Good morning and welcome to KeyCorp's Third Quarter 2020 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to the Chairman and CEO, Chris Gorman. Please go ahead.

Well thank you, operator, and good morning and welcome to KeyCorp's third quarter 2020 earnings conference call. Joining me for the call today are Don Kimble, our Chief Financial Officer; and Mark Midkiff, our Chief Risk Officer. Slide 2 is our statement on forward-looking disclosure and non-GAAP financial measures. It covers our presentation materials and comments, as well as the question-and-answer segment of our call. I'm now turning to Slide 3. As you saw in our press release this morning, we reported third-quarter earnings per common share of $0.41. Our EPS was more than double that which we reported in the prior quarter and up from the year-ago period, which was impacted by notable items. Despite the challenging environment, we generated pre-provision net revenue of 1.9 billion and added 1 billion to our reserve for credit losses through the first nine months of this year. Revenue in the third quarter was up 3% from the year-ago period. Our net interest income continues to reflect the low-rate environment, elevated liquidity, and changes in balance sheet mix. Average loans reflect strong performance from consumer mortgage and Laurel Road, offset by paydowns of consumer line draws that were made earlier in the year. Our consumer mortgage business generated funding volume of more than 2.3 billion this quarter, which was up more than 75% from the year-ago period and up 5% from last quarter. Over one half of our originations were purchase mortgages. Our pipelines remained strong, and we expect to show sustainable growth and continued market share gains. Laurel Road continues to originate high-quality loans that provide us with an opportunity to build broader digital relationships with these targeted clients. In the third quarter, Laurel Road originated over $400 million. We believe that both Laurel Road and consumer mortgage will continue to be relationship-based growth engines for our consumer business. With our strong consumer platform, we have decided to discontinue originating indirect auto loans. The current portfolio of approximately 4.6 billion will run off over time. Now let me turn to fee income. We had another good quarter. Non-interest income was up from the year-ago period, reflecting stronger than expected performance. Investment banking and consumer mortgage had another solid quarter. Cards and payments and service charges on deposit accounts both posted strong linked-quarter increases. Don will discuss our revenue outlook in his remarks. We believe we are well-positioned to continue to grow both our commercial and consumer businesses. Our expenses this quarter reflect higher variable costs related to cards and payments activity, production-related incentives, as well as elevated pandemic-related costs associated with keeping our teammates and our clients safe. Through our continuous improvement efforts, we are maintaining our focus on expenses, improving our efficiency while continuing to invest for growth, particularly our digital capabilities across the franchise. Credit quality remains solid this quarter as we have remained true to our moderate risk profile throughout the cycle. Net charge-offs for the quarter were 49 basis points. In the deck, we have updated our disclosure on commercial portfolio focus areas. Don will cover these focus areas in his comments, but I will just say that these portfolios have generally performed consistent with or better than our expectations. The quality of our loan book is also reflected in the level of loan deferrals. Last quarter, our deferrals were the lowest in our peer group, based upon public disclosures. As of September 30, loans subject to forbearance terms were less than 2% of total loans. That's down from 4.3% at June 30. This equates to less than 1% of clients in both our commercial and consumer businesses. In the third quarter, our provision expense exceeded charge-offs by $32 million. Our allowance for credit losses as a percentage of period-end loans now stands at 1.88% or 2.04%, excluding PPP loans. Finally, we have maintained our strong capital position while continuing to return capital to our shareholders. In the third quarter, our common equity tier one ratio increased to 9.5%, which is at the upper end of our targeted range of 9% to 9.5%. In September, we paid a common stock dividend of $0.185 per share, the same amount we paid in the second quarter. I will close by restating that this was another good quarter for Key, which demonstrates our underlying strengths. It starts with our dedicated team and their unwavering commitment to first and foremost our clients being very targeted about where we can compete and where we can win. Next, costs, maintaining a strong focus on expenses while investing for the future, a big part of this investment going forward will continue to be digital. Credit: continuing our strong risk management practices. And lastly, capital, focusing both on the return on and the return of capital. I am confident in our ability to manage through the current environment and over time achieve our long-term financial targets. And importantly, deliver value for all of our stakeholders. Now, let me turn the call over to Don to go through the results of the quarter.

