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 March 31, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ______ To ______
Commission File Number 0-850
[KeyCorp LOGO]
------------------------------------------------------
(Exact name of registrant as specified in its
charter)
OHIO 34-6542451
- --------------------------------------------- -------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
- --------------------------------------------- -------------------------
(Address of principal executive offices) (Zip Code)
(216) 689-6300
------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate 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 425,961,013 Shares
- --------------------------------------------- -------------------------------
(Title of class) (Outstanding at April 30, 2002)
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
-------------------- -----------
Consolidated Balance Sheets --
March 31, 2002, December 31, 2001 and March 31, 2001 3
Consolidated Statements of Income --
Three months ended March 31, 2002 and 2001 4
Consolidated Statements of Changes in Shareholders' Equity --
Three months ended March 31, 2002 and 2001 5
Consolidated Statements of Cash Flow --
Three months ended March 31, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 28
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 29
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK 61
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 61
Item 5. OTHER INFORMATION 61
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 61
Signature 62
2
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 2002 2001 2001
===================================================================================================================================
(UNAUDITED) (UNAUDITED)
ASSETS
Cash and due from banks $ 2,483 $ 2,891 $ 2,484
Short-term investments 1,487 1,898 1,892
Securities available for sale 5,795 5,346 6,900
Investment securities (fair value: $1,152, $1,128 and $1,220) 1,144 1,119 1,208
Loans, net of unearned income of $1,803, $1,778 and $1,783 63,956 63,309 67,027
Less: Allowance for loan losses 1,607 1,677 1,001
- --------------------------------------------------------------------------------------------------------------------------------
Net loans 62,349 61,632 66,026
Premises and equipment 663 687 703
Goodwill 1,101 1,101 1,311
Corporate-owned life insurance 2,334 2,313 2,241
Accrued income and other assets 4,003 3,951 3,692
- --------------------------------------------------------------------------------------------------------------------------------
Total assets $ 81,359 $ 80,938 $ 86,457
======== ======== ========
LIABILITIES
Deposits in domestic offices:
Money market deposit accounts $ 12,902 $ 12,845 $ 12,603
Savings deposits 2,014 1,918 2,007
NOW Accounts 632 616 589
Certificates of deposit ($100,0000 or more) 4,505 4,493 6,128
Other time deposits 13,231 13,657 14,825
- --------------------------------------------------------------------------------------------------------------------------------
Total interest bearing 33,284 33,529 36,152
Noninterest-bearing 8,688 9,667 8,329
Deposits in foreign office-- interest-bearing 1,261 1,599 1,484
- --------------------------------------------------------------------------------------------------------------------------------
Total deposits 43,233 44,795 45,965
Federal funds purchased and securities sold under repurchase agreements 7,338 3,735 4,463
Bank notes and other short-term borrowings 3,174 5,549 8,721
Accrued expense and other liabilities 4,683 4,862 4,803
Long-term debt 15,256 14,554 14,495
Corporation-obligated mandatorily redeemable preferred capital securities
of subsidiary trusts holding solely subordinated debentures of KeyCorp (See Note 10) 1,273 1,288 1,308
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities 74,957 74,783 79,755
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 1,385 1,390 1,399
Retained earnings 6,096 5,856 6,444
Loans to ESOP trustee -- -- (13)
Treasury stock, at cost (66,434,962, 67,883,724 and 67,474,937 shares) (1,551) (1,585) (1,573)
Accumulated other comprehensive income (loss) (20) 2 (47)
- --------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,402 6,155 6,702
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 81,359 $ 80,938 $ 86,457
======== ======== ========
===================================================================================================================================
See Notes to Consolidated Financial Statements (Unaudited).
3
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
------------------------------------
dollars in millions, except per share amounts 2002 2001
===================================================================================================================================
INTEREST INCOME
Loans $ 985 $1,418
Taxable investment securities 6 7
Tax-exempt investment securities 3 5
Securities available for sale 89 120
Short-term investments 9 20
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest income 1,092 1,570
INTEREST EXPENSE
Deposits 250 460
Federal funds purchased and securities sold under repurchase agreements 23 70
Bank notes and other short-term borrowings 27 105
Long-term debt, including capital securities 138 247
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest expense 438 882
- -----------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 654 688
Provision for loan losses 136 110
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 518 578
NONINTEREST INCOME
Trust and investment services income 135 141
Investment banking and capital markets income 72 65
Service charges on deposit accounts 100 84
Corporate-owned life insurance income 26 27
Letter of credit and loan fees 28 29
Net securities gains -- 26
Other income 82 83
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 443 455
NONINTEREST EXPENSE
Personnel 363 364
Net occupancy 57 57
Computer processing 54 62
Equipment 34 38
Marketing 26 27
Amortization of intangibles 3 26
Professional fees 21 18
Other expense 103 106
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 661 698
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGE 300 335
Income taxes 60 117
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 240 218
Cumulative effect of accounting change, net of tax (see Note 14) -- (1)
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 240 $ 217
====== ======
Per common share:
Income before cumulative effect of accounting change $.56 $.51
Net income .56 .51
Income before cumulative effect of accounting change-- assuming dilution .56 .51
Net income-- assuming dilution .56 .51
Weighted average common shares outstanding (000) 424,855 424,024
Weighted average common shares and potential common
shares outstanding (000) 430,019 429,917
===================================================================================================================================
See Notes to Consolidated Financial Statements (Unaudited).
