Good morning. And welcome to KeyCorp’s Third Quarter 2022 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 for joining us for KeyCorp’s third quarter 2022 earnings conference call. Joining me on the call today are Don Kimble, our Chief Financial Officer; Clark Khayat, our Chief Strategy Officer; and Mark Midkiff, our Chief Risk Officer. On slide two, you will find 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 am now moving to slide three. This morning, we reported earnings of $513 million or $0.55 per common share. Our results included $0.06 per share of additional loan loss provision in excess of net charge-offs. Revenue was up 5% relative to the second quarter, driven by higher net interest income with a 13-basis-point increase in our debt interest margin. One thing that sets Key apart is our approach to managing interest rate risk. We have been very deliberate and intentional in managing with a long-term perspective. While our net interest income is expected to be up double-digits this year, our balance sheet positioning presents a unique and significant upside for Key over the next two years. Even in the event that rates remain at current levels, we will experience a meaningful benefit as our securities and swaps re-price. If we were to re-price our existing short-term treasuries and swaps at today’s interest rates, we would have an annualized net interest income benefit of over $1.2 billion. Our balance sheet benefits from our strong stable deposit base. Approximately 60% of our deposits are in stable, low cost retail and escrow balances. In our commercial businesses, approximately 85% of our deposits are from core operating accounts. We grew our loans again this quarter as we continue to add and expand relationships with our targeted clients. Our growth came from both our commercial and our consumer businesses. We remain diligent in our underwriting practices and have walked away from business that does not meet our moderate risk profile. Our fee-based businesses continue to reflect current market conditions. Investment banking and debt placement fees were up $5 million from the prior quarter, but down meaningfully from the year-ago period, reflecting the slowdown in the capital markets. The new issue equity market is virtually non-existent and the M&A market is currently engaged in price discovery. Our pipelines remain solid, particularly in M&A. However, the pull-through rate continues to be adversely impacted by market uncertainty. We continue to see more activity moving onto our balance sheet. In the third quarter, we raised a record $39 billion for our clients, of which 23% was retained on our balance sheet, well above our long-term average of 18%. We will continue to do what is best for our clients, including offering on and off-balance sheet solutions. Importantly, we continue to make progress with respect to our targeted scale sectors, which are not only high growth opportunities for Key, but areas that matter to both our country and our economy. We have made a conscious decision to invest and focus our resources in certain vital growing sectors, including healthcare, renewable energy, and affordable housing that impact both our clients and our communities. Both renewable energy and affordable housing are areas of investment and recently passed Federal Legislation. Combined, the Inflation Reduction Act and the Bipartisan Infrastructure Bill have allocated over $300 billion for energy transition. In healthcare, we are growing relationships with significant healthcare providers and expanding our Laurel Road business, including our recent market extension to include nurses. We are also very pleased with the early results from our May 2022 acquisition of GradFin. Since the GradFin team joined Key, they have held over 14,000 individual consultations for refinance and public service loan forgiveness. These consultations are with pre-qualified potential prospects, all new to Key. Our expenses continue to reflect our investments in our teammates, digital and analytics. We continue to balance expense discipline with investments for the future. Credit quality remained strong this quarter, with net charge-offs as a percentage of average loans of 15 basis points. Non-performing loans declined from the prior quarter. We remain committed to delivering sound, profitable growth by maintaining our discipline with respect to risk. We will continue to support our clients while maintaining our moderate-risk profile, which positions the company to perform well through all business cycles. Our capital remains strong, providing us with sufficient capacity to support our clients and return capital to our shareholders. Our fourth quarter guidance keeps us on a path to deliver positive operating leverage again in 2022, and concurrently, make progress against each of our long-term goals. We also continue to make tangible progress against the three commitments we announced earlier this year at our Investor Day. These goals for 2025 are as follows: growing relationship households in our consumer business by 20%, growing our senior bankers by 25%, and growing our Laurel Road member households to 250,000 from 50,000. We are on pace to achieve all three measures. We have grown consumer households and Laurel Road members, as well as the number of our senior bankers, although our senior banker hires have been slower in the back half of this year, reflecting current market conditions. Overall, Key delivered another solid quarter. I remain confident in our future and our ability to create value for all of our stakeholders. With that, I will turn it over to Don to provide more details on the results of the quarter and our outlook. Don?

