Oct 16, 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 Joseph M.
Vayda - Executive Vice President, Treasurer and Member of Executive Council
Analysts
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division Stephen Scinicariello - UBS Investment Bank, Research Division Ken A.
Zerbe - Morgan Stanley, Research Division Bob Ramsey - FBR Capital Markets & Co., Research Division Erika Najarian - BofA Merrill Lynch, Research Division Bryan Batory - Jefferies LLC, Research Division Keith Murray - ISI Group Inc., Research Division Terence J. McEvoy - Oppenheimer & Co.
Inc., Research Division Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division Tom Hennessy - CLSA Limited, Research Division Nicholas Karzon - Crédit Suisse AG, Research Division Marty Mosby - Guggenheim Securities, LLC, Research Division
Operator
Good morning, and welcome to KeyCorp's Third Quarter 2013 Earnings Conference Call. Today's call is being recorded.
At this time, I would like to turn the call over to Chairman and CEO, Ms. Beth Mooney.
Please go ahead.
Beth E. Mooney
Thank you, operator. Good morning, and welcome to KeyCorp's Third 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 to Slide 3.
Our results reflect another quarter of improved performance as we had positive trends in core revenue and expenses, and our credit quality improved to levels we haven't seen since 2007. We also continue to execute on our capital priorities.
Revenue benefited from solid loan growth, driven by an 11% increase from the prior year in commercial, financial and agricultural loans, as well as improved trends in several of our fee-based businesses. Importantly, we continue to have success in acquiring and expanding relationships.
For example, in our corporate investment banking and real estate areas, we have generated 21% more revenue from new clients year-to-date versus the same period in 2012, reflecting our more targeted approach and the benefits of our distinctive business model. As you have seen over the past several quarters, this model has allowed us to capitalize on revenue opportunities.
Whether through execution in the capital markets when conditions are favorable or by offering on balance sheet alternatives, our commitment remains the same: to do what's right for our clients. We also continue to invest in our businesses, as well as address areas that do not fit our relationship strategy.
In this quarter, we have examples of both. As announced, we completed our commercial real estate servicing acquisition.
This brought in over $1 billion in low-cost escrow deposits and further leverages our existing platform. We are now the third largest servicer of commercial and multifamily loans and the fifth largest special servicer of CMBS in the United States.
The sale of Victory Capital Management was also completed on July 31, resulting in an after-tax gain of $92 million. Additional gain may be realized as the profits of receiving client consent continues through January of 2014.
We also made good progress on expenses this quarter. Importantly, we met our announced expense target that we set in June of 2012 to achieve annualized savings of $200 million.
This reflects the dedication and hard work of our entire team to make some difficult choices, to reduce costs and make us a more efficient company. As a result, noninterest expense, excluding efficiency-related charges, was down 4% from the prior year.
And as Don will discuss, our adjusted cash efficiency ratio was 64% this quarter, at the upper end of our near-term goal of 60% to 65%. Although this is an important milestone for us, it is not an endpoint.
This is now part of our culture, and we are already working to improve efficiency and productivity by identifying new opportunities to grow revenue and reduce and variabilize our expenses. I'll finish with a couple of comments on capital.
During the third quarter, we repurchased $198 million in common shares as we continue to execute on our current repurchase authorization, and our Tier 1 common ratio remained above 11%. We will remain disciplined in the way we manage our strong capital position and stay consistent with our stated priorities of supporting organic growth, dividend, share repurchase and opportunistic growth.
Overall, it was a very good quarter for Key, and it positions us well through the end of the year and as we move into 2014. We are optimistic that progress is being made in Washington, and we continue to encourage our leaders to work together to find a solution that is in the best interest of our country.
It would be regrettable to reverse the progress we've made in the recovery, as well as the progress we've made to regain client, investor and global confidence in our financial system. However, at Key, our focus remains the same and that is to execute on our business model, drive and invest for growth, become more efficient and productive and to be disciplined in the way we manage our capital.
Now let me turn the presentation over to Don for some details on our third quarter results. Don?
Donald R. Kimble
Thank you, Beth. Slide 5 provides highlights from the company's third quarter 2013 results.
This morning, we reported net income from continuing operations of $0.25 per common share for the third quarter, compared to $0.21 for the second quarter of 2013 and $0.22 for the third quarter of 2012. I'll cover many of these results in my remarks later, so let's turn on to Slide 6.
Third quarter results include a number of significant items, which have been detailed for you on this slide. First, results reflect the impact of early termination of leveraged leases.
These transactions reduced net interest income by $8 million and increase noninterest income by $23 million, resulting in a net gain of $15 million or $0.02 per share. As with the prior lease terminations, the gains associated with these transactions were not taxable.