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
LOANS TO
COMMON CAPITAL RETAINED ESOP
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 $492 $1,402 $6,352 $(13)
Net income 217
Other comprehensive income (losses):
Net unrealized losses on securities available
for sale, net of income taxes of ($1) (a)
Cumulative effect of change in accounting for
derivative financial instruments, net of income
taxes of ($12)
Net unrealized losses on derivative financial instruments,
net of income taxes of ($7)
Foreign currency translation adjustments
Total comprehensive income
Cash dividends declared on common shares ($.295 per share) (125)
Issuance of common shares:
Acquisition-- 370,830 shares
Employee benefit and dividend reinvestment
plans-- 789,113 net shares (3)
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2001 $492 $1,399 $6,444 $(13)
==== ======= ======= =====
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 $492 $1,390 $5,856 --
Net income 240
Other comprehensive income (losses):
Net unrealized losses on securities available
for sale, net of income taxes of ($13) (a)
Net unrealized gains on derivative financial instruments,
net of income taxes of $1
Foreign currency translation adjustments
Total comprehensive income
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 1,448,762 net shares (5)
- -------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2002 $492 $1,385 $6,096 --
==== ======= ======= ====
=========================================================================================================================
ACCUMULATED
TREASURY OTHER
STOCK COMPREHENSIVE COMPREHENSIVE
dollars in millions, except per share amounts AT COST INCOME (LOSS) INCOME
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 $(1,600) $(10)
Net income $217
Other comprehensive income (losses):
Net unrealized losses on securities available
for sale, net of income taxes of ($1) (a) (9) (9)
Cumulative effect of change in accounting for
derivative financial instruments, net of income
taxes of ($12) (22) (22)
Net unrealized losses on derivative financial instruments,
net of income taxes of ($7) (11) (11)
Foreign currency translation adjustments 5 5
----------
Total comprehensive income $180
=====
Cash dividends declared on common shares ($.295 per share)
Issuance of common shares:
Acquisition-- 370,830 shares
Employee benefit and dividend reinvestment 9
plans-- 789,113 net shares 18
- -------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2001 $(1,573) $(47)
======== =====
- -------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 $(1,585) $ 2
Net income $240
Other comprehensive income (losses):
Net unrealized losses on securities available
for sale, net of income taxes of ($13) (a) (24) (24)
Net unrealized gains on derivative financial instruments,
net of income taxes of $1 3 3
Foreign currency translation adjustments (1) (1)
----------
Total comprehensive income $218
Issuance of common shares: ====
Employee benefit and dividend reinvestment
plans-- 1,448,762 net shares 34
- -------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2002 $(1,551) $(20)
======== =====
===========================================================================================
(a) Net of reclassification adjustments.
See Notes to Consolidated Financial Statements (Unaudited).
5
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 2002 2001
- -------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 240 $ 217
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 136 110
Cumulative effect of accounting change, net of tax -- 1
Depreciation expense and software amortization 61 71
Amortization of intangibles 3 26
Net securities gains -- (26)
Net (gains) losses from venture capital investments (1) 16
Net gains from loan securitizations and sales (6) (5)
Deferred income taxes (6) 43
Net (increase) decrease in mortgage loans held for sale 167 (190)
Net increase in trading account assets (95) (132)
Net decrease in accrued restructuring charges (7) (22)
Other operating activities, net (162) (66)
- ------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 330 43
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (1,476) (744)
Purchases of loans -- (107)
Proceeds from loan securitizations and sales 450 796
Purchases of investment securities (35) (55)
Proceeds from sales of investment securities 13 26
Proceeds from prepayments and maturities of investment securities 17 26
Purchases of securities available for sale (1,511) (1,751)
Proceeds from sales of securities available for sale 84 110
Proceeds from prepayments and maturities of securities available for sale 936 2,082
Net decrease in other short-term investments 506 124
Purchases of premises and equipment (15) (20)
Proceeds from sales of premises and equipment 5 --
Proceeds from sales of other real estate owned 7 10
Cash used in acquisitions, net of cash acquired -- (3)
- ------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (1,019) 494
FINANCING ACTIVITIES
Net decrease in deposits (1,555) (2,700)
Net increase in short-term borrowings 1,228 1,278
Net proceeds from issuance of long-term debt, including capital securities 2,055 1,256
Payments on long-term debt, including capital securities (1,336) (962)
Net proceeds from issuance of common stock 16 11
Cash dividends paid (127) (125)
- ------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 281 (1,242)
- ------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND DUE FROM BANKS (408) (705)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 2,891 3,189
- ------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 2,483 $ 2,484
======= =======
=======================================================================================================
Additional disclosures relative to cash flow:
Interest paid $ 396 $ 953
Income taxes paid (refunded) 9 (8)
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).
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited condensed consolidated interim financial statements include the
accounts of KeyCorp and its subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation. 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
2001 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 2002
GOODWILL AND OTHER INTANGIBLE ASSETS. "Goodwill" represents the amount by which
the cost of net assets acquired exceeds their fair value. "Other intangibles"
currently represent primarily the net present value of future economic benefits
to be derived from the purchase of core deposits.
Effective January 1, 2002, Key adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." The new
standard replaces Accounting Principles Board Opinion No. 17, "Intangible
Assets," and eliminates the amortization of goodwill and intangible assets
deemed to have indefinite lives. This change will reduce Key's noninterest
expense and increase its net income by approximately $80 million, or $.19 per
share, for 2002.
Under the new accounting standard, goodwill and certain intangible assets are
subject to impairment testing, which must be conducted at least annually. The
first step in this testing requires Key to determine the fair value of its
reporting units by using various valuation techniques recommended by the
standard. The fair value of each reporting unit is compared with its carrying
amount. If the fair value of a particular reporting unit exceeds its carrying
amount, no impairment is indicated and further testing is not required. If the
carrying amount of any reporting unit exceeds its fair value, goodwill
impairment may be indicated and the second step of this testing is required. Key
would assume that the purchase price of the reporting unit is the fair value as
determined in the first step and then allocate that purchase price to the fair
value of the assets (excluding goodwill) and liabilities of the reporting unit.
Any excess of the purchase price over the fair value of the reporting unit's
assets and liabilities represents the implied fair value of goodwill. An
impairment loss would be recognized, as a charge to earnings, to the extent that
the carrying amount of the reporting unit's recorded goodwill exceeds the
implied fair value of goodwill.