Thanks, Chris. I'm now on Slide 5. As Chris said, we reported third quarter net income from continuing operations of $0.41 per common share. Results also reflected momentum across our businesses, including growth in our balance sheet and fee income as well as continued strong risk discipline and capital management. I will cover many of the remaining items on this slide in the rest of my presentation. So turning to Slide 6, total average loans were $105 billion, up 14% from the third quarter of last year driven by growth in both commercial and consumer loans. Commercial loans reflect an increase of over $8 billion from PPP loans. Consumer loans benefited from continued growth from Laurel Road, and as Chris mentioned strong performance from our residential mortgage business. Laurel Road originated over $400 million of student consolidation loans this quarter, and we generated $2.3 billion of consumer mortgage loans. The investments we have made in these areas continue to drive results and importantly add high-quality loans to our portfolio. Linked-quarter average loan balances were down 3%, reflecting paydowns from the heightened commercial line draws earlier this year. The paydowns on the lines were greater than expected, and now the utilization rate is below the start of the year. Importantly, we have remained disciplined with our credit underwriting and have walked away from business that does not meet our moderate risk profile. We remain committed to performing well through the business cycle, and we manage our credit quality with this longer-term perspective. Continuing on to Slide 7, average deposits totaled $135 billion for the third quarter of 2020, up $25 billion or 22% compared to the year-ago period and up 5% from the prior quarter. The linked quarter increase reflects broad-based commercial loan growth, … This growth was offset by a decline in time deposits, primarily related to lower interest rates. Growth from the prior year was driven by both consumer and commercial clients. Total interest bearing deposit costs came down 20 basis points from the prior quarter, reflecting the impact of lower interest rates and the associated lag in pricing. We would expect deposit costs to continue to decline about 6 basis points to 9 basis points in the fourth quarter. We continue to have a strong stable core deposit base with consumer deposits accounting for over 60% of our total deposit mix. Turning to Slide 8, taxable equivalent net interest income was $1 billion for the third quarter of 2020, compared to $980 million a year ago and $1.025 billion for the prior quarter. Our net interest margin was 2.62% for the third quarter of 2020, compared to 3% for the same period last year and 2.76% for the prior quarter. Both net interest income and net interest margin were meaningfully impacted by the significant growth in our balance sheet in the third quarter of 2020. The larger balance sheet benefited net interest income while reducing our net interest margin due to the significant increase in liquidity driven by strong deposit inflows. Compared to the prior quarter, net interest income decreased $19 million, driven by lower commercial loan balances. The net interest margin was primarily impacted by continued elevated levels of liquidity. Elevated liquidity levels negatively impacted the margin by 13 basis points, with all other drivers netting to an additional 1 basis point of pressure on the margin. The lower than expected commercial loan balances contributed an additional 5 basis points of margin compression. Recently, we've received several questions about the future impact of our interest rate swap maturities on our net interest margin. On Slide 20, in the appendix, we provide a schedule that details maturities of our swaps. Also, it is important to understand that this portfolio is only one of the fixed-rate asset classes, as all banks are impacted by maturities of fixed-rate loans and investment securities. We also show on this slide that our level of these assets combined as a percentage of total earning assets is in line with peers. Moving on to Slide 9, our fee-based businesses had another strong quarter. Non-interest income was $681 million for the third quarter of 2020, compared to $650 million for the year-ago period and $692 million in the second quarter. Compared to the year-ago period, non-interest income increased $31 million. The primary driver was an increase of $35 million in the consumer mortgage business as we continue to grow the business and see record levels of origination. Cards and payments income also increased $45 million related to the prepaid card activity from the state government support programs. Compared to the second quarter of 2020, non-interest income decreased by $11 million. The largest driver of the quarterly decrease was $22 million of lower operating lease income as we had gains on leveraged leases in the prior quarter, which impacted the quarter-over-quarter comparison. Consumer mortgage income was down $11 million, following a record quarter for related fees in the second quarter. These were partially offset by an increase in cards and payments related income and higher service charges on deposit accounts. Though down quarter-over-quarter, investment banking and debt placement fees had another solid quarter given the volatile environment, coming in at $146 million for the quarter. I’m now turning to Slide 10. Total non-interest expense for the quarter was $1.037 billion, compared to $939 million last year and $1.013 billion in the prior quarter. The increase from the prior year is primarily related to $52 million of payments related costs, reported another expense, as well as COVID-19 related expenses to ensure the health and safety of our teammates. Higher personnel costs from the year-ago quarter reflect lower deferred loan origination costs, merit increases, and higher employee benefit costs. Compared to the prior quarter, non-interest expense increased $24 million. The increase was largely due to higher payments-related costs, as well as personnel costs related to elevated employee benefits, primarily healthcare, which was up $15 million last quarter. Moving on to Slide 11. Overall credit quality remains solid. For the quarter, net charge-offs were $128 million or 49 basis points of the average loans. Our provision for credit losses exceeded net charge-offs by $32 million or $0.03 per share. Non-performing loans were $834 million this quarter or 81 basis points of period-end loans compared to $585 million or 63 basis points from the year-ago quarter. Additionally, delinquencies actually improved quarter-over-quarter, a 6 basis point decrease in our 30 to 89 day past dues and the 90-day plus category also declining quarter-over-quarter. We continue to monitor the level of assistance requests we received from our customers. Over the past quarter, the number of requests for loan forbearance has decreased dramatically. As of September 30, loans subject to forbearance were less than 1% based on the number of accounts for both commercial and consumer loans, and less than 2% when using outstanding balances. Turning to Slide 12. As Chris mentioned, we updated our disclosure that highlights certain portfolios that are receiving greater focus in the environment. These areas represent a small percentage of our total loan balances. Each relationship in these focused areas continues to be subject to active reviews and enhanced monitoring. Importantly, as a group, they continue to perform consistent with our expectations. Turning to Slide 13, we had shared a summary of our deferrals compared to peers at our recent Investor Conference. As shown here, our deferral level was peer-leading in the second quarter. As noted earlier, we have seen a dramatic reduction in the deferral levels during the third quarter. Now on to Slide 14. We have continued to maintain a strong level of capital. We ended the third quarter with our common equity Tier 1 ratio of 9.5%, up 40 basis points from 9.1% in the second quarter. This places us at the upper end of our target range of 9% to 9.5%. We believe that this provides us with sufficient capacity to continue to support our customers and their borrowing needs and return capital to our shareholders. In the third quarter, we paid a common dividend of $0.185 per share, which was consistent with our second quarter level. Importantly, over the last four quarters, beginning with the fourth quarter of 2019, we have earned $1.14 per share well above our current dividend run rate of $0.74 per share. On Slide 15, we have provided our outlook for the fourth quarter. We expect average loans to be down low single digits reflecting lower period imbalances coming into the fourth quarter. Consumer loans should continue to grow. We expect deposits to remain relatively stable. Core net interest income should increase low single digits with a relatively stable net interest margin, reflecting the expected benefit of repayment of PPP loans. The benefit of repayment is estimated to be $20 million to $25 million. Non-interest income in the fourth quarter will remain relatively stable, reflecting an expected decline in consumer mortgage offset by growth in investment banking and debt placement fees. Non-interest expenses are expected to be down low single digits that are highly dependent on the level of variable costs, including production-related incentives. Net charge-offs are expected to be in the 55 basis point to 65 basis point range next quarter. And finally, shown on the bottom of the slide, are our long-term targets. On a reported basis, we will not achieve all the targets this year. As we emerge from the pandemic and the economy strengthens, we expect to be back on the path that would lead us to operate within all of our target ranges. With that, I'll now turn the call back over to the operator for instructions of the Q&A portion of our call.

