Jul 18, 2013
Executives
Beth E. Mooney - Chairman, Chief Executive Officer, President, Member of Executive Council, Chairman of Executive Committee and Chairman of Enterprise Risk Management Committee Donald R.
Kimble - Chief Financial Officer and Member of Executive Council Christopher Marrott Gorman - Vice Chairman of Keybank National Association and President of Key Corporate Bank William R. Koehler - President of Key Community Bank
Analysts
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division Bob Ramsey - FBR Capital Markets & Co., Research Division Erika Penala - BofA Merrill Lynch, Research Division Jennifer H.
Demba - SunTrust Robinson Humphrey, Inc., Research Division Josh Levin - Citigroup Inc, Research Division Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division Michael Mayo - CLSA Limited, Research Division Bryan Batory - Jefferies & Company, Inc., Research Division Marty Mosby - Guggenheim Securities, LLC, Research Division Gerard S.
Cassidy - RBC Capital Markets, LLC, Research Division Alan Straus Brian Foran - Autonomous Research LLP Terence J. McEvoy - Oppenheimer & Co.
Inc., Research Division Ryan M. Nash - Goldman Sachs Group Inc., Research Division John V.
Moran - Macquarie Research
Operator
Good morning, and welcome to the KeyCorp's Second Quarter 2013 Earnings Conference Call. This call is being recorded.
At this time, I would like to turn the call over to Ms. Beth Mooney, Chairman and CEO.
Please go ahead, ma'am.
Beth E. Mooney
Thank you, operator, and good morning, and welcome to KeyCorp's second quarter 2013 earnings conference call. Joining me for today's presentation is Don Kimble, our Chief Financial Officer.
And available for the Q&A portion of the call are the leaders of Key Corporate Bank and Key Community Bank, Chris Gorman and Bill Koehler. Also joining us for the Q&A discussion are our Chief Risk Officer, Bill Hartmann; and our Treasurer, Joe Vayda.
Slide 2 is our statement on forward-looking disclosure and non-GAAP financial measures. It covers our presentation materials and comments, as well as the question-and-answer segment of our call.
Turning now to Slide 3. Our results in the second quarter reflect the clear progress we have made in implementing our growth initiative, improving our cost structure and executing on our capital priorities.
Year-over-year, revenue grew for the fifth consecutive quarter with current period results benefiting from our branch and credit card portfolio acquisitions, loan growth and lower funding costs. Revenue trends compared to the first quarter were relatively stable with flat loan balances, with stronger fee income from commercial clients who are taking advantage of favorable capital market conditions.
And because of our distinctive model, we were able to capture the economics from these transactions while doing what was right for our clients. During the second quarter, we also continued to invest to drive future revenue growth.
We acquired a commercial servicing portfolio and added to our special servicing business. This allows us to leverage our existing platform and meaningfully changes the competitive profile of our commercial loan servicing business, positioning us as the third largest servicer of commercial and multi-family loan and the fifth largest special servicer of CMBS in the United States.
The first phase of the transaction closed as expected at the end of June. We've also continued to invest in our online and mobile offerings.
In the second quarter, we launched new remote deposit capabilities for both our commercial and consumer clients, which add value and convenience, consistent with changing client preferences. Reducing our cost structure and improving efficiency also remain among our top priorities.
From the launch of our expense initiative 1 year ago, we have achieved annual run rate savings of $171 million, a substantial portion of the $200 million target we committed to reach by December of this year. Importantly, reaching our target will be a significant milestone but not an endpoint.
We are already identifying new opportunities to both grow revenue and reduce and variabilize our expenses. And as we previously communicated, we expected this quarter to be the high point in terms of charges associated with our efficiency plans.
Consistent with our guidance, we incurred charges of $37 million, with a large portion related to the realignment of our Community Bank and the consolidation of 33 branches. In the second half of the year, we have another 14 branches identified for closure, which will bring our total to approximately 7% of our total branch networks.
As a result, noninterest expense was down $45 million from the prior year, excluding the charges for our efficiency initiative, as well as costs related to our recent acquisitions of credit card in the Western New York branches. And as Don will discuss, our cash efficiency ratio adjusted for the efficiency charges was 65.4% this quarter, just above the upper end of our near term goal of 60% to 65%.
And finally, we continue to manage our capital consistent with our stated priority. During the second quarter, our board approved a 10% increase in our common share dividend, and we executed on our share repurchase program by buying back $112 million in common shares.
This is consistent with our 2013 CCAR submission, which places us among the highest in our peer group for estimated payout ratio. And as we look forward, capital management will remain a clear priority.
Along with improving our operating leverage, we're both executing on our revenue initiatives and improving our cost structure. Now let me turn the presentation over to Don for some details on our financial results.
Don?
Donald R. Kimble
Thank you, Beth. Slide 5 provides highlights from the company's second quarter 2013 results.
This morning, we recorded net income from continuing operations of $0.21 per common share for the second quarter, compared to $0.21 for the first quarter of 2013 and $0.23 for the second quarter of 2012. And importantly, as Beth pointed out, we incurred $37 million or $0.03 per share of costs associated with our efficiency initiative this quarter.
I'll cover many of these results in my remarks, so I'll now turn to Slide 6. Average total loans for the second quarter were up $70 million or an annualized 1%, compared with the first quarter of 2013, and up $3.3 billion or 7% compared to a year-ago quarter.
Loan growth continues to be impacted by cautious client behavior, a competitive environment, and as Beth mentioned, the attractiveness of capital markets alternatives, which are well positioned to deliver to our clients. Our outlook for loan growth remains positive and consistent with our prior guidance of mid-single-digit growth for the year driven by CF&A.
