disciplined in managing our strong capital position. Staying consistent with our capital priorities is an integral part of our past to maximize shareholder value. In fact through the third quarter of this year we paid out 79% of net income to shareholders which is a payout ratio that is at the top of our peer group and that is up from a 46% payout ratio last year. Importantly even with our higher payout and the investments we've made to grow our business our Tier 1 common ratio has remained above 11%, providing us with a strong foundation for the capital planning and stress testing that we are doing as part of the 2014 CCAR process and similar to past year we will be working with our Board on our capital plan submission and we will not be in a position to comment or share until we receive the results from the Federal Reserve in March.

As I close on slide 9. I want to reiterate our commitment. Our well-defined strategy survived us with a roadmap for growth. In the coming year I look forward to continuing down the path of driving positive operating leverage, executing effective risk reward and delivering a disciplined approach to capital management. And as I stand here today I believe that Key is a strong company more focused than ever before and committed to delivering value for our clients and for our shareholder. Our efforts in recent years to reposition and refocus our business to strengthen our execution and become more efficient and a productive company has produced results and momentum and by building on our momentum, our strategy, our rigor and our discipline we can execute on these commitments and continue to grow and improve our returns. So with that I will say thank you for the opportunity to share those observations and Don and I will be happy to answer questions and I’m going to turn it back to Ryan and I will you join you at the chair. Thank you.

Question-and-Answer Session

Unidentified Analyst

Can you just start off you talked a lot about you know delivering the operating leverage as you look forward and it sounds like it's going to be, as we look forward it's going to be a bit more balanced in terms of revenue and issues (indiscernible). So as you look out over the next 12 to 18 months give us a sense you outlined a lot of things on the slides that has helped the revenue. What is the two or three things on the revenue side of this thing will is the big difference (indiscernible).

Beth Mooney

One is a huge push around productivity, you heard me talk about sales and service productivity. So some big piece of what, so one big piece of it is within our existing sales force how do we equip them with the right tools and abilities to make sure that we up our average sales productivity. So that’s been a big focus of ours. Second as we look at our commercial businesses again which if we were talking three years ago, we talk a lot about our focus will going to be driving our strategy within companies from 25 million in revenues upto a $1.5 billion it's adding bankers, we have added over a 100 senior bankers in our corporate bank over the last couple of years potentially adding another vertical to our corporate bank and leveraging that platform and capability. So as we look at our growth rate up 11% year-over-year in C&I as well as the increase we’re getting in investment banking and debt placement fees. That model still has run-way so has capacity for investment and growth and we see that as critically important and then as we look into our consumer franchise I really think how we utilize digital marketing and online capabilities to drive client acquisition as well as products and services out to our consumer client system [ph] being an important area of growth as well.

Unidentified Analyst

And just thinking more of what it will be the expense side of the equation. You know I’m assuming you know the 200 million plus of expense you kick out was some of it was little hanging fruit; a lot of it was improving process. As you look forward where is the next leg of expense/ (indiscernible) where are you looking deeper in the organization now to further in these products?

Beth Mooney

We continue to have opportunities, our $200 million target was what we identified basically in mid-2012 that we have executed on as we move into 2014 it's not (indiscernible) program per say but it does continue to have opportunities. We have developed with link Six Sigma as an opportunity for us and that has a long lead time so in ’14 we’re really getting into some of the end to end process redesign. We continue to look at third party vendor and partnerships in terms of where we can get capabilities at a more effective cost or even with more sophistication I think we own the client relationship, how we fulfill needs to be in the most efficient way and potentially and varied [ph] by cost base and then we continue to be very rigorous in terms of our staffing and making sure we have the right mix of client facing and not too heavy on the back end and I would look to Don and say what else would you add to that.

Don Kimble

I think you’ve have hit the highlight and I think the only thing I have to add to that is the real benefit of the last program that hit on us was just the investment and more of a process end to end approach and it really has been growing as part of the culture here at Key and so I think that really is where the value is at long term. It's not so much; we have another named program that our people focusing on how we can be more efficient, more effective and the efforts we’re taking on.

Unidentified Analyst

Don just with your outlook and expectations you’re going for downward pressure and then as the result of higher liquidity so I guess a couple of questions on that first you know what is driving the higher liquidity and second as you look at what sort of a time horizon do we think it's going to take for you to actually see some of that liquidity get deployed and then third is there any change to the longer term outlook to the margin over the next three to four quarters?

Don Kimble

As far as the near term guidance essentially what we’re seeing is that we’re still seeing the guidance stick which is that our net interest income will be relatively stable at the third quarter but what we have seen so far in the fourth quarter is some greater deposit flows mainly coming from our commercial mortgage servicing business and the acquisition that we did in the third quarter we’re seeing a little bit higher levels of cash being driven from that business and it's staying on our balance sheet longer. We also had two dead issuances here in the fourth quarter which added to our liquidity position. So just to put things in perspective, for every $1 billion of additional liquidity so we increase our deposits and our funding and also increase basically our cash position that cost is about four basis points and margin, it doesn’t impact net interest income per say in any meaningful way but does cost our margin and this quarter so far we have seen have about $2.5 billion to $3 billion of increased liquidity position from those type of activities and so it does have an adjustment to our margin. We had highlighted at the end of the third quarter that we thought that it will be relatively stable as far as our margin except for our potential pressure and liquidity and we’re seeing that so far this quarter.

