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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ______ To ______
Commission File Number 0-850
[KEYCORP LOGO]
------------------------------------------------------
(Exact name of registrant as specified in its charter)
OHIO 34-6542451
- ------------------------------------ --------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
- -------------------------------------- ---------------------------
Address of principal executive offices) (Zip Code)
(216) 689-6300
------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Shares with a par value of $1 each 422,799,824 Shares
- ---------------------------------------------- ----------------------------
(Title of class) (Outstanding at April 30, 2003)
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page Number
-----------
Item 1. Financial Statements
Consolidated Balance Sheets --
March 31, 2003, December 31, 2002 and March 31, 2002 3
Consolidated Statements of Income --
Three months ended March 31, 2003 and 2002 4
Consolidated Statements of Changes in Shareholders' Equity --
Three months ended March 31, 2003 and 2002 5
Consolidated Statements of Cash Flow --
Three months ended March 31, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 29
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 30
Item 3. Quantitative and Qualitative Disclosure of Market Risk 65
Item 4. Controls and Procedures 65
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 65
Item 6. Exhibits and Reports on Form 8-K 65
Signature 67
Management Certifications 68
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
ASSETS
Cash and due from banks $ 3,074 $ 3,364 $ 2,483
Short-term investments 2,837 1,632 1,487
Securities available for sale 8,455 8,507 5,859
Investment securities (fair value: $140, $129 and $224) 132 120 216
Other investments 970 919 864
Loans, net of unearned income of $1,813, $1,776 and $1,803 62,719 62,457 63,956
Less: Allowance for loan losses 1,421 1,452 1,607
- ---------------------------------------------------------------------------------------------------------------------------------
Net loans 61,298 61,005 62,349
Premises and equipment 623 644 663
Goodwill 1,142 1,142 1,101
Other intangible assets 34 35 28
Corporate-owned life insurance 2,442 2,414 2,334
Accrued income and other assets 5,483 5,420 3,975
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 86,490 $ 85,202 $ 81,359
========== ============ ==========
LIABILITIES
Deposits in domestic offices:
NOW and money market deposit accounts $ 17,356 $ 16,249 $ 13,534
Savings deposits 2,095 2,029 2,014
Certificates of deposit ($100,000 or more) 4,667 4,749 4,505
Other time deposits 11,620 11,946 13,231
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing 35,738 34,973 33,284
Noninterest-bearing 10,811 10,630 8,688
Deposits in foreign office -- interest-bearing 3,906 3,743 1,261
- ---------------------------------------------------------------------------------------------------------------------------------
Total deposits 50,455 49,346 43,233
Federal funds purchased and securities sold under repurchase agreements 3,721 3,862 7,338
Bank notes and other short-term borrowings 2,551 2,823 3,174
Accrued expense and other liabilities 5,346 5,471 4,683
Long-term debt 16,269 15,605 15,256
Corporation-obligated mandatorily redeemable preferred capital securities of subsidiary
trusts holding solely subordinated debentures of KeyCorp (See Note 9) 1,250 1,260 1,273
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 79,592 78,367 74,957
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- --
Common shares, $1 par value; authorized 1,400,000,000 shares;
issued 491,888,780 shares 492 492 492
Capital surplus 1,449 1,449 1,385
Retained earnings 6,536 6,448 6,096
Treasury stock, at cost (69,108,570, 67,945,135 and 66,434,962 shares) (1,621) (1,593) (1,551)
Accumulated other comprehensive income (loss) 42 39 (20)
- ---------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,898 6,835 6,402
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 86,490 $ 85,202 $ 81,359
========== ============ ==========
- ---------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements(Unaudited).
3
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions, except per share amounts 2003 2002
- ------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 904 $ 985
Tax-exempt investment securities 2 3
Securities available for sale 101 89
Short-term investments 8 9
Other investments 6 6
- ------------------------------------------------------------------------------------------------------------
Total interest income 1,021 1,092
INTEREST EXPENSE
Deposits 188 250
Federal funds purchased and securities sold under repurchase agreements 16 23
Bank notes and other short-term borrowings 16 27
Long-term debt, including capital securities 120 138
- ------------------------------------------------------------------------------------------------------------
Total interest expense 340 438
- ------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 681 654
Provision for loan losses 130 136
- ------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 551 518
NONINTEREST INCOME
Trust and investment services income 132 158
Service charges on deposit accounts 92 100
Investment banking and capital markets income 34 49
Letter of credit and loan fees 31 28
Corporate-owned life insurance income 27 26
Electronic banking fees 19 18
Net securities gains 4 --
Other income 58 64
- ------------------------------------------------------------------------------------------------------------
Total noninterest income 397 443
NONINTEREST EXPENSE
Personnel 363 363
Net occupancy 59 57
Computer processing 44 54
Equipment 32 34
Marketing 25 26
Professional fees 25 21
Other expense 109 106
- ------------------------------------------------------------------------------------------------------------
Total noninterest expense 657 661
INCOME BEFORE INCOME TAXES 291 300
Income taxes 74 60
- ------------------------------------------------------------------------------------------------------------
NET INCOME $ 217 $ 240
========= ==========
Per common share:
Net income $ .51 $ .56
Net income -- assuming dilution .51 .56
Weighted average common shares outstanding (000) 425,275 424,855
Weighted average common shares and potential common
shares outstanding (000) 428,090 430,019
- ------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
ACCUMULATED
TREASURY OTHER
COMMON CAPITAL RETAINED STOCK, COMPREHENSIVE COMPREHENSIVE
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS AT COST INCOME (LOSS) INCOME
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 $ 492 $ 1,390 $ 5,856 $ (1,585) $ 2
Net income 240 $ 240
Other comprehensive income (losses):
Net unrealized losses on securities available
for sale, net of income taxes of ($13) ( a) (24) (24)
Net unrealized gains on derivative financial instruments,
net of income taxes of $1 3 3
Foreign currency translation adjustments (1) (1)
------------
Total comprehensive income $ 218
============
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 1,448,762 net shares (5) 34
- --------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2002 $ 492 $ 1,385 $ 6,096 $ (1,551) $ (20)
====== ======= ======== ======== ==============
- --------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 $ 492 $ 1,449 $ 6,448 $(1,593) $ 39
Net income 217 $ 217
Other comprehensive income (losses):
Net unrealized losses on securities available
for sale, net of income taxes of ($15) (a) (26) (26)
Net unrealized gains on derivative financial instruments,
net of income taxes of $7 13 13
Foreign currency translation adjustments 16 16
------------
Total comprehensive income $ 220
============
Deferred compensation obligation 1
Cash dividends declared on common shares ($.305 per share) (129)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 836,565 net shares (1) 20
Repurchase of common shares - 2,000,000 shares (48)
- --------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2003 $ 492 $ 1,449 $ 6,536 $ (1,621) $ 42
====== ======= ======== ======== ==============
- --------------------------------------------------------------------------------------------------------------------
(a) Net of reclassification adjustments.
See Notes to Consolidated Financial Statements (Unaudited).
5
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 217 $ 240
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 130 136
Depreciation expense and software amortization 50 61
Net securities gains (4) --
Net (gains) losses from principal investments 3 (1)
Net gains from loan securitizations and sales (15) (6)
Deferred income taxes 74 (6)
Net (increase) decrease in mortgage loans held for sale (19) 167
Net increase in trading account assets (158) (95)
Net decrease in accrued restructuring charges (3) (7)
Other operating activities, net (171) (159)
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 104 330
INVESTING ACTIVITIES
Net (increase) decrease in other short-term investments (1,047) 506
Purchases of securities available for sale (2,457) (1,511)
Proceeds from sales of securities available for sale 1,631 84
Proceeds from prepayments and maturities of securities available for sale 813 936
Purchases of investment securities (18) (7)
Proceeds from prepayments and maturities of investment securities 7 15
Purchases of other investments (90) (28)
Proceeds from sales of other investments 33 13
Proceeds from prepayments and maturities of other investments 26 2
Net increase in loans, excluding acquisitions, sales and divestitures (533) (1,476)
Purchases of loans (419) --
Proceeds from loan securitizations and sales 493 450
Purchases of premises and equipment (10) (15)
Proceeds from sales of premises and equipment 1 5
Proceeds from sales of other real estate owned 11 7
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (1,559) (1,019)
FINANCING ACTIVITIES
Net increase (decrease) in deposits 1,110 (1,555)
Net increase (decrease) in short-term borrowings (413) 1,228
Net proceeds from issuance of long-term debt, including capital securities 1,871 2,055
Payments on long-term debt, including capital securities (1,234) (1,336)
Purchases of treasury shares (48) --
Net proceeds from issuance of common stock 8 16
Cash dividends paid (129) (127)
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,165 281
- ----------------------------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND DUE FROM BANKS (290) (408)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,364 2,891
- ----------------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 3,074 $ 2,483
========= ========
- ----------------------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $ 325 $ 396
Income taxes paid 5 9
Noncash items:
Transfer of investment securities to other investments -- $ 864
Transfer of investment securities to securities available for sale -- 64
- ----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited condensed consolidated interim financial statements include the
accounts of KeyCorp and its subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation.
The Financial Accounting Standards Board ("FASB") issued FASB Interpretation No.
46 in January 2003. The "Accounting Pronouncements Pending Adoption" section of
this note, on page 10, and Note 7 ("Variable Interest Entities"), which begins
on page 19, provide information on Interpretation No. 46. This interpretation
changes the method for evaluating when to consolidate an entity depending on
whether the entity is a voting interest entity or a variable interest entity. It
was effective immediately for entities created after January 31, 2003, and
applies to previously existing entities in quarters beginning after June 15,
2003.
Key currently evaluates whether to consolidate entities in which it invested
prior to February 1, 2003, based on the nature and amount of equity contributed
by third parties, the decision-making power granted to those parties and the
extent of their control over the entity's operating and financial policies.
Entities that Key controls, generally through majority ownership, are
consolidated and are considered subsidiaries.
Unconsolidated investments in entities in which Key has significant influence
over operating and financing decisions (usually defined as a voting or economic
interest of 20 to 50%) are accounted for by the equity method. Unconsolidated
investments in entities in which Key has a voting or economic interest of less
than 20% are generally carried at cost. Investments held by KeyCorp's
broker/dealer and investment company subsidiaries (principal investments) are
carried at estimated fair value.
Key uses special purpose entities ("SPEs"), including securitization trusts, in
the normal course of business for funding purposes. SPEs established by Key as
qualifying SPEs under the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities," are not consolidated. Nonqualifying
SPEs established before February 1, 2003, are evaluated for consolidation by Key
based on the nature and amount of equity contributed by third parties, the risks
and rewards the parties assume and the control the respective parties exercise
over the SPE's activities. Securitization trusts sponsored by Key are not
consolidated since they are qualifying SPEs. Additional information on SFAS No.
140 is summarized in Note 1 ("Summary of Significant Accounting Policies") of
Key's 2002 Annual Report to Shareholders under the heading "Loan
Securitizations" on page 59.
Key also does not consolidate an asset-backed commercial paper conduit for which
it is a referral agent. The conduit is owned by a third party and administered
by an unaffiliated financial institution. Key shares the risks and rewards of
the conduit's activities with multiple third parties. Additional information on
the conduit is summarized in Note 7 ("Variable Interest Entities"), which begins
on page 19 and in Note 10 ("Contingent Liabilities and Guarantees"), which
begins on page 23.
Management believes that the unaudited condensed consolidated interim financial
statements reflect all adjustments of a normal recurring nature and disclosures
which are necessary for a fair presentation of the results for the interim
periods presented. Some previously reported results have been reclassified to
conform to current reporting practices. The results of operations for the
interim periods are not necessarily indicative of the results of operations to
be expected for the full year. When you read these financial statements, you
should also look at the audited consolidated financial statements and related
notes included in Key's 2002 Annual Report to Shareholders.
As used in these Notes, KEYCORP refers solely to the parent company and KEY
refers to the consolidated entity consisting of KeyCorp and its subsidiaries.
7
STOCK-BASED COMPENSATION
Through December 31, 2002, Key accounted for stock options issued to employees
using the intrinsic value method. This method required that compensation expense
be recognized to the extent that the fair value of the stock exceeded the
exercise price of the option at the grant date. Key's employee stock options
generally have fixed terms and exercise prices that are equal to or greater than
the fair value of Key's common shares at the grant date, so Key generally had
not recognized compensation expense related to stock options.
In September 2002, KeyCorp's Board of Directors approved management's
recommendation to change Key's method of accounting for stock options granted to
eligible employees and directors. Effective January 1, 2003, Key adopted the
fair value method of accounting as outlined in SFAS No. 123, "Accounting for
Stock-Based Compensation." Additional information pertaining to this accounting
change is summarized on page 9 under the heading "Accounting Pronouncements
Adopted in 2003."
SFAS No. 123 requires companies like Key that have used the intrinsic value
method to account for employee stock options to provide pro forma disclosures of
the net income and earnings per share effect of stock options using the fair
value method. Management estimates the fair value of options granted using the
Black-Scholes option-pricing model. This model was originally developed to
estimate the fair value of exchange-traded equity options, which (unlike
employee stock options) have no vesting period or transferability restrictions.
As a result, the Black-Scholes model is not a perfect indicator of the value of
an option, but it is commonly used for this purpose.
The Black-Scholes model requires several assumptions, which management developed
and updates based on historical trends and current market observations. These
assumptions include:
- - an average option life of 6.0 years for the first three months of 2003
and 5.0 years for the first three months of 2002;
- - a future dividend yield of 5.10% for the first three months of 2003 and
4.87% for the first three months of 2002;
- - share price volatility of .293 for the first three months of 2003 and
.276 for the first three months of 2002; and
- - a weighted average risk-free interest rate of 3.3% for the first three
months of 2003 and 4.1% for the first three months of 2002.
The level of accuracy achieved in deriving the estimated fair values is directly
related to the accuracy of the underlying assumptions.
The model assumes that the estimated fair value of an option is amortized over
the option's vesting period and would be included in personnel expense on the
income statement. The pro forma effect of applying the fair value method of
accounting to all forms of stock-based compensation (e.g., stock options, stock
purchase plans, restricted stock, etc.) for the first three months of 2003 and
2002 is shown in the following table. The information presented may not be
indicative of the effect in future periods.
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions, except per share amounts 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 217 $ 240
Add: Stock-based employee compensation expense included in
reported net income, net of related tax effects 2 1
Deduct: Total stock-based employee compensation expense determined under
fair value-based method for all awards, net of related tax effects 5 7
- ----------------------------------------------------------------------------------------------------------------------------
Net income -- pro forma $ 214 $ 234
========= ========
Per common share:
Net income $ .51 $ .56
Net income -- pro forma .50 .55
Net income assuming dilution .51 .56
Net income assuming dilution -- pro forma .50 .54
- ----------------------------------------------------------------------------------------------------------------------------
8
ACCOUNTING PRONOUNCEMENTS ADOPTED IN 2003
ACCOUNTING FOR AND DISCLOSURE OF GUARANTEES. In November 2002, the FASB issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others." This
interpretation requires a guarantor to recognize, at the inception of a
guarantee, a liability for the fair value of obligations undertaken. The
liability that must be recognized is specifically related to the obligation to
stand ready to perform over the term of the guarantee. The initial recognition
and measurement provisions of this guidance became effective on a prospective
basis for guarantees issued or modified on or after January 1, 2003.
For guarantees subject to the liability recognition provisions of this
interpretation for which Key receives a fee, the initial fair value stand ready
obligation is recognized at an amount equal to the fee. For guarantees for which
no fee is received, the fair value of the stand ready obligations is determined
using expected present value measurement techniques, unless observable
transactions for identical or similar guarantees are available. The subsequent
accounting for these stand ready obligations depends on the nature of the
underlying guarantees. Key accounts for its release from risk for a particular
guarantee either upon expiration or settlement, or by a systematic and rational
amortization method depending on the risk profile of the particular guarantee.
This new accounting guidance also expands the disclosures that a guarantor must
make about its obligations under certain guarantees. These disclosure
requirements took effect for financial statements of interim or annual periods
ending after October 15, 2002. The required disclosures for Key are provided in
Note 10 ("Contingent Liabilities and Guarantees"), which begins on page 23.
The adoption of Interpretation No. 45 did not have any material effect on Key's
financial condition or results of operations.
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. In July 2002, the FASB issued
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." This new standard took effect for exit or disposal activities
(e.g., activities related to ceasing a line of business, relocating operations,
etc.) initiated after December 31, 2002. SFAS No. 146 substantially changes the
rules for recognizing costs, such as lease or other contract termination costs
and one-time employee termination benefits associated with exit or disposal
activities arising from corporate restructurings. Generally, these costs must be
recognized when incurred. Previously, those costs could be recognized earlier,
for example, when a company committed to an exit or disposal plan. Key adopted
SFAS No. 146 for restructuring activities initiated on or after January 1, 2003.
The adoption of SFAS No. 146 did not significantly affect Key's financial
condition or results of operations.
ASSET RETIREMENT OBLIGATIONS. In August 2001, the FASB issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." The new standard was effective
for fiscal years beginning after June 15, 2002. SFAS No. 143 addresses the
accounting for legal obligations associated with the retirement of tangible
long-lived assets and requires a liability to be recognized for the fair value
of these obligations in the period they are incurred. Related costs are
capitalized as part of the carrying amounts of the assets to be retired and are
amortized over the assets' useful lives. Key adopted SFAS No. 143 as of January
1, 2003. The adoption of this accounting guidance did not significantly affect
Key's financial condition or results of operations.
ACCOUNTING FOR STOCK-BASED COMPENSATION. Under SFAS No. 123, "Accounting for
Stock-Based Compensation," companies may either recognize the compensation cost
associated with stock options as expense over the respective vesting periods or
disclose the pro forma impact on earnings in their financial statements. Key has
historically followed the latter approach, but in September 2002, KeyCorp's
Board of Directors approved management's recommendation to recognize the
compensation cost for stock options. Effective January 1, 2003, Key adopted the
fair value method of accounting as outlined in SFAS No. 123. Management is
applying the change in accounting prospectively (prospective method) to all
awards as permitted under the transition provisions in SFAS No. 148, "Accounting
for Stock-Based Compensation Transition and Disclosure," which was issued in
December 2002. SFAS No. 148 amends SFAS No. 123 to provide alternative methods
of transition for an entity that voluntarily changes to the fair value method of
accounting for stock compensation. These alternative methods include: (i) the
prospective method; (ii) the
9
modified prospective method; and, (iii) the retroactive restatement method. This
accounting guidance also amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock compensation and the effect of the
method used on reported financial results. The required interim disclosures for
Key are provided under the heading "Stock-Based Compensation" on page 8.
Based on the valuation and anticipated mid-year timing of option grants in 2003,
management estimates that the accounting change will reduce Key's diluted
earnings per common share by approximately $.02 in 2003. The effect on Key's
earnings per common share in subsequent years will depend on the number and
timing of options granted and the assumptions used to estimate their fair value.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
CONSOLIDATION OF VARIABLE INTEREST ENTITIES. In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities," which
significantly changes how Key and other companies determine when to consolidate
other entities. Under this guidance, entities are classified as either voting
interest entities or variable interest entities ("VIEs"). A voting interest
entity is evaluated for consolidation under existing accounting standards, which
focus on the equity owner with voting control, while a VIE is consolidated by
its primary beneficiary. The primary beneficiary is the party that holds
variable interests that expose it to a majority of the entity's expected losses
and/or residual returns. Variable interests include equity interests,
subordinated debt, derivative contracts, leases, service agreements, guarantees,
standby letters of credit, loan commitments and other instruments.
Interpretation No. 46 was effective immediately for entities created after
January 31, 2003, and applies to previously existing entities in quarters
beginning after June 15, 2003. It requires additional disclosures by primary
beneficiaries and other significant variable interest holders. Management is
currently evaluating Key's involvement with entities created prior to February
1, 2003, to identify those that must be consolidated or only disclosed in
accordance with this guidance. The most significant impact of this new guidance
will be on Key's balance sheet since consolidating additional entities will
increase assets and liabilities and change leverage and capital ratios, as well
as asset concentrations. While the consolidation of previously unconsolidated
entities under Interpretation No. 46 will represent an accounting change, it
will not affect Key's legal rights or obligations to these entities. Additional
information is summarized in Note 7 ("Variable Interest Entities"), which begins
on page 19, and in Note 10 ("Contingent Liabilities and Guarantees"), which
begins on page 23.
2. EARNINGS PER COMMON SHARE
Key calculates its basic and diluted earnings per common share as follows:
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions, except per share amounts 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 217 $ 240
========== ==========
- -------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 425,275 424,855
Effect of dilutive common stock options (000) 2,815 5,164
- -------------------------------------------------------------------------------------------------------------------------
Weighted average common shares and potential
common shares outstanding (000) 428,090 430,019
========== ==========
- -------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per common share $ .51 $ .56
Net income per common share-- assuming dilution .51 .56
- -------------------------------------------------------------------------------------------------------------------------
10
3. ACQUISITIONS AND DIVESTITURE
Business acquisitions and the divestiture that Key completed during 2002 are
summarized below. There were no such transactions completed during the first
quarter of 2003.
ACQUISITIONS
UNION BANKSHARES, LTD.
On December 12, 2002, Key purchased Union Bankshares, Ltd., the holding company
for Union Bank & Trust, a seven-branch bank headquartered in Denver, Colorado.
Key paid $22.63 per Union Bankshares common share for a total cash consideration
of $66 million. Goodwill of approximately $34 million and core deposit
intangibles of $13 million were recorded. Union Bankshares, Ltd. had assets of
$475 million at the date of acquisition. On January 17, 2003, Union Bank & Trust
was merged into Key Bank National Association ("KBNA").
CONNING ASSET MANAGEMENT
On June 28, 2002, Key purchased substantially all of the mortgage loan and real
estate business of Conning Asset Management, headquartered in Hartford,
Connecticut. Conning's mortgage loan and real estate business originates,
securitizes and services multi-family, retail, industrial and office property
mortgage loans on behalf of pension fund and life insurance company investors.
At the date of acquisition, the business had net assets of $17 million and
serviced approximately $4 billion in commercial mortgage loans through its St.
Louis office. In accordance with a confidentiality clause in the purchase
agreement, the terms, which are not material, have not been disclosed.
DIVESTITURE
401(k) RECORDKEEPING BUSINESS
On June 12, 2002, Key sold its 401(k) recordkeeping business. Key recognized a
gain of $3 million ($2 million after tax) on the transaction.
11
4. LINE OF BUSINESS RESULTS
CONSUMER BANKING
RETAIL BANKING provides individuals with branch-based deposit and investment
products, personal finance services and loans, including residential mortgages,
home equity and various types of installment loans.