Any impairment losses that result from the initial application of SFAS No. 142
would be accounted for as a "cumulative effect of accounting change" on Key's
income statement. Transitional impairment tests to determine the amount of any
such losses must be completed no later than December 31, 2002. Key completed its
transitional goodwill impairment testing during the first quarter of 2002, and
determined that no impairment existed as of January 1, 2002. Any future
impairment losses will be recorded as part of income from operations.
For additional information pertaining to Key's intangible assets and the effect
of adopting SFAS No. 142, see Note 8 ("Goodwill and Other Intangible Assets"),
on page 17.
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. Effective January 1, 2002, Key
adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." The new standard maintains the previous accounting for the impairment
or disposal of long-lived assets, but also establishes more
7
restrictive criteria that have to be met to classify such an asset as "held for
sale." SFAS No. 144 also increases the range of dispositions that qualify for
reporting as discontinued operations, and changes the manner in which expected
future operating losses from such operations are to be reported.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
ASSET RETIREMENT OBLIGATIONS. In August 2001, the FASB issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." The new standard takes effect for
fiscal years beginning after June 15, 2002. SFAS No. 143 addresses the
accounting for obligations associated with the retirement of tangible long-lived
assets and requires a liability to be recognized for the fair value of these
obligations in the period they are incurred. Related costs are capitalized as
part of the carrying amounts of the assets to be retired and amortized over the
assets' useful lives. Key will adopt SFAS No. 143 as of January 1, 2003.
Management is evaluating the extent to which it may affect Key's financial
condition and results of operations.
2. EARNINGS PER COMMON SHARE
Key calculates its basic and diluted earnings per common share as follows:
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions, except per share amounts 2002 2001
- -------------------------------------------------------------------------------------------------
EARNINGS
Income before cumulative effect of accounting change $240 $218
Net income 240 217
- -------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 424,855 424,024
Effect of dilutive common stock options (000) 5,164 5,893
- -------------------------------------------------------------------------------------------------
Weighted average common shares and potential
common shares outstanding (000) 430,019 429,917
======= =======
- -------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Income per common share before cumulative effect of accounting change $.56 $.51
Net income per common share .56 .51
Income per common share before cumulative effect of accounting change
-- assuming dilution .56 .51
Net income per common share - assuming dilution .56 .51
- -------------------------------------------------------------------------------------------------
3. ACQUISITION
On January 2, 2001, Key purchased The Wallach Company, Inc., an investment
banking firm headquartered in Denver, Colorado. Key paid the purchase price of
approximately $11 million using a combination of cash and 370,830 Key common
shares. Goodwill of approximately $9 million was recorded and, through December
31, 2001, was being amortized using the straight-line method over a period of 10
years.
8
4. LINE OF BUSINESS RESULTS
Key has three major business groups that consist of 10 lines of business:
KEY CONSUMER BANKING GROUP
RETAIL BANKING provides individuals with branch-based deposit, investment and
credit products and personal finance services.
SMALL BUSINESS provides small businesses with deposit, investment and credit
products and business advisory services.
INDIRECT LENDING offers automobile, marine and recreational vehicle (RV) loans
to consumers through dealers, and finances inventory for automobile, marine and
RV dealers. For students and their parents, it also provides education loans,
insurance and interest-free payment plans.
NATIONAL HOME EQUITY provides prime and near-prime mortgage and home equity loan
products to individuals. It originates these products outside of Key's retail
branch system. It also works with mortgage brokers and home improvement
contractors to provide home equity and home improvement solutions.
KEY CORPORATE FINANCE GROUP
CORPORATE BANKING provides financing, cash and investment management and
business advisory services to middle-market companies and large corporations.
NATIONAL COMMERCIAL REAL ESTATE provides construction and interim lending,
permanent debt placements and servicing, and equity and investment banking
services to developers, brokers and owner-investors.
NATIONAL EQUIPMENT FINANCE meets the equipment leasing needs of companies
worldwide and provides equipment manufacturers, distributors and resellers with
equipment financing options for their clients. Lease financing receivables and
related revenues are assigned to Corporate Banking or National Commercial Real
Estate if one of those businesses is principally responsible for maintaining the
relationship with the client.
KEY CAPITAL PARTNERS GROUP
VICTORY CAPITAL MANAGEMENT manages or advises investment portfolios, nationally,
for corporations, labor unions, not-for-profit organizations, governments and
individuals. These portfolios may be managed in separate accounts, commingled
funds or the Victory family of mutual funds. It also provides administrative
services for retirement plans.
HIGH NET WORTH Offers financial, estate and retirement planning and asset
management services. Its solutions address clients' banking, brokerage, trust,
portfolio management, insurance, charitable giving and related needs.
CAPITAL MARKETS offers investment banking, capital raising, hedging strategies,
trading and financial strategies to public and privately held companies,
institutions and government organizations.
In addition to the three major business groups, Key has "Other Segments"
consisting of Treasury, Principal Investing and the net effect of funds transfer
pricing.
The table that spans the top of pages 11 and 12 shows selected financial data
for each major business group for the three-month periods ended March 31, 2002
and 2001. This table is accompanied by additional supplemental information for
each of the lines of business that comprise these groups. 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 the businesses. As such:
9
- - Net interest income is 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 "Other Segments" columns.
- - Indirect expenses, such as computer servicing costs and corporate
overhead, are allocated based on the extent to which each line actually
uses the services.
- - The provision for loan losses reflects credit quality expectations 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 management uses to estimate Key's
consolidated allowance for loan losses. This methodology is described
in Note 1 ("Summary of Significant Accounting Policies") under the
heading "Allowance for Loan Losses," on page 59 of Key's 2001 Annual
Report to Shareholders.