Thanks, Chris. I am now on slide five. For the third quarter, net income from continuing operations was $0.55 per common share, up $0.01 in the prior quarter and down $0.10 from last year. Our results in the current quarter reflect strong core operating performance and the resiliency of our business model as we continue to navigate through the current market conditions. Pre-provision net revenues were up 9% from the second quarter, with a 5% increase in revenue driven by loan growth and by the way that we positioned our balance sheet to benefit from higher interest rates. Our results also reflect our ongoing focus on expense management and our strong risk profile. Turning to slide six. Average loans for the quarter were $114 billion, up 14% from the year ago period and up 5% from the prior quarter. We continue to add and deepen client relationships across our franchise, which drove loan growth in both our commercial and consumer businesses. Commercial loans increased 5% from last quarter reflecting broad-based growth across our industry verticals. Our consumer business continued its strong performance as we saw residential real estate originations of $1.9 billion. Consistent with our focus on the healthcare segment, 30% of our consumer mortgage originations were to healthcare professionals. Laurel Road originated approximately $200 million of loans this quarter reflecting the ongoing federal student loan payment holiday, as well as the impact of interest rates. Continuing on to slide seven. Average deposits totaled $144 billion for the third quarter of 2022, down $3 billion or 2% compared to both the prior quarter and the year ago period. Year-over-year, we saw a decline in non-operating commercial deposit balances, partially offset by an increase in retail deposits. The decline from the prior quarter reflected lower commercial and consumer balances; both areas were impacted by a reduction in stimulus-related funds. Interest-bearing deposit costs increased 17 basis points from the prior quarter. This resulted in a cumulative deposit beta of 9%. We continue to have a strong stable core deposit base with consumer deposits accounting for approximately 60% of our total deposit mix. In addition, 85% of our commercial deposits are from core operating accounts. Turning to slide eight. Taxable equivalent net interest income was $1.2 billion for the third quarter, compared to $1.0 billion in the year-ago quarter and $1.1 billion in the prior quarter. Our net interest margin was 2.74% for the third quarter, compared to 2.47% for the same period last year and 2.61% for the prior quarter. Year-over-year, net interest income benefited from higher earning asset balances and a favorable balance sheet mix, as well as from the benefit of higher interest rates. Quarter-over-quarter, net interest income and margin benefited from higher interest rates and loan growth, partially offset by higher interest-bearing deposit costs. Both net interest income and net interest margin reflect lower loan fees related to PPP loan forgiveness, as well as the impact of the sale of our indirect auto portfolio in the third quarter of 2021. Included in the appendix is additional detail on our investment portfolio and asset liability position. As Chris mentioned, we have intentionally positioned Key to continue to benefit from higher interest rates over the next few years. For example, if we were to re-price our existing $9 billion in short-term treasuries and $26 billion of swaps for today’s interest rates, we would have an annualized net interest income benefit of over $1.2 billion. This positions us to continue to grow net interest income and the net interest margin over each of the next few years even if rates do not increase. Moving to slide nine. Non-interest income was $683 million for the third quarter of 2022, compared to $797 million for the year-ago period and $688 million in the second quarter. Our fee businesses continue to be impacted by the slowdown in capital markets. Investment banking and debt placement fees were $154 million for the quarter, up $5 million from last quarter, but down $81 million year-over-year. Compared to last year, in addition to lower investment banking fees, cards and payments income was $20 million lower, driven by lower prepaid card revenue, which was partially offset by core growth. Consumer mortgage income was also lower, reflecting lower gain on sale margins. Strength in the corporate services income from higher derivatives income partially offset these declines. Quarter-over-quarter fees were down $5 million. Trust and investment services income declined, reflecting lower commercial brokerage commissions. Operating lease income was lower due to lease terminations in the quarter. Increases in cards and payments income and the $5 million increase in investment banking fees partially offset these declines. Despite the increase in other income, this line also reflects a $9 million reduction related to the litigation settlement. This quarter we also reclassified certain customer-related derivative income items from our other income line to corporate services income. This change was reflected in the current period, as well as reclassified in prior periods for comparability. I am now on slide 10. Total non-interest expense for the quarter was $1.1 billion, relatively stable with last year and up $28 million from last quarter. Our expenses reflect our ongoing investments in digital, analytics, and our teammates. Compared to the year-ago quarter, our expenses were down $6 million. We saw declines across most non-personnel line items, including business services and professional fees. Higher personnel costs partially offset these declines related to an increase in salaries expense. This increase included $8 million of lower deferred costs from slower loan originations and $10 million of higher contract labor related to technology initiatives. Compared to the prior quarter, non-interest expense was up $28 million. Higher personnel costs drove this increase. This increase was caused by higher salaries related to seasonal staffing and $10 million of lower deferred costs from slower loan originations. In addition, higher incentives and stock-based compensation were driven by a $12 million increase related to the relative stock price change on incentive compensation. Partially offsetting these increases were declines across most non-personnel line items, including occupancy and business services and professional fees. Now moving on to slide 11. Overall credit quality remains strong. For the third quarter, net charge-offs were $43 million or 15 basis points of average loans. Non-performing loans totaled $390 million this quarter or 34 basis points of period-end loans, a decline of $39 million from the prior quarter. We did see a very slight increase in our 30-day to 89-day delinquencies and criticized loans this quarter, although both remain near historic lows. Our provision for credit losses was $109 million for the quarter, up from $45 million in the second quarter and exceeding net charge-offs by $66 million. The increase in the provision was driven by the change in the economic outlook. Now on to slide 12. We ended the third quarter with a common equity Tier 1 ratio of 9.1%, within our targeted range of 9% to 9.5%. This provides us with sufficient capacity to continue to support our customers and their borrowing needs, and return capital to our shareholders. We will continue to manage our capital consistent with our capital priorities; first, supporting organic growth of our businesses; second, paying dividends and as we have mentioned before, our Board of Directors will evaluate a dividend increase in the fourth quarter; and third, repurchasing shares. During the quarter, our Board of Directors approved an extension of our share repurchase authorization of $790 million, which is now in place through the third quarter of 2023. We did not complete any share repurchases in the current period. As we have done in prior years, we have updated slide 13 to show our fourth quarter outlook relative to our third quarter results, using the midpoints of our guidance ranges, which support Chris’ comments about delivering another year of positive operating leverage in 2022. We expect average loans will be up between 2% and 4% and average deposits up 1% to 3%. Net interest income is expected to be up between 4% and 6%, reflecting growth in average loan balances and higher interest rates. Our guidance is based on the forward curve assuming a Fed funds rate of 4.25% by the end of 2022. Non-interest income is expected to be up between 1% and 3%. This reflects an expected seasonal pickup in investment banking and debt placement fees, so we would expect the fourth quarter of 2022 to be well below the fourth quarter of 2021 results. This also accounts for the implementation of our new NSF OD fee structure, which will decrease service charges on deposit accounts by approximately $25 million this quarter. The higher interest rate environment will also impact the earnings credit in our commercial businesses and is expected to further pressure this line item. We expect non-interest expense to be up between 1% and 3% for the fourth quarter, reflecting higher incentive compensation relative to fee production, as well as $20 million of one-time charges in the fourth quarter, including a pension settlement charge, which will flow through other expense. For the quarter, we expect credit quality to remain strong and net charge-offs to be at the lower end of our 15-basis-point to 25-basis-point range. Our guidance for GAAP tax rate remains the same at approximately 19%. Finally, shown at the bottom of the slide are our long-term targets, which remain unchanged. We expect to continue to make progress on these targets by maintaining our moderate risk profile and improving our productivity and efficiency, which will drive returns. Overall, it was a solid quarter and we remain confident in our ability to grow and deliver on our commitments.