Longer term that we will be providing little bit more guidance as far as the margin prospectively but again it will be impacted to the extent that liquidity stays in place and not really changing much in a way of our guidance on net interest income but margin still has some moving parts based on the links of that liquidity remains on the balance sheet.

Unidentified Analyst

And given the excess liquidity, do you make any changes to deposit pricing and stuff that time of the pressure, is there anything on the longer term debt funding side that you’re looking throughout the month?

Don Kimble

Well as far deposit pricing we had already pulled a lot of those levers and some of those are working their way through the system that the biggest area of opportunity we have as far as bringing down the deposit cost, our CD rates and we still have some higher CDs that are maturing through the next four quarters and that will help drive our cost of funds down there. As far as other efforts on the national market funding, we really don’t have a lot of other issuances out there that are available for call that aren’t already at that fairly little rate and so we don’t see that as a big opportunity for us.

Unidentified Analyst

Beth you guys have done a great job growing the corporate bank you know deepening penetration across the client base. You made a reference to potentially other looking at other vertical [ph]. Given your client base that you have in the business what other verticals would leave themselves for you guys to be active participants in that business.

Beth Mooney

At this point we haven't disclosed what we’re looking at but we are looking at potentially two more vertical and one I think we will be in a position to launch in 2014 and we will be looking assimilate a team of people who can come in and help us move that forward quickly but the criteria we were using were a couple, one we looked at where do we already have adjacent fees or capability. So it's not from a cold standing start, you know where within our products and our abilities do we see adjacent fees that we can comfortably move. Then we did a rigorous analysis of companies within our market, their size, how they are capitalized, owned and what their structure to again say our high likelihood that our model translates into that vertical where we could become relevant, meaningful and take play lead towards the transactional roles with them and we have identified a couple that I think are very, very complimentary, will provide us growth and are prepared to start investing in 2014 and I think we will talk more broadly about that once we get it announced and get a few people under our belt.

Unidentified Analyst

Great. Just thinking ahead to CCAR as you think about the capital planning process. You have been on the high end of capital returns over the past couple of years. Any changes to your expectations in terms of mix or given that the stock is now 50% higher is there a less of sales force buyback just look so given where the shares are now trading [ph]?

Beth Mooney

Ryan I would tell you that I don’t think any of us have seen any change in tone out of Washington in terms of how they are thinking about the CCAR process very much still capital return being governed by net income and so you’re correct in the last couple of years we have been able to be kind of ahead of the pack based on our strong capital position which I always say is a true advantage and strength for our company overtime. So without a shift in tone you know kind of the guideline still tend to be up 230% of net income and dividends and in our capital priorities we say dividends you know first of all supporting our organic growth then comes dividend, so we will be looking at our dividend capacity within that and then as it relates to share repurchase still highly attractive. A lot of gratitude if the increase in our stock valuation this year but it is still a good use of our capital for our shareholders to repurchase shares so that will be within the next priority something we will also be looking at as we finalize our plan and our submission.

Unidentified Analyst

But just one follow up, you’ve been one of the more strategic banks in terms of use of your capital whether it was buying the branches in your (indiscernible) and I guess selling Victory capital. As you look is there anything else that you’re currently looking at or thinking about strategically that will be a good use of your capital outside of just traditional organic growth and return to shareholder?

Beth Mooney

Ryan as we go through the capital priorities like I said it's supporting our organic growth dividends and share repurchase, (indiscernible) is what I call opportunistic growth and I do think well they have none of them being significant blockbuster type deals I think we have shown a lot of rigor in trying to think about capabilities, complementing our business strategic, being additive and as you mentioned Victory existing where it didn’t really fit our strategy and converting that gain into a return of capital to shareholders. Those tend to happen opportunistically not rapidly [ph] and I would tell you we would continue to look where we could see products capabilities, businesses that fit our strategy and I think that’s a huge thing we got to mention is the discipline to be on strategy and have it be a fit as those things would come up in the market we would look with interest and say could it be additive to our business model, our ability to acquire and grow client relationships and would you add anything on that Don?

Don Kimble

No I think that the key really is being strategic in their focus and making sure that we keep a line what our long term strategy is and to the extent that there are opportunities that can help facilitate that then we will take a look but we want to be prudent with the capital we have. It was expected to raise, we don’t want to use it in a way that it will be detrimental to our current shareholders.

Unidentified Analyst

Just getting back to loan growth for a second you put up the slide that showed risk management and we have obviously seen a big transition of the portfolio towards CF&A you know based on some of the higher risk areas. Are you supporting now mix wise where you know we can now start to see some of the commercial real estate portfolio beginning to grow and on the CF&A side at the point now where we have seen a lot of the growth has come from business wins and now it needs to be more about just you know more client engagement or is there still lot more with the job in terms of client relationships?