- - Income taxes are allocated based on the statutory Federal income tax
rate of 35% (adjusted for tax-exempt income from corporate-owned life
insurance and tax credits associated with investments in low-income
housing projects) and a blended state income tax rate (net of the
Federal income tax benefit) of 2%.
- - Capital is assigned based on management's assessment of economic risk
factors (primarily credit, operating and market risk).
Developing and applying the methodologies that management uses to allocate items
among Key's lines of business is a dynamic process. Accordingly, financial
results may be revised periodically to reflect accounting enhancements, changes
in the risk profile of a particular business or changes in Key's structure. The
financial data presented in the following tables reflect the following changes
that occurred during the first quarter of 2002:
- - The Small Business line of business moved from Key Corporate Finance to
Key Consumer Banking.
- - Methodologies used to allocate certain overhead costs were refined.
- - The use of revenue and expense sharing was discontinued. Under this
approach, noninterest income and expense attributable to Key Capital
Partners had been assigned to the other business groups if one of those
groups was principally responsible for maintaining the relationship
with the client that used Key Capital Partner's products and services.
Accounting principles generally accepted in the United States guide financial
accounting, but there is no authoritative guidance for "management
accounting"--the way management uses its judgment and experience to make
reporting decisions. Consequently, the line of business results Key reports may
not be comparable with results presented by other companies.
10
<Table>
<Caption>
THREE MONTHS ENDED MARCH 31, KEY CONSUMER KEY CORPORATE KEY CAPITAL
BANKING GROUP FINANCE GROUP PARTNERS GROUP
------------------------ --------------------------- -----------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ 442 $ 442 $ 284 $ 262 $ 52 $ 53
Noninterest income 116 119 57 53 224 243
- --------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) 558 561 341 315 276 296
Provision for loan losses 62 55 45 43 2 3
Depreciation and amortization expense 37 56 11 16 16 24
Noninterest expense 296 285 111 118 200 217
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable
equivalent) and cumulative effect of
accounting change 163 165 174 138 58 52
Allocated income taxes and taxable-
equivalent adjustments 61 66 65 53 22 22
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of
accounting change 102 99 109 85 36 30
Cumulative effect of accounting change ___ ___ ___ ___ ___ ___
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 102 $ 99 $ 109 $ 85 $ 36 $ 30
======= ======= ======= ======= ======= =======
Percent of consolidated net income 43% 46% 45% 39% 15% 14%
Percent of total segments net income 43 44 45 38 15 14
- --------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $27,248 $28,025 $29,829 $31,308 $ 4,781 $ 5,561
Total assets(a) 29,421 30,887 31,065 32,766 8,089 9,069
Deposits 34,286 36,103 3,156 3,083 3,675 3,904
- --------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs $ 82 $ 67 $ 121 $ 41 $ 3 $ 1
Return on average allocated equity 21.09% 17.09% 15.80% 12.49% 15.46% 11.39%
- --------------------------------------------------------------------------------------------------------------------------------
Supplementary information (Key Consumer Banking lines of business)
THREE MONTHS ENDED MARCH 31, RETAIL BANKING SMALL BUSINESS INDIRECT LENDING NATIONAL HOME EQUITY
------------------- ---------------------- ----------------------- ---------------------
dollars in millions 2002 2001 2002 2001 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 312 $ 325 $ 95 $ 89 $ 91 $ 106 $ 60 $ 41
Provision for loan losses 13 12 9 9 28 28 12 6
Noninterest expense 198 215 41 42 48 49 46 35
Net income 63 59 28 23 10 18 1 (1)
Net loan charge-offs 14 13 15 9 38 43 11 3
Return on average allocated equity 48.65% 38.59% 37.82% 27.68% 5.74% 7.30% 1.21% (.48)
Full-time equivalent employees 6,038 6,357 259 275 753 806 1,408 1,245
- -----------------------------------------------------------------------------------------------------------------------------------
Supplementary information (Key Corporate Finance lines of business)
THREE MONTHS ENDED MARCH 31, CORPORATE BANKING NATIONAL COMMERCIAL REAL ESTATE NATIONAL EQUIPMENT FINANCE
----------------- ------------------------------- --------------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $188 $191 $ 91 $ 82 $ 62 $ 42
Provision for loan losses 25 24 11 10 9 9
Noninterest expense 73 83 29 27 20 24
Net income 56 52 32 28 21 5
Net loan charge-offs 104 37 3 2 14 2
Return on average allocated equity 13.70% 12.79% 17.84% 16.37% 20.76% 5.12%
Full-time equivalent employees 638 754 503 481 609 685
- ------------------------------------------------------------------------------------------------------------------------------
Supplementary information (Key Capital Partners lines of business)
THREE MONTHS ENDED MARCH 31, VICTORY CAPITAL MANAGEMENT HIGH NET WORTH CAPITAL MARKETS
-------------------------- --------------------- -------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 53 $ 56 $ 145 $ 159 $ 78 $ 81
Provision for loan losses -- -- 2 3 -- --
Noninterest expense 40 45 119 133 57 63
Net income 8 7 15 13 13 10
Net loan charge-offs -- -- 3 1 -- --
Return on average allocated equity 27.96% 19.63% 13.59% 10.13% 13.62% 10.32%
Full-time equivalent employees 465 476 2,706 2,845 540 559
- -------------------------------------------------------------------------------------------------------------------------
11
OTHER SEGMENTS TOTAL SEGMENTS RECONCILING ITEMS KEY
- ----------------------------- ------------------------ --------------------- ------------------------
2002 2001 2002 2001 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------
$(53) $(33) $725 $724 $(23) $(29) $702 $695
33 38 430 453 13 2 443 455
- ------------------------------------------------------------------------------------------------------------------
(20) 5 1,155 1,177 (10)(b) (27)(b) 1,145 1,150
1 1 110 102 26 8 136 110
-- -- 64 96 -- -- 64 96
6 6 613 626 (16) (24) 597 602
- ------------------------------------------------------------------------------------------------------------------
(27) (2) 368 353 (20) (11) 348 342
(20) (12) 128 129 (20) (5) 108 124
- ------------------------------------------------------------------------------------------------------------------
(7) 10 240 224 -- (6) 240 218
-- (1) -- (1) -- -- -- (1)
- ------------------------------------------------------------------------------------------------------------------
$ (7) $9 $240 $223 -- $ (6) $240 $217
===== === ===== ===== ====== ===== ===== =====
(3)% 4% 100% 103% -% (3)% 100% 100%
(3) 4 100 100 N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------
$1,444 $2,040 $63,302 $66,934 $186 $ 99 $63,488 $67,033
10,586 12,093 79,161 84,815 1,710(c) 1,509(c) 80,871 86,324
2,941 3,658 44,058 46,748 (89) (24) 43,969 46,724
- ------------------------------------------------------------------------------------------------------------------
-- -- $206 $109 -- -- $206 $109
(6.73)% 7.35% 16.00% 13.56% N/M N/M 15.53% 13.28%
- ------------------------------------------------------------------------------------------------------------------
(a) Substantially all revenue generated by Key's major business groups is
derived from clients resident in the United States. Substantially all
long-lived assets, including premises and equipment, capitalized software
and goodwill, held by Key's major business groups are located in the United
States.