Thank you, Don. I will now turn it back over to the operator for instructions on the Q&A portion of our call.

Our first question is from Steven Alexopoulos with JPMorgan. Please go ahead.

Good morning, everybody.

Good morning. You changed your name, Steve?

Yeah. So I want to start on the deposit side. So if we look at the $4 billion decline in the non-interest bearing, right, you are appropriately calling out the decline in non-operating deposits. If you look at the $47 billion where you ended the quarter, how much of that is still non-operational and at risk to see outflows?

I would say that at the end of the quarter, when we look at our commercial balances, it’s still in that 85% range. And we do believe that part of that decline, to be honest, is that we were a little stingy on some of our deposit rates and it’s part of our outlook for the fourth quarter of showing deposits increase. We really have two factors, one is seasonal changes, and then also, two, is to use some of that deposit beta and maybe retain or attract additional customer relationships that are non-operating.

Okay. That’s helpful commentary, Don. Follow-up, so if we look at the interest-bearing deposit costs and only 25 basis points and the three-month fee bills is now at 4%, why aren’t deposit costs going to materially ramp in the quarters ahead for you guys or really for everybody? I know that, historically, retail was sleepy, right, the money that moves but it’s a different era today. What gives you confidence that you could continue to see NIM expansion, which you clearly are signaling with the commentary around treasuries and swaps? Could you really flesh that out for us? Thanks.

So, Steve, it's Chris. I want to mention a couple of points. First, during the time we had excess liquidity, we were quite disciplined regarding our deposits. This gives us a starting point that is somewhat different from previous cycles. Additionally, it's important to note that about 60% to 65% of our deposits come from consumer deposits and our escrow business, which holds a significant amount. We've been concentrating on four main pillars, one of which has been a priority for quite a while. Therefore, I believe we are in a unique position as the cycle evolves. We're currently observing that our cumulative beta is 9% for the first three quarters, and we expect it to rise to 15% by year-end. We project a spot basis endpoint just above 30%. While we foresee a notable increase, it won't resemble the experiences we've faced in the past, thanks to the preparations we made before interest rates began to climb.

Okay. So is it safe to say most banks are guiding that NIMs are going to peak in the first half than probably of next year and then trend down in the second half. Are you guys confident you will see NIM expansion through 2023? Thanks.

We will share more details on the 2023 outlook in January. As we evaluate our position, the short-term swaps and short-term treasuries provide us with a strong foundation. We believe that we will be able to grow net interest income and margin even beyond the first half of 2023, despite the higher deposit beta. This strategy was deliberately focused on long-term management of interest rate risk. While it may impact us slightly in the short term, we anticipate recovering that impact in the latter part of 2023 and into 2024.

Okay. Thanks for all the color.

Thank you.

Next we will go to the line of Erika Najarian with UBS. Please go ahead.

Hi. Good morning.

Good morning.

Good morning, Erika.

