Good morning, and welcome to KeyCorp's Third Quarter 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.

Thank you for joining us for KeyCorp's third quarter 2023 earnings conference call. Joining me on the call today are Clark Khayat, our Chief Financial Officer; and Mark Midkiff, our Chief Risk Officer. On Slide 2, you will find our statement on forward-looking disclosure and certain financial measures, including non-GAAP measures. These statements cover our presentation materials and comments as well as the question-and-answer segment of our call. I am now moving to Slide 3. This morning, we reported earnings of $266 million or $0.29 per share. Our results reflect broad-based growth across our franchise supported by our strong balance sheet and disciplined risk management. We continue to benefit from our focus on relationship banking and primacy, namely having our client’s primary operating account. We continue to add and deepen relationships in both our consumer and commercial businesses as well as improved both the quality and diversity of our deposits. Average deposits increased relative to the prior quarter and the year-ago period. Our focus on relationships continues to guide our balance sheet optimization efforts. This quarter, we reduced average loans by over $3 billion as we deemphasized credit only and other non-relationship business. Importantly, our common equity Tier 1 ratio increased by 50 basis points to 9.8% as a result of our proactive balance sheet management. Risk-weighted assets decreased by $7 billion in the third quarter and $9 billion from the beginning of the year, which is approaching our 2023 full-year target of $10 billion. The increase in our common equity Tier 1 ratio this quarter moves us above our current targeted capital range of 9% to 9.5% where we would expect to remain for the foreseeable future. Other capital ratios were relatively stable this quarter, including our tangible common equity ratio, which was down 10 basis points, despite the impact of higher interest rates. Overall, our capital remains strong and we are well positioned relative to our capital priorities and of the phase-in of the proposed future capital requirements. Although we would not expect the same magnitude of change in risk-weighted assets next year, we will continue to take steps to manage our balance sheet in conjunction with anticipated regulatory changes. Net interest income in the quarter reflected the continued high interest rate environment and our balance sheet positioning. Clark will discuss our balance sheet in his remarks, but I would point out that Key has a very well-defined net interest income opportunity over the next five quarters as our short-term swaps and treasuries reprice. In our slide deck, we show net interest income benefit will reach approximately $1 billion on an annualized basis by the first quarter of 2025. Our net interest margin has been a challenge for us this year. We believe, however, the third quarter represented the low point for the cycle. Our results continue to benefit from our strong fee-based businesses, which consistently make up 40% of our revenue. This revenue mix will be a clear competitive advantage under the proposed regulatory framework. This quarter, fee income was up 6% driven by a 17% linked quarter increase in investment banking and debt placement fees. We expect investment banking fees to increase again in the fourth quarter based on current pipelines. The absolute level of improvement is of course market dependent. Given the significance of our integrated corporate and investment bank, any normalization in the capital markets represents an upside opportunity for Key from both a fee generation and balance sheet management perspective. In addition to capital markets, our fee income will continue to benefit from our strong positions in payments, an area where we have consistently invested, and as well where we benefit from critical mass with assets under management of $53 billion. Expense management remains a priority. Our results reflect the successful completion earlier this year of a company-wide effort to improve productivity and efficiency. We are continuing our efficiency journey by further simplifying and streamlining our businesses. As we narrow our focus, we will continue to drive additional expense savings, which provide the funding to continue to invest in our business. Finally, I want to comment on credit quality, which I believe is the most important determinant of return on tangible common equity and shareholder value over time. Credit quality remains a clear strength of Key. Our credit measures reflect the derisking we have done over the past decade and our distinctive underwriting model. This quarter, our net charge-offs were 24 basis points. Over the next several quarters, we expect to continue to operate below our targeted through-the-cycle range of 40 to 60 basis points. The quality of our loan portfolio continues to serve us well with over half of our C&I loans rated as investment grade or the equivalent. Similarly, our consumer clients have a weighted average FICO score of approximately 770 at origination. As a reminder, we have limited exposure to leveraged lending, office loans and other high-risk categories. B and C class office exposure in Central Business Districts totaled $116 million. Two-thirds of our commercial real estate exposure is in multifamily, including affordable housing, which continues to be a significant unmet need in this country. I will close by underscoring my confidence in the long-term outlook for Key. Our businesses are well positioned and we continue to strengthen our balance sheet. Credit quality remains one of our most significant strengths. We will continue to focus on maintaining the quality of our loan book and enhancing our risk management framework. This positions us well to deliver sound profitable growth and create value for our shareholders. With that, I'll turn it over to Clark to provide more details on our results for the quarter.