(b) "Reconciling items"include 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.
(c) Total assets represent primarily the unallocated portion of nonearning
assets of corporate support functions.
N/A = Not Applicable
N/M = Not Meaningful
12
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 ($692 million, $597 million and $875
million at March 31, 2002, December 31, 2001 and March 31, 2001, 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.
The equity securities consist mainly of investments held in Key's Principal
Investing unit. Principal investments include direct and indirect investments
predominantly in privately held companies. These investments are carried at
estimated fair value as determined by management. Changes in estimated fair
values and actual gains and losses on sales of these investments are included in
"investment banking and capital markets income" on the income statement.
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. Unrealized gains and
losses (net of income taxes) deemed temporary are recorded in shareholders'
equity as a component of "accumulated other comprehensive income (loss)." Actual
gains and losses on 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 loans it securitizes, it bears the risk that the
loans will be prepaid (which would reduce interest income) or not paid at all.
Key accounts for these retained interests (which include both certificated and
uncertificated interests) as debt securities, classifying them as available for
sale or as trading account assets.
The amortized cost, unrealized gains and losses, and approximate fair value of
Key's investment securities and securities available for sale were as follows:
MARCH 31, 2002
------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 216 $ 8 -- $ 224
Other securities 928 -- -- 928
- --------------------------------------------------------------------------------------
Total investment securities $1,144 $ 8 -- $1,152
====== ====== ==== ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 97 -- -- $ 97
States and political subdivisions 20 -- -- 20
Collateralized mortgage obligations 4,409 $ 67 $ 97 4,379
Other mortgage-backed securities 900 23 -- 923
Retained interests in securitizations 195 27 -- 222
Other securities 169 -- 15 154
- --------------------------------------------------------------------------------------
Total securities available for sale $5,790 $ 117 $112 $5,795
====== ====== ==== ======
- --------------------------------------------------------------------------------------
13
DECEMBER 31, 2001
------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 225 $ 9 -- $ 234
Other securities 894 -- -- 894
- --------------------------------------------------------------------------------------
Total investment securities $1,119 $ 9 -- $1,128
====== ====== ==== ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 99 -- -- $ 99
States and political subdivisions 21 -- -- 21
Collateralized mortgage obligations 3,791 $ 86 $ 72 3,805
Other mortgage-backed securities 1,008 24 -- 1,032
Retained interests in securitizations 214 20 -- 234
Other securities 170 1 16 155
- --------------------------------------------------------------------------------------
Total securities available for sale $5,303 $ 131 $ 88 $5,346
====== ====== ==== ======
======================================================================================
MARCH 31, 2001
------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 316 $ 12 -- $ 328
Other securities 892 -- -- 892
- --------------------------------------------------------------------------------------
Total investment securities $1,208 $ 12 -- $1,220
====== ====== ==== ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 220 -- -- $ 220
States and political subdivisions 31 -- -- 31
Collateralized mortgage obligations 4,680 $ 85 $ 57 4,708
Other mortgage-backed securities 1,289 20 3 1,306
Retained interests in securitizations 320 -- 33 287
Other securities 350 4 6 348
- --------------------------------------------------------------------------------------
Total securities available for sale $6,890 $ 109 $ 99 $6,900
====== ====== ==== ======
======================================================================================
14
6. LOANS
Key's loans by category are summarized as follows:
MARCH 31, DECEMBER 31, MARCH 31,
in millions 2002 2001 2001
=================================================================================================================
Commercial, financial and agricultural $18,247 $18,159 $20,214
Commercial real estate:
Commercial mortgage 6,531 6,669 6,873
Construction 5,884 5,878 5,351
- ----------------------------------------------------------------------------------------------------------------
Total commercial real estate loans 12,415 12,547 12,224
Commercial lease financing 7,318 7,357 7,091
- ----------------------------------------------------------------------------------------------------------------
Total commercial loans 37,980 38,063 39,529
Real estate - residential mortgage 2,195 2,315 4,125
Home equity 12,662 11,184 10,288
Consumer - direct 2,256 2,342 2,425
Consumer - indirect:
Lease financing 1,669 2,036 2,855
Automobile 2,367 2,497 2,759
Marine 1,821 1,780 1,663
Other 968 1,036 1,201
- ----------------------------------------------------------------------------------------------------------------
Total consumer - indirect loans 6,825 7,349 8,478
- ----------------------------------------------------------------------------------------------------------------
Total consumer loans 23,938 23,190 25,316
Loans held for sale:
Real estate - commercial mortgage 186 252 491
Real estate - residential mortgage 15 116 57
Education 1,837 1,688 1,634
- ----------------------------------------------------------------------------------------------------------------
Total loans held for sale 2,038 2,056 2,182
- ----------------------------------------------------------------------------------------------------------------
Total loans $63,956 $63,309 $67,027
======= ======= =======
================================================================================================================
Key uses interest rate swaps to manage interest rate risk; these swaps modify
the repricing and maturity characteristics of certain loans. For more
information about such swaps at March 31, 2002, see Note 14 ("Derivatives and
Hedging Activities"), which begins on page 25.
Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 2002 2001
- -------------------------------------------------------------------------------
Balance at beginning of period $ 1,677 $ 1,001
Charge-offs (233) (135)
Recoveries 27 26
- -------------------------------------------------------------------------------
Net charge-offs (206) (109)
Allowance related to loans sold -- (1)
Provision for loan losses 136 110
- -------------------------------------------------------------------------------
Balance at end of period $ 1,607 $ 1,001
======= =======
===============================================================================
15
7. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
At March 31, 2002, impaired loans totaled $685 million. This amount includes
$453 million of impaired loans with a specifically allocated allowance for loan
losses of $176 million, and $232 million of impaired loans that are carried at
their estimated fair value without a specifically allocated allowance. At the
end of 2001, impaired loans totaled $661 million, including $417 million of
loans with a specifically allocated allowance of $180 million, and $244 million
that were carried at their estimated fair value. Impaired loans averaged $673
million and $396 million for the first quarters of 2002 and 2001, respectively.
Key's nonperforming assets were as follows:
MARCH 31, DECEMBER 31, MARCH 31,
in millions 2002 2001 2001
================================================================================================================
Impaired loans $ 685 $661 $395
Other nonaccrual loans 288 249 318
- --------------------------------------------------------------------------------------------------------------
Total nonperforming loans 973 910 713
OREO 41 38 28
Allowance for OREO losses (2) (1) (1)
- ---------------------------------------------------------------------------------------------------------------
OREO, net of allowance 39 37 27
- ---------------------------------------------------------------------------------------------------------------
Total nonperforming assets $1,012 $947 $740
====== ==== ====
================================================================================================================
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 flows or collateral values do not
justify the carrying amount of the loan, the amount that management deems
uncollectible (the impaired amount) is charged against the allowance for loan
losses. Even when collateral value or other sources of repayment appear
sufficient, if management remains uncertain about whether the loan will be
repaid in full, an amount is specifically allocated in the allowance for loan
losses.
However, Key does not perform a specific impairment valuation for
smaller-balance, homogeneous, nonaccrual loans (shown in the preceding table as
"Other nonaccrual loans"). Generally, these include residential mortgages and
automobile and marine loans. Instead, management applies historical loss
experience rates to these loans, adjusted to reflect emerging credit trends and
other factors, and then allocates a portion of the allowance for loan losses to
each loan type.
16
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, Key adopted SFAS No. 142, which eliminates the
amortization of goodwill and intangible assets deemed to have indefinite lives.
Key's total amortization expense for the three-month periods ended March 31,
2002 and 2001 was $3 million and $26 million, respectively. Estimated
amortization expense for the next five years is as follows: 2002 -- $11 million;
2003 -- $10 million; 2004 -- $6 million; 2005 -- $1 million; and 2006 -- $1
million. The computation of Key's net income and earnings per common share,
excluding goodwill amoritization for the three-month period ended March 31,
2001, is presented below.
THREE MONTHS ENDED MARCH 31,
--------------------------------
dollars in millions, except per share amounts 2002 2001
- -------------------------------------------------------------------------------------------------------------
EARNINGS
Net income $ 240 $ 217
Add: Goodwill amortization -- 22
- ----------------------------------------------------------------------------------------------------------
Adjusted net income $ 240 $ 239
======== ========
- ----------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 424,855 424,024
Weighted average common shares and potential common shares outstanding (000) 430,019 429,917
- ----------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per common share $ .56 $ .51
Add: Goodwill amortization -- .05
- ----------------------------------------------------------------------------------------------------------
Adjusted net income per common share $ .56 $ .56
======== ========
Adjusted net income per common share -- assuming dilution $ .56 $ .56
======== ========
==========================================================================================================
The following table shows the gross carrying amount and the accumulated
amortization of intangible assets that are subject to amortization.
MARCH 31, 2002 DECEMBER 31, 2001
-------------------------------- ---------------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
IN MILLIONS AMOUNT AMORTIZATION AMOUNT AMORTIZATION
=======================================================================================================================
Intangible assets subject to amortization:
Core deposit intangibles $215 $189 $215 $187
Other intangible assets 8 6 9 6
- ----------------------------------------------------------------------------------------------------------------------
Total $223 $195 $224 $193
==== ==== ==== ====
=======================================================================================================================
At March 31, 2002 and December 31, 2001, the carrying amount of goodwill by
major business group was as follows: Key Consumer Banking -- $446 million; Key
Corporate Finance -- $200 million; and Key Capital Partners -- $455 million. For
additional information pertaining to the new accounting guidance, see the
section entitled "Accounting Pronouncements Adopted in 2002" included in Note 1
("Basis of Presentation") starting on page 7.