SMALL BUSINESS provides businesses that have annual sales revenues of $10
million or less with deposit, investment and credit products, and business
advisory services.
CONSUMER FINANCE consists of two primary business units: Indirect Lending and
National Home Equity.
Indirect Lending offers automobile and marine loans to consumers through
dealers, and finances inventory for automobile and marine dealers. This business
unit also provides education loans, insurance and interest-free payment plans
for students and their parents.
National Home Equity provides both prime and nonprime mortgage and home equity
loan products to individuals. These products originate outside of Key's retail
branch system. This business unit also works with mortgage brokers and home
improvement contractors to provide home equity and home improvement solutions.
CORPORATE AND INVESTMENT BANKING
CORPORATE BANKING provides a full array of products and services to large
corporations, middle-market companies, financial institutions and government
organizations. These products and services include: financing, treasury
management, investment banking, derivatives and foreign exchange, equity and
debt trading, and syndicated finance.
KEYBANK REAL ESTATE CAPITAL provides construction and interim lending, permanent
debt placements and servicing, and equity and investment banking services to
developers, brokers and owner-investors. This line of business deals exclusively
with nonowner-occupied properties (i.e., generally properties for which the
owner occupies less than 60% of the premises).
KEY EQUIPMENT FINANCE meets the equipment leasing needs of companies worldwide
and provides equipment manufacturers, distributors and resellers with financing
options for their clients. Lease financing receivables and related revenues are
assigned to Corporate Banking or KeyBank Real Estate Capital if one of those
businesses is principally responsible for maintaining the relationship with the
client.
INVESTMENT MANAGEMENT SERVICES
INVESTMENT MANAGEMENT SERVICES consists of two primary business units: Victory
Capital Management and McDonald Financial Group.
Victory Capital Management manages or gives advice regarding investment
portfolios for a national client base, including corporations, labor unions,
not-for-profit organizations, governments and individuals. These portfolios may
be managed in separate accounts, common funds or the Victory family of mutual
funds.
McDonald Financial Group offers financial, estate and retirement planning and
asset management services to assist high-net-worth clients with their banking,
brokerage, trust, portfolio management, insurance, charitable giving and related
needs. This unit also provides banking services to public sector institutions.
OTHER SEGMENTS
Other segments consists primarily of Treasury, Principal Investing and the net
effect of funds transfer pricing.
RECONCILING ITEMS
Total assets included under "Reconciling Items" represent primarily the
unallocated portion of nonearning assets of corporate support functions. Charges
related to the funding of these assets are part of net interest income and are
allocated to the business segments through noninterest expense. Reconciling
Items also
12
include certain items that are not allocated to the business segments because
they are not reflective of their normal operations.
The table that spans pages 14 and 15 shows selected financial data for each
major business group for the three months ended March 31, 2003 and 2002. This
table is accompanied by additional supplementary information for each of the
lines of business that comprise these groups. The information was derived from
the internal financial reporting system that management uses to monitor and
manage Key's financial performance. Accounting principles generally accepted in
the United States guide financial accounting, but there is no authoritative
guidance for "management accounting"--the way management uses its judgment and
experience to make reporting decisions. Consequently, the line of business
results Key reports may not be comparable with line of business results
presented by other companies.
The selected financial data are based on internal accounting policies designed
to compile results on a consistent basis and in a manner that reflects the
underlying economics of the businesses. As such:
- - Net interest income is determined by assigning a standard cost for
funds used to assets or a standard credit for funds provided to
liabilities based on their maturity, prepayment and/or repricing
characteristics. The net effect of this funds transfer pricing is
included in the "Other Segments" columns.
- - Indirect expenses, such as computer servicing costs and corporate
overhead, are allocated based on assumptions of the extent to which
each line actually uses the services.
- - Key's consolidated provision for loan losses is allocated among the
lines of business based primarily on their actual net charge-offs
(excluding those discussed on page 57 that are recorded in the
nonreplenished allowance), adjusted periodically for loan growth and
changes in risk profile. The level of the consolidated provision is
based on the methodology that management uses to estimate Key's
consolidated allowance for loan losses. This methodology is described
in Note 1 ("Summary of Significant Accounting Policies") under the
heading "Allowance for Loan Losses" on page 58 of Key's 2002 Annual
Report to Shareholders.
- - Income taxes are allocated based on the statutory federal income tax
rate of 35% (adjusted for tax-exempt interest income, income from
corporate-owned life insurance and tax credits associated with
investments in low-income housing projects) and a blended state income
tax rate (net of the federal income tax benefit) of 2.5%.
- - Capital is assigned based on management's assessment of economic risk
factors (primarily credit, operating and market risk).
Developing and applying the methodologies that management uses to allocate items
among Key's lines of business is a dynamic process. Accordingly, financial
results may be revised periodically to reflect accounting enhancements, changes
in the risk profile of a particular business or changes in Key's organization
structure. The financial data reported for all periods presented in the tables
reflect a number of changes, which occurred during the first quarter of 2003:
- - Key reorganized and renamed some of its business groups and lines of
business. Key's Capital Markets line of business moved from the
Investment Management Services group (formerly Key Capital Partners) to
the Corporate Banking line within the Corporate and Investment Banking
group (formerly Key Corporate Finance). Also within Corporate and
Investment Banking, Key changed the name of its National Commercial
Real Estate line of business to KeyBank Real Estate Capital, and
changed the name of its National Equipment Finance line of business to
Key Equipment Finance. In addition, Key consolidated the reporting of
its National Home Equity and Indirect Lending lines of business into
one line of business named Consumer Finance.
- - Methodologies used to allocate certain overhead and funding costs were
refined.
13
CORPORATE AND INVESTMENT
CONSUMER BANKING INVESTMENT BANKING MANAGEMENT SERVICES
------------------------ ----------------------- ---------------------
THREE MONTHS ENDED MARCH 31,
dollars in millions 2003 2002 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 450 $ 434 $ 279 $ 284 $ 59 $ 53
Noninterest income 114 117 110 121 133 160
- -------------------------------------------------------------------------------------------------------------------------
Total revenue (TE) (a) 564 551 389 405 192 213
Provision for loan losses 78 81 50 52 2 3
Depreciation and amortization expense 34 39 9 11 10 14
Other noninterest expense 299 302 160 159 148 159
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (TE) 153 129 170 183 32 37
Allocated income taxes and TE adjustments 57 48 64 69 12 14
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 96 $ 81 $ 106 $ 114 $ 20 $ 23
========== ========== ========= ========== =========== ======
Percent of consolidated net income 44 % 34 % 49 % 48 % 9 % 10 %
Percent of total segments net income 45 37 50 52 9 10
- -------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 28,434 $ 27,318 $ 28,385 $ 29,842 $ 4,958 $4,699
Total assets(a) 30,863 29,660 32,822 33,060 5,913 5,771
Deposits 34,360 34,311 4,039 3,134 5,216 3,671
- -------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs $ 78 $ 81 $ 79 $ 122 $ 3 $ 3
Return on average allocated equity 18.37 % 16.20 % 13.00 % 14.18 % 13.02 % 15.22 %
Average full-time equivalent employees 8,519 8,514 2,262 2,248 2,944 3,206
- -------------------------------------------------------------------------------------------------------------------------
Supplementary information (Consumer Banking lines of business)
RETAIL BANKING SMALL BUSINESS CONSUMER FINANCE
-------------------------- --------------------- ------------------------
THREE MONTHS ENDED MARCH 31,
dollars in millions 2003 2002 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 320 $ 311 $ 94 $ 90 $ 150 $ 150
Provision for loan losses 16 18 17 14 45 49
Noninterest expense 205 207 42 43 86 91
Net income 62 54 22 21 12 6
Average loans 9,571 7,856 4,374 4,303 14,489 15,159
Average deposits 29,932 30,493 4,076 3,499 352 319
Net loan charge-offs 16 18 17 14 45 49
Return on average allocated equity 40.49 % 40.71 % 24.85 % 26.70 % 4.27 % 2.08 %
Average full-time equivalent employees 6,192 6,173 378 320 1,949 2,021
- --------------------------------------------------------------------------------------------------------------------------
Supplementary information (Corporate and Investment Banking lines of business)
CORPORATE BANKING KEYBANK REAL ESTATE CAPITAL KEY EQUIPMENT FINANCE
-------------------------- ----------------------------- ------------------------
THREE MONTHS ENDED MARCH 31,
dollars in millions 2003 2002 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 234 $ 249 $ 84 $ 90 $ 71 $ 66
Provision for loan losses 40 36 4 3 6 13
Noninterest expense 112 117 32 30 25 23
Net income 51 59 30 36 25 19
Average loans 14,261 16,365 7,497 7,832 6,627 5,645
Average deposits 3,362 2,568 665 558 12 8
Net loan charge-offs 69 106 4 3 6 13
Return on average allocated equity 10.25 % 11.56 % 15.08 % 18.99 % 20.99 % 18.26 %
Average full-time equivalent employees 1,021 1,103 635 510 606 635
- ----------------------------------------------------------------------------------------------------------------------------------
14
OTHER SEGMENTS TOTAL SEGMENTS RECONCILING ITEMS KEY
- ------------------------ ----------------------- ------------------------- ------------------------
2003 2002 2003 2002 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------
$ (59) $ (39) $ 729 $ 732 $ (26) $ (30) $ 703 $ 702
34 33 391 431 6 12 397 443
- -------------------------------------------------------------------------------------------------------------
(25) (6) 1,120 1,163 (20) (18) 1,100 1,145
-- -- 130 136 -- -- 130 136
-- -- 53 64 -- -- 53 64
8 6 615 626 (11) (29) 604 597
- -------------------------------------------------------------------------------------------------------------
(33) (12) 322 337 (9) 11 313 348
(23) (15) 110 116 (14) (8) 96 108
- -------------------------------------------------------------------------------------------------------------
$ (10) $ 3 $ 212 $ 221 $ 5 $ 19 $ 217 $ 240
========== ========== ======== ========== =========== ========== ========== ==========
(4) % -- % 98 % 92 % 2 % 8 % 100 % 100 %
(4) 1 100 100 N/A N/A N/A N/A
- -------------------------------------------------------------------------------------------------------------
$ 962 $ 1,444 $ 62,739 $ 63,303 $ 106 $ 185 $ 62,845 $ 63,488
12,796 10,594 82,394 79,085 1,520 1,786 83,914 80,871
3,207 2,941 46,822 44,057 (72) (88) 46,750 43,969
- -------------------------------------------------------------------------------------------------------------
-- -- $ 160 $ 206 -- -- $ 160 $ 206
(11.05) % 2.97 % 13.40 % 14.20 % N/M N/M 12.91 % 15.53 %
35 31 13,760 13,999 6,687 7,080 20,447 21,079
- -------------------------------------------------------------------------------------------------------------
(a) Substantially all revenue generated by Key's major business groups is
derived from clients resident in the United States. Substantially all
long-lived assets, including premises and equipment, capitalized software
and goodwill, held by Key's major business groups are located in the United
States.
TE = Taxable Equivalent, N/A = Not Applicable, N/M = Not Meaningful
15
5. SECURITIES
Key classifies its securities into four categories: trading, available for sale,
investment and other investments.
TRADING ACCOUNT SECURITIES. These are debt and equity securities that are
purchased and held by Key with the intent of selling them in the near term, and
certain interests retained in loan securitizations. All of these assets are
reported at fair value ($959 million at March 31, 2003, $801 million at December
31, 2002, and $692 million at March 31, 2002) and are included in "short-term
investments" on the balance sheet. Realized and unrealized gains and losses on
trading account securities are reported in "investment banking and capital
markets income" on the income statement.
SECURITIES AVAILABLE FOR SALE. These include securities that Key intends to hold
for an indefinite period of time and that may be sold in response to changes in
interest rates, prepayment risk, liquidity needs or other factors. Securities
available for sale are reported at fair value and include debt and marketable
equity securities with readily determinable fair values. Unrealized gains and
losses (net of income taxes) deemed temporary are recorded in shareholders'
equity as a component of "accumulated other comprehensive income (loss)."
Unrealized gains and losses on specific securities deemed to be "other than
temporary" are included in "net securities gains (losses)" on the income
statement. Also included in "net securities gains (losses)" are actual gains and
losses resulting from sales of specific securities.
When Key retains an interest in loans it securitizes, it bears risk that the
loans will be prepaid (which would reduce expected interest income) or not paid
at all. Key accounts for these retained interests (which include both
certificated and uncertificated interests) as debt securities, classifying them
as available for sale or as trading account assets.
"Other securities" held in the available for sale portfolio primarily are
marketable equity securities, including an internally managed portfolio of
common stock investments in financial services companies.
INVESTMENT SECURITIES. These are debt securities that Key has the intent and
ability to hold until maturity. Debt securities are carried at cost, adjusted
for amortization of premiums and accretion of discounts using the interest
method. This method produces a constant rate of return on the basis of the
adjusted carrying amount.
OTHER INVESTMENTS. Principal investments - investments in equity and mezzanine
instruments made by Key's Principal Investing unit - represent the majority of
other investments and are carried at fair value. They include direct and
indirect investments predominately in privately-held companies. Direct
investments are those made in a particular company, while indirect investments
are made through funds that include other investors. Changes in estimated fair
values and actual gains and losses on sales of principal investments are
included in "investment banking and capital markets income" on the income
statement.
In addition to principal investments, other investments include equity
securities that do not have readily determinable fair values. These securities
include certain real estate-related investments that are carried at estimated
fair value, as well as other types of securities that are generally carried at
cost. The carrying amount of the securities carried at cost is adjusted for
declines in value that are considered to be "other than temporary." These
adjustments are included in "net securities gains " on the income statement.
The amortized cost, unrealized gains and losses, and approximate fair value of
Key's investment securities, securities available for sale and other investments
are presented in the following tables. Gross "unrealized" gains and losses are
represented by the difference between the amortized cost and the fair values of
securities on the balance sheet as of the dates indicated. Accordingly, the
amount of these gains and losses may change in the future as market conditions
improve or worsen.
16
MARCH 31, 2003
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
U.S. Treasury, agencies and corporations $ 15 -- -- $ 15
States and political subdivisions 113 $ 8 -- 121
Other securities 4 -- -- 4
- ---------------------------------------------------------------------------------------------
Total investment securities $ 132 $ 8 -- $ 140
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 23 $ 1 -- $ 24
States and political subdivisions 27 1 -- 28
Collateralized mortgage obligations 7,283 103 $ 76 7,310
Other mortgage-backed securities 698 32 -- 730
Retained interests in securitizations 148 45 -- 193
Other securities 200 -- 30 170
- ---------------------------------------------------------------------------------------------
Total securities available for sale $ 8,379 $ 182 $ 106 $ 8,455
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Principal investments $ 687 $ 70 $ 59 $ 698
Other securities 272 -- -- 272
- ---------------------------------------------------------------------------------------------
Total other investments $ 959 $ 70 $ 59 $ 970
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
DECEMBER 31, 2002
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 120 $ 9 -- $ 129
- ---------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 22 $ 1 -- $ 23
States and political subdivisions 35 -- -- 35
Collateralized mortgage obligations 7,143 129 $ 65 7,207
Other mortgage-backed securities 815 37 -- 852
Retained interests in securitizations 166 43 -- 209
Other securities 208 -- 27 181
- ---------------------------------------------------------------------------------------------
Total securities available for sale $ 8,389 $ 210 $ 92 $ 8,507
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Principal investments $ 702 $ 36 $ 61 $ 677
Other securities 242 -- -- 242
- ---------------------------------------------------------------------------------------------
Total other investments $ 944 $ 36 $ 61 $ 919
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
March 31, 2002
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 216 $ 8 -- $ 224
- ---------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 97 -- -- $ 97
States and political subdivisions 20 -- -- 20
Collateralized mortgage obligations 4,409 $ 67 $ 97 4,379
Other mortgage-backed securities 900 23 -- 923
Retained interests in securitizations 195 27 -- 222
Other securities 233 -- 15 218
- ---------------------------------------------------------------------------------------------
Total securities available for sale $ 5,854 $ 117 $ 112 $ 5,859
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Principal investments $ 719 -- $ 83 $ 636
Other securities 228 -- -- 228
- ---------------------------------------------------------------------------------------------
Total other investments $ 947 -- $ 83 $ 864
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
17
6. LOANS
Key's loans by category are summarized as follows:
MARCH 31, DECEMBER 31, MARCH 31,
in millions 2003 2002 2002
- ---------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 17,292 $ 17,425 $ 18,247
Commercial real estate:
Commercial mortgage 6,029 6,015 6,531
Construction 5,437 5,659 5,884
- ---------------------------------------------------------------------------------------
Total commercial real estate loans 11,466 11,674 12,415
Commercial lease financing 7,848 7,513 7,318
- --------------------------------------------------------------------------------------
Total commercial loans 36,606 36,612 37,980
Real estate-- residential mortgage 1,862 1,968 2,195
Home equity 14,144 13,804 12,662
Consumer-- direct 2,100 2,161 2,256
Consumer-- indirect:
Automobile lease financing 680 873 1,669
Automobile loans 2,127 2,181 2,367
Marine 2,197 2,088 1,821
Other 619 667 968
- ---------------------------------------------------------------------------------------
Total consumer-- indirect loans 5,623 5,809 6,825
- ---------------------------------------------------------------------------------------
Total consumer loans 23,729 23,742 23,938
Loans held for sale:
Commercial, financial and agricultural -- 41 --
Real estate-- commercial mortgage 237 193 186
Real estate-- residential mortgage 32 57 15
Education 2,115 1,812 1,837
- ---------------------------------------------------------------------------------------
Total loans held for sale 2,384 2,103 2,038
- ---------------------------------------------------------------------------------------
Total loans $ 62,719 $ 62,457 $ 63,956
========= ============ =========
- ---------------------------------------------------------------------------------------
Key uses interest rate swaps to manage interest rate risk; these swaps modify
the repricing and maturity characteristics of certain loans. For more
information about such swaps at March 31, 2003, see Note 20 ("Derivatives and
Hedging Activities"), which begins on page 84 of Key's 2002 Annual Report to
Shareholders.
Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 2003 2002
- ------------------------------------------------------------------------
Balance at beginning of period $ 1,452 $ 1,677
Charge-offs (190) (233)
Recoveries 29 27
- ------------------------------------------------------------------------
Net charge-offs (161) (206)
Provision for loan losses 130 136
- ------------------------------------------------------------------------
Balance at end of period $ 1,421 $ 1,607
========= =========
- ------------------------------------------------------------------------
18
7. VARIABLE INTEREST ENTITIES
A variable interest entity ("VIE") is a partnership, limited liability company,
trust or other legal entity that is not controlled through a voting equity
interest and/or does not have enough equity at risk invested to finance its
activities without subordinated financial support from another party. FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities," addresses
the consolidation of VIEs. This interpretation is summarized in Note 1 ("Basis
of Presentation"), under the heading "Accounting Pronouncements Pending
Adoption" on page 10. Under Interpretation No. 46, VIEs are consolidated by the
party (the primary beneficiary) who is exposed to the majority of the VIE's
expected losses and/or residual returns.
Key's securitization trusts are exempt from consolidation under Interpretation
No. 46 because they are qualifying special purpose entities as defined by SFAS
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities."
As required by Interpretation No. 46, Key is assessing its relationships and
arrangements with legal entities formed prior to February 1, 2003, to identify
VIEs in which Key holds a significant variable interest and to determine if Key
is the primary beneficiary of these entities and should therefore consolidate
them.
Based on the review performed to date, Key expects to consolidate the following
two VIE groups beginning in the third quarter of 2003.
COMMERCIAL PAPER CONDUITS. Key, among others, refers third party assets and
borrowers and provides liquidity and credit enhancement to an asset-backed
commercial paper conduit. The conduit had assets of $408 million at March 31,
2003. As currently structured, Key will be required to consolidate the conduit
in the third quarter of 2003; however, management is assessing restructuring
alternatives that may enable the conduit to meet the criteria for
nonconsolidation.
In addition, Key holds a subordinated note in and provides referral services and
liquidity to one program within another asset-backed commercial paper conduit.
This program, which is in the process of being liquidated, had assets of $61
million at March 31, 2003.
At March 31, 2003, Key's maximum exposure to loss from its interests in these
conduits totaled $78 million, which represents a $68 million committed credit
enhancement facility and a $10 million subordinated note.
Additional information pertaining to Key's involvement with conduits is
summarized in Note 1 ("Basis of Presentation"), which begins on page 7 and in
Note 10 ("Contingent Liabilities and Guarantees") under the heading "Guarantees"
on page 24 and the heading "Other Off-Balance Sheet Risk" on page 26.
LOW-INCOME HOUSING TAX CREDIT ("LIHTC") GUARANTEED FUNDS. Key Affordable Housing
Corporation ("KAHC") forms limited partnerships (funds) which invest in LIHTC
projects. Interests in these funds are offered to qualified investors, who pay a
fee to KAHC for a guaranteed return. Key also earns syndication and asset
management fees from these funds. At March 31, 2003, the guaranteed funds had
unamortized equity of $663 million. Additional information on the return
guaranty agreement with LIHTC investors is summarized in Note 10 ("Contingent
Liabilities and Guarantees") under the heading "Guarantees" on page 24.
Key's maximum exposure to loss from its relationships with guaranteed LIHTC
funds was $834 million at March 31, 2003, which represents undiscounted future
payments due to investors for the return on and of their investments. KAHC has
established a reserve in the amount of $33 million at March 31, 2003, which
management believes will be sufficient to absorb future estimated losses under
the guarantees.
As required by Interpretation No. 46, assets, liabilities and noncontrolling
interests of newly consolidated entities will initially be recorded at their
carrying amounts. If determining the carrying amounts is impractical, fair
values at the date Interpretation No. 46 first applies may be used. Any
difference between
19
the net assets added to Key's balance sheet and the amount of any previously
recognized interest in the newly consolidated entities will be recognized as a
cumulative effect of an accounting change.
Due to the complexity of Interpretation No. 46 and evolving interpretations of
its provisions, Key has not yet completed its analysis of the impact of this
guidance on the entity groups described below. However, based on the review
performed to date, it is reasonably possible that Key will have to disclose
significant interests in these entities or consolidate them as primary
beneficiary when Interpretation No. 46 is implemented in the third quarter of
2003.
LIHTC NONGUARANTEED FUNDS. KAHC sells investments in certain LIHTC funds without
guaranteeing a return to the investors. Key earns syndication and asset
management fees for services provided to these nonguaranteed funds. At March 31,
2003, assets of nonguaranteed LIHTC funds were estimated to be $311 million.
