Conference Transcript - KEY 2026-06-10

Clark Khayat, CFO

I'm Jason Goldberg. I cover the large cap banks in the U.S. for those that missed this morning's sessions. Last two large cap banks of the day, we have KeyCorp and then Citigroup from Key, which is up next. Please have Clark Hyatt, Chief Financial Officer. Clark, good afternoon.

Speaker 3

Thank you, Jason.

Clark Khayat, CFO

Nice to be here. I guess last year when you were on stage, the macro backdrop looked quite different than it does today. Just how are you thinking about the outlook for the U.S. economy and the passive rates and just any notable changes in client behavior or sentiment recently?

Speaker 3

Yeah, so if we were here a year ago, we would have been talking about how many cuts there were going to be coming into 26. We obviously haven't seen that. And if you look at the forwards this morning, now it's three pretty high probability hikes, so very different. That said, I think client activity generally remains constructive. The economy appears resilient, and I think some aspect of that is, you know, throughout 26, we've been working with an underlying constructive economy and a bunch of uncertainty, and every month the driver of the uncertainty changes a little bit, but it's uncertainty. So this is, I think, a flavor of it, and I feel like when we talk to our clients, they're telling us regardless of that source of uncertainty, they're getting comfortable sort of navigating this area. So business is performing well. You know, loan growth continues to be strong, albeit a little bit moderated in the second half versus the first half. But the first half was exceptionally strong. We continue to grow clients. We continue to see really good activity in, you know, pipelines and fee-based businesses. So overall, I think we're feeling quite good about the health of the business. And then, you know, credit quality continues to be pretty benign to improving. So, again, you know, you can point to a lot of things that we're watching, and we are watching, as you mentioned, rates, you know, some of the general tariff activity, the geopolitical risks. We're watching all those things. But generally speaking, it feels like the activity continues to be pretty good.

Clark Khayat, CFO

I guess another change since last year, about six months ago, you also assumed responsibility for tech and ops services at Key. and just maybe delve more into that, just, you know, what opportunities do you see to drive additional efficiency? And where is incremental investment needed? You have a billion-dollar tech budget. Is that enough in its backdrop? And just, you know, more broadly, what role do you see AI playing across functions throughout the organization?

Speaker 3

So the first thing I'd say is we've, you know, we've been on this journey since I got to Key in 2012 of kind of some proactive modernization of core systems every year. So we pick a couple, we modernize, and we make sure we're never, you know, too far behind. I think while we spend some money every year that feels like, you know, maybe not the most valuable in the moment, over time you just have a portfolio that's generally current and you're avoiding, you know, any significant huge investments. So I think that's – we've continued to do that. We'll continue to do that. The second thing I'd say is, you know, I inherited technology and ops over the course of, you know, March to July. We sort of assessed that, and I no longer have ops. I moved all the ops to the business. So that now is aligned directly with the businesses they support, and we did that because we think at this point it's really more important to have visibility end-to-end on that client and employee journey to understand that process, to have the data that underlies that, and frankly that's where we've seen AI be most powerful when you have all of those components in there. So you'll see us sitting here where everybody in the building has got access to co-pilot and things like that, and they're becoming more efficient, but we're looking at some of these big end-to-end areas to find some real AI-driven efficiencies, and we think they're there. So I'm sure we'll talk about it as we go here, but from this technology seat, I'm pretty optimistic about the ways we're unlocking the power of some of these tools, and I think they have the potential to create some real efficiency, And the question is, is that expense dollars out, or is it effectively just more revenue for the same dollar of expense?

Clark Khayat, CFO

Maybe shifting to the loans, I want to follow up on something you said. But, you know, in July, you raised your average loan growth outlook for the year to 4 to 5%, which had 8% to 10% in commercial loan growth. Within C&I, you know, strengthening utilities, power renewables, technology. You know, you talked about loan growth moderating in the back half of the year. Is that kind of, you know, in line with expectations? Just any update on how commercial loan goes trending so far?

