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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2001
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]
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(Exact name of registrant as specified in its charter)
OHIO 34-6542451
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
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(Address of principal executive offices) (Zip Code)
(216) 689-6300
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(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 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 425,192,697 Shares
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(Title of class) (Outstanding at July 31, 2001)
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KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
-----------
Consolidated Balance Sheets --
June 30, 2001, December 31, 2000 and June 30, 2000 3
Consolidated Statements of Income --
Three and six months ended June 30, 2001 and 2000 4
Consolidated Statements of Changes in Shareholders' Equity --
Six months ended June 30, 2001 and 2000 5
Consolidated Statements of Cash Flow --
Six months ended June 30, 2001 and 2000 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 26
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 27
Item 3. Quantitative and Qualitative Disclosure of Market Risk 55
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 56
Item 4. Submission of Matters to a Vote of Security Holders 56
Item 5. Other Information 56
Item 6. Exhibits and Reports on Form 8-K 57
Signature 57
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2001 2000 2000
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(UNAUDITED) (UNAUDITED)
ASSETS
Cash and due from banks $ 2,781 $ 3,189 $ 3,178
Short-term investments 1,961 1,884 1,759
Securities available for sale 6,706 7,329 6,249
Investment securities (fair value: $1,182, $1,208 and $1,136) 1,171 1,198 1,128
Loans, net of unearned income of $1,762, $1,789 and $1,660 66,693 66,905 65,612
Less: Allowance for loan losses 1,231 1,001 979
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Net loans 65,462 65,904 64,633
Premises and equipment 694 717 726
Goodwill 1,141 1,324 1,357
Other intangible assets 36 44 52
Corporate-owned life insurance 2,265 2,215 2,159
Accrued income and other assets 3,621 3,466 3,478
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Total assets $85,838 $87,270 $84,719
======== ======= =======
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $8,376 $9,076 $9,057
Interest-bearing 33,986 35,519 34,733
Deposits in foreign office - interest-bearing 3,381 4,054 5,286
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Total deposits 45,743 48,649 49,076
Federal funds purchased and securities sold under repurchase agreements 5,919 4,936 3,511
Bank notes and other short-term borrowings 7,128 6,957 5,998
Accrued expense and other liabilities 4,627 4,701 4,287
Long-term debt 14,675 14,161 14,097
Corporation-obligated mandatorily redeemable preferred capital securities
of subsidiary trusts holding solely subordinated debentures of KeyCorp (See Note 9) 1,279 1,243 1,243
- -----------------------------------------------------------------------------------------------------------------------------
Total liabilities 79,371 80,647 78,212
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 1,395 1,402 1,405
Retained earnings 6,159 6,352 6,203
Loans to ESOP trustee (13) (13) (24)
Treasury stock, at cost (66,930,892, 68,634,881 and 60,723,102 shares) (1,560) (1,600) (1,421)
Accumulated other comprehensive loss (6) (10) (148)
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Total shareholders' equity 6,467 6,623 6,507
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Total liabilities and shareholders' equity $85,838 $87,270 $84,719
======= ======= =======
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See Notes to Consolidated Financial Statements (Unaudited).
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CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
dollars in millions, except per share amounts 2001 2000 2001 2000
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INTEREST INCOME
Loans $ 1,321 $ 1,397 $ 2,739 $ 2,744
Taxable investment securities 8 6 15 10
Tax-exempt investment securities 4 7 9 13
Securities available for sale 115 107 235 219
Short-term investments 19 23 39 43
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Total interest income 1,467 1,540 3,037 3,029
INTEREST EXPENSE
Deposits 388 436 848 813
Federal funds purchased and securities sold under repurchase agreements 52 58 122 106
Bank notes and other short-term borrowings 94 103 199 229
Long-term debt, including capital securities 220 270 467 537
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Total interest expense 754 867 1,636 1,685
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NET INTEREST INCOME 713 673 1,401 1,344
Provision for loan losses 401 68 511 251
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Net interest income after provision for loan losses 312 605 890 1,093
NONINTEREST INCOME
Trust and investment services income 132 150 273 310
Investment banking and capital markets income 72 98 137 187
Service charges on deposit accounts 90 85 174 171
Corporate-owned life insurance income 27 25 54 50
Letter of credit and loan fees 30 24 59 47
Net securities gains 8 2 34 3
Gain from divestiture -- -- -- 332
Other income 39 91 122 181
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Total noninterest income 398 475 853 1,281
NONINTEREST EXPENSE
Personnel 345 361 709 743
Net occupancy 56 56 113 113
Computer processing 63 60 125 119
Equipment 40 42 78 90
Marketing 29 31 56 53
Amortization of intangibles 174 25 200 50
Professional fees 19 21 37 40
Restructuring charges -- -- (4) 7
Other expense 132 102 242 210
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Total noninterest expense 858 698 1,556 1,425
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGES (148) 382 187 949
Income taxes (12) 134 105 334
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INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES (136) 248 82 615
Cumulative effect of accounting changes, net of tax (see Note 1) (24) -- (25) --
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NET INCOME (LOSS) $ (160) $ 248 $ 57 $ 615
========= ========= ========= =========
Per common share:
Income (loss) before cumulative effect of accounting changes $ (.32) $ .57 $ .19 $ 1.40
Net income (loss) (.38) .57 .14 1.40
Income (loss) before cumulative effect of accounting changes
- assuming dilution (.32) .57 .19 1.40
Net income (loss) - assuming dilution (.38) .57 .13 1.40
Weighted average common shares outstanding (000) 424,675 434,112 424,352 437,973
Weighted average common shares and potential common
shares outstanding (000) 424,675 436,022 429,838 439,889
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See Notes to Consolidated Financial Statements (Unaudited).
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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
ACCUMULATED
LOANS TO TREASURY OTHER COMPREHENSIVE
COMMON CAPITAL RETAINED ESOP STOCK, COMPREHENSIVE INCOME
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST INCOME (LOSS) (LOSS)(b)
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BALANCE AT DECEMBER 31, 1999 $492 $1,412 $5,833 $(24) $(1,197) $(127)
Net income 615 $615
Other comprehensive losses:
Net unrealized losses on securities
available for sale, net of income
taxes of ($19)(a) (17) (17)
Foreign currency translation adjustments (4) (4)
--------
Total comprehensive income $594
====
Cash dividends on common shares
($.56 per share) (245)
Issuance of common shares:
Employee benefit and dividend
reinvestment plans - 528,057
net shares (7) 20
Repurchase of common shares - 6,365,000 shares (244)
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BALANCE AT JUNE 30, 2000 $492 $1,405 $6,203 $(24) $(1,421) $(148)
==== ====== ====== ==== ======= =====
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BALANCE AT DECEMBER 31, 2000 $492 $1,402 $6,352 $(13) $(1,600) $ (10)
Net income 57 $57
Other comprehensive income (losses):
Net unrealized gains on securities
available for sale, net of income
taxes of $14 (a) 20 20
Cumulative effect of change in
accounting for derivative financial
instruments, net of income taxes
of ($12) (22) (22)
Net unrealized gains on derivative
financial instruments, net of
income taxes of $3 6 6
--------
Total comprehensive income $ 61
====
Cash dividends on common shares ($.59 per share) (250)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans -1,703,988 net shares (7) 40
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BALANCE AT JUNE 30, 2001 $492 $1,395 $6,159 $(13) $(1,560) $(6)
==== ====== ====== ==== ======= ===
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(a) Net of reclassification adjustments.
(b) For the three months ended June 30, 2001 and 2000, comprehensive income
(loss) was $(119) million and $257 million, respectively.
See Notes to Consolidated Financial Statements (Unaudited).
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CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
SIX MONTHS ENDED JUNE 30,
in millions 2001 2000
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OPERATING ACTIVITIES
Net income $ 57 $ 615
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 511 251
Cumulative effect of accounting changes, net of tax 25 --
Depreciation expense and software amortization 144 141
Amortization of intangibles 200 50
Net gain from divestiture -- (332)
Net securities gains (34) (3)
Net (gains) losses from venture capital investments 24 (33)
Net gains from loan securitizations and sales (13) (21)
Deferred income taxes 17 138
Net (increase) decrease in mortgage loans held for sale 68 (270)
Net increase in trading account assets (288) (34)
Net decrease in accrued restructuring charges (34) (41)
Other operating activities, net (211) 126
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NET CASH PROVIDED BY OPERATING ACTIVITIES 466 587
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (1,685) (4,214)
Purchases of loans (107) --
Proceeds from loan securitizations and sales 1,647 3,586
Purchases of investment securities (187) (203)
Proceeds from sales of investment securities 22 11
Proceeds from prepayments and maturities of investment securities 185 94
Purchases of securities available for sale (4,569) (2,176)
Proceeds from sales of securities available for sale 2,049 2,030
Proceeds from prepayments and maturities of securities available for sale 3,106 385
Net decrease in other short-term investments 211 135
Purchases of premises and equipment (48) (39)
Proceeds from sales of premises and equipment -- 18
Proceeds from sales of other real estate owned 12 12
Cash used in acquisitions, net of cash acquired (3) (357)
- -------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 633 (718)
FINANCING ACTIVITIES
Net increase (decrease) in deposits (2,915) 5,843
Net increase (decrease) in short-term borrowings 1,140 (3,107)
Net proceeds from issuance of long-term debt, including capital securities 2,058 1,789
Payments on long-term debt, including capital securities (1,557) (3,555)
Purchases of treasury shares -- (240)
Net proceeds from issuance of common stock 17 8
Cash dividends (250) (245)
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NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (1,507) 493
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NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (408) 362
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,189 2,816
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CASH AND DUE FROM BANKS AT END OF PERIOD $2,781 $3,178
====== ======
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Additional disclosures relative to cash flow:
Interest paid $1,726 $1,667
Income taxes paid 94 43
Noncash items:
Derivative assets resulting from adoption of new accounting standard $120 --
Derivative liabilities resulting from adoption of new accounting standard 152 --
- -------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
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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. 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
2000 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.
ACCOUNTING PRONOUNCEMENTS ADOPTED IN 2001
DERIVATIVES AND HEDGING ACTIVITIES. Effective January 1, 2001, Key adopted
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133), which establishes accounting and
reporting standards for derivative instruments ("derivatives") and for hedging
activities. SFAS 133 requires that all derivatives be recognized as either
assets or liabilities on the balance sheet at fair value. The accounting for
changes in the fair value (i.e. gains or losses) of derivatives depends on
whether they have been designated and qualify as part of a hedging relationship
and further, on the type of hedging relationship. Derivatives that are
designated and qualify as hedging instruments must be designated as either a
fair value hedge, a cash flow hedge or a hedge of a net investment in a foreign
operation. Key does not have any derivatives that hedge net investments in
foreign operations.
Derivatives that are used to hedge changes in the fair value of existing assets,
liabilities, and firm commitments against changes in interest rates or other
economic factors are designated as fair value hedges. The gain or loss on the
derivative as well as the related loss or gain on the hedged item attributable
to the hedged risk are recognized in earnings during the period of the change in
fair values. Derivatives that are used to hedge the variability of future cash
flows against changes in interest rates or other economic factors are designated
as cash flow hedges. The effective portion of a gain or loss on a derivative
designated as a cash flow hedge is reported as a component of other
comprehensive income or loss and reclassified into earnings in the same period
or periods that the hedged transaction affects earnings. The ineffective portion
of the derivative gain or loss, if any, is recognized in earnings during the
current period. For derivatives not designated as hedging instruments, the gain
or loss is recognized immediately in earnings.
As a result of adopting SFAS 133, Key recorded a cumulative loss of $1 million
in net income and a cumulative loss of $22 million in other comprehensive income
(loss) during the first quarter of 2001.
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES.
In September 2000, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities" (SFAS 140), which
replaces SFAS 125. SFAS 140 retains most of the SFAS 125 provisions related to
controlling interests and adds three significant new rules. These new rules:
o prescribe the test that determines whether a special purpose entity
("SPE") is a "qualifying" SPE, and prescribe the amount and type of
derivative instruments a qualifying SPE can hold and the activities it may
pursue;
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o provide more restrictive guidance regarding the circumstances under
which a company that transfers assets to a qualifying SPE will be deemed to
have relinquished control of such assets and may account for the
transaction as a sale; and
o require extensive disclosures about collateral, assets securitized and
accounted for as a sale, and retained interests in securitized assets.
Effective April 1, 2001, Key adopted SFAS 140 which is effective for
transactions entered into after March 31, 2001. Although no securitization
transactions were completed during the second quarter, the prescribed guidance
will be followed for future transactions. The statement was effective for
recognition and reclassification of collateral and for disclosures relating to
securitization transactions and collateral for fiscal years ending after
December 15, 2000. Key included the disclosures required by SFAS 140 in the
notes to its December 31, 2000, financial statements.
RECOGNITION OF INTEREST INCOME AND IMPAIRMENT ON CERTAIN INVESTMENTS. In July
2000, the Emerging Issues Task Force ("EITF"), a standard-setting group under
the auspices of the Financial Accounting Standards Board, reached a consensus in
EITF 99-20 that provides guidance on how to record interest income and measure
impairment on beneficial interests retained in a securitization transaction
accounted for as a sale under SFAS 140, and purchased beneficial interests in
securitized financial assets. Assets subject to this accounting guidance are
carried on the balance sheet as securities available for sale [see Note 5
("Securities") starting on page 14] or as trading account assets. This
accounting guidance is effective for fiscal quarters beginning after March 15,
2001. Key adopted this guidance on April 1, 2001. As a result, during the second
quarter, Key recorded a cumulative loss of $24 million in net income. This loss
is presented as a "cumulative effect of accounting change" on Key's income
statement.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
BUSINESS COMBINATIONS. In July 2001, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 141, "Business
Combinations" (SFAS 141), which replaces Accounting Principles Board Opinion
No.16. SFAS 141 eliminates the pooling-of-interests method of accounting for
business combinations initiated after June 30, 2001. Subsequent to June 30,
2001, Key has not initiated any business combinations that would have qualified
for the pooling-of-interest method of accounting.
GOODWILL AND OTHER INTANGIBLE ASSETS. In July 2001, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" (SFAS 142), which takes effect for fiscal
years beginning after December 15, 2001. SFAS 142 replaces Accounting Principles
Board Opinion No.17 and eliminates the amortization of goodwill and intangible
assets deemed to have indefinite lives. Based on the level of Key's goodwill at
June 30, 2001, management anticipates that the elimination of the related
amortization may reduce noninterest expense and increase net income by
approximately $80 million for 2002.
Under the new accounting standard, goodwill and certain intangible assets are
subject to impairment tests, which must be conducted at least annually.
Impairment losses that result from the initial application of SFAS 142 will be
accounted for as a "cumulative effect of accounting change" on Key's income
statement. Management has not yet completed the initial goodwill impairment test
to determine whether any "transition impairment charge" may be necessary. Key
will adopt SFAS 142 as of January 1, 2002.
ACCOUNTING GUIDANCE ISSUED DURING 2001
ACCOUNTING AND REPORTING FOR CERTAIN LOANS HELD FOR SALE. The Office of the
Comptroller of the Currency, the Federal Deposit Insurance Corporation, the
Federal Reserve Board, the Office of Thrift Supervision, and the National Credit
Union Administration issued Interagency Guidance in March 2001, instructing
institutions and examiners about the appropriate accounting and reporting
treatment for certain loans that are sold directly from the loan portfolio or
transferred to a held for sale account. This guidance, which is directed toward
loans that have declined in credit quality, did not have a significant impact on
Key during the first half of 2001, nor would it have had a significant impact on
prior periods had it been issued earlier. Key implemented this guidance in its
June 2001 sale of certain nonperforming consumer (primarily home equity) loans.
The Securities and Exchange Commission has expressed views which support the
Interagency Guidance.
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2. EARNINGS PER COMMON SHARE
The computation of Key's basic and diluted earnings per common share is as
follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
dollars in millions, except per share amounts 2001 2000 2001 2000
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EARNINGS
Income (loss) before cumulative effect of accounting changes $(136) $248 $82 $615
Net income (loss) (160) 248 57 615
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WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 424,675 434,112 424,352 437,973
Effect of dilutive common stock options (000) -- 1,910 5,486 1,916
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Weighted average common shares and potential
common shares outstanding (000) 424,675 436,022 429,838 439,889
======= ======= ======= =======
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EARNINGS PER COMMON SHARE
Income (loss) per common share before cumulative
effect of accounting changes $(.32) $.57 $.19 $1.40
Net income (loss) per common share (.38) .57 .14 1.40
Income (loss) per common share before cumulative
effect of accounting changes - assuming dilution (.32) .57 .19 1.40
Net income (loss) per common share - assuming dilution (.38) .57 .13 1.40
- ----------------------------------------------------------------------------------------------------------------------------------
3. ACQUISITIONS AND DIVESTITURE
Business acquisitions and the divestiture that Key completed during 2000 and the
first six months of 2001 are summarized below.
ACQUISITIONS
THE WALLACH COMPANY INC.
On January 2, 2001, Key purchased The Wallach Company, Inc., an investment
banking firm headquartered in Denver, Colorado. The purchase price of
approximately $11 million was paid partly in cash and partly in the form of
370,830 Key common shares. Goodwill of approximately $9 million was recorded and
is currently being amortized using the straight-line method over a period of 10
years.
NEWPORT MORTGAGE COMPANY L.P.
On September 30, 2000, Key purchased certain net assets of Newport Mortgage
Company L.P., a commercial mortgage company headquartered in Dallas, Texas.
Goodwill of approximately $10 million was recorded and is currently being
amortized using the straight-line method over a period of 10 years.
NATIONAL REALTY FUNDING L.C.
On January 31, 2000, Key purchased certain net assets of National Realty Funding
L.C., a commercial finance company headquartered in Kansas City, Missouri.
Goodwill of approximately $10 million was recorded and is currently being
amortized using the straight-line method over a period of 15 years.
DIVESTITURE
CREDIT CARD PORTFOLIO
On January 31, 2000, Key sold its credit card portfolio of $1.3 billion in
receivables and nearly 600,000 active VISA and MasterCard accounts to Associates
National Bank (Delaware). Key recognized a gain of $332 million ($207 million
after tax), which is included in "gain from divestiture" on the income
statement.
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4. LINE OF BUSINESS RESULTS
Key's three major lines of business are Key Consumer Banking, Key Corporate
Finance and Key Capital Partners.
KEY CONSUMER BANKING
Retail Banking (a division of Key Consumer Banking)
Retail Banking delivers a complete line of branch-based financial products and
services to consumers through 926 KeyCenters (retail banking branches). These
KeyCenters are operated by relationship managers supported by a 24-hour
telephone banking call center services group, 2,383 ATMs that access 15
different networks (resulting in one of the largest ATM networks in the United
States) and a leading-edge Internet banking service, Key.com.
Home Equity and Consumer Finance (a division of Key Consumer Banking)
Home Equity and Consumer Finance provides indirect, non-branch-based consumer
loan products, including automobile loans, home equity loans, education loans,
and marine and recreational vehicle loans. As of December 31, 2000, based on the
volume of loans generated, Home Equity and Consumer Finance was one of the
foremost lenders for education, automobile purchases, and purchases of marine
and recreational vehicles in the United States.
KEY CORPORATE FINANCE
Key Corporate Finance offers a complete range of financing, transaction
processing, electronic commerce and financial advisory services to corporations
nationwide, and operates one of the largest bank-affiliated equipment leasing
companies in the world, with operations in the United States, Europe and Asia.