Continue with Slide 7. From the liability side of the balance sheet, average deposits, excluding foreign branch balances, were up $1.7 billion for the first quarter and up $4.6 billion from 1 year ago.
Deposit growth for the first quarter was primarily due to an increase in demand and interest-bearing commercial deposits, including higher balances from some of Key's larger clients. Compared to the prior year, deposit growth also benefited from Key's acquisition of branches in Western New York.
Over the past year, our mix of deposits has significantly changed, with CDs declining and lower-cost transaction accounts increasing 13%. As a result, year-over-year deposit cost declined from 47 to 26 basis points.
Turning to Slide 8. Our taxable equivalent net interest income was $586 million for the second quarter compared to $589 million for the first quarter and $544 million for the second quarter 1 year ago.
Compared to the second quarter of last year, net interest income increased $42 million or 8% due to growth in average earning assets, which included our recent acquisitions, and an improvement in funding cost. I would also point out in the second quarter of 2012, Key's results reflected the impact of the early termination of leverage leases.
These transactions reduced net interest income by $10 million but provided a gain of $31 million in noninterest income, resulting in a net pretax gain of $21 million. For the second quarter, the company's net interest margin was 3.13% compared to 3.24% in the first quarter and 3.06% from the second quarter of last year.
As you can see on this slide, the decline in net interest margin from the prior quarter was primarily due to lower earning asset yields and higher-than-expected levels of liquidity resulting from softer-than-anticipated loan demand and higher levels of deposits. The higher level of deposits and as resulting impact on liquidity and investment securities was the primary difference from our prior guidance, as it reduced our margin by approximately 5 basis points.
The net interest margin also was impacted by the termination and maturity of $4.4 billion of interest rate swaps that were not replaced as we continue to increase our overall asset sensitivity. Importantly, the use of interest rate swaps provides us with the flexibility to manage and quickly adjust our rate risk position.
While Key was a little off with other asset-sensitive banks generally benefit from a rise in both short-term and long-term rates. The duration and characteristics of Key's loan portfolio and also investment portfolio position us to realize more benefit from a rise in the shorter end of the curve.
Recognizing that asset yields remain under pressure and given our higher levels of liquidity, we expect net interest margin to experience modest pressure in the range of 1 to 3 basis points per quarter in the second half of the year. We anticipate for the balance of 2013, loan growth will exceed deposit growth, which should result in a relatively stable net interest income.
Slide 9 shows a summary of noninterest income, which accounts for approximately 42% of total revenue. Noninterest income in the second quarter was $429 million, up from $425 million in the first quarter, but below the $457 million in the second quarter of last year.
Adjusting for the $31 million gain from the leverage lease terminations in the second quarter of 2012, noninterest income would be slightly higher than in the prior year. Additionally, principal investing gains were down year-over-year.
Many of our core fee income categories have shown strength through the second quarter. Investment banking and debt placement fees continue to grow and are up 46% on a rolling 4-quarter average basis as we continue to do more business with our commercial clients and win market share.
And cards and payment income is up 35% compared to the same period 1 year ago, reflecting our investment in and our focus on payment products, including our reentry into the credit card market during the third quarter of last year. Turning to Slide 10.
Noninterest expense for the second quarter was $711 million. The increase was expected and driven by several factors.
Importantly, as I mentioned earlier, expenses for the quarter included $37 million in charges related to our efficiency initiative. Compared with the same period last year, expenses increased $18 million.
Included in the current period expense, along with the charges for our efficiency initiative of $37 million, were costs of approximately $26 million associated with our 2 acquisitions completed in the third quarter of last year. Excluding these 2 items, expenses for the quarter were $45 million lower than the prior year.
Overall, we are seeing the benefits from our expense initiative come through to the bottom line. As Beth commented on earlier, we have captured approximately $171 million in annualized savings as of June 30.
During the quarter, we closed 33 more branches and aggressively continued with other efficiency initiative implementation plans. We also incurred additional expense from marketing associated with our spring home equity campaign and for contract programming as we continue to implement new technologies.
We continue to expect that expenses will decline to the $680 million to $700 million range by the fourth quarter of this year. Included in this forecast are efficiency initiative charges of approximately $20 million.
Turning to Slide 11. Our net charge-off declined to $45 million or 34 basis points of average total loans in the second quarter.
Overall, gross charge-off declined and recoveries remained strong. Total commercial loan charge-offs remained low at 5 basis points of average loans.
The breakdown of asset quality by loan portfolio is shown on Slide 18 in the appendix. We anticipate that net charge-offs will remain at or below the lower end of our targeted range for the balance of the current year and for provision expense to be near the same level.
At June 30, 2013, our reserve for loan losses represented 1.65% of period-end loans and 134% coverage of nonperforming loans. And turning to Slide 12.
Our tangible common equity ratio and our estimated Tier 1 common equity ratio both remained strong as of the end of the quarter at 9.96% and 11.2% -- 11.25%, respectively. Earlier this month, regulators approved the final rule for implementing the Basel III regulatory capital standards.
The mandatory compliance date for Key begins in January of 2015 with transitional provisions extending to January of 2019. Our current estimate of Tier 1 common equity as calculated under the final rule was 10.8%, which exceeds the fully phased-in minimum requirement.
As Beth mentioned, during the second quarter, we also repurchased $112 million or 10.8 million shares of common stock. And the board increased our common dividend 10% to $0.055 per share.
We also expect the Victory divestiture to close during the third quarter. The after-tax realized gain, which was originally estimated to be $145 million to $155 million, is now expected to be in the range of $100 million to $115 million.