Thank you. And first, we'll go to Scott Siefers with Piper Sandler. Please go ahead.

Good morning, everyone. Thank you for taking the question. Hi. Let's say, Don, maybe wanted to ask first just on the decision to stop originating indirect auto, so the $4.6 billion that'll run off, how long is it going to take for those to run off? I'm imagining three years or less. But I guess more importantly, do you guys feel like you can outrun that run-off and still generate net growth? For example, via mortgage and Laurel Road where you’ve got strong origination outlooks?

Sure, Scott, the average life of that portfolio was about 2.5 years. So, it will take probably in total about 5 years before it fully runs off. So, we will see declines each year in those balances. And Chris can highlight a little bit more as far as the rationale and thoughts as far as the exit of those originations, and also why we're excited about the consumer loan origination capacity we can generate now.

So, Scott, you know, we've talked a lot about relationships, we've talked a lot about targeted scale, and frankly the indirect book from a quality perspective is just fine. From a return perspective, obviously, you can't generate the kind of relationship returns that we would expect because it's a single product. Conversely, as you look at our consumer business, you know, as you well know, two years ago we really didn't have a mortgage business. This year, we’ll originate more than $8 billion. Two years ago, we didn't have a Laurel Road business. This year, we’ll generate more than $2 billion, and we have big plans, obviously to continue to grow both of those. So, the premise of your question, do we think we can outrun it in our consumer business? We do, and we think we can do it on a relationship basis, and really use our capital to support our clients or for other things, whether it's stock buybacks or whatever that we think are better uses of capital.

Alright, perfect. Thank you. Thank you very much. I appreciate that. And then separately, just sort of a top-level question, you know, now that, sort of – coming out of the worst of the pandemic, you know, a lot of banks are going to be kind of applying lessons learned from, you know, the ability to operate without the same sort of infrastructure, just curious how you guys are thinking about the branch footprint, if you might see any opportunities for something broader to do on the cost side here as we sort of stare down a challenging revenue environment for the next couple of years?

Sure, Scott. We think the pandemic certainly accelerated some trends that were already there. Just to give you some texture, you know, when we bought First Niagara, we had 1,600 branches. Today, we have 1,077. We've invested heavily in digital. Our digital take-up – you know, more than 60% of our customers are now digitally active. And so, we actually think there is a significant opportunity to take a look at the fleet, and we're in the final throes of planning that, and you – we’ll have more to say on that in January. But in addition to some other things that are fundamental changes, we do think there'll be a change in kind of how we look at the density of our branches. And as you know, we're in some fast-growing areas where we have relatively thin branch footprints and we think we can replicate that and get the mix right of digital and physical in other parts of our franchise.

Okay, perfect. Alright. So, I’ll stay tuned until January then. Good. Alright. Well, thank you. I appreciate it.

Our next question is from Ken Zerbe with Morgan Stanley. Please go ahead.

Hey, thanks. Don, you mentioned that you expect the $20 million to $25 million of PPP accelerated amortization in fourth quarter. I think you're actually one of the only banks that I've heard of so far, at least, that's building that in. I think most are looking at first quarter. Has the SBA actually opened up the portal or the forgiveness portal? And are they approving loans or is this sort of a question mark in terms of whether or not it actually goes into fourth quarter and not based on the SBA?