The total tax impact of leveraged lease terminations was $13 million or an incremental $0.01 per common share. This lowered our tax rate by about 4% this quarter.
I would expect our tax rate to return to a more normal level next year in the range of 26% to 28% on a GAAP basis. Next, we incurred $41 million or $0.03 per share of costs associated with our efficiency initiative, including pension settlements this quarter.
The pension settlement of $25 million recorded as lump sum distributions exceeded a threshold that triggered the recognition of a curtailment loss. While we could have additional settlement losses in the fourth quarter, it is not expected to repeat in 2014.
Within discontinued operations, we also realized a pretax gain of $146 million from the sale of Victory. After tax, this gain equated to $92 million with the cash portion totaling to $72 million.
Importantly, this represents the amount of the gain we have realized to date. And as Beth pointed out, an additional gain may be realized resulting from client consents received through January of 2014.
Also included in discontinued operations, we recorded an after-tax charge of $48 million related to the fair value of loans and securities in Key's 10 education loan securitization trusts. This charge resulted from additional market information about projected trends for default and recovery rates that became available during the quarter.
Based on this information and Key's internal analysis, certain assumptions related to valuing the loans in these securitization trusts were adjusted. Turning on to Slide 7.
Average total loans for the third quarter were up $575 million or an annualized 4%, compared to the second quarter of 2013 and up $2.6 billion or 5% compared to the year ago quarter. Loan growth continues to benefit from Key's focus on targeted segments and the capabilities we're able to provide commercial clients.
Our loan growth outpaced industry measures in the third quarter and the quality of our loan originations continues to be high and consistent with our moderate risk profile. While clients remain cautious, our outlook for loan growth remains consistent with our prior guidance of mid-single digit year-over-year growth driven by CF&A lending.
Continuing on to Slide 8. From the liability side of the balance sheet, average deposits, excluding foreign branch balances, were up $494 million from the second quarter and up $3.4 billion from 1 year ago.
Deposit growth from both the prior quarter and year ago quarter was primarily due to an increase in demand in interest-bearing commercial deposits and higher escrow balances from Key's recent commercial real estate servicing acquisition. Over the past year, our mix of deposits has significantly changed with CDs declining and low-cost transaction accounts increasing 10%.
As a result, year-over-year deposit costs declined from 38 to 22 basis points. Turning on to Slide 9.
Our taxable equivalent net interest income was $584 million for the third quarter, compared to $586 million for the second quarter and $578 million for the third quarter 1 year ago. Results in both the third quarter 2013 and the prior year reflect the impact of early termination of leveraged leases.
These transactions reduced net interest income by $8 million in the third quarter of this year and by $13 million in the third quarter of 2012. Excluding the impact of leveraged lease terminations, net interest income in the third quarter of this year would be slightly higher than a year ago period and 4% higher than the second quarter on an annualized basis.
For the third quarter, the company's net interest margin was 3.11% or 3.15% when adjusted for the 4 basis point negative impact of the leveraged lease terminations. This compares to 3.13% for the second quarter.
As you can see on this slide, the net interest margin this quarter was negatively impacted by lower earning asset yields, offset by lower funding costs. Over the next couple of quarters, we expect the net interest margin to be relatively stable to the reported third quarter level with potential downward pressure dependent on levels of liquidity.
We also maintained our modest asset-sensitive position. Importantly, the use of interest rate swaps provides us with the flexibility to manage and quickly adjust our rate risk position.
While Key, along 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 and investment portfolio position us to realize more benefit from a rise in the shorter end of the yield curve. We anticipate for the next few quarters, loan growth will exceed deposit growth, which should result in a relatively stable net interest income.
Slide 10 shows a summary of noninterest income, which accounts for approximately 44% of our total revenues. Noninterest income in the third quarter was $459 million, up from $429 million in the second quarter, but below the $518 million in the third quarter of last year.
Importantly, the third quarter of 2012 included gains of $54 million associated with the redemption of trust preferred securities. As I mentioned previously, we had leveraged lease terminations in both the third quarter of 2013 and the prior year, which led to the gain of $23 million in the third quarter of this year and $39 million in the prior year.
Adjusting for gains from the trust preferred securities and the leveraged lease terminations, noninterest income in the third quarter was up 3% from the prior year and up 7% analyzed from the prior quarter. Many of our core fee income categories have shown strength through the third quarter.
Investment banking and debt placement fees continue to grow and are up 29% on a rolling 4-quarter average basis as we continue to do more business with our commercial clients and win market share. Corporate services is also -- have also performed well, up 13% from the prior year.