We anticipate the cash portion of the gain to be between $75 million and $90 million. The difference from the original estimate is due to higher-than-expected client attrition that has taken place during the consent process, which is difficult to predict.
Key has received no objection from the Federal Reserve to use the cash portion of the gain for common share repurchases. The remaining amount of the gain is expected to be considered in our 2014 CCAR submission.
That concludes our remarks, and now I will turn the call back over to the operator to provide instructions for the Q&A segment of the call. Operator?
Operator
[Operator Instructions] Let's begin with Steve Alexopoulos with JPMorgan.
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division
I'm curious. On the expenses with $171 million of the cost saves already in the run rate at the midpoint of the year, is this a function of getting to the $200 million in targeted cost saves more quickly?
Because I thought originally you were saying more of this is going to come in the back half of the year. Or is it a function of the opportunity for cost saves potentially being above $200 million?
Donald R. Kimble
Steve, this is Don. And as far as our cost save projection, you are right.
$171 million is probably earlier than what we would have initially expected. We are very focused on delivering against our plan.
I think that it's important to note that even once we achieve this, this is more of a milestone as opposed to the endgame. And we do believe that once we implement our initiatives to achieve the $200 million, we'll continue to be looking for additional opportunities to improve the overall efficiency of the company.
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division
Okay. Just one separate question, on the sale of Victory, Don, could you review again why is the gain now estimated $40 million to $45 million lower?
And then could you just review again the timing of when you expect to buy back the stock related to the cash portion of the gain?
Donald R. Kimble
Sure. The reason for the lower amount of gain is that throughout any sale of an asset manager, there is a consent process that occurs.
And during the time period, the customers have the ability to consent to the transfer or not. We have seen greater attrition from that process than what we would have expected, which is resulting in a lower gain for us.
Our expectation is the transaction will close here in the third quarter, and then we can initiate share repurchases once the transaction's closed equivalent to the cash portion of the gain.
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division
So the buyback's in 3Q for this?
Donald R. Kimble
That would be our expectation as far as timing, yes.
Operator
And we'll take our next question from Bob Ramsey with FBR.
Bob Ramsey - FBR Capital Markets & Co., Research Division
I just -- or maybe I wanted to follow up a little bit on the buyback to be sure I'm thinking about it the right way. If you all have approval for $426 million plus the $75 million to $90 million from Victory less the $112 million you did this quarter, rough math tells me you've got about $390 million left over the next 3 quarters.
Should we think about that -- one, is that right? And then two, should we think about that equally distributed over the next 3 quarters?
Or will you do the Victory piece sooner since you'll have that gain in the third quarter?
Donald R. Kimble
A couple of minor tweaks. One is that the $112 million did include some share repurchases associated with some employee benefit plans.
And so the net number for the current quarter was about $103 million. And so that would be the portion that will be tied up against the $426 million of total purchases.
Generally, it is fairly consistent throughout the 4 quarters. The timing of the Victory purchase would probably be more accelerated than spread out throughout the rest of the year.
Bob Ramsey - FBR Capital Markets & Co., Research Division
Okay, great, that's helpful. And then just a couple of follow-up questions on the guidance you gave.
I think you've said provision should be near the same levels on the back half year. I was just curious if that's the same level as this quarter or the same level as the first half of the year.
Donald R. Kimble
Good clarification question, that is our guidance would be more equivalent to the charge-off level so that we will not be anticipating changes and provision being significantly different than charge-offs.
Bob Ramsey - FBR Capital Markets & Co., Research Division
Okay, I got you. And then also, I think you gave expense guidance, but I missed.
It was $670 million to, I think, you said $690 million including efficiency charges, but I couldn't quite catch that number.
Donald R. Kimble
The number was $680 million to $700 million and including about $20 million of onetime charges.
Operator
And we'll take our next question from Erika Penala with Bank of America Merrill Lynch.
Erika Penala - BofA Merrill Lynch, Research Division
I just wanted to ask Steven's question another way on the expense side. As we look out to 2014, do we think of the run rate, quarterly run rate for next year sort of that $680 million to $700 million range minus the $20 million of inefficiency charges?
And if so, if that's the right base, are you growing core expenses from there? Or is the message that maybe additional savings will offset any investments back into the business?
Donald R. Kimble
Erika, this is Don. And as far as the outlook into '14, we really haven't provided guidance out into that range yet.
But I would suggest that we are going to continue to focus on efficiency improvements beyond achievement of the $200 million. And we would expect to be able to utilize some of those savings for further investments in the business to drive growth.
And so as we start to wrap up our outlook for next year, we'll provide more guidance on that.
Beth E. Mooney
Erika, this is Beth Mooney. I would just add that as we have -- are obviously closing in on that $200 million target, which we have done at a quicker pace than I think we would have anticipated a year ago with a lot of focus and energy by our teams.
We've been intentional in talking about efficiency ratio because I think that's important that you recognize that we are focused on what we can do to both drive revenue, as well as lower our cost and variabilize our cost base and also focus on including [ph] an operating leverage through these investments, the strategic things we do within our businesses.
Erika Penala - BofA Merrill Lynch, Research Division
Got it. And just a question on Slide 8, given that this has been a big topic among the investor community.
The 2.5% increase in annual NII, I mean the 200 basis point rate simulation, is that a parallel increase across the curve or is that just a short end? And also could you give us a sense of what you're assuming in terms of spread compression and deposit runoff in that scenario?
Donald R. Kimble
As far as the assumption, it's a 200 basis point increase over the 12-month period on a consistent basis across the curve as opposed to one and/or the other. And as far as deposit compression, we do have assumptions as far as the level of participation in our deposit rates going up in this rate environment.