17
9. LONG-TERM DEBT
The components of Key's long-term debt, presented net of unamortized discount
where applicable, were as follows:
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 2002 2001 2001
================================================================================================
Senior medium-term notes due through 2005(a) $ 1,286 $ 1,286 $ 546
Subordinated medium-term notes due through 2005(a) 85 85 103
Senior euro medium-term notes due through 2003(b) 50 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) 200 200 200
8.00% Subordinated notes due 2004(c) 125 125 125
8.404% Notes due through 2001 -- -- 13
All other long-term debt(i) 10 16 15
- -------------------------------------------------------------------------------------------------
Total parent company(j) 2,206 2,212 1,452
Senior medium-term bank notes due through 2039(d) 3,875 4,525 5,725
Senior euro medium-term bank notes due through 2007(e) 4,905 3,989 3,814
6.50% Subordinated remarketable securities due 2027(f) 311 311 312
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) 608 506 506
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) 479 519 569
Federal Home Loan Bank advances due through 2030(h) 1,164 762 453
All other long-term debt(i) 248 270 204
- -------------------------------------------------------------------------------------------------
Total subsidiaries 13,050 12,342 13,043
- -------------------------------------------------------------------------------------------------
Total long-term debt $15,256 $14,554 $14,495
======= ======= =======
================================================================================================
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 March 31, 2002, see Note 14
("Derivatives and Hedging Activities"),which begins on page 25.
(a) At March 31, 2002, December 31, 2001 and March 31,2001, the senior
medium-term notes had weighted average interest rates of 2.13%, 2.51% and
5.58%, respectively, and the subordinated medium-term notes had a weighted
average interest rate of 7.42%, 7.42% 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 2.10%
at March 31, 2002. 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 2.46%, 2.45% and 5.47%, at March 31, 2002, December 31, 2001 and
March 31, 2001, respectively. These notes had a combination of fixed and
floating interest rates.
(e) Senior euro medium-term notes had weighted average interest rates of 2.30%,
2.58%, and 6.15%, at March 31, 2002, December 31, 2001 and March 31, 2001,
respectively. These notes, which are obligations of KeyBank National
Association, had fixed interest rates and floating interest rates based on
LIBOR.
18
(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 7.36% at March
31, 2002, 7.41% at December 31, 2001 and 7.79% at March 31, 2001. This
category of debt consists of primarily 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 2.01% at March 31, 2002, 2.19% at December 31, 2001 and
5.23% at March 31, 2001. These advances, which had a combination of fixed
and floating interest rates, were secured by $1.7 billion, $1.1 billion,
and $679 million of real estate loans and securities at March 31, 2002,
December 31, 2001 and March 31, 2001, respectively.
(i) Other long-term debt, consisting of industrial revenue bonds, capital lease
obligations, and various secured and unsecured obligations of corporate
subsidiaries, had weighted average interest rates of 6.63%, 6.72%, and
7.88% at March 31, 2002, December 31, 2001 and March 31, 2001,
respectively.
(j) At March 31, 2002, unused capacity under KeyCorp's shelf registration
totaled $2.2 billion, including $1.0 billion reserved for issuance as
medium-term notes.
10. CAPITAL SECURITIES
KeyCorp has five subsidiary business trusts that have issued
corporation-obligated mandatorily redeemable preferred capital securities
("capital securities"), which are carried as liabilities on Key's balance sheet.
These securities provide an attractive source of funds since they are given Tier
I capital treatment for financial reporting purposes, but have the same tax
advantages as debt for Federal income tax purposes. As guarantor, KeyCorp
unconditionally guarantees payment of:
- - required distributions - both accrued and unpaid - on the capital
securities;
- - the redemption price when a capital security is redeemed; and
- - amounts due if a trust is liquidated or terminated.
KeyCorp owns the outstanding common stock of each of the trusts. The trusts used
the proceeds from the issuance of their capital securities and common stock to
buy debentures issued by KeyCorp. These debentures are the trusts' only assets
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 effects on the income statement because they are eliminated in
consolidation.
The capital securities, common stock and related debentures are summarized as
follows:
PRINCIPAL INTEREST RATE MATURITY
CAPITAL AMOUNT OF OF CAPITAL OF CAPITAL
SECURITIES, COMMON DEBENTURES, SECURITIES AND SECURITIES AND
dollars in millions NET OF DISCOUNT(a) SECURITIES NET OF DISCOUNT(b) DEBENTURES(c) DEBENTURES
=======================================================================================================================
March 31, 2002
KeyCorp Institutional Capital A $ 374 $ 11 $ 361 7.826% 2026
KeyCorp Institutional Capital B 161 4 154 8.250 2026
KeyCorp Capital I 247 8 255 2.621 2028
KeyCorp Capital II 233 8 245 6.875 2029
KeyCorp Capital III 258 8 256 7.750 2029
- ------------------------------------------------------------------------------------------------------------------------
Total $1,273 $ 39 $1,271 6.680% --
====== ====== ======
- ------------------------------------------------------------------------------------------------------------------------
December 31, 2001 $1,288 $ 39 $1,282 6.824% --
====== ====== ======
- ------------------------------------------------------------------------------------------------------------------------
March 31, 2001 $1,308 $ 39 $1,282 7.558% --
====== ====== ======
- ------------------------------------------------------------------------------------------------------------------------
(a) The capital securities must be redeemed when the related debentures mature,
or earlier if provided in the governing indenture. Each issue of capital
securities carries an interest rate identical to that of the related
debenture. The capital securities constitute minority interests in the
equity accounts of KeyCorp's consolidated subsidiaries and, therefore,
qualify as Tier 1 capital under Federal Reserve Board guidelines. Included
in certain capital securities at March 31, 2002, December 31, 2001 and March
31, 2001, are basis adjustments of $41 million, $45 million and $65 million,
respectively, related to fair value hedges.
19
(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: (a) the principal
amount, plus any accrued but unpaid interest or (b) the sum of the present
values of principal and interest payments discounted at the Treasury Rate
(as defined in the applicable offering circular), plus 20 basis points (25
basis points for Capital III), plus any accrued but unpaid interest. When
debentures are redeemed in response to tax or capital treatment events, the
redemption price 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 equal to three-month LIBOR
plus 74 basis points; it reprices quarterly. The rates shown as the total at
March 31, 2002, December 31, 2001, and March 31, 2001, are weighted average
rates.
11. RESTRUCTURING CHARGES
In November 1999, KeyCorp instituted a competitiveness initiative to improve
Key's operating efficiency and profitability.
