KEY
#Essentially what happens here is that, based on the accounting rules, that we have a threshold established based on the interest rate component of our pension expense.
With rates being so low that hurdle for this year was $32 million of lump-sum distributions.
And as soon as we go over that it triggers a settlement loss.
So, if rates remain at this low level for a long period of time there risk that we could continue to see that in the third or fourth quarter of subsequent years.
But at this point in time it's difficult for us to predict when that would occur and how.
You're right.
There is the exposure there.
But what would have to happen is each of those participants would have to retire and then each of them would have to have a lump-sum distribution; otherwise, you're going to see that $250 million being recognized over a 30-plus year time period.
Difficult to predict exactly what people will select and the timing of that recognition.
And, <UNK>, this is <UNK>.
I would just add that it is, as <UNK> accurately points out, a function of the interest rate environment.
But if you also look at our FTE line this charge has been triggered for the last couple years related to our significant repositioning of our workforce, which we have brought down over the last several years.
And, as you heard, we've been adding to client-facing and senior bankers but overall we've been bringing down our headcount.
So, that remixing and reduction in headcount is also triggering the opportunity for people to make those elections as they exit.
So, it really takes both of them to happen in order for us to incur a charge.
As far as our loan growth exceeding deposit growth, we've been talking about that for a period of time because we expect that to be an area to help us see a little bit more stable net interest margin.
And you are right that we're still below where we would target as far as our loan to deposit ratio long term.
So, we think that is an area that we can continue to manage up.
If you look at the LCR at the end of the third quarter, we were north of 100%.
Our requirement is to be at 90%-plus range in the first quarter of next year so we think that we're well-positioned from that perspective.
And I'd also like to note that in the third quarter we did see some of the more short-term focused deposits leave the bank and that will put some additional pressure on a linked quarter basis as far as the deposits being down slightly compared to the second quarter.
I'll take a first crack at it and then asked <UNK> <UNK> to chip in, as well.
If you look at the charge-offs, the change over the last four quarters really has been in the level of recovery.
The actual growth charge-offs are pretty flat over the last five or six quarters, so we haven't seen much change from that.
The recoveries are down primarily in the commercial category and that just reflects that we haven't been replenishing the inventory, which is good as far as problem assets to collect on and therefore don't have the higher level of recoveries.
We think that we're getting closer to more of a stable level of recovery.
To your point, we're still well below that 40 to 60 basis point range.
We would expect to continue to be under that for a period of time but we have seen some increases in charge-offs reflecting the lower level of recoveries.
<UNK>, anything else you would add to that.
This is <UNK>.
We think that our business model is unique.
We're focused on seven sectors.
We're focused on the middle market.
For example, we have 46 research analysts covering 777 companies.
And while clearly our model can be replicated, it's not just as easy as hiring a few bankers because you need the product experts and you need the industry experts.
Because of that, we feel like we have a bit of a competitive advantage in the marketplace.
<UNK>, this is <UNK>.
The one thing I would add that we also always talk about is when you look at the growth in our loans to our commercial clients, and as you look at it also with our investment banking and debt placement fee, you can see a high correlation that that's where the business model comes to light ---+ that it's both what we can put on our balance sheet how we attract clients and actually lend into them but also through our broader product suite, which as <UNK> says, we think is unique and differentiated.
We're able to drive M&A fees, debt placement fees, equity fees, and a variety of robust fees coming out of our payments capabilities.
So, it's really a very holistic approach.
And loans are a significant part but also, I think, indicative of the broader model that we are able to bring across a continuum of commercial and middle-market clients.
What we just said is our full-year number would be in our guidance range of mid-single-digit growth.
So, that would imply that it's going to be in the 4% to 6% range on a full-year basis.
Our principal investing gains with market conditions overall and with the size of the portfolio shrinking, I would say that the $11 million that we have in the current quarter and for the past couple quarters is probably an appropriate run rate for us.
You will see some volatility there but generally I think that's a decent outlook.
The operating lease income line item is down this quarter and that reflects a couple things.
One, we had about a $4 million loss in the current quarter and we had a slight gain in the previous quarter.
So, that really created the change on a period over period.
But I'll say that the current level is probably a little low given the impact of that loss.
This is <UNK>.
Because of the fact that we are in the transaction business you will from time to time see lumpiness, particularly with respect to commitment fees.
But underlying the entire line item ---+ and this cuts across both the Corporate Bank and <UNK>'s business in the Community Bank, as well ---+ we have seen elevated levels in both foreign exchange and derivatives.
So, yes, there's some lumpiness but the underlying trend line is also positive.
Yes, Geoff, this is <UNK>.
As we've said before, we have articulated our capital priorities and have said our capital position is the strength of this Company.
So, we're pleased to continue to be among the peer-leading level return of capital to our shareholders.