You mentioned, Chris, the $1.2 billion benefit over time early on in your prepared remarks, and Don, you mentioned it again. So, I guess, let me ask the question. Number one, your C&I loan beta was 53% this quarter. Is that essentially the impact from the swaps and should we expect a similar loan beta as the Fed continues to raise rates? And as we think about that $1.2 billion benefit coming back, how much of that is coming from the swap book versus the securities book and over what period of time do you realize that $1.2 billion back into your net interest income?

Sure. Maybe I can go ahead and take a crack at that, Erika. And I don’t have it broken out for C&I but for total commercial, the swap impact for commercial yields cost us 43 basis points on a linked-quarter basis. And so instead of the increase that you are seeing for commercial yields, that just the actual loan itself would have translated to a 116 basis point increase. And so I think that’s going to be much more consistent with what you might be seeing for some others that don’t have that hedge impact and so this quarter we did see that kind of relative change on that category as far as the impact from swaps. As far as that $1.2 billion, that really relates to the swap book and the maturities and also the short-term treasuries. Those treasuries which total about $9 billion really mature throughout late 2023 and throughout 2024. The swap book between now and the end of 2023, we have got $7.3 billion of swap maturities and another $7.5 billion in 2024. And so if we just look at that time period for the next two years and using that same math as far as the re-pricing, we will have $900 million of that $1.2 billion annualized net income pickup occur in that two-year time period.

$1.2 billion.

Of the $1.2 billion, I am sorry. Yeah. The $900 million out of the $1.2 billion occur in that two-year time period.

I understand. My follow-up question is regarding expenses. I believe Key has consistently managed its expenses well, especially when it comes to fees, which may have surprised analysts, particularly concerning personnel costs compared to fees. Considering you mentioned some of the $12 million and $10 million in your slides, how should we view the $655 million moving forward? Additionally, I apologize for not articulating this more clearly, but is this situation driven by ongoing issues in the capital markets, along with inflation and talent competition, which will likely continue to elevate costs?

Yeah. A couple of things. One, our expenses were higher than what we had guided to for this quarter and for the second half of the year. If you look at the components of what drove that change, and I will get to your question as part of this is that, there are three items that really caused our outlook for all of 2022 to be higher than what we previously expected. One is more a one-time item. We have got a pension settlement loss projected in the fourth quarter and also some building consolidation type of costs associated with that, and those two combined to $20 million. Outside of personnel, but within our operating losses, during the second quarter, we were seeing our operating losses from the prepaid card product come down through the second quarter and we expected that to continue through the third and fourth quarter. What we actually saw was those costs actually go up, and so it wasn’t a huge increase, but compared to what our relative positioning was and the expectation was for that category, it’s about a $30 million increase for the second half of the year expense structure for us. The good thing about that is that we have taken action to address that and we will start to see that over time, but the other good thing is it has a limited life for us. These are related to funds that were distributed as part of the stimulus programs and they are winding down and so we don’t think that will have an ongoing impact on us. The third component, Erika, really is deferred loan origination costs and that cost us about $20 million. Most of that is with our reset of our consumer loan originations and the cost that gets deferred associated with that, and so we will see increases from that continue for some time because we are not seeing a return of the previous origination levels. So that will be there. For the fourth quarter, we expect to see our capital markets revenues pick up. As we have said before, the incentive compensation expense tends to be correlated to the tune of about $0.30 on the dollar. So for every dollar of investment banking and debt placement fee increase, we will see that come through incentives. As far as where we see for other salary and personnel costs, that I would say, just looking at the year-over-year, adjusting for some of these items, I talked about for the deferred loan origination costs and things. Our total salary dollars were up about 10% and headcount is up about 5%. Now some of that includes some of the smaller acquisitions we have done throughout the year, and so that does imply a 4% to 5% inflationary impact for some of the salaries. Some of that is because the lower end of the pay scale continues to have increases, some of its market pressure and we will be working through that as we said, our expectation for merit increases for 2023 and beyond. And I think that the important thing here, Erika, also is that we are very focused on driving positive operating leverage. We expect to do that this year and we haven’t given guidance for 2023 or beyond yet, but we expect to continue that through the next several years as well.

Thank you.

Thank you.

Next we will go to John Pancari with Evercore. Please go ahead.

Good morning.

Good morning.

In response to your previous comment about operating leverage, your cash efficiency ratio stands at approximately 60% year-to-date. I'm curious about how you are approaching this for 2023 and whether you could provide insight into the potential pause in leverage that we may experience in 2023. Additionally, you have maintained your long-term target at 54% to 56%. What conditions would need to be met for you to reach that target? Thank you.

John, it’s Chris. Good morning. Our efficiency ratio for the recent quarter was around 58%. We aim to reach a range of 54% to 56%. However, as Don mentioned, our primary focus is on achieving positive operating leverage. Considering the recovery in our capital markets business, the successful outcomes of our ongoing investments, and the positive trajectory in net interest income that Don outlined, we are steadily moving closer to our long-term target of 54% to 56%.

Okay. All right. Thanks, Chris. And then, separately, in terms of deposit growth expectations, I appreciate the color you gave near-term. I wanted to just get a little bit of color on how you think about deposit growth as you look into 2023. Maybe if you could talk about the mix shift of non-interest-bearing towards interest-bearing and then overall growth levels. Do you think incremental declines are possible as we look into the early part of 2023? Thanks.