Thanks, Chris. I'm now on Slide 5. The third quarter net income from continuing operations was $0.29 per common share, up $0.02 from the prior quarter and down $0.26 from last year. Our results were generally consistent with the guidance we provided for the quarter and we've affirmed the full year outlook we shared at our last earnings call. As Chris highlighted in his remarks, our results reflect the strength of our core business, focus on primacy, balance sheet optimization and our disciplined risk management. I'll cover each of these strategic focus areas in my remarks this morning. Turning to Slide 6. Average loans for the quarter were $117.6 billion, up 3% from the year-ago period and down 3% from the prior quarter. Total loans ended the period at $115.5 billion, down $3.5 billion from the prior quarter. The decline in average loans was driven primarily by a reduction in C&I balances, which were down almost 4% from the prior quarter. The reduction reflects our balance sheet optimization which prioritizes full relationships and deemphasizes credit-only and non-relationship business as we prepare the balance sheet for Basel III endgame rules. The reduction in loans contributed to the decline in risk-weighted assets representing roughly half of the RWA decline this quarter. RWAs were also impacted by our optimization efforts to which we were able to apply more attractive capital treatment to existing portfolios. Importantly, this allowed us to manage RWAs proactively while minimizing impacts in net interest income. Turning to Slide 7. Key's longstanding commitment to primacy continues to support a stable, diverse base of core deposits for funding. This quarter, average deposits totaled $144.8 billion, relatively stable from the year-ago period and up nearly $2 billion from the prior quarter. The increase in average deposit balances from the prior quarter was driven by an increase in both consumer and commercial deposit balances. Importantly, we've continued to improve the quality of our funding mix by growing core relationship balances and reducing wholesale and broker deposits. This quarter, broker deposits declined by $2.6 billion on average and $3.2 billion relative to period-end balances. At the end of the quarter, we took advantage of our improved funding profile and called $1.2 billion of outstanding bank debt for redemption. We expect to redeem the debt at the end of October. Our total cost of deposits was 188 basis points in the third quarter and our cumulative deposit beta, which includes all interest-bearing deposits, was 46% since the Fed began raising interest rates in March 2022. Higher interest rates resulted in the continued deposit mix shift this quarter. We've seen this mix shift slow and we are testing reduced rates in certain markets. We did not deploy higher rates in our retail business against the July interest rate hike. We continue to expect that our cumulative deposit beta will approach 50% by the end of the year. Turning to Slide 8. Taxable net interest income was $923 million for the third quarter, down 23% from the year-ago period and down 6% from the prior quarter. Our net interest margin was 2.01% in the third quarter compared to 2.74% for the same period last year and 2.12% for the prior quarter. Year-over-year, net interest income and the net interest margin were impacted by higher interest-bearing deposit costs and a shift in funding mix to higher-cost deposits and borrowings. Relative to the second quarter, the decline in net interest income reflects a planned reduction in earning asset balances from our balance sheet optimization efforts and higher interest-bearing deposit costs. Our net interest margin and net interest income continue to reflect a headwind from our short-dated treasuries and swaps. Our swap portfolio and short-dated treasuries reduced net interest income by $370 million and lowered our net interest margin by 80 basis points this quarter. We believe that NIM bottomed in the third quarter as we see continued benefit from maturity of swaps and treasuries. Consistent with our previous comments, we expect that we are at or near the bottom on NII. In the third quarter, we executed $6.7 billion of spot pay-fixed swaps. In October, subsequent to the quarter end, we terminated $7.5 billion of received fixed cash flow swaps which were scheduled to mature throughout 2024. The swap termination locked in the AOCI position of those swaps, which will amortize throughout 2024 on the original maturity schedule. This should have no impact on our AOCI position at the end of 2024, but will guard against future hikes or reduction in rates that is slower than the forward curve predicts. These actions along with the planned maturity of our short-term treasuries make Key less liability sensitive, protect capital and reduce our exposure to higher rates. Turning to Slide 9. As Chris mentioned earlier, our balance sheet positioning, which has been a near-term drag on earnings, represents a clear and well-defined opportunity. Based on the forward curve which continues to adjust to higher levels, we project an annualized net interest income benefit of approximately $1 billion from the maturities of our short-term treasuries and swaps by the first quarter of 2025. We'll continue to take a measured but opportunistic approach to lock in this benefit. Moving to Slide 10. Noninterest income was $643 million for the third quarter of 2023, down $40 million from the year-ago period and up $34 million from the second quarter. The decrease in noninterest income from the year-ago period reflects a $23 million decline in corporate services income due to lower customer derivatives trading revenue. Additionally, service charges on deposit accounts declined $23 million driven by the previously announced and implemented changes in our NSF/OD fee structure and lower account analysis fees related to interest rates. The increase in noninterest income from the second quarter reflects a $21 million increase in investment banking and debt placement fees and an $18 million increase in other income from higher trading income and a gain on a loan sale. I'm now on Slide 11. Total net interest expense for the quarter was $1.1 billion, up $4 million from the year-ago period and up $34 million from last quarter. Compared to the year-ago quarter, computer processing expense increased $12 million driven by technology investments and personnel expense increased $8 million driven by higher salaries and employee benefits partially offset by lower incentive and stock-based compensation. The increase in expenses relative to the prior quarter was driven by personnel expense, which increased $41 million from incentive and stock-based compensation, a majority of which was from production-related expenses and a higher stock price at the end of the quarter. As we continue to proactively manage our expense base and simplify and streamline our businesses, this will improve the client experience, reduce complexity in costs and provide flexibility to continue to invest for the future. Our goal, as expressed previously, is to again keep core expenses flat in 2024. We expect to have additional efficiency-related expenses in the fourth quarter connected with these efforts. With that complete, we would estimate those charges to be in the range of $50 million. We'll provide full 2025 guidance during our fourth quarter earnings call. Moving now to Slide 12. Overall, credit quality and our related outlook remain strong. For the third quarter, net charge-offs were $71 million or 24 basis points of average loans. While non-performing loans and criticized loans continue to move up from their historical lows, we believe Key is well positioned in terms of credit migration and potential loss content. Our provision for credit losses was $81 million for the third quarter and our allowance for credit losses period-end loans increased from 1.49% to 1.54%. Turning to Slide 13. We ended the third quarter with a common equity Tier 1 ratio of 9.8%, up 50 basis points from the prior quarter and well above our targeted range of 9% to 9.5%. Going forward, we expect to stay above our current targeted range. We will determine and share any changes to that targeted range once the new capital rules are finalized. We will remain focused on building capital in advance of newly proposed capital rules and continue to support client activity and the return of capital. We do not expect to engage in material share repurchases in the near term. The right side of this slide shows Key's expected reduction in our AOCI mark. The AOCI mark is expected to decline by approximately 27% by the end of 2024 and 39% by the end of 2025, which will provide approximately $2.5 billion of capital build through that timeframe. During the third quarter, the AOCI position decreased by $500 million in structural burn down. The increase in rates, specifically in the five-year timeframe, increased the position by approximately $1.1 billion, which resulted in a net change of $600 million. Importantly, only 10% of our projected $2.5 billion of AOCI reduction between now and 2025 is driven by the benefit of lower rates represented in the current forward curve. Said differently, more than 90% of this reduction will occur even if rates remain flat to current levels driven by maturities, cash flows and timing. Given the proposed capital rules, we believe our reduction in AOCI marks along with our future earnings and balance sheet management would allow us to organically accrete capital to the required levels. Slide 14 provides an outlook for the fourth quarter relative to the third quarter as well as the full year compared to the prior year. Our guidance uses the forward curve as of September 30, which holds Fed funds flat at 5.5% through August of 2024 ending 2024 at 5%. Balance sheet trends are tracking as anticipated. We expect average loans to be down 1% to 3% in the fourth quarter versus the prior quarter as we continue to optimize our balance sheet and recycle capital to support relationship clients. We expect average deposits to be relatively stable in the fourth quarter. Our outlook assumes a cumulative deposit beta approaching 50 by year-end. We also expect to continue to improve our funding mix and liquidity. On a linked quarter basis, net interest income is expected to be relatively stable in the fourth quarter changed from our previous guidance of flat to down 2%. Our guidance for noninterest income has changed to up 1% to 3% reflecting stronger fee income in the third quarter compared to the fourth quarter. Our full-year outlook for fees remains unchanged. Noninterest expense is expected to remain relatively stable in the fourth quarter, excluding the potential FDIC special assessment charge, additional efficiency-related expenses and an expected pension settlement charge of $15 million to $20 million. We expect credit quality to remain solid and net charge-offs to average loans to be in the range of 25 to 35 basis points in the fourth quarter below our expected over-the-cycle targeted range of 40 to 60 basis points. Guidance for the fourth quarter GAAP tax rate is 18% to 19%. Once again, our full-year outlook for 2023 versus the prior year has not changed. We feel confident in the foundation of our business and in our strategic efforts to strengthen capital and liquidity, manage risks and improve earnings. With that, I'll now turn the call back to the operator for instructions for the Q&A portion of the call.