No. We were hearing earlier that several other banks were using the same type of assumptions or if not even more aggressive as far as the prepayment. But the SBA has opened. We've actually started to see some of the requests from customers go through and actually get funded here recently, too. So, it still is more of a trickle, but we're starting to see volumes and activity levels pick up, and that's what gives us the basis for our outlook.

Okay, that's great. And then, the other question I had, I guess, what are you guys planning to do with the excess liquidity on the balance sheet? Like, how quickly can you deploy? Do you want to deploy it? You know, where's it going into? Thanks.

Yeah. We've been looking at all different kinds of uses of that and whether or not we can put it to better use than just sitting in cash. Our challenge right now is that we tend to keep a fairly conservative investment portfolio and really don't want to venture into credit risk in that area. And so, the returns on similar type of agency securities that we would invest in are right around the 100 basis points. And so, we'll continue to assess that to see if we lean into that a little bit more. I would say that we, on a trial basis, started to buy some longer dated assets and put some forward starting swaps against that that will convert that asset to a variable rate, say, five years down the road, which is better aligned with our overall strategy and risk profile. And so, we'll consider doing things like that. But near term, I think we will continue to see elevated levels of liquidity, including cash and treasury bills just because we feel that that's more prudent for us to do in this environment.

Alright, great. Thank you.

Thank you.

And next, we'll go to Erika Najarian with Bank of America Merrill Lynch. Please go ahead.

Hi, good morning.

Good morning.

Good morning.

My first question is for you, Don. I've noticed that investor discussions have shifted from merely assessing credit to evaluating banks based on normalized returns. As I consider the progression of net interest income, specifically excluding any PPP impact, I’m curious if you could help clarify what the quarterly run rate might look like in 2021 when excluding PPP. The recent decline of the indirect portfolio is new information, especially in light of the high cash levels that were just mentioned and the potential for redeployment. Also, I'm aware there's a $40 million fluctuation in hedge income contribution from this quarter to possibly the fourth quarter of 2021. Any insights you can provide regarding where net interest income might stabilize, assuming no loan growth or changes in the rate environment, would be greatly appreciated.

You know, we'll provide more specifics on 2021 in January. I would say that as far as some of the moving parts that you're right, that our swap portfolio will continue to mature over time. I would say that as we highlight on Slide 20 that there are a number of fixed-rate type of asset classes, including the swaps, the loan portfolio, and also the investment portfolio. And I would say that as we look at how we're positioned compared to others, we think that we're right in line with peers as far as that relative mix – as far as fixed rate assets. As we look at going forward, we think that our margin will probably bottom out something fairly close to where we're at today with over time having a redeployment of some of that liquidity into other loan categories, whether it's consumer or at some point in time seeing some commercial loan growth back up again. And so, the pressure from these rates and the impact on the maturity and the rollover of those fixed-rate asset classes would be offset by the utilization of some of those liquidity sources. And so, that would include in that outlook some reinvestment of or, excuse me, prepayment of those PPP loans.

Got it. And just a follow-up question, and maybe this one – this is for Chris. You know, clearly in 2020, it was an exceptional year. As we think about 2021 and you sort of teased out a potential announcement and are thinking about infrastructure and branches for January. You know, if you think – as you weigh the revenue headwinds with efficiency opportunities, do you think KeyCorp can get back on a positive operating leverage track next year?

I do. I do. And, you know, continuous improvement, Erika, is part of our culture. Each year, we've taken out sort of 3% to 5% and used that as raw material to invest and we will continue to do that. I think there's some fundamental changes in the way banking is done and I am confident in both the trajectory of our earning streams and also our ability to manage our expenses. You know, we do have kind of a unique situation this quarter in that half of the year-over-year increase is attributable to prepaid cards. I'm not saying that that's completely nonrecurring, but I will say that we've invested a bunch of time, energy, people, and technology to tamp that down. So, the answer to your question is yes.

Great. Thank you.

Thank you.

And next, we’ll go to the line of Matt O'Connor with Deutsche Bank. Please go ahead.

Good morning.

Good morning.

I just want to follow up on the exit of the indirect auto. I mean, it’s not that big of a deal, but it's also a portfolio that you've been growing, I think pretty nicely, you know, just in the past years here. I think that was kind of one of the strategic additions you got from First Niagara. So, I'm just wondering, like, has something changed in the marketplace in the last, you know, three or six months? Or let me just elaborate on kind of the timing now, especially at a time when, you know, there's just not a lot of loan growth for the industry overall?

So, Matt, the real timing is we've now successfully, from a standing start, built the Laurel Road platform and our mortgage platform. When we acquired First Niagara in 2016, we really didn't have an engine for consumer loans and it was a good bridge. It being, indirect auto was a good bridge, but we've always stayed pretty true to the notion that we're a relationship bank and we're focused on targeted scale where we can be relevant. And as we look at that portfolio, in conjunction with the returns, it just didn't achieve what we wanted it to do vis-à-vis investing our capital elsewhere. Now, in terms of anything changing in the market, this isn't what drove the decision, but as you know, the automobile market right now is very hot. Our analysts think that sales at retail next year will be up like 9.5%. The value of used vehicles right now, because of shutdowns due to COVID-19 are up 15% or 20%. That's not what drove the decision, but that is a fundamental macro driver that's out there.