Speaker 3

So, you know, I think we're confident here on the loan, midpoint of the overall loan guide for the year. I think, if anything, we might be leaning a little higher on the commercial side. So, again, we're seeing really good client relationship growth in those businesses, the industries you talked about, but also just broad-based middle market across all geographies. So, again, continue to see really positive opportunities there to add clients and add good return relationships over time. So it's moderating relative to, again, what was a significant first-half growth, but it's still, you know, quite valuable and quite strong.

Clark Khayat, CFO

Any thoughts just how AI-related investments, what role AI-related investments is playing? And then you're just looking further out, you know, to the extent that rates back up, those three hikes that you talked about, you know, how does that impact overall borrower demand?

Speaker 3

Yeah, so, you know, for us, we've been a leader in renewables now for a couple decades, and we're seeing the demand for power just drive a lot of utilities and renewable growth, and we're well positioned to take advantage of that, and we are. We don't have huge direct exposure to data centers, maybe, you know, $700, $800 million, not a lot in the broad scheme. But we don't see the power demand abating really anytime soon unless, you know, something pretty significant happens. So we feel good about, like, how we're picking our spots there and what we're seeing. You know, our guidance on NII and NIM is pretty kind of rate movement agnostic right now. So I think, you know, we're set up to be neutral, as we have been for several quarters, and we can kind of zig and zag with those moves. I think the thing I would have expected maybe at this point just coming into the year is a little bit less loan demand than we've seen, just because rates are not necessarily historically high, but they're certainly higher than people would have thought at the beginning of the year. That hasn't seemed to drive through the bank loan market. I think if we got three more hikes, you know, you might start to see something slow. but we just haven't seen that yet.

Clark Khayat, CFO

And then, you know, something on the second quarter earnings call that a bunch of banks called out was just kind of loan spread narrowing. Just, you know, maybe give us some color in terms of what you're seeing.

Speaker 3

Yeah, so we saw a little bit of dip through maybe the middle of the second quarter. It stabilized at, you know, prior levels at the end of the quarter, and we've seen that be stable through the third quarter so far. I think for us the loan spreads at this point are almost 100% a function of the credit quality of the borrower. So as we're, you know, going up the credit spectrum, we're obviously going to see naturally thinner spreads, but it's not a pricing issue or a competitive issue as much as it is just the quality of the borrower.

Clark Khayat, CFO

And then one of the things kind of weighing on loan growth overall and just, you know, why total loan growth is less than commercial loan growth is you've been running off some of these lower-yielding consumer loans. Just where are you in that initiative today? How much further do you have to go in that process?

Speaker 3

Yeah, so what's interesting is we have a little bit higher loan balances this year because of rates, and so we haven't seen that book run down as much as possible. If you care about loan balances, you like that. If you care about the composition of those, you don't. So I'd rather see those run off faster because we're recycling those dollars for funding, and obviously we're picking up spread and return profile. So that's been a little bit of a headwind, actually, the lack of that, and call that, you know, we would have expected maybe $500 million to $600 million rolling off in a quarter. Now it feels like closer to $400 million. So we've got some time to go. I don't think today there's a lot of volume to replace that. You know, mortgage rates, I think, are maybe as high as they've been since pre-financial crisis or close.

Clark Khayat, CFO

So I don't think we're going to be replacing any of that with current mortgage.

Speaker 3

We do have some opportunities in home equity. I think those are a little further out. So I'd expect this runoff pace to sort of continue through 27. But, again, for us right now, it's a good recycling mechanism and an opportunity to pick up both spread and overall return.

Clark Khayat, CFO

And then I guess on the second quarter earnings call, you talked about deposits. We saw the period deposits rise after dropping in May, but I think you noted there were sometimes one-time factors involved. At the same time, you're calling for average client deposits increase by more than 2% or I think $3 billion in the back half of this year. Or is that still the way to think about that? Maybe just talk about current trends, whether it's balances, mix, pricing.