Based on total transaction volume, Key Corporate Finance is one of the leading
cash management providers in the United States. This line of business also
serves the needs of Key's small business clients.
Key Corporate Finance's business units are organized around six specialized
industry client segments: commercial banking, commercial real estate, lease
financing, healthcare, media/telecommunications and technology. These targeted
client segments can receive a number of specialized services, including
international banking, cash management and corporate finance advisory services.
Key Corporate Finance also offers investment banking, capital markets, 401(k)
and trust custody products in cooperation with Key Capital Partners.
KEY CAPITAL PARTNERS
Key Capital Partners provides asset management, employee benefits services,
brokerage services, investment banking, capital markets and insurance expertise,
and conducts equity capital investing. It also offers specialized services to
high-net-worth clients through the wealth management and private banking
businesses. Key Capital Partners employs a range of distribution outlets,
including those of Key's other lines of business.
The table that spans pages 12 and 13 shows selected financial data for each
major line of business for the three- and six-month periods ended June 30, 2001
and 2000. The financial information was derived from the internal profitability
reporting system that management uses to monitor and manage Key's financial
performance. The selected financial data are based on internal accounting
policies designed to ensure that results are compiled on a consistent basis and
reflect the underlying economics of Key's three major businesses. In accordance
with these policies:
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o Net interest income for each line of business was determined by assigning a
standard cost for funds used (or a standard credit for funds provided) to
assets and liabilities based on their maturity, prepayment and/or repricing
characteristics. The net effect of this funds transfer pricing is included
in the "Treasury" columns of the table.
o Indirect expenses, such as computer servicing costs and corporate overhead,
were allocated based on the extent to which each line of business actually
used the service.
o The provision for loan losses assigned to each line of business reflects
credit quality expectations within each line over a normal business cycle.
This "normalized provision for loan losses" does not necessarily coincide
with actual net loan charge-offs at any given point in the cycle. The level
of the consolidated provision is based upon the methodology that Key uses
to estimate its 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 66 of Key's 2000 Annual
Report to Shareholders.
o Income taxes were allocated based on the statutory Federal income tax rate
of 35% (adjusted for tax-exempt income from corporate-owned life insurance,
nondeductible goodwill amortization 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% for the periods
presented.
o Capital was assigned to each line of business based on management's
assessment of economic risk factors (primarily credit, operating and market
risk).
Developing and applying the methodologies that management follows 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 segment of Key's business or changes in
Key's structure. The financial data for both 2001 and 2000 presented in the
accompanying table reflects the following changes that occurred during the first
half of 2001:
o A number of businesses have been reclassified. The Key Electronic Services
unit moved from Treasury to Retail Banking, the Small Business unit moved
from Retail Banking to Key Corporate Finance, and the Community Development
unit moved from Key Corporate Finance to Retail Banking.
o The methodology used to assign a provision for loan losses to each line of
business was changed from one based primarily upon actual net charge-offs
to a methodology based on the credit quality expectations within each line
over a normal business cycle.
Generally accepted accounting principles guide financial accounting, but there
is no authoritative guidance for "management accounting"--the way management
uses its judgment and experience to guide reporting decisions. Consequently, the
line of business results Key reports cannot necessarily be compared with results
presented by other companies.
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<Table>
<Caption>
KEY CONSUMER BANKING
----------------------------------
HOME EQUITY AND
THREE MONTHS ENDED JUNE 30, RETAIL BANKING CONSUMER FINANCE KEY CORPORATE FINANCE
-------------- ---------------- ---------------------
dollars in millions 2001 2000 2001 2000 2001 2000
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SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $232 $232 $148 $126 $352 $330
Noninterest income 93 93 (2) 19 86 77
Revenue sharing(a) 13 19 1 1 35 35
- -------------------------------------------------------------------------------------------------------
Total revenue(b) 338 344 147 146 473 442
Provision for loan losses 12 13 33 32 52 50
Depreciation and amortization expense 40 40 11 12 20 20
Noninterest expense 160 167 72 67 169 160
Expense sharing(a) 9 16 -- -- 21 22
- -------------------------------------------------------------------------------------------------------
Income (loss) before income taxes
(taxable equivalent) and cumulative
effect of accounting change 117 108 31 35 211 190
Allocated income taxes and taxable
equivalent adjustments 46 42 13 15 81 74
- --------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect
of accounting change 71 66 18 20 130 116
Cumulative effect of accounting change -- -- (24) -- -- --
- --------------------------------------------------------------------------------------------------------
Net income (loss) $ 71 $ 66 $ (6) $ 20 $130 $116
==== ==== ==== ==== ==== ====
Percent of consolidated net income N/M % 27 % N/M % 8 % N/M % 47 %
Percent of total segments' net income N/M 28 N/M 8 N/M 49
- -------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 7,766 $ 7,773 $15,775 $14,911 $35,888 $34,369
Total assets(b) 9,125 9,241 16,815 16,051 37,577 36,344
Deposits 32,000 31,500 135 122 6,508 6,351
- -------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
KEY CONSUMER BANKING
----------------------------------
HOME EQUITY AND
SIX MONTHS ENDED JUNE 30, RETAIL BANKING CONSUMER FINANCE KEY CORPORATE FINANCE
-------------- ---------------- ---------------------
dollars in millions 2001 2000 2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $460 $457 $290 $254 $691 $649
Noninterest income 190 180 4 37 155 147
Revenue sharing(a) 26 35 1 1 72 64
- -------------------------------------------------------------------------------------------------------
Total revenue(b) 676 672 295 292 918 860
Provision for loan losses 24 25 66 65 104 97
Depreciation and amortization expense 79 80 23 25 41 39
Noninterest expense 318 332 140 138 340 315
Expense sharing(a) 19 29 -- -- 42 40
- -------------------------------------------------------------------------------------------------------
Income (loss) before income taxes
(taxable equivalent) and cumulative
effect of accounting changes 236 206 66 64 391 369
Allocated income taxes and taxable
equivalent adjustments 92 81 28 27 150 142
- -------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect
of accounting changes 144 125 38 37 241 227
Cumulative effect of accounting changes -- -- (24) -- -- --
- -------------------------------------------------------------------------------------------------------
Net income (loss) $144 $125 $14 $37 $241 $227
==== ==== === === ==== ====
Percent of consolidated net income 253 % 21 % 25 % 6 % 423 % 37 %
Percent of total segments' net income 33 27 3 8 56 50
- -------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 7,792 $ 7,685 $15,821 $14,786 $35,768 $34,044
Total assets(b) 9,155 9,169 16,887 15,983 37,410 35,904
Deposits 32,284 30,963 139 126 6,494 6,248
- -------------------------------------------------------------------------------------------------------
</Table>
(a) Represents the assignment of Key Capital Partners' revenue and expense to
the lines of business principally responsible for maintaining the
relationships with the clients that used Key Capital Partners' products and
services.
(b) Substantially all revenue generated by Key's major lines of business 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 lines of business are located in the
United States.
(c) "Reconciling items" reflect certain nonrecurring items, the results of the
divested credit card business and charges related to unallocated nonearning
assets of corporate support functions. These latter charges are part of net
interest income and are allocated to the business segments through
noninterest expense.
Noninterest income for the second quarter of 2001 includes a loss of $40
million ($25 million after tax) recorded in connection with the decline in
leased vehicle residual values.
For the first six months of 2001, noninterest income includes the $40
million loss described above. Noninterest income in the first half of 2000
includes a gain of $332 million ($207 million after tax) from the January
sale of Key's credit card business and $5 million ($3 million after tax)
earned by the divested credit card business. This business also added $13
million ($8 million after tax) in the first six months of 2000 to net
interest income.
12
13
<Table>
<Caption>
KEY CAPITAL PARTNERS TREASURY TOTAL SEGMENTS RECONCILING ITEMS KEY
-------------------- -------------- --------------- ----------------- ------------------
2001 2000 2001 2000 2001 2000 2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------
$ 50 $ 53 $(33) $(23) $749 $718 $(30) $(38) $719 $680
228 259 31 25 436 473 (38) 2 398 475
(49) (55) -- -- -- -- -- -- -- --
- -------------------------------------------------------------------------------------------------------------
229 257 (2) 2 1,185 1,191 (68)(c) (36)(c) 1,117 1,155
3 3 1 1 101 99 300 (d) (31) 401 68
25 23 -- -- 96 95 151 (e) -- 247 95
221 221 3 4 625 619 (14)(e) (16)(e) 611 603
(30) (38) -- -- -- -- -- -- -- --
- -------------------------------------------------------------------------------------------------------------
10 48 (6) (3) 363 378 (505) 11 (142) 389
6 20 (13) (11) 133 140 (139) 1 (6) 141
- -------------------------------------------------------------------------------------------------------------
4 28 7 8 230 238 (366) 10 (136) 248
-- -- -- -- (24) -- -- -- (24) --
- -------------------------------------------------------------------------------------------------------------
$ 4 $ 28 $ 7 $ 8 $206 $ 238 $(366) $10 $ (160) $248
==== ==== ==== ==== ==== ===== ===== === ====== ====
N/M % 11 % N/M % 3 % N/M % 96 % N/M % 4 % N/M % 100 %
N/M 12 N/M 3 N/M 100 N/A N/A N/A N/A
- -------------------------------------------------------------------------------------------------------------
$ 5,496 $5,326 $ 1,916 $ 2,335 $66,841 $64,714 $ 113 $ 184 $66,954 $64,898
10,009 9,450 10,827 10,815 84,353 81,901 1,634 (f) 1,504 (f) 85,987 83,405
3,805 3,382 2,907 4,462 45,355 45,817 (44) 17 45,311 45,834
- -------------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
KEY CAPITAL PARTNERS TREASURY TOTAL SEGMENTS RECONCILING ITEMS KEY
-------------------- -------------- --------------- ----------------- ------------------
2001 2000 2001 2000 2001 2000 2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------
$100 $ 98 $(65) $(38) $1,476 $1,420 $(62) $ (62) $1,414 $1,358
456 524 83 50 888 938 (35) 343 853 1,281
(99) (100) -- -- -- -- -- -- -- --
- -------------------------------------------------------------------------------------------------------------
457 522 18 12 2,364 2,358 (97)(c) 281 (c) 2,267 2,639
6 5 2 3 202 195 309 (d) 56 (d) 511 251
49 47 -- -- 192 191 152 (e) -- 344 191
446 452 6 8 1,250 1,245 (38)(e) (11)(e) 1,212 1,234
(61) (69) -- -- -- -- -- -- -- --
- -------------------------------------------------------------------------------------------------------------
17 87 10 1 720 727 (520) 236 200 963
11 37 (18) (19) 263 268 (145) 80 118 348
- -------------------------------------------------------------------------------------------------------------
6 50 28 20 457 459 (375) 156 82 615
-- -- (1) -- (25) -- -- -- (25) --
- -------------------------------------------------------------------------------------------------------------
$ 6 $ 50 $ 27 $ 20 $432 $459 $(375) $156 $ 57 $ 615
==== ==== ==== ==== ==== ==== ===== ==== ==== =====
10 % 8 % 47 % 3 % 758 % 75 % (658)% 25 % 100 % 100 %
2 11 6 4 100 100 N/A N/A N/A N/A
- -------------------------------------------------------------------------------------------------------------
$5,533 $5,189 $1,973 $2,389 $66,887 $64,093 $106 $399 $66,993 $64,492
9,930 9,523 11,084 10,898 84,466 81,477 1,688 (f) 1,819 (f) 86,154 83,296
3,861 3,378 3,276 3,718 46,054 44,433 (40) 21 46,014 44,454
- -------------------------------------------------------------------------------------------------------------
</Table>
(d) The second quarter of 2001 includes an additional provision for loan losses
of $300 million ($189 million after tax) recorded in connection with Key's
decision to eliminate nonrelationship credit-only transactions.
In the first half of 2000, the provision for loan losses includes an
additional first quarter provision of $121 million ($76 million after tax).
This provision resulted from the implementation of an enhanced methodology
for assessing credit risk, particularly in the commercial loan portfolio.
(e) Noninterest expense for the second quarter of 2001 includes a goodwill
write-down of $150 million associated with Key's decision to downsize its
automobile finance business, additional litigation reserves of $20 million
($13 million after tax) and $2 million ($1 million after tax) of
nonrecurring charges recorded in connection with strategic actions being
taken to improve Key's operating efficiency and profitability. Noninterest
expense in the second quarter of 2000 includes $2 million ($1 million after
tax) of the latter charges.
For the first half of 2001, noninterest expense includes the second quarter
charges described above. For the first six months of 2000, noninterest
expense includes $16 million ($10 million after tax) of nonrecurring charges
recorded in connection with strategic actions being taken to improve Key's
operating efficiency and profitability and $7 million ($4 million after tax)
incurred by the divested credit card business.
(f) Total assets represent primarily the unallocated portion of nonearning
assets of corporate support functions.
(g) This ratio, which measures the extent to which recurring revenues are
absorbed by operating expenses, is calculated as follows: noninterest
expense (excluding significant nonrecurring items) divided by the sum of
taxable-equivalent net interest income and noninterest income (excluding
significant nonrecurring items).
N/A = Not Applicable
N/M = Not Meaningful
13
14
5. SECURITIES
Key classifies its securities into three categories: trading, investment and
available for sale.
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.
These securities are reported at fair value ($1.0 billion, $743 million and $802
million at June 30, 2001, December 31, 2000 and June 30, 2000, respectively) and
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.
INVESTMENT SECURITIES. These include debt securities that Key has the intent and
ability to hold until maturity and equity securities that do not have readily
determinable fair values. The 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.
SECURITIES AVAILABLE FOR SALE. These are debt and equity securities that Key has
not classified as trading account securities or investment securities.
Securities available for sale are reported at fair value with unrealized gains
and losses (net of income taxes) recorded in shareholders' equity as a component
of "accumulated other comprehensive loss." Actual gains and losses on the sales
of these securities are computed for each specific security sold and included in
"net securities gains " on the income statement.
When Key retains an interest in securitized loans, Key bears the risk that the
loans will be prepaid (which results in less interest income) or not paid at
all. Key's retained interests (which include both certificated and
uncertificated interests) are accounted for like debt securities that are
classified as securities available for sale or as trading account securities.
The amortized cost, unrealized gains and losses, and approximate fair value of
Key's investment securities and securities available for sale were as follows:
JUNE 30, 2001
--------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ----------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 262 $ 11 -- $ 273
Other securities 909 -- -- 909
- ----------------------------------------------------------------------------------------------------------------
Total investment securities $1,171 $ 11 -- $1,182
====== ==== === ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 120 $ 1 -- $ 121
States and political subdivisions 28 -- -- 28
Collateralized mortgage obligations 4,877 80 $62 4,895
Other mortgage-backed securities 1,192 22 2 1,212
Retained interests in securitizations 252 13 -- 265
Other securities 183 6 4 185
- ----------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,652 $122 $68 $6,706
====== ==== === ======
- ----------------------------------------------------------------------------------------------------------------
14
15
DECEMBER 31, 2000
--------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
in millions COST GAINS LOSSES VALUE
- ----------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 323 $ 10 -- $ 333
Other securities 875 -- -- 875
- ----------------------------------------------------------------------------------------------------------------
Total investment securities $1,198 $ 10 -- $1,208
====== ==== === ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 984 -- -- $ 984
States and political subdivisions 33 -- -- 33
Collateralized mortgage obligations 4,296 $ 63 $61 4,298
Other mortgage-backed securities 1,355 12 12 1,355
Retained interests in securitizations 334 -- 18 316
Other securities 307 42 6 343
- ----------------------------------------------------------------------------------------------------------------
Total securities available for sale $7,309 $117 $97 $7,329
====== ==== === ======
- ----------------------------------------------------------------------------------------------------------------
JUNE 30, 2000
--------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ----------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 380 $ 8 -- $ 388
Other securities 748 -- -- 748
- ----------------------------------------------------------------------------------------------------------------
Total investment securities $1,128 $ 8 -- $1,136
====== === ==== ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 121 -- -- $ 121
States and political subdivisions 56 -- -- 56
Collateralized mortgage obligations 4,185 -- $195 3,990
Other mortgage-backed securities 1,551 $ 3 36 1,518
Retained interests in securitizations 335 -- 20 315
Other securities 259 1 11 249
- ----------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,507 $ 4 $262 $6,249
====== === ==== ======
- ----------------------------------------------------------------------------------------------------------------
</Table>
15
16
6. LOANS
Key's loans by category are summarized as follows:
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2001 2000 2000
- ------------------------------------------------------------------------------------
Commercial, financial and agricultural $19,812 $20,100 $19,759
Real estate--commercial mortgage 6,940 6,876 6,962
Real estate--construction 5,744 5,154 4,713
Commercial lease financing 6,930 7,164 6,902
- ------------------------------------------------------------------------------------
Total commercial loans 39,426 39,294 38,336
Real estate--residential mortgage 3,998 4,212 4,251
Home equity 10,666 9,908 8,863
Consumer--direct 2,448 2,539 2,609
Consumer--indirect lease financing 2,693 3,005 3,081
Consumer--indirect other 5,571 5,718 6,019
- ------------------------------------------------------------------------------------
Total consumer loans 25,376 25,382 24,823
Real estate--commercial mortgage 208 316 340
Real estate--residential mortgage 82 42 124
Education 1,601 1,871 1,989
- ------------------------------------------------------------------------------------
Total loans held for sale 1,891 2,229 2,453
- ------------------------------------------------------------------------------------
Total loans $66,693 $66,905 $65,612
======= ======= =======
- ------------------------------------------------------------------------------------
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 June 30, 2001, see Note 12 ("Derivatives and
Hedging Activities"), which begins on page 23.
Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
in millions 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------
Balance at beginning of period $1,001 $979 $1,001 $930
Charge-offs (201) (94) (337) (258)
Recoveries 30 26 57 56
- ---------------------------------------------------------------------------------------------
Net charge-offs (171) (68) (280) (202)
Allowance related to loans sold -- -- (1) --
Provision for loan losses 401 68 511 251
- ---------------------------------------------------------------------------------------------
Balance at end of period $1,231 $979 $1,231 $979
====== ==== ====== ====
- ---------------------------------------------------------------------------------------------
16
17
7. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
At June 30, 2001, impaired loans totaled $455 million. This amount includes $330
million of impaired loans with a specifically allocated allowance for loan
losses of $129 million, and $125 million of impaired loans that are carried at
their estimated fair value without a specifically allocated allowance. At the
end of 2000, impaired loans totaled $364 million, including $213 million of
loans with a specifically allocated allowance of $102 million, and $151 million
that were carried at their estimated fair value. The average investment in
impaired loans for the second quarters of 2001 and 2000 was $420 million and
$279 million, respectively.