LIHTC INVESTMENTS. Key makes investments directly in LIHTC projects through the
Retail Banking line of business. As a limited partner in these unconsolidated
projects, Key is allocated tax credits and deductions associated with the
underlying properties. At March 31, 2003, Key's investments in these projects
totaled $304 million.
COMMERCIAL REAL ESTATE INVESTMENTS. Through the KeyBank Real Estate Capital line
of business, Key provides real estate financing for new construction,
acquisition and rehabilitation projects. In certain of these unconsolidated
projects, Key has provided or committed funds through limited partnership
interests, mezzanine investments or standby letters of credit. At March 31,
2003, these investments and facilities totaled $160 million.
As Key continues its implementation efforts, additional entities may be
identified that will need to be consolidated or disclosed.
20
8. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
Impaired loans, which account for the largest portion of Key's nonperforming
assets, totaled $553 million at March 31, 2003, compared with $610 million at
December 31, 2002. Impaired loans averaged $581 million for the first quarter
of 2003 and $673 million for the first quarter of 2002.
Key's nonperforming assets were as follows:
MARCH 31, DECEMBER 31, MARCH 31,
in millions 2003 2002 2002
- ----------------------------------------------------------------------------
Impaired loans $ 553 $ 610 $ 685
Other nonaccrual loans 351 333 288
- ----------------------------------------------------------------------------
Total nonperforming loans 904 943 973
Other real estate owned ("OREO") 62 48 41
Allowance for OREO losses (3) (3) (2)
- ----------------------------------------------------------------------------
OREO, net of allowance 59 45 39
Other nonperforming assets 5 5 --
- ----------------------------------------------------------------------------
Total nonperforming assets $ 968 $ 993 $ 1,012
========= ============ =========
- ----------------------------------------------------------------------------
At March 31, 2003, Key did not have any significant commitments to lend
additional funds to borrowers with loans on nonperforming status.
When expected cash flows or collateral values do not justify the carrying amount
of an impaired loan, the loan is assigned a specific allowance. Management
calculates the extent of the impairment, which is the carrying amount of the
loan less the estimated present value of future cash flows and the fair value of
any existing collateral. The amount that management deems uncollectible (the
impaired amount) is charged against the allowance for loan losses. Even when
collateral value or other sources of repayment appear sufficient, if management
remains uncertain about whether the loan will be repaid in full, an amount is
specifically allocated in the allowance for loan losses. At March 31, 2003, Key
had $348 million of impaired loans with a specifically allocated allowance for
loan losses of $142 million, and $205 million of impaired loans that were
carried at their estimated fair value without a specifically allocated
allowance. At December 31, 2002, impaired loans included $377 million of loans
with a specifically allocated allowance of $179 million, and $233 million that
were carried at their estimated fair value.
Key does not perform a specific impairment valuation for smaller-balance,
homogeneous, nonaccrual loans (shown in the preceding table as "Other nonaccrual
loans"). These typically are consumer loans, including residential mortgages,
home equity loans and various types of installment loans. Management applies
historical loss experience rates to these loans, adjusted to reflect emerging
credit trends and other factors, and then allocates a portion of the allowance
for loan losses to each loan type.
21
9. CAPITAL SECURITIES
KeyCorp has six fully-consolidated subsidiary business trusts that have issued
corporation-obligated mandatorily redeemable preferred capital securities
("capital securities"). These securities are carried as liabilities on Key's
balance sheet. They provide an attractive source of funds since they constitute
Tier I capital for regulatory reporting purposes, but have the same tax
advantages as debt for federal income tax purposes. As guarantor, KeyCorp
unconditionally guarantees payment of:
- - required distributions on the capital securities;
- - the redemption price when a capital security is redeemed; and
- - amounts due if a trust is liquidated or terminated.
KeyCorp owns the outstanding common stock of each of the trusts. The trusts used
the proceeds from the issuance of their capital securities and common stock to
buy debentures issued by KeyCorp. These debentures are the trusts' only assets;
the interest payments from the debentures finance the distributions paid on the
capital securities. Key's financial statements do not reflect the debentures or
the related effects on the income statement because they are eliminated in
consolidation.
The capital securities, common stock and related debentures are summarized as
follows:
PRINCIPAL INTEREST RATE MATURITY
CAPITAL AMOUNT OF OF CAPITAL OF CAPITAL
SECURITIES, COMMON DEBENTURES, SECURITIES AND SECURITIES AND
dollars in millions NET OF DISCOUNT (a) SECURITIES NET OF DISCOUNT (b) DEBENTURES (c) DEBENTURES
- ---------------------------------------------------------------------------------------------------------------------------
March 31, 2003
KeyCorp Institutional Capital A $ 410 $ 11 $ 361 7.826 % 2026
KeyCorp Institutional Capital B 176 4 154 8.250 2026
KeyCorp Capital I 225 8 233 2.120 2028
KeyCorp Capital II 182 8 166 6.875 2029
KeyCorp Capital III 247 8 207 7.750 2029
Union Bankshares Capital Trust I 10 1 11 9.000 2028
- --------------------------------------------------------------------------------------------------------------------------
Total $1,250 $ 40 $ 1,132 6.715 % --
====== ====== ========
- --------------------------------------------------------------------------------------------------------------------------
December 31, 2002 $1,260 $ 40 $ 1,136 6.779 % --
====== ====== ========
- --------------------------------------------------------------------------------------------------------------------------
March 31, 2002 $1,273 $ 39 $ 1,271 6.680 % --
====== ====== ========
- --------------------------------------------------------------------------------------------------------------------------
(a) The capital securities must be redeemed when the related debentures mature,
or earlier if provided in the governing indenture. Each issue of capital
securities carries an interest rate identical to that of the related
debenture. The capital securities constitute minority interests in the
equity accounts of KeyCorp's consolidated subsidiaries and, therefore,
qualify as Tier 1 capital under Federal Reserve Board guidelines. Included
in certain capital securities at March 31, 2003, December 31, 2002 and
March 31,2002, are basis adjustments of $158 million, $164 million and $41
million, respectively, related to fair value hedges. See Note 20
("Derivatives and Hedging Activities"), which begins on page 84 of Key's
2002 Annual Report to Shareholders, for an explanation of fair value
hedges.
(b) KeyCorp has the right to redeem its debentures: (i) in whole or in part, on
or after December 1, 2006 (for debentures owned by Capital A), December 15,
2006 (for debentures owned by Capital B), July 1, 2008 (for debentures
owned by Capital I), March 18, 1999 (for debentures owned by Capital II),
July 16, 1999 (for debentures owned by Capital III), and December 17, 2003
(for debentures owned by Union Bankshares Capital Trust I); and (ii) in
whole at any time within 90 days after and during the continuation of a
"tax event" or a "capital treatment event" (as defined in the applicable
offering circular). If the debentures purchased by Capital A or Capital B
are redeemed before they mature, the redemption price will be the principal
amount, plus a premium, plus any accrued but unpaid interest. If the
debentures purchased by Capital I or Union Bankshares Capital Trust I are
redeemed before they mature, the redemption price will be the principal
amount, plus any accrued but unpaid interest. If the debentures purchased
by Capital II or Capital III are redeemed before they mature, the
redemption price will be the greater of: (a) the principal amount, plus any
accrued but unpaid interest or (b) the sum of the present values of
principal and interest payments discounted at the Treasury Rate (as defined
in the applicable offering circular), plus 20 basis points (25 basis points
for Capital III), plus any accrued but unpaid interest. When debentures are
redeemed in response to tax or capital treatment events, the redemption
price generally is slightly more favorable to Key.
(c) The interest rates for Capital A, Capital B, Capital II, Capital III and
Union Bankshares Capital Trust I are fixed. Capital I has a floating
interest rate equal to three-month LIBOR plus 74 basis points; it reprices
quarterly. The rates shown as the total at March 31, 2003, December 31,
2002 and March 31, 2002, are weighted average rates.
During the first three months of 2003, the subsidiary business trusts
repurchased an aggregate of $5 million of their outstanding capital securities
and KeyCorp repurchased a like amount of the related debentures. Management
intends to replace the capital securities at some future date with capital
securities that will yield a lower cost.
22
10. CONTINGENT LIABILITIES AND GUARANTEES
LEGAL PROCEEDINGS
RESIDUAL VALUE INSURANCE LITIGATION. Key Bank USA, National Association ("Key
Bank USA") obtained two insurance policies from Reliance Insurance Company
("Reliance") insuring the residual value of certain automobiles leased through
Key Bank USA. The two policies ("the Policies"), the "4011 Policy" and the "4019
Policy," together covered leases entered into during the period from January 1,
1997 to January 1, 2001.
The 4019 Policy contains an endorsement stating that Swiss Reinsurance America
Corporation ("Swiss Re") will assume and reinsure 100% of Reliance's obligations
under the 4019 Policy in the event Reliance Group Holdings' ("Reliance's
parent") so-called "claims-paying ability" were to fall below investment grade.
Key Bank USA also entered into an agreement with Swiss Re and Reliance whereby
Swiss Re agreed to issue to Key Bank USA an insurance policy on the same terms
and conditions as the 4011 Policy in the event the financial condition of
Reliance Group Holdings fell below a certain level. Around May 2000, the
conditions under both the 4019 Policy and the Swiss Re agreement were triggered.
The 4011 Policy was canceled and replaced as of May 1, 2000, by a policy issued
by North American Specialty Insurance Company (a subsidiary or affiliate of
Swiss Re) ("the NAS Policy"). Tri-Arc Financial Services, Inc. ("Tri-Arc") acted
as agent for Reliance, Swiss Re and NAS. Since February 2000, Key Bank USA has
been filing claims under the Policies, but none of these claims has been paid.
In July 2000, Key Bank USA filed a claim for arbitration against Reliance, Swiss
Re, NAS and Tri-Arc seeking, among other things, a declaration of the scope of
coverage under the Policies and for damages. On January 8, 2001, Reliance filed
an action (litigation) against Key Bank USA in Federal District Court in Ohio
seeking rescission or reformation of the Policies because they allegedly do not
reflect the intent of the parties with respect to the scope of coverage and how
and when claims were to be paid. Key filed an answer and counterclaim against
Reliance, Swiss Re, NAS and Tri-Arc seeking, among other things, declaratory
relief as to the scope of coverage under the Policies, damages for breach of
contract and failure to act in good faith, and punitive damages. The parties
agreed to proceed with this court action and to dismiss the arbitration without
prejudice.
On May 29, 2001, the Commonwealth Court of Pennsylvania entered an order placing
Reliance in a court supervised "rehabilitation" and purporting to stay all
litigation against Reliance. On July 23, 2001, the Federal District Court in
Ohio stayed the litigation to allow the rehabilitator to complete her task. On
October 3, 2001, the Court in Pennsylvania entered an order placing Reliance
into liquidation and canceling all Reliance insurance policies as of November 2,
2001. On November 20, 2001, the Federal District Court in Ohio entered an order
that, among other things, required Reliance to report to the Court on the
progress of the liquidation. On January 15, 2002, Reliance filed a status report
requesting the continuance of the stay for an indefinite period. On February 20,
2002, Key Bank USA filed a Motion for Partial Lifting of the July 23, 2001, Stay
in which it asked the Court to allow the case to proceed against the parties
other than Reliance. The Court granted Key Bank USA's motion on May 17, 2002. As
of February 19, 2003, all claims against Tri-Arc were dismissed through a
combination of court action and voluntary dismissal by Key Bank USA.
Management believes that Key Bank USA has valid insurance coverage or claims for
damages relating to the residual value of automobiles leased through Key Bank
USA during the four-year period ending January 1, 2001. With respect to each
individual lease, however, it is not until the lease expires and the vehicle is
sold that Key Bank USA can determine the existence and amount of any actual loss
(i.e., the difference between the residual value provided for in the lease
agreement and the vehicle's actual market value at lease expiration). Key Bank
USA's actual total losses for which it will file claims will depend to a large
measure upon the viability of, and pricing within, the market for used cars
throughout the lease run-off period, which extends through 2006. The market for
used cars varies.
23
Accordingly, the total expected loss on the portfolio for which Key Bank USA
will file claims cannot be determined with certainty at this time. Claims filed
by Key Bank USA through March 31, 2003, total approximately $296 million, and
management currently estimates that approximately $81 million of additional
claims may be filed through year-end 2006 bringing the total aggregate amount of
actual and potential claims to $377 million. As discussed previously, a number
of factors could affect Key Bank USA's actual loss experience, which may be
higher or lower than management's current estimates.
Key is filing insurance claims for the entire amount of its losses and is
recording as a receivable on its balance sheet a portion of the amount of the
insurance claims as and when they are filed. Management believes the amount
being recorded as a receivable due from the insurance carriers is appropriate to
reflect the collectibility risk associated with the insurance litigation;
however, litigation is inherently not without risk, and any actual recovery from
the litigation may be more or less than the receivable. While management does
not expect an adverse decision, if a court were to make an adverse final
determination, such result would cause Key to record a material one-time expense
during the period when such determination is made. An adverse determination
would not have a material effect on Key's financial condition, but could have a
material adverse effect on Key's results of operations in the quarter it occurs.
OTHER LITIGATION. In the ordinary course of business, Key is subject to legal
actions that involve claims for substantial monetary relief. Based on
information presently known to management, management does not believe there is
any legal action to which KeyCorp or any of its subsidiaries is a party, or
involving any of their properties, that, individually or in the aggregate, could
reasonably be expected to have a material adverse effect on Key's financial
condition or annual results of operations.
GUARANTEES
Key is a guarantor in various agreements with third parties. In accordance with
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others,"
certain guarantees issued or modified on or after January 1, 2003, require the
recognition of a liability on Key's balance sheet for the "stand ready"
obligation associated with such guarantees. The accounting for guarantees
existing at December 31, 2002, was not revised. Thus, the stand ready obligation
related to the majority of Key's guarantees was not recorded on the balance
sheet at December 31, 2002. Additional information pertaining to Interpretation
No. 45 is summarized in Note 1 ("Basis of Presentation") under the heading
"Accounting Pronouncements Adopted in 2003" on page 9. The following table shows
the types of guarantees (as defined by Interpretation No. 45) that Key had
outstanding at March 31, 2003.
MAXIMUM POTENTIAL
UNDISCOUNTED LIABILITY
in millions FUTURE PAYMENTS RECORDED
- -------------------------------------------------------------------------------------------------------------
Financial Guarantees:
Standby letters of credit $4,671 $ 5
Credit enhancement for asset-backed commercial paper conduit 68 --
Recourse agreement with FNMA 273 4
Return guaranty agreement with LIHTC investors 834 33
Default guarantees 9 --
Written interest rate caps (a) 42 21
- -------------------------------------------------------------------------------------------------------------
Total $5,897 $ 63
====== ====
- -------------------------------------------------------------------------------------------------------------
(a) As of March 31, 2003, the weighted average interest rate of written
interest rate caps was 1.4%. Maximum potential undiscounted future payments
were calculated assuming a 10% interest rate.
STANDBY LETTERS OF CREDIT. These instruments obligate Key to pay a third-party
beneficiary when a customer fails to repay an outstanding loan or debt
instrument, or fails to perform some contractual nonfinancial obligation.
Standby letters of credit are issued by many of Key's lines of business to
address clients' financing needs. If amounts are drawn under standby letters of
credit, such amounts are treated as loans; they bear interest (generally at
variable rates) and pose the same credit risk to Key as a loan. At March 31,
2003, Key's standby letters of credit had a remaining weighted average life of
approximately 2 years, with remaining actual lives ranging from less than 1 year
to as many as 17 years.
24
CREDIT ENHANCEMENT FOR ASSET-BACKED COMMERCIAL PAPER CONDUIT. Key provides
credit enhancement in the form of a committed facility to ensure the continuing
operations of an asset-backed commercial paper conduit, which is owned by a
third party and administered by an unaffiliated financial institution. The
commitment to provide credit enhancement extends until September 26, 2003, and
specifies that in the event of default by certain borrowers whose loans are held
by the conduit, Key will provide financial relief to the conduit in an amount
that is based on defined criteria that consider the level of credit risk
involved and other factors.
At March 31, 2003, Key's funding requirement under the credit enhancement
facility totaled $59 million. However, there were no drawdowns under the
facility during the three-month period ended March 31, 2003. Key has no recourse
or other collateral available to offset any amounts that may be funded under
this credit enhancement facility. Key's commitments to provide increased credit
enhancement to the conduit are periodically evaluated by management.
RECOURSE AGREEMENT WITH FEDERAL NATIONAL MORTGAGE ASSOCIATION. KBNA participates
as a lender in the Federal National Mortgage Association ("FNMA") Delegated
Underwriting and Servicing ("DUS") program. As a condition to FNMA's delegation
of responsibility for originating, underwriting and servicing mortgages, KBNA
has agreed to assume a limited portion of the risk of loss during the remaining
term on each commercial mortgage loan sold. Accordingly, a reserve for such
potential losses has been established and is maintained in an amount estimated
by management to approximate the fair value of the liability undertaken by KBNA.
At March 31, 2003, the outstanding commercial mortgage loans in this program had
a weighted average remaining term of 10 years and the unpaid principal balance
outstanding of loans sold by KBNA as a participant in this program was
approximately $1.4 billion. The maximum potential amount of undiscounted future
payments that may be required under this program is equal to 20% of the
principal balance of loans outstanding at March 31, 2003. If payment is required
under this program, Key would have an interest in the collateral underlying the
commercial mortgage loan on which the loss occurred.
RETURN GUARANTEE AGREEMENT WITH LOW-INCOME HOUSING TAX CREDIT ("LIHTC")
INVESTORS. Key Affordable Housing Corporation ("KAHC"), a subsidiary of KBNA,
offers limited partnership interests to qualified investors. Unconsolidated
partnerships formed by KAHC invest in low-income residential rental properties
that qualify for federal LIHTCs under Section 42 of the Internal Revenue Code.
In certain partnerships, investors pay a fee to KAHC for a guaranteed return
that is dependent on the financial performance of the property and the
property's ability to maintain its LIHTC status throughout the fifteen-year
compliance period. If these two conditions are not achieved, Key is obligated to
make any necessary payments to investors to provide the guaranteed return. KAHC
has the ability to affect changes in the management of the properties to improve
performance. However, other than the underlying income stream from the
properties, no recourse or collateral would be available to offset the guarantee
obligation. These guarantees have expiration dates that extend through 2018. Key
meets its obligations pertaining to the guaranteed returns generally through the
distribution of tax credits and deductions associated with the specific
properties.
As shown in the preceding table, KAHC had established a reserve in the amount of
$33 million at March 31, 2003, which management believes will be sufficient to
cover estimated future obligations under the guarantees. In accordance with
Interpretation No. 45, for any return guarantee agreements entered into or
modified with LIHTC investors on or after January 1, 2003, the amount of all
fees received in consideration for the guarantee has been recognized as the fair
value stand ready obligation.
VARIOUS TYPES OF DEFAULT GUARANTEES. Some lines of business provide or
participate in guarantees that obligate Key to perform if the debtor fails to
pay all or a portion of the subject indebtedness and/or related interest. These
guarantees are generally undertaken when Key is supporting or protecting its
underlying investment or where the risk profile of the debtor should provide an
investment return. The terms of these default guarantees range from less than 1
year to as many as 19 years. Although no collateral is held, Key would have
recourse against the debtors for any payments made under these default
guarantees.
WRITTEN INTEREST RATE CAPS. In the ordinary course of business, Key writes
interest rate caps for commercial loan clients that have variable rate loans
with Key. These caps are purchased by clients to limit their
25
exposure to interest rate increases and at March 31, 2003, had a weighted
average life of approximately 8.0 years.
Key is obligated to pay the interest rate counterparty if the applicable
benchmark interest rate exceeds a specified level (known as the "strike rate").
These instruments are accounted for as derivatives with the fair value liability
recorded in "other liabilities" on the balance sheet. Key's potential amount of
future payments under these obligations is mitigated by the fact that the
company enters into offsetting positions with third parties.
OTHER OFF-BALANCE SHEET RISK
Other off-balance sheet risk stems from financial instruments that do not meet
the definition of a guarantee as specified in Interpretation No. 45 and from
other relationships.
LIQUIDITY FACILITIES THAT SUPPORT ASSET-BACKED COMMERCIAL PAPER CONDUITS. Key
provides liquidity to all or a portion of two separate asset-backed commercial
paper conduits that are owned by third parties and administered by unaffiliated
financial institutions. These liquidity facilities obligate Key through February
15, 2005, to provide funding if such is required as a result of a disruption in
the markets or other factors. Additional information about these asset-backed
commercial paper conduits is summarized in Note 1 ("Basis of Presentation"),
which begins on page 7 and in Note 7 ("Variable Interest Entities"), which
begins on page 19.
Key provides liquidity to the conduits in the form of committed facilities of
$1.7 billion. The amount available to be drawn on these facilities was $700
million at March 31, 2003. However, there were no drawdowns under either of the
committed facilities at that time. Of the $1.7 billion of liquidity facility
commitments, $107 million is associated with a conduit program that is in the
process of being liquidated. Therefore, Key's commitment will decrease as the
assets in this conduit program decrease. Key's commitments to provide liquidity
are periodically evaluated by management.
INDEMNIFICATIONS PROVIDED IN THE ORDINARY COURSE OF BUSINESS. Key provides
certain indemnifications primarily through representations and warranties in
contracts that are entered into in the ordinary course of business in connection
with purchases and sales of businesses, loan sales and other ongoing activities.
Management's past experience with these indemnifications has been that the
amounts paid, if any, have not had a significant effect on Key's financial
condition or results of operations.
INTERCOMPANY GUARANTEES. KeyCorp and primarily KBNA are parties to various
guarantees that are undertaken to facilitate the ongoing business activities of
other Key affiliates. These business activities encompass debt issuance, certain
lease and insurance obligations, investments and securities, and certain leasing
transactions involving clients.
RELATIONSHIP WITH MASTERCARD INTERNATIONAL INC. AND VISA U.S.A. INC. KBNA and
Key Bank USA are members of MasterCard International Inc. ("MasterCard") and
Visa U.S.A. Inc. ("Visa"). MasterCard's charter documents and bylaws state that
MasterCard may assess its members for certain liabilities that it incurs,
including litigation liabilities. Visa's charter documents state that Visa may
fix fees payable by members in connection with Visa's operations. We understand
that descriptions of significant pending lawsuits and MasterCard's and Visa's
positions regarding the potential impact of those lawsuits on members are set
forth on MasterCard's and Visa's respective websites, as well as in MasterCard's
public filings with the Securities and Exchange Commission. Key is not a party
to any significant litigation by third parties against MasterCard or Visa.