Speaker 3

Yeah, so, look, I think appropriately, you know, the question on the call was, hey, how do you have confidence that you can actually grow a deposit at that level and do it at a valuable, you know, balanced price mix? So what I would say gave us confidence there, and we're seeing it pull through, so I feel obviously better about it, is we have a lot of data over time on seasonal trends, particularly in our commercial operating book. We've seen those build back up after that kind of May bottom, and we're seeing that happen, and we're seeing it happen at what is a constructive price. So we're not seeing a ton of movement on overall deposit costs, maybe a basis point or two so far. I think we're on pace to meet or exceed that deposit growth. So, so far, you know, if we've seen net loan growth in the quarter up maybe, you know, a billion and a half dollars, we're seeing deposit growth exceed that by, exceed that by more than a billion, right? So we're seeing, you know, those things bounce back the way we had historically expected. And on top of that, as we add new relationships, we're seeing new to bank deposits come in and often those are going to be operating in nature, and so they're well-priced.

Clark Khayat, CFO

So deposits are a little bit better than expected. I guess when you look across your markets, whether it's kind of northeast, midwest, Pacific, northwest, west, just any differences in the petodynamics or pricing behavior, and then say the Fed hikes on Wednesday, what kind of data should we be thinking about?

Speaker 3

Yeah, so let me bifurcate just consumer and commercial because we're talking a little bit about that. I think commercial deposits, you know, I'm not sure the markets are hugely different, you know, particularly kind of middle market and up. They're sort of a kind of market-based view of that generally, and so I don't view those often as hugely geographic specific. And, frankly, we lend all over the country, so it's not as tied to the branch network as the consumer deposits. In our consumer book, and by the way, we're seeing more of the growth in the commercial side. So, you know, that understanding that dynamics has been very helpful. On the consumer side, you know, we think of three markets, kind of the Northeast, the Midwest, and the West. We aren't seeing a change really in the competitive intensity or the behaviors, but they are three very different markets that give us a little bit of a, you know, of a balance effect because we're not getting hit in any one way all at once. and so that's been sort of the way it's operated for the last few years and that hasn't really changed this year from a Fed hike standpoint you know if we got a hike we'd be slightly that'd be slightly beneficial but again we're pretty neutral and my expectation is you'd see kind of a low 40s beta pretty quickly as kind of the consumer term stuff rolls in over time That, again, would be slightly accretive to us in 26, and then it would sort of get more neutral over time as that deposit beta. I presume we get back to kind of 50 to 55 as it has in the last up-and-down cycle.

Clark Khayat, CFO

Got it. And you mentioned this quarter deposit growth outbasing loan growth. Last quarter loan growth was outbasing deposit growth. Who knows what the fourth quarter will bring. But, you know, in the second quarter you kind of added some short-term borrowings. Just maybe talk to just how you think about just overall borrowings and the balance sheet funding. You guys have these hybrid accounts. And just how you think about just balancing the overall funding strategy.

Speaker 3

Yeah, I mean, at the end of the day, we talk a lot about deposits and deposit betas for all the reasons that make sense. It's the gross majority of funding. But at the end of the day, what really matters is what's your cost of funds overall and how effectively are you managing that. So our view is we want to be core client deposit funded for the most part. And when we're seeing the seasonality that we tend to see, and we saw it in the second quarter, we've talked a little bit about that, you don't want to move the entire interest-bearing book to solve a short-term problem. So, you know, again, we have the confidence there that it was going to rebound post-May. It's done that. And because we had some historic visibility into that, We used some wholesale borrowings to fill that gap in that time frame. As these deposits grow and they outpace loan growth, we'll be able to bring those back down. And, again, we'll always sort of pull that lever on the margin, but we're trying to be as client deposit funded as possible, you know, pretty much all the time.

Clark Khayat, CFO

Got it. And then, you know, on non-interest margin, you're 289 in the second quarter. Maybe just walk us through the path to reach kind of their 4Q target of 305, but that's still the level. And then, you know, 325 plus, you know, for next year. And, you know, as we think about next year, just kind of, you know, what do you need to do or need to see to get to that plus figure?