Key's nonperforming assets were as follows:
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2001 2000 2000
- -------------------------------------------------------------------------
Impaired loans $455 $364 $277
Other nonaccrual loans 342 283 268
- -------------------------------------------------------------------------
Total nonaccrual loans 797 647 545
Restructured loans(a) -- 3 --
- -------------------------------------------------------------------------
Total nonperforming loans 797 650 545
OREO 27 23 30
Allowance for OREO losses (1) (1) (1)
- -------------------------------------------------------------------------
OREO, net of allowance 26 22 29
Other nonperforming assets -- -- 3
- -------------------------------------------------------------------------
Total nonperforming assets $823 $672 $577
==== ==== ====
- -------------------------------------------------------------------------
(a) Excludes restructured loans on nonaccrual status
When appropriate, an impaired 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. When expected cash flow and/or collateral value does
not justify the carrying amount of a loan, the amount that management deems
uncollectible (the impaired amount) is charged against the allowance for loan
losses. When collateral value or other sources of repayment appear sufficient,
but management remains uncertain about whether the loan will be repaid in full,
an amount is specifically allocated in the allowance for loan losses.
Key does not perform a specific impairment valuation for smaller-balance,
homogeneous, nonaccrual loans (shown in the preceding table as "Other nonaccrual
loans"). Generally, this portfolio includes loans to finance residential
mortgages, automobiles, recreational vehicles, boats and mobile homes.
Management applies historical loss experience rates, which are adjusted based on
assessments of emerging credit trends and other factors, to these loans and then
allocates a portion of the allowance for loan losses to each loan type.
17
18
8. LONG-TERM DEBT
The components of Key's long-term debt, presented net of unamortized discount
where applicable, were as follows:
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2001 2000 2000
- -------------------------------------------------------------------------------------------------------------------------
Senior medium-term notes due through 2005(a) $ 796 $ 393 $ 391
Subordinated medium-term notes due through 2005(a) 85 103 103
Senior euro medium-term notes due through 2003(b) 50 -- --
7.50% Subordinated notes due 2006(c) 250 250 250
6.75% Subordinated notes due 2006(c) 200 200 200
8.125% Subordinated notes due 2002(c) 200 199 199
8.00% Subordinated notes due 2004(c) 125 125 125
8.404% Notes due through 2001 13 13 24
All other long-term debt(i) 48 -- 1
- -------------------------------------------------------------------------------------------------------------------------
Total parent company(j) 1,767 1,283 1,293
Senior medium-term bank notes due through 2039(d) 5,655 5,979 6,848
Senior euro medium-term bank notes due through 2007(e) 3,752 3,955 3,248
6.50 % Subordinated remarketable securities due 2027(f) 312 312 312
6.95% Subordinated notes due 2028(f) 300 300 300
7.125% Subordinated notes due 2006(f) 250 250 250
7.25% Subordinated notes due 2005(f) 200 200 200
6.75% Subordinated notes due 2003(f) 200 200 200
7.50% Subordinated notes due 2008(f) 165 165 165
7.00% Subordinated notes due 2011(f) 506 -- --
7.30% Subordinated notes due 2011(f) 107 107 107
7.85% Subordinated notes due 2002(f) 93 93 93
7.55% Subordinated notes due 2006(f) 75 75 75
7.375% Subordinated notes due 2008(f) 70 70 70
Lease financing debt due through 2006(g) 548 581 590
Federal Home Loan Bank advances due through 2030(h) 506 452 249
All other long-term debt(i) 205 139 97
- -------------------------------------------------------------------------------------------------------------------------
Total subsidiaries 12,944 12,878 12,804
- -------------------------------------------------------------------------------------------------------------------------
Total long-term debt $14,711 $14,161 $14,097
======= ======= =======
- -------------------------------------------------------------------------------------------------------------------------
Key uses interest rate swaps and caps, which modify the repricing and maturity
characteristics of certain long-term debt, to manage interest rate risk. For
more information about such financial instruments at June 30, 2001, see Note 12
("Derivatives and Hedging Activities"),which begins on page 23.
(a) At June 30, 2001, December 31, 2000 and June 30,2000, the senior
medium-term notes had weighted average interest rates of 4.483%, 6.81% and
6.85%, respectively, and the subordinated medium-term notes had a weighted
average interest rate of 7.42%, 7.32% and 7.32% at each respective date.
These notes had a combination of fixed and floating interest rates.
(b) Senior euro medium-term notes had a weighted average interest rate of 4.26%
at June 30, 2001. These notes, which are obligations of KeyCorp, had a
floating interest rate based on the three-month London Interbank Offered
Rate (known as "LIBOR").
(c) The notes may not be redeemed or prepaid prior to maturity.
(d) Senior medium-term bank notes of subsidiaries had weighted average interest
rates of 4.30%, 6.72% and 6.56%, at June 30, 2001, December 31, 2000 and
June 30, 2000, respectively. These notes had a combination of fixed and
floating interest rates.
18
19
(e) Senior euro medium-term notes had weighted average interest rates of 4.78%,
6.89%, and 6.47%, at June 30, 2001, December 31, 2000 and June 30, 2000,
respectively. These notes, which are obligations of KeyBank National
Association, had fixed interest rates and floating interest rates based on
LIBOR.
(f) These notes and securities are all obligations of KeyBank National
Association, with the exception of the 7.55% notes, which are obligations
of Key Bank USA, National Association. None of the subordinated notes may
be redeemed prior to their maturity dates.
(g) Lease financing debt had weighted average interest rates of 7.81% at June
30, 2001, 7.80% at December 31, 2000 and 7.74% at June 30, 2000. This
category of debt primarily comprises nonrecourse debt collateralized by
leased equipment under operating, direct financing and sales type.
(h) Long-term advances from the Federal Home Loan Bank had weighted average
interest rates of 4.05% at June 30, 2001, 6.66% at December 31, 2000 and
6.59% at June 30, 2000. These advances, which had a combination of fixed
and floating interest rates, were secured by $759 million, $678 million,
and $373 million of real estate loans and securities at June 30, 2001,
December 31, 2000 and June 30, 2000, respectively.
(i) Other long-term debt, comprising industrial revenue bonds, capital lease
obligations, and various secured and unsecured obligations of corporate
subsidiaries, had weighted average interest rates of 6.84%, 7.91%, and
8.14% at June 30, 2001, December 31, 2000 and June 30, 2000, respectively.
(j) At June 30, 2001, unused capacity under KeyCorp's shelf registration
totaled $769 million, including $269 million reserved for issuance as
medium-term notes.
9. CAPITAL SECURITIES
Five subsidiary business trusts of KeyCorp (KeyCorp Institutional Capital A,
KeyCorp Institutional Capital B, KeyCorp Capital I, KeyCorp Capital II and
KeyCorp Capital III) have issued corporation-obligated mandatorily redeemable
preferred capital securities ("capital securities"). As guarantor, KeyCorp
unconditionally guarantees payment of:
o accrued and unpaid distributions required to be paid on the capital
securities;
o the redemption price when a capital security is called for redemption; and
o amounts due if a trust is liquidated or terminated.
KeyCorp owns all of the outstanding common stock of each of the five 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 and 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 income statement effects because they are
eliminated in consolidation.
The capital securities, common securities 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
- --------------------------------------------------------------------------------------------------------------------------------
June 30, 2001
KeyCorp Institutional Capital A $ 380 $11 $ 361 7.826% 2026
KeyCorp Institutional Capital B 163 4 154 8.250 2026
KeyCorp Capital I 247 8 255 5.616 2028
KeyCorp Capital II 235 8 255 6.875 2029
KeyCorp Capital III 254 8 257 7.750 2029
- --------------------------------------------------------------------------------------------------------------------------------
Total $1,279 $39 $1,282 7.263% --
====== === ======
- --------------------------------------------------------------------------------------------------------------------------------
December 31, 2000 $1,243 $39 $1,282 7.619% --
====== === ======
- --------------------------------------------------------------------------------------------------------------------------------
June 30, 2000 $1,243 $39 $1,282 7.515% --
====== === ======
- --------------------------------------------------------------------------------------------------------------------------------
(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
19
20
constitute minority interests in the equity accounts of KeyCorp's
consolidated subsidiaries and, therefore, qualify as Tier 1 capital under
Federal Reserve Board guidelines.
(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),
and July 16, 1999 (for debentures owned by Capital III); 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 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:
(i) the principal amount, plus any accrued but unpaid interest or (ii) 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 is generally slightly more favorable
to Key.
(c) The interest rates for Capital A, Capital B, Capital II and Capital III are
fixed. Capital I has a floating interest rate (which reprices quarterly)
equal to three-month LIBOR plus 74 basis points. The rates shown as the
total at June 30, 2001, December 31, 2000, and June 30, 2000, are weighted
average rates.
10. RESTRUCTURING CHARGES
During the first half of 2001, KeyCorp recorded a restructuring charge credit of
$4 million ($2 million after tax) in connection with a three-year
"competitiveness initiative" instituted in November 1999 to improve Key's
operating efficiency and profitability. Restructuring charges previously accrued
under this initiative totaled $104 million ($66 million after tax) in 2000 and
$98 million ($62 million after tax) in 1999.
In the first phase of the initiative, Key's primary strategic actions were
outsourcing certain technology and other corporate support functions,
consolidating sites in a number of Key's businesses and reducing the number of
management layers. This phase was completed last year. The final phase, which
started during the second half of 2000, is focusing on:
o simplifying Key's business structure by consolidating 22 business lines
into 12;
o streamlining and automating business operations and processes;
o standardizing product offerings and internal processes;
o consolidating operating facilities and service centers; and
o outsourcing certain noncore activities.
As a result of the competitiveness initiative, Key's workforce was to be reduced
by approximately 4,000 positions from its November 1999 level. Those reductions
were to occur at all levels throughout the organization. At June 30, 2001, more
than 3,200 positions had been eliminated. Key's management expects the remaining
reductions (comprising both staffed and vacant positions) to occur around the
end of 2001.
Changes in the restructuring charge liability associated with the above actions
are as follows:
DECEMBER 31, RESTRUCTURING CASH JUNE 30,
in millions 2000 CHARGES PAYMENTS 2001
- ------------------------------------------------------------------------------------
Severance $ 62 $(7) $19 $36
Site consolidations 60 3 11 52
Equipment and other 2 --- --- 2
- ----------------------------------------------------------------------------------
Total $124 $(4) $30 $90
==== === === ===
- ------------------------------------------------------------------------------------
20
21
11. LEGAL PROCEEDINGS
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 and Key's counsel, management does not believe there is any legal
action to which Key is a party, or involving any of its properties, that,
individually or in the aggregate, will have a material adverse effect on Key's
financial condition.
RESIDUAL VALUE INSURANCE LITIGATION. Key Bank USA, National Association
("KeyBank") obtained two insurance policies from Reliance Insurance Company
("Reliance") insuring the residual value of certain automobiles leased through
KeyBank. The two policies, the "4011 Policy" and the "4019 Policy", together
covered the period January 1, 1997 to January 1, 2001. The 4019 Policy contains
an endorsement stating that Swiss Reinsurance America Corporation ("Swiss Re")
would assume and reinsure 100% of Reliance's obligations under the 4019 Policy
in the event that Reliance Group Holdings' (Reliance's parent) claims paying
ability fell below investment grade. KeyBank also entered into a letter
agreement with Swiss Re and Reliance whereby Swiss Re agreed to issue a policy
on the same terms and conditions as the 4011 Policy in the event that Reliance
Group Holdings' financial condition fell below a certain level. Around May 2000,
those conditions were met. Effective May 1, 2000, the 4011 Policy was terminated
and replaced 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 with
regard to the Policies. Since February 2000, KeyBank has been filing claims
under the Policies, but Reliance, Swiss Re, NAS, and Tri-Arc (the "Insurance
Parties") have not paid any of the claims submitted under the respective
policies.
In July 2000, KeyBank filed a claim for arbitration with the American
Arbitration Association against the Insurance Parties 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 (the "Litigation") against
KeyBank in Federal district court in Ohio seeking rescission of the 4019 and
4011 Policies because, according to Reliance, they do not reflect the intent of
the parties as to the scope of coverage and how and when claims were to be paid.
In the alternative, Reliance is seeking reformation of those policies. The other
Insurance Parties have also joined in this suit; and Swiss Re and NAS are
asserting claims similar to the Reliance claims. In response, KeyBank filed an
answer and counterclaim in the Litigation, asserting claims under the Policies
against the Insurance Parties. KeyBank is seeking, among other things,
declaratory relief as to the scope of coverage under the Policies, damages for
breach of contract and the Insurance Parties' failure to act in good faith, and
punitive damages. By agreement of the parties to proceed in the Litigation,
KeyBank subsequently dismissed the arbitration without prejudice.
On May 29, 2001, the Commonwealth Court of Pennsylvania entered an order placing
Reliance in rehabilitation and purporting to stay all litigation pending against
Reliance. Reliance subsequently petitioned the Federal district court in Ohio to
stay the Litigation, which stay was granted on July 23, 2001. KeyBank has filed
a motion asking the court to lift and to amend the stay.
Management believes that KeyBank has valid insurance coverage for the residual
value of automobiles leased during the four-year period ending January 1, 2001.
Because the leases in question are 3 to 5 year leases, the terms of the leases
will expire over time through 2006. Consequently, the aggregate amount in
dispute is not currently known and will be dependent upon the residual value of
the automobiles at the end of the respective lease terms.
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NSM LITIGATION. In March 1998, McDonald Investments Inc. ("McDonald"), now a
subsidiary of KeyCorp, participated in an offering to institutional investors of
certain securities of Nakornthai Strip Mill Public Company Ltd. ("NSM"), a
Thailand public company, and certain NSM affiliates. The offering was part of
the financing of an NSM steel mini-mill located in Chonburi, Thailand. McDonald
served as a financial advisor to NSM and was an initial purchaser in connection
with the offering (under Rule 144A of the Securities and Exchange Commission) of
the approximately $452 million in NSM debt securities and related warrants. On
December 24, 1998, holders of NSM securities gave a Notice of Default alleging a
number of defaults under the terms of the securities. NSM is currently working
to restructure its obligations, including obligations to holders of the
securities and other creditors.
Certain purchasers of the NSM securities have commenced litigation against
McDonald and several other parties, claiming that McDonald, the other initial
purchasers and certain other of NSM's third party service providers violated
certain state and federal securities and other laws. The lawsuits are based on
alleged misstatements and omissions in the Offering Memorandum for the
securities, and on certain other information allegedly provided and oral
statements allegedly made to potential investors. In each lawsuit the plaintiffs
allege misrepresentations relating to (among other things) the physical
facilities at the mill, the management of the mill, the supply of inputs to the
mill and the use of the proceeds of the offering.
Nine separate lawsuits have been brought against McDonald and others by
purchasers of the NSM securities: two in Federal court in Minnesota; two in
Federal court in New York; two in California; and one in each of Connecticut,
Illinois and New Jersey. The aggregate amount of securities alleged to have been
purchased by the plaintiffs in these nine lawsuits is at least $260 million.
While the relief claimed in the lawsuits varies, generally the plaintiffs seek
rescission of the sale of the securities, compensatory damages, punitive
damages, pre- and post- judgment interest, legal fees and expenses.
McDonald has filed responses to each complaint denying liability and has been
vigorously defending these actions. In addition, McDonald has reached settlement
agreements with the plaintiffs in the two lawsuits in California, the two
lawsuits in New York, and the lawsuits in New Jersey and Connecticut, pursuant
to which those plaintiffs' claims against McDonald are being dismissed. The
terms of those settlement agreements, including the consideration paid by
McDonald, are confidential.
Key believes that it has insurance coverage (above certain self-insurance layers
which have been exhausted) for the settlements that have been reached. The
insurance companies in question have denied coverage and declaratory judgment
actions have been filed. On August 2, 2001, the parties agreed to an informal
stay of the lawsuits for a period of ninety days to pursue a consensual
mediation of their dispute.
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12. DERIVATIVES AND HEDGING ACTIVITIES
Key, mainly through its lead bank (KeyBank National Association), is party to
various derivative instruments. These derivatives 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 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 of the foreign exchange forward
contracts and interest rate swaps and caps held are over-the-counter
instruments.
ACCOUNTING TREATMENT AND VALUATION
Effective January 1, 2001, Key adopted SFAS 133, which establishes accounting
and reporting standards for derivatives and hedging activities. The new
standards are summarized in Note 1 ("Basis of Presentation") under the heading
"Derivatives and hedging activities," on page 7.
As a result of adopting SFAS 133, Key recorded a cumulative loss of $1 million
in net income and a cumulative loss of $22 million in other comprehensive income
(loss) during the first quarter of 2001. Of the $22 million loss, approximately
$13 million will be reclassified to earnings during 2001.
At June 30, 2001, Key had $150 million of derivative assets recorded in "accrued
income and other assets" and $258 million of derivative liabilities recorded in
"accrued expense and other liabilities" on the balance sheet.
ASSET AND LIABILITY MANAGEMENT
FAIR VALUE HEDGING STRATEGIES. Key enters into primarily receive fixed/pay
variable interest rate swap contracts to modify its exposure to interest rate
risk by converting specified fixed-rate deposits, short-term borrowings and
long-term debt to variable rate obligations. These contracts involve the receipt
of fixed-rate interest payments in exchange for variable rate payments over the
life of the contracts without an exchange of the underlying notional amount.
During the first half of 2001, Key recognized a net gain of $1 million related
to the ineffective portion of its fair value hedging instruments. The
ineffective portion of the hedge relationship was recorded in "other income" on
the income statement.
CASH FLOW HEDGING STRATEGIES. Key also enters into primarily pay fixed/receive
variable interest rate swap contracts that effectively convert a portion of its
floating-rate debt to fixed-rate, thereby reducing the potential adverse impact
of interest rate increases on future interest expense. With these contracts,
variable-rate interest payments are exchanged for fixed-rate payments over the
life of the contracts without an exchange of the underlying notional amount.
Similarly, Key has converted certain floating-rate commercial loans to
fixed-rate by entering into receive fixed/pay variable interest rate swap
contracts. With these contracts, Key receives fixed-rate interest payments in
exchange for variable-rate payments over the life of the contracts.
Key also uses pay fixed/receive variable interest rate swaps to manage the
interest rate risk associated with anticipated sales/securitizations of certain
commercial real estate loans. These swaps protect against a possible short-term
decline in the value of the loans between the time they are originated and the
time of the anticipated sale/securitization. Key's policy is to generally sell
or securitize these loans within one year
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of their origination and to hedge the related interest rate risk over the period
during which the loans are held.
As a result of the strategic actions announced in May, Key's anticipated
future debt needs were revised. Consequently, during the second quarter of 2001,
Key reclassified a $3 million gain from accumulated other comprehensive income
(loss) to "other income" on the income statement. This reclassification relates
to a cash flow hedge of a previously forecasted debt issuance which is now not
probable of occurring.
During the first half of 2001, the net gain recognized by Key in connection with
the ineffective portion of its cash flow hedging instruments was not
significant. There was no impact on earnings during the first half of 2001
related to the exclusion of portions of hedging instruments from the assessment
of hedge effectiveness. Any hedge ineffectiveness was recorded in "other income"
on the income statement.
The change in accumulated other comprehensive income (loss) resulting from cash
flow hedges is as follows:
CUMULATIVE
EFFECT
DECEMBER 31, OF ADOPTING 2001 RECLASSIFICATION JUNE 30,
in millions 2000 SFAS 133 HEDGING ACTIVITY TO EARNINGS 2001
- -----------------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income
(loss) resulting from cash flow hedges -- $(22) $(6) $12 $(16)
- -----------------------------------------------------------------------------------------------------------------------------
At June 30, 2001, Key expects to reclassify approximately $10 million of net
losses on derivative instruments from accumulated other comprehensive income
(loss) to earnings during the next twelve months, coinciding 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/securitization of commercial real estate loans.