According to published reports, on or about April 30, 2003, MasterCard and Visa
agreed independently to settle a lawsuit that was brought against them by
Wal-mart Stores Inc. and many other retailers. The lawsuit alleged that
MasterCard and Visa violated federal antitrust laws by conspiring to monopolize
the debit card services market and by requiring merchants that accept certain of
their debit and credit card services to also accept their higher priced
"off-line," signature-verified debit card services. The final terms of the
settlement agreements entered into by MasterCard and Visa are not yet publicly
available. However, based on information available to Key, management believes
that the settlement will result in the reduction of fees earned from off-line
debit card transactions. Management estimates that the impact of the settlement
on
26
Key will be a reduction of less than $10 million of pre-tax net income for the
balance of 2003 and less than $25 million of pre-tax net income in 2004. This
estimate is subject to change once the final terms of the settlement are known
and management evaluates alternative actions that may be available to it in
response to the settlement.
11. DERIVATIVES AND HEDGING ACTIVITIES
Key, mainly through its lead bank, KBNA, is party to various derivative
instruments. These instruments are used for asset and liability management and
trading purposes. Generally, these instruments help Key meet clients' financing
needs and manage exposure to "market risk"--the possibility that economic value
or net interest income will be adversely affected by changes in interest rates
or other economic factors. However, like other financial instruments, these
derivatives contain an element of "credit risk"--the possibility that Key will
incur a loss because a counterparty fails to meet its contractual obligations.
The primary derivatives that Key uses are interest rate swaps, caps and futures,
and foreign exchange forward contracts. All foreign exchange forward contracts
and interest rate swaps and caps held are over-the-counter instruments.
At March 31, 2003, Key had $865 million of derivative assets and $149 million of
derivative liabilities on its balance sheet that arose from derivatives that
were being used for hedging purposes. As of the same date, the fair value of
derivative assets and liabilities classified as trading derivatives totaled $1.5
billion and $1.4 billion, respectively. Derivative assets and liabilities are
recorded in "accrued income and other assets" and "accrued expense and other
liabilities," respectively, on the balance sheet.
Key uses a fair value hedging strategy to modify its exposure to interest rate
risk and a cash flow hedging strategy to reduce the potential adverse impact of
interest rate increases on future interest expense. For more information about
these asset and liability management strategies used to modify Key's exposure to
interest rate risk, see Note 20 ("Derivatives and Hedging Activities"), which
begins on page 84 of Key's 2002 Annual Report to Shareholders.
The change in "accumulated other comprehensive income (loss)" resulting from
cash flow hedges is as follows:
RECLASSIFICATION
DECEMBER 31, 2003 OF GAINS TO MARCH 31,
in millions 2002 HEDGING ACTIVITY NET INCOME 2003
- -----------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income
(loss) resulting from cash flow hedges $ 6 $ 20 $ (7) $ 19
- -----------------------------------------------------------------------------------------------------------
Key expects to reclassify an estimated $8 million of net gains on derivative
instruments from "accumulated other comprehensive income (loss)" to earnings
during the next twelve months. Reclassifications will coincide with the income
statement impact of the hedged item through the payment of variable-rate
interest on debt, the receipt of variable-rate interest on commercial loans and
the sale or securitization of commercial real estate loans.
TRADING PORTFOLIO
Key's trading portfolio includes:
- - interest rate swap contracts entered into to accommodate the needs of
clients;
- - positions with third parties that are intended to offset or mitigate
the interest rate risk of client positions;
- - foreign exchange forward contracts entered into to accommodate the
needs of clients; and
- - proprietary trading positions in financial assets and liabilities.
27
Adjustments to the fair value of these instruments are included in "investment
banking and capital markets income" on the income statement. Additional
information pertaining to these instruments is summarized in Note 20
("Derivatives and Hedging Activities"), which begins on page 84 of Key's 2002
Annual Report to Shareholders.
The following table shows trading income recognized on interest rate swaps and
foreign exchange forward contracts.
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 2003 2002
- ------------------------------------------------------------------------
Interest rate swap contracts $ 4 $ 4
Foreign exchange forward contracts 7 10
- ------------------------------------------------------------------------
COUNTERPARTY CREDIT RISK
Swaps and caps present credit risk because the counterparty may not meet the
terms of the contract. This risk is measured as the expected positive
replacement value of contracts. To mitigate credit risk, Key deals exclusively
with counterparties that have high credit ratings.
Key uses two additional precautions to manage exposure to credit risk on swap
contracts. First, Key generally enters into bilateral collateral and master
netting arrangements. These agreements include legal rights of setoff that
provide for the net settlement of the related contracts with the same
counterparty in the event of default. Second, Credit Administration monitors
credit risk exposure to the counterparty on each interest rate swap to determine
appropriate limits on Key's total credit exposure and whether it is advisable to
demand collateral.
At March 31, 2003, Key was party to interest rate swaps and caps with 54
different counterparties. Among these were swaps and caps entered into to offset
the risk of client exposure. Key had aggregate credit exposure of $122 million
(net of collateral of $509 million) on these instruments to 31 of the
counterparties. The largest credit exposure to an individual counterparty
amounted to approximately $21 million.
28
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
SHAREHOLDERS AND BOARD OF DIRECTORS
KEYCORP
We have reviewed the unaudited condensed consolidated balance sheets of KeyCorp
and subsidiaries ("Key") as of March 31, 2003 and 2002, and the related
condensed consolidated statements of income, changes in shareholders' equity and
cash flow for the three-month periods then ended. These financial statements are
the responsibility of Key's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Key as of
December 31, 2002, and the related consolidated statements of income, changes in
shareholders' equity, and cash flow for the year then ended (not presented
herein) and in our report dated January 13, 2003, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 2002, is fairly stated, in all material respects, in relation
to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
April 14, 2003
29
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This section generally reviews the financial condition and results of operations
of KeyCorp and its subsidiaries for the first three months of 2003 and 2002.
Some tables may cover more periods to comply with disclosure requirements or to
illustrate trends in greater depth. When you read this discussion, you should
also refer to the consolidated financial statements and related notes that
appear on pages 3 through 28.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Key's business is dynamic and complex. Consequently, management must exercise
judgment in choosing and applying accounting policies and methodologies in many
areas. These choices are important; not only are they necessary to comply with
accounting principles generally accepted in the United States, they also reflect
management's view of the most appropriate manner in which to record and report
Key's overall financial performance. All accounting policies are important, and
all policies described in Note 1 ("Summary of Significant Accounting Policies"),
which begins on page 57 of Key's 2002 Annual Report to Shareholders, should be
reviewed for a greater understanding of how Key's financial performance is
recorded and reported.
In management's opinion, some accounting policies are more likely than others to
have a significant effect on Key's financial results and to expose those results
to potentially greater volatility. These policies apply to areas of relatively
greater business importance or require management to make assumptions and
estimates that affect amounts reported in the financial statements. Because
these assumptions and estimates are based on current circumstances, they may
change over time or prove to be inaccurate based on actual experience. For Key,
the areas that rely most heavily on the use of assumptions and estimates include
accounting for the allowance for loan losses, loan securitizations, contingent
liabilities and guarantees, principal investments, goodwill, and pension and
other postretirement obligations. A brief discussion of each of these areas
appears below.
ALLOWANCE FOR LOAN LOSSES. Management determines probable losses inherent in
Key's loan portfolio (which represents by far the largest category of assets on
Key's balance sheet) and establishes an allowance that is sufficient to absorb
those losses by considering factors including historical loss rates, expected
cash flows and estimated collateral values. In assessing these factors,
management benefits from a lengthy organizational history and experience with
credit decisions and related outcomes. Nonetheless, if management's underlying
assumptions prove to be inaccurate, the allowance for loan losses would have to
be adjusted. Our accounting policy related to the allowance is disclosed in Note
1 under the heading "Allowance for Loan Losses" on page 58 of the Annual Report.
LOAN SECURITIZATIONS. Key securitizes certain types of loans and accounts for
such transactions as sales when the criteria set forth in SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities" are met. If future events were to preclude accounting for such
transactions as sales, the loans would have to be placed back on Key's balance
sheet. This could have a potentially adverse effect on Key's capital ratios and
other unfavorable financial implications. In addition, determining the gain or
loss resulting from securitization transactions and the subsequent carrying
amount of retained interests is dependent on underlying assumptions made by
management, the most significant of which are described in Note 8 ("Loan
Securitizations and Variable Interest Entities"), which begins on page 70 of the
Annual Report. The use of alternative ranges of possible outcomes for these
assumptions would change the amount of the initial gain or loss recognized. It
could also result in changes in the carrying amount of retained interests, with
related effects on results of operations. Our accounting policy related to loan
securitizations is disclosed in Note 1 under the heading "Loan Securitizations"
on page 59 of the Annual Report.
30
CONTINGENT LIABILITIES AND GUARANTEES. Contingent liabilities arising from
litigation, guarantees in various agreements with third parties in which Key is
a guarantor and the potential effects of these items on Key's results of
operations, are summarized in Note 10 ("Contingent Liabilities and Guarantees"),
which begins on page 23.
Since Key records a liability for only the fair value of the obligation to stand
ready to perform over the term of a guarantee, the risk exists that potential
future payments that would be made by Key in the event of a default by a third
party could exceed the liability recorded on Key's balance sheet. See Note 10
for a comparison of the liability recorded and the maximum potential
undiscounted future payments for the various types of guarantees that Key had
outstanding at March 31, 2003.
In the normal course of business, Key is routinely subject to examinations and
challenges from tax authorities regarding the amount of taxes due in connection
with investments and business activities. Currently, the Internal Revenue
Service is challenging Key's tax treatment of certain leveraged lease
investments. This and other challenges by tax authorities may result in
adjustments to the timing or amount of Key's taxable income or deductions or the
allocation of income among tax jurisdictions. Management believes these
challenges will be resolved without having any material effect on Key's
financial condition or results of operations.
VALUATION METHODOLOGIES. Valuation methodologies employed by management often
involve a significant degree of judgment, particularly when there are no
observable liquid markets for the items being valued. The outcome of valuations
performed by management have a direct bearing on the carrying amounts of certain
assets and liabilities, such as principal investments, goodwill, and pension and
other postretirement benefit obligations. To determine the values of these
assets and liabilities, as well as the extent to which related assets may be
impaired, management makes assumptions and estimates related to discount rates,
asset returns, repayment rates and other factors. The use of different discount
rates or other valuation assumptions could produce significantly different
results, which could have material positive or negative effects on Key's results
of operations.
The valuation methodology management uses for principal investments is
summarized in Note 21 ("Fair Value Disclosures of Financial Instruments") on
page 86 of the Annual Report and the methodology used in the testing for
goodwill impairment is summarized in Note 1 under the heading "Goodwill and
Other Intangible Assets" on page 59 of the Annual Report. The primary
assumptions used in determining Key's pension and other postretirement benefit
obligations and related expenses are presented in Note 16 ("Employee Benefits"),
which begins on page 78 of the Annual Report.
When a potential asset impairment is identified through testing, observable
changes in liquid markets or other means, management must also exercise judgment
in determining the nature of the potential impairment (i.e., whether the
impairment is temporary or other than temporary) in order to apply the
appropriate accounting treatment. For example, unrealized losses on securities
available for sale that are deemed temporary are recorded in shareholders'
equity, whereas those deemed "other than temporary" are recorded in earnings.
REVENUE RECOGNITION
Corporate improprieties related to revenue recognition have received a great
deal of attention by regulatory authorities and the news media. Although all
companies face the risk of intentional or unintentional misstatements, such
misstatements are less likely in the financial services industry because most of
the revenue (i.e., interest accruals) recorded is driven by nondiscretionary
formulas based on written contracts, such as loan agreements.
TERMINOLOGY
This report contains some shortened names and industry-specific terms. We want
to explain some of these terms at the outset so you can better understand the
discussion that follows.
- - KEYCORP refers solely to the parent holding company.
31
- - KBNA refers to Key's lead bank, KeyBank National Association.
- - KEY refers to the consolidated entity consisting of KeyCorp and its
subsidiaries.
- - A KEYCENTER is one of Key's full-service retail banking facilities or
branches.
- - Key engages in CAPITAL MARKETS ACTIVITIES. These activities encompass a
variety of products and services. Among other things, we trade
securities as a dealer, enter into derivative contracts (both to
accommodate clients' financing needs and for proprietary trading
purposes), and conduct transactions in foreign currencies (both to
accommodate clients' needs and to benefit from fluctuations in exchange
rates).
- - All earnings per share data included in this discussion are presented
on a DILUTED basis, which takes into account all common shares
outstanding as well as potential common shares that could result from
the exercise of outstanding stock options. Some of the financial
information tables also include BASIC earnings per share, which takes
into account only common shares outstanding.
- - For regulatory purposes, capital is divided into two classes. Federal
regulations prescribe that at least one-half of a bank or bank holding
company's TOTAL RISK-BASED CAPITAL must qualify as TIER 1. Both total
and Tier 1 capital serve as bases for several measures of capital
adequacy, which is an important indicator of financial stability and
condition. You will find a more detailed explanation of total and Tier
1 capital and how they are calculated in the section entitled
"Capital," which begins on page 62.
- - When we want to draw your attention to a particular item in Key's Notes
to Consolidated Financial Statements, we refer to NOTE ___, giving the
particular number, name and starting page number.
FORWARD-LOOKING STATEMENTS
This report may contain "forward-looking statements" about issues like
anticipated earnings, anticipated levels of net loan charge-offs and
nonperforming assets, anticipated improvement in profitability and
competitiveness and long-term goals. These statements usually can be identified
by the use of forward-looking language such as "our goal," "our objective," "our
plan," "will likely result," "will be," "are expected to," "as planned," "is
anticipated," "intends to," "is projected," or similar words. Forward-looking
statements by their nature are subject to assumptions, risks and uncertainties.
For a variety of reasons, including the following, actual results could differ
materially from those contained in or implied by the forward-looking statements.
- - Interest rates could change more quickly or more significantly than we
expect, which may have an adverse effect on our financial results.
- - If the economy or segments of the economy fail to recover or, decline
further, the demand for new loans and the ability of borrowers to repay
outstanding loans may decline.
- - The stock and bond markets could suffer additional declines or
disruptions, which may have adverse effects on our financial condition
and that of our borrowers, and on our ability to raise money by issuing
new securities.
- - It could take us longer than we anticipate to implement strategic
initiatives designed to increase revenues or manage expenses; we may be
unable to implement certain initiatives; or the initiatives may be
unsuccessful.
- - Acquisitions and dispositions of assets, business units or affiliates
could adversely affect us in ways that management has not anticipated.
- - We may become subject to new legal obligations, or the resolution of
pending litigation may have an adverse effect on our financial results.
32
- - Terrorist activities or military actions could further disrupt the
economy and the general business climate, which may have an adverse
effect on our financial results or condition and that of our borrowers.
- - We may become subject to new accounting, tax, or regulatory practices
or requirements.
HIGHLIGHTS OF KEY'S PERFORMANCE
FINANCIAL PERFORMANCE
The primary measures of Key's financial performance for the first quarters of
2003 and 2002 are summarized below.
- - Net income for the first quarter of 2003 was $217 million, or $.51 per
common share. These results compare with $240 million, or $.56 per
share, for the first three months of 2002.
- - Key's return on average equity for the first quarter of 2003 was
12.91%, down from 15.53% for the year-ago quarter.
- - Key's first quarter return on average total assets was 1.05%, compared
with 1.20% for the first quarter of last year.
Key's first quarter results fell short of our expectations, reflecting continued
weakness in the economy. Growing revenue under such conditions has proven
difficult for Key. Contracting interest rate spreads and continuing soft loan
demand are negatively affecting net interest income, while continued pressure on
market-sensitive businesses is adversely affecting noninterest income.
In this challenging environment, Key has continued to focus successfully on
controlling expenses and growing core deposits. Expenses were below the first
quarter 2002 level and were down an annualized 7% from the prior quarter.
Average core deposits grew 8% from the year-ago quarter and an annualized 12%
from the fourth quarter of 2002.
In addition, the level of Key's nonperforming loans declined for the second
consecutive quarter and net loan charge-offs fell to their lowest level since
the first quarter of 2001.
We expect the economy to continue posing a significant challenge. While it's a
difficult environment in which to predict future earnings, we expect modest
improvement in the second quarter. For the full year, we expect earnings per
share to be in the range of $2.15 to $2.30. We will continue to focus on expense
control, deposit growth and asset quality improvement so that we are well
positioned for the eventual economic rebound.
The primary reasons that Key's specific revenue and expense components changed
from those of the first quarter of 2002 are reviewed in detail in the remainder
of this discussion.
Figure 1 on page 35 summarizes Key's financial performance for each of the past
five quarters.
LONG-TERM GOALS
Our long-term goals are to achieve an annual return on average equity in the
range of 16% to 18% and to grow earnings per common share at an annual rate of
7% to 8%.
CORPORATE STRATEGY
Our strategy for achieving our long-term goals comprises the following five
primary elements:
- - FOCUS ON OUR CORE BUSINESSES. We intend to focus on businesses that
enable us to build relationships with our clients. We will focus on our
"footprint" businesses that serve individuals, small businesses and
middle market companies. In addition, we intend to focus nationwide on
our commercial real estate lending, asset management, home equity
lending and equipment leasing businesses. These are businesses in which
we believe we possess resources of the scale necessary to compete
nationally.
33
- - PUT OUR CLIENTS FIRST. We will work to deepen our relationship with our
existing clients, and to build relationships with new clients who have
the potential to purchase multiple products and services or to generate
repeat business. One way in which we are pursuing this goal is by
emphasizing deposit growth across all of our lines of business.
We also want to ensure that our clients are receiving a distinctive
level of service, so we are putting considerable effort into enhancing
our service quality.
- - ENHANCE OUR BUSINESS. We intend to build on the success of our
competitiveness initiative by pursuing a continuous improvement
process. We will continue to focus on increasing revenues, controlling
expenses and better serving our clients, and we will also continue to
leverage technology - both to reduce costs and to enhance service
quality. Over time, we also intend to diversify our revenue mix by
emphasizing the growth of fee income while investing in higher-growth
and higher-return businesses.
- - CULTIVATE A WORKFORCE THAT DEMONSTRATES KEY'S VALUES AND WORKS TOGETHER
FOR A COMMON PURPOSE. Key intends to achieve this by:
--paying for performance, but only if achieved in ways that are
consistent with Key's values;
--attracting, developing and retaining a quality, high-performing and
inclusive workforce;
--developing leadership at all levels in the company; and
--creating a positive, stimulating and entrepreneurial work
environment.
- - ENHANCE PERFORMANCE MEASUREMENT. We will continue to refine and to rely
upon performance measurement mechanisms that help us ensure that we are
maximizing returns for our shareholders, that those returns are
appropriate considering the inherent levels of risk involved and that
our incentive compensation plans are commensurate with the
contributions made to our profitability.
34
FIGURE 1. SELECTED FINANCIAL DATA
2003 2002
----------- -----------------------------------------------
dollars in millions, except per share amounts FIRST FOURTH THIRD SECOND FIRST
- ---------------------------------------------------------------------------------------------------------------
FOR THE QUARTER
Interest income $ 1,021 $ 1,077 $ 1,095 $ 1,102 $ 1,092
Interest expense 340 365 395 419 438
Net interest income 681 712 700 683 654
Provision for loan losses 130 147 135 135 136
Noninterest income 397 446 432 448 443
Noninterest expense 657 668 659 665 661
Income before income taxes 291 343 338 331 300
Net income 217 245 245 246 240
- ---------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .51 $ .58 $ .57 $ .58 $ .56
Net income-- assuming dilution .51 .57 .57 .57 .56
Cash dividends paid .305 .30 .30 .30 .30
Book value at period end 16.32 16.12 15.66 15.46 15.05
Market price:
High 27.11 26.75 27.35 29.40 27.26
Low 22.31 21.25 20.96 25.95 22.92
Close 22.56 25.14 24.97 27.30 26.65
Weighted average common shares (000) 425,275 424,578 426,274 426,092 424,855
Weighted average common shares and
potential common shares (000) 428,090 429,531 431,326 431,935 430,019
- ---------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 62,719 $ 62,457 $ 62,951 $ 63,881 $ 63,956
Earning assets 75,113 73,635 72,548 72,820 72,382
Total assets 86,490 85,202 83,518 82,778 81,359
Deposits 50,455 49,346 44,610 44,805 43,233
Long-term debt 16,269 15,605 16,276 16,895 15,256
Shareholders' equity 6,898 6,835 6,654 6,592 6,402
- ---------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.05 % 1.17 % 1.19 % 1.21 % 1.20 %
Return on average equity 12.91 14.46 14.74 15.16 15.53
Net interest margin (taxable equivalent) 3.86 3.98 3.99 3.98 3.93
- ---------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.98 % 8.02 % 7.97 % 7.96 % 7.87 %
Tangible equity to tangible assets 6.71 6.73 6.71 6.69 6.57
Tier 1 risk-based capital 8.22 8.09 8.34 8.23 7.92
Total risk-based capital 12.62 12.51 12.69 12.29 12.02
Leverage 8.12 8.15 8.15 8.14 8.13
- ---------------------------------------------------------------------------------------------------------------
OTHER DATA
Average full-time equivalent employees 20,447 20,485 20,802 20,903 21,079
KeyCenters 911 910 903 905 911
- ---------------------------------------------------------------------------------------------------------------
35
LINE OF BUSINESS RESULTS
This section summarizes the financial performance and related strategic
developments of each of Key's three major business groups: Consumer Banking,
Corporate and Investment Banking and Investment Management Services. To better
understand this discussion, see Note 4 ("Line of Business Results"), which
begins on page 12. Note 4 includes a brief description of the products and
services offered by each of the three major business groups, more detailed
financial information pertaining to the groups and their respective lines of
business and brief descriptions of "Other Segments" and "Reconciling Items"
presented in Figure 2.
Figure 2 summarizes the contribution made by each major business group to Key's
taxable-equivalent revenue and net income for the first quarters of 2003 and
2002. Key's line of business results for both quarters reflect a new
organizational structure that took effect earlier this year.