And then, I understand how mortgage is a relationship product, but just remind us on Laurel Road? How you’ve transformed that into more of a relationship product versus kind of a one-off?

Sure. So, this is something that we're frankly very excited about. We're building a national digital bank and it's going to be focused on healthcare professionals. And so, we've already obviously built the loan consolidation business, that's all digital. Then in many cases, within six months, something like 50% of those customers that refinance their doctor and dental school loans buy a home. We've now built a complete digital mortgage application. And where we can take it from there is, on a national basis, to be really focused, Matt, around doctors and dentists in terms of opening accounts, et cetera. And that will open up then the opportunity for us, in the case of dentists most, because they're mostly independent business people as opposed to doctors who are part of large groups. That will give us an avenue to do a lot with them. So, we see Laurel Road as a platform that we've grown a lot. It's achieved everything we hoped it would, and we think there's a lot to do on top of it. And then, one other area where we could potentially focus is expand beyond doctors and dentists, but within healthcare. Healthcare, as you know, is – you know, 18% of the GDP.

Okay. Thanks.

And next, we’ll go to Gerard Cassidy with RBC. Please go ahead.

Good morning, Chris. Good morning, Don.

Good morning.

Good morning.

Can you guys share with us – I think you mentioned on the call that you're at the top-end of your capital guidelines of 9.5%. We know the share repurchase programs have been temporarily suspended by the Federal Reserve at least through the end of the year. Can you share with us your thinking of share repurchases for 2021 and where you'd like to bring that capital ratio down to? And because the change in the stress test where the Fed does not approve any longer a bank’s plan to buy back stock or pay a dividend as long as you surpass the required minimum capital ratio, you've got, you know, the latitude or the optionality to kind of do the buyback the way you see it fit. So could you give us some thoughts on, could you ever consider a Dutch option if, you know, this suspension goes into the second half of next year in your capital ratios in the high nines to do one big buyback at one time to bring down the capital ratio?

Gerard, this is Don, and as far as the share repurchases, we feel very good about where our capital position is today. I would say to your points that we would expect that the capital ratios to continue to increase as long as we're not buying back shares. And so, we highlighted that we're up 40 basis points as far as the consideration for when we would be back in the buy shares that we'd want to have a little bit better clarity as far as the clear direction on the economy and where that's heading and making sure that we continue to have the capital to support our customers, support our organic growth, and continue to support the dividend. And so, those would be priorities for us above just the share buyback. One other potential consideration is that with the impact of the CECL accounting change and how it impacts our capital ratios, there's about a 30 basis point or so impact that we'll see over time there as well, but we do feel very good about where we're at from a capital perspective. I do believe that it will increase, and if available and things allow and permit, we could consider adjustments that would allow us to probably more proactively manage that overall share count with either a large share repurchase program or market purchases like we've done in the past.

Very good. And then, circling back to credit, obviously, Key in the past has had issues with credit during a recession and I know it's been a goal of management to prove to investors that's not going to be the case in this cycle. If we exclude, for a moment, the change in mix of your portfolio today versus what it was like in 2007 and you take a look at, obviously, the government fiscal programs that have been implemented to help people through this downturn, what are you guys seeing today that really strikes you is different than what you've seen in the past on the behaviors of your borrowers?

Yes. Maybe I'll go ahead and start, Gerard, and Chris and Mark might have some thoughts to add to that. But I would say this is the biggest difference that I would see and this was just coming in the midstream in this. But the – Key really has pivoted to a relationship strategy. And if you take a look at where the portfolio was before the last crisis, it was more transaction oriented as opposed to relationship. And so, we had outsize exposure and some commercial real estate developers, and it was more on the project as opposed to an ongoing steady stream of cash flow for us. And so, I'd say that the migration to that relationship strategy is having a huge payback for us. On the consumer side, we're following similar trends, and it's a very high-quality, very consistent portfolio, and as we’ve talked earlier, we really want to continue to have that more on a relationship type of approach as opposed to transactions. I don’t know, Chris, what would you add to that?

No. What I would add, it's been a 10-year journey. After the financial crisis, we sat down and evaluated where we lost money, how we lost money, and it basically was principally in real estate. It was project-level real estate. It was where we didn't have a deep relationship. In some cases, it was business that was indirect business, third-party business. And we went about the business of de-risking our portfolio and we have been disciplined enough that we have foregone revenues such that we could position ourselves so we have the capital and the ability to support our clients and targeted prospects in an environment like this. The other thing I would just remind everyone of is, of the capital we raised for our customers, Gerard. You know, only 18% of it goes onto our balance sheet, and so, that too is something that I think is unique for us and that we can serve our clients without necessarily putting it on our balance sheet, but it's – you're exactly right, it's been a long journey.

Great, thank you.

Thanks, Gerard.