TRADING PORTFOLIO
FUTURES CONTRACTS AND INTEREST RATE SWAPS, CAPS AND FLOORS. Key uses these
instruments for dealer activities (which are generally limited to the banks'
commercial loan clients), and enters into other positions with third parties to
mitigate the interest rate risk of the client positions. The swaps entered into
with clients are generally limited to conventional swaps. All of the futures
contracts and interest rate swaps, caps and floors are recorded at their
estimated fair values. Adjustments to fair value are included in "investment
banking and capital markets income" on the income statement.
FOREIGN EXCHANGE FORWARD CONTRACTS. Key uses these instruments to accommodate
the business needs of clients and for proprietary trading purposes. Foreign
exchange forward contracts provide for the delayed delivery or purchase of
foreign currency. Key mitigates the associated foreign exchange risk by entering
into other foreign exchange contracts with third parties. Adjustments to the
fair value of all foreign exchange forward contracts are included in "investment
banking and capital markets income" on the income statement.
OPTIONS AND FUTURES. Key uses these instruments for proprietary trading
purposes. Adjustments to the fair value of options are included in "investment
banking and capital markets income" on the income statement. Such adjustments
netted to zero for the first six months of 2001 and 2000.
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25
The following table shows trading income recognized on interest rate swap and
foreign exchange forward contracts.
SIX MONTHS ENDED JUNE 30,
-------------------------
in millions 2001 2000
- ----------------------------------------------------------------
Interest rate swap contracts $ 8 $29
Foreign exchange forward contracts 22 17
- ----------------------------------------------------------------
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 cost of replacing
contracts--at current market rates-- that have generated unrealized gains. 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 subject contracts with the same
counterparty in the event of default. Second, a credit committee monitors credit
risk exposure to the counterparty on each interest rate swap to determine
appropriate limits on Key's total credit exposure and the amount of collateral
required, if any.
At June 30, 2001, Key had 37 different counterparties to swaps, including swaps
entered into to offset the risk of client swaps. Key had aggregate credit
exposure of $63 million to 17 of these counterparties, with the largest credit
exposure to an individual counterparty amounting to $19 million. As of the same
date, Key's aggregate credit exposure on its interest rate caps totaled $34
million. Based on management's assessment, as of June 30, 2001, all
counterparties were expected to meet their obligations.
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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 June 30, 2001 and 2000, and the related condensed
consolidated statements of income for the three- and six-month periods then
ended, and the condensed consolidated statements of changes in shareholders'
equity and cash flow for the six-month periods ended June 30, 2001 and 2000.
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, 2000, 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 12, 2001, 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, 2000, 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
July 13, 2001
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
- ------------
This Management's Discussion and Analysis reviews the financial condition and
results of operations of KeyCorp and its subsidiaries for the quarterly and
year-to-date periods ended June 30, 2001 and 2000. Some tables may cover more
than these periods to comply with Securities and Exchange Commission disclosure
requirements or to illustrate trends over a longer period of time. When you read
this discussion, you should also look at the consolidated financial statements
and related notes that appear on pages 3 through 25.
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 company.
- - 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, primarily through the Key
Capital Partners line of business. These activities encompass a variety of
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), invest in privately held companies (also
referred to as principal investing) and conduct transactions in foreign
currencies (both to accommodate clients' needs and to benefit from
fluctuations in exchange rates).
- - CORE financial results exclude the effects of significant nonrecurring
items such as accounting changes, write-downs of certain assets in
connection with the implementation of strategic actions, gains from
divestitures and restructuring charges.
- - 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.
- - All earnings per share data included in this discussion are presented on a
DILUTED basis, which takes into account all common shares outstanding and
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 several classes. Federal
regulations prescribe that at least half of a bank or bank holding company's
TOTAL RISK-ADJUSTED 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 and dividends," which begins on
page 54.
OUR PROJECTIONS ARE NOT FOOLPROOF
This report contains "forward-looking statements" about issues like anticipated
cost savings and revenue growth, and the anticipated reduction in Key's
employment base. 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.
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- - Interest rates could change more quickly or more significantly than we
expect.
- - If the economy or segments of the economy fail to rebound, the demand for
new loans and the ability of borrowers to repay outstanding loans may
decline.
- - The stock and bond markets could suffer a disruption, which may have a
negative effect 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, or we may be
unable to implement those initiatives at all.
- - Acquisitions and dispositions of assets, business units or affiliates could
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 a negative effect on our financial condition.
- - We may become subject to new and unanticipated accounting, tax, or
regulatory practices or requirements.
MAJOR ASPECTS OF KEY'S PERFORMANCE
FINANCIAL PERFORMANCE
On May 17, concurrent with the election of Chief Executive Officer, Henry L.
Meyer III, as Chairman of the Board of Directors, we announced the
implementation of strategic actions designed to sharpen our business focus and
strengthen our financial performance. Specific actions include exiting the
automobile leasing business, de-emphasizing indirect prime automobile lending
and discontinuing nonrelationship, credit-only commercial lending.
As a result of the above actions, we recorded several nonrecurring charges
during the second quarter, which had a short-term adverse affect on Key's
financial performance. These charges include a noncore $150 million goodwill
write-down, as well as two large charges included in Key's core financial
results. The core charges include an additional provision for loan losses of
$300 million ($189 million after tax) and $40 million ($25 million after tax)
for losses incurred on the residual values of leased vehicles. Each of these
charges is discussed in greater detail throughout the remainder of this
discussion.
The core charges are reflected in the following primary measures of Key's core
financial performance for the second quarter and first six months of 2001.
Comparable measures of performance on a reported basis are included in Figure 2
on page 30.
- - Core net income was $28 million, or $.07 per common share, compared with
$249 million, or $.57 per share for the second quarter of 2000. For the
first six months of the year, Key's core net income was $245 million, or
$.57 per common share, compared with $492 million, or $1.12 for the same
period last year.
- - Key's core return on average equity was 1.69% and 15.46% for the second
quarter of 2001 and 2000, respectively. For the first six months of the
year, Key's core return on average equity was 7.45%, compared with 15.24%
for the first half of 2000.
- - Key's second quarter core return on average total assets was .13% compared
with 1.20% for the second quarter of 2000. For the first six months of the
year, Key's core return on average total assets was .57%, down from 1.19%
for the comparable period in 2000.
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In both the current and prior year, Key's financial results have been affected
by various nonrecurring items, including those related to the implementation of
the strategic actions announced on May 17. The most significant of the noncore
items and their impact on both earnings and primary financial ratios are
summarized in Figure 1. Despite the effect of these items, core earnings for the
second quarter of 2001 include several positive performance trends. Relative to
the first quarter, these include a $25 million increase in Key's net interest
income, which benefited from a 14 basis point improvement in the net interest
margin and continued strong demand for home equity loans. At the same time,
noninterest income from investment banking and capital markets activities rose
by $7 million, despite ongoing weakness in the economy, and noninterest expense
fell by $12 million due primarily to the continuing benefits of PEG, Key's
competitiveness initiative.
FIGURE 1. SIGNIFICANT NONRECURRING ITEMS
Three months ended June 30, Six months ended June 30,
dollars in millions, except per share amounts 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------------
Net income as reported $(160) $248 $57 $ 615
Nonrecurring items (net of tax):
Goodwill write-down (automobile finance business) 150 - 150 -
Cumulative effect of accounting change - EITF 99-20 24 - 24 -
Additional litigation reserves 13 - 13 -
Restructuring and other special charges 1 - 1 9
Gain from sale of credit card portfolio - - - (207)
Enhancement of loan loss provision methodology - - - 76
Other nonrecurring items - 1 - (1)
- ---------------------------------------------------------------------------------------------------------------------------------
Net income - core $ 28 $249 $245 $ 492
===== ==== ==== =====
Net income per diluted common share $(.38) $.57 $.13 $1.40
Net income per diluted common share - core .07 .57 .57 1.12
Return on average total assets (.75)% 1.20% .13% 1.48%
Return on average total assets - core .13 1.20 .57 1.19
Return on average equity (9.67) 15.40 1.73 19.04
Return on average equity - core 1.69 15.46 7.45 15.24
- ---------------------------------------------------------------------------------------------------------------------------------
Figure 2 summarizes Key's financial performance on a reported basis for each of
the past five quarters and the first six months of 2001 and 2000.
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FIGURE 2. SELECTED FINANCIAL DATA
2001 2000
------------------------ ---------------------------------
dollars in millions, except per share amounts SECOND FIRST FOURTH THIRD SECOND
- --------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $ 1,467 $ 1,570 $ 1,652 $ 1,596 $ 1,540
Interest expense 754 882 950 912 867
Net interest income 713 688 702 684 673
Provision for loan losses 401 110 108 131 68
Noninterest income 398 455 508 405 475
Noninterest expense 858 698 705 787 698
Income (loss) before income taxes and cumulative effect
of accounting changes (148) 335 397 171 382
Income (loss) before cumulative effect of accounting changes (136) 218 266 121 248
Net income (loss) (160) 217 266 121 248
- --------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect of accounting changes $ (.32) $ .51 $ .63 $ .28 $ .57
Income (loss) before cumulative effect of accounting changes
-assuming dilution (.32) .51 .62 .28 .57
Net income (loss) (.38) .51 .63 .28 .57
Net income (loss)-assuming dilution (.38) .51 .62 .28 .57
Cash dividends .295 .295 .28 .28 .28
Book value at period end 15.22 15.79 15.65 15.26 15.09
Market price:
High 26.43 27.58 28.50 27.06 23.00
Low 22.10 22.65 21.50 17.50 17.00
Close 26.05 25.80 28.00 25.31 17.63
Weighted average common shares (000) 424,675 424,024 425,054 429,584 434,112
Weighted average common shares and
potential common shares (000) 424,675 429,917 430,634 431,972 436,022
- --------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 66,693 $ 67,027 $ 66,905 $ 66,299 $ 65,612
Earning assets 76,531 77,027 77,316 75,786 74,748
Total assets 85,838 86,457 87,270 85,500 84,719
Deposits 45,743 45,965 48,649 47,809 49,076
Long-term debt 14,675 14,495 14,161 13,800 14,097
Shareholders' equity 6,467 6,702 6,623 6,520 6,507
Full-time equivalent employees 21,742 21,882 22,142 22,457 23,005
Branches 926 922 922 932 938
- --------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets (.75)% 1.02% 1.24% .57% 1.20%
Return on average equity (9.67) 13.28 16.16 7.39 15.40
Net interest margin (taxable equivalent) 3.77 3.63 3.71 3.68 3.68
- --------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.53% 7.75% 7.59% 7.63% 7.68%
Tangible equity to tangible assets 6.25 6.29 6.12 6.10 6.12
Tier 1 risk-adjusted capital 7.71 7.99 7.72 7.59 7.88
Total risk-adjusted capital 11.81 12.32 11.48 11.34 11.74
Leverage 7.68 7.79 7.71 7.76 7.90
- --------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30,
---------------------------
dollars in millions, except per share amounts 2001 2000
- --------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $ 3,037 $ 3,029
Interest expense 1,636 1,685
Net interest income 1,401 1,344
Provision for loan losses 511 251
Noninterest income 853 1,281
Noninterest expense 1,556 1,425
Income (loss) before income taxes and cumulative effect
of accounting changes 187 949
Income (loss) before cumulative effect of accounting changes 82 615
Net income (loss) 57 615
- --------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect of accounting changes $ .19 $ 1.40
Income (loss) before cumulative effect of accounting changes
-assuming dilution .19 1.40
Net income (loss) .14 1.40
Net income (loss)-assuming dilution .13 1.40
Cash dividends .59 .56
Book value at period end 15.22 15.09
Market price:
High 29.25 23.00
Low 22.10 15.56
Close 26.05 17.63
Weighted average common shares (000) 424,352 437,973
Weighted average common shares and
potential common shares (000) 429,838 439,889
- --------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 66,693 $ 65,612
Earning assets 76,531 74,748
Total assets 85,838 84,719
Deposits 45,743 49,076
Long-term debt 14,675 14,097
Shareholders' equity 6,467 6,507
Full-time equivalent employees 21,742 23,005
Branches 926 938
- --------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets .13% 1.48%
Return on average equity 1.73 19.04
Net interest margin (taxable equivalent) 3.70 3.68
- --------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.53% 7.68%
Tangible equity to tangible assets 6.25 6.12
Tier 1 risk-adjusted capital 7.71 7.88
Total risk-adjusted capital 11.81 11.74
Leverage 7.68 7.90
- --------------------------------------------------------------------------------------
Key completed several acquisitions and a divestiture during the periods shown in
this table. One or more of these transactions may have had a significant effect
on Key's results, making it difficult to compare results from one period to the
next. Note 3 ("Acquisitions and Divestiture") on page 9 has specific information
about the acquisitions and divestiture that Key completed in the periods
presented above to help you understand how those transactions impacted Key's
financial condition and results of operations.
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CORPORATE STRATEGY
Key's management reviews Key's business lines on an ongoing basis to identify
opportunities to improve earnings by shifting capital from low-growth to
high-growth businesses. We continue to focus on acquiring or developing
businesses that we believe are capable of achieving double-digit earnings growth
rates, and selling portfolios and business units that have low anticipated
growth rates or do not have a competitive advantage or significant market share.
Key's corporate strategy also reflects the growing importance of the Internet
and related information technologies to all daily activities. In particular, the
strategy calls for the continual and thoughtful application of such technologies
to enhance Key's product and service offerings and to streamline our internal
business practices.
This long-standing strategy was supplemented in the fourth quarter of 1999 by a
new three-year competitiveness initiative to improve profitability by reducing
the costs of doing business, sharpening the focus on the most profitable growth
businesses and enhancing revenues. More specific information on the status of
this initiative is provided in the section below entitled "Status of three-year
competitiveness initiative." Importantly, it is Key's plan to convert this
competitiveness initiative into a continuous process in order to improve client
service levels and to control expenses.
PRINCIPAL STRATEGIC ACTIONS DURING THE FIRST SIX MONTHS OF 2001
- - Early in the first quarter, we acquired The Wallach Company, Inc., an
investment-banking firm based in Denver, Colorado. We expect this
acquisition to enhance our position in this fast-growth region and to
provide additional expertise in the information technology and financial
institutions sectors.
- - During the second quarter, we announced strategic actions, discussed on
page 28, which are designed to sharpen our business focus and strengthen
our financial performance. These efforts will help us build on progress
already made in streamlining the company.
STATUS OF THREE-YEAR COMPETITIVENESS INITIATIVE
During the third quarter of 2000, we entered the second and final phase of our
three-year competitiveness initiative. Management expects that Key will achieve
an annual savings rate of approximately $360 million from the overall initiative
when actions are fully implemented before the end of 2002. Approximately $60
million of this savings will be reinvested to fund activities that will enhance
Key's strategic competitive position, fuel higher growth and improve customer
service. In the initial phase, which began in November 1999, Key reduced its
operating expenses by approximately $100 million by outsourcing certain
nonstrategic support functions, consolidating sites in a number of our
businesses and reducing management layers. The final phase is focusing on:
- - simplifying Key's business structure by consolidating 22 business lines
into 12;
- - streamlining and automating business operations and processes;
- - standardizing product offerings and internal processes;
- - consolidating operating facilities and service centers; and
- - outsourcing additional noncore activities.
As of June 30, 2001, almost 75% of the projects related to the final phase have
been completed, although many of the expected benefits from these projects have
only begun to be realized. Management expects that the actions taken in the
final phase will reduce Key's workforce by approximately 2,300 positions
(comprising both staffed and vacant positions) around the end of 2001. This
would bring workforce reductions to approximately 4,000 positions for the
entire three-year initiative. In connection with the competitiveness
initiative, we have recorded cumulative charges amounting to a net $279
million. During the first half of 2001, we reduced our related restructuring
charges by $4 million, but this was offset by a $4 million increase in other
special charges related to the initiative. The section entitled "Noninterest
expense," which begins on page 44, and Note 10 ("Restructuring Charges"), on
page 20, provide more information about Key's restructuring charges.
31
32
CASH BASIS FINANCIAL DATA
The selected financial data presented in Figure 3 highlight Key's performance on
a cash basis for each of the past five quarters and the first six months of 2001
and 2000. We provide cash basis financial data because we believe it offers a
useful tool for measuring Key's ability to support future growth, evaluating
liquidity and assessing Key's ability to pay dividends and repurchase shares.
When we apply "cash basis" accounting, the only adjustments that we make to get
from the information in Figure 2 (which is presented on an accrual basis) to the
comparable line items in Figure 3 are to exclude goodwill and other intangibles
that do not qualify as Tier 1 capital, and to exclude the amortization of those
assets. Figure 3 does not exclude the impact of other noncash items (such as
depreciation and deferred taxes) and significant nonrecurring items.
Key's goodwill and other intangibles that do not qualify as Tier 1 capital are
the result of business combinations that Key recorded using the "purchase"
method of accounting. Under the purchase method, assets and liabilities of
acquired companies are recorded at their fair values and any amount paid in
excess of the fair value of the net assets acquired is recorded as goodwill. (If
the same transactions had qualified for accounting using the "pooling of
interests" method, the acquired company's financial statements would simply have
been combined with Key's.) After a combination using purchase accounting, Key
must amortize goodwill and other intangibles by taking periodic charges against
income, but those charges are only accounting entries, not actual cash expenses.
Thus, from an investor's perspective, the economic effect of a transaction is
the same whether we account for it as a purchase or a pooling. For the same
reason, the amortization of intangibles does not impact Key's liquidity and
funds management activities.
In June 2001, new accounting standards were issued that eliminate the
pooling-of-interests method of accounting for business combinations initiated
after June 30, 2001, and, effective January 1, 2002, eliminate the amortization
of goodwill and other intangible assets deemed to have indefinite lives. These
changes will essentially eliminate the difference between Key's reported results
and those presented on a cash basis in this section. For more information
pertaining to the new accounting standards, see the section entitled "Accounting
standards pending adoption," included in Note 1 ("Basis of Presentation"),
beginning on page 7.
This is the only section of this Financial Review that discusses Key's financial
results on a cash basis.