Thank you. Our first question will come from Scott Siefers from Piper Sandler. Please go ahead.

Good morning, everyone. Thanks for taking the questions. So great news that we hit the low on the margin and are at or near the bottom on NII. I guess I'm curious. Does that outlook contemplate any further risk-weighted asset reductions that might be outside the scope of the 10 billion you've articulated for this year? And I guess along those lines, do you see a need to do anything beyond what you'll do this year? It looks like you're ramping up the capital base more quickly. So how are we thinking about overall balance sheet size within the scheme of bottoming a NII trajectory?

Yes. Thanks, Scott. Our prompt bet was that your first question would be expenses, but I would think about it is we've guided the loan balances down 1 to 3 in the fourth quarter. I think that's going to be the vast majority of any reduction in the balance sheet. We could still see cash come down a bit. And we are still doing some optimization efforts. They won't carry the same size that we would have seen in this quarter. So you'll see a leveling off of that. And that 10 billion I think is the right number to be focused on.

Okay. Perfect. That's good. Thank you. I did have an expense question. I think you largely hit it in there. So I'll refrain from asking about that one. I guess maybe a broader question though. Clark, I think you talked about a 3% margin in a normal environment. I think that's still well above what would be implied by the extra billion or so of benefit through next year. So maybe just sort of top level, what else would have to happen to get you there? How are we sort of thinking about that, that 3% normalized margin?