I would suggest that we believe that the market will probably underperform that, meaning that the rates will probably go up on the deposit side slower than what we generally think our models would include.
Erika Penala - BofA Merrill Lynch, Research Division
And on the spread side, on the loan side, given your comments on deposits, do you think that spread tightening, that could follow an increase in benchmark rates and also slow?
Donald R. Kimble
Yes. Our model would assume, at this point in time, keeping spreads in a general same range as what we're seeing today, which is probably about 25 basis points lower than what we were seeing a year ago.
So we have not anticipated further compression beyond that at this point.
Operator
And we'll take our next question from Jennifer Demba from SunTrust Robinson.
Jennifer H. Demba - SunTrust Robinson Humphrey, Inc., Research Division
Just wondering if you could give us some color on what your customers are -- current customers are acting these days given you only had sort of stable loan growth on a linked quarter basis. What's your feeling -- what are you seeing and what's your feeling on the economic improvement in the pace?
Christopher Marrott Gorman
Sure. Jennifer, this is Chris Gorman speaking.
What we're seeing on the part of our clients is they're cautious. Their businesses are performing well, but one of the -- I think one of the real telling points of the cautiousness is we're not seeing really a pickup in utilization, but we continue to see, for example, very strong deposit growth, which I think is kind of one of the things I would point to.
The cautiousness, obviously, relates around just some of the uncertainty, the 1-or-so percent GDP growth that we're seeing. So I think they're fairly cautious, but at the same point, I think they're all performing fairly well.
So that's what we're seeing from our clients.
William R. Koehler
Okay. Jennifer, this is Bill Koehler.
The only thing I would add to that, as you can imagine in the Community Bank where we're focusing on smaller companies, they feel a little more susceptible to potential changes in Affordable Care Act, any lingering effects from sequestration because their businesses just aren't as broad and diversified as some of the larger corporate kinds we have. So you can imagine that they are very careful about how they're choosing to invest right now.
Operator
And we'll take our next question from Josh Levin with Citi.
Josh Levin - Citigroup Inc, Research Division
Your shares have run up quite a bit and I was wondering, as you think about your CCAR for the remainder of the year, does the share price appreciation affect how you think about buying back shares?
Donald R. Kimble
We do, on an ongoing basis, evaluate our share repurchase activity based on price and overall return. But I would say at this point that we still believe it's appropriate for us to continue to purchase Key shares and are very excited about the opportunity to deploy capital in that way.
Beth E. Mooney
And Josh, this is Beth Mooney. I would just underscore that I continue to believe even at these prices, our shares are an attractive purchase and return of capital to our shareholders.
Josh Levin - Citigroup Inc, Research Division
Okay. And going back to the loan growth, I think when we came into the year, I think Key and your competitors, you all sounded pretty optimistic about loan growth picking up in the second half of the year.
But now it sounds like you and your peers are all sort of dialing back expectations for loan growth for the second half of the year. What's changed?
I mean, why are your consumer -- your customers less confident now than they might have been, say, 6 months ago?
Christopher Marrott Gorman
Josh, this is Chris Gorman speaking. I think all the things I just mentioned, I think, clearly impact our customers.
The other thing about our business model that impacts our loan growth is we, depending on what the market is, we have competition not only from other banks that are very competitive from a perspective of price, structure, tenor, limits, but we also have competition from other capital sources. So for example, in our real estate business in the first half of the year, we raised a total of $18 billion of capital, but very little of that actually hit our balance sheet because we were placing that capital elsewhere acting as agent not as principal.
Now the interesting thing that could happen is we get these changes in interest rates when you think about the steepness of the curve and you think about what's going on with interest rates. Some of that, as we go forward, some of our clients may elect the best option may be to put it on our balance sheet going forward.
So there's really a lot of puts and takes. There's been a ton of liquidity just across all markets.
And when it's right and it fits our moderate risk profile, we clearly are putting it on the books. But other times, we're actually looking for other people to provide other types of securities.
William R. Koehler
Josh, I would only add -- this is Bill. If you look at the economic data, it's been relatively volatile month-to-month, quarter-to-quarter in terms of inventory build or inventory drawdown.
If you look at rates, the comments that have come out by the Fed and the impact that has on rates, that only creates uncertainty in the market that our clients are reacting to and trying to figure out how to invest against.
Beth E. Mooney
But, Josh, we do feel good about our mid-single-digit guidance for year-end our loan growth.
Operator
And we'll take our next question from Todd Hagerman with Sterne Agee.
Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division
Just perhaps a question for Chris and Beth. I just want to follow up on the commercial servicing, in part the purchases that you announced.
One is basically given what we've seen in terms of commercial loan growth, so to speak over, say, the past 4 quarters, I would have expected to see a little bit more transparency in terms of the growth in that business given your position. And then secondly, based on the purchases at this point in the expected close, how should we think about kind of the potential revenue capture there, as well as the offset in terms of expenses?
Christopher Marrott Gorman
Todd, it's Chris. Let me give you kind of an overview.
As Beth mentioned in her initial remarks, this was a very important acquisition for us because it made us the #3 servicer of CMBS, but it also made us the #5 special servicer. And as we think through the cycle and you think to the next real estate cycle, we initially actually thought we would be named special servicer on 47 billion.
As it's turned out, because there are a lot of moving pieces, we're actually named special servicer on 52.4 billion. In terms of the conversion, it's right on target.
We converted the first 3,900 loans on the 24th of June, and we picked up about $700 million in deposit. So we did give some clarity on that.