Speaker 3

Yeah. So the, I mean, the story I think is now maybe becoming a little boring because it's a similar story. There's a bunch of fixed asset repricing, you know, we'll see 9 billion in the second half of 26. And then the rest is really around what we just talked about, which is deposit balances at the appropriate rate and otherwise funding optimization, right? So that's really what we're seeing there on the NIM side. And we feel good about that given the trajectory we're seeing year to date. If you roll into 27, kind of similar story, another 21 billion or so of fixed asset repricing, and then deposit balance, funding optimization, the same sort of dynamics. Look, I think if we see three rates, more rate hikes or more. I think the real question is what's happened to loan demand. So, and, you know, while the loan demand is obviously should be in most cases NII creative, it is on the margin today a little bit NIM dilutive. So, if we're just talking about NIM for the moment, right? Less loan demand means less requirement for funding, which means you can price the deposits a little bit less aggressively, right? So, you got some trade-offs there on the NIM side, and I think we just have to watch as that rolls out because again as I watched this year I would have expected as rates stayed high, loan demand to come down it just hasn't happened I guess you mentioned $21 billion of fixed rate assets repricing next year Kenya broke 5% today you mentioned mortgage rates very historically elevated I assume that kind of helps the repricing story it helps the repricing story on certainly our investment portfolio and to the extent you're putting swaps in place on the floating rate book, you're seeing levels, swap levels we haven't seen in quite some time. On the loan demand level, the question is how much loan demand will there be? And then I think the other point is if there are going to be those hikes, our funding costs are obviously going to go up across the board. The question is, is spread going to move? And I think the question really is if you're not willing to take more credit risk, is the spread for that quality client really moving even though overall funding costs are going up and that that's just you touched on kind of balancing nai growth with nim growth and kind of sometimes the trade-offs um you know between the two just how do you balance that carefully um i mean look i think in a perfect world we're often looking at something that is nii accretive and NIM neutral, or maybe it's NIM accretive and NII neutral, you're trying not to have to go down on either one really aggressively. And again, we've been on the margin. I think, you know, we took our NIM guidance down a couple basis points just because we were putting on good relationships. And we thought that was the right thing to do long term.

Clark Khayat, CFO

Because I think if I'm sitting here in a year and I tell you, this would be hard to do.

Speaker 3

But theoretically, if I said, hey, we're going to hit our NIM guidance, but miss our return guidance, I think that's a worse answer than the alternative. So we're obviously trying to do both, but we're also trying to build long-term, consistent franchise value and returns. And so really, at some point, it's discussion about what are we looking at, what's available, and how much confidence do we have that the return profile, if it is NIM dilutive, is valuable.

Clark Khayat, CFO

Makes sense. And maybe just time this loan deposit NIM discussion together. You talked to 9% to 11% NII growth for this year, average earning assets of, you know, up roughly $1 to $2 billion in the back half of the year. Is that still the right way to think about it?

Speaker 3

Yeah, I think we feel really good about the 9 to 11. The earning asset piece, again, still feels about right. So we're on trend for both. We, you know, we put out some updated guidance today. Didn't impact that at all. So, again, still feeling good about it.

Clark Khayat, CFO

Any other changes in the guidance we should know about?

Speaker 3

We really changed fees and expenses to reflect the Clearwater – closing the Clearwater acquisition in August. I'll cut that question off. I guess on investment banking – I didn't see what you got into, so I can't – Okay, so we took fees and expenses from three to four to four to five – or, sorry, fees to three to four to four to five, and we took our expenses from three to four to about four.

Clark Khayat, CFO

So think about that as roughly kind of a PPNR-neutral transaction in the back half of the year, just given some deal structures and integration costs and things.

Speaker 3

We're competent over time. It migrates to sort of standard profitability. But really, that is the driver of the guidance change.

Clark Khayat, CFO

I guess maybe sticking on investment banking, you were talking about 20% sequential growth, that line item, fee pools down. this quarter. Maybe just update us there. And just looking further out, middle market M&A activity has yet to normalize and financial sponsors have not returned. What's your outlook for these businesses?