Well, I mean, we are really kind of going into a bit of uncharted territory. I will tell you this, though, we have been pretty consistent in that our non-interest-bearing have been right around 32% and that hasn’t moved and I don’t anticipate that moving a lot as we go forward. And as I mentioned earlier, this deposit book has been pretty well scrubbed over a period of time. Having said all that, as interest rates continue to rise, some deposits that previously were deemed to be not interest rate sensitive will, in fact, be interest rate sensitive. We saw some of that movement in the third quarter where some of our public sector customers that are more interest rate sensitive moved. So we are, obviously, watching it very closely and it’s certainly an interesting dynamic, particularly as the Fed unwinds their balance sheet concurrently.

Okay. Thanks for taking my question.

Next we will go to the line of Gerard Cassidy with RBC. Please go ahead.

Good morning, Chris. Good morning, Don.

Good morning, Gerard.

Good morning.

Chris, you talked about the strength in commercial and industrial loan growth, and you have taken on more of your originations than you have in the past as more of your customers are coming on to your balance sheet rather than going to the capital markets. A couple of questions; one, can you share with us what percentage of that portfolio is considered leveraged loans; and then also, in that same kind of vein, how big is your syndicated loan portfolio and did that impact the growth this quarter?

Our leverage book has remained consistently around 2.5% of total loans, which is noteworthy since it was also at that level when we were a smaller company. This portfolio has significant activity and aligns with our focus areas. Recently, there have been discussions about some deals that are stalled, but we've only seen minimal changes in that book over the past six months, which gives us a lot of confidence. The growth you’re observing is primarily from investment-grade credit, as the market was dislocated, prompting our clients to act quickly. Consequently, we have increased the proportion of our commercial and industrial loans that are investment-grade. Currently, about 50% of our C&I book consists of investment-grade loans, which is somewhat unusual for a bank of our size.

When you underwrite new originations, do you usually stress test for higher rates, like 200 to 300 basis points, to ensure you're protected if rates increase significantly from here?

Certainly. Our initial stress test involves a 300 basis point scenario and we conduct several other stress tests as well. In leveraged situations, we focus on stressing EBITDA and interest rates because the risk arises when EBITDA declines concurrently with rising borrowing costs. We put significant emphasis on these factors for the credits we evaluate.

Very good. As a follow-up question, your credit quality is excellent, similar to many of your peers, and I know that will be a pivotal factor for you throughout the cycle. My question is about the consumer loan portfolio regarding the FICO scores, which I believe average 772. There has been some discussion about whether FICO scores are inflated, specifically if you compare them to scores from five years ago. Are you observing any indications that these scores are indeed inflated or is that not the case?

I haven’t personally done the analysis but just because we look at the stuff all the time. I think there’s probably a lot of like they teach the SAP. I think there is some instruction on how to get your FICO score up. Having said that if you think about the super prime customers that we are focused on, doctors, dentists, which for example, were 30% of our mortgage originations last quarter. We feel really, really good about our consumer book as we look kind of across all the metrics.

And Gerard, you are right, there actually was some technical change in some of the FICO scores and I don’t know if it was by law or what. They had to exclude certain, like, medical-related costs or loans or expenses. And so if you would adjust for that, I think, today’s FICO score is probably 10 basis points to 15 basis points higher and the same would be several years ago. Instead of our 772, it might be a 760, which is still a super prime even in historic standards.

Very good. Thank you, Don. Thank you, Chris.

Thanks, Gerard.

Next we will go to the line of Ebrahim Poonawala with Bank of America. Please go ahead.

Hey. Good morning.

Good morning.

Good morning, Ebrahim.

I wanted to ask about the swap and the treasury securities portfolio. I understand how this should benefit net interest income, assuming rates remain high for the next 12 to 18 months. Are there any plans to secure that advantage in advance? I'm concerned that if rates decrease in the next three to six months, we could lose some benefits. Is there a strategy to lock that in early?

We are continuing to review that on a regular basis. I would say that our ALCO committee, as we get together, we tend to think that we are going to see rates higher for longer just given what we have experienced in the current marketplace. But even with that, you have seen a little bit of a tick up again as far as our forward starting swaps and that’s exactly the purpose of that, Ebrahim, is that we are looking to put on swaps that actually kick in as some of these will mature and start to lock in some of that forward benefit for us as well. We are not ready to do a wholesale type of repositioning to achieve that, but we do expect to continue to use that tool over the next several quarters to help lock in some of that benefit.

That's fair. On a different note, regarding credit related to your portfolio, you have insight into the middle market commercial real estate. How stressed do you anticipate that customer base to be? Are you observing areas where you've reduced exposure because of the rapid increase in Fed interest rates and the widening spreads in the market? Which areas are you identifying as experiencing difficulties where you've pulled back as a bank, and do you believe a 4% to 4.5% Fed funds rate could exert more pressure on a portion of that segment?