This includes fees from letters of credit, foreign exchange and derivative trading, among others. And cards and payments income is up 16% compared to the same period 1 year ago, reflecting our investment in and our focus on payment products, including our reentry in the credit cards during the third quarter of last year.
Turning to Slide 11. Our noninterest expense for the third quarter was $716 million, including $41 million in charges related to the efficiency initiative and pension settlement.
As discussed earlier, the $25 million pension settlement was triggered by high levels of lump sum distributions from the plan. While we may have additional settlement losses in the fourth quarter, we do not expect this to repeat in 2014.
Adjusting for these charges, expenses were down 4% from the prior year and up slightly from the prior quarter as we increased marketing expenses related to our client acquisition and borrowing campaigns. During the quarter, we closed 8 more branches and continued with other efficiency initiative implementation plans.
As Beth commented earlier, we achieved our target by capturing $207 million in annual expense savings. We plan to provide a final count of our cost savings associated with our efficiency initiative when we announce our full year results in January.
Going forward from that point, the savings from our continuous improvement efforts will be embedded within our expense run rate and will help drive our efficiency ratio lower. We have made a lot of progress over the last 5 to 6 quarters, but there still is a lot more we can do to improve our overall productivity.
Turning to Slide 12. Our net charge-offs declined to $37 million or 28 basis points of average loans in the third quarter.
This continues to be below our targeted range and is the lowest level since the first quarter of 2007. You may recall that in the third quarter of 2012, Key, along with other banks, received updated regulatory guidance on consumer loans, which is -- which is what led to elevated charge-offs in the year ago quarter.
Adjusting for this guidance, net charge-offs were still down by 42% from the prior year. Total commercial loan net charge-offs this quarter remained low at 5 basis points of average loans, and recoveries were up $12 million or 41% from the prior quarter.
The breakdown of asset quality by loan portfolio is shown on Slide 19 in the Appendix. At September 30, 2013, our reserve for loan losses represented 1.62% of period-end loans and 160% coverage of our nonperforming loans.
We anticipate that net charge-offs will remain at or below the lower end of our targeted range for the next few quarters and for provision expense to be near the same level. Turning to Slide 13.
Our tangible common equity ratio estimated -- and estimated Tier 1 common equity ratio both remained strong, at September 30, at 9.93% and 11.11%, respectively. Earlier in the quarter, regulators approved the final rule for implementing the Basel III regulatory capital standards.
The mandatory compliance day for Key begins in January of 2015 with transitional provisions extending to January of 2019. Our current estimates of Tier 1 common equity as calculated under the final rule was 10.6%, which exceeds the fully phased-in minimum requirement.
As Beth mentioned, during the third quarter, we also repurchased $198 million of shares of our common stock. This amount includes repurchases related to the cash portion of the net after-tax gain from the sale of Victory.
Moving on to Slide 14. This is a summary of our near-term outlook and expectations, which are generally consistent with our prior guidance and assume an orderly and timely resolution of current issues in Washington.
As I stated earlier, we expect average loans to continue to grow year-over-year in the mid-single-digit range and our net interest margin to remain relatively stable with our reported level this quarter. Our net interest margin may be impacted further by liquidity levels and competitive and/or economic environment.
Revenue trends, over time, should also benefit from continued growth in our fee-based businesses. We continue to anticipate expenses in the range of $680 million to $700 million in the fourth quarter, and remain committed to achieving a cash efficiency ratio of 60% to 65%.
While i've reached our $200 million expense savings target, we will continue to identify additional savings opportunities. And it's important to keep in mind that there is variability in our expense levels related to items such as incentive payouts, tide to production, reserves for unfunded loan commitments and seasonal factors.
Credit quality should remain a good story with net charge-offs at or below our targeted range of 60 -- 40 to 60 basis points. And we expect our loan loss provision to be near the same level of net charge-offs.
And finally, capital management will remain a priority, including continuing to execute on our remaining share repurchase authorization of $187 million. With that, I'll close and turn the call back over to the operator for instructions for the Q&A portion of our call.
Operator?
Operator
[Operator Instructions] We'll take our first question from Steven Alexopoulos with JPMorgan.
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division
In terms of the efficiency initiative with you guys now being above the $200 million and you're now in your targeted range, moving forward, how much do you think is left to drive additional improvements in the efficiency ratio? Could there be another $50 million?
$100 million? Or is that too aggressive given what you've already realized?
Donald R. Kimble
This is Don, and I'll go ahead and take the first crack at that. As far as the additional expense savings, we will continue to target areas of opportunity.