FIGURE 2. MAJOR BUSINESS GROUPS - TAXABLE-EQUIVALENT REVENUE AND NET INCOME
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- ----------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
Consumer Banking $ 564 $ 551 $ 13 2.4 %
Corporate and Investment Banking 389 405 (16) (4.0)
Investment Management Services 192 213 (21) (9.9)
Other Segments (25) (6) (19) (316.7)
- ------------------------------------------------------------------------------------------------------
Total segments 1,120 1,163 (43) (3.7)
Reconciling items (20) (18) (2) (11.1)
- ------------------------------------------------------------------------------------------------------
Total $ 1,100 $ 1,145 $ (45) (3.9)%
========== ========== ========
Net income (loss)
Consumer Banking $ 96 $ 81 $ 15 18.5 %
Corporate and Investment Banking 106 114 (8) (7.0)
Investment Management Services 20 23 (3) (13.0)
Other Segments (10) 3 (13) N/M
- ------------------------------------------------------------------------------------------------------
Total segments 212 221 (9) (4.1)
Reconciling items 5 19 (14) (73.7)
- ------------------------------------------------------------------------------------------------------
Total $ 217 $ 240 $ (23) (9.6)%
========== ========== ========
- ------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
CONSUMER BANKING
As shown in Figure 3, net income for Consumer Banking was $96 million for the
first quarter of 2003, representing a $15 million increase from the year-ago
quarter. The improvement was attributable to an increase in taxable-equivalent
net interest income, a lower provision for loan losses and a reduction in
noninterest expense. These positive results were partially offset by a decline
in noninterest income.
Taxable-equivalent net interest income grew by $16 million, or 4%, from the
first quarter of 2002, due largely to a more favorable deposit mix and a 4%
increase in average loans outstanding, primarily in the home equity and
commercial portfolios. These positive results were offset in part by a decline
in yield-related loan fees in the Indirect Lending unit.
Noninterest income decreased by $3 million, or 3%, due primarily to an aggregate
$6 million reduction in service charges on deposit accounts generated by the
Retail Banking and Small Business lines of business.
36
The decrease in deposit service charges reflects the introduction of free
checking products during the second half of 2002. In addition, the year-ago
quarter included a $6 million gain recorded in connection with the change in
control of the majority interest in a merchant credit card processing affiliate
in which Key is part owner. The overall reduction in noninterest income was
moderated, however, by an $8 million increase in net gains from loan sales in
the National Home Equity unit.
Noninterest expense decreased by $8 million, or 2%, from the first quarter of
2002. This decrease includes lower costs for software amortization, collections
and mortgage loan processing activities, partially offset by higher personnel
expense.
The provision for loan losses decreased by $3 million, or 4%, reflecting a lower
level of net charge-offs, primarily in the Indirect Lending unit. This
improvement was largely the result of Key's decision in 2001 to exit the
automobile leasing business and to de-emphasize indirect prime automobile
lending.
FIGURE 3. CONSUMER BANKING
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- --------------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 450 $ 434 $ 16 3.7 %
Noninterest income 114 117 (3) (2.6)
- ----------------------------------------------------------------------------------------------------------------
Total revenue (TE) 564 551 13 2.4
Provision for loan losses 78 81 (3) (3.7)
Noninterest expense 333 341 (8) (2.3)
- ----------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 153 129 24 18.6
Allocated income taxes and TE adjustments 57 48 9 18.8
- ----------------------------------------------------------------------------------------------------------------
Net income $ 96 $ 81 $ 15 18.5 %
======= ======== ========
Percent of consolidated net income 44 % 34 % N/A N/A
AVERAGE BALANCES
Loans $28,434 $ 27,318 $ 1,116 4.1 %
Total assets 30,863 29,660 1,203 4.1
Deposits 34,360 34,311 49 .1
- ----------------------------------------------------------------------------------------------------------------
TE = Taxable Equivalent, N/A = Not Applicable
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- ---------------------------
ADDITIONAL CONSUMER BANKING DATA
dollars in billions 2003 2002 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------------------
AVERAGE DEPOSITS OUTSTANDING
Noninterest-bearing $ 5,298 $ 4,953 $ 345 7.0 %
Money market deposit accounts and other savings 14,544 12,910 1,634 12.7
Time 14,518 16,448 (1,930) (11.7)
- -----------------------------------------------------------------------------------------------------------------------
Total deposits $ 34,360 $ 34,311 $ 49 .1 %
========== ============= ==========
- -----------------------------------------------------------------------------------------------------------------------
HOME EQUITY LOANS
Retail Banking and Small Business
- ---------------------------------
Average balance $7.7 $6.0
Average loan-to-value ratio 72 % 72 %
Percent first lien positions 53 44
National Home Equity
- --------------------
Average balance $5.0 $4.8
Average loan-to-value ratio 78 % 77 %
Percent first lien positions 82 83
- --------------------------------------------------------------------------------------
OTHER DATA
On-line clients / percent penetration 623,039/33 % 450,762/26 %
KeyCenters 911 911
Automated teller machines 2,179 2,329
- --------------------------------------------------------------------------------------
37
CORPORATE AND INVESTMENT BANKING
As shown in Figure 4, net income for Corporate and Investment Banking was $106
million for the first quarter of 2003, compared with $114 million for the same
period last year. The decrease was due to reductions in both taxable-equivalent
net interest income and noninterest income. These negative changes were offset
in part by a lower provision for loan losses, while noninterest expense was
essentially unchanged.
Taxable-equivalent net interest income decreased by $5 million, or 2%, from the
first quarter of 2002 as the negative effect of declines in average loans
outstanding and yield-related loan fees more than offset the positive effect of
deposit growth.
Noninterest income decreased by $11 million, or 9%, due primarily to lower
income from investment banking and capital markets activities (down $9 million)
and service charges on deposit accounts (down $2 million), both in the Corporate
Banking line of business. These negative changes were partially offset by
increases in gains from the residual values of leased equipment in Key Equipment
Finance and non-yield-related loan fees in KeyBank Real Estate Capital.
Noninterest expense decreased by $1 million, or less than 1%, as higher
professional fees in the Key Equipment Finance and Corporate Banking lines were
more than offset by decreases in various indirect charges.
The provision for loan losses decreased by $2 million, or 4%, reflecting a lower
level of net charge-offs in Corporate Banking and Key Equipment Finance.
FIGURE 4. CORPORATE AND INVESTMENT BANKING
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- ----------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 279 $ 284 $ (5) (1.8)%
Noninterest income 110 121 (11) (9.1)
- -----------------------------------------------------------------------------------------------------------------
Total revenue (TE) 389 405 (16) (4.0)
Provision for loan losses 50 52 (2) (3.8)
Noninterest expense 169 170 (1) (.6)
- -----------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 170 183 (13) (7.1)
Allocated income taxes and TE adjustments 64 69 (5) (7.2)
- -----------------------------------------------------------------------------------------------------------------
Net income $ 106 $ 114 $ (8) (7.0)%
======= ========= =======
Percent of consolidated net income 49 % 48 % N/A N/A
AVERAGE BALANCES
Loans $28,385 $ 29,842 $(1,457) (4.9)%
Total assets 32,822 33,060 (238) (.7)
Deposits 4,039 3,134 905 28.9
- -----------------------------------------------------------------------------------------------------------------
TE = Taxable Equivalent, N/A = Not Applicable
INVESTMENT MANAGEMENT SERVICES
As shown in Figure 5, net income for Investment Management Services was $20
million for the first quarter of 2003, down from $23 million in the first
quarter of last year. The decrease was attributable to a significant reduction
in noninterest income. This reduction more than offset an increase in
taxable-equivalent net interest income and decreases in both noninterest expense
and the provision for loan losses.
38
Taxable-equivalent net interest income increased by $6 million, or 11%, from the
first quarter of 2002. The growth was due primarily to improved interest rate
spreads on both earning assets and borrowings, along with a significant increase
in average deposits.
Noninterest income decreased by $27 million, or 17%, as market-sensitive
businesses continue to be adversely affected by the weak economy. The reduction
was due primarily to an aggregate decline of $27 million in trust and investment
services income in the McDonald Financial Group and in Victory Capital
Management. This decline was largely attributable to a decrease in the market
value of assets under management. In addition, net asset outflows resulted from
the June 2002 sale of Key's 401(k) recordkeeping business. Funds that clients
elected to move from money market funds under management to an FDIC insured
deposit account with Key also contributed to the decline in assets under
management.
Noninterest expense decreased by $15 million, or 9%, due primarily to lower
variable compensation expense associated with revenue generation, a reduction in
depreciation expense related to equipment, lower costs for software amortization
and declines in various indirect charges.
FIGURE 5. INVESTMENT MANAGEMENT SERVICES
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- -----------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 59 $ 53 $ 6 11.3 %
Noninterest income 133 160 (27) (16.9)
- -----------------------------------------------------------------------------------------------------------------
Total revenue (TE) 192 213 (21) (9.9)
Provision for loan losses 2 3 (1) (33.3)
Noninterest expense 158 173 (15) (8.7)
- -----------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 32 37 (5) (13.5)
Allocated income taxes and TE adjustments 12 14 (2) (14.3)
- -----------------------------------------------------------------------------------------------------------------
Net income $ 20 $ 23 $ (3) (13.0)%
======= ========= ========
Percent of consolidated net income 9 % 10 % N/A N/A
AVERAGE BALANCES
Loans $ 4,958 $ 4,699 $ 259 5.5 %
Total assets 5,913 5,771 142 2.5
Deposits 5,216 3,671 1,545 42.1
- -----------------------------------------------------------------------------------------------------------------
TE = Taxable Equivalent, N/A = Not Applicable
ADDITIONAL INVESTMENT MANAGEMENT SERVICES DATA MARCH 31, DECEMBER 31, MARCH 31,
dollars in billions 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------------
Assets under management $ 60.8 $ 61.7 $ 72.4
Nonmanaged and brokerage assets 57.9 65.0 77.8
- ---------------------------------------------------------------------------------------------------------------
OTHER SEGMENTS
Other segments consist primarily of Treasury, Principal Investing and the net
effect of funds transfer pricing. This segment generated a net loss of $10
million for the first quarter of 2003, compared with net income of $3 million
for the same period last year.
39
RESULTS OF OPERATIONS
NET INTEREST INCOME
Key's principal source of earnings is net interest income, which includes
interest paid to Key on earning assets such as loans and securities, as well as
loan-related fee income; less interest expense paid on deposits and borrowings.
There are several factors that affect net interest income, including:
- - the volume, pricing, mix and maturity of earning assets and
interest-bearing liabilities;
- - the use of derivative instruments to manage interest rate risk;
- - market interest rate fluctuations; and
- - asset quality.
To make it easier to compare results among several periods and the yields on
various types of earning assets, we present all net interest income on a
"taxable-equivalent basis." In other words, if we earn $100 of tax-exempt
income, we present those earnings at a higher amount (specifically, $154)
that--if taxed at the statutory federal income tax rate of 35%--would yield
$100. Figure 7, which spans pages 42 and 43, shows the various components of
Key's balance sheet that affect interest income and expense, and their
respective yields or rates over the past five quarters. This figure also
includes a reconciliation to net interest income as reported under generally
accepted accounting principles ("GAAP").
Net interest income for the first quarter of 2003 was $703 million, essentially
unchanged from the year-ago quarter as the effect of a reduction in the net
interest margin was offset by the positive effect of an increase in average
earning assets. Key's net interest margin decreased 7 basis points to 3.86%. The
net interest margin is an indicator of the profitability of the earning asset
portfolio and is calculated by dividing net interest income by average earning
assets. During the same period, average earning assets grew by 2% to $73.4
billion. The significant growth in Key's core deposits was a contributing factor
in both developments. Over the past twelve months, the growth of core deposits
has exceeded net loan growth. The excess funds have been either invested in
securities or used to reduce wholesale funding. These changes in the balance
sheet have placed pressure on the net interest margin; however, they have also
improved Key's liquidity position.
NET INTEREST MARGIN. Key's net interest margin decreased over the past twelve
months, primarily because:
- - competitive market conditions precluded us from passing on the full
amount of the Federal Reserve's November 2002 reduction in interest
rates to clients' deposit accounts;
- - we have experienced a higher level of loan refinancings and prepayments
as a result of the low interest rate environment; and
- - we invested more heavily in securities available for sale since
opportunities to originate loans have been adversely affected by the
weak economy.
INTEREST EARNING ASSETS. Average earning assets for the first quarter of 2003
totaled $73.4 billion, which was $1.4 billion, or 2%, higher than the first
quarter 2002 level. This growth came principally from home equity lending and
the securities-available-for-sale portfolio. During the same period, weak loan
demand resulting from the general economic slowdown contributed to a decline in
average commercial loans outstanding.
40
Over the past twelve months, the growth and composition of Key's loan portfolio
has been affected by several actions:
- - During the first quarter of 2003, we acquired a $311 million commercial
lease financing portfolio and a $71 million commercial loan portfolio
from a Canadian financial institution. The acquisition of the lease
financing portfolio further diversifies our asset base and is expected
to result in additional equipment financing opportunities.
- - During the second quarter of 2001, management announced that Key would
exit the automobile leasing business, de-emphasize indirect prime
automobile lending and discontinue certain credit-only commercial
relationships. As of March 31, 2003, these portfolios, in the
aggregate, have declined by approximately $3.7 billion since the date
of the announcement and by approximately $1.7 billion since March 31,
2002.
- - We sold commercial mortgage loans of $253 million during the first
quarter of 2003 and $1.4 billion during 2002. Since some of these loans
have been sold with limited recourse, Key established a loss reserve of
an amount estimated by management to be appropriate to reflect the
recourse risk. More information about the related recourse agreement is
provided in Note 10 ("Contingent Liabilities and Guarantees") under the
section entitled "Recourse agreement with Federal National Mortgage
Association" on page 25. Our business of originating and servicing
commercial mortgage loans has grown in part as a result of acquiring
Conning Asset Management in the second quarter of 2002 and both Newport
Mortgage Company, L.P. and National Realty Funding L.C. in 2000.
- - We sold education loans of $96 million during the first quarter of 2003
and $1.1 billion ($750 million through securitizations) during 2002.
Figure 6 shows how the changes in yields or rates and average balances from the
prior year affected net interest income. The section entitled "Financial
Condition," which begins on page 50, contains more discussion about changes in
earning assets and funding sources.
FIGURE 6. COMPONENTS OF NET INTEREST INCOME CHANGES
FROM THREE MONTHS ENDED MARCH 31, 2002
TO THREE MONTHS ENDED MARCH 31, 2003
--------------------------------------
AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE
- -----------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ (10) $ (96) $ (106)
Tax-exempt investment securities (2) -- (2)
Securities available for sale 34 (22) 12
Short-term investments (2) 1 (1)
Other investments 1 (1) --
- -----------------------------------------------------------------------------------------
Total interest income (taxable equivalent) 21 (118) (97)
INTEREST EXPENSE
NOW and money market deposit accounts 8 2 10
Certificates of deposit ($100,000 or more) 2 (11) (9)
Other time deposits (17) (42) (59)
Deposits in foreign office (2) (2) (4)
- -----------------------------------------------------------------------------------------
Total interest-bearing deposits (9) (53) (62)
Federal funds purchased and securities sold
under repurchase agreements (1) (6) (7)
Bank notes and other short-term borrowings (11) -- (11)
Long-term debt, including capital securities 10 (28) (18)
- -----------------------------------------------------------------------------------------
Total interest expense (11) (87) (98)
- -----------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $ 32 $ (31) $ 1
======= ======== ========
- -----------------------------------------------------------------------------------------
The change in interest not due solely to volume or rate has been allocated in
proportion to the absolute dollar amounts of the change in each.
41
FIGURE 7. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
FIRST QUARTER 2003 FOURTH QUARTER 2002
--------------------------------- -------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a,b)
Commercial, financial and agricultural $17,221 $ 206 4.86 % $17,362 $ 220 5.01 %
Real estate-- commercial mortgage 6,034 82 5.49 6,168 88 5.66
Real estate-- construction 5,683 72 5.16 5,856 78 5.27
Commercial lease financing 7,790 123 6.30 7,356 112 6.13
- -----------------------------------------------------------------------------------------------------------------------------
Total commercial loans 36,728 483 5.31 36,742 498 5.39
Real estate-- residential 1,904 32 6.66 2,029 33 6.72
Home equity 14,005 217 6.29 13,649 226 6.55
Consumer-- direct 2,129 40 7.68 2,153 44 8.17
Consumer--indirect lease financing 772 18 9.40 1,001 24 9.42
Consumer-- indirect other 4,917 107 8.74 5,117 116 9.05
- -----------------------------------------------------------------------------------------------------------------------------
Total consumer loans 23,727 414 7.05 23,949 443 7.36
Loans held for sale 2,390 28 4.70 1,986 26 5.28
- -----------------------------------------------------------------------------------------------------------------------------
Total loans 62,845 925 5.95 62,677 967 6.14
Taxable investment securities 2 -- 8.43 1 -- 8.85
Tax-exempt investment securities(a) 125 3 8.89 132 3 9.32
- -----------------------------------------------------------------------------------------------------------------------------
Total investment securities 127 3 8.88 133 3 9.31
Securities available for sale(a,c) 7,790 101 5.21 7,598 106 5.60
Short-term investments 1,706 8 1.87 1,240 7 2.12
Other investments(c) 956 6 2.46 906 6 2.39
- -----------------------------------------------------------------------------------------------------------------------------
Total earning assets 73,424 1,043 5.73 72,554 1,089 5.97
Allowance for loan losses (1,438) (1,471)
Accrued income and other assets 11,928 11,652
- -----------------------------------------------------------------------------------------------------------------------------
$83,914 $82,735
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
NOW and money market deposit accounts $16,747 42 1.03 $15,131 40 1.03
Savings deposits 2,043 3 .60 1,981 4 .63
Certificates of deposit ($100,000 or more)(d) 4,654 48 4.20 4,741 51 4.29
Other time deposits 11,799 90 3.09 12,213 101 3.29
Deposits in foreign office 1,719 5 1.24 1,974 6 1.43
- -----------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 36,962 188 2.07 36,040 202 2.22
Federal funds purchased and securities
sold under repurchase agreements 5,220 16 1.26 5,502 20 1.44
Bank notes and other short-term borrowings (d) 2,382 16 2.75 2,192 14 2.53
Long-term debt, including capital securities (d) 17,278 120 2.90 17,040 129 3.09
- -----------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 61,842 340 2.25 60,774 365 2.40
Noninterest-bearing deposits 9,788 9,926
Accrued expense and other liabilities 5,465 5,314
Shareholders' equity 6,819 6,721
- -----------------------------------------------------------------------------------------------------------------------------
$83,914 $82,735
======= =======
Interest rate spread (TE) 3.48 % 3.57 %
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) 703 3.86 % 724 3.98 %
==== ====
TE adjustment(a) 22 12
- -----------------------------------------------------------------------------------------------------------------------------
Net interest income, GAAP basis $ 681 $ 712
======== ========
Capital securities $ 1,254 $ 18 $ 1,233 $ 18
- -----------------------------------------------------------------------------------------------------------------------------
(a) Interest income on tax-exempt securities and loans has been adjusted to a
taxable-equivalent basis using the statutory federal income tax rate of
35%.
(b) For purposes of these computations, nonaccrual loans are included in
average loan balances.
(c) Yield is calculated on the basis of amortized cost.
(d) Rate calculation excludes basis adjustments related to fair value hedges.
See Note 20 ("Derivatives and Hedging Activities"), which begins on page 84
of Key's Annual Report to Shareholders, for an explanation of fair value
hedges.
TE = Taxable Equivalent
42
FIGURE 7. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
(CONTINUED)
THIRD QUARTER 2002 SECOND QUARTER 2002 FIRST QUARTER 2002
- ----------------------------------- ------------------------------- -------------------------------
Average Yield/ Average Yield/ AVERAGE YIELD/
Balance Interest Rate Balance Interest Rate BALANCE INTEREST RATE
- -----------------------------------------------------------------------------------------------------------
$ 17,485 $ 225 5.11 % $ 18,213 $ 232 5.11 % $18,016 $ 230 5.18 %
6,207 93 5.92 6,414 95 5.94 6,598 97 5.97
5,822 79 5.37 5,870 79 5.40 5,856 79 5.49
7,215 121 6.72 7,206 126 6.96 7,275 132 7.25
- -----------------------------------------------------------------------------------------------------------
36,729 518 5.60 37,703 532 5.65 37,745 538 5.76
2,089 37 7.00 2,148 38 7.04 2,241 41 7.21
13,505 222 6.52 13,072 229 7.03 11,863 212 7.26
2,172 46 8.32 2,210 46 8.37 2,289 47 8.30
1,264 28 8.98 1,514 33 8.84 1,852 41 8.74
5,143 117 9.13 5,131 118 9.19 5,231 120 9.21
- -----------------------------------------------------------------------------------------------------------
24,173 450 7.41 24,075 464 7.73 23,476 461 7.91
2,584 35 5.48 2,150 30 5.58 2,267 32 5.70
- -----------------------------------------------------------------------------------------------------------
63,486 1,003 6.29 63,928 1,026 6.43 63,488 1,031 6.55
1 -- 8.45 1 -- 8.17 2 -- 8.88
166 4 8.76 205 4 8.31 219 5 8.52
- -----------------------------------------------------------------------------------------------------------
167 4 8.75 206 4 8.31 221 5 8.52
6,424 98 6.11 6,014 96 6.40 5,379 89 6.69
1,151 6 2.28 1,561 8 1.97 2,041 9 1.76
855 6 2.46 870 6 3.14 852 6 2.28
- -----------------------------------------------------------------------------------------------------------
72,083 1,117 6.17 72,579 1,140 6.30 71,981 1,140 6.38
(1,509) (1,579) (1,657)
11,361 10,560 10,547
- -----------------------------------------------------------------------------------------------------------
$ 81,935 $ 81,560 $80,871
========== ========== =======
$ 13,293 30 .91 $ 13,232 29 .88 $13,374 32 .96
2,002 3 .67 2,014 3 .67 1,947 3 .71
4,886 54 4.45 4,816 56 4.69 4,516 57 5.10
12,713 115 3.57 13,085 131 4.02 13,443 149 4.51
2,593 12 1.76 2,638 12 1.76 2,136 9 1.69
- -----------------------------------------------------------------------------------------------------------
35,487 214 2.40 35,785 231 2.59 35,416 250 2.86
5,483 23 1.69 5,541 24 1.71 5,584 23 1.70
2,581 18 2.73 2,995 20 2.73 4,028 27 2.68
17,455 140 3.25 17,230 144 3.37 16,103 138 3.46
- -----------------------------------------------------------------------------------------------------------
61,006 395 2.59 61,551 419 2.73 61,131 438 2.90
9,177 8,719 8,553
5,159 4,783 4,918
6,593 6,507 6,269
- -----------------------------------------------------------------------------------------------------------
$ 81,935 $ 81,560 $80,871
========== ========== =======
3.58 % 3.57 % 3.48 %
- -----------------------------------------------------------------------------------------------------------
722 3.99 % 721 3.98 % 702 3.93 %
==== ==== ====
22 38 48
- -----------------------------------------------------------------------------------------------------------
$ 700 $ 683 $ 654
======== ======== ========
$ 1,249 $ 19 $ 1,236 $ 20 $ 1,298 $ 21
- -----------------------------------------------------------------------------------------------------------
43
MARKET RISK MANAGEMENT
The values of some financial instruments vary not only with changes in market
interest rates, but also with changes in foreign exchange rates, factors
influencing valuations in the equity securities markets, and other market-driven
rates or prices. For example, the value of a fixed-rate bond will decline if
market interest rates increase. As a result, the bond will become a less
attractive investment to the holder. Similarly, the value of the U.S. dollar
regularly fluctuates in relation to other currencies. The exposure that
instruments tied to such external factors present is called "market risk." Most
of Key's market risk is derived from interest rate fluctuations.