In the first phase of the initiative, Key outsourced certain technology and
corporate support functions, consolidated sites in a number of Key's businesses
and reduced the number of management layers. This phase was completed in 2000.
As of March 31, 2002, Key has substantially completed the implementation of all
projects related to the second and final phase, which started during the second
half of 2000. This phase focused on:
- - simplifying Key's business structure by consolidating 22 business lines
into 10;
- - streamlining and automating business operations and processes;
- - standardizing product offerings and internal processes;
- - consolidating operating facilities and service centers; and
- - outsourcing certain noncore activities.
As a result of the initiative, Key estimated that it would reduce its workforce
by approximately 4,000 positions. Those reductions were to occur at all levels
throughout the organization. At March 31, 2002, nearly 4,100 positions had been
eliminated.
Changes in the components of the restructuring charge liability associated with
the above actions are as follows:
DECEMBER 31, RESTRUCTURING CASH MARCH 31,
in millions 2001 CHARGES (CREDITS) PAYMENTS 2002
- -------------------------------------------------------------------------------------------------------------------------------
Severance $27 $(4) $5 $18
Site consolidations 33 3 1 35
Equipment and other 1 -- -- 1
- -----------------------------------------------------------------------------------------------------------------------------
Total $61 $(1) $6 $54
=== === == ===
- -------------------------------------------------------------------------------------------------------------------------------
20
12. LEGAL PROCEEDINGS
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 Policies"), the "4011 Policy" and the "4019
Policy," together covered leases entered into during the period January 1, 1997
to January 1, 2001.
The 4019 Policy contains an endorsement stating that Swiss Reinsurance America
Corporation ("Swiss Re") will assume and reinsure 100% of Reliance's obligations
under the 4019 Policy in the event that Reliance Group Holdings' ("Reliance's
parent") so-called "claims-paying ability" were to fall below investment grade.
KeyBank also entered into an agreement with Swiss Re and Reliance whereby Swiss
Re agreed to issue to KeyBank an insurance policy on the same terms and
conditions as the 4011 Policy in the event that the financial condition of
Reliance Group Holdings fell below a certain level. Around May 2000, the
conditions under both the 4019 Policy and the Swiss Re agreement were triggered.
The 4011 Policy was canceled and replaced as of May 1, 2000, by a policy issued
by North American Specialty Insurance Company (a subsidiary or affiliate of
Swiss Re) ("the NAS Policy"). Tri-Arc Financial Services, Inc. ("Tri-Arc") acted
as agent for Reliance, Swiss Re and NAS. Since February 2000, KeyBank has been
filing claims under the Policies, but none of these claims has been paid.
In July 2000, KeyBank filed a claim for arbitration against Reliance, Swiss Re,
NAS and Tri-Arc seeking, among other things, a declaration of the scope of
coverage under the Policies and for damages. On January 8, 2001, Reliance filed
an action (litigation) against KeyBank in Federal District Court in Ohio seeking
rescission or reformation of the Policies claiming that they do not reflect the
intent of the parties with respect to the scope of coverage and how and when
claims were to be paid. Key filed an answer and counterclaim against Reliance,
Swiss Re, NAS and Tri-Arc seeking, among other things, declaratory relief as to
the scope of coverage under the Policies, damages for breach of contract,
failure to act in good faith, and punitive damages. The parties have agreed to
proceed with this court action and to dismiss the arbitration without prejudice.
On May 29, 2001, the Commonwealth Court of Pennsylvania entered an order placing
Reliance in a court supervised "rehabilitation" and purporting to Stay all
litigation against Reliance. On July 23, 2001, the Federal District Court in
Ohio Stayed the litigation to allow the Rehabilitator to complete her task. On
October 3, 2001, the Court in Pennsylvania entered an order placing Reliance
into liquidation and canceling all Reliance insurance policies as of November 2,
2001. On November 20, 2001, the Federal District Court in Ohio entered an order
which, among other things, required Reliance to report to the Court on the
progress of the liquidation. On January 15, 2002, Reliance filed a status report
requesting the continuance of the Stay for an indefinite period. On February 20,
2002, KeyBank filed a Motion for Partial Lifting of the July 23, 2001, Stay in
which it asked the Court to allow the case to proceed against the parties other
than Reliance. That Motion is pending before the Court.
Management believes that KeyBank has valid insurance coverage or claims for
damages relating to the residual value of automobiles leased through KeyBank
during the four-year period ending January 1, 2001. With respect to each
individual lease, however, it is not until the lease expires and the vehicle is
sold that KeyBank can determine the existence and amount of any actual loss on
the lease - i.e., the difference between the residual value provided for in the
lease agreement and the vehicle's actual market value at lease expiration.
KeyBank's actual total losses for which it will file claims will depend to a
large measure upon the viability of, and pricing within, the market for used
cars throughout the lease runoff period, which extends through 2006.
Accordingly, the total expected loss on the portfolio cannot be determined with
certainty at this time. Claims filed by KeyBank through March 31, 2002, total
approximately $152 million, and management currently estimates that
approximately $143 million of additional claims may be filed through year-end
2006. During this time frame, a number of factors will affect KeyBank's actual
loss experience, which may be higher or lower than management's current
estimates.
21
Key is recording as a receivable the amount of the claims as and when filed,
less an amount Key has estimated to be an appropriate reserve to reflect the
collectibility risk associated with the insurance litigation.
NSM LITIGATION. In March 1998, McDonald Investments Inc. ("McDonald"), now a
subsidiary of KeyCorp, participated in an offering to institutional investors of
approximately $452 million of debt securities and related warrants of Nakornthai
Strip Mill Public Company Ltd. ("NSM"), a Thailand public company, and certain
NSM affiliates. The offering was part of the financing of NSM's steel mini-mill
located in Chonburi, Thailand. McDonald served as a financial