Our next question is from the line of Bill Carcache with Wolfe Research. Please go ahead.

Thank you. Good morning, Chris and Don. Thanks for the disclosures on Slide 20. I wanted to ask about the hedging program run-off on the bottom right-hand side of the slide. Is the right way to read this chart that if we multiply the weighted average yield by the notional value of the on and off balance sheet hedges we get the quarterly contribution from the hedging program. And if so, it looks like the declining hedging benefit would translate into $160 million headwind in 2021 and $114 million headwind in 2022. Is that the right thought process?

I would say that this assumes that we have no replacement of the slots going forward. So this is just a run-off of the existing book. And so, depending upon where the yield curve moves and how that would reposition, we could see some differences there. And then, also it would assume that we're taking no other actions on balance sheet to minimize or mitigate some of that impact.

Understood. And if I may, just as a follow-up, so beyond the hedging portfolio run-off, can you discuss a little bit maybe just some color on the front book, back book dynamics, if the low rate environment persists? Maybe just give us a sense of how much you're receiving in paydowns of back book loans and securities that would have to get redeployed, and you know, what the yield differential is between new money rates, you know, now and what's coming off?

Sure. Generally, our loan portfolio has an average life of about three years, which we can use as a proxy for the roll-off and re-pricing of the portfolio. Looking at our commercial and industrial as well as most of our commercial portfolios, they are predominantly based on LIBOR. The spreads on new originations are fairly consistent with those of the existing portfolio, and we are not seeing significant changes in overall re-pricing for that. There has been some increased acceptance of certain floors set on the products, which will aid us moving forward. Typically, that part of the portfolio does not experience much re-pricing or risk. Regarding fixed-rate portfolios, particularly residential mortgages, this is a relatively new area for us. We are experiencing growth, and the current yield on this portfolio is approximately 3.50% on the balance sheet, while current production is yielding around 3%. This is slightly below the average current rate, but not by a significant margin. As far as some of the other consumer categories, whether it's a home equity or Laurel Road student loans or some of the other categories, we're looking at probably about an 80 basis point or so gap between what the existing portfolio is compared to what the legacy book is on that side. For the investment portfolio that – for the core portfolio, excluding the treasury bills that we've been adding as far as some of the excess liquidity position, we're seeing a roll-off of those yields around the 240 and a replacement yield of around a 1%, so about 140 basis points of shift there. Keep in mind too, that, as we highlighted on the deposit side, we're expecting to see our average interest bearing cost of deposits decreased by 6 basis points to 9 basis points in the fourth quarter, and we should see some additional opportunities for benefit there going forward as well, and so, probably at a slower pace, but still helping to offset or minimize some of the exposure there.

It's super helpful. Thank you for all the additional details.

Thank you.

And next, we’ll go to Ken Usdin with Jefferies. Please go ahead.

Hey, thanks. Guys, I was wondering if you can dig in a little bit more on the outlook for loans. So obviously, not surprising to see the declines this quarter from the paydowns and you mentioned that loans will continue to detract going forward a little bit, but what do you see in terms of just any change in improvement and activity on the manufacturing side, on inventory, et cetera, that we might look forward and start to see a point of stabilization? Some others are even wanting to grow, so just your broader outlook on the potential inflection on loans? Thanks.

Yes, Ken. It’s Chris. Good morning. So there's no question that as we look at our C&I book, the utilization is below where we would have thought it would be right now. It's frankly below the beginning of the COVID-19 crisis. I think there's a few things that can serve as a driver to loan growth on the C&I side. One is an inventory rebuild, and as the economy ramps up – I mean, to state the obvious, as the economy ramps down, these companies throw off a lot of cash; as it ramps up, they consume cash. I think that could give us an opportunity as well. The other thing that is going on, you know, M&A discussions, you know, in the beginning of the second quarter were non-existent. As we look at what are the discussions we're having with our customers day-in and day-out, I think people are really starting – you won't see it in the fourth quarter, but people are really starting to think strategically. Just this week, I met with three clients and they are in areas that you would think that might still be hunkered down and they are really starting to think strategically. So, I think the levers on the C&I book will be transactional, but even before transactional, you know, I'd like to see obviously some greater utilization. I think those are a couple opportunities.

Okay. And then, on the follow-up to that on the corporate activity side, I just wondering if you could talk a little bit more about the pipeline for investment banking and what the mix of investment banking, you know has been in terms of like the public versus private in CRE markets? Like is any of that kind of back to a normal or still have, you know, good pipelines ahead, if you could fill that in to? Thank you.

Sure. As we look forward, I would describe the pipelines as solid. The real variable was our M&A business, which is a strong business, which basically, you know, was non-existent, as I mentioned, kind of in the second quarter. Our backlogs now, Ken, in M&A are equal to what they were going into the crisis, and obviously, a lot of deals went away. So, I find that to be encouraging. As I look at our fees, you know, this quarter, we were about at $146 million. I believe we’ll be up in the fourth quarter. I don't think it'll be at the record, Ken. We've had $200 million quarters before. I don't think we'll be at $200 million, but we'll certainly be somewhere between $146 million and $200 million. The pipelines are solid. The real estate commercial mortgage business is, obviously, in this rate environment, continues to be pretty strong.