Interest rate risk management
Key's Asset/Liability Management Policy Committee has developed a program to
measure and manage interest rate risk. This committee is also responsible for
approving Key's asset/liability management policies, overseeing the formulation
and implementation of strategies to improve balance sheet positioning and
earnings, and reviewing Key's interest rate sensitivity exposure.
FACTORS CONTRIBUTING TO INTEREST RATE EXPOSURE. Key uses interest rate exposure
models to quantify the potential impact on earnings and economic value of equity
arising from a variety of possible future interest rate scenarios. The many
interest rate scenarios modeled estimate the level of Key's interest rate
exposure arising from option risk, basis risk and gap risk. Each of these types
of risk is defined in the discussion of market risk management, which begins on
page 30 of Key's 2002 Annual Report to Shareholders.
MEASUREMENT OF SHORT-TERM INTEREST RATE EXPOSURE. Key uses a net interest income
simulation model to measure interest rate risk over a short time frame. These
simulations estimate the impact that various changes in the overall level of
interest rates over one- and two-year time horizons would have on net interest
income. The results help Key develop strategies for managing exposure to
interest rate risk.
Like any forecasting technique, interest rate simulation modeling is based on a
large number of assumptions and judgments. In this case, the assumptions relate
primarily to loan and deposit growth, asset and liability prepayments, interest
rates, and on- and off-balance sheet management strategies. Management believes
that, both individually and in the aggregate, the assumptions Key makes are
reasonable. Nevertheless, the simulation modeling process produces only a
sophisticated estimate, not a precise calculation of exposure.
Key's guidelines for risk management call for preventive measures to be taken if
the simulation modeling demonstrates that a gradual 200 basis point increase or
decrease in short-term rates over the next twelve months would adversely affect
net interest income over the same period by more than 2%. Key is operating
within these guidelines. Since short-term interest rates were relatively low at
March 31, 2003, management modified Key's standard rate scenario of a gradual
decrease of 200 basis points over twelve months to a gradual decrease of 50
basis points over three months and no change over the following nine months. As
of March 31, 2003, based on the results of our simulation model, and assuming
that management does not take action to alter the outcome, Key would expect net
interest income to decrease by approximately .37% if short-term interest rates
gradually increase by 200 basis points. Conversely, if short-term interest rates
gradually decrease by 50 basis points over the next three months, net interest
income would be expected to decrease by approximately .37% over the next twelve
months.
The decline in net interest income under both of the above scenarios reflects
the fact that Key is currently in a liability sensitive position when interest
rates increase and an asset sensitive position when rates decrease. Key's asset
sensitive position to a decrease in interest rates stems from the fact that
short-term rates are at historically low levels. Consequently, the results of
the simulation model reflect management's assumption that deposit rates will not
decline from current levels, while interest rates on earning assets will
continue to do so. To mitigate the risk of a potentially adverse effect on
earnings, management is using interest rate contracts while maintaining the
flexibility to lower rates on deposits, if necessary.
Key has historically been in a liability sensitive position when interest rates
are rising. Management actively monitors the risk to higher rates and would
endeavor to take preventive actions to ensure that net interest income at risk
does not exceed guidelines established by the Asset/Liability Management Policy
44
Committee. Also, Key's lines of business have the ability to mitigate the
negative effect on net interest income from rising interest rates by growing
loans and deposits with profitable interest rate spreads.
MEASUREMENT OF LONG-TERM INTEREST RATE EXPOSURE. Key uses an economic value of
equity model to complement short-term interest rate risk analysis. The benefit
of this model is that it measures exposure to interest rate changes over time
frames longer than two years. The economic value of Key's equity is determined
by aggregating the present value of projected future cash flows for asset,
liability and derivative positions based on the current yield curve. However,
economic value does not represent the fair values of asset, liability and
derivative positions since it does not consider factors like credit risk and
liquidity.
Key's guidelines for risk management call for preventive measures to be taken if
an immediate 200 basis point increase or decrease in interest rates is estimated
to reduce the economic value of equity by more than 15%. Key is operating within
these guidelines. Certain short-term interest rates were limited to reductions
of less than 200 basis points since interest rates cannot decrease below zero in
Key's economic value of equity model.
MANAGEMENT OF INTEREST RATE EXPOSURE. Management uses the results of short-term
and long-term interest rate exposure models to formulate strategies to improve
balance sheet positioning, earnings, or both, within the bounds of Key's
interest rate risk, liquidity and capital guidelines. We manage interest rate
risk by using portfolio swaps and caps, which modify the repricing or maturity
characteristics of some of our assets and liabilities. The decision to use these
instruments rather than securities, debt or other on-balance sheet alternatives
depends on many factors, including the mix and cost of funding sources,
liquidity and capital requirements, and interest rate implications. A brief
description of interest rate swaps and caps is included in the discussion of
market risk management, which begins on page 30 of Key's 2002 Annual Report to
Shareholders. For more information about how Key uses interest rate swaps and
caps to manage its balance sheet, see Note 11 ("Derivatives and Hedging
Activities"), which begins on page 27.
Over the past year, we have invested more heavily in collateralized mortgage
obligations as opportunities to originate loans have been adversely affected by
the weak economy, while our core deposits have grown significantly. These
securities, the majority of which have relatively short average lives, have been
used in conjunction with swaps and caps to maintain an approximately neutral
interest rate risk position.
Trading portfolio risk management
Key's trading portfolio includes:
- - interest rate swap contracts entered into to accommodate the needs of
clients;
- - positions with third parties that are intended to offset or mitigate
the interest rate risk of client positions;
- - foreign exchange contracts entered into to accommodate the needs of
clients, and
- - proprietary trading positions in financial assets and liabilities.
The fair values of these trading portfolio items are included in "accrued income
and other assets" or "accrued expense and other liabilities" on the balance
sheet. For more information about these items, see Note 20 ("Derivatives and
Hedging Activities"), which begins on page 84 of Key's 2002 Annual Report to
Shareholders.
Management uses a value at risk ("VAR") model to estimate the potential adverse
effect of changes in interest and foreign exchange rates, and equity prices on
the fair value of Key's trading portfolio. Using statistical methods, this model
estimates the maximum potential one-day loss with 95% probability. At March 31,
2003, Key's aggregate daily VAR was $1.0 million, compared with $1.1 million at
March 31, 2002. Aggregate daily VAR averaged $1.0 million for the first three
months of 2003, compared with an average of $1.3 million for the same period
last year. VAR modeling augments other controls that Key uses to mitigate the
market risk exposure of the trading portfolio. These controls include loss and
portfolio size limits that are based on market liquidity and the level of
activity and volatility of trading products.
45
NONINTEREST INCOME
Noninterest income for the first quarter of 2003 was $397 million, representing
a $46 million, or 10%, decrease from the same period last year. Continued
weakness in the financial markets resulted in lower income from trust and
investment services (down $26 million) and investment banking and capital
markets activities (down $15 million). Net asset outflows resulting from the
June 2002 sale of Key's 401(k) recordkeeping business also contributed to the
decline in revenue generated from trust and investment services. Until market
conditions improve, Key expects these income components to remain under
pressure.
Figure 8 shows the major components of Key's noninterest income. The discussion
that follows provides additional information, such as the composition of certain
components and the factors that caused them to change from the prior year.
FIGURE 8. NONINTEREST INCOME
THREE MONTHS ENDED MARCH 31, CHANGE
------------------------------ ----------------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- --------------------------------------------------------------------------------------------------------------------------
Trust and investment services income $132 $158 $ (26) (16.5)%
Service charges on deposit accounts 92 100 (8) (8.0)
Investment banking and capital markets income 34 49 (15) (30.6)
Letter of credit and loan fees 31 28 3 10.7
Corporate-owned life insurance income 27 26 1 3.8
Electronic banking fees 19 18 1 5.6
Net securities gains 4 -- 4 N/M
Other income:
Insurance income 13 13 -- --
Net gains from loan securitizations and sales 15 6 9 150.0
Loan securitization servicing fees 2 3 (1) (33.3)
Credit card fees 3 2 1 50.0
Miscellaneous income 25 40 (15) (37.5)
- --------------------------------------------------------------------------------------------------------------------------
Total other income 58 64 (6) (9.4)
- --------------------------------------------------------------------------------------------------------------------------
Total noninterest income $397 $443 $ (46) (10.4)%
===== ==== ======
- --------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
TRUST AND INVESTMENT SERVICES INCOME. Trust and investment services provide
Key's largest source of noninterest income. Its primary components are shown in
Figure 9. A significant portion of this income is based on the value of assets
under management. Thus, over the past twelve months, the level of revenue
derived from these services has been adversely affected by continued declines in
the equity markets.
FIGURE 9. TRUST AND INVESTMENT SERVICES INCOME
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- -----------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------
Personal asset management and custody fees $ 35 $ 41 $ ( 6) (14.6)%
Institutional asset management and custody fees 11 20 (9) (45.0)
Bond services 9 10 (1) (10.0)
Brokerage commission income 47 51 (4) (7.8)
All other fees 30 36 (6) (16.7)
- ------------------------------------------------------------------------------------------------------------------------
Total trust and investment services income $132 $158 $ (26) (16.5)%
==== ==== =====
- ------------------------------------------------------------------------------------------------------------------------
At March 31, 2003, Key's bank, trust and registered investment advisory
subsidiaries had assets under management of $60.8 billion, compared with $72.4
billion at March 31, 2002. These assets are managed on behalf of both
institutions and individuals through a variety of equity, fixed income and money
market accounts. The composition of Key's assets under management is shown in
Figure 10. Over the past twelve months, the value of total assets under
management decreased by a net 16%. This decrease reflects a decline in the
market value of assets under management, as well as net asset outflows of
approximately $2.5 billion. Included in the net asset outflows is approximately
$2.9 billion of funds that have been transferred to an outside vendor in
connection with Key's sale of the 401(k) recordkeeping business.
46
Another $880 million of the outflows is attributable to funds which clients have
elected to move from money market funds under management to an FDIC insured
deposit account with Key. As shown in Figure 10, 58% of the assets Key manages
are invested in more stable fixed income or money market funds.
FIGURE 10. ASSETS UNDER MANAGEMENT
2003 2002
------- ---------------------------------------------
in millions FIRST FOURTH THIRD SECOND FIRST
- -----------------------------------------------------------------------------------------------------------------------
Assets under management by investment type:
Equity $25,415 $27,224 $25,422 $ 31,064 $34,497
Fixed income 16,310 16,133 17,588 18,905 18,536
Money market 19,073 18,337 19,364 20,756 19,413
- -----------------------------------------------------------------------------------------------------------------------
Total $60,798 $61,694 $62,374 $ 70,725 $72,446
======= ======= ======= ======== =======
Proprietary mutual funds included in assets under management:
Equity $ 2,236 $ 2,878 $ 2,965 $ 3,709 $ 4,080
Fixed income 1,125 1,215 1,377 1,262 1,211
Money market 10,762 11,457 12,129 12,568 13,094
- -----------------------------------------------------------------------------------------------------------------------
Total $14,123 $15,550 $16,471 $ 17,539 $18,385
======= ======= ======= ======== =======
- -----------------------------------------------------------------------------------------------------------------------
INVESTMENT BANKING AND CAPITAL MARKETS INCOME. As shown in Figure 11, the
decrease in investment banking and capital markets income resulted from declines
in three of its four major revenue sources, reflecting the adverse effects of
continued economic weakness.
Key's principal investing income is susceptible to volatility since it is
derived from investments in small to medium-sized businesses in various stages
of economic development and strategy implementation. Principal investments
consist of direct and indirect investments in predominantly privately-held
companies and are carried on the balance sheet at fair value ($698 million at
March 31, 2003, and $636 million at March 31, 2002). Thus, the net gains and
losses presented in Figure 11 stem from changes in estimated fair values, as
well as actual gains and losses on sales of principal investments.
FIGURE 11. INVESTMENT BANKING AND CAPITAL MARKETS INCOME
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- --------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $ 8 $ 17 $ (9) (52.9)%
Investment banking income 22 21 1 4.8
Net gains (losses) from principal investing (3) 1 (4) N/M
Foreign exchange income 7 10 (3) (30.0)
- ----------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $ 34 $ 49 $(15) (30.6)%
==== ==== =====
- -----------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
SERVICE CHARGES ON DEPOSIT ACCOUNTS. Income from service charges on deposit
accounts decreased by $8 million, or 8%, from the first quarter of 2002 due in
part to free checking products, which were introduced in the third quarter of
2002 and rolled out to all of Key's markets by the end of the year.
OTHER INCOME. Other income decreased by $6 million, or 9%, from the first
quarter of 2002, due primarily to an $11 million increase in losses from the
residual values of leased equipment included in miscellaneous income. As shown
in Figure 8, these losses were substantially offset by a $9 million increase in
net gains from loan securitizations and sales.
47
NONINTEREST EXPENSE
Noninterest expense of $657 million for the first quarter of 2003 was down from
$661 million for the same period last year, due primarily to lower incentive
compensation and a decline in software amortization.
Figure 12 shows the components of Key's noninterest expense. The discussion that
follows explains the composition of certain components and the factors that
caused them to change from the prior year.
FIGURE 12. NONINTEREST EXPENSE
THREE MONTHS ENDED MARCH 31, CHANGE
----------------------------------- -----------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------
Personnel $ 363 $ 363 -- --
Net occupancy 59 57 $ 2 3.5 %
Computer processing 44 54 (10) (18.5)
Equipment 32 34 (2) (5.9)
Marketing 25 26 (1) (3.8)
Professional fees 25 21 4 19.0
Other expense:
Postage and delivery 15 15 -- --
Telecommunications 8 8 -- --
Equity- and gross receipts-based taxes 5 6 (1) (16.7)
OREO expense, net 1 1 -- --
Miscellaneous expense 80 76 4 5.3
- ------------------------------------------------------------------------------------------------------------------------
Total other expense 109 106 3 2.8
- -------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 657 $ 661 $ (4) (.6)%
======= ======= ======
Average full-time equivalent employees 20,447 21,079 (632) (3.0)%
- ------------------------------------------------------------------------------------------------------------------------
PERSONNEL. Personnel expense, the largest category of Key's noninterest expense,
was unchanged from the year-ago quarter as increases in salaries and employee
benefit costs (primarily pension costs) were offset by lower incentive
compensation. The level of Key's personnel expense continues to reflect the
benefits derived from our competitiveness initiative completed last year, as
well as the continuous improvement efforts that have evolved from it. We will
continue to evaluate staffing levels and to make appropriate changes when they
can be accomplished without negatively affecting either customer service or our
ability to grow higher return businesses. For the first quarter of 2003, the
number of average full-time equivalent employees was 20,447, compared with
20,485 for the fourth quarter of 2002 and 21,079 for the year-ago quarter.
Figure 13 shows the major components of Key's personnel expense.
Effective January 1, 2003, Key adopted the fair value method of accounting as
outlined in SFAS No. 123, "Accounting for Stock-Based Compensation."
Compensation expense related to stock option grants totaled less than $1 million
in the first quarter of 2003 and is included in incentive compensation in Figure
13. Additional information pertaining to this accounting change is included in
Note 1 ("Basis of Presentation") under the headings "Stock-Based Compensation"
on page 8 and "Accounting Pronouncements Adopted in 2003" on page 9.
FIGURE 13. PERSONNEL EXPENSE
THREE MONTHS ENDED MARCH 31, CHANGE
------------------------------------ ----------------------------
dollars in millions 2003 2002 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------
Salaries $ 225 $ 215 $10 4.7 %
Employee benefits 72 63 9 14.3
Incentive compensation 66 85 (19) (22.4)
- -------------------------------------------------------------------------------------------------------
Total personnel expense $ 363 $ 363 -- --
======== ===== ===
- -------------------------------------------------------------------------------------------------------
48
COMPUTER PROCESSING. Computer processing expense decreased by $10 million, or
19%, from the first quarter of last year, due primarily to a lower level of
computer software amortization. This reduction is attributable to a decline in
the number of capitalized software projects.
INCOME TAXES
The provision for income taxes was $74 million for the first quarter of 2003,
compared with $60 million for the first three months of 2002. The effective tax
rate, which is the provision for income taxes as a percentage of income before
income taxes, was 25.4% for the first quarter of 2003, compared with 20.0% for
the first quarter of 2002. As discussed below, the management of certain leases
has been transferred to a foreign subsidiary in a lower tax jurisdiction. The
increase in the effective rate was due primarily to the fact that a smaller
number of leases were transferred in the first quarter of this year, compared
with the year-ago quarter.
The effective tax rate for both the current and prior year is substantially
below Key's combined statutory federal and state rate of 37.5% (37% in 2002)
primarily because portions of our equipment leasing portfolio became subject to
a lower income tax rate in the latter half of 2001. Responsibility for the
management of portions of Key's leasing portfolio was transferred to a foreign
subsidiary in a lower tax jurisdiction. Since Key intends to permanently
reinvest the earnings of this subsidiary, no deferred income taxes have been
recorded on those earnings in accordance with SFAS No. 109, "Accounting for
Income Taxes." Other factors that account for the difference between the
effective and statutory tax rates in the current and prior year include tax
deductions associated with dividends paid to Key's 401(k) savings plan, income
from investments in tax-advantaged assets (such as tax-exempt securities and
corporate-owned life insurance) and credits associated with investments in
low-income housing projects.
49
FINANCIAL CONDITION
LOANS
At March 31, 2003, total loans outstanding were $62.7 billion, compared with
$62.5 billion at the end of 2002 and $64.0 billion a year ago. Among the factors
that contributed to the decrease in our loans from one year ago are:
- - Loan sales completed to improve the profitability of the overall
portfolio or to accommodate our funding needs;
- - Weakening loan demand due to the sluggish economy; and
- - Our decision to exit the automobile leasing business, de-emphasize
indirect prime automobile lending and discontinue certain credit-only
commercial relationships.
Over the past several years, we have used alternative funding sources like loan
sales and securitizations to allow us to continue to capitalize on our loan
origination capabilities. In addition, Key has completed acquisitions that have
improved our ability to generate and securitize new loans, especially in the
area of commercial real estate. These acquisitions include the purchase of
Conning Asset Management in June 2002, and both Newport Mortgage Company, L.P.
and National Realty Funding L.C. in 2000.
The level of Key's total loans outstanding (excluding loans held for sale)
decreased by $1.6 billion, or 3%, from one year ago. In the commercial loan
portfolio, growth in lease financing receivables was more than offset by a net
decline in all other commercial portfolios, reflecting continued weakness in the
economy and our decision to discontinue many credit-only relationships in the
leveraged financing and nationally syndicated lending businesses.
At March 31, 2003, Key's commercial real estate portfolio included mortgage
loans of $6.0 billion and construction loans of $5.4 billion. The average size
of a mortgage loan was $.5 million and the largest mortgage loan had a balance
of $68 million. The average size of a construction loan was $8 million. The
largest construction loan commitment was $47 million, of which $23 million was
outstanding.
Key conducts its commercial real estate lending business through two primary
sources: a 12-state banking franchise and KeyBank Real Estate Capital (a
national line of business that cultivates relationships both within and beyond
the branch system). This line of business deals exclusively with
nonowner-occupied properties (i.e., generally properties in which the owner
occupies less than 60% of the premises) and accounted for approximately 54% of
Key's total average commercial real estate loans during the first quarter of
2003. At March 31, less than 2% of Key's nonowner-occupied portfolio was either
nonperforming or delinquent in payments. Our commercial real estate business as
a whole focuses on larger real estate developers and, as shown in Figure 14, is
diversified by both industry type and geography.
50
FIGURE 14. COMMERCIAL REAL ESTATE LOANS
GEOGRAPHIC REGION
MARCH 31, 2003 ---------------------------------------------------- TOTAL PERCENT OF
dollars in millions EAST MIDWEST CENTRAL WEST AMOUNT TOTAL
- -----------------------------------------------------------------------------------------------------------------------------------
Nonowner-occupied:
Multi-family properties $ 621 $ 567 $ 613 $ 818 $ 2,619 22.8%
Retail properties 290 516 118 238 1,162 10.1
Office buildings 184 132 154 248 718 6.3
Residential properties 99 58 138 429 724 6.3
Warehouses 53 217 99 107 476 4.2
Manufacturing facilities 15 32 6 7 60 .5
Hotels/Motels 6 9 1 9 25 .2
Other 146 281 59 120 606 5.3
- -----------------------------------------------------------------------------------------------------------------------------------
1,414 1,812 1,188 1,976 6,390 55.7
Owner-occupied 682 2,175 634 1,585 5,076 44.3
- -----------------------------------------------------------------------------------------------------------------------------------
Total $ 2,096 $ 3,987 $ 1,822 $ 3,561 $11,466 100.0%
======= ======= ======= ======= ======= =======
- -----------------------------------------------------------------------------------------------------------------------------------
Nonowner-occupied:
Nonperforming loans $ 5 $ 1 $ 3 $ 8 $ 17 N/M
Accruing loans past due 90 days or more 8 6 1 - 15 N/M
Accruing loans past due 30 through 89 days 21 13 1 26 61 N/M
- -----------------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
Consumer loans decreased by $209 million, or less than 1%, since March 31, 2002.
Excluding loan sales and acquisitions, consumer loans would have increased by
$380 million, or 2%, during the same period. This development was attributable
to a $1.9 billion increase in our home equity portfolio, largely as a result of
our focused efforts to grow this business, facilitated by a period of lower
interest rates. The growth of the home equity portfolio more than offset
declines of $229 million in installment loans, $989 million in automobile lease
financing receivables and $333 million in residential real estate mortgage
loans. The declines in installment loans and automobile lease financing
receivables reflect our decision to de-emphasize indirect prime automobile
lending and exit the automobile leasing business.
Key's home equity portfolio is derived primarily from our Retail Banking line of
business (53% of the home equity portfolio at March 31, 2003) and the National
Home Equity unit within our Consumer Finance line of business.
The National Home Equity unit has two components: Champion Mortgage Company, a
home equity finance company, and Key Home Equity Services, which purchases
individual loans from an extensive network of correspondents and agents. Prior
to the third quarter of 2002, Key Home Equity Services also purchased loans
through bulk portfolio acquisitions from home equity loan companies. The average
loan-to-value ratio at origination for a loan generated by the National Home
Equity unit is 78%. First lien positions comprised 82% of the portfolio for this
unit at March 31, 2003.