We're going to be much more focused on driving positive operating leverage, which will drive us to the lower end of that near-term target of 60% to 65%. We think that's appropriate for now that we clearly will identify specific areas.
But right now, we're not planning on having any named initiatives or named programs that would target a specific dollar amount.
Steven A. Alexopoulos - JP Morgan Chase & Co, Research Division
Okay. And maybe just one follow-up, Don.
You guys had good C&I loan growth in the quarter where other banks are seeing declines or talking about borrowers being very cautious. What are you seeing on the pipeline?
And do you expect strong C&I to continue through year end?
Christopher Marrott Gorman
Steve, it's Chris Gorman here. We -- our pipelines look pretty good.
As we look forward, both on the fee side and on the loan side and we compare kind of where we are year-over-year where we were this time last year, we feel good about it. And we think it's a direct result of being pretty focused about and disciplined about who we're targeting doing business with.
So as you know, we're not necessarily focused necessarily in growing loans. What we're focused on is growing clients and expanding relationships.
And as we look at the pipelines that have come out of that, we feel pretty good about it.
William R. Koehler
Steve, this is Bill. On the commercial side, we would say -- I would say something similar.
We have seen continued moderate improvement in the consumer, which has helped us over the past few quarters as our consumer loan volumes continue to improve.
Operator
And we'll go next to Steve Scinicariello with UBS.
Stephen Scinicariello - UBS Investment Bank, Research Division
Just want to get some color on some of the kind of productivity enhancements that you guys are going to try to start working on and have been working on, but especially as we look into 2014 and what that might mean in terms of kind of revenue growth initiatives as well?
Beth E. Mooney
Steve, this is Beth Mooney. I will go ahead and give a couple thoughts in that regard.
We have been definitely thinking about, and as we've talked about, balancing our ability to become more efficient and productive with our ability to invest and support revenue growth, which is incredibly important that we do both. So as we look into 2014, we see opportunities, as Don outlined, to continue to become more cost effective and work at additional efficiency.
But we also look at opportunities to invest in additional client-facing people and relationship managers as we see success in our businesses, as we are growing CF&A loans. So we continue to think we can invest to acquire and deepen relationships.
We've talked about technology as an enabler and making sure that we remain competitive within mobile and digital, supported by further branch rationalization and continuing to make sure our consumer segments are more efficient. We also see opportunity to look at potentially adding and expanding to our product capability such as credit cards and payments.
And you've seen us do a number of things this year, both through the commercial real estate servicing as well as the exit of Victory, that shows that we're very much trying to keep within our business model of a relationship strategy that we believe is differentiated and pull both levers of investing and creating more productivity for revenue, as well as becoming a more efficient and cost-productive company.
Stephen Scinicariello - UBS Investment Bank, Research Division
That's perfect. And then if you could -- as you look forward into 2014, what might some of your priorities be to accomplish by the end of that year?
Beth E. Mooney
Priorities to accomplish by the end of the year, I would tell you, is, I think, as we talked about, is the continuing efficiency and productivity both of our income statement, as well as our balance sheet. We've talked about the mix of assets and our opportunities within our cost of liabilities.
We also think we could become more efficient within our operations. And we also want to make sure we invest in our businesses for growth and remain very disciplined in capital.
We think that we've had a good opportunity this year to return capital to our shareholders, as well as at the margin have a few opportunities to utilize capital and enhance our capabilities and products.
Operator
And we'll go next to Ken Zerbe with Morgan Stanley.
Ken A. Zerbe - Morgan Stanley, Research Division
Just want to clarify. On the termination of the leveraged leases, Slide 6, you have the impact of $15 million after-tax.
But in the footnote, and I think you referenced this, Don, the $13 million of tax benefit. Should we be adding those numbers up to think about the total impacts of $28 million of, I guess, technically, onetime gain related to the leveraged leases?
Donald R. Kimble
That's an accurate description, Ken. Yes, the $13 million is incremental.
It's not necessarily just specific to that transaction, but as a result of it. So you're right.
Ken A. Zerbe - Morgan Stanley, Research Division
Okay, got it. And then just a follow-up question.
In terms of your excess liquidity, I was a little surprised when you were talking about the NIM or the downward pressure due to excess liquidity. I'm kind of curious what your expectations or your outlook is for your liquidity position.
Like do you expect to get much more? Is there something that we don't know about that would drive up your excess?
Donald R. Kimble
Yes, Ken, that's a great question. I think in this environment, we're not exactly sure what might happen as far as changes that could impact that.
But right now, our guidance is based on our loan growth slightly exceeding our deposit growth. But there are a couple of things that could impact that.
That if the economy slows, we could see less loan growth. We could also see greater inflows to Key.