Sure, I'll address that. Clearly, our position has been that inflation will persist and that interest rates will remain elevated for an extended period. Reflecting on last September, when we exited the indirect auto sector with a portfolio worth $3.3 billion, we believed and still believe that this segment will face significant market stress. I also closely monitor any areas of leverage; for instance, we've received inquiries regarding leveraged loans, which is another area we observe closely. The real estate market is important to us as well, particularly focusing on apartments, multifamily, and industrial properties. Interestingly, values in these categories have risen significantly from pre-pandemic levels by 15% and 39%, respectively. However, I foresee considerable challenges in the office sector, especially for B and C class buildings, as they're leveraged and work patterns have changed. While we don't have substantial exposure in that sector, we do administer a $600 billion third-party commercial loan servicing portfolio, which consists of debt that we don't own. Notably, B and C class offices in central business districts are increasingly entering active special servicing, and those are a few areas worth your attention.

And just on the office, do you think it’s a cliff event just given the nature of the leases or is it going to be more like what we have seen with big box retail, malls, where it’s played out over the last decade as opposed to in any given quarter or any given year?

I don’t believe it’s a sudden drop. Instead, it will be a gradual decline. When considering B and C class office spaces, there are numerous tenants with different lease termination dates, which suggests a steady but slow decline.

Thanks for taking my questions.

Sure.

Next we will go to the line of Scott Siefers with Piper Sandler. Please go ahead.

Good morning, guys. Thanks for taking my question. Hey.

Good morning.

Chris, I was hoping you could sort of walk through the investment banking pipelines and pull-through. I think we can all see what’s happening in the industry. But some companies are noting that there’s still enough activity taking place at sort of the smaller end of the segment, middle market and below that it’s keeping sort of activity going enough to prop up numbers. So where are you seeing healthier activity versus what’s still slow? And just given your background, do you think there’s a point where we will say get price discovery and then increased activity despite higher rates and a weaker economic backdrop?

So I do. So where the activity has remained strong, and we had a very good quarter in this area, it was areas like syndicated finance. So that area continues to be strong. The areas that are really challenged are the public equity market. And that’s a market, unlike the debt market where it’s binary; either you can issue equity or you can’t basically and right now, you clearly can’t. The M&A markets, I am confident will come back. We are involved in a lot of these strategic discussions. And what’s happening, Scott, is if you are a buyer, you basically have sort of a free option. There’s no huge impetus to close. Everyone is looking out over the horizon and predicting a downturn, and so if you have a deal locked up, you sort of drag your feet and wait and see what the downturn is going to look like. Our pipelines remain strong in that business. We continue to selectively hire people. It will come back. I don’t think it’s going to come back. I don’t see any significant market change in the fourth quarter, by the way. But I do think that the business will come back. Having said that, I have been doing this for a long time, there’s an inverse relationship between the amount of time you have been working on the deal and the probability that it’s actually going to close and so I throw that out as a watch point.

Perfect. Okay. That’s good color. Thank you. And then maybe, Don, this notion of AOCI marks and the tangible book and TCE heads has gotten a lot more attention. A lot of companies have begun to move pretty substantial amounts of their curious portfolios to held to maturity. So in a sense, you can sort of make the TCE tangible book as you go away with a wave of the hand, so to speak. So maybe just some thoughts on why you guys are keeping mostly available-for-sale. To what degree does TCE matter in your eyes, does it govern any of your capital management thinking or things like that?

Sure. As we plan our future security purchases, we're beginning to allocate some of those into held-to-maturity, whereas previously they were mainly in available-for-sale. We are distinguishing some investments where we might want bullet maturities and end-of-life swaps, which we prefer to keep in available-for-sale instead of moving to held-to-maturity. The tangible common equity ratio isn’t our top priority. Our primary focus is on the common equity Tier 1 ratio and other regulatory ratios such as Tier 1 or total. This is why we took action in the third quarter with a preferred stock issuance and also a subordinated debt issuance, and we feel confident about our position in terms of capital. Additionally, if you exclude the AOCI impact from the tangible common equity, our ratio would increase by 330 basis points. On that adjusted basis, which we expect to normalize over time, we're confident in the safety of those investments as they consist of agencies or U.S. treasuries, and we anticipate seeing that realized. This aspect is also a key area of focus for us.

Perfect. Okay. Good. Thank you guys for taking the questions.

Yeah.

Next we have a question from Matt O’Connor with Deutsche Bank. Please go ahead.

Good morning. I’m curious about the trends in loan pricing, particularly in the commercial sector. While we know that absolute yields are increasing due to rising rates, are you noticing any improvement in spreads given the widening trends in the public markets?

That’s a great question, Matt. And what’s ironic about this is, to-date what we have seen is credit spreads widen out for the investment grade companies that we serve and because they are seeing that in the capital markets for the middle market space, because of the competition there it tends to be more local. We haven’t seen the commercial spreads widen that much yet. We would expect that to pick up over time here. But near-term the spreads are holding in but not expanding on the commercial for the lower middle market customers.

Any way to quantify on the investment-grade, as you mentioned, your overweight investment grade versus others, so that’s probably a positive for you.