Thanks, Chris.

And next, we'll go to a John Pancari with Evercore ISI. Please go ahead.

Good morning.

Good morning.

Good morning.

I want to see if we can get some incremental color on risk of migration this quarter with a 24% increase in your criticized assets. Just want to see if you can give us a little bit of the granularity on what drove that migration and what asset types? And then, also is that increase in criticized reflected at this point in your existing loan loss reserves? Thanks.

Sure. I'll go ahead and answer the last part of that question first, and then, Mark can help provide some of the clarity as far as migration. But as far as our loan loss reserve that we established at June 30, and now it's September 30, keep in mind, under CECL that you're looking for the life of loan type of losses. And so, embedded in there is the assumption that you're going to see migration into criticized and classified and increased losses throughout the next several quarters. And so, those were all baked into both June 30 and September 30. If we look at where we're at today, whether it's criticized, classified, charge-offs and non-performing, we're actually better at September 30 than what our models would have assumed as of June 30 for this first quarter of that time period. And so, we're actually seeing better credit quality migration than what would have been expected and contemplated as part of our June 30 reserves.

Yes, migration has performed better than we initially anticipated. The main factors driving this improvement are consistent with our focus areas outlined in the disclosure. Specifically, the consumer business segments such as consumer discretionary and consumer services, as well as the oil and gas sector and some transportation, are the primary contributors we are observing.

Okay. All right, thanks. And then, another question just on credit, if you – you know, it sounds like you're confident in the adequacy of where the reserve stands now. So, if the charge-off continues to rise as they did this quarter, for the fourth quarter and beyond, would you expect that you would under provide for those charge-offs?

We've previously discussed how CECL operates, focusing on three main drivers. The first is the economic outlook, and I would caution against trying to predict where that will stand on December 31, given the current environment and the upcoming election. This will undoubtedly influence our reserve levels. Comparing the second quarter to the third quarter, we noticed that the economic outlook appeared more favorable in the September summary than what we anticipated in June; however, the long-term recovery rate was somewhat slower. Unemployment rates were slightly higher as of September 30, and our GDP recovery lagged behind our expectations, leading to a somewhat negative overall impact. The second driver is the migration of our portfolio, which our loss models for CECL predict will shift based on the economic outlook. If the migration performs better or worse than expected, we may need to adjust reserves accordingly. The third factor is new loan production. As we pointed out last quarter, we usually anticipate a provision expense of $80 million to $100 million per quarter for loan production, but we saw $160 million this quarter, which is higher than normal. This quarter, we enhanced what our quantitative models indicated by adding around $100 million through model overlays and qualitative assessments to our reserves. This was to ensure we didn't prematurely recognize the benefits from migration, particularly given the economic uncertainties we continue to face. We believe this was a prudent decision, as we would have observed a lower provision level if we hadn't taken this action.

Got it. All right. Thanks, Don. That's very helpful.

Our next question is from Mike Mayo with Wells Fargo Securities. Please go ahead.

Hi, just in simple terms, why did you guys build reserves this quarter when many of your peers didn't? And where do you think charge-offs 49 basis points in the third quarter peak? And when do you think that happens?

Sure, as far as the building reserve, I say it's fairly modest and what we wanted to do was to make sure that we weren't taking credit too early, as far as the better than expected migration and also uncertainty on the overall economic outlook. And so, we felt that was appropriate to do. Last quarter, we were being challenged as to whether or not our reserves were adequate. And we still are a little low compared to peers as far as the reserves. And so, that also influenced our assessment as to whether or not we want to show reserve declines this quarter. And so we decided to go in and layer on top of that some additional model overlays and also qualitative reserves. And so, if you look at our total allowance for credit losses, Mike, it's at 1.88%. And if our average loan life is roughly three years, that would imply charge offs around 60 basis points for some time, and I would say that as we take a look at what our projections would have, we would probably see some continuing increases through the middle of next year, and that would probably be the peak and then start to trail off again.

So the peak would be like double or 70, or 80 or? I mean, I know, not many have given this, but some have.

I would say that it would be elevated a little bit from the 49 basis points, and we're talking about 55 to 65 next quarter. Do they go up a little bit from there, yes, but they're probably not doubling from here.

Okay, and then the tougher question. So, 2% of your loans are in forbearance and you said that's down significantly, I guess that's 1.6% commercial, 2.3% consumer. If the music were to stop today, because at some point, you'll start with the forbearance, what would be the impact on charge-offs and revenues?

Regarding charge-offs, we've already set aside additional reserves for loans in forbearance, which is a necessary step. When it comes to forbearance, particularly on the commercial side, we do not automatically approve it. We need to collaborate with the customer to ensure that it serves as a temporary solution rather than just postponing the inevitable. We are assessing credit quality without fully relying on the forbearance. On the consumer side, despite having loans in forbearance, we remain pleased with the quality of our customer base. We still have consumers who will eventually be able to continue making payments, and the collateral values for these products, such as home equity and residential mortgages, remain robust. Therefore, I don't anticipate a significant negative effect on charge-offs or our P&L as these loans mature. Mark, would you like to add your perspective?