Yes. So to be clear, I think the 3% area is not out of the realm. I think to your point, Scott, you adjusted today the 80 basis points that we talked about on drag, it would be 2.81. It would have been 2.85 last quarter, kind of 3.19 before that. So I think it's going to be a continued asset mix over time and funding mix. And what you're seeing, if I just point to the third quarter, you saw kind of flattish deposits and that included a significant reduction in brokered, so more client deposits. But the other piece that I think is really important is that we did and we will continue to focus on reducing our reliance on wholesale funding. So you would have seen that come down on the order of like $4 billion in the quarter, and obviously that has more expense over time. Now your next question is probably once we get into long-term debt rules and we're issuing more wholesale debt, how does that impact that? I think we size that a little bit. We will factor that in. But again, I think when you start to put all these pieces together in a more normalized environment, something in the high 2% to 3% is not out of the realm of possibility.

Okay. Perfect. All right. Thank you guys very much.

Thank you. The next question is from Erika Najarian from UBS. Please go ahead.

Hi. Good morning. I guess my question was on the RWA mitigation. So I'm going to follow up in terms of Clark's answer to that question. So you're pointing us to the $10 billion as the right area, which is a lot, it’s a lot of RWA to take out. And I guess I'm wondering, number one, could you give us a sense of how much has already been taken out and what's to come? And second, as we think about the net interest income trajectory for next year, there's a comment of the NII bottoming about here or in the fourth quarter, consider the cost of the RWA mitigation that you have left?

Sure. So the answer to the first part of your question, Erika, is we're currently through the third quarter, we've reduced $9 billion. So in the third quarter, we reduced $7 billion on a cumulative basis for the year. We've reduced $9 billion of RWAs. We are well on target to hit our 10 billion. As you try to kind of pivot from RWAs to the impact on NII, interestingly, there is a certain universe of those RWAs that we were able to get just different treatment on, namely the treatment that we qualify for in any event. Secondly, there was a lot of unused line fees in there that obviously those two categories don't have any impact on NII. As you look forward, the other reduction in RWAs would have a marginal impact on NII but a positive impact certainly on our returns, certainly on our margins. The other thing that taking out all these RWAs enables us to do is to focus on rightsizing our expense base as we take out these RWAs. So that's kind of how I think about it.

Got it. And, Chris, I guess the follow up to there is, Basel III endgame clearly gives the banks time. And as you mentioned, the moves that you're making in terms of improving the margin, being mindful of balance sheet size, being mindful of the expense base, the target would be to improve CET1 generation from here. I guess how do you balance the notion of, okay, we have this $10 billion of RWA reduction, check, that's done, and potentially we're ready to be a little bit more aggressive in the market or not. You told me, one of your peers said that they're ready for loan growth next year versus the notion of, with U.S. Bank being freed from its Category II commitments, whenever everyone runs data on adjusted CET1, Key sort of ends up at the bottom of the list. So how do you balance in terms of running the bank day-to-day versus how your investors are thinking about KeyCorp in sort of this new world order for regulation?

Sure. Well, first of all, as you know, the rules are still preliminary and they're probably likely to change. That said, we're certainly confident under the proposed current rules, including the definitions and the associated timeframes, Erika, that we can hit them. And so what we need to do is sort of when the events of March happened and then these rules came out in July, I wanted us to hit the reset button and reset our business and make the difficult decisions so we can get back to growing our business. As I've always said, the underlying business is in good shape. We're adding clients on the consumer side. We're adding clients on the commercial side. And what I want to do is right-size our balance sheet, get our loan to deposit where it needs to be, get our wholesale funding mix where it needs to be, and then free up our people to get back out in the marketplace and do what they do and that's grow our business. So that is the needle that we're currently threading.

Thank you.

Our next question is from the line of Peter Winter from D.A. Davidson. Please go ahead.

Good morning. You guys mentioned that capital markets should be up in the fourth quarter. But I was just wondering, just between higher rates and the geopolitical risks, just how you're thinking about the outlook for capital markets over the medium term?

I feel optimistic about the medium term, Peter. In the near term, particularly in the fourth quarter, we face challenges related to both factors you mentioned. Looking at our backlog, we will see an increase compared to the previous quarter. However, the exact level of that increase remains uncertain. Clearly, geopolitical issues are a concern. Additionally, recent trends in the bond market will also have an effect. Thus, I expect potential headwinds in the short term. However, I am confident about the medium-term outlook. Private equity firms are starting to make transactions, which is a positive sign. This year, M&A activity in the $100 billion range has decreased by about 50%, but historically, this will bounce back. So, while I anticipate an increase in the near term, I can't specify the extent. Looking ahead to 2024, as we gain clarity on interest rates and geopolitical issues, I expect a significant uptick in activity.

Got it. And then, Chris, if I could ask about the dividend? You have 70% plus payout ratio. Can you just talk about your commitment to maintaining that dividend? And is there any risk that you could be forced to cut the dividend?