And one thing to keep in mind, too, that is part of our commercial real estate servicing business that while we have a very stable base of deposits there, there might be temporary flows that could result in increases to overall liquidity position, which could impact our net interest margin percentage, but not have a significant impact on the overall net interest income.
Operator
And we'll go next to Bob Ramsey with FBR.
Bob Ramsey - FBR Capital Markets & Co., Research Division
It's maybe a silly question, but could you explain to me sort of what it is that triggers the early termination of leveraged leases? Is this basically like a loan prepayment with prepayment penalty income?
Or what is it exactly?
Donald R. Kimble
Yes, this is customer driven and would allow, similar to what you said, as far as an early prepayment. But it's not necessarily a penalty that's triggered there.
It's just the way that the revenues are recognized. And by the early termination, there are certain things that are accelerated as far as the recognition.
Bob Ramsey - FBR Capital Markets & Co., Research Division
Okay. And I guess, the question about tax benefit there was answered.
But even when I sort of adjust that $13 million out, looks like your tax rate was 24%, 25%, kind of below what you're expecting for next year. I'm curious what the other factors are there this quarter for tax rate?
And then how you're thinking about the tax rate in the fourth quarter?
Donald R. Kimble
Yes, as far as next year, you're right. We're providing guidance of 26% to 28%.
That's about where we were on a GAAP basis through the second quarter that we said that this transaction had an impact of about 4 percentage points. And this was a primary adjustment that occurred.
But the remaining adjustments occurred from essentially recognition of additional tax credits that were taken in the third quarter. So we do believe the core rate is 26% to 28%.
And fourth quarter should be slightly higher than the third quarter, but in line with the full year expectation.
Operator
And we'll go next to Erika Najarian with Bank of America Merrill Lynch.
Erika Najarian - BofA Merrill Lynch, Research Division
My first question is on your comment and your ability to flex your interest rate risk position through the use of swaps. And is there any way that you can help us think about the puts and takes of the swap income that you could potentially give up in exchange for x percent more of asset sensitivity?
Donald R. Kimble
Great question, Erika. As far as the swaps, we note that we have about $14 billion worth of swaps, about $9 billion of which we use to manage our overall rate risk position.
If we increase or decrease that, we tend to have a fairly short average life for those swaps than the 2- to 3-year time period. And so the average spread there is about 70 basis points.
So for every $1 billion of swaps, you would be giving up 70 basis points of future income associated with that swaps on a near-term basis. But it does help reduce our over -- increase, excuse me, our overall asset sensitivity.
And Joe, it's about 0.5 point for every $1 billion? What's the impact there?
Joseph M. Vayda
That sounds about right. Erika, the way to think about it is simply take the current swap curve and roughly the 2- to 3-year maturity off of short-term LIBOR and that differential in spread times whatever volume you want to use is a good proxy for an income differential.
Erika Najarian - BofA Merrill Lynch, Research Division
I see, okay. And just my second follow-up question is as -- clearly, you are well in excess of all the regulatory capital hurdles that you need to adhere to.
As you prepare for the CCAR next year, do you expect a backup in long rates to be included in the severely adverse case? And have you modeled your capital return and capital return potential asks for more stringent interest rate risk tests on the bond portfolio?
Donald R. Kimble
Last year's part of the CCAR process, the -- one of the stress scenarios did assume a rate increase to see what the impact would be on your bond portfolio from that. One of the benefits we have of being a CCAR bank, but not being a [indiscernible] is the ability to go ahead and opt in or out associated with the OCI impact to capital.
And so even though it could have an impact on TCE, we have the flexibility up through the first quarter of '15 to make the determination as to whether or not we want to include or exclude that impact. And I think that provides us with a little bit more cushion than many of the larger banks might have to deal with.
Beth E. Mooney
And I would just add, Erika, too, that we have talked in the past that our portfolio is also intentionally very short, average duration of around 3.6 years. And so when you look at our mix of investments that are in that portfolio, we have what I would call less risk and less extension risk than many other portfolio.
Operator
And we'll go next to Ken Usdin with Jefferies.
Bryan Batory - Jefferies LLC, Research Division
This is actually Bryan Batory from Ken's team. My first question is on the other fee line.
So that was down $2 million quarter-over-quarter, which looked a little bit light considering the commercial servicing deal closed at the end of 2Q. Can you just comment on if there's anything noncore that ran through that line this quarter?
And what the pickup from the commercial servicing deal was in the third quarter?
Donald R. Kimble
We've not provided a lot of detail as far as the fee income impact from the commercial servicing deal. There are increased fees that we do receive, but part of the real benefit really is coming from the $1 billion in additional core deposits we're getting from that relationship.