Speaker 3

How is the broad market performing versus our expectations? And there was a strong second quarter. We weren't as strong in some of that natural business mix versus some of the league tables. The other piece is we tend to zoom out and really think about capital markets on more than a quarter basis because it's hard sometimes to time exactly when the transaction is going to happen. But our view is when we get into a specific quarter and we guide it up, as you said, 20% plus, which we feel good about based on current activity, it really is a bottom-up client activity. It has a little bit less to do with kind of the broader market trends in a particular quarter, we tend to see those trends play out a little bit more over time, assuming they apply to our book, right? So we're not a big trading business, right? But we're, you know, bigger in obviously things like syndications, M&A.

Clark Khayat, CFO

We continue to see very strong pipelines, record pipelines we talked about in M&A.

Speaker 3

We hadn't seen those pull through. We're starting to see some of that pull through, but I would not call it normalized. And I wouldn't say the sponsor behavior is normalized either. The guide that we've given on, you know, 26 and 27 as it relates to, you know, returns doesn't require those to be sort of going full go. So if those markets opened up and really started going, I think there's some upside there. But right now we're seeing, you know, again, good client activity and expecting to see that pull through. The one place that rates really does impact in the near term is kind of commercial mortgage placement. So as rates go up, you know, people tend to want to sort of watch and time the market a little bit on a permanent rate before they hit the market.

Clark Khayat, CFO

Got it. And you touched on clear water. It's now closed. Maybe just talk about, you know, just how that impacts your overall franchise and just kind of the strategic rationale for that business.

Speaker 3

So, you know, we've obviously over time done a fair amount of capital markets add-ons. Clearwater is a firm based in the U.K. with some European footprint where we've been a referral partner now for five or six years. We've, you know, co-led some transactions together or referred. So we know the partners. We know the principles. Good cultural fit between the businesses. And we've operated, you know, quite well as a team. So it felt like this is just a formalization of a prior referral relationship. So on the integration side, on the cultural fit side, on the overall execution of a transaction, it felt very low risk. And it gives us, you know, now very connected distribution into the UK and Europe and vice So there is a natural fit there that we feel benefits the firm strategically over time. As I said, it's, you know, pretty neutral from a PPNR standpoint this year. We'd expect it to add something in the sort of $60 to $70 million of revenue next year. Again, market neutral. You know, if the market remains constructive, we'll see what happens. And that doesn't necessarily require us to be, you know, realizing a ton of synergies on top of that. It's just it's a very solid business with folks that we know. so it's consistent with us and kind of lower risk we'll continue to look at transactions that sort of fit that either by expanding distribution capabilities or filling or building industry net so we've been an industry focused bank for decades now and that served us well and these platforms tend to be most productive when they're not generalist but are kind of equally focused on certain industry groups and when we look at the change in fee guide it was solely due to Clipwater.

Clark Khayat, CFO

And then maybe away from capital markets, you know, when you just think about fee income in general, what do you see the biggest opportunities for growth?

Speaker 3

Yeah, for us, it continues to be payments and wealth. So, you know, the payment side, we've seen, you know, low double-digit growth in those platforms, you know, year over year. We continue to see really good deepening of client relationships. We've had a focus on payments now for over a decade. If you were sort of in our pipeline meetings, you'd hear people talk about payment attachment. When we make a loan, we expect the deposits and the payment products to be connected to that loan and then sort of get those clients up and running as quickly as we can. You talked earlier about hybrid accounts. Just recall those are sort of put your non-interest-bearing and your interest-bearing deposits in one pool. We do the calculation on compensating balances for the client. We apply the excess rate we've agreed to. It also gives us opportunity to deepen those relationships through additional payments products. And we've done a phenomenal job expanding that. And what that means is we either get more hard fees or we get more compensating balances that show up as non-interest bearing. So that's been a phenomenal opportunity for us. We'll continue to do that. And then if you think about wealth, you know, second quarter we hit a record AUM for key at $74 billion. We continue to drive great traction in our mass affluent segment. And we continue to be pretty lightly penetrated, even though we've added something around 60,000 accounts in the last two and a half, three years. And we see pretty good runway there, and we'll continue to invest in that. I think both of those areas from an M&A standpoint are challenging for banks, just given the multiples in those businesses. So at this point, we're kind of a decade plus into making equity investments, commercializing fintech capability in the payment space. We feel very capable and very experienced doing that. We'll continue to do that where it makes sense. On the wealth side, it's a much more organic story because it's just a little bit harder to make those deals work.