FIGURE 3. CASH BASIS SELECTED FINANCIAL DATA
2001 2000
------------------- --------------------------------
dollars in millions, except per share amounts SECOND FIRST FOURTH THIRD SECOND
- ---------------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Noninterest expense $ 684 $ 672 $ 679 $ 763 $ 672
Income before income taxes and cumulative effect of accounting changes 26 361 423 195 408
Income before cumulative effect of accounting changes 36 242 290 143 271
Net income 12 241 290 143 271
- ---------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income before cumulative effect of accounting changes $ .08 $ .57 $ .68 $ .33 $ .62
Income before cumulative effect of accounting changes-assuming dilution .08 .56 .67 .33 .62
Net income .03 .57 .68 .33 .62
Net income - assuming dilution .03 .56 .67 .33 .62
Weighted average common shares (000) 424,675 424,024 425,054 429,584 434,112
Weighted average common shares and potential
common shares (000) 429,760 429,917 430,634 431,972 436,022
- ---------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets .06 % 1.15 % 1.37 % .69 % 1.33 %
Return on average equity .90 18.57 22.33 11.12 21.56
- ---------------------------------------------------------------------------------------------------------------------------------
GOODWILL AND NONQUALIFYING INTANGIBLES
Goodwill average balance $ 1,223 $ 1,323 $ 1,335 $ 1,346 $ 1,370
Nonqualifying intangibles average balance 38 42 46 50 54
Goodwill amortization (after tax) 170 21 21 20 21
Nonqualifying intangibles amortization (after tax) 2 3 3 2 2
- ---------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30,
-------------------------
dollars in millions, except per share amounts 2001 2000
- ---------------------------------------------------------------------------------------------------
FOR THE PERIOD
Noninterest expense $ 1,356 $ 1,374
Income before income taxes and cumulative effect of accounting changes 387 1,000
Income before cumulative effect of accounting changes 278 661
Net income 253 661
- ---------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income before cumulative effect of accounting changes $ .66 $ 1.51
Income before cumulative effect of accounting changes-assuming dilution .65 1.50
Net income .60 1.51
Net income - assuming dilution .59 1.50
Weighted average common shares (000) 424,352 437,973
Weighted average common shares and potential
common shares (000) 429,838 439,889
- ---------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets .60 % 1.62 %
Return on average equity 9.59 26.27
- ---------------------------------------------------------------------------------------------------
GOODWILL AND NONQUALIFYING INTANGIBLES
Goodwill average balance $ 1,273 $ 1,378
Nonqualifying intangibles average balance 40 56
Goodwill amortization (after tax) 191 41
Nonqualifying intangibles amortization (after tax) 5 5
- ---------------------------------------------------------------------------------------------------
Key completed several acquisitions and a divestiture during the periods
presented in this table. One or more of these transactions may have had a
significant effect on Key's results, making it difficult to compare results from
one period to the next. Note 3 ("Acquisitions and Divestiture") on page 9 has
specific information about the acquisitions and divestiture that Key completed
in the periods presented above to help you understand how those transactions
impacted Key's financial condition and results of operations.
32
33
LINE OF BUSINESS RESULTS
Key has three major lines of business:
KEY CONSUMER BANKING comprises two of Key's primary divisions: RETAIL BANKING,
and HOME EQUITY AND CONSUMER FINANCE.
- - RETAIL BANKING offers branch-based deposit, investment and credit products
and personal financial services to consumers.
- - HOME EQUITY AND CONSUMER FINANCE offers non-branch-based consumer loan
products, such as education loans, home equity loans, automobile loans, and
marine and recreational vehicle loans.
KEY CORPORATE FINANCE offers financing and specialized services related to,
among other things, transaction processing, corporate electronic commerce,
financial advice and equipment leasing. It also serves the needs of Key's small
business clients.
KEY CAPITAL PARTNERS offers asset management, employee benefits services,
brokerage services, investment banking, capital markets and insurance expertise,
and conducts equity capital investing. It also provides specialized services to
high-net-worth clients through the wealth management and private banking
businesses.
This section summarizes the financial performance of each line of business and
related strategic developments. To better understand this discussion, see Note 4
("Line of Business Results"), which begins on page 10 and discloses the
activities and financial results of each line of business in greater detail.
Figure 4 shows the results contributed by each of Key's major lines of business
for the three- and six-month periods ended June 30, 2001 and 2000.
FIGURE 4. RESULTS BY LINE OF BUSINESS(a)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, CHANGE ENDED JUNE 30, CHANGE
------------------- ----------------------- ----------------- ---------------------
dollars in millions 2001 2000 AMOUNT PERCENT 2001 2000 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Key Consumer Banking:
Retail Banking $ 71 $ 66 $ 5 7.6 % $ 144 $ 125 $ 19 15.2%
Home Equity and Consumer Finance(b) 18 20 (2) (10.0) 38 37 1 2.7
Key Corporate Finance 130 116 14 12.1 241 227 14 6.2
Key Capital Partners(c) 4 28 (24) (85.7) 6 50 (44) (88.0)
Treasury 7 8 (1) (12.5) 27 20 7 35.0
- ------------------------------------------------------------------------------------------------------------------------------------
Total segments 230 238 (8) (3.4) 456 459 (3) (.7)
Reconciling items(d) (390) 10 (400) N/M (399) 156 (555) N/M
- ------------------------------------------------------------------------------------------------------------------------------------
Total net income (loss) $(160) $ 248 $(408) N/M $ 57 $ 615 $(558) (90.7)%
===== ===== ===== ===== ===== =====
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Key's management accounting system utilizes a methodology for loan loss
provisioning by line of business that reflects credit quality expectations
within each line of business over a normal business cycle. The "normalized
provision for loan losses" assigned to each line as a result of this
methodology does not necessarily coincide with the level of net loan
charge-offs at any given point in the cycle.
(b) Results for 2001 exclude a second quarter one-time cumulative charge of $39
million ($24 million after tax) resulting from a prescribed change,
applicable to all companies, in the accounting for retained interests in
securitized assets (See note (d) below).
(c) Noninterest income and expense attributable to Key Capital Partners is
assigned to Retail Banking, Home Equity and Consumer Finance or Key
Corporate Finance if one of those businesses is principally responsible for
maintaining the relationship with the client that used Key Capital
Partners' products and services. Key Capital Partners had net income of $16
million and $39 million in the second quarter of 2001 and 2000,
respectively, and $31 million and $70 million in the first six months of
2001 and 2000, respectively, before its income and expense were reassigned.
(d) Reconciling items include certain strategic and nonrecurring items. Among
these items are the second quarter 2001 additional provision for loan
losses recorded in connection with Key's decision to eliminate
nonrelationship credit-only transactions and the write-down of goodwill
associated with Key's decision to downsize its automobile finance business.
Included in 2000 results is the gain from the January sale of Key's credit
card business. Also included are charges related to unallocated nonearning
assets of corporate support functions and the effect of the accounting
change described in note (b) above. For more specific information regarding
the above items, see notes (c), (d) and (e) to the table included in Note 4
("Line of Business Results"), which begins on page 10.
N/M= Not Meaningful
33
34
KEY CONSUMER BANKING
Retail Banking (a division of Key Consumer Banking)
- ---------------------------------------------------
Net income for Key Retail Banking totaled $71 million for the second quarter of
2001, up from $66 million for the same period in 2000. The increase in net
income is primarily attributable to a reduction in noninterest expense, offset
in part by a decline in total revenue.
Noninterest expense decreased by 6% from the year-ago quarter, largely due to
lower costs associated with personnel, capital markets activities and various
indirect charges. This improvement was reflected in the efficiency ratio, which
decreased to 50.18% from 53.43% for the second quarter of 2000. Net interest
income was essentially unchanged from the second quarter of last year, as the
positive effects of a 2% increase in average deposits was offset by the effect
of narrower interest rate spreads used in determining the profit contribution
from deposits generated by Retail Banking. Noninterest income declined by 5%
from the year-ago quarter, primarily due to a reduction in revenue generated by
various capital markets activities. The revenues and costs related to capital
markets activities are primarily the result of the income and expense sharing
relationship described in the Key Capital Partners section below.
Home Equity and Consumer Finance (a division of Key Consumer Banking)
- ---------------------------------------------------------------------
Excluding the one-time charge pertaining to a prescribed change in the
accounting for retained interests in securitized assets, Home Equity and
Consumer Finance had net income of $18 million for the second quarter,
representing a $2 million decrease from the second quarter of 2000. Total
revenue rose slightly from the year-ago quarter, reflecting growth in net
interest income that was largely offset by a decrease in noninterest income. At
the same time, the level of noninterest expense increased by 5%.
Although total revenue grew only slightly from the second quarter of 2000, its
composition changed due to our decision to cease securitizing and selling our
home equity loans. These assets have an attractive risk/reward profile and
retaining them was a significant factor in contributing to a 6% increase in
average loans outstanding and a $22 million, or 17%, increase in net interest
income. This decision also contributed to a decline in noninterest income due to
lower securitization gains (to be expected in the first year after ceasing
securitizations) and lower fee income from the servicing of securitized assets.
Also adding to the decline in noninterest income was an increase in losses on
leased vehicle residual values. The moderate increase in noninterest expense was
primarily due to higher costs associated with collections, computer processing
and professional services.
KEY CORPORATE FINANCE
Net income for Key Corporate Finance was $130 million for the second quarter of
2001, up from $116 million for the same period last year. The improvement from
the year-ago quarter was driven by revenue growth, but was offset in part by a
rise in noninterest expense and a higher normalized provision for loan losses.
In comparison with the second quarter of 2000, total average loans grew by 4%,
resulting in a $22 million, or 7%, improvement in net interest income. The
growth in loans was distributed among most major business units. At the same
time, noninterest income rose 8% due to higher income from loan fees, service
charges on deposit accounts and loan sale gains. These increases in revenue were
partially offset by higher costs associated with computer processing and credit
extensions.
KEY CAPITAL PARTNERS
Net income for Key Capital Partners was $4 million in the second quarter of
2001, compared with $28 million for the same period last year. Prior to
assigning revenue and expense to other business lines whose clients utilize
products and services offered by Key Capital Partners, net income was $16
million in the second quarter, compared with $39 million for the year-ago
quarter.
34
35
Total revenue for Key Capital Partners decreased by $28 million, or 11%, ($34
million, or 11%, prior to revenue sharing) from the second quarter of last year.
Weaker equity markets and a slowdown in the economy led to net losses on equity
capital investments attributable to unrealized mark-to-market adjustments. Such
conditions also resulted in declines in revenue derived from brokerage services,
investment banking fees and investment advisory fees. These declines were offset
in part by growth in fixed income revenues that resulted from the stronger bond
markets. Net interest income decreased by $3 million, or 6%, from second quarter
of 2000.
Noninterest expense increased by $10 million, or 5%, ($2 million, or 1%, prior
to expense sharing) from the year-ago quarter, primarily due to a decrease in
the level of expenses shared with other business lines and an increase in
various indirect charges. The rise in noninterest expense resulting from these
factors was partially offset by lower personnel costs.
TREASURY
Treasury includes the Treasury business unit, as well as the net effect of funds
transfer pricing. In the second quarter of 2001, this segment generated net
income of $7 million, compared with $8 million in the same period last year. Net
securities gains and corporate-owned life insurance income increased by $5
million and $2 million, respectively. However, these increases were more than
offset by a $10 million reduction in net interest income.
35
36
RESULTS OF OPERATIONS
NET INTEREST INCOME
Key's principal source of earnings is net interest income, which comprises
interest and loan-related fee income less interest expense. 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 off-balance sheet instruments to manage interest rate risk;
- - 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 5 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. Net interest income for the second quarter of 2001 was $719
million, representing a $39 million, or 6%, increase from the same period last
year. Average earning assets (primarily commercial and home equity loans)
increased by 4% to $76.5 billion, while the net interest margin rose from 3.68%
in the second quarter of 2000 to 3.77% in the second quarter of 2001.
For the first six months of 2001, net interest income totaled $1.4 billion, up
$56 million, or 4%, from the first half of last year. The year-to-date growth
reflected a slight improvement in the net interest margin which increased 2
basis points to 3.70%, while the growth of commercial and home equity loans was
the primary contributor to a 4% increase in average earning assets to $76.7
billion.
NET INTEREST MARGIN. There are several reasons that the net interest margin
improved over the past year:
- - Key aggressively reduced the rates paid for deposits late in the first
quarter of 2001 and throughout the second quarter; due to competitive
factors, we did not lower the rates paid for deposits at the same time that
the Federal Reserve reduced interest rates earlier in the first quarter;
- - we improved the profitability of our total loan portfolio by continuing to
focus on those businesses, such as home equity lending, that typically
generate a higher rate of return; and
- - our loan fees grew significantly.
INTEREST EARNING ASSETS. Average earning assets for the second quarter totaled
$76.5 billion, which was $2.7 billion, or 4%, higher than the second quarter
2000 level. For the first six months of the year, average earning assets rose
$2.9 billion to $76.7 billion from the first half of 2000. Both the quarterly
and year-to-date increases came principally from the commercial and home equity
loan portfolios.
Key's loan growth has been affected by several strategic developments:
- - During 2000, we sold $805 million of low interest spread commercial loans
to a loan conduit. This arrangement allowed us to continue to originate
loans to meet our customers' funding needs and to generate servicing
revenue without having to retain these low interest spread assets on the
balance sheet;
36
37
FIGURE 5: AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
SECOND QUARTER 2001 FIRST QUARTER 2001
-------------------------------- ------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a,b)
Commercial, financial and agricultural $ 20,030 $ 361 7.24% $ 20,025 $ 406 8.22%
Real estate-- commercial mortgage 6,837 135 7.91 6,897 147 8.63
Real estate-- construction 5,504 108 7.81 5,273 117 9.03
Commercial lease financing 6,990 120 6.86 7,102 125 7.07
- -----------------------------------------------------------------------------------------------------------------------
Total commercial loans 39,361 724 7.37 39,297 795 8.19
Real estate-- residential 4,065 79 7.81 4,172 81 7.74
Home equity 10,459 228 8.74 10,086 233 9.38
Consumer - direct 2,458 60 9.74 2,480 64 10.43
Consumer - indirect lease financing 2,778 57 8.27 2,936 59 8.02
Consumer - indirect other 5,593 134 9.61 5,673 136 9.58
- -----------------------------------------------------------------------------------------------------------------------
Total consumer loans 25,353 558 8.83 25,347 573 9.10
Loans held for sale 2,240 43 7.69 2,389 54 9.09
- -----------------------------------------------------------------------------------------------------------------------
Total loans 66,954 1,325 7.93 67,033 1,422 8.57
Taxable investment securities 911 8 3.41 892 7 3.24
Tax-exempt investment securities(a) 297 6 8.79 317 8 8.83
- -----------------------------------------------------------------------------------------------------------------------
Total investment securities 1,208 14 4.74 1,209 15 4.70
Securities available for sale(a,c) 6,572 115 6.99 7,026 120 6.87
Short-term investments 1,812 19 4.19 1,604 20 5.00
- -----------------------------------------------------------------------------------------------------------------------
Total earning assets 76,546 1,473 7.71 76,872 1,577 8.28
Allowance for loan losses (988) (1,006)
Accrued income and other assets 10,429 10,458
- -----------------------------------------------------------------------------------------------------------------------
$ 85,987 $ 86,324
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $ 12,296 67 2.22 $ 12,070 95 3.17
Savings deposits 1,969 5 1.06 1,993 7 1.34
NOW accounts 610 3 1.50 602 2 1.54
Certificates of deposit ($100,000 or more)(d) 5,571 81 5.85 5,994 92 6.25
Other time deposits 14,479 209 5.77 15,011 224 6.06
Deposits in foreign office 2,173 23 4.27 2,869 40 5.64
- -----------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 37,098 388 4.20 38,539 460 4.84
Federal funds purchased and securities
sold under repurchase agreements 5,177 52 4.06 5,263 70 5.39
Bank notes and other short-term borrowings(d) 8,016 94 4.67 7,532 105 5.67
Long-term debt, including capital securities(d,e) 16,068 220 5.49 15,412 247 6.58
- -----------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 66,359 754 4.56 66,746 882 5.38
Noninterest-bearing deposits 8,213 8,185
Accrued expense and other liabilities 4,779 4,766
Common shareholders' equity 6,636 6,627
- -----------------------------------------------------------------------------------------------------------------------
$ 85,987 $ 86,324
======== ========
Interest rate spread (TE) 3.15 2.90
- -----------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 719 3.77 % $ 695 3.63%
======== ======= ======== ==========
Capital securities $ 1,292 $ 23 $ 1,307 $ 24
Taxable-equivalent adjustment(a) 6 7
- -----------------------------------------------------------------------------------------------------------------------
(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 the
average loan balances.
(c) Yield is calculated on the basis of amortized cost.
(d) Rate calculation excludes basis adjustments related to fair value hedges.
(e) Rate calculation excludes ESOP debt.
TE = Taxable Equivalent
37
38
FIGURE 5. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES (CONTINUED)
FOURTH QUARTER 2000 THIRD QUARTER 2000
-------------------------------------- ---------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a,b)
Commercial, financial and agricultural $ 20,093 $ 451 8.92% $ 19,647 $ 434 8.87%
Real estate-- commercial mortgage 6,855 162 9.42 6,932 160 9.29
Real estate-- construction 5,164 129 9.97 4,866 121 9.98
Commercial lease financing 6,965 125 7.20 6,861 122 7.14
- -----------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 39,077 867 8.84 38,306 837 8.78
Real estate-- residential 4,232 81 7.68 4,273 80 7.51
Home equity 9,591 228 9.45 9,095 219 9.68
Consumer - direct 2,582 69 10.57 2,595 68 10.50
Consumer - indirect lease financing 3,023 62 8.16 3,052 62 8.08
Consumer - indirect other 5,813 141 9.72 5,952 142 9.55
- -----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 25,241 581 9.18 24,967 571 9.17
Loans held for sale 2,220 51 9.13 2,504 56 8.96
- -----------------------------------------------------------------------------------------------------------------------------------
Total loans 66,538 1,499 8.98 65,777 1,464 8.93
Taxable investment securities 898 8 3.73 787 8 3.63
Tax-exempt investment securities(a) 344 8 8.73 369 7 8.12
- -----------------------------------------------------------------------------------------------------------------------------------
Total investment securities 1,242 16 5.12 1,156 15 5.06
Securities available for sale(a,c) 6,807 121 7.02 6,275 107 6.67
Short-term investments 1,449 23 6.20 1,501 17 4.76
- -----------------------------------------------------------------------------------------------------------------------------------
Total earning assets 76,036 1,659 8.69 74,709 1,603 8.61
Allowance for loan losses (989) (969)
Accrued income and other assets 10,380 10,365
- -----------------------------------------------------------------------------------------------------------------------------------
$ 85,427 $ 84,105
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $ 11,873 103 3.44 $ 11,956 102 3.43
Savings deposits 2,045 7 1.32 2,151 8 1.49
NOW accounts 600 2 1.55 592 2 1.59
Certificates of deposit ($100,000 or more)(d) 5,789 94 6.44 5,269 84 6.40
Other time deposits 15,037 232 6.15 14,634 218 6.01
Deposits in foreign office 3,265 54 6.60 2,860 48 6.70
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 38,609 492 5.07 37,462 462 4.96
Federal funds purchased and securities
sold under repurchase agreements 5,859 93 6.33 5,746 88 6.17
Bank notes and other short-term borrowings(d) 6,446 101 6.22 6,403 99 6.19
Long-term debt, including capital securities(d,e) 15,235 264 6.91 15,356 263 6.91
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 66,149 950 5.72 64,967 912 5.65
Noninterest-bearing deposits 8,363 8,377
Accrued expense and other liabilities 4,368 4,248
Common shareholders' equity 6,547 6,513
- -----------------------------------------------------------------------------------------------------------------------------------
$ 85,427 $ 84,105
======== ========
Interest rate spread (TE) 2.97 2.96
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 709 3.71% $ 691 3.68%
======== ======== ======== ========
Capital securities $ 1,243 $ 24 $ 1,243 $ 24
Taxable-equivalent adjustment(a) 7 7
- ------------------------------------------------------------------------------------------------------------------------------------
SECOND QUARTER 2000
-----------------------------------
AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE
- -------------------------------------------------------------------------------------
ASSETS
Loans(a,b)
Commercial, financial and agricultural $ 19,046 $ 405 8.56 %
Real estate-- commercial mortgage 6,967 156 9.03
Real estate-- construction 4,625 110 9.51
Commercial lease financing 6,773 124 7.30
- ----------------------------------------------------------------------------------
Total commercial loans 37,411 795 8.53
Real estate-- residential 4,276 83 7.80
Home equity 8,600 196 9.16
Consumer - direct 2,620 66 10.09
Consumer - indirect lease financing 3,107 62 7.97
Consumer - indirect other 6,078 142 9.33
- ----------------------------------------------------------------------------------
Total consumer loans 24,681 549 8.92
Loans held for sale 2,725 58 8.52
- ----------------------------------------------------------------------------------
Total loans 64,817 1,402 8.68
Taxable investment securities 671 6 3.63
Tax-exempt investment securities(a) 415 9 8.77
- ----------------------------------------------------------------------------------
Total investment securities 1,086 15 5.60
Securities available for sale(a,c) 6,198 107 6.73
Short-term investments 1,757 23 5.29
- ----------------------------------------------------------------------------------
Total earning assets 73,858 1,547 8.40
Allowance for loan losses (976)
Accrued income and other assets 10,523
- ----------------------------------------------------------------------------------
$ 83,405
========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $ 12,403 105 3.41
Savings deposits 2,275 8 1.44
NOW accounts 628 3 1.61
Certificates of deposit ($100,000 or more)(d) 5,430 82 6.06
Other time deposits 13,656 190 5.61
Deposits in foreign office 3,029 48 6.39
- ----------------------------------------------------------------------------------
Total interest-bearing deposits 37,421 436 4.69
Federal funds purchased and securities
sold under repurchase agreements 4,096 58 5.64
Bank notes and other short-term borrowings(d) 6,972 103 5.96
Long-term debt, including capital securities(d,e) 15,668 270 6.92
- ----------------------------------------------------------------------------------
Total interest-bearing liabilities 64,157 867 5.43
Noninterest-bearing deposits 8,412
Accrued expense and other liabilities 4,357
Common shareholders' equity 6,479
- ----------------------------------------------------------------------------------
$ 83,405
========
Interest rate spread (TE) 2.97
- ----------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 680 3.68%
======== ==========
Capital securities $ 1,243 $ 24
Taxable-equivalent adjustment(a) 7
- ----------------------------------------------------------------------------------
38
39
- - during 2000 and the first six months of 2001, Key sold without recourse
$1.3 billion of its commercial mortgage loans. Our business of originating
and servicing commercial mortgage loans is expected to grow as a result of
Key's acquisitions of Newport Mortgage Company, L.P. and National Realty
Funding L.C. last year;
- - early in 2000, management announced that Key would de-emphasize the
securitization and sale of home equity loans generated by our home equity
finance affiliate. We have not effected any such transactions since the
1999 year end. By retaining the assets attributable to this growing
business on Key's balance sheet, we intend to replace over time the
earnings formerly generated by the divested credit card business. We will
continue, however, to consider securitizations of other portfolios as a
source of alternative funding when conditions in the capital markets are
favorable. Key did not securitize any of its loans during the first half of
2001; and
- - during the second quarter of 2001, management announced that Key would exit
the automobile leasing business, de-emphasize indirect prime automobile
lending and discontinue nonrelationship credit-only commercial lending.