As you've seen over the last couple years, we've also used the opportunity to enhance our business model and our strategy as we've expanded our product offerings such as acquiring our credit cards last year.
We are on the one-year mark of our acquisition of Pacific Crest Securities.
And we've done some things over time to enhance our distribution.
So, as we look at it we would look at opportunities that are consistent with our model, things that would add to our client base and would be good for our shareholders.
And I think the things we have done in recent years have met that standard.
It is good to see that some transactions have been announced and approved and the market has cleared those.
I think it is an indication that there is more confidence or perhaps certainty.
I think that's good for the markets, I think it's good for buyers and sellers alike.
This is <UNK>.
Let me just step back for a moment.
We don't really look at it as separate.
In other words, we don't look at the loan product, the fee product.
What we're really doing in a very holistic way, in a very targeted way, is pursuing client relationships.
And when we pursue those we get the benefit of both fees and loan growth.
If you look, for example, in the Corporate Bank, our noninterest income this quarter is about 51%.
We like that mix of half and half.
We think it's a competitive advantage to have a balance sheet.
But we really think it's our job to identify clients and serve them in any way that we possibly can.
As I mentioned earlier, the preponderance of the time that involves us accessing capital elsewhere.
In terms of the actual pricing on loans we have seen a slowdown in the rate of decline.
So, if a year ago the year-over-year rate of decline for a similarly risked loan was down maybe 25 basis points, maybe this year it's down maybe half of that.
But with our business model we're able to generate very good returns for our shareholders and not take excessive risk in terms of growing growth.
We don't look at them as one or the other.
We focus on client relationships.
And the outcome of those could be loans, could be fees, or any derivation thereof.
The only thing I would add to that are two points.
One is that if you look at the new loan originations, they have a better credit quality than the existing portfolio, so you would expect to have a little bit lower yield if the credit quality is better.
That's helpful for our overall credit picture but it has a little bit of additional pressure on the margin.
And then, second, I would say that linked quarter we did see our loan fees come down a little bit, which cost us a couple basis points there, as well.
So, not necessarily reflective of the aggregate pricing for the portfolio but from time to time we do see some variance there, as well.
Great.
And you're absolutely right, one of the things we focus on quite a bit is just what kind of return on capital are we generating from our customers, and whether that's in the Community Bank or the Corporate Bank.
Our fee businesses clearly have a stronger ROE for us.
So, that's something that we're very excited about.
And if you look at just, for example, the Corporate Bank, the return on capital in that business has been hovering around a 30% type of level, clearly north of 20%.
So, that clearly is in an area that we want to see growth going forward.
Sometimes that comes in areas where it's a higher efficiency ratio and we're fine with that as long as we can get the return on capital and get the return for our shareholders, which we think is exceeding the cost to deliver that.
Again, we look at it as accretive.
As far as digital, we continue to make a lot of investments there.
If you look at our technology deployment, I would say that somewhere between 15% and 20% of that budget on an annual basis is facing off against our digital investment, and it is enhancing our customer experience and providing more opportunities for those customers to engage and open new accounts with us.
<UNK>, anything else you would want to add there from the digital side.
Thanks, <UNK>.
The only thing I would add is you see a deliberate remixing of our distribution to our clients ---+ so, you see the branch counts coming down meaningfully over the years ---+ while that investment in digital is taking place.
So, there's no doubt that we see significant growth in the engagement of our clients from a digital perspective.
You see a real focus on the relationship strategy so that the investments we make are to bring ease, value and expertise to our clients through the digital environment, making sure that there's relevant offers to them in the digital space.
You see some partnerships that we've announced to bring that to life, as well.
That's in the run rate.
We've really ramped up the investments in digital and I'd expect to see that continue.
<UNK>, I will tell you that we will provide more clarity as far as our 2016 outlook at next quarter's call.
But as we've talked about over the next quarter and on a year-over-year basis we're still expecting to have net interest income increase from the low single digits.
So, not seeing anything fundamentally that would change that dramatically.
But then, again, we will provide more clarity after next quarter.
Sure.
If you look at just the salary line by itself, that $7 million, linked quarter, a little over half of that is because the number of business days increased by one this quarter versus the second quarter.
So, it was a little over $3.5 million of the increase there.
The rest of it really is the investments in the talent we talked about, and also reflective of in the current quarter is our first quarter of every year where we add our new rotational programs, whether it's in the Corporate Bank or credit or other areas.
We bring in a group of college graduates to the Key organization and that resulted in an increase in headcount linked quarter from that effort.
If you look at the incentive and stock-based compensation, it's down $6 million and that really is tied to that change in our capital markets revenue.
Not only did you see a decline in the investment banking and debt placement fees but you saw an increase in some of the corporate services income which was primarily driven by capital markets related areas, as well.
So, the net change there of roughly $19 million had an impact of about a $6 million decline in our overall incentive and stock-based compensation expense.
We would continue to have some branch consolidations.