Yeah, I'd say the same, and they do continue to come down. And we – also what rolls off of and exits we're seeing really high current rates, you know, sort of 96%, 97% or higher. So, seeing good performance.

And if I can just squeeze in one more, Chris, acquisitions, bank acquisition, the environment, I mean the competitors are under pressure, the industry is rather under pressure. What's the appetite?

So, as you know, we've been successful in acquiring niche businesses and I think you can expect us to continue to look at those. I'm really proud of the fact that we've been able to acquire, you know, born digital companies and successfully integrate those investment banking boutiques and integrate those. In terms of whole bank acquisitions, that's not really a focus of ours, Mike. We think we have everything we need to be successful. And we think the right strategy is to execute our strategy to create value for the shareholders.

All right, thank you.

Thank you.

Our final question will be from Steve Alexopoulos with JPMorgan. Please go ahead.

Good morning. This is Janet Lee on Steve. Of the 23 million quarter-over-quarter increase in card and payment income this quarter, what percentage of that is from the prepaid card activity supporting state government programs that is going to start winding down in 2021? And also, can you comment on the level of organic spending and transaction volumes during the quarter, excluding the prepaid card activity? Thanks.

Sure, as far as the percentage increase, I would say the majority of the increase in that cards and payments related revenues was related to the prepaid card activity. Keep in mind also that we saw a similar increase in the expense was linked quarter and so the earnings risk for that is nominal as far as a change is on that front. As far as the activity for other card balances that – I would say that in the third quarter, we're seeing levels that are fairly comparable to what we would have seen as far as spend on both the credit card and debit card, and maybe transaction counts might be a little lower on debit card, but the average ticket size is a little higher. And so, we're seeing it getting closer to a return to normal. I don’t know, Chris, any thoughts there?

No. Obviously, the mix has changed a bit. People aren't traveling, people aren't going to restaurants, but in the third quarter it actually the spend eclipsed that of the third quarter of last year.

All right, that's helpful. And my follow-up is on the deferral. On your 1.8 billion loans on deferral, how much of that is on loans and COVID-19 exposed categories, and which industry are you seeing the highest fee deferral rates?

Mark, do you have thoughts on that, as far as, I would say generally that we're seeing a higher percentage in those industries, but I don't know that there is any one section.

One that kind of stands out and the referral rates are, you know, it's been in the kind of 15% range has been very, very low.

Alright, that's helpful. Thank you.

Thank you.

And we will take another question from the line of Saul Martinez with UBS. Please go ahead.

Thanks for squeezing me in. A couple of follow-ups. First, here on the prepaid card income, you just mentioned that, you know the majority of increase are for almost all the increase, you know, payments come from that and payments. Is it fair to say that it seems like your guidance for fourth quarter still includes pretty elevated level of prepaid income and associated expenses? Is that correct, and can you just help us understand what kind of magnitude is sort of baked into the fourth quarter?

I would say both the revenues and expenses remain elevated, compared to the normal levels, but down slightly from what we have seen in the third quarter. And so, there's a number of different things that would drive both the revenue and expenses. And we were seeing some of the activity levels for those areas declined slightly in our outlook.

Got it. And secondly, I wanted to go back to the earlier question on hedges, I want to clear if you blessed or not, but you know, based on that, can you just help us understand what is the sort of NII protection that you're currently getting from your swamp of just doing the math on, you know, Slide 20? Seems like it's in the neighborhood of about 500 million or 730 million a quarter with a weighted average maturity of 3.4 years showing this, you know, rolls off over six, seven years, you know, which would imply sort of $82 million headwinds, you know, annually from just – and I say, no, this is assuming no replacements, and no other stuff that can do to offset it. But I mean, is that math broadly correct, if that's, you know, kind of the protection you're getting today, and the run-off will provide something close to say $80 million, $90 million, $100 million headwind annually, or is that completely off?

As we examine our loan portfolio, over 70% is variable, which sets us apart from many of our peers. The swap book we have is intended to align our net adjusted position more closely with our peers' overall percentage. Regarding the figures, we're around 27 basis points of our margin this quarter, which relates to the benefit from interest rate swaps, so those calculations are likely accurate. I would need to go back and confirm all those numbers to ensure accuracy, but just focusing on that single line item seems correct. However, it's important to note that we're also experiencing a decline in our net interest income from commercial loans tied to LIBOR, which we're using the swaps to hedge against. Therefore, it's challenging to determine the impact by looking solely at that one line item; one must consider the overall balance sheet to accurately assess the true effect moving forward.

Got it. All right. That's super helpful. Thank you very much.

Thank you.

And with that, I'll turn the call over to the company for any closing comments.

Well, thank you, operator. Again, we thank all of you for participating in our call today. If you have any follow-up questions, you can direct them to our Investor Relations Team 216-689-4221. This concludes our remarks. Thank you.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.