Clark Khayat, CFO

Makes sense. On expenses, even adjusting for the acquisition, it seems like a pickup in the back half of the year versus the front half. but just maybe just talk about any seasonality to that and how you're thinking about it. Yeah, so a couple things happen every year.

Speaker 3

We tend to have, because of our capital markets focus, we tend to have more client activity in the back half, which drives a little bit more incentive comp. So that's very normal for us. And if it doesn't happen, obviously we don't pay out the incentive comp. So we have some variability in that base. We tend to do a little bit more marketing in the fourth quarter in the back half of the year. And we tend to, over the course of the year, ramp up some of our technology investment spend. So that's normal. We don't see anything there that's, you know, that's going to pop or out of line. We are, again, seeing the clear water piece add to that. So we just wanted to reflect that in the guide because we know that will come.

Clark Khayat, CFO

Got it. And I guess maybe, you know, your guide still kind of 400 basis points plus a positive operating leverage, you know, for this year. You know, we talked earlier kind of starting the 2027 budgeting process. Just how are you thinking about expense growth, investment priorities, and just operating leverage in 2027?

Speaker 3

Yeah, I mean, one, we tend to want to be very focused on operating leverage for all the obvious reasons, and we continue to feel really good about the organic growth story. So we think we've got runway, again, subject to anything changing in the macro environment. We're going to invest in the business. We've added a lot of bankers. We've invested in technology. We'll continue to do that. We haven't really determined the pace of that. You know, as you and I were talking before we started, we're sort of in the beginnings of our 27 planning, so we'll obviously share that in January. But we feel good that we can continue to invest in the business and manage expenses in a disciplined way. And, again, I feel like some of the early AI proliferation we're seeing inside of Key makes me really optimistic that we're finding ways to scale that don't actually require us to add a lot of people.

Clark Khayat, CFO

So if revenue came down, we might have a different conversation.

Speaker 3

But right now, if you're seeing revenue growth, I feel like we can do a lot of the current activities we're doing today through the benefit of AI. We don't have to add staffing to support more clients and more revenue because some of that work can be done on those platforms.

Clark Khayat, CFO

And maybe shifting gears to credit quality, non-performing assets were up $126 million in the second quarter. You talked about a few specific credits in real estate, consumer goods and agricultural sectors, I know charge-offs were relatively benign, and you didn't change your charter accounts for the year. But just maybe update us on those three credits and those sectors of concern, just what else are you watching more broadly?

Speaker 3

Yeah, I think those three sort of reflect the overall sectors of concern. So, you know, if you think about where we're watching things, it's commercial real estate, it's agriculture, it's consumer goods, right? Those three, whether it's rates, whether it's tariffs, whether it's labor availability, you know, whether it's the ongoing Amazon effect, all those things sort of hit those three areas. That said, you know, we're seeing all our credit metrics improve in the quarter. The NPAs we talked about last quarter, we thought we had line of sight to resolution. We're seeing that happen. Our charge-offs are coming in, I think, or they're going to come in below the guide. So, you know, that's one quarter, so we're going to continue to watch that. But if we see the current progression, you know, we might have some opportunity to lower that view for the year. But right now, you know, credit quality just continues to be really benign.

Clark Khayat, CFO

I guess against that backdrop, you know, how do we think about maybe reserve levels going forward?

Speaker 3

You actually had a release in 2Q despite, you know, the MPA rise. um yeah i mean i i feel like one um we built through a lot of 25 um just given some of the uncertainty um we as you noted we did have a little bit of release last quarter i think we feel pretty good about our reserve levels but you know the trends overall continue to improve so at some point you know you have to figure out what you're holding and um how supportable that is so So I don't know where we are exactly on that, but I wouldn't see, obviously, a build coming unless something changes dramatically in the next two weeks. And I could see some opportunity to release. The question is how much, just given the trends we've seen so far in the quarter.

Clark Khayat, CFO

I guess does the potential backup in rates frighten you at all?