I'd be happy to address that. Let me start by just saying my views on our dividend are unchanged. As we've managed this business, we manage the business for the long term. Similarly, our Board tends to take the same approach on everything, including the dividend. And so when we gather in November, we'll review the dividend as we always do. In the context of a range of scenarios, you were just talking about geopolitical scenarios, et cetera, the macro conditions, but importantly, we're going to take into consideration as we always do the normalized earnings power of our company, and our capital priorities are unchanged. We want to support our relationships as our clients and prospects and secondly, the dividend. The other factors that I think are really important. First and foremost is credit quality because there's nothing that denigrates capital more than credit losses. I feel really good about our credit quality. We'll also obviously be looking at the burned out of AOCI. That obviously is tied in. And then our ability to organically build capital. We've already talked about that a little bit through a reduction of RWAs and other actions we took. We’re able to grow our capital, our CET1 by 50 basis points this quarter. So that's kind of how I think about it. But I'll end where I start is that my views on the dividend haven't changed.

And the next question will come from Ken Usdin from Jefferies. Please go ahead.

Hi. Thanks. Good morning, Clark, I was wondering if you could kind of walk through some of the hedging strategy changes to Slide 22, a lot of new executions and terminations this quarter. I guess to start just can you help us understand like the net impact of these new moves in terms of like, does that help or hurt fourth quarter NII just to kind of put it into perspective?

Sure. So just to be clear, on that page, Ken, you'll see an incremental $6.7 billion of pay-fixed swaps. Those were put on to provide some AOCI protection to higher rates. And then the termination of the $7.5 billion of 2024 pay-fixed swaps that we've been obviously talking about now for a couple of quarters. Also done really to guard against higher rates or the prospect of higher rates or as we said kind of rates that remain higher than the forward curve, which is relatively flat down through '24, but has some cuts in the back end. So anything that's sort of there or higher we'll get some protection from both of those positions. I would think about in terms of reducing our kind of NII at risk to higher rates kind of by half to a staged 200 basis point rise, so kind of an extreme scenario, but we're kind of reducing that liability sensitivity there just to protect both capital and earnings.

Okay. I'm trying to understand your outlook for stable net interest income from the third to the fourth quarter, especially with the risk-weighted asset reductions impacting that. Additionally, in relation to the slide on maturities you provided, are the new additions also contributing positively in the fourth quarter and supporting your forecast for this period?

So if I think about the NII fourth versus third, Ken, the swaps and treasuries maturing, which we've talked about and think about, like, if rates don't change, the swap terminations won't have a huge impact versus what we've already shared. It's really protection against rates going up. The payers will add a little bit of NII because we're picking up a little bit of incremental positive carry there. And then you'll see the benefit of a pull through in the quarter of lower wholesale borrowing.

Got it. Okay. All right. Perfect. Thanks.

And then all that incorporates I think this was, sorry, implicit or maybe explicit in your question, it all incorporates RWA reduction and the loan reduction specifically that we talked about.

Understood. Thanks. Just to clarify, will we see a return of the treasury book run-off? Do you have any updates on how you plan to handle the rest of the securities portfolio? Will it also continue to cash flow down over time?

Yes. So we're seeing about anywhere, just call it roughly $1 billion of cash flow per quarter, coming out of that book. We've used some of that sort of through the course of this year as cash and just short-term liquidity just given some of the things that have happened. You'll see us start to deploy that back into the portfolio in a variety of different ways, but really focused on bringing the duration of that overall portfolio down.

Thank you. And the next question is from Gerard Cassidy from RBC. Please go ahead.

Hi, Chris. Hi, Clark.

Hi, Gerard.

Chris, you were very emphatic about the strength of the credit book for KeyCorp which is great. Can you guys share with us the second derivative risk? And what I mean by that is maybe some of the non-depository competitors or even depository competitors in your footprint or franchise may be taking undue risk and you may have a customer that borrows from them as well that could then impact your credit quality. Do you know if the competitors are being more rational than in prior cycles, which would obviously have an impact on everybody, not just KeyCorp?

Thank you for your question. Given the excess capacity in the loan market, we're not seeing the expected increase in spreads in the private loan market at this stage of the cycle. Additionally, there haven't been significant structural changes that one might anticipate. As I have mentioned before, on a risk-adjusted basis, a properly graded standalone credit seldom returns its cost of capital; if that's the case, I believe much of that lending is actually underpriced. On another note, we have excellent visibility into our third-party commercial loan servicing business, where we service over $640 billion, including more than $200 billion in special servicing, managing complex deals we aren't directly involved in. This segment has already set a record for the year, providing some insight into the current landscape. Clark, would you like to add anything?

Yes, I have a couple of points to mention. Firstly, Gerard, among banks, it's consistent with our previous comments about managing relationships. You'll see us protecting our best credit relationships, but this also involves additional business to support those relationships, which ties back to Chris's point about standalone credit. Overall, I believe banks are acting rationally while safeguarding their top relationships. Reflecting on the third-party non-bank credit market, I'd like to make a retrospective and a prospective comment. In the past, a significant amount of credit has moved outside the bank market. The question to consider is whether some of these non-bank or FinTech originated loans end up on bank balance sheets. We should be asking this broadly, although at Key, we have very little, if any, of that business. Looking ahead, some capital rules are prompting private credit funds to discuss flow agreements and taking credit over time. While that hasn't been finalized yet, there is certainly a lot of discussion and activity taking place.