We also, this weekend, will convert another batch of loans that will represent $300 million in deposits. We've never given a lot of numbers around it.
One of the things I will share with you though is you can imagine what the change in interest rates if you look at the MSRs. While we liked the deal initially, kind of the 2 things that have happened to the positive is, a, we're executing on time.
And the next, the other thing is we have a little -- we have more in terms of special servicing. And lastly, with the change in interest rates, obviously, that has an impact on the value of the MSRs.
Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division
That's very helpful. And then as I combine that with the sale of Victory, for example, which I know the impact is not significantly material.
But as I take a step back and think about this purchase and how significant it is, I would suspect that as you look towards the back half of the year that, Beth, you would expect to be able to grow revenue year-over-year at relatively a healthy pace, so to speak.
Beth E. Mooney
Well, Todd, as you've seen, I think we have done a variety of things to both invest in our businesses as well as make sure we're supporting our organic growth to acquire and deepen client relationship. This particular acquisition I do think both brings in stable funding, as Chris outlined, about $1 billion of incremental deposits.
It is a market where scale matters. And moving to #3 servicer, we think, puts us in a position to be in good stead for whatever activity is out there in the CMBS market in terms of new issuance, as well as fee income out of special servicing.
And as we look at Victory, it did not align with our relationship strategy. We continue to think strategically that it is a good move and that Key was not the best owner for that asset.
And they'll look forward to doing a lot of things of the gain proceeds, particularly the cash portion we expect to realize in the quarter to return that capital to our shareholders.
Operator
And we'll take our next question from Mike Mayo with CLSA.
Michael Mayo - CLSA Limited, Research Division
The commercial servicing platform acquisition, how much did that add in the second quarter for revenues and expenses and earnings?
Donald R. Kimble
Mike, this is Don. They really did not add a whole lot to the closing of that initial phase as late in June.
So we'd see more of the benefit from that going into the third quarter.
Michael Mayo - CLSA Limited, Research Division
Can you size that a little bit?
Donald R. Kimble
Now that we've provided much detail there that again, it's going to be both in the form of deposits and also some fee income. And we would not provide any additional clarity there.
Michael Mayo - CLSA Limited, Research Division
Okay. And the margin going down a couple basis points for the rest of the year, what's the impact of the $3 billion of CDs that are maturing for the next 2 quarters?
And then you have another $3 billion next year. I guess that's offset by the pressure on the asset yields.
Can you elaborate?
Donald R. Kimble
I sure can. No, as we've said, we were down 11 basis points this quarter, but 5 of that came from excess liquidity.
And also 2 basis points came from reduction of our swaps. And so we don't believe that either one of those will be negative nearly to the same extent that we experienced this quarter.
As far as loan yields, they were down 6 basis points in the current quarter. About 2 basis points of that was related to loan fees, which tend to be a little difficult to predict as far as the timing of those.
And so normal core loan yields were down about 4 bps. Then we would expect the deposit repricing to add about 2 basis points back to the margin as we see some of those higher-cost CDs mature.
And so the net of those, of the 4 basis point decline in the earning assets and the 2 basis point improvement in the cost of funds is really how we get to that 1 to 3 basis point outlook per quarter going forward.
Michael Mayo - CLSA Limited, Research Division
And then my main question relates to the growth initiatives. Don, you're -- I guess this is the first call you've been on as CFO.
And it'd be great to hear about your philosophy for controlling expenses, improving efficiency. Beth, I know you said this is a milestone, not a stopping point for your efficiency targets.
What's the plan ahead? When do you guys meet?
I guess you probably have budget planning meetings later this year. Can you give us some sense of the ultimate target?
And I'll just note, I mean the expense guidance you gave for yearend, on a core basis, it looks like not a lot of these expenses are hitting the bottom line. So just any color you can give.
Donald R. Kimble
Mike, this is Don. And you're right, this is my first call.
It's day 45 today, so still learning as we go here. But I think the approach that we're using here is very appropriate, that we are keenly focused on driving positive operating leverage and driving improved efficiency for the company.
As far as how I think that we're going to see that improvement efficiency come through, it's really from 4 levers. One is executing against our existing plan and making sure that we deliver that to the bottom line.
And then from that point forward, showing a continued discipline to make sure that we remain focused on additional efficiency improvements, not necessarily having stated targets of $200 million here or $150 million there, but driving this is as a part of the core culture of the organization. Second, we need to get more productivity from our existing resources.
And that's both people and also our distribution and technology. And so that will help drive some of the efficiency for us as well.
Right now, our third item is our balance sheet efficiency. We're at 84% loan-to-deposit ratio.
That is a real drag on us as far as the overall efficiency ratio and margin. And we need to see improvement in that going forward.
And some of that improvement will come from the additional productivity I just talked about. And the fourth component is interest rates.
Just like every other bank in the country, these low rates are painful as it relates to our margin and also our efficiency ratio. And when we think that returning to more normal rates will drive our efficiency ratio down somewhere between 300 and 400 basis points.
And so that will be a big plus for us. So this isn't an endgame as far as our $200 million of cost saves.
It's just the start of a foundation, and the team around here is very focused on delivering it. We have weekly meetings, and it doesn't go by without each of those meetings talking about some of the initiatives that we're taking on and the success that we are as far as executing against it.
And contrary to what you said, I would believe that we are showing this drop to the bottom line. In the second quarter, what we've demonstrated that we got a $45 million improvement in expenses year-over-year backing up the impact of our acquisitions and these onetime cost.
So that, on an annualized basis, was $180 million. And that's real money for us.
And we think that we will deliver existing future improvement from that as well.