Speaker 3

I mean, it's 100% something we're going to watch, right? So the question is in which areas, and we talked about commercial real estate, the way that is manifested over the last few quarters when it happens is good clients stay on, they put more dollars in the interest reserves, they decide they want to extend, they put more capital up, and they basically say, hey, we're going to stay with you until the market changes. we're generally comfortable with that so we'll see where that goes but that certainly is a watch point and then I think if you look at some of the geopolitical risk and other things that are happening we're always watching that and that's been reflected in our reserve builds over the last several years and those reserve builds have often been a qualitative offset to what our models are telling us so the question is do you keep building qualitatively if you see good performance And then on capital, you know, CT1 marked with like 9.8 last quarter within the 9.5%, 10% guide you talked about.

Clark Khayat, CFO

Potential bottle changes should be beneficial. You know, share repurchase, I think you're going to do at least $1.3 billion this year. Just how do we think about, you know, capital deployment going forward against a backdrop where we maybe don't need as much?

Speaker 3

Yeah, I mean, our capital priorities remain pretty consistent. So, you know, you support client growth where you can, And obviously, we've had a fair amount of that. So we would have seen some real capital consumption in commercial loan growth this year. We're more than happy to do that. You know, you pay the dividend. We don't see that changing or a need to change that over time. And then, you know, you think about how to monitor the overall ratio and you tend to use those share buybacks to manage that. so we've been out there saying 1.3. I feel very good about that number. I don't see any reason to back off that. I do think, you know, we've talked a lot about rates as it relates to deposit competition, loan demand, general economy. The one place where it's had a significant impact is just on the AOCI and the portfolio. So, you know, the rules aren't official, but we've been operating as if they are. That'll have an impact on our mark capital in the quarter. I would expect us to be below the nine and a half in the quarter, just given that AOCI move. And I think we're very comfortable there given we've taken a very measured approach to capital return. There's nothing in front of us right now that would say don't achieve the 1.3. We think that's the right answer. And frankly, you mentioned the Basel III, you know, not official yet. Our expectation at this point is by probability, it looks the way it's been proposed, probably gets implemented in 27 for, you know, realization in 28. And I think we'd probably be short-sighted not to consider that aspect of it, which we think is 100-plus basis points of marked capital. We're not spending it today, but the question is, would you start pulling back on activities if you have some confidence that that's coming in the relative near term? So I think that's the balance. And right now, we feel very good about operating below that 9.5 given everything else going on.

Clark Khayat, CFO

Before, when we were talking about clear water, you kind of went through some non-bank acquisition and sectors you're looking at, maybe just shift gears to kind of bank acquisitions. I know you kind of always emphasize organic growth, but we do expect industry consolidation to pick up over the next few years just where does a traditional bank M&A fit in with that capital hierarchy?

Speaker 3

Yeah, I mean, I would continue to say at this point it's just not really a focus. And the question, you know, we've sat down and said we feel very good about the organic growth opportunity. I think we've demonstrated we can do that. We've done these fill-ins because we think they're overall just incrementally accretive to what we're trying to do. And I think we feel like the risk profile of those types of transactions is manageable. But I think we are focused on executing, on delivering on the commitments we've made. We've made them out now to fourth quarter 27. We feel very committed to delivering on those. And I think other things need to be different for us to really feel comfortable that the time is right for Bank M&A. And that's, you know, we need to deliver. We need to get our multiples and returns in a different place. And we think we have the organic path to do that. So that's job one, two, and three at the moment. And if, you know, if things change or some, you know, opportunity emerged that we weren't thinking about, maybe we'd think differently. But right now, there just isn't anything on the horizon.

Clark Khayat, CFO

And maybe sticking with the capital theme, I saw last month the final notice redeemed $500 million of preferreds. Just thinking about the capital back going forward.