As far as the other income category, there really aren't any other significant large unusual items going through this quarter, but we did have some small incremental gains last quarter. But I would suggest that, that is more of an ongoing level at the current quarter amount.
Bryan Batory - Jefferies LLC, Research Division
Okay. And my next question is for Chris.
You mentioned that pipelines, both for commercial fees and loans, were pretty -- in pretty good shape. But I'm just wondering if you've seen any change in customer appetite to drawing on lines or whatnot over the past couple of weeks just in light of what's going on in D.C.?
Christopher Marrott Gorman
Bryan, what we've seen over the last couple of weeks has been fairly consistent. I think most of our clients have been very cautious.
I think there's been a lot of uncertainty. We've seen a willingness, interestingly enough, to look at strategic alternatives, but not really a willingness to invest in people or property, plant and equipment.
And I would say that is unchanged over the last couple of weeks. The only new data point I have for you recently, as I know a couple of our clients that wanted to roll over CP, 30-day CP, and this is specifically yesterday, they could have rolled 45, but they couldn't roll 30-day.
But I am not seeing our clients really adjust yet to some of the uncertainty that's been generated in Washington.
Operator
And we'll go next to Keith Murray with ISI Financial.
Keith Murray - ISI Group Inc., Research Division
Just on the fourth quarter expenses. So the core number for the third quarter looked like around $675 million.
You mentioned that marketing was up in the quarter. When we think about the guidance for the fourth quarter that you gave us, what's the right core number?
I know there'll be noise in there related to efficiency, et cetera, but what's the right way to think about the core?
Donald R. Kimble
Consistent with our guidance last quarter, that $680 million to $700 million does include onetime transition or severance type of costs. And so we had estimated that somewhere in the $15 million to $20 million range.
And so that would be included in that $680 million to $700 million.
Keith Murray - ISI Group Inc., Research Division
Okay. And then just conceptually, if you looked at your ROA target this quarter, you guys are sort of right in the middle of the range, the 100 to 125.
Do you think about the ROE, the annualized sort of $0.26 or so that you're in this quarter to around a 9% or so ROE? If you think about the future and if you get up to the 125 basis point target, let's say, from an ROE point of view, how much upside do you see?
Do you feel like you have to grow the overall balance sheet to sort of increase leverage to get the ROE to a more meaningful target range? I know it's tough.
Given the CCAR, you probably won't be able to return over 100% of net income, so capital will grow. Just trying to get a framework of how you guys think about the ROE.
Donald R. Kimble
No, I think that you hit on some of the challenges there. And I don't know that we want to speculate as to what kind of additional leverage can we get off the balance sheet.
We do believe that our balance sheet can become more efficient than it is today. Our loan-to-deposit ratio is in the low 80% type of range and it's 82% or 83% and our target there is 90% to 100%.
And so by making the balance sheet more efficient, it should drive a stronger margin for us. Combine that with the benefits from increased interest rates, we think that 1.25% type of ROA range should increase, reflecting the impact of interest rates and it'll allow us to get a stronger return on equity.
Operator
We'll go next to Terry McEvoy with Oppenheimer.
Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division
The strength in the investment banking and debt placement fees, could you talk about what industry verticals those have been coming from? And would those be in similar targeted segments as the commercial bank?
What I'm getting at is are you continuing to see a better link between both those parts of Key and generating both loans and now a nice fee income as well?
Christopher Marrott Gorman
Terry, it's Chris. Clearly, the growth that we've enjoyed has come specifically from our targeting of certain industries.
And you look at things like real estate, our industrial business, our growing health care business, we've actually had a lot of lift in our consumer and our energy business. So it's really very focused in the areas that we're in.
And that's where our pipelines are as well. Now as it relates to our coordination with the community bank, there similarly we are focusing where we're really strong in those industry groups.
And so those trends we looked to continue as well.
Terence J. McEvoy - Oppenheimer & Co. Inc., Research Division
And just as a follow-up. Part of the third quarter loan growth, your strength in loan growth, was home equity, which is somewhat seasonal.
I think you hinted that in the press release. Would you expect to see some slowing in Q4 if home equity does not replicate the growth they had in Q3?
William R. Koehler
So Terry, this is Bill. We would see home equity slowing down a little bit into the fourth quarter.
We have seen -- we're pleased that our home equity loan origination extended into the summer longer that it has in the past. And we think that is a good indication that, as I said earlier, the consumer is getting stronger.
And we think that's good for the business and the economy long term, but the fourth quarter is always slower.