Figure 15 summarizes Key's home equity loan portfolio at the end of each of the
last five quarters, as well as certain asset quality statistics and the yields
achieved on the portfolio as a whole.
51
FIGURE 15. HOME EQUITY LOANS
2003 2002
------- ------------------------------------------
dollars in millions FIRST FOURTH THIRD SECOND FIRST
- ------------------------------------------------------------------------------------------------------
SOURCES OF LOANS OUTSTANDING AT PERIOD END
Retail KeyCenters and other sources $ 9,145 $ 8,867 $ 8,680 $ 8,381 $ 7,761
Champion Mortgage Company 2,332 2,210 2,109 2,153 2,031
Key Home Equity Services division 2,667 2,727 2,727 2,845 2,870
- ------------------------------------------------------------------------------------------------------
National Home Equity unit 4,999 4,937 4,836 4,998 4,901
- ------------------------------------------------------------------------------------------------------
Total $14,144 $13,804 $13,516 $13,379 $12,662
======= ======= ======= ======= =======
- ------------------------------------------------------------------------------------------------------
Nonperforming loans at period end $ 154 $ 146 $ 125 $ 107 $ 95
Net charge-offs for the period 13 13 12 13 14
Yield for the period 6.29% 6.55% 6.52% 7.03% 7.26%
- ------------------------------------------------------------------------------------------------------
SALES, SECURITIZATIONS AND DIVESTITURES. During the past twelve months, Key sold
$1.4 billion of commercial real estate loans, $1.1 billion of education loans
($750 million through a securitization) and $955 million of other types of
loans. Since 1999, Key has securitized only education loans.
Among the factors that Key considers in determining which loans to securitize
are:
- - whether the characteristics of a specific loan portfolio make it
conducive to securitization;
- - the relative cost of funds;
- - the level of credit risk; and
- - capital requirements.
Figure 16 summarizes Key's loan sales (including securitizations) for the first
quarter of 2003 and all of 2002.
FIGURE 16. LOANS SOLD AND DIVESTED
COMMERCIAL COMMERCIAL RESIDENTIAL HOME CONSUMER
in millions COMMERCIAL REAL ESTATE LEASE FINANCING REAL ESTATE EQUITY -INDIRECT EDUCATION TOTAL
- ------------------------------------------------------------------------------------------------------------------
2003
- --------------
First quarter $ 52 $ 253 -- $ 4 $ 73 -- $ 96 $ 478
- ------------------------------------------------------------------------------------------------------------------
Total $ 52 $ 253 -- $ 4 $ 73 -- $ 96 $ 478
====== ====== ====== ====== ====== ====== ====== ======
2002
- --------------
Fourth quarter $ 93 $ 603 -- $ 65 $ 110 $ 177 $ 100 $1,148
Third quarter 18 352 -- 25 242 3 784 1,424
Second quarter 31 159 $ 18 20 24 -- 70 322
First quarter -- 319 -- -- 9 -- 116 444
- ------------------------------------------------------------------------------------------------------------------
Total $ 142 $1,433 $ 18 $ 110 $ 385 $ 180 $1,070 $3,338
====== ====== ====== ====== ====== ====== ====== ======
- ------------------------------------------------------------------------------------------------------------------
Figure 17 shows loans that are either administered or serviced by Key, but not
recorded on the balance sheet. Included are loans that have been both
securitized and sold, or simply sold outright. In the event of default, Key is
subject to recourse with respect to approximately $273 million of the $25.4
billion of loans administered or serviced at March 31, 2003.
52
Key derives income from two sources when we sell or securitize loans but retain
the right to administer or service them. We earn noninterest income (recorded as
"other income") from servicing or administering the loans, and we earn interest
income from any securitized assets retained. Conning Asset Management and
National Realty Funding L.C. service the commercial real estate loans shown in
Figure 17; however, other financial institutions originated most of these loans.
Approximately $77 million of the assets held in the asset-backed commercial
paper conduit, for which Key serves as a referral agent, are also included in
Figure 17. For more information regarding the conduit, see Note 10 ("Contingent
Liabilities and Guarantees") under the heading "Guarantees" on page 24.
FIGURE 17. LOANS ADMINISTERED OR SERVICED
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
in millions 2003 2002 2002 2002 2002
- ------------------------------------------------------------------------------------------------
Education loans $ 4,381 $ 4,605 $ 4,756 $ 4,095 $ 4,258
Automobile loans 40 54 69 87 108
Home equity loans 389 456 519 596 668
Commercial real estate loans 20,508 19,508 17,002 16,483(a) 11,621
Commercial loans 130 123 110 103 446
- ------------------------------------------------------------------------------------------------
Total $25,448 $24,746 $22,456 $21,364 $17,101
======= ======= ======= ======= =======
- ------------------------------------------------------------------------------------------------
(a) Includes $4.1 billion of serviced loans purchased in the June 28, 2002,
acquisition of Conning Asset Management.
SECURITIES
At March 31, 2003, the securities portfolio totaled $9.6 billion and included
$8.5 billion of securities available for sale, $132 million of investment
securities and $970 million of other investments (primarily principal
investments). In comparison, the total portfolio at December 31, 2002, was $9.5
billion, including $8.5 billion of securities available for sale, $120 million
of investment securities and $919 million of other investments. The weighted
average maturity of the total portfolio was 3.0 years at March 31, 2003,
unchanged from that at December 31, 2002.
The size and composition of Key's securities portfolio are dependent largely on
our needs for liquidity and the extent to which we are required or elect to hold
these assets as collateral to secure public and trust deposits. Although debt
securities are generally used for this purpose, other assets, such as securities
purchased under resale agreements, may be used temporarily when they provide
more favorable yields.
SECURITIES AVAILABLE FOR SALE. The majority of Key's securities available for
sale portfolio consists of collateralized mortgage obligations that provide a
source of interest income and serve as collateral in connection with pledging
requirements. A collateralized mortgage obligation (sometimes called a "CMO") is
a debt security that is secured by a pool of mortgages, mortgage-backed
securities, U.S. government securities, corporate debt obligations or other
bonds. At March 31, 2003, Key had $8.0 billion invested in collateralized
mortgage obligations and other mortgage-backed securities in the
available-for-sale portfolio, compared with $8.1 billion at December 31, 2002,
and $5.3 billion at March 31, 2002. Over the past twelve months, Key has
invested more heavily in these securities as opportunities to originate loans
(Key's preferred earning asset) have been adversely affected by the weak
economy. Substantially all of these securities were issued or backed by federal
agencies. The CMO securities held by Key are shorter-maturity class bonds that
were structured to have more predictable cash flows during periods of changing
interest rates than other longer-term class bonds.
Figure 18 shows the composition, yields and remaining maturities of Key's
securities available for sale. For more information about retained interests in
securitizations and gross unrealized gains and losses by type of security, see
Note 5 ("Securities"), which begins on page 16.
53
FIGURE 18. SECURITIES AVAILABLE FOR SALE
OTHER
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- RETAINED
AGENCIES AND POLITICAL MORTGAGE BACKED INTERESTS IN
dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS (a) SECURITIES (a) SECURITIZATIONS (a)
=================================================================================================================================
MARCH 31, 2003
Remaining maturity:
One year or less $ 2 $ 1 $ 418 $ 19 $ 8
After one through five years 9 4 6,564 687 185
After five through ten years 6 10 183 2 -
After ten years 7 13 145 22 -
- ---------------------------------------------------------------------------------------------------------------------------------
Fair value $ 24 $ 28 $ 7,310 $ 730 $ 193
Amortized cost 23 27 7,283 698 148
Weighted average yield 5.15% 6.40% 4.74% 6.19% 24.21%
Weighted average maturity 8.3 YEARS 10.8 YEARS 2.8 YEARS 1.9 YEARS 3.4 YEARS
- ---------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
Fair value $ 23 $ 35 $ 7,207 $ 852 $ 209
Amortized cost 22 35 7,143 815 166
- ---------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2002
Fair value $ 97 $ 20 $ 4,379 $ 923 $ 222
Amortized cost 97 20 4,409 900 195
- ---------------------------------------------------------------------------------------------------------------------------------
WEIGHTED
OTHER AVERAGE
dollars in millions SECURITIES TOTAL YIELD (b)
- -------------------------------------------------------------------------------
MARCH 31, 2003
Remaining maturity:
One year or less $ 1 $ 449 4.62%
After one through five years 11 7,460 5.06
After five through ten years 6 207 8.66
After ten years 152 (c) 339 8.97
- -------------------------------------------------------------------------------
Fair value $ 170 $8,455 --
Amortized cost 200 8,379 5.22%
Weighted average yield 5.39%(b) 5.22% --
Weighted average maturity 9.7 YEARS 3.0 YEARS --
- -------------------------------------------------------------------------------
DECEMBER 31, 2002
Fair value $ 181 $8,507 --
Amortized cost 208 8,389 5.76%
- -------------------------------------------------------------------------------
MARCH 31, 2002
Fair value $ 218 $5,859 --
Amortized cost 233 5,854 6.71%
- -------------------------------------------------------------------------------
(a) Maturity is based upon expected average lives rather than contractual
terms.
(b) Weighted average yields are calculated based on amortized cost and
exclude equity securities of $181 million that have no stated yield.
Such yields have been adjusted to a taxable-equivalent basis using the
statutory federal income tax rate of 35%.
(c) Includes primarily marketable equity securities (including an
internally managed portfolio of common stock investments in financial
services companies) with no stated maturity.
INVESTMENT SECURITIES. Securities issued by states and political subdivisions
account for the majority of Key's investment securities. Figure 19 shows the
composition, yields and remaining maturities of these securities.
FIGURE 19. INVESTMENT SECURITIES
U.S TREASURY, STATES AND WEIGHTED
AGENCIES AND POLITICAL OTHER AVERAGE
dollars in millions CORPORATIONS SUBDIVISIONS SECURITIES TOTAL YIELD (a)
- ---------------------------------------------------------------------------------------------------------------------
MARCH 31, 2003
Remaining maturity:
One year or less $15 $ 30 -- $ 45 6.95%
After one through five years -- 65 -- 65 9.49
After five through ten years -- 17 $ 4 21 7.55
After ten years -- 1 -- 1 11.22
- --------------------------------------------------------------------------------------------------------------------
Amortized cost $15 $113 $ 4 $ 132 8.32%
Fair value 15 121 4 140 --
Weighted average maturity .1 YEARS 2.7 YEARS 4.7 YEARS 2.5 YEARS --
- --------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
Amortized cost -- $120 -- $ 120 9.43%
Fair value -- 129 -- 129 --
- --------------------------------------------------------------------------------------------------------------------
MARCH 31, 2002
Amortized cost -- $216 -- $ 216 8.52%
Fair value -- 224 -- 224 --
- --------------------------------------------------------------------------------------------------------------------
(a) Weighted average yields are calculated based on amortized cost. Such
yields have been adjusted to a taxable-equivalent basis using the
statutory federal income tax rate of 35%.
54
OTHER INVESTMENTS. Principal investments - investments in equity and mezzanine
instruments made by Key's Principal Investing unit - are carried at fair value,
which aggregated $698 million at March 31, 2003. They represent approximately
72% of other investments and include direct and indirect investments
predominately in privately-held companies. Direct investments are those made in
a particular company, while indirect investments are made through funds that
include other investors.
In addition to principal investments, other investments include securities that
do not have readily determinable fair values. These securities include certain
real estate-related investments. Neither these securities nor principal
investments have stated maturities.
ASSET QUALITY
Key has a multi-faceted program to manage asset quality. Our professionals:
- - evaluate and monitor credit quality and risk in credit-related assets;
- - develop commercial and consumer credit policies and systems;
- - monitor compliance with internal underwriting standards;
- - establish credit-related concentration limits; and
- - review the adequacy of the allowance for loan losses.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses at March 31, 2003, was
$1.4 billion, or 2.27% of loans. This compares with $1.6 billion, or 2.51% of
loans, at March 31, 2002. The allowance includes $142 million that was
specifically allocated for impaired loans of $348 million at March 31, 2003,
compared with $176 million that was allocated for impaired loans of $453 million
a year ago. For more information about impaired loans, see Note 8 ("Impaired
Loans and Other Nonperforming Assets") on page 21. At March 31, 2003, the
allowance for loan losses was 157.19% of nonperforming loans, compared with
165.16% at March 31, 2002.
Management estimates the appropriate level of the allowance for loan losses on a
quarterly (and at times more frequent) basis. The methodology used is described
in Note 1 ("Summary of Significant Accounting Policies") under the heading
"Allowance for Loan Losses" on page 58 of Key's 2002 Annual Report to
Shareholders. Briefly, management assigns a specific allowance to an impaired
loan when the carrying amount of the loan exceeds the estimated present value of
related future cash flows and the fair value of any existing collateral. The
allowance for loan losses arising from nonimpaired loans is determined by
applying historical loss rates to existing loans with similar risk
characteristics and by exercising judgment to assess the impact of factors such
as changes in economic conditions, credit policies or underwriting standards,
and the level of credit risk associated with specific industries and markets.
The aggregate balance of the allowance for loan losses at March 31, 2003,
represents management's best estimate of the losses inherent in the loan
portfolio at that date.
The allowance specifically allocated for Key's impaired loans decreased by $34
million, or 19%, over the past twelve months, reflecting Key's continued efforts
to resolve problem credits, combined with stabilizing credit quality trends in
certain portfolios. During the same period, the allowance allocated for
nonimpaired loans decreased by $152 million, or 11%, due largely to slow loan
growth and stabilizing credit quality trends in certain portfolios.
The level of watch credits in several commercial portfolios decreased from
year-ago levels. Watch credits are loans with the potential for further
deterioration in quality based on the debtor's current financial condition and
related ability to perform in accordance with the terms of the loan. The decline
in watch credits in commercial portfolios was due primarily to more conservative
underwriting. The commercial loan portfolios with the most significant decreases
in watch credits were large corporate and media. Other portfolios, including
middle market, showed signs of stability or modest improvement. At the same
time, the healthcare portfolio experienced a higher level of watch credits.
These changes reflect the fluctuations that occur in loan portfolios from time
to time. Management does not believe that such changes require any adjustment to
the allowance at this time.
55
RUN-OFF LOAN PORTFOLIO. In the second quarter of 2001, a portion of Key's
allowance for loan losses was segregated in connection with management's
decision to discontinue many credit-only relationships in the leveraged
financing and nationally syndicated lending businesses and to facilitate sales
of distressed loans in other portfolios. The segregated portion of the allowance
is being used to exit approximately $2.7 billion in related commitments (which
were moved to the run-off portfolio in May 2001) and to absorb losses incurred
in connection with sales of distressed loans in the continuing portfolio. As
losses are charged to this segregated allowance, Key does not intend to
replenish it. Within the run-off portfolio, approximately $766 million of
commitments (including $496 million of loans outstanding) remained as of March
31, 2003. Only $58 million of these loans were nonperforming. Management
believes that the $17 million remaining in the segregated allowance is
sufficient to absorb the losses inherent in the run-off portfolio. Considering
the progress that has been made in exiting the commitments discussed above,
management anticipates that sometime during the second quarter it will no longer
be necessary to segregate the run-off portfolio and related allowance for
reporting purposes.
Figure 20 summarizes certain asset quality indicators, segregated between Key's
continuing and run-off loan portfolios. Additional information pertaining to the
run-off portfolio is presented in Figure 21.
FIGURE 20. ASSET QUALITY INDICATORS -- CONTINUING AND RUN-OFF LOAN PORTFOLIOS
RUN-OFF LOAN PORTFOLIO AND
MARCH 31, CONTINUING LOAN PORTFOLIO NONREPLENISHED ALLOWANCE TOTAL LOAN PORTFOLIO
-------------------------- --------------------------- -----------------------
in millions 2003 2002 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Loans outstanding $62,223 $63,015 $496 $941 $62,719 $63,956
Nonperforming loans 846 765 58 208 904 973
Net loan charge-offs for the period 130 136 31 (a) 70 (a) 161 206
Allowance for loan losses 1,404 1,402 17 205 1,421 1,607
- ----------------------------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to the sales of
distressed loans in the continuing portfolio.
FIGURE 21. RUN-OFF LOAN PORTFOLIO
SUMMARY OF CHANGES IN COMMITMENTS
AND LOANS OUTSTANDING
TOTAL LOANS
in millions COMMITMENTS OUTSTANDING
- ----------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $ 940 $599
Charge-offs (10) (10)
Payments, expirations and other changes, net (164) (93)
- ----------------------------------------------------------------------------------------------------
Balance at March 31, 2003 $ 766 $496
===== ====
- ------------------------------------------------------------------------------------------------------
SUMMARY OF CHANGES IN NONPERFORMING LOANS
AND NONREPLENISHED ALLOWANCE FOR LOAN LOSSES (a)
NONPERFORMING NONREPLENISHED
in millions LOANS ALLOWANCE
- ------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 $ 85 $ 48
Loans placed on nonaccrual status 5 N/A
Charge-offs (10) (31)
Payments and other changes, net (22) N/A
- ------------------------------------------------------------------------------------------------------
Balance at March 31, 2003 $ 58 $ 17
===== ====
- ------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to sales of
distressed loans in the continuing portfolio.
N/A = Not Applicable
56
NET LOAN CHARGE-OFFS. Net loan charge-offs for the first quarter of 2003 totaled
$161 million, or 1.04% of average loans, representing the lowest level of net
charge-offs since the first quarter of 2001. These results compare with net
charge-offs of $206 million, or 1.32% of average loans, for the same period last
year. The composition of Key's loan charge-offs and recoveries by type of loan
is shown in Figure 22. The decrease in net charge-offs from the year-ago quarter
occurred primarily in the commercial mortgage portfolio. As shown in Figure 21,
we used $31 million of Key's nonreplenished allowance during the first quarter
of 2003 to absorb losses arising from the run-off loan portfolio and from sales
of distressed loans in the continuing portfolio.
FIGURE 22. SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions 2003 2002
- -------------------------------------------------------------------------------
Average loans outstanding during the period $ 62,845 $ 63,488
- ------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $ 1,452 $ 1,677
Loans charged off:
Commercial, financial and agricultural 87 97
Real estate -- commercial mortgage 11 35
Real estate -- construction 4 --
- ------------------------------------------------------------------------------
Total commercial real estate loans (a) 15 35
Commercial lease financing 12 20
- ------------------------------------------------------------------------------
Total commercial loans 114 152
Real estate -- residential mortgage 2 1
Home equity 14 14
Consumer -- direct 12 14
Consumer -- indirect lease financing 5 7
Consumer -- indirect other 43 45
- ------------------------------------------------------------------------------
Total consumer loans 76 81
- ------------------------------------------------------------------------------
190 233
Recoveries:
Commercial, financial and agricultural 6 10
Real estate -- commercial mortgage 5 1
Real estate -- construction 3 --
- ------------------------------------------------------------------------------
Total commercial real estate loans (a) 8 1
Commercial lease financing 1 1
- ------------------------------------------------------------------------------
Total commercial loans 15 12
Real estate -- residential mortgage -- 1
Home equity 1 --
Consumer -- direct 2 2
Consumer -- indirect lease financing 1 2
Consumer -- indirect other 10 10
- ------------------------------------------------------------------------------
Total consumer loans 14 15
- ------------------------------------------------------------------------------
29 27
- ------------------------------------------------------------------------------
Net loans charged off (161) (206)
Provision for loan losses 130 136
- ------------------------------------------------------------------------------
Allowance for loan losses at end of period $ 1,421 $ 1,607
======== ========
- ------------------------------------------------------------------------------
Net loan charge-offs to average loans 1.04% 1.32%
Allowance for loan losses to period-end loans 2.27 2.51
Allowance for loan losses to nonperforming loans 157.19 165.16
- ------------------------------------------------------------------------------
(a) See Figure 14 on page 51 and the accompanying discussion on page 50 for
more information related to Key's commercial real estate portfolio.
57
NONPERFORMING ASSETS. Figure 23 shows the composition of Key's nonperforming
assets. These assets totaled $968 million at March 31, 2003, and represented
1.54% of loans, other real estate owned (known as "OREO") and other
nonperforming assets, compared with $993 million, or 1.59%, at December 31,
2002, and $1.0 billion, or 1.58%, at March 31, 2002.
FIGURE 23. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
dollars in millions 2003 2002 2002 2002 2002
- -----------------------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 381 $ 448 $ 484 $ 471 $ 470
Real estate -- commercial mortgage 165 157 149 179 156
Real estate -- construction 37 50 79 61 77
- ----------------------------------------------------------------------------------------------------------------------------
Total commercial real estate loans (a) 202 207 228 240 233
Commercial lease financing 91 69 88 76 100
- ----------------------------------------------------------------------------------------------------------------------------
Total commercial loans 674 724 800 787 803
Real estate -- residential mortgage 39 36 34 34 33
Home equity 154 146 124 107 95
Consumer -- direct 13 13 6 6 9
Consumer -- indirect lease financing 5 5 6 7 8
Consumer -- indirect other 19 19 17 16 25
- ----------------------------------------------------------------------------------------------------------------------------
Total consumer loans 230 219 187 170 170
- ----------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 904 943 987 957 973
OREO 62 48 30 40 41
Allowance for OREO losses (3) (3) (2) (2) (2)
- ----------------------------------------------------------------------------------------------------------------------------
OREO, net of allowance 59 45 28 38 39
Other nonperforming assets 5 5 2 -- --
- ----------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 968 $ 993 $ 1,017 $ 995 $ 1,012
======= ======= ======= ======= =======
- ----------------------------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 207 $ 198 $ 208 $ 186 $ 203
Accruing loans past due 30 through 89 days 721 790 787 780 897
- ----------------------------------------------------------------------------------------------------------------------------
Nonperforming loans to period-end loans 1.44% 1.51% 1.57% 1.50% 1.52%
Nonperforming assets to period-end loans
plus OREO and other nonperforming assets 1.54 1.59 1.61 1.56 1.58
- ----------------------------------------------------------------------------------------------------------------------------
(a) See Figure 14 on page 51 and the accompanying discussion on page 50 for
more information related to Key's commercial real estate portfolio.
The reduction in nonperforming loans during the first quarter was attributable
largely to improvement in the structured finance portfolio. Structured finance
refers to a type of lending characterized by a high degree of leverage in the
borrower's financial condition and a relatively low level of tangible loan
collateral. These extensions of credit are included in the commercial, financial
and agricultural component of the loan portfolio represented in Figure 23.