We didn't call it out but we recognize that's more a part of our ongoing run rate, that we did have our branches come down by 17 this quarter, would expect to continue to have a 2% to 3% decline year over year.
That would imply some additional branch consolidations in the fourth quarter.
Nothing outsized from what we experienced this quarter, that's correct.
This is an ongoing question that we have not only for our investors but also for our Board and our management team.
We're always trying to read the signals and messages that we're hearing from DC and our regulators to see if there is more willingness or appetite to see that type of payout increase.
We do recognize that we are highly capitalized and we want to be one of the top returners of capital going forward.
So, we're looking for every indication we can get to see if that tone has changed or shifted.
Right now we just want to make sure that we're disciplined with it, that we recognize that part of our value really comes to our shareholders in the form of dividends and our share buyback.
And we want to make sure that we can continue those going forward.
We think there is greater opportunity for us long term.
We still think our loan to deposit ratio is lower than where we would like to target it long term, so we do have some additional flexibility.
I'd say that the current quarter coming down by $1 billion in the short-term earning assets is probably outsized from what you would see in subsequent quarters because it reflects some of the impact of some of those short-term deposits that we expected to go out of the house over the last quarter, and wouldn't expect the same pace going forward.
When we take a look at that, part of our challenges that we see is we're not seeing a differentiated performance market by market.
We're seeing improvements across the footprint and seeing better performance in all of our markets.
And our challenge really is if we exit the market what happens is that we eliminate 100% of the revenue and a portion of the expenses, but not 100% of the expenses because we still have an infrastructure that supports the technology, risk management and other functions that may not be quite as variable in nature.
We haven't seen a benefit to our shareholders for truly exiting the markets.
But our focus, really, is continuing to improve the performance across our footprint And we're seeing that and it's starting to translate to bottom-line improvement from that, as well.
Absolutely the case.
And all my business partners here are all nodding their head across the table from me, so I think we have absolute agreement on that.
A commitment and confidence to be more productive and more efficient.
This is <UNK>.
Let me address that, if I could.
There's a couple areas that we've invested in significantly that we're really starting to see a lot of traction.
First is the purchase card business.
And what we've done ---+ and I'm going to turn it over to <UNK> in a minute ---+ but what we've done is worked very closely with the Community Bank, not only in terms of penetration rates which are 3X or 4X what they've been but also the size of the clients are higher.
So, that's one area.
Another area where we've had a lot of wins but it isn't really reflected yet because it takes a while to set up these programs is we got into the prepaid business.
And we've had some very significant wins out of our public sector area.
Those don't really come online until 2016 but it gives us confidence as we look forward.
The other area where I think we've had some success ---+ I'm going to ask <UNK> to comment on it ---+ is on the merchant side where <UNK>' team has been very closely aligned, and thanks to <UNK>, have been really coordinated.
Thanks, <UNK>.
The cards and payment line, to <UNK>'s point, you see on that line tangible payoff of the investments that we've been talking about.
We acquired our credit card portfolio and we now self-originate.
To <UNK>'s point, you see that same activity in the merchant business.
You also just see core client growth occurring across the Community Bank, across the consumer and business banking portfolio.
With client growth comes activation and active cards.
Very proactively managed businesses.
But you can see a portfolio of investments that are really paying off with client growth and the active evidence of our relationship strategy.
Every one of these clients, every one of these products is not a standalone but in the context of the broader relationship we're bringing to market each day.
We're always looking for a new vertical.
As we look back, I think the most important thing about Pacific Crest has been the fit from a cultural perspective, the willingness of our team at Pacific Crest to be part of a bigger platform where they can offer more things to their clients.
And it does give us confidence that if we could find the right niche ---+ and, again, our business is all built around niches ---+ if we could find the right niche we would definitely look at trying to continue to leverage our platform, which we think is not as leveraged as it could be.
Josh, clearly the disruption in the market in the last part of the third quarter caused some of our deals and probably everybody else's deals to be pushed out a bit.
So, there's no question.
And it also, as I mentioned earlier, for us I think opens the opportunity for us to look at alternative ways to finance transactions for the benefit of our clients.
The answer to your question is yes, some things undoubtedly were pushed off.
As far as the expense build we are already starting to occur some of that because we're really investing in the infrastructure to make sure we do it right.
So, we have added to our team already and you'll see a slow add to it over the next several quarters.
As far as truly launching it, we're looking at some time later in 2016 are far as really when you start to see the revenues pick up.
Anything else you would add to that, <UNK>.
No, <UNK>, I think that's correct.
As we've talked about before, we try to calibrate our investment with our other expenses.
And you wouldn't expect to see much difference in that business until the second half of 2016.
All right, thank you, operator.
And, again, thank you for taking time from your schedule to participate in our call today.
If you have any follow-up questions you can direct them to our investor relations team at 216-689-4221.
That concludes our remarks and thank you again.