Operator
And we'll take our next question from Ken Usdin with Jefferies.
Bryan Batory - Jefferies & Company, Inc., Research Division
This is Bryan Batory from Ken's team. I was wondering if you guys could us a sense of just timing for how the remaining swap portfolio rolls off and what the asset sensitivity profile would look like without the swap portfolio.
Donald R. Kimble
Sure. We had, as of the end of the first quarter, about $20 billion in interest rate swaps.
About $15 billion of that was related to our asset liability management. That dropped by $4.4 billion this quarter.
And so as far as those that are usually -- are used to hedge our loan book, it's down to about $11 billion. The average life of that is 2.3 years.
And for that $11 billion to come off the balance sheet, it would probably take that 2.5% asset sensitivity all the way up to about 8% would be my best guess. So it's a meaningful impact to overall asset sensitivity.
Bryan Batory - Jefferies & Company, Inc., Research Division
Okay, great. And just one quick one for Chris.
Can you just give us a little bit of color on what the investment banking pipeline looks like relative to last quarter and the same quarter last year?
Christopher Marrott Gorman
Yes. Bryan, as we look at it, the investment banking pipeline, as we look year-over-year, is stronger than it was at this time a year ago.
So assuming -- what's interesting about our business model is when all the markets are working perfectly, it's not as -- it's harder for us than when you get some volatility as we've had in this market, because our business model enables us to go from one type of financing to the other. So -- and then, of course, we go to market with senior-level people talking to these middle-market companies.
So our pipelines are up from a year ago. And actually, some of the turbulence that we've experienced in the market since the beginning of May is actually in many ways helpful to us.
Operator
And we'll take our next question from Marty Mosby with Guggenheim.
Marty Mosby - Guggenheim Securities, LLC, Research Division
I wanted to ask about the asset sensitivity and the increase of that sensitivity about 25% from a 2% hit to a 2.5% advantage in the sense of you increasing that asset sensitivity. Was that in line with where rates were back in the second quarter?
Do you feel like you're going to continue, like you said, if the swaps run off, that number would explode up to 8%? Are you going to manage that at this level?
Or are you going to kind of think about increasing asset sensitivity? Or do you have enough of a yield curve to start using some of that now?
Donald R. Kimble
Yes, Marty, this is Don. And as far as the asset sensitivity on an organic basis, our balance sheet will migrate to much more asset-sensitive over time.
We do believe that we're going to be conservative in how we position the balance sheet. That if you would've asked me 3 years ago where rates were going, they were going nowhere but up.
And I've been wrong since then. So I don't like taking big bets.
But we could see that asset sensitivity drift up a little bit. Our expectation is over the next, say, 18 months, we would start to see some of the short end of the curve maybe move up as well.
And so we'd like to be in a position to better benefit from that. I think that the one advantage that we do have is given the relative size of that swap portfolio, we have the ability to shift our asset sensitivity much quicker than many of our peers.
And so we think that we have a lever there that we can pull to be much more responsive to that overall effort. Keep in mind too that, that swap book has a fairly short life.
And our investment portfolio is fairly short in duration as well, but it's at 3.2 years even with rates going up. And so we intentionally manage the balance sheet so that we can capture the benefit of those rate increases fairly quickly.
Marty Mosby - Guggenheim Securities, LLC, Research Division
And then, Beth, just a follow-up question on the efficiency ratio. If you finish out the $200 million, under my estimate, it would add -- improve your efficiency ratio by another 2 percentage points, down to around 63, which puts you right in the middle of your range.
So going forward, I know you're still kind of talking or gauging it, but when the momentum, if you can get some revenue growth and start to see some of the other things, loan growth coming back, would you still feel like you would migrate towards the maybe lower end of that range over the next couple years?
Beth E. Mooney
Yes, Marty, this is Beth. As you've correctly noted, part of what we committed when we unveiled this a year ago was that our intent was to be within a near term target of 65% on our efficiency ratio, and that we would achieve that target by the first quarter of 2014.
As the time in the intervening quarters has played out, we have realized our expense savings faster than we would have thought a year ago. And I think you're seeing evidence of that as we are now already at the upper end of that 60% to 65%.
As we go into next year and we finalize our plans, and as Don said, we are instituting this notion of continuous improvement and the cultural change in terms of how we drive not only our cost structure but our productivity. Those are the sorts of things that will drive further improvement within that range.
So I would tell you that with revenue momentum, with productivity, with cost efficiencies, we are very much top of mind that 60% to 65% is a near term target and that we believe clearly, obviously, we're on a path to meet our commitment of being there by the first quarter of 2014.
Operator
And we'll take our next question from Gerard Cassidy with RBC.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
Beth, when you look at your Tier 1 common ratio, obviously it's very strong under the Basel III interpretation. Now that we have that, and you folks are not obviously in the top 8 banks, what kind of Tier 1 common ratio are you comfortable running at since you're going to be required to hold 7?
Maybe there's a small SIFI buffer of 25 basis points that will be assessed to KeyCorp. But what number do you think is a comfortable level as you go forward?
Beth E. Mooney
Well, Gerard, I'm going to also let Don augment my answer here. I will tell you that clearly at 10.8 is our estimate, if you were to phase in the Basel III rules as they've been released, we well exceed the 7% floor, as well as any SIFI buffer that would be appropriate.
I think we've always talked about our capital as both currently having an opportunity to continue to return to our shareholders what is more than needed even with a phase-in of the rules. But we would also talk in terms that we would also always want to have our own operating buffer for a variety of reasons as well.
So we are well positioned. I think Key is -- continues to be purely [ph] in its capital levels, which includes a lot of flexibility for us in the future as we go through our plans.