Very good. Thank you for those insights. And then as a follow-up question, Clark, on the hedging strategy, you've given us a lot of detail. And we all acknowledge forecasting interest rate is very difficult. In fact, I find it very interesting. If you go back to the Federal Reserve's June 21 dot’s forecast for the Fed funds rate, at the end of '23 they were forecasting a 0.625 Fed funds rate. They missed it by 500 basis points. So my question for you guys, the long tail risk, what is that for next year? Everybody sees, you've been very clear about the benefits by the net interest income on an annualized basis first quarter '25. Everybody sees that. What could go wrong? Or what's that long tail risk that we need to just keep our eyes on or you guys are keeping your eyes on?

Yes, there are likely a few different scenarios to consider. Right now, we find ourselves particularly vulnerable to rising interest rates. We're carefully evaluating what will happen when rates increase, as there is a time factor involved when treasuries and swaps mature. The immediate impact is felt in the yields. We are considering situations like stagflation, where the economy might be slowing down while rates are high. It's common to think that a weaker economy would mean lower rates, but there are certainly situations where this isn't true. We're assessing all the potential consequences and the adjustments we can make in response. Additionally, in the past, we discussed how quickly rates might fall as refinancings occur and whether we could secure favorable repricing when treasuries and swaps mature. We've mentioned our hedging strategies for 2023, and we have several key advantages if rates were to decrease quickly. We are considering a wide range of conditions and doing our best to forecast accurately, while also ensuring we are ready for various potential outcomes.

Clark, regarding your point about rates potentially decreasing more quickly, I'm pleased to hear you are considering that, even if it seems unlikely. If such a scenario were to occur, do you believe your funding costs and deposit rates would decrease as swiftly as the changes we would see on the asset side of your balance sheet, based on your experience, or would they be slower to adjust?

So the nice thing on the way down from the commercial deposit book, which I know you know, Gerard, but it's sort of $55 billion was $33 billion pre-pandemic, so it's pretty meaningful for us. A lot of that's indexed, so it will move when rates move. Now, they're not all indexed at 100%. So you'd have to take that into account. But that stuff tends to move as the market moves. And I think that's a positive. What's always tougher to predict is the consumer book, which obviously was a little sticky going up and it generally is a little sticky coming down. And I think that'll be as much a function of micro market and micro competitive environment. So how are people thinking about those and other sources of funding? If rates do come down quickly, it does tend to make people, people being sort of the industry broadly, think about wholesale funding differently. So you might see more relief on deposits that would cause the consumer to follow faster, but the pace at which consumer rates come down is always the question there.

Great. Thank you so much.

Sure.

Thank you. And the next question is from the line of John Pancari from Evercore. Please go ahead.

Good morning.

Good morning.

Hi, John.

On the only expense outlook, just wanted to get a little bit more color. I know third quarter came in a little bit above expectations, and some of that is on fee revenue. But as you look at fourth quarter and your flat expectation for 2024, can you maybe talk about the puts and takes there, like, what are some of the areas where you could see pressure? And where do you really see an opportunity to pull back and keep the number stable? Thank you.

Sure. So let me just hit the third quarter for a second, John, as I just want to clarify. So we came in a little bit high. As you mentioned, I would just point to kind of about $20 million of one-time costs in the quarter related to illegal reserve build, a Visa settlement that came in late in the quarter and then some elevated medical claims. I think net of those we were sort of consistent with the relatively stable guidance. The core in fourth quarter we think will be consistent there as well, again, relatively stable. Just to reiterate kind of pointing out a couple of very or a few very identifiable one-timers, namely FDIC assessment should it come through, some additional expense management related charges, and a pension charge. So relative or net of those, we feel like it'll be stable. The big move also in the quarter was around personnel. And that was primarily driven by the change in stock price. So that is a variable. But the work that we did earlier in the year, as Chris referenced, kind of the beginning of the year getting '23 flat and some of the work we're doing in anticipation of making '24 flat, aside from the charges we take, will provide a little bit of tailwind on expenses in the quarter. And we continue to push hard on real estate and things like third-party contracts, which we historically have talked to, but we're moving more and more away from third parties and more focused on using our own folks to do the work we're doing. So we think we have that circle and there's obviously always surprises that can come through, but we feel pretty good about the core stability.

And in that real estate rationalization and the third-party contracts, are they the main areas of opportunity as you look at 2024 as well?

There will be, as Chris said, as you kind of shrink the balance sheet, you do have to shrink the expense base, and our largest cost is personnel. So there will of course be some personnel related to that. But we are starting to understand the trajectory of in-office now. And I think we're going to be even more aggressive than we have been about real estate positioning. And again getting those third-party contracts, so I would view it as meaningful pieces of all three of those, but certainly people will be part of it. Chris, it's Chris. We will continue to work across the board of all of these things. We’re down from an FTE perspective in the last year, about 900 people, teammates. And so as we continue to focus on simplifying our business, streamlining our business being a smaller, simpler, more profitable company, a lot more to say on that as we wrap up the fourth quarter.