Operator
We'll go next to the Gerard Cassidy with RBC.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
A question I have is regarding the capital ratios. Obviously, your Basel III Tier 1 common ratio is very strong with the estimate.
Some of the banks, JPMorgan and Citi, in particular, had given us their level that they expect to manage that, which in their cases, will be 10%, 10.5%. Do you guys have a level where you want to carry that Basel III Tier 1 common ratio that you want to manage that you could give to us?
Donald R. Kimble
This is Don. And I would just like to add to that, that we are one step further as far as being able to define what we believe is the appropriate capital level with the release of the final rules.
We think a more appropriate time period for us to get more specific as far as our operating range would be after this next year's CCAR process and making sure that we have a full appreciation for what to expect prospectively on the impact in the capital requirements. Unlike the large banks that you had referenced, it's not as clear to us as far as what kind of capital buffer would be required for an organization that's in the lower end of the CCAR buckets.
And we want to make sure that we can fully assess the impact of the stress testing and base the capital requirements with the results from that next year.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
So once you have confidence on what the numbers that you're going to be expected to carry, all the regional banks, not just you guys, you guys will disclose to us at some point in the future where you're comfortable relative to those requirements?
Donald R. Kimble
It would be our expectation to disclose that at some point down the road. And I wouldn't suggest that being in January of next year, but I think it will be appropriate for us to establish a target there, I guess.
Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division
Yes, okay. And then on the loan growth.
You guys had obviously nice year-over-year loan growth, double digit. But the sequential annualized number, as you pointed out, has slowed down.
Is there been a slowdown with your customers in loan demand? Or what's caused the slowdown on an annualized basis relative to that year-over-year basis number that you gave us?
William R. Koehler
Gerard, this is Bill. We've had -- the comments that were made earlier by Chris about our clients being a little more cautious and watching the developments and watching -- looking for more visibility with respect to tax and health care policy, all those things contribute to an environment where our clients are less comfortable investing, especially in people.
So we have seen that and I would say that has contributed to some of the slowing down in the sequential growth.
Beth E. Mooney
And Gerard, I would just add that I think it's a little bit, in some ways, a tale of 2 cities, that if you look at it by segment in terms of the size of the company, I think the smaller businesses to midsized businesses, which would be typically in our Community Bank, have been more cautious than what we have seen in some of our targeted clients that's in the Corporate Bank.
Operator
And we'll go next to Mike Mayo with CLSA.
Tom Hennessy - CLSA Limited, Research Division
This is Tom in for Mike. My first question's related to just generally on loans, and I may have missed this.
Did you see any utilization rate changes on the commercial side? And then on the CRE side, just incremental commentary.
The competition's picked up there. What are you seeing and what are you targeting?
Christopher Marrott Gorman
So Tom, it's Chris Gorman. A couple of things.
First of all, with respect to utilization, utilization picked up slightly quarter-over-quarter. But in general, there has not been any market change in utilization for some time x some activity that occurred late last year that was tax driven.
So that's point one. With respect to what's going on in the real estate market, we feel like we have a pretty good eye on what's going on in real estate.
We have generated -- we've actually generated fundings of about $30.5 billion this year and only about 13% actually did we put on our balance sheet. So our business model is such that we sort of see both the syndication market, we see what's going on in the equity market, the debt market, and of course, the commercial mortgage banking business.
There is no question that, as it is across-the-board, competition has increased. And we've seen some compression of spreads both in the real estate business, and frankly, across all businesses.
But for us and our approach where we're really focused on owners of real estate and we're focused on mid-cap REITs, we see plenty of opportunity as we look forward.
Tom Hennessy - CLSA Limited, Research Division
Excellent, that helps a lot. And then just as my -- as a follow-up, a little more technical of a question, though.
Just generally, share buybacks have been on a good trend. Your basic share count declined by about 11 million, 12 million this quarter, but I noticed a $10 million increase actually on the diluted side.
Is there anything that triggered that out of the ordinary? And I mean, I'm just used to the spread being a little tighter on those 2.
Donald R. Kimble
Yes, as the price fluctuates here, you're going to see changes in the impact of stock options and other diluted shares. So that's really what's driving it.
And beyond that, it's just the timing of the actual share repurchases and when they occurred.
Operator
[Operator Instructions] We'll go next to Craig Siegenthaler with Crédit Suisse.
Nicholas Karzon - Crédit Suisse AG, Research Division
This is actually Nick Karzon for Craig. I guess, first, on the $41 million of efficiency charges, I think I saw $25 million on the pension settlement and $6 million in severance.
Can you help us think about which bucket's the remainder -- the remaining $10 million were in?