But I'm going to let Don talk a little more about his thought into the ranges.
Donald R. Kimble
Sure, Gerard. And I think that we do have one piece of the puzzle has been solved for us with the new rules.
I would say that, that's only one component. So we really haven't stated what our objectives are as far as long-term capital position publicly.
One of the other variables that does impact that is the stress test. And I think the stress test will probably result in larger buffers than what's publicly stated as part of Basel III.
And so we just need to make sure that we continue to understand what the impact is there and what level of capital that we feel comfortable operating at beyond that. I will tell you that we all believe that our capital position is very strong and with the position that it's in at this point, that we do have the ability to continue to return levels of earnings to the shareholders that are probably in excess of our peers just because we do believe that we're operating from a position of strength at this point.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
Do you guys expect to publicly disclose to us at some point what those levels will be when you take into account CCAR so the market will know that you're very comfortable at an 8.5% number or whatever it is?
Donald R. Kimble
Yes. We will disclose at some point in time more guidance.
But I don't know -- I wouldn't want to project the timing of that at this point.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
Okay. And then just as a follow-up to all of this, if your buyback -- obviously you received approval from CCAR.
Would you guys use a special dividend as a way of accelerating the return of capital to shareholders if you thought your stock price did get too high?
Donald R. Kimble
My understanding, and I haven't reviewed this since I've been here, but my understanding is that the non-objection relates to a cash dividend component and then also to a share buyback and that the share buyback cannot be substituted for a onetime cash dividend.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
No, no, I agree. But going forward for '14 and '15, you sit down and think about what you want to apply for.
Philosophically, you guys think about a special dividend because I see your capital is going to be accumulating, if growth remains modest, very rapidly. And would you consider that as an alternative for giving it back to shareholders?
Donald R. Kimble
Yes. With our 80% combined payout, if you look at the total payout compared to the Street consensus at the time that the CCAR was announced, that should translate to us continuing to leverage our capital position.
You can see in the last quarter that we did see slight declines in some of our capital ratios. And it would be difficult for me to speculate what might be available to us under CCAR 2014.
So I'll go silent at this point.
Beth E. Mooney
And Gerard, I would just add, as you know that [indiscernible] there usually is more insight into what will create acceptable plans. And it's really too soon to have any visibility into that.
Operator
[Operator Instructions] And we'll take our next question from Alan Straus with Schroders investment firm.
Alan Straus
I think you did a good job controlling what you can control in this environment. When your customers don't want to borrow money, you don't want to just make bad loans.
But could you comment on the mortgage servicing business? Do you see any ability to get some loans out of those customers?
Or is this really more just servicing and gaining deposits?
Christopher Marrott Gorman
So, Alan, it's Chris. There's -- we have -- there is an opportunity when you service loans to convert some of those into borrowing customers.
Candidly, in the past, we have not been real successful in doing that. Basically, the economics stand on their own in terms of servicing rights.
Well, I think the more interesting opportunity is this whole notion of this big pool where we're named special servicer. And as named special servicer, these will be loans that need to be restructured, Alan, where we don't have any capital, but we can be the solution to the problem without having any exposure to it.
That, I think, is even a better -- a more interesting opportunity as we look forward.
Beth E. Mooney
Special servicing drives fee income so that you get paid for the various activities. So it is an interesting book to continue to build special servicing rights.
Donald R. Kimble
And for example, you could raise junior capital, et cetera.
Alan Straus
Right. I mean, your investment back should be teed up or are you hiring there in the investment bank on the special servicing side?
Donald R. Kimble
Well, Alan, we haven't hired on the special servicing side per se, but we clearly have ramped up on our real estate investment banking side over the last several years, including hiring people that are experts in raising private capital. In the real estate business, it's often called JVs.
But we have a whole team of people that raise noncontrolled junior capital for developers. So the answer is yes.
Beth E. Mooney
And Alan, I would just add, one of the things, as we look at these various things, they create opportunity for us to leverage what we think is a very distinctive platform. So we have the capacity to do a number of these things without necessarily having to increase headcount as it goes back to this notion of how to think about efficiency that Don outlined, that it's not just efficiency in cost, but it's efficiency of your balance sheet and efficiency of your platform that we can put more throughput in it.
Operator
And we'll take our next question from Brian Foran with Autonomous Research.
Brian Foran - Autonomous Research LLP
I guess -- Don, I apologize. I guess I'm probably going to screw up this description.
But your old -- in your old role a couple years ago, there was a swap transaction where, if I understand it right, that the benefit was kind of pulled forward. There was a stair step down and the life was shortened and you end up more asset-sensitive at the end.
But the benefit of the swap income kind of shortens up. Can you just remind us, when you talk about levers you can pull on swaps, is that something that's always available or was that transaction kind of unique to that point in time?
Donald R. Kimble
That transaction was not unique. It was basically terminating swaps early.
And then you can go back in and enter into new swaps over a longer duration. So we did terminate some swaps early this quarter.
That of the $4.4 billion, I believe $2.5 billion were early terminations or thereabouts. And we decided not to go back in and enter into new swaps.
And so we allow the asset sensitivity to increase as a result of that. And by being more proactive, I think it's much easier for us to reposition our asset sensitivity by managing the overall swap book than it is for any other asset class on the balance sheet.
So for instance, you can get more asset-sensitive by selling out of your investment portfolio. But that will result in a gain or loss on the security.
And then you have to figure out what to do with those proceeds. On the swaps, you can just go ahead and terminate those, and that automatically switches your balance sheet to being more asset-sensitive.