Figure 6 shows how 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 46, contains more discussion about changes in
earning assets and funding sources.
FIGURE 6. COMPONENTS OF NET INTEREST INCOME CHANGES
FROM THREE MONTHS ENDED JUNE 30, 2000 FROM SIX MONTHS ENDED JUNE 30, 2000
TO THREE MONTHS ENDED JUNE 30, 2001 TO SIX MONTHS ENDED JUNE 30, 2001
-------------------------------------- -------------------------------------
AVERAGE YIELD/ NET AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE VOLUME RATE CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 45 $(122) $ (77) $ 108 $(113) $ (5)
Taxable investment securities 2 -- 2 5 -- 5
Tax-exempt investment securities (2) (1) (3) (5) -- (5)
Securities available for sale 7 1 8 16 -- 16
Short-term investments 1 (5) (4) (6) 2 (4)
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest income (taxable equivalent) 53 (127) (74) 118 (111) 7
INTEREST EXPENSE
Money market deposit accounts (1) (37) (38) (5) (42) (47)
Savings deposits (1) (2) (3) (2) (3) (5)
NOW accounts -- -- -- -- (1) (1)
Certificates of deposit ($100,000 or more) 2 (3) (1) 9 2 11
Other time deposits 12 7 19 47 32 79
Deposits in foreign office (11) (14) (25) 11 (13) (2)
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 1 (49) (48) 60 (25) 35
Federal funds purchased and securities sold
under repurchase agreements 13 (19) (6) 28 (12) 16
Bank notes and other short-term borrowings 14 (23) (9) (1) (29) (30)
Long-term debt, including capital securities 7 (57) (50) (12) (58) (70)
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest expense 35 (148) (113) 75 (124) (49)
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $ 18 $ 21 $ 39 $ 43 $ 13 $ 56
===== ===== ===== ===== ===== =====
====================================================================================================================================
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.
INTEREST RATE SWAPS AND CAPS. Key uses interest rate swaps and caps to help
manage its interest rate sensitivity position. Interest rate swaps and caps are
complicated instruments, but briefly:
- - INTEREST RATE SWAPS are contracts under which two parties agree to exchange
interest payment streams that are calculated on agreed-upon amounts (known
as "notional amounts"). For example, party A will pay interest at a fixed
rate to, and receive interest at a variable rate from, party B. Key
generally uses interest rate swaps to mitigate its exposure to interest
rate risk on certain loans, securities, deposits, short-term borrowings and
long-term debt.
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- - INTEREST RATE CAPS are contracts that provide for the holder to be
compensated based on an agreed-upon notional amount when a benchmark
interest rate exceeds a specified level (known as the "strike rate"). Key
uses interest rate caps to manage the risk of adverse movements in interest
rates on certain of our long-term debt and short-term borrowings. A cap
limits Key's exposure to interest rate increases; caps do not have any
impact if interest rates decline.
For more information about how Key uses interest rate swaps and caps to manage
its balance sheet, see the next section, entitled "Market risk management" and
Note 12 ("Derivatives and Hedging Activities"), starting on page 23.
MARKET RISK MANAGEMENT
The values of some financial instruments vary with changes in external interest
rates, foreign exchange rates, equity prices (the value of equity securities
held as assets), or other market-driven rates or prices. For example, the value
of a fixed-rate bond will decline if market interest rates increase because the
bond will become a less attractive investment. Similarly, the value of the U.S.
dollar regularly fluctuates in relation to other currencies. (Key is not
affected in any material way by changes in foreign exchange rates or the prices
of various equity securities held as assets.) The exposure that instruments tied
to such external factors presents is called "market risk."
Asset and liability 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 position.
MEASUREMENT OF SHORT-TERM INTEREST RATE EXPOSURE. The primary tool that
management uses to measure interest rate risk is a net interest income
simulation model. 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. 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 we make 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 if a gradual
200 basis point increase or decrease in short-term rates over the next twelve
months would affect net interest income over the same period by more than 2%.
Key has been operating well within these guidelines. As of June 30, 2001, based
on the results of our simulation model, Key would expect net interest income to
increase by approximately 1.29% if short-term interest rates gradually decrease
by 200 basis points. Conversely, if short-term interest rates gradually increase
by 200 basis points, net interest income would be expected to decrease by
approximately 1.29%.
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.
Economic value analysis has several limitations. For example, the economic
values of asset, liability and off-balance sheet positions do not represent the
true fair values of the positions, since economic values do
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not consider factors like credit risk and liquidity. In addition, we must
estimate cash flow for assets and liabilities with indeterminate maturities.
Moreover, our present value calculations do not take into consideration future
changes in the balance sheet that will likely result from ongoing loan and
deposit activities conducted by Key's core businesses. Finally, the analysis
requires assumptions about events that span several years. Despite its
limitations, the economic value of equity model is a relatively sophisticated
tool for evaluating the longer-term effect of possible interest rate movements.
Key's guidelines for risk management call for preventive measures if an
immediate 200 basis point increase or decrease in interest rates would reduce
the economic value of equity by more than 15%. Key has been operating well
within these guidelines.
OTHER SOURCES 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 also periodically
measure the risk to earnings and economic value arising from various other pro
forma changes in the overall level of interest rates. The many interest rate
scenarios modeled, and their potential impact on earnings and economic value,
quantify the level of Key's interest rate exposure arising from option risk,
basis risk and gap risk.
- - A financial instrument presents "OPTION RISK" when one party can take
advantage of changes in interest rates without penalty. For example, when
interest rates decline, borrowers may choose to prepay fixed-rate loans by
refinancing at a lower rate. Such a prepayment gives Key a return on its
investment (the principal plus some interest), but unless there is a
prepayment penalty, that return will not be as much as the loan would have
generated had payments been received as originally scheduled. Floating rate
loans that are capped against potential interest rate increases and
deposits that can be withdrawn on demand also present option risk.
- - One approach that Key follows to manage interest rate risk is to use
floating-rate liabilities (such as borrowings) to fund floating-rate assets
(such as loans). That way, as our interest expense increases, so will our
interest income. We face "BASIS RISK" when our floating-rate assets and
floating-rate liabilities reprice in response to different market factors
or indices. Under those circumstances, even if equal amounts of assets and
liabilities are repricing at the same time, interest expense and interest
income may not change by the same amount.
- - We often use an interest-bearing liability to provide funding for an
interest-earning asset. For example, Key may sell certificates of deposit
and use the proceeds to make loans. That strategy presents "GAP RISK" if
the related liabilities and assets do not mature or reprice at the same
time.
MANAGEMENT OF INTEREST RATE EXPOSURE. Key manages 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. In addition, management considers interest rate
implications when adding to Key's securities portfolio, issuing new debt and
packaging loans for securitization.
Trading portfolio risk management
- ---------------------------------
Key's trading portfolio includes interest rate swap contracts entered into to
accommodate the needs of clients, other positions with third parties that are
intended to mitigate the interest rate risk of client positions, foreign
exchange contracts entered into to accommodate the needs of clients, and
financial assets and liabilities (trading positions) included in "accrued income
and other assets" and "accrued expense and other liabilities," respectively, on
the balance sheet. For more information about these contracts, see Note 12
("Derivatives and Hedging Activities"), which begins on page 23.
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42
Management uses a value at risk ("VAR") model to estimate the potential adverse
effect of changes in interest and foreign exchange rates on the fair value of
Key's trading portfolio. Using statistical methods, this model estimates the
maximum potential one-day loss with 95% certainty. At June 30, 2001, Key's
aggregate daily VAR was $1.4 million compared with $.9 million at June 30, 2000.
Aggregate daily VAR averaged $1.3 million for the first six months of 2001,
compared with an average of less than $1 million during 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.
NONINTEREST INCOME
Noninterest income for the second quarter of 2001 totaled $398 million, down $77
million, or 16%, from the same period last year. For the first six months of the
year, noninterest income was $853 million, representing a decrease of $428
million, or 33%, from the first half of 2000. In both the current and prior
year, noninterest income has been affected by various nonrecurring items. The
most significant of these items, which are shown in Figure 7, is the $332
million gain from the January 2000 sale of Key's credit card business. For more
information on this transaction, see Note 3 ("Acquisitions and Divestiture"), on
page 9.
Key's core noninterest income for the second quarter of 2001 includes a $40
million charge (included in miscellaneous income) for losses incurred on the
residual values of leased vehicles. Excluding this strategic charge, core
noninterest income for the second quarter totaled $438 million (38% of total
core revenue), compared with $475 million (41% of total core revenue) for the
same period last year. One of management's long-term objectives is to increase
core noninterest income as a percentage of total core revenue to 50%. The
decrease in core noninterest income from the year-ago quarter was attributable
primarily to the effects of weaker conditions in the capital markets. These
adverse conditions led to declines in revenue derived from various capital
markets activities; the impact was particularly noticeable in our equity capital
investing and brokerage businesses.
Adjusting for the $40 million loss on residual values, core noninterest income
for the first six months of 2001 was $893 million compared with core noninterest
income of $951 million for the first half of 2000. The decrease in year-to-date
results also reflects the effects of continued weakness in the economy on Key's
capital markets-sensitive revenues.
Figure 7 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. For
detailed information about trust and investment services, and investment banking
and capital markets income, see Figures 8 and 9, respectively.
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FIGURE 7. NONINTEREST INCOME
THREE MONTHS ENDED JUNE 30, CHANGE
---------------------------- ------------------------
dollars in millions 2001 2000 AMOUNT PERCENT
- ---------------------------------------------------------------------------------------------------------------------
Trust and investment services income $ 132 $ 150 $ (18) (12.0)%
Investment banking and capital markets income 72 98 (26) (26.5)
Service charges on deposit accounts 90 85 5 5.9
Corporate-owned life insurance income 27 25 2 8.0
Letter of credit and loan fees 30 24 6 25.0
Net securities gains 8 2 6 300.0
Other income:
Electronic banking fees 18 17 1 5.9
Insurance income 12 14 (2) (14.3)
Loan securitization servicing fees 5 7 (2) (28.6)
Net gains from loan securitizations and sales 8 12 (4) (33.3)
Miscellaneous income (4) 41 (45) N/M
- ---------------------------------------------------------------------------------------------------------------------
Total other income 39 91 (52) (57.1)
- ---------------------------------------------------------------------------------------------------------------------
Total core noninterest income 398 475 (77) (16.2)
Gain from sale of credit card portfolio -- -- -- --
Other nonrecurring items -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Total significant nonrecurring items -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 398 $ 475 $ (77) (16.2)%
======= ======= =======
=====================================================================================================================
SIX MONTHS ENDED JUNE 30, CHANGE
------------------------ --------------------------
dollars in millions 2001 2000 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------
Trust and investment services income $ 273 $ 310 $ (37) (11.9)%
Investment banking and capital markets income 137 187 (50) (26.7)
Service charges on deposit accounts 174 171 3 1.8
Corporate-owned life insurance income 54 50 4 8.0
Letter of credit and loan fees 59 47 12 25.5
Net securities gains 34 3 31 N/M
Other income:
Electronic banking fees 35 32 3 9.4
Insurance income 26 31 (5) (16.1)
Loan securitization servicing fees 9 13 (4) (30.8)
Net gains from loan securitizations and sales 13 23 (10) (43.5)
Miscellaneous income 39 84 (45) (53.6)
- ------------------------------------------------------------------------------------------------------------------
Total other income 122 183 (61) (33.3)
- ------------------------------------------------------------------------------------------------------------------
Total core noninterest income 853 951 (98) (10.3)
Gain from sale of credit card portfolio -- 332 (332) (100.0)
Other nonrecurring items -- (2) 2 (100.0)
- ------------------------------------------------------------------------------------------------------------------
Total significant nonrecurring items -- 330 (330) (100.0)
- ------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 853 $ 1,281 $ (428) (33.4)%
======= ======= =======
==================================================================================================================
N/M = Not Meaningful
FIGURE 8. TRUST AND INVESTMENT SERVICES
THREE MONTHS ENDED JUNE 30, CHANGE
--------------------------- ------------------
dollars in millions 2001 2000 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------
Personal asset management and custody fees $44 $46 $(2) (4.3)%
Institutional asset management and custody fees 22 24 (2) (8.3)
Bond services 9 15 (6) (40.0)
Brokerage commission income 21 34 (13) (38.2)
All other fees 36 31 5 16.1
- -----------------------------------------------------------------------------------------------
Total trust and investment services income $132 $150 $(18) (12.0)%
==== ==== =====
dollars in billions
- -----------------------------------------------------------------------------------------------
JUNE 30,
Discretionary trust assets $71 $70 $1 1.4%
Nondiscretionary trust assets 57 54 3 5.6
- -----------------------------------------------------------------------------------------------
Total trust assets $128 $124 $4 3.2%
==== ==== ===
===============================================================================================
SIX MONTHS ENDED JUNE 30, CHANGE
------------------------- ----------------------
dollars in millions 2001 2000 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------
Personal asset management and custody fees $90 $93 $(3) (3.2)%
Institutional asset management and custody fees 44 48 (4) (8.3)
Bond services 19 24 (5) (20.8)
Brokerage commission income 47 79 (32) (40.5)
All other fees 73 66 7 10.6
- ----------------------------------------------------------------------------------------------------
Total trust and investment services income $273 $310 $(37) (11.9)%
==== ==== =====
====================================================================================================
FIGURE 9. INVESTMENT BANKING AND CAPITAL MARKETS INCOME
THREE MONTHS ENDED JUNE 30, CHANGE
--------------------------- ----------------------
dollars in millions 2001 2000 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $ 41 $ 40 $ 1 2.5%
Investment banking income 28 32 (4) (12.5)
Equity capital gains (losses) (8) 18 (26) N/M
Foreign exchange income 11 8 3 37.5
- ------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $ 72 $ 98 $ (26) (26.5)%
===== ===== ===== =====
==================================================================================================================
SIX MONTHS ENDED JUNE 30, CHANGE
------------------------- -------------------
dollars in millions 2001 2000 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $ 91 $ 84 $ 7 8.3%
Investment banking income 48 53 (5) (9.4)
Equity capital gains (losses) (24) 33 (57) N/M
Foreign exchange income 22 17 5 29.4
- ----------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $ 137 $ 187 $ (50) (26.7)%
===== ===== ===== =====
================================================================================================================
N/M = Not Meaningful
TRUST AND INVESTMENT SERVICES. Trust and investment services provide Key's
largest source of noninterest income. As shown in Figure 8, the decrease in
revenue derived from these services was largely due to a decline in brokerage
commission income, reflecting the impact of a weakening economy. The softer
economic environment also resulted in a decrease in fee income that is based on
the value of assets managed by Key for its clients. At June 30, 2001, Key's
bank, trust and registered investment advisory subsidiaries had assets under
discretionary management (excluding corporate trust assets) of $71 billion,
compared with $70 billion at June 30, 2000.
INVESTMENT BANKING AND CAPITAL MARKETS INCOME. The decrease in this revenue
component also reflects the effects of a weakening economy. As shown in Figure
9, results for the current year include net equity capital losses, compared with
net equity capital gains last year. The net equity capital losses in the current
year are attributable to unrealized mark-to-market adjustments, which totaled
$23 million in the second quarter and $44 million for the year-to-date period.
The negative $57 million swing in total equity investing results from the first
half of 2000 was substantially offset by an increase in net realized gains from
the sales of certain securities held in Key's available for sale portfolio
discussed on page 44.
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SECURITIES TRANSACTIONS. During the first half of 2001, Key realized $34 million
of core net securities gains from the sales of securities held in the available
for sale portfolio, compared with net gains of $3 million a year ago. Since the
sales involved primarily equity securities issued by financial service
companies, the sales of these assets will not have a significant adverse affect
on Key's future net interest income.
NONINTEREST EXPENSE
Noninterest expense for the second quarter of 2001 totaled $858 million, up $160
million, or 23%, from the second quarter of 2000. For the first six months of
the year, noninterest expense was $1.6 billion, representing an increase of $131
million, or 9%, from the first half of last year. Items that hinder a direct
comparison of results between reporting periods are shown in Figure 10. In the
current year, these items include a $150 million write-down of goodwill
associated with Key' decision to downsize its automobile finance business and
additional litigation reserves of $20 million; both were recorded in the second
quarter. In the prior year, these items include restructuring and other special
charges recorded during the first quarter in connection with strategic actions
that Key has been taking to improve operating efficiency and profitability. You
can find more information about these charges under the heading "Restructuring
and other special charges," on page 45.