Got it. All right. Thanks, Chris. I'd just ask one last one on the commercial portfolio, Shared National Credit, sorry if I missed this, but have you sized up the size of that Shared National Credit book, and then what portion of that is your lead agent?

So we've never given numbers around the SNC book. Everyone obviously just got their SNC results. And I can tell you in all my time in this business, our results were the absolute best we've ever had. But we've never disclosed the numbers in terms of dollars or amounts.

Okay. You plan to?

No, we really haven't disclosed that in the past. But as I mentioned, we just received our results, John, and I am very pleased with them.

Got it. Okay. Thanks so much, Chris.

Thank you. The next question is from the line of Manan Gosalia from Morgan Stanley. Please go ahead.

Hi. Good morning.

Good morning, Manan.

On the RWA reduction, it sounds like you're saying $10 billion down is the right level and you don't see the need to do any more next year. But does that mean you can grow next year and can you lean into loan growth a little bit in certain areas? And if so, does a level of rates in the future matter?

That's a great question. In response to Erika's question, I want to clarify that we will not focus on reducing RWAs in the same way as we have this year. However, we will continue to evaluate each of our portfolios and optimize our RWAs, as they are essential for expanding our client base. Our efforts regarding RWAs are ongoing. What I meant to convey is that, at this stage in the cycle, we will be pursuing both strategies.

Got it. Okay. And then as we think about cash and liquidity levels, I think you noted there might still be some more room to bring down cash a little bit. A lot of your peers seem to be building cash quite meaningfully this quarter. So how are you thinking about the right levels of liquidity? Is it just a function of you might be replacing the maturing treasuries with cash or other low-duration treasuries? And what's the right level you think you need to hold right now?

Yes, good question. So historically, Manan, we would have been kind of $2 billion on any given day. I think we went as high as $11 or $12 this year in the kind of $6, $7, $8 range in the quarter. I think we would migrate that down to $4 to $5 over time. But your view on as treasuries mature, holding those in cash or a shorter duration treasury portfolio is the right way to think about it.

Got it. Thank you.

Thank you. The next question is from the line of Matt O’Connor. Please go ahead.

Good morning. I wanted to follow up on expenses and a couple of things. I guess, first, what's the base of expense for this year that you're trying to keep flat too, because you have some items coming in 4Q called out from this quarter and obviously had some in 1Q as well? So what's the base as we think about flat costs for '24 that you're targeting?

I would think the range of kind of $4.4 billion, Matt.

Okay, that's helpful. And then the pension settlement charge just for modeling purposes, I know that's ex the guidance for 4Q, but how much do you expect that to be?

We said $15 to $20, in that range.

Okay. Sorry, I missed that. And then just lastly, anything on the criticized loans. Not everybody discloses this, but you've got a slide in your deck that shows it and it's bumped up a couple of quarters in a row here. Is that just kind of normal progression or what would you call out there?

Yes, we are critically reviewing our portfolio. There are a few categories we are focusing on, such as transportation and healthcare, along with some consumer product businesses. We take great pride in this process, and Mark Midkiff is helping us analyze it closely. I don't believe there are any additional loss contents at this time. However, given the current cycle, it's important to closely examine anyone with floating-rate debt. This is primarily why we've seen the increase from 3.3% to 3.9%.

Okay, that's helpful. Thank you.

Thanks, Matt.

Our next question is from Ebrahim Poonawala from Bank of America. Please go ahead.

Good morning.

Good morning.

I would like to follow up with you, Clark. Referring back to your discussion with Ken, regarding the $46 million in net interest income expected from the roll off in the fourth quarter, your net interest income guidance remains flat. Excluding that $46 million, net interest income would decrease by 5% quarter-over-quarter. I understand there are several factors at play. What are your expectations for the core level of net interest income beyond the fourth quarter regarding RWA optimization and depository pricing? Will that net interest income remain stable, or do you anticipate it to decline on a core basis?

Yes. When you mention core basis, I want to ensure I understand correctly.

If we remove the lift from the Slide 9 that you have from the swaps and the treasury maturities, if we didn't have that, what in your view would NII do through the next few quarters?

I understand your point. To clarify, I believe the core business remains intact even without those positions. It’s vital to highlight this aspect of the business. I agree that there are various factors at play. If interest rates remain stable, we've noticed a slowdown in deposit pricing from the second quarter to the third quarter, and while net interest income is still declining, it appears to be stabilizing. You'll continue to observe some increases in deposit costs. Additionally, we're gradually reducing the loan book, which presents some challenges. However, we are actively working to decrease wholesale funding costs, which are typically higher than deposit costs, providing some relief to the trends you mentioned. I would recommend focusing on the overall performance of the core business, excluding swaps and treasuries. We mentioned that we’re at or near the lowest point for net interest income, which is encouraging, assuming interest rates follow the current trajectory. One concern is that the first quarter has one fewer day, affecting seasonality in deposit balances. Historically, aside from 2021, we've usually seen a decline in deposit balances of 1% to 3% in the first quarter. These are the factors we are analyzing, and we will have a clearer perspective on 2024 when we provide guidance in the fourth quarter call.