And so that's why I think that we're fortunate here in the way that Key has positioned its overall balance sheet and interest rate position to be able to leverage that swap book a little bit more disproportionately than many of our peers might be able to.
Brian Foran - Autonomous Research LLP
And you touched briefly on it, but do you have a strong view right now on when rates are likely to go up? Or is it more just you felt there was no way rates were going down from where they were back in April and May?
Donald R. Kimble
Brian, I hope you have somebody with a better crystal ball than I do at this point because I think that we do believe that rates are going to go up at some point in time. But right now, I wouldn't see that occurring in '13 on the short end of the curve or even the first half of '14.
And that will be my personal expectation, but we'll wait and see how things play out here over the next couple quarters.
Operator
And we'll take our next question from Terry McEvoy with Oppenheimer & Co.
Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division
A question for Beth. Beyond closing branches, can you talk about the realignment of the Community Bank?
Was the decision more than just finding a way to cut costs? And any early data on customer attrition and does it give you more confidence or less confidence on continuing to look at the opportunity to close branches?
Beth E. Mooney
Terry, I'll also let Bill Koehler, the President of our Community Bank, add to some of my comments. But as it relates to branch closures, based on what we have accomplished and will through the balance of the year, it will be about a 7% of our branches.
And what we've identified in these branches tend to be low profitability, low traffic count. And as we have closed and/or consolidated and many of them are near another branch of service, we have experienced very little attrition, well below what we would have expected when we modeled this a year ago.
So it does give us confidence that -- and as we rationalize both our ATM natural net ranges that this could be done in a way that is helpful to our cost initiatives, our efficiency, without material client impact. And then with that, I'm going to let Bill Koehler just give a couple headlines about what was done in the broader Community Bank alignment, where both will make us more efficient, more productive and more focused.
William R. Koehler
Terry, this is Bill. The realignment was really focused around 2 things.
Obviously efficiency, but more importantly, putting our teams in a better position to drive revenue growth through more focused execution of better defined strategies. So to the -- so part of that related to creating one fully integrated national consumer franchise where we could focus our teams on more consistent sales execution throughout the platform.
And we think there's an opportunity to grow revenue there. And the second was around refining our go-to-market strategies and value proposition with respect to little market business banking and private banking.
And there, it's very much about identifying those clients who tend to typically be privately owned businesses, their owners, their employees, and finding ways to target our broad capabilities in a more relevant way to those clients to drive better growth.
Operator
And we'll take our next question from Ryan Nash with Goldman Sachs.
Ryan M. Nash - Goldman Sachs Group Inc., Research Division
Just one follow-up from a question from earlier. I guess, Beth or Don, when I look at the capital position now, you're at 10.8% Tier 1 common under Basel III.
And someone mentioned this morning that they think that we could see a fairly decent pickup in M&A in 2014, as we start to get a lot of the new regulations moving into place. So I guess my question would be given that you've shown in the past the willingness to be acquisitive, do you agree with that view that we could see a pickup across the industry?
And what is your appetite given -- to do deals given the strong capital position?
Beth E. Mooney
Ryan, this is Beth. We've always said that I think our capital priority has been fully stated, that our capital is and does create advantage and opportunity for us.
It's obviously been able to support our organic growth platform, it has been able to [indiscernible] dividend and share repurchase in order to return capital to our shareholders. And then it also creates and has been able to assist us as we've opportunistically over the last year or so done a variety of acquisitions to augment product capabilities, add to geographies and definitely [ph] create our scale and presence in the commercial servicing markets.
But with that, I think this is another crystal ball question as to when M&A will actually and actively pick up. I think as we have gone through the last couple years, it has been a pretty muted market and most transactions have been for very particular reasons.
We have said that with our geographic franchise as well as our differentiated platforms that we could be opportunistic and would evaluate if things are additive to our business model, if they are additive to our client relationship philosophy and that they are good for our shareholders. So as this, too, unrolls and unveils, know that we would be opportunistic.
But I've also always said very, very disciplined that it has to fit our business model to be good for our shareholders.
Ryan M. Nash - Goldman Sachs Group Inc., Research Division
Great. And just in case I missed it earlier in the call.
In the 1 to 3 basis points of quarterly NIM compression, is there an assumption that you will be redeploying some of the higher liquidity that you talked about earlier in the call?
Donald R. Kimble
The assumption is modest. What we did say in the call was that we expected loan growth to exceed deposit growth.
And so there would be some implication there that we would see some of that liquidity being used but that we're not reliant solely on that.
Operator
And we'll take our final question from John Moran with Macquarie Capital.
John V. Moran - Macquarie Research
Really the last thing that I have left on the list here is just kind of circling back on the OpEx guidance. Don, just wanted to make sure that, that guidance is inclusive of any incremental cost on the commercial servicing deal.
Beth E. Mooney
That is. That's correct.
John V. Moran - Macquarie Research
Okay. And then the $20 million in charges on the efficiency program, we would expect to see $20 million in both third quarter and fourth quarter or is that only -- are you only talking about third quarter there?
Donald R. Kimble
That $20 million is really more a reflection of what our fourth quarter forecast would have shown, but it wouldn't be out of line for third quarter as well.
Operator
And I'd like to turn it back to our speakers for any additional or closing remarks.
Beth E. Mooney
Thank you, operator. And again, thank you, all, for taking time from your schedule to participate in our call today.
And if you have any follow-up questions, you can direct them to our Investor Relations team, Vern Patterson or Kelly Dillon at (216) 689-3133. That concludes our remarks.
And thank you, operator.
Operator
And this concludes today's conference. Thank you for your participation.