Beth Mooney

First as it relates to exit in the commercial real estate portfolio. You know again if we could go back three years ago some piece of powering the growth of our balance sheet and the efficiency of our balance sheet plus we were having to go through what we’re running our portfolios as we sit here today in 2013 I would tell you that piece of our business is stable you know it's amortizing or paying off in a very orderly way. So what you now see is a more stable base off of which we can grow our portfolio. Within real estate what we do is more there is some increased demand for on balance sheet real estate lending within owners and developers of real estate. The huge piece of our growth for the last couple of years has really been in our commercial mortgage banking and our ability to debt placement, Fannie, Freddie and other kinds of long term debt placements but I don’t think it will be the kind of growth that will change the trajectory of our overall loan growth. I just think it's an active category that appropriately when we can we will put some of those on our balance sheet and in terms of commercial loan growth I think there continues to be, that’s a very granular portfolio. It's spread across six verticals in our corporate bank, in our markets across our community bank. That is just being as I said in front of the right client with the right opportunity, with the right banker and winning the business. So I think that’s a continued area where we can grow both through client acquisition, expanding with our existing client base and that has been an area where we have shown higher than peer average availability to grown on.

Unidentified Analyst

Great. I’m going to open up to the audience for any questions.

Unidentified Analyst

(Indiscernible) pick up.

Beth Mooney

The question was that there has been a comment earlier today that there are signs of more demand in the small business in the middle market space. We tell you that this has been a recovery where the larger companies have had more demand and more stability faster than the small end of the market. We do see solid signs of growth within middle market but those borrowers tend to be more cautious. So some of what we have observed is their willingness to pull the trigger and actually incur that has more caution to it than some of our larger companies. Then as you go down into the small business sector of the market I think they have really hit the inflection point of being more stable 18 months to 2 years ago but the still in my view from based on what I see within our loan books are slower to use leverage. They like you said our capital is expensive to raise, de-levering and surviving the downturn I think in the small business sector was very, very higher than I think they had been for most for (indiscernible) to look at leverage as part of their business strategy but they are stable in growing. They are just not growing at the same pace as some of the larger companies.

Unidentified Analyst

I guess you’ve outlined an efficiency target of 60% to 65% you’re now at the high end of it. If we don’t see a material improvement in the economy whether it's from tapering, slowing economy demand or any sort of the pickup and non-utilization. Can you continue to make progress towards the middle of or the low end of the efficiency chart [ph]?

Beth Mooney

I will give you some comments on that and then I think Don has some perspectives that I would like him to share and I would tell you there is room for incremental progress for 60 to 65 we said was a target for us to get to and as we said we got there a quarter early and that expenses really were what’s going to drive us into the high end. Movement within the range in meaningful ways will be driven by two things, one basically revenue growth that’s why we have always talked about it in terms of the efficiency and an accelerant to that revenue growth clearly would be interest rates moving which none of us really see at least within the immediate time frame. So we’re coming up with plans to stay focused on positive operating leverage, investing in our business, continuing to become a more efficient productive company and then I will let Don add any of his observations.

Don Kimble

I would agree with those comments and essentially that we’re seeing opportunities to drive that down into the middle into the range and maybe even slightly lower even without rates that could take them time because it could be a slower process as far as continuing to focus on and generate positive operating leverage and overtime that will drive us down lowering that targeted range as part of the efficiency ratio.

Unidentified Analyst

Shifting gears a little bit just one question on competition. We have (indiscernible) this obviously at the lowest levels that we have all seen in a very long period of time and you know from what we hear from the outside within the underwriting has obviously gotten a lot looser. As you look at the new business that you’re referring on do you think we will see an environment where as the economy picks up and loan growth accelerates we will actually see charge offs stay at similar levels that they are now or has the underwriting gotten to the point now where it could be cash flow, risk down the road and we will have a pickup in loan growth and also pickup in charge offs.

Beth Mooney

That is a very hard one to speculate on because it some piece of the strength of the cycle and how the cycle lasts. I will tell you an important comment I made was the quality of our new loan origination, so I’ve been targeted around client’s capabilities in the market as well as our underwriting. We feel very good about the quality of loans that we’re putting on our balance sheet and as we have said we have remixed where the overhang of exists and the old construction lending portfolio have pretty well worked through. So my sense of the near-term is that we are in a pretty strong, fundamental economy. It may not be a very robustly growing economy but doesn’t have weakness or downside risk that we would have even been talking about over the last couple of years. So I some mobility for this benign credit environment to extend out. I don't think we are on the verge of another credit cycle, but we’re also at a point when you have 28 basis points in charge offs you know one deal here and there can start moving your numbers. So we have both gotten to a point where it's going to be lumpier but I don’t see anything within the economy or our particular portfolio that suggest the credit cycle is turning anytime soon.

Unidentified Analyst

Let’s see if we have one more question, well there is not, we will end it there. Please join me in thanking Beth and Don for their time.

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