The economic slowdown can be expected to continue to impact Key's loan portfolio
in general, although Key's nonperforming loans are disproportionately
concentrated. At March 31, 2003, two segments of the commercial, financial and
agricultural portfolio (loans to middle market clients and loans underwritten as
structured finance credits) accounted for $222 million and $118 million,
respectively, of Key's nonperforming loans. Although these two segments
comprised only 14% of Key's total loans, they accounted for 38% of total
nonperforming loans.
At March 31, 2003, our 20 largest nonperforming loans totaled $258 million,
representing 29% of total loans on nonperforming status. At March 31, 2003, the
run-off loan portfolio accounted for $58 million, or 6%, of Key's total
nonperforming loans presented in Figure 23.
Information pertaining to the credit exposure by industry classification
inherent in the largest sector of Key's loan portfolio, commercial, financial
and agricultural loans, is presented in Figure 24. Within the transportation
category, Key had approximately $271 million of exposure to the commercial
passenger airline industry at March 31, 2003. The types of activity that caused
the change in Key's nonperforming loans during the last five quarters are
summarized in Figure 25.
58
FIGURE 24. COMMERCIAL, FINANCIAL AND AGRICULTURAL LOANS
NONPERFORMING LOANS
---------------------
MARCH 31, 2003 TOTAL LOANS % OF LOANS
dollars in millions COMMITMENTS OUTSTANDING AMOUNT OUTSTANDING
- -------------------------------------------------------------------------------------------
Industry classification:
Manufacturing $ 9,561 $ 3,964 $ 148 3.7%
Services 6,228 2,544 65 2.6
Financial services 4,833 973 3 .3
Retail trade 4,171 2,596 25 1.0
Property management 2,733 1,086 6 .6
Wholesale trade 2,642 1,247 40 3.2
Public utilities 1,532 281 -- --
Building contractors 1,359 661 23 3.5
Communications 1,243 467 12 2.6
Agriculture/forestry/fishing 1,068 661 17 2.6
Transportation 829 464 19 4.1
Public administration 753 256 -- --
Insurance 723 149 -- --
Mining 409 176 -- --
Individuals 196 129 1 .8
Other 2,503 1,638 22 1.3
- ------------------------------------------------------------------------------------------
Total $40,783 $17,292 $ 381 2.2%
======= ======= =======
- ------------------------------------------------------------------------------------------
FIGURE 25. SUMMARY OF CHANGES IN NONPERFORMING LOANS
2003 2002
----- ------------------------------------------------
in millions FIRST FOURTH THIRD SECOND FIRST
- -----------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 943 $ 987 $ 957 $ 973 $ 910
Loans placed on nonaccrual status 237 339 281 254 294
Charge-offs (161) (186) (185) (203) (206)
Loans sold (23) (36) (25) (18) --
Payments (58) (149) (41) (49) (22)
Transfers to OREO (19) -- -- -- (3)
Loans returned to accrual status (15) (13) -- -- --
Acquisition -- 1 -- -- --
- -----------------------------------------------------------------------------------------------------------
Balance at end of period $ 904 $ 943 $ 987 $ 957 $ 973
===== ===== ===== ===== =====
- -----------------------------------------------------------------------------------------------------------
59
DEPOSITS AND OTHER SOURCES OF FUNDS
"Core deposits" -- domestic deposits other than certificates of deposit of
$100,000 or more -- are Key's primary source of funding. During the first
quarter of 2003, core deposits averaged $40.4 billion, and represented 55% of
the funds Key used to support earning assets, compared with $37.3 billion and
52% during the same quarter in 2002. The composition of Key's deposits is shown
in Figure 7, which spans pages 42 and 43.
The increase in the level of Key's core deposits over the past twelve months was
due primarily to higher levels of NOW and money market deposit accounts as well
as noninterest-bearing deposits. The growth of these deposits reflected client
preferences for investments that provide high levels of liquidity in a low
interest rate environment. Also contributing to the significant growth in
noninterest-bearing deposits were our intensified cross-sell efforts and the
introduction of new products, including free checking. A more aggressive pricing
structure implemented in mid 2002 supported the growth in savings deposits.
During the same period, time deposits decreased by 12% in part because, like our
competitors, Key reduced the rates paid for them, as the Federal Reserve reduced
interest rates in general.
Purchased funds, comprising large certificates of deposit, deposits in the
foreign branch and short-term borrowings, averaged $14.0 billion during the
first quarter of 2003, compared with $16.3 billion during the year-ago quarter.
As shown in Figure 7, both short-term borrowings and deposits in the foreign
branch have declined as funding sources. This is attributable in part to reduced
funding needs resulting from deposit growth, loan sales, slow demand for loans
and our decision to scale back or discontinue certain types of lending.
Key continues to consider loan sales and securitizations as a funding
alternative when market conditions are favorable.
LIQUIDITY
"Liquidity" measures whether an entity has sufficient cash flow to meet its
financial obligations when due. Key has sufficient liquidity when it can meet
its obligations to depositors, borrowers and creditors at a reasonable cost, on
a timely basis, and without adverse consequences. KeyCorp has sufficient
liquidity when it can pay dividends to shareholders, service its debt, and
support customary corporate operations and activities, including acquisitions,
at a reasonable cost, in a timely manner and without adverse consequences.
LIQUIDITY RISK. There are both direct and indirect circumstances that could
adversely affect Key's liquidity or materially affect the cost of funds. For
example, events unrelated to Key, such as terrorism or war, natural disasters,
political events, or the default or bankruptcy of a major corporation, mutual
fund or hedge fund can have market-wide consequences. A direct (but
hypothetical) event would be a significant downgrade in Key's public credit
rating by a rating agency due to a deterioration in asset quality, a large
charge to earnings, a significant merger or acquisition or other events.
Similarly, market speculation or rumors about Key or the banking industry in
general may cause normal funding sources to withdraw credit until further
information becomes available.
LIQUIDITY FOR KEY. Key's Funding and Investment Management Group monitors the
overall mix of funding sources with the objective of maintaining an appropriate
mix in light of the structure of the asset portfolios. We use several tools to
maintain sufficient liquidity.
- - We maintain portfolios of short-term money market investments and
securities available for sale, substantially all of which could be
converted to cash quickly at a small expense.
- - Key's portfolio of investment securities generates prepayments (often
at a premium) and payments at maturity.
- - We try to structure the maturities of our loans so we receive a
relatively consistent stream of payments from borrowers.
60
- - We have the ability to access the securitization markets for a variety
of loan types.
- - Our 911 full-service KeyCenters in 12 states generate a sizable volume
of core deposits. We monitor deposit flows and use alternative pricing
structures to attract deposits when necessary. For more information
about core deposits, see the previous section entitled "Deposits and
other sources of funds."
- - Key has access to various sources of money market funding (such as
federal funds purchased, securities sold under repurchase agreements,
and bank notes) and also can borrow from the Federal Reserve Bank to
meet short-term liquidity requirements. Key did not have any borrowings
from the Federal Reserve Bank outstanding at March 31, 2003.
The Consolidated Statements of Cash Flow on page 6 summarize Key's sources and
uses of cash by type of activity for the three-month periods ended March 31,
2003 and 2002. As shown in these statements, Key's largest cash flows relate to
both investing and financing activities. Over the past two years, the primary
sources of cash from investing activities have been loan securitizations and
sales and the sales, prepayments and maturities of securities available for
sale. Investing activities that have required the greatest use of cash include
lending and the purchases of new securities.
Over the past two years, the primary source of cash from financing activities
has been the issuance of long-term debt. However, in 2002, deposits were also a
significant source of cash. In each of the past two years, major outlays of cash
have been made to repay debt issued in prior periods and to reduce the levels of
short-term borrowings.
LIQUIDITY FOR KEYCORP. KeyCorp meets its liquidity requirements principally
through regular dividends from affiliate banks. Federal banking law limits the
amount of capital distributions that banks can make to their holding companies
without obtaining prior regulatory approval. A national bank's dividend paying
capacity is affected by several factors, including the amount of its net profits
(as defined by statute) for the two previous calendar years, and net profits for
the current year up to the date of dividend declaration. Due to this constraint,
and the restructuring charges taken by KBNA and Key Bank USA in 2001, as of
January 1, 2003, neither bank could pay dividends or make other capital
distributions to KeyCorp without prior regulatory approval.
In February 2003, KBNA obtained regulatory approval to make capital
distributions to KeyCorp of up to $365 million in the aggregate in the first and
second quarters. During the first quarter, KeyCorp received a $200 million
distribution of surplus in the form of cash from KBNA. Following distribution of
the remaining $165 million, KBNA will not have further dividend paying capacity
until it accumulates at least $130 million of additional net profits. Management
expects this to occur during the second quarter of 2003. Key Bank USA restored
its dividend paying capacity during the first quarter.
At March 31, 2003, KeyCorp had approximately $1.1 billion of cash or short-term
investments available to pay dividends on its common shares, to service its debt
and to finance its corporate operations. Management does not expect current
constraints on KBNA to pay dividends to KeyCorp to have any material effect on
the ability of KeyCorp to pay dividends to its shareholders, to service its debt
or to meet its other obligations.
ADDITIONAL SOURCES OF LIQUIDITY. Management has implemented several programs
that enable Key and KeyCorp to raise money in the public and private markets
when necessary. The proceeds from all of these programs can be used for general
corporate purposes, including acquisitions. Each of the programs is replaced or
extended from time to time as needed.
Bank note program. During the first three months of 2003, Key's affiliate banks
raised $1.2 billion under Key's bank note program. Of the notes issued during
the quarter, $825 million have original maturities in excess of one year and are
included in long-term debt. The remaining notes have original maturities of one
year or less and are included in short-term borrowings. Key's current bank note
program provides for the issuance of both long- and short-term debt of up to
$20.0 billion ($19.0 billion by KBNA and $1.0 billion by Key Bank USA). At March
31, 2003, $16.9 billion was available for future issuance under this program.
61
Euro note program. Under Key's euro note program, KeyCorp, KBNA and Key Bank USA
may issue both long- and short-term debt of up to $10.0 billion in the
aggregate. The notes are offered exclusively to non-U.S. investors and can be
denominated in U.S. dollars and many foreign currencies. There were $197 million
of borrowings issued under this program during the first three months of 2003.
At March 31, 2003, $4.0 billion was available for future issuance.
KeyCorp medium-term note program and other securities. KeyCorp may issue, under
a registration statement filed with the Securities and Exchange Commission, up
to $2.2 billion of securities, which could include long- or short-term debt, or
equity securities. Of the amount registered, $1.0 billion has been allocated for
the issuance of medium-term notes. At March 31, 2003, unused capacity under
KeyCorp's universal shelf registration statement totaled $1.8 billion, including
$575 million allocated for the issuance of medium-term notes.
Commercial paper and revolving credit. KeyCorp has a commercial paper program
and a revolving credit agreement with an unaffiliated financial institution that
provide funding availability of up to $500 million and $400 million,
respectively. As of March 31, 2003, there were no borrowings outstanding under
either the commercial paper program or the revolving credit agreement.
Key has favorable debt ratings as shown in Figure 26 below. As long as those
debt ratings are maintained, management believes that, under normal conditions
in the capital markets, future offerings of securities by KeyCorp or its
affiliate banks would be marketable to investors at a competitive cost.
FIGURE 26. DEBT RATINGS
SENIOR SUBORDINATED
SHORT-TERM LONG-TERM LONG-TERM CAPITAL
March 31, 2003 BORROWINGS DEBT DEBT SECURITIES
- --------------------------------------------------------------------------------------------------------------------
KEYCORP
Standard & Poor's A-2 A- BBB+ BBB
Moody's P-1 A2 A3 "Baal"
Fitch F1 A A- A
KBNA
Standard & Poor's A-1 A A- N/A
Moody's P-1 A1 A2 N/A
Fitch F1 A A- N/A
- ------------------------------------------------------------------------------------------------------------------
N/A=Not Applicable
CAPITAL
SHAREHOLDERS' EQUITY. Total shareholders' equity at March 31, 2003, was $6.9
billion, up $63 million from the balance at December 31, 2002. Growth in
retained earnings and the issuance of common shares out of the treasury stock
account in connection with employee stock purchase, 401(k), dividend
reinvestment and stock option programs contributed to the increase. Other
factors contributing to the change in shareholders' equity during the first
quarter of 2003 are shown in the Consolidated Statements of Changes in
Shareholders' Equity presented on page 5.
SHARE REPURCHASES. In September 2000, the Board of Directors authorized the
repurchase of up to 25,000,000 common shares, including 3,647,200 shares
remaining at the time from an earlier repurchase program. These shares may be
repurchased in the open market or through negotiated transactions. During the
first three months of 2003, Key repurchased a total of 2,000,000 of its common
shares at an average price per share of $23.91. At March 31, 2003, a remaining
balance of 11,764,670 shares may be repurchased under the September 2000
authorization.
At March 31, 2003, Key had 69,108,570 treasury shares. Management expects to
reissue those shares over time to support the employee stock purchase, 401(k),
stock option, deferred compensation and dividend
62
reinvestment plans, and for other corporate purposes. During the first three
months of 2003, Key reissued 836,565 treasury shares for employee benefit and
dividend reinvestment plans.
CAPITAL ADEQUACY. Capital adequacy is an important indicator of financial
stability and performance. Overall, Key's capital position remains strong: the
ratio of total shareholders' equity to total assets was 7.98% at March 31, 2003,
and 7.87% at March 31, 2002.
Banking industry regulators prescribe minimum capital ratios for bank holding
companies and their banking subsidiaries. Note 14 ("Shareholders' Equity"),
which begins on page 76 of Key's 2002 Annual Report to Shareholders, explains
the implications of failing to meet specific capital requirements imposed by the
banking regulators. Risk-based capital guidelines require a minimum level of
capital as a percent of "risk-weighted assets," which is total assets plus
certain off-balance sheet items, both adjusted for predefined credit risk
factors. Currently, banks and bank holding companies must maintain, at a
minimum, Tier 1 capital as a percent of risk-weighted assets of 4.00%, and total
capital as a percent of risk-weighted assets of 8.00%. As of March 31, 2003,
Key's Tier 1 capital ratio was 8.22%, and its total capital ratio was 12.62%.
Another indicator of capital adequacy, the leverage ratio, is defined as Tier 1
capital as a percentage of average quarterly tangible assets. Leverage ratio
requirements vary with the condition of the financial institution. Bank holding
companies that either have the highest supervisory rating or have implemented
the Federal Reserve's risk-adjusted measure for market risk--as KeyCorp
has--must maintain a minimum leverage ratio of 3.00%. All other bank holding
companies must maintain a minimum ratio of 4.00%. As of March 31, 2003, Key had
a leverage ratio of 8.12%.
Federal bank regulators group FDIC-insured depository institutions into five
categories, ranging from "critically undercapitalized" to "well capitalized."
Both of Key's affiliate banks qualified as "well capitalized" at March 31, 2003,
since each exceeded the prescribed thresholds of 10.00% for total capital, 6.00%
for Tier 1 capital and 5.00% for the leverage ratio. If these provisions applied
to bank holding companies, Key would also qualify as "well capitalized" at March
31, 2002. The FDIC-defined capital categories serve a limited supervisory
function. Investors should not treat them as a representation of the overall
financial condition or prospects of Key or its affiliate banks.
Figure 27 presents the details of Key's regulatory capital position at March 31,
2003, December 31, 2002 and March 31, 2002.
63
FIGURE 27. CAPITAL COMPONENTS AND RISK-WEIGHTED ASSETS
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 2003 2002 2002
- ----------------------------------------------------------------------------------------
TIER 1 CAPITAL
Common shareholders' equity (a) $ 6,813 $ 6,738 $ 6,388
Qualifying capital securities 1,091 1,096 1,232
Less: Goodwill 1,142 1,142 1,101
Other assets (b) 61 60 35
- ----------------------------------------------------------------------------------------
Total Tier 1 capital 6,701 6,632 6,484
- ----------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses (c) 986 986 1,017
Qualifying long-term debt 2,599 2,639 2,338
- ----------------------------------------------------------------------------------------
Total Tier 2 capital 3,585 3,625 3,355
- ----------------------------------------------------------------------------------------
Total risk-based capital $10,286 $10,257 $ 9,839
======= ======= =======
RISK-WEIGHTED ASSETS
Risk-weighted assets on balance sheet $67,570 $67,051 $68,090
Risk-weighted off-balance sheet exposure 15,615 16,595 15,270
Less: Goodwill 1,142 1,142 1,101
Other assets (b) 288 251 35
Plus: Market risk-equivalent assets 170 192 215
- ----------------------------------------------------------------------------------------
Gross risk-weighted assets 81,925 82,445 82,439
Less: Excess allowance for loan losses (c) 435 466 590
- ----------------------------------------------------------------------------------------
Net risk-weighted assets $81,490 $81,979 $81,849
======= ======= =======
AVERAGE QUARTERLY TOTAL ASSETS $83,914 $82,735 $80,871
======= ======= =======
CAPITAL RATIOS
Tier 1 risk-based capital ratio 8.22% 8.09% 7.92%
Total risk-based capital ratio 12.62 12.51 12.02
Leverage ratio (d) 8.12 8.15 8.13
- ----------------------------------------------------------------------------------------
(a) Common shareholders' equity does not include net unrealized gains or losses
on securities (except for net unrealized losses on marketable equity
securities) nor net gains or losses on cash flow hedges.
(b) "Other assets" deducted from Tier 1 capital consists of intangible assets
(excluding goodwill) recorded after February 19, 1992, deductible portions
of purchased mortgage servicing rights and deductible portions of
nonfinancial equity investments.
"Other assets" deducted from risk-weighted assets consists of intangible
assets (excluding goodwill) recorded after February 19, 1992, deductible
portions of purchased mortgage servicing rights and nonfinancial equity
investments.
(c) The allowance for loan losses included in Tier 2 capital is limited by
regulation to 1.25% of gross risk-weighted assets, excluding those with
low-level recourse.
(d) This ratio is Tier 1 capital divided by average quarterly total assets less
goodwill and the nonqualifying intangible assets described in footnote (b).
64
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information presented in the Market Risk Management section of the
Management's Discussion and Analysis of Financial Condition and Results of
Operations, which begins on page 44, is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
As a bank holding company, KeyCorp is subject to the internal control reporting
requirements of the Federal Deposit Insurance Corporation Improvement Act, which
became effective in 1993 ("FDICIA"). FDICIA requirements include an annual
assessment by our Chief Executive Officer and Chief Financial Officer of the
effectiveness of our internal controls over financial reporting, which generally
include those controls relating to the preparation of our financial statements
in conformity with accounting principles generally accepted in the United
States. In addition, under FDICIA, our independent auditors have annually
examined and attested to, without qualification, management's assertions
regarding the effectiveness of our internal controls. Accordingly, we have had
an established process of maintaining and evaluating our internal controls over
financial reporting.
In connection with recent legislation and regulations, our management has also
focused its attention on our "disclosure controls and procedures" which, as
defined by the SEC, are generally those controls and procedures designed to
ensure that financial and nonfinancial information required to be disclosed in
KeyCorp's reports filed with the SEC is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms and that
such information is accumulated and communicated to KeyCorp's management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. In light
of the new requirements, we have engaged in a process of reviewing our
disclosure controls and procedures. As a result of our review, and although we
believe that our pre-existing disclosure controls and procedures were effective
in enabling us to comply with our disclosure obligations, we have implemented
enhancements, which include establishing a disclosure committee and generally
formalizing and documenting disclosure controls and procedures that we already
have in place. Any future refinements to our controls and procedures will
continue to build upon our existing framework.
Following the review described above and the establishment of our disclosure
committee and within the 90-day period prior to the filing of this report,
KeyCorp carried out an evaluation, under the supervision and with the
participation of KeyCorp's management, including our Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of
KeyCorp's disclosure controls and procedures. Based upon that evaluation,
KeyCorp's Chief Executive Officer and Chief Financial Officer concluded that the
design and operation of these disclosure controls and procedures were effective.
There have been no significant changes in internal controls that could
significantly affect internal controls subsequent to the date the Chief
Executive Officer and Chief Financial Officer completed their evaluation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information presented in Note 10 ("Contingent Liabilities and Guarantees"),
which begins on page 23 of the Notes to Consolidated Financial Statements is
incorporated herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
10.1 Form of Award of Restricted Stock (2003 - 2005).
10.2 Award of Phantom Stock to Henry L. Meyer III (2003 - 2005).
65
10.3 KeyCorp Amended and Restated 1991 Equity Compensation Plan
(amended as of March 13, 2003).
10.4 Second Amendment to KeyCorp Excess Cash Balance Pension Plan,
effective January 1, 2003.
10.5 First Amendment to KeyCorp Supplemental Retirement Plan,
effective January 1, 2003.
10.6 Fourth Amendment to KeyCorp Executive Supplemental Pension
Plan, effective January 1, 2003.
15 Acknowledgment Letter of Independent Auditors.
99.1 Certification of Chief Executive Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Chief Financial Officer Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) REPORTS ON FORM 8-K
January 15, 2003 - Item 5. Other Events and Regulation FD Disclosure,
Item 7. Financial Statements and Exhibits and Item 9. Regulation FD
Disclosure. Reporting that on January 15, 2003, the Registrant issued a
press release announcing its earnings results for the three- and
twelve-month period ended December 31, 2002, and providing a slide
presentation reviewed in the related conference call/webcast.
January 24, 2003 - Item 5. Other Events and Regulation FD Disclosure
and Item 7. Financial Statements and Exhibits. Reporting that on
January 24, 2003, the Registrant sent a notice to its directors and
executive officers informing them that the KeyCorp 401(k) Savings Plan
is changing its recordkeeper and that, as a result of this change,
there will be a blackout period from February 20, 2003 through March 5,
2003.
No other reports on Form 8-K were filed during the three-month period
ended March 31, 2003.
INFORMATION AVAILABLE ON WEBSITE
KeyCorp makes available free of charge on its website, www.Key.com, its annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K
and amendments to these reports as soon as reasonably practicable after KeyCorp
electronically files such material with, or furnishes it to, the SEC.
66
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
------------------------------------
(Registrant)
Date: May 12, 2003 /s/ Lee Irving
------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
67
CERTIFICATION PURSUANT TO
SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, Henry L. Meyer III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of KeyCorp;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 12, 2003 /s/ Henry L. Meyer III
-------------------------
Henry L. Meyer III
Chairman, President and
Chief Executive Officer
68
CERTIFICATION PURSUANT TO
SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002
I, Jeffrey B. Weeden, certify that:
1. I have reviewed this quarterly report on Form 10-Q of KeyCorp;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) All significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 12, 2003 /s/ Jeffrey B. Weeden
-----------------------
Jeffrey B. Weeden
Chief Financial Officer
69