Donald R. Kimble
Yes, they really are spread in the number of categories including occupancy costs, professional fees and other. And much of it relates to the costs associated with the additional branch closures and also some contract renegotiations.
Nicholas Karzon - Crédit Suisse AG, Research Division
Okay. And then as a follow-up, I think you mentioned $15 million to $20 million of onetime charges are included in the fourth quarter guidance.
Is that just including efficiency initiative charges or would that -- does that also include some portion of pension settlement as well?
Donald R. Kimble
No, that's primarily the efficiency initiative charges. Not sure how much we would have associated with pension.
Since we did trigger that recognition threshold, any lump sum distributions that would occur in the fourth quarter would also trigger an additional loss. But we think it would be much smaller than the year-to-date catch-up that we had for $25 million in the current quarter.
Operator
And we'll take our next question from Marty Mosby with Guggenheim.
Marty Mosby - Guggenheim Securities, LLC, Research Division
Beth, I wanting to ask a little bit about the capital ratios. As you've been able to deploy a good portion of your earnings, your capital ratios have actually been able to drift lower.
Do you still think you'll be able to continue to kind of push at that level of 90% to 100% of your earnings in total payout going into the foreseeable future?
Beth E. Mooney
Marty, this is Beth, as you asked for. And that would be reflective of trying to have a point of view on what 2014 CCAR guidance and rules and opportunities will be.
We've been pleased this year that we were able to, at an analyst average, have an 80% payout as well as the opportunity to return the net after-tax gain of Victory. So you're right, we've had a good year in our ability to return capital to shareholders and that is one of our capital priorities.
But I think it is too soon to have a view of what the 2014 CCAR will be. But it is incredibly important to us to continue to look at our dividend and share repurchase and return of capital to our shareholders.
Marty Mosby - Guggenheim Securities, LLC, Research Division
And just a follow-up to that. Is there any re kind of composition in the sense that you were a little bit conservative on the dividend and pushed the share repurchase as your stock price was below tangible value.
As that flipped going into next year, would you redistribute your priorities between dividends and share repurchase?
Beth E. Mooney
And again, at this point in time, we have not gotten the 2014 CCAR guidance nor started working and formulating our response in terms of what will be the mix that we request for the return to our shareholders. So again, premature, but something obviously that we will look at as we submit our application in January.
Marty Mosby - Guggenheim Securities, LLC, Research Division
And then just, lastly, on the -- we've accomplished the efficiency initiative that we started off talking about over 1 year ago. And now, are there follow-through projects that are coming out?
What is the focused kind of to start pushing efficiencies initiatives to still get some benefit out of that?
Beth E. Mooney
As we've said, we did realize our $200 million targeted goal. And Don mentioned in his comments, many of those will be fully realized in our run rate in 2014.
We do have some initial projects that we are working on and we've also introduced a very robust Lean Six Sigma process into our company to look at end-to-end processes, as well as client experience. So we look at those opportunities and middle office opportunities in terms of how certain transactions and processes are done, as well as we continue to look at, organizationally, how we do things in various areas of the banks that could possibly be done in more efficient ways, as well as continuing to say what in terms of both our staffing, our distribution and how we are aligned and organized can we do to be more effective and efficient.
Christopher Marrott Gorman
Marty, it's Chris. The only thing I would add to what Beth has mentioned is this is really a cultural change for us.
And so while we haven't quantified it and there's certainly no name to the program, we will continue across all of our businesses to look for efficiencies, and my guess is we'll find some.
Beth E. Mooney
We talk every earnings day to our broader employees after we do this call and that is very much a theme that the highest performing company, this is a way they do business culturally, what they do year in and year out. We think we've gotten a lot of discipline, we've gotten a lot of rigor, we've learned a lot in our ability to meet these objectives.
We will continue to expect this of ourselves outside of a named program, but a way, to certainly support our plan for growth, as well as becoming more efficient and productive.
Marty Mosby - Guggenheim Securities, LLC, Research Division
So then the momentum you feel kind of coming out of this culture change and initiative would make you feel, at least directionally, that you should see further improvements and efficiencies are likely?
Beth E. Mooney
We are requiring that of ourselves.
Operator
And there are no other questions at this time. I'd like to turn the conference back over to Beth Mooney for closing remarks.
Beth E. Mooney
Thank you, operator. And we thank you all for taking time from your schedule today to participate in our call.
If you have any follow-up questions, you can direct them to our Investor Relations team, Vernon Patterson or Kelly Dillon at (216) 689-3133. And that concludes our remarks for today.
Thank you.
Operator
Thank you, everyone. That does conclude today's conference.
We thank you for your participation.