Core noninterest expense, which excludes significant nonrecurring items,
decreased by $10 million, or 1%, from the year-ago quarter, due primarily to a
$16 million reduction in personnel expense. For the year-to-date period, core
noninterest expense improved by $30 million, or 2%, reflecting a $34 million
decrease in personnel expense and a $12 million decrease in equipment expense.
Figure 10 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 10. NONINTEREST EXPENSE
THREE MONTHS SIX MONTHS
ENDED JUNE 30, CHANGE ENDED JUNE 30,
------------------- ------------------- ----------------
dollars in millions 2001 2000 AMOUNT PERCENT 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
Personnel $ 345 $ 361 $ (16) (4.4)% $ 709 $ 743
Net occupancy 56 56 -- -- 113 113
Computer processing 63 60 3 5.0 125 119
Equipment 40 42 (2) (4.8) 78 90
Marketing 29 31 (2) (6.5) 56 53
Amortization of intangibles 24 25 (1) (4.0) 50 50
Professional fees 19 21 (2) (9.5) 37 40
Other expense:
Postage and delivery 16 17 (1) (5.9) 33 34
Telecommunications 12 13 (1) (7.7) 23 27
Equity- and gross receipts- based taxes 7 8 (1) (12.5) 15 16
OREO expense, net 2 1 1 100.0 4 3
Miscellaneous expense 73 61 12 19.7 141 126
- --------------------------------------------------------------------------------------------------------------------------
Total other expense 110 100 10 10.0 216 206
- --------------------------------------------------------------------------------------------------------------------------
Total core noninterest expense 686 696 (10) (1.4) 1,384 1,414
Goodwill write-down (automobile finance business) 150 -- 150 N/M 150 --
Additional litigation reserves 20 -- 20 N/M 20 --
Restructuring and other special charges 2 2 -- -- 2 14
Other nonrecurring items -- -- -- -- -- (3)
- --------------------------------------------------------------------------------------------------------------------------
Total significant nonrecurring items 172 2 170 N/M 172 11
- --------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 858 $ 698 $ 160 22.9 % $ 1,556 $ 1,425
======= ======== ======== ======== ========
Full-time equivalent employees at period end 21,742 23,005 21,742 23,005
- --------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------
CHANGE
------------------
dollars in millions AMOUNT PERCENT
- -----------------------------------------------------------------------------
Personnel $ (34) (4.6)%
Net occupancy -- --
Computer processing 6 5.0
Equipment (12) (13.3)
Marketing 3 5.7
Amortization of intangibles -- --
Professional fees (3) (7.5)
Other expense:
Postage and delivery (1) (2.9)
Telecommunications (4) (14.8)
Equity- and gross receipts- based taxes (1) (6.3)
OREO expense, net 1 33.3
Miscellaneous expense 15 11.9
- --------------------------------------------------------------------------
Total other expense 10 4.9
- --------------------------------------------------------------------------
Total core noninterest expense (30) (2.1)
Goodwill write-down (automobile finance business) 150 N/M
Additional litigation reserves 20 N/M
Restructuring and other special charges (12) (85.7)
Other nonrecurring items 3 (100.0)
- --------------------------------------------------------------------------
Total significant nonrecurring items 161 N/M
- --------------------------------------------------------------------------
Total noninterest expense $ 131 9.2 %
========
Full-time equivalent employees at period end
- --------------------------------------------------------------------------
N/M= Not Meaningful
PERSONNEL. Personnel expense, the largest category of Key's noninterest expense,
posted decreases from the prior year for both the quarterly and year-to-date
periods. These improvements occurred despite the impact of annual merit
increases that took effect on April 1. The improvements are largely attributable
to the effectiveness of our competitiveness initiative. Through this initiative
we have improved efficiency, reduced the level of personnel required to conduct
our business, and instilled a greater sense of awareness
44
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among all employees of the need to manage costs. Lower levels of incentive
compensation also contributed to the reduction in personnel expense. Revenues on
which various incentive programs (including those related to investment banking
and capital markets activities) are based were down from the prior year, due
largely to the weaker economic conditions. Figure 11 shows the major components
of Key's core personnel expense.
FIGURE 11. CORE PERSONNEL EXPENSE
THREE MONTHS ENDED JUNE 30, CHANGE
--------------------------------- ------------------------------
dollars in millions 2001 2000 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------
Salaries $214 $216 $(2) (.9)%
Employee benefits 45 46 (1) (2.2)
Incentive compensation 86 99 (13) (13.1)
- ----------------------------------------------------------------------------------------------------------
Total core personnel expense $345 $361 $(16) (4.4)%
==== ==== ====
- ----------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CHANGE
---------------------------------- -----------------------------
dollars in millions 2001 2000 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------
Salaries $425 $441 $(16) (3.6)%
Employee benefits 102 107 (5) (4.7)
Incentive compensation 182 195 (13) (6.7)
- ----------------------------------------------------------------------------------------------------------
Total core personnel expense $709 $743 $(34) (4.6)%
===== ===== =====
- ----------------------------------------------------------------------------------------------------------
At June 30, 2001, the number of full-time equivalent employees was 21,742,
compared with 22,142 at the end of 2000 and 23,005 a year ago. The decrease in
the number of employees is primarily a result of Key's competitiveness
initiative.
EQUIPMENT. The decrease in equipment expense from the first six months of 2000
was driven by reductions in depreciation, maintenance expense and rental expense
stemming from cost management efforts and our competitiveness initiative.
RESTRUCTURING AND OTHER SPECIAL CHARGES. During the first six months of last
year, Key recorded net nonrecurring charges of $14 million (including net
restructuring charges of $9 million) in connection with strategic actions
related to the competitiveness initiative. For more information related to the
actions being taken, anticipated cost savings and expected reductions to Key's
workforce, see the section entitled "Status of three-year competitiveness
initiative," on page 31. Additional information related to the restructuring
charges can be found in Note 10 ("Restructuring Charges"), on page 20. Cash
generated by Key's operations will fund the restructuring charge liability; none
of the charges will have a material impact on Key's liquidity.
INCOME TAXES
For the second quarter of 2001, Key recorded a tax benefit of $12 million,
compared with a provision for income taxes of $134 million for the comparable
period in 2000. The tax benefit recorded in the current year was largely
attributable to several significant nonrecurring charges, which resulted in a
loss for the second quarter. Most of the charges are associated with the
implementation of strategic actions announced in May. The effective tax rate for
the second quarter of 2001 was 8.1% (which is the tax benefit as a percentage of
the pretax loss), compared with 35.1% (which is the provision for income taxes
as a percentage of pretax income) for the same period last year. The substantial
decline in the effective tax rate was due to a $150 million nondeductible
write-down of goodwill recorded in the second quarter of 2001 in connection with
Key's decision to downsize its automobile finance business. This write-down
reduced the effective tax rate by approximately 36%. The levels of tax credits
and tax-exempt income from corporate-owned life insurance and securities
included in each quarter also affect the comparability of effective tax rates.
In the case of a pretax loss, the effect of these items is to increase, rather
than decrease, the effective tax benefit.
For the first six months of 2001, the provision for income taxes was $105
million compared with $334 million for the first half of last year. The
effective tax rates for these periods were 56.1% and 35.2%, respectively.
Excluding the $150 million nondeductible write-down of goodwill, the effective
tax rate for the first six months of 2001 was approximately 31.2%. The adjusted
effective income tax rate remains below Key's combined statutory Federal and
state rate of 37%, primarily because we continue to invest in tax-advantaged
assets (such as tax-exempt securities and corporate-owned life insurance) and to
recognize credits associated with investments in low-income housing projects.
45
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FINANCIAL CONDITION
- -------------------
LOANS
At June 30, 2001, total loans outstanding were $66.7 billion, compared with
$66.9 billion at the end of 2000 and $65.6 billion a year ago. The composition
of the loan portfolio at each of these respective dates is summarized in Note 6
("Loans") on page 16. Despite the effects of a weakening economy, Key achieved a
2% increase in loans over the past twelve months, primarily as a result of
strong growth in the home equity and construction portfolios.
Because of Key's success in generating new loan volume, loan growth has outpaced
deposit growth over the past several years. To mitigate this imbalance, we have
used alternative funding sources like loan sales and securitizations so we can
continue to capitalize on our lending opportunities. Management expects Newport
Mortgage Company, L.P. and National Realty Funding L.C., which were acquired
last year, to improve Key's ability to generate and securitize new loans,
especially in the area of commercial real estate. In addition, early in 2000, we
sold loans to a loan conduit. This arrangement allowed us to continue to meet
our corporate customers' funding needs and to generate servicing revenue without
having to retain certain low interest spread assets on the balance sheet.
Loans outstanding (excluding loans held for sale) would have grown by $3.4
billion, or 5%, over the past twelve months, if we had not sold $3.0 billion of
loans ($502 million through securitizations) during that time period. Excluding
the impact of loan sales, commercial loans rose by $2.7 billion, or 7%, since
June 30, 2000. This growth was principally due to a $1.5 billion increase in
commercial real estate mortgage loans and a $1.0 billion increase in real estate
construction loans. Consumer loans rose (excluding loan sales) by $741 million,
or 3%. This growth reflects a $2.0 billion increase in the home equity
portfolio. We opted to not securitize these loans starting in 2000. By retaining
these assets, we intend to replace over time the revenue generated by our former
credit card business, which was sold in January 2000. The growth of the home
equity portfolio was moderated by declines of $609 million in installment loans,
$388 million in automobile lease financing receivables and $232 million in
residential real estate mortgage loans. The decline in lease financing
receivables is due in part to our recently-announced decision to exit the
automobile leasing business.
SALES, SECURITIZATIONS AND DIVESTITURES. During the past twelve months, Key sold
$1.5 billion of commercial real estate loans, $1.2 billion of education loans
($502 million through securitizations) and $259 million of other types of 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 12 summarizes Key's loan sales (including securitizations) for the first
six months of 2001 and all of 2000.
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FIGURE 12. LOANS SOLD AND DIVESTED
COMMERCIAL RESIDENTIAL HOME CREDIT CARD
in millions COMMERCIAL REAL ESTATE REAL ESTATE EQUITY RECEIVABLES EDUCATION TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
2001
- ---------------------------------------
Second quarter $ 44 $ 577 $ 20 $ 59 -- $ 144 $ 844
First quarter -- 327 1 14 -- 449 791
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 44 $ 904 $ 21 $ 73 -- $ 593 $1,635
====== ====== ====== ====== ====== ====== ======
2000
- ---------------------------------------
Fourth quarter -- $ 560 -- $ 22 -- $ 13 $ 595
Third quarter $ 27 70 -- 72 -- 618 787
Second quarter 451 499 -- 23 -- 518 1,491
First quarter 354 6 -- 24 $1,339 29 1,752
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 832 $1,135 -- $ 141 $1,339 $1,178 $4,625
====== ====== ====== ====== ====== ====== ======
- ------------------------------------------------------------------------------------------------------------------------------------
Figure 13 shows loans that are either administered or serviced by Key, but are
not recorded on the balance sheet. This includes loans that have been both
securitized and sold, or simply sold outright. 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 the
securitized assets retained.
FIGURE 13. LOANS ADMINISTERED OR SERVICED
JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30,
in millions 2001 2001 2000 2000 2000
- -------------------------------------------------------------------------------------------------------------------------
Education loans $ 4,305 $ 4,428 $ 4,113 $ 3,946 $ 3,783
Automobile loans 254 340 422 505 602
Home equity loans 965 1,085 1,176 1,266 1,361
Commercial real estate loans 7,549 6,549 5,322 4,071 3,700
Commercial loans 951 1,023 973 916 805
- -------------------------------------------------------------------------------------------------------------------------
Totalsecuritized $14,024 $13,425 $12,006 $10,704 $10,251
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------------
SECURITIES
At June 30, 2001, the securities portfolio totaled $7.9 billion and included
$6.7 billion of securities available for sale and $1.2 billion of investment
securities. In comparison, the total portfolio at December 31, 2000, was $8.5
billion, including $7.3 billion of securities available for sale and $1.2
billion of investment securities.
Figure 14 shows the composition, yields and remaining maturities of Key's
securities available for sale. Figure 15 provides the same information about
Key's investment securities. 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 14.
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FIGURE 14. 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)
- -------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2001
Remaining maturity:
One year or less $ 1 $1 $ 122 $ 1 $35
After one through five years 106 13 4,391 953 230
After five through ten years 5 14 206 229 --
After ten years 9 -- 176 29 --
- -------------------------------------------------------------------------------------------------------------------------------
Fair value $121 $28 $4,895 $1,212 $265
Amortized cost 120 28 4,877 1,192 252
Weighted average yield(b) 4.76 % 4.61 % 6.98 % 7.19 % 13.03 %
Weighted average maturity 3.1 years 5.1 years 3.2 years 4.1 years 3.4 years
- -------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2000
Fair value $984 $33 $4,298 $1,355 $316
Amortized cost 984 33 4,296 1,355 334
- -------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2000
Fair value $121 $56 $3,990 $1,518 $315
Amortized cost 121 56 4,185 1,551 335
- -------------------------------------------------------------------------------------------------------------------------------
WEIGHTED
OTHER AVERAGE
dollars in millions SECURITIES TOTAL YIELD(b)
- -----------------------------------------------------------------------------------
JUNE 30, 2001
Remaining maturity:
One year or less $13 $ 173 7.41 %
After one through five years 12 5,705 7.08
After five through ten years 7 461 7.75
After ten years 153(c) 367 8.64
- ------------------------------------------------------------------------------------
Fair value $185 $6,706 --
Amortized cost 183 6,652 7.20 %
Weighted average yield(b) 6.50 % 7.20 % --
Weighted average maturity 10.7 years 3.5 years --
- ------------------------------------------------------------------------------------
DECEMBER 31, 2000
Fair value $343 $7,329 --
Amortized cost 307 7,309 7.16 %
- ------------------------------------------------------------------------------------
JUNE 30, 2000
Fair value $249 $6,249 --
Amortized cost 259 6,507 6.88 %
- ------------------------------------------------------------------------------------
(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 that have no stated yield. Stated yields have been
adjusted to a taxable-equivalent basis using the statutory Federal income
tax rate of 35%.
(c) Includes equity securities with no stated maturity.
FIGURE 15. INVESTMENT SECURITIES
STATES AND WEIGHTED
POLITICAL OTHER AVERAGE
dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(a)
- ----------------------------------------------------------------------------------------------------------
JUNE 30, 2001
Remaining maturity:
One year or less $94 $ 4 $ 98 8.30 %
After one through five years 116 -- 116 9.73
After five through ten years 49 39 88 8.00
After ten years 3 866(b) 869 5.11
- ----------------------------------------------------------------------------------------------------------
Amortized cost $262 $909 $1,171 7.92 %
Fair value 273 909 1,182 --
Weighted average yield(a) 9.12 % 5.50 % 7.92 % --
Weighted average maturity 2.7 YEARS 10.0 YEARS 8.3 YEARS --
- ----------------------------------------------------------------------------------------------------------
DECEMBER 31, 2000
Amortized cost $323 $875 $1,198 8.16 %
Fair value 333 875 1,208 --
- ----------------------------------------------------------------------------------------------------------
JUNE 30, 2000
Amortized cost $380 $748 $1,128 4.30 %
Fair value 388 748 1,136 --
- ----------------------------------------------------------------------------------------------------------
(a) Weighted average yields are calculated based on amortized cost and exclude
equity securities that have no stated yield. Stated yields have been
adjusted to a taxable-equivalent basis using the statutory Federal income
tax rate of 35%.
(b) Includes equity securities with no stated maturity.
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ASSET QUALITY
Key manages asset quality by following procedures that address the issue from
many perspectives. Specifically, Key has professionals that:
- - evaluate and monitor the level of risk in credit-related assets;
- - formulate underwriting standards and guidelines for line management;
- - develop commercial and consumer credit policies and systems;
- - establish credit-related concentration limits;
- - review loans, leases and other corporate assets to evaluate credit quality;
and
- - review the adequacy of the allowance for loan losses.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses at June 30, 2001, was
$1.2 billion, or 1.85% of loans. This compares with $979 million, or 1.49%, at
June 30, 2000. The allowance includes $129 million (for 2001) and $92 million
(for 2000) that is specifically allocated for impaired loans. For more
information about impaired loans, see Note 7 ("Impaired Loans and Other
Nonperforming Assets") on page 17. At June 30, 2001, the allowance for loan
losses was 154.45% of nonperforming loans, compared with 179.63% at June 30,
2000.
Management estimates the appropriate level of the allowance for loan losses on a
quarterly (and at times more frequent) basis using an iterative methodology. The
methodology is described in Note 1 ("Summary of Significant Accounting
Policies") under the heading "Allowance for Loan Losses," on page 66 of Key's
2000 Annual Report to Shareholders. Since the allowance is established through
the provision for loan losses, this methodology also has a direct impact on the
level of the provision that Key records.
In the second quarter of 2001, Key recorded an additional provision for loan
losses in connection with management's decision to eliminate nonrelationship
lending in the leveraged financing and nationally syndicated lending businesses.
The added provision will be used to exit and resolve approximately $2.7 billion
in related commitments that were moved to a separate loan run-off portfolio. The
majority of these commitments are performing in accordance with their
contractual repayment terms. Approximately $2.4 billion of these commitments
were remaining as of June 30. As charge-offs or write-downs on the run-off
portfolio occur over time, the related allowance will not be replenished. Figure
16 segregates certain asset quality data at June 30, 2001, and for the
three-month period then ended, between Key's continuing and run-off loan
portfolios. In the prior year, Key's year-to-date provision for loan losses
includes an additional noncore provision of $121 million recorded in the first
quarter as a result of an enhancement in Key's methodology for assessing credit
risk.
FIGURE 16. SELECTED ASSET QUALITY DATA-CONTINUING AND RUNOFF LOAN PORTFOLIOS
THREE MONTHS ENDED
JUNE 30, 2001 JUNE 30, 2001
-------------------------------------------------------- --------------------------
Allowance for Loan Losses Net Loan Charge-offs
Loans ------------------------- Nonperforming --------------------------
dollars in millions Outstanding Amount % of Loans Loans Amount % of Loans
- -------------------------------------------------------------------------------------------------------------------------
Continuing loan portfolio $65,270 $ 1,002 1.54 % $ 555 $ 100 .61 %
Loan run-off portfolio 1,423 229 N/M 242 71 N/M
------- ------- ------- -------
Total loan portfolio $66,693 $ 1,231 1.85 % $ 797 $ 171 1.02 %
======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
NET LOAN CHARGE-OFFS. Net loan charge-offs for the second quarter of 2001 were
$171 million, or 1.02% of average loans, compared with $68 million, or .42%, for
the same period last year. For the first six months of 2001, net loan
charge-offs totaled $280 million, or .84% of average loans, compared with $202
million, or .63%, for the first half of 2000. The composition of Key's loan
charge-offs and recoveries by type of loan portfolio is shown in Figure 17. The
increase in net charge-offs relative to the year-ago quarter was primarily due
to aggressive efforts made to resolve credits within the commercial loan run-off
portfolio.