Well, it is for us, and I would say that, on the credit spread widening, we have probably seen a good 20 basis points of widening generally on pricing reflective of credit spreads in the market.

Okay. Thank you very much.

Next we have a question from Mike Mayo with Wells Fargo Securities. Please go ahead.

Hi. There is one negative and one positive. The negative is the significant increase in personnel expenses from quarter to quarter, and I understand there are one-time items impacting this. It seems that these one-time items are recurring, which raises the question of how many more we might encounter in the fourth quarter. Looking ahead to next year, do you anticipate more one-time items, or when will we see more core expense figures, as they appeared to be a bit higher than expected? On the positive side, regarding your outlook for net interest income and the net interest margin, your net interest margin is currently at 2.7%, compared to approximately 3.7% a decade ago. We have experienced nearly 14 years of zero interest rates, and as we move away from that, do you think it's possible to return to 3.7%, and what factors since the global financial crisis could influence this?

Sure. As far as personnel, a couple of things that we have talked about is being one-time or just different. One is the pension settlement loss that we will have in the fourth quarter. The good thing there is that, with rates being higher, the threshold is higher for us to be in a position to have to realize losses in the future and so we do think this truly is more one-time. And as long as rates remain where they are at or even go a little higher, we shouldn’t see that come through as far as a charge. The one thing that you will see, Mike, is that a good portion of our long-term incentive compensation is tied to our stock price. We want our employees to be shareholders and have a consistent objective to what our shareholders have as well. Part of that incentive compensation expense does fluctuate from time to time with our share price, and so our expectation and hope is that we will see our share price increase, and so from that, you will see the incentive compensation expense increase with that as well. Beyond that, Mike, that I would say, for the current quarter versus a year ago, as I mentioned before, the core salary line item is up about 10%, with about 5% of that coming from headcount-related increases. Some of that’s from acquisitions we have done. And we had about a 4% kind of merit increase impact to that as well throughout the year and that reflects some of the experience we had for right-sizing the lower salaries, but also the market pressure that we are seeing. And so near-term, I think we will probably see a little higher than our typical 2% as far as wage inflation going forward, but I think we will see that settle down. As Chris has said, that we will continue to make investments in talent and especially in our frontline bankers and also in the technology space to continue to grow our business, but with that, we will be holding the people accountable to make sure that we are getting the appropriate returns on those investments and showing the growth going forward.

And then just one follow-up on that comment about technology, so less consultants and more full-time tech employees so that you can better control your tech destiny, is that the idea of this and what was the tipping point for that change?

The tipping point was, as we were in the pandemic and everybody was short on talent, we were getting more turnover from some of our contractors than frankly we wanted to get and we wanted to be able to literally have the continuity and we wanted to drive our strategy in a consistent way with leadership and so we made the decision in certain areas to dial back contract labor and to hire in. When I say it's full-stack engineers, the nice thing is that with some of the acquisitions we have made, Mike, we have the kind of leaders that can attract the kind of people onto our platform that we want as we go to the next level.

All right. Thank you.

Thank you.

And our next question is from Ken Usdin with Jefferies. Please go ahead.

Thanks a lot. Good morning. Don, just one more follow-up on the balance sheet mix, so the securities portfolio has been hanging around $50 billion and just want to understand with that planned run-off in that good slide have in the back about the maturities, do you expect to keep the securities portfolio around the size from here and then just I am trying to understand how that gets funded incrementally given that you are still expecting decent loan growth?

There are essentially two parts to our investment portfolio. One is the core book, which totals approximately $40 billion, and the other is the U.S. treasuries, amounting to about $9 billion. Our near-term outlook suggests that the core portfolio will remain around the $40 billion mark, which we consider appropriate from both a liquidity standpoint and for the balance sheet mix. Regarding the U.S. treasury portion, we will evaluate our options as maturities arrive, considering whether to use those for future funding or to roll them into the core portfolio. The outcome of that decision is yet to be determined, but I would note that there is likely less certainty surrounding the $9 billion short-term treasury portfolio.

Following up on that, does the $1.2 billion benefit take into account any changes in the size of both the securities book and the overall swaps book as we move into those future years?

The swap book assumes that it would stay the same and then on the treasury portfolio, it has either the assumed impact of rolling that over into more one-year treasuries or using that for funding and it has the same net bottom line impact at this point in time.

Okay. And then just, sorry, one more follow-up, just do you have an understanding or can you help us understand just when the near-term swaps detriment just from the natural higher rates kind of gets to its bottom and then you start to get this that incremental benefit rate of change starts to happen, I guess, it sounds like that’s in next year, but do you have an understanding of kind of when that pivot happens?

Well, I would say that, a couple of things we would have to know for that, when do short-term rates peak, because that’s going to be the main driver as to when that negative impact happens for the existing portfolio. And then as we have the rollovers of that book, we will be picking up over 400 basis points on, excuse me, over 300 basis points on the swaps as they would rollover. And so that will help offset that, but it’s probably sometime in 2023 that we start to see that peak and move the other direction.