Speaker 3

Yeah, that's a great question. So we redeemed, I think, about $525 million of our Series D. With that will come a little bit of redemption premium, so you'll see a little bit of noise in that preferred dividend line for us in the quarter. We have a Series E, another half a billion coming up in, I think, December. In both cases, what you were getting was, at the call date, a pretty meaningful step up in the back-end floating rate. So it was very efficient for us to take those out. I suspect we will, you know, go through the same calculus, and it will probably tell us to redeem the E. Within that, our hope would be to issue some new preferred, not at the full amount of those, but maybe something on the order of about 50%. The market hasn't been as kind on that profile, you know, in the last few weeks. We watched that closely, so we'll see if there presents an opportunity there. But all of this is probably noise in the second half on the preferred dividend line, and all of it to be in a more capital-efficient position over time, which frankly is very likely to lower those dividends.

Clark Khayat, CFO

Do you want to quantify the 3Q incremental impact?

Speaker 3

I think it's probably on the order of about $5 million.

Clark Khayat, CFO

And then on Scotiabank, I know they own 15% McKee. They filed to take it to $19.9 million. So just, you know, maybe update us on that and just the relationship and opportunities with them.

Speaker 3

Yeah, I mean, one, overall, I think we continue to have a very constructive relationship with them, although, at least from my seat, not a lot of interaction. So I think if you are listening to their calls, they've frequently touched on this as a financial investment, and I think one that they're quite happy with. And, frankly, if you're going from 14-9 to 19-9, like, presumably you think there's benefit in holding more. I do think it's important just to remind people that the original deal in 24 allowed them to go to 19.9, so there's nothing from the key Scotia relationship here that is different. We aren't contemplating nor would we contemplate issuing additional shares to get there. This is really Scotia and the Fed dealing with their allowable ownership percentage within that 19.9, and they have basically two paths to get to that ownership percentage. One is go buy in the open market. We view that as positive for us. The other is to not sell to us in the buyback and just allow themselves to float up. I think we've seen more of the latter, and my suspicion is it's a little bit about not wanting their absolute dollar investment to go down while preserving the appropriate level of ownership. So it really doesn't have much to do with Key, but we view it as a positive sign that they're happy with the investment.

Clark Khayat, CFO

Helpful. And then I guess, you know, based on what we've discussed so far, it feels like you're on track to outperform the 15% plus, you know, 4Q27 ROTC target. Is that correct? And then, you know, beyond 2027, you know, what do you need to do to kind of get back to that 16% to 19% ROTC range?

Speaker 3

Yeah, look, I think we said on the call in July that we were incrementally more confident. I think that holds. Again, subject to market conditions holding, so I think that caveat's always out there, but worth stating. I think it's not the sexiest answer in the world, but it is about continued NIM optimization and improvement over time. So getting to 325 and above, you know, obviously adds lots of value to that return profile, continuing to invest and realize our fee-based businesses. So, frankly, when we're adding commercial loans at the rate we are, we expect our bankers to be able to cross all those into our fee businesses, and we should see, you know, better fee growth performance over time, and we should be accountable for that. I think the third is continued discipline expense management. So, we think we can be in that kind of 3%-ish range over time and feel very good about doing that while investing appropriately because you don't want to starve the franchise. Managing capital at the right level, so Basel 3 comes in, is 9.5 still the right lower end or not? And if it is, what levers are we pulling to make sure we stay in that? And then obviously you've got to manage credit well because that tends to put a hole in the boat when you don't. So I think it's a pretty simple recipe and it really comes down to executing it effectively and appropriately. But I don't think there's probably anything I said there that you haven't heard repeatedly in your, you know, long career of doing this.

Clark Khayat, CFO

That makes sense. In the minute we have remaining, I guess anything I forgot to ask, anything one investor's focused on?

Speaker 3

No, look, I think despite some of the, you know, rate concerns and maybe some of the continued uncertainty, I think we feel very good about where the bank's position and how the business performing. Clients continue to express a lot of confidence, and we've been the beneficiary of that, and we'll continue to engage with them. I think we're on track to meet the commitments we've made, and we take that seriously. So, you know, subject to a lot of uncertainty, and it's our job to manage that effectively. We feel, you know, as we sit here today, we feel quite good about where we are.

Clark Khayat, CFO

Great. On that note, please join me in thanking Clark for his time today.