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50
As shown in Figure 16, this portfolio accounted for $71 million of total net
charge-offs recorded in the second quarter of 2001. In addition, net charge-offs
within the home equity portfolio rose by $23 million, reflecting the growth of
this portfolio, the accelerated disposition of certain nonperforming loans and
the impact of continued weakness in the economy. Management anticipates that the
level of Key's net charge-offs, relative to that of the second quarter of 2001,
will stabilize or decline in the third quarter.
FIGURE 17. SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ---------------------------
dollars in millions 2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------------
Average loans outstanding during the period $ 66,954 $ 64,817 $ 66,993 $ 64,420
- ---------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $ 1,001 $ 979 $ 1,001 $ 930
Loans charged off:
Commercial, financial and agricultural 91 37 144 71
Real estate-commercial mortgage 7 2 10 4
Commercial lease financing 10 3 13 7
- ---------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 108 42 167 82
Real estate-residential mortgage 5 3 7 4
Home equity 26 3 32 11
Credit card -- -- -- 16
Consumer-direct 12 9 24 29
Consumer-indirect lease financing 7 4 13 11
Consumer-indirect other 44 33 94 105
- ---------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 94 52 170 176
- ---------------------------------------------------------------------------------------------------------------------------------
202 94 337 258
Recoveries:
Commercial, financial and agricultural 7 4 14 14
Real estate-commercial mortgage 2 1 2 3
Commercial lease financing 3 -- 4 2
- ---------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 12 5 20 19
Real estate-residential mortgage 1 2 3 2
Home Equity 1 1 1 1
Credit card -- 2 -- 3
Consumer-direct 2 2 4 3
Consumer-indirect lease financing 2 -- 4 2
Consumer-indirect other 13 14 25 26
- ---------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 19 21 37 37
- ---------------------------------------------------------------------------------------------------------------------------------
31 26 57 56
- ---------------------------------------------------------------------------------------------------------------------------------
Net loans charged off (171) (68) (280) (202)
Provision for loan losses 401 68 511 251
Allowance related to loans sold, net -- -- (1) --
- ---------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $ 1,231 $ 979 $ 1,231 $ 979
======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans 1.02 % .42 % .84 % .63 %
Allowance for loan losses to period-end loans 1.85 1.49 1.85 1.49
Allowance for loan losses to nonperforming loans 154.45 179.63 154.45 179.63
- ---------------------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS. Figure 18 shows the composition of Key's nonperforming
assets. These assets totaled $823 million at June 30, 2001, and represented
1.23% of loans, other real estate owned (known as "OREO") and other
nonperforming assets, compared with $672 million, or 1.00%, at December 31,
2000, and $577 million, or .88%, at June 30, 2000. The increase in the level of
nonperforming assets in general is attributable to a number of factors,
including continued economic weakness, the significant growth of the loan
portfolio as a whole and the aging of certain segments of the portfolio. While
the economic slowdown is expected to continue to impact Key's loan portfolio
generally, the erosion in credit quality that we are experiencing is
disproportionately concentrated in three distinct commercial portfolios of
limited size: healthcare, agriculture and the leveraged lending sector of
structured finance. Although aggregate loans outstanding in these portfolios
account for only 5% of Key's total loans, these portfolios account for
approximately 29% of the commercial loans on nonperforming status at June 30,
2001. As shown in Figure 16, $242 million, or more than 30%, of Key's
nonperforming loans at June 30, 2001, are contained within the commercial loan
run-off portfolio.
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FIGURE 18. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2001 2000 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 384 $ 301 $ 224
Real estate-- commercial mortgage 128 90 95
Real estate-- construction 35 28 20
Commercial lease financing 83 48 54
- -----------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 630 467 393
Real estate-- residential mortgage 32 52 40
Home equity 90 80 68
Consumer-- direct 8 8 8
Consumer-- indirect lease financing 11 7 5
Consumer-- indirect other 26 36 31
- -----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 167 183 152
- -----------------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 797 650 545
OREO 27 23 30
Allowance for OREO losses (1) (1) (1)
- -----------------------------------------------------------------------------------------------------------------------------------
OREO, net of allowance 26 22 29
Other nonperforming assets -- -- 3
- -----------------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 823 $ 672 $ 577
===== ===== =====
- -----------------------------------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 280 $ 236 $ 276
Accruing loans past due 30 through 89 days 937 963 996
- -----------------------------------------------------------------------------------------------------------------------------------
Nonperforming loans to period-end loans 1.20% .97% .83%
Nonperforming assets to period-end loans
plus OREO and other nonperforming assets 1.23 1.00 .88
- -----------------------------------------------------------------------------------------------------------------------------------
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 second
quarter of 2001, core deposits averaged $37.6 billion, and represented 49% of
the funds Key used to support earning assets, compared with $37.4 billion and
51%, respectively, during the same period last year. As shown in Figure 5 (which
spans pages 37 and 38), the mix of Key's deposits has changed over the past
twelve months. The levels of money market deposits, savings deposits and NOW
accounts declined, while Key's time deposits have grown as a result of our
marketing efforts and client preferences for investments that offer higher
returns. Weaker conditions in the securities markets have also contributed to
the growth of time deposits, which offer a more stable rate of return than
equity investing alternatives. Average deposits in Key's Retail Banking division
grew by 4% from the year-ago quarter and allowed us to moderate our dependence
on higher-cost funds.
In comparison with the first quarter of 2001, Key's time deposits decreased by
$532 million, or 4%. This decline reflects actions taken by management to
aggressively reduce rates paid for deposits late in the first quarter and
throughout the second quarter. Due to competitive factors, the timing of our
reductions did not coincide with the rate reductions instituted by the Federal
Reserve earlier in the first quarter.
Purchased funds, comprising large certificates of deposit, deposits in the
foreign branch and short-term borrowings, averaged $20.9 billion during the
second quarter of 2001, compared with $19.5 billion a year ago. As shown in
Figure 5, Key has relied more heavily on purchased funds and long-term debt over
the past several quarters to fund earning assets. In addition, Key continues to
consider loan securitizations as a
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funding alternative when market conditions are favorable. No securitizations
were completed during the first half of 2001.
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
the needs of depositors, borrowers and creditors at a reasonable cost, on a
timely basis, and without adverse consequences. KeyCorp, the parent company, has
sufficient liquidity when it can pay dividends to shareholders, service its
debt, and support customary corporate operations and activities, including
acquisitions.
LIQUIDITY FOR KEY. Management actively analyzes and manages Key's liquidity. In
particular, 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. We also selectively
securitize and package loans for sale.
- - Our 926 full-service KeyCenters in 13 states generate a sizable volume of
core deposits. Key's Funding and Investment Management Group monitors
deposit flows and considers alternate 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 outstanding as of June 30, 2001.
LIQUIDITY FOR THE PARENT COMPANY. KeyCorp meets its liquidity requirements
principally through regular dividends from affiliate banks. During the first
half of 2001, affiliate banks paid KeyCorp a total of $19 million in dividends
and KeyCorp also received a $700 million distribution of surplus in the form of
cash from KeyBank National Association. As of June 30, 2001, the affiliate banks
had an additional $863 million available to pay dividends without prior
regulatory approval. Key generally maintains excess funds in short-term
investments.
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.
BANK NOTE PROGRAM. During the first six months of 2001, Key's affiliate banks
raised $3.1 billion under Key's bank note program. Of the notes issued during
this period of time, $639 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 up
to $20.0 billion ($19.0 billion by KeyBank National Association and $1.0 billion
by Key Bank USA, National Association). At June 30, 2001, Key Bank National
Association had $10.0 billion of debt outstanding under this program.
EURO NOTE PROGRAM. Under Key's euro note program, KeyCorp, KeyBank National
Association and Key Bank USA, National Association may issue both long- and
short-term debt of up to $10.0 billion in the
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53
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 $3.8 billion
of borrowings outstanding under this facility as of June 30, 2001, $50 million
of which were issued during the current year.
COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp has a commercial paper program
and a two-year revolving credit agreement that provide funding availability of
up to $500 million and $400 million, respectively. As of June 30, 2001, $33
million of borrowings were outstanding under the commercial paper program; no
amount was outstanding under the revolving credit agreement.
OTHER PUBLICLY ISSUED SECURITIES. KeyCorp has a universal shelf registration
statement on file with the Securities and Exchange Commission that provides for
the possible issuance of up to $1.5 billion of debt and equity securities in
addition to the unused capacity under a previous shelf registration. At June 30,
2001, unused capacity under the new shelf registration totaled $769 million,
including $269 million reserved for issuance as medium-term notes. Key has
favorable debt ratings, shown in Figure 19 below, and management believes that,
under normal conditions in the capital markets, any eventual offering of
securities would be well-received by investors at a competitive cost.
FIGURE 19. DEBT RATINGS
SENIOR SUBORDINATED
SHORT-TERM LONG-TERM LONG-TERM CAPITAL
June 30, 2001 BORROWINGS DEBT DEBT SECURITIES
- --------------------------------------------------------------------------------------------------
KeyCorp
- ----------------------------
Standard & Poor's A-2 A- BBB+ BBB
Moody's P-1 A1 A2 "al"
KEYBANK NATIONAL ASSOCIATION
- ----------------------------
Standard & Poor's A-1 A A- N/A
Moody's P-1 Aa3 A1 N/A
- --------------------------------------------------------------------------------------------------
N/A=Not Applicable
For more information about Key's sources and uses of cash for the six-month
periods ended June 30, 2001 and 2000, see the Consolidated Statements of Cash
Flow on page 6.
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CAPITAL AND DIVIDENDS
SHAREHOLDERS' EQUITY. Total shareholders' equity at June 30, 2001, was $6.5
billion, down $156 million from the balance at December 31, 2000, and $40
million from the end of the second quarter of 2000. The decrease in
shareholders' equity from the end of 2000 and the year-ago quarter was due
primarily to the decrease in retained earnings. Several nonrecurring charges
recorded in the second quarter of 2001 associated with the implementation of
recently-announced strategies caused the decline in retained earnings. Other
factors contributing to the change in shareholders' equity during the first six
months of 2001 are shown in the Statement of Changes in Shareholders' Equity
presented on page 5.
SHARE REPURCHASES. In light of Key's earnings outlook and strong capital
position, in September 2000 the Board of Directors authorized the repurchase of
25,000,000 common shares, including the 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 half of 2001, Key
did not repurchase any of its common shares. At June 30, 2001, a remaining
balance of 18,800,000 shares may be repurchased under the September 2000
authorization.
At June 30, 2001, Key had 66,930,892 treasury shares. Management expects to
reissue those shares over time to support the employee stock purchase, 401(k),
stock option, and dividend reinvestment plans, and for other corporate purposes.
During the first half of 2001, Key reissued 1,703,988 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 7.53% at June 30, 2001,
compared with 7.59% at December 31, 2000, and 7.68% at June 30, 2000.
Banking industry regulators prescribe minimum capital ratios for bank holding
companies and their banking subsidiaries. Risk-based capital guidelines require
a minimum level of capital as a percent of "risk-adjusted assets," which is
total assets plus certain off-balance sheet items that are 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-adjusted assets of
4.0%, and total capital as a percent of risk-adjusted assets of 8.0%. As of June
30, 2001, Key's Tier 1 capital ratio was 7.71%, and its total capital ratio was
11.81%.
The leverage ratio is 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 3.0%. All other bank holding companies must maintain a minimum ratio of 4%.
As of June 30, 2001, KeyCorp had a leverage ratio of 7.68%, which is
substantially higher than the minimum requirement.
Federal bank regulators group FDIC-insured depository institutions into the
following five categories based on certain capital ratios: "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
and "critically undercapitalized." Both of Key's affiliate banks qualified as
"well capitalized" at June 30, 2001, since each exceeded the prescribed
thresholds of 10% for total capital, 6% for Tier 1 capital and 5% for the
leverage ratio. If these provisions applied to bank holding companies, KeyCorp
would also qualify as "well capitalized" at June 30, 2001. The FDIC-defined
capital categories serve a limited regulatory function. Investors should not
treat them as a representation of the overall financial condition or prospects
of Key or its affiliates.
Figure 20 presents the details of Key's regulatory capital position at June 30,
2001, December 31, 2000 and June 30, 2000.
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FIGURE 20. CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2001 2000 2000
- ------------------------------------------------------------------------------------------------------------------------------
TIER 1 CAPITAL
Common shareholders' equity(a) $ 6,451 $ 6,609 $ 6,643
Qualifying capital securities 1,243 1,243 1,243
Less: Goodwill 1,141 1,324 1,357
Other intangible assets(b) 42 44 49
- ------------------------------------------------------------------------------------------------------------------------------
Total Tier 1 capital 6,511 6,484 6,480
- ------------------------------------------------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(c) 1,051 1,001 979
Net unrealized holding gains(d) 1 16 --
Qualifying long-term debt 2,402 2,136 2,191
- ------------------------------------------------------------------------------------------------------------------------------
Total Tier 2 capital 3,454 3,153 3,170
- ------------------------------------------------------------------------------------------------------------------------------
Total capital $ 9,965 $ 9,637 $ 9,650
======= ======= =======
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $70,899 $71,326 $69,733
Risk-adjusted off-balance sheet exposure 14,645 13,776 13,754
Less: Goodwill 1,141 1,324 1,357
Other intangible assets(b) 42 44 49
Plus: Market risk-equivalent assets 215 225 150
Net unrealized holding gains(d) 1 16 --
- ------------------------------------------------------------------------------------------------------------------------------
Gross risk-adjusted assets 84,577 83,975 82,231
Less: Excess allowance for loan losses(c) 180 -- --
- ------------------------------------------------------------------------------------------------------------------------------
Net risk-adjusted assets $84,397 $83,975 $82,231
======= ======= =======
AVERAGE QUARTERLY TOTAL ASSETS $85,987 $85,427 $83,405
======= ======= =======
CAPITAL RATIOS
Tier 1 risk-adjusted capital ratio 7.71 % 7.72 % 7.88 %
Total risk-adjusted capital ratio 11.81 11.48 11.74
Leverage ratio(e) 7.68 7.71 7.90
- ---------------------------------------------------------------------------------------------------------------------------
(a) Common shareholders' equity excludes net unrealized gains or losses on
securities, (except for net unrealized losses on marketable equity
securities) and net gains or losses on cash flow hedges.
(b) Intangible assets (excluding goodwill) recorded after February 19, 1992,
and deductible portions of purchased mortgage servicing rights.
(c) The allowance for loan losses included in Tier 2 capital is limited by
regulation to 1.25% of gross risk-adjusted assets, excluding those
with low-level recourse.
(d) Net unrealized holding gains included in Tier 2 capital are limited by
regulation to 45% of net unrealized holding gains on available for sale
equity securities with readily determinable fair values.
(e) Tier 1 capital divided by average quarterly total assets less goodwill and
other nonqualifying intangible assets as defined in footnote (b).
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information presented in the Market Risk Management section beginning on
page 40 of the Management's Discussion and Analysis of Financial Condition and
Results of Operations is incorporated herein by reference.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information presented in Note 11 ("Legal Proceedings"), beginning
on page 21, of the Notes to Consolidated Financial Statements is
incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the 2001 Annual Meeting of Shareholders of KeyCorp held on May 17,
2001, five directors were elected for three-year terms expiring in
2004, and shareholders adopted a resolution to ratify the appointment
by the Board of Directors of Ernst & Young LLP as independent auditors
for KeyCorp for the fiscal year ending December 31, 2001. Shareholders
approved a shareholder proposal requesting that the Board of Directors
take the necessary steps to cause annual election of all directors.
Director nominees for terms expiring in 2004 were: Cecil D. Andrus,
Alexander M. Cutler, Douglas J. McGregor, Henry L. Meyer III, and
Peter G. Ten Eyck, II. Directors whose term in office as a director
continued after the Annual Meeting of Shareholders were: William G.
Bares, Albert C. Bersticker, Edward P. Campbell, Dr. Carol A.
Cartwright, Kenneth M. Curtis, Robert W. Gillespie, Henry S.
Hemingway, Charles R. Hogan, Steven A. Minter, Bill R. Sanford, Ronald
B. Stafford, and Dennis W. Sullivan. After the Annual Meeting, Mr.
Gillespie retired as a Director, and the Board elected Thomas C.
Stevens to fill the vacancy created by Mr. Gillespie's retirement.
The vote on each issue was as follows:
For Against Abstain
------------------------------------------------
Election of Directors:
Cecil D. Andrus 357,134,850 * 17,443,095
Alexander M. Cutler 357,797,696 * 16,780,248
Douglas J. McGregor 357,562,138 * 17,015,806
Henry L. Meyer III 357,499,084 * 17,078,861
Peter G. Ten Eyck, II 357,454,048 * 17,123,897
Ratification of Ernst & Young as
independent auditors of KeyCorp 364,123,530 7,404,009 3,050,404
Shareholder proposal requesting
necessary steps to cause
annual election of all Directors 166,909,093 137,653,744 6,165,662 **
*Proxies provide that shareholders may either cast a vote for, or
abstain from voting for, directors.
**In addition, there were 63,849,446 broker non-votes on this matter.
ITEM 5. OTHER INFORMATION
FINANCIAL MODERNIZATION LEGISLATION. Effective in May of 2001, the
Gramm-Leach-Bliley Act repealed the blanket exception of banks and
savings associations from the definitions of "broker" and "dealer"
under the Securities Exchange Act of 1934, and replaced this full
exception with functional exceptions. Under the statute, these
institutions that engage in securities activities either must conduct
those activities through a broker-dealer or conform their securities
activities to those which qualify for functional exceptions. The
Securities and Exchange Commission issued interim final rules in May of
2001 which included exemptions providing these institutions
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with additional time within which to conform their securities
activities to those permitted by the statute. In July of 2001, the
Securities and Exchange Commission further extended this compliance
deadline to May of 2002.
SUBPRIME LENDING. In April of 2001, the Federal Banking agencies
clarified that the guidance provided to examiners in connection with
their examination of subprime lending programs was neither intended
nor considered by the agencies to be a capital regulation, and that
the guidance did not represent a change in policy by the agencies.
Moreover, the agencies specifically indicated that examiners would not
unilaterally require additional reserves or capital based upon the
guidance, and that any determination made by an examiner that an
institution's reserves or capital is deficient would be discussed with
the institution's management and each agency's appropriate supervisory
office before a final decision is made. Neither the Federal Reserve
Board nor the Office of the Comptroller of the Currency has advised
KeyCorp or any of its national bank subsidiaries of any such
deficiency.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(15) Acknowledgment Letter of Independent Auditors
(b) Reports on Form 8-K
April 18, 2001 - Item 5. Other Events, Item 7. Financial Statements
and Exhibits and Item 9. Regulation FD Disclosure. Reporting that on
April 18, 2001, the Registrant issued a press release announcing its
earnings results for the three-month period ended March 31, 2001, and
providing a slide presentation reviewed in the related conference
call/webcast.
May 17, 2001- Item 5. Other Events, Item 7. Financial Statements and
Exhibits and Item 9. Regulation FD Disclosure. Reporting that on May
17, 2001, the Registrant issued a press release announcing: (a) the
election of Henry L. Meyer III to the post of chairman, (b) the
election of Thomas C. Stevens to the Board of Directors and (c) the
Board's approval of a business plan to sharpen the Registrant's
strategic focus and business performance; and providing a slide
presentation reviewed in the related conference call/webcast.
No other reports on Form 8-K were filed during the three-month period
ended June 30, 2001.
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
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(Registrant)
Date: August 13, 2001 /s/ Lee Irving
----------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
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