That's helpful. All I'm trying to get to is if you're at $920 million in the fourth quarter, the roll off should take that $900 million to $1.1 billion something in that vicinity. And I'm just trying to think what would be the mitigations to get into a $1.1 billion quarterly NII by the end of next year, but that was good color. Thank you. That's all I have.

Thank you. Our next question is from Bill Carcache from Wolfe Research. Please go ahead.

Thank you. Good morning, Chris and Clark. I wanted to follow up on the points you've made around the NII opportunity from repricing. There's a debate around the possibility that some of the upside from the repricing of the swaps and the securities could be offset by the need to further reduce RWA levels beyond that $10 billion level that you've highlighted. And I think you've talked around some of the surrounding points, but maybe if you could speak to that specifically, that'd be helpful?

Yes. So maybe just to clarify so that we're all talking about the same thing, that Page 9 I believe which we've shared a few quarters in a row now, just to make sure, that is focused on specifically the impact from the treasuries and the swaps. So as we've said before, there are other components when rates go up and that improves. There are obviously funding pressures as well that come in and conversely when rates come down and these numbers look a little lower, there's funding pressure relief, so just want to make sure that we are isolating the thing that we're talking about. As it relates to this pool, Bill, this is obviously hedging a portion of the loan book and not all of the loan book. So even if we reduce loans, we expect we would see the benefits here. But there are obviously NII pressures if we were to continue to reduce the loan book beyond what we've talked about. Does that answer your question?

Understood. That's helpful. If I may ask separately, do you feel confident about your understanding of key customers who engaged in swaps when rates were low and are now facing pressure from rising rates? Can you provide any insights on that situation? I know that credit metrics are very strong, but any additional information on that aspect across your commercial portfolio would be appreciated. Also, if you think that is already reflected in the allowance, that would be great.

So there's no question. One of the things that we are focused on relates to the increase in criticized loans. We are monitoring customers who are exposed to rate increases, as they are significantly affected. Since we maintain a primary relationship with these customers, we have valuable insights about them. Therefore, to the extent we have visibility into this situation, we are indeed monitoring it, and it is incorporated into our financial projections.

Understood. Thank you for taking my questions.

Sure, Bill.

Thank you. And the next question is from Steven Alexopoulos from JPMorgan. Please go ahead.

Hi. Good morning, everyone.

Hi, Steve.

I want to start, so on positive operating leverage, if we look at the third quarter, revenue is down 17% or so year-over-year, expenses flat. Just given the trajectory of revenue through 2023, is there any chance you could deliver positive operating leverage in 2024? And I know you said you plan to hold expenses flat, but do you feel more of a sense of urgency to do more on the expense side? I think the last time you actually delivered positive operating leverage at least of consequence was 2019.

We will provide guidance regarding 2024 when we report our fourth-quarter results. However, we recognize the need to take further actions on our expenses. In the first quarter, we reduced expenses by $200 million, which amounts to roughly 4%. Currently, we are focused on simplifying our business and reducing risk-weighted assets. We will share more details in the fourth quarter. There is indeed a sense of urgency to streamline our cost base, especially since we are evolving into a smaller, simpler organization.

Okay. Is there any chance you think, Chris, that you do deliver positive operating leverage next year? I know we'll get more next quarter. But how are you thinking right now?

We'll know more when we finish our planning for 2024, Steve.

Okay. And then separately, obviously a lot of investor focus on your capital levels. I'm curious, given what we've seen out of the 5-year and 10-year part of the curve so far, how does that change the projected AOCI impact for year-end for what you're calling out on Slide 13 here?

Sorry, Steve. It's Clark. Can you just be a little clearer? How does it change?

So in other words, rates are moving up, which is working against your AOCI. You're saying you used the forward curve. I don't believe the forward curve in September contemplated the 5 or 10-year where it is. So were you saying you'll go from negative $6.6 billion to $6.2 billion? How does that $6.2 billion change given what we've seen in the intermediate part of the curve?

Got it. I don't have that number in front of me. It's obviously up given where we're really sort of focused on the five-year. So we have taken as we talked about some steps to at least mitigate that. But clearly when rates are moving at this magnitude, you can't cover all of it. So we continue to watch that closely. We managed TCE I think reasonably well in the quarter given some of those changes that you've talked about. But we're really focused on managing, assuming as Chris said to the contemplated new capital rules and timeframe making sure that we're in a position to get our capital to the right level as things phase in and markets move and we'll take the steps that we need to take to be compliant with those rules.

Okay, fair enough. Thanks for taking my questions.

Sure. Thanks, Steve.

Thank you. And at this time, there are no further questions in queue. And I would like to turn the conference back to CEO, Chris Gorman, for closing remarks. Please go ahead.

Again, we thank you for participating in our call today. If you have any follow-up questions, you can direct them to our Investor Relations team at 216-689-4221. That concludes our remarks. Thank you again and have a good afternoon. Goodbye.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T event conferencing. You may now disconnect.