Okay. Got it. Thanks, Don.

Thank you.

And our next question is from Betsy Graseck with Morgan Stanley. Please go ahead.

Hi. Good morning.

Good morning.

Good morning.

A couple of questions. One, I just wanted to understand what kind of loan growth you have got baked into your outlook and what is your expectation for how you are going to fund that loan growth?

We do not anticipate seeing the same loan growth trajectory as we have in the past few quarters. Our guidance for the fourth quarter is between 2% and 4%. We have seen considerable growth on the consumer side recently, but I do not expect that same level of growth moving forward. While we have not provided guidance for 2023 yet, we are aiming for a loan growth of 2% to 4% in the fourth quarter.

Our guidance for the fourth quarter indicates a 1% to 3% increase in our deposits. The calculations show that the midpoints of both are around the $3 billion range. We believe we will be fairly close to achieving this through core balance sheet growth. While we have utilized other wholesale funding to bridge the gap in the last few quarters, we expect to rely more on core funding moving forward.

And if the deposits don’t come through for whatever reason, can you just give us your hierarchy of how you would go about funding it, is it securities roll-off or you first go to the wholesale funding piece?

Near-term we have been using FHLB advances and locking those into set maturities or term maturities. So we would probably continue that. And then, as I mentioned before, we are still yet undecided as far as the roll-off of the U.S. treasuries when they start coming through next year and then 2024 is to how we use those proceeds.

And then just lastly, I know the forward curve is looking for the Fed to be done in early 2023, but if they end up extending with the rate hike cycle going further into 2023, how should we expect that impacts the outlook here? I know you mentioned that you have got the benefit of the short-term of the swaps rolling off that should help, but I am just wondering, is there any timing that we should be considering here?

Yeah. I don’t think there’s any cliff or any events there that we still view the rates going up. We will still have a net positive even with deposit betas being higher than what they have been before, and then just the re-pricing of the swaps and the treasuries will be additive for us. And so we think that we still will be able to grow net interest income and margin throughout the next couple of years, even if rates do go beyond the current outlook.

Got it. Okay. And then just last question, going back to the quarter in mortgage for the quarter. Very strong results here with. I just wanted to understand what the main driver of that was and the tail, the legs on that type of increase? Thanks.

Sure. For us, the main factor was that 87% of our originations were purchased, highlighting the relationship-based nature of our business, with 30% coming from medical professionals. Essentially, our refinance business has completely dried up. Moving forward, I expect that purchased mortgages will continue to decline in this environment, as we anticipate being in a period of prolonged higher rates.

Right. So this is reflecting in loans that had probably started a quarter or two ago, so we should expect that to tail off and are these 30-year fixed you are putting on or 15-year ARM floaters, can you give us a sense of the construct?

It tends to be more ARMs in 15-year. We do have some 30-year fixed in some of our doctor, dentist program that we have had. But I’d say, it’s a mix of those. And we would expect to see the fourth quarter origination levels be lower than what the third quarter was. It still is a core product for us and something that we had underweighted in the past, so we still think there is room for some modest growth in the balance sheet there.

Okay. Great. Thank you.

Thank you.

And our final question will come from Bill Carcache with Wolfe Research. Please go ahead.

Hey. Good morning, Chris and Don.

Hi.

I wanted to follow up on your comments around the modest increase in the reserve rate due to the economic outlook. Can you give a little bit more detail on what kind of unemployment assumption is implicit in that reserve and what you would expect the reserve rate to go to if unemployment were to increase to, say, the 5% to 5.5% range?

Yeah. As far as what we use as our baseline for our CECL reserves, we tend to start with the consensus assessments for Moody’s and so we did see a shift in that from last year to this year. I would say that Moody’s unemployment levels are using about a 4% unemployment level for 2023 and I don’t know that off the top of my head what the impact would be of seeing that going to 5%, because we would have to have the other components of the economic outlook. But I’d say that if we look at where our reserves were back at January 1, 2020, I’d say that the unemployment levels and economic outlook were a little worse than what we are seeing now today, and our reserve levels there were about 10 basis points or 15 basis points higher than what they are today for us. So it’s a lot of moving parts and pieces. But I think that it’s not going to be a huge change, but still would be reflective in our reserves.

That's helpful. Thank you. It seems reasonable to assume that the group you're targeting with your Laurel Road products would perform relatively well during an economic downturn. However, do they have less credit history in this asset class? If that's the case, could you provide some insight into the data and analytics you use to assess potential customers? Also, what is the approval rate for customers applying for a loan through Laurel Road compared to those who actually receive one?

We have data for doctors and dentists programs related to both residential mortgages and student loans. This information is continuously being developed, and we use these insights to guide our credit underwriting decisions. While I don't have the specific approval rate for loans, it would be reasonable to expect it to be relatively high, considering the type of doctor we target, who typically transitions from a salary of around $80,000 to over $300,000, along with a firm commitment and a new position at a large hospital. Therefore, I would assume the approval rate is likely to be quite high.

Understood. Thank you for taking my questions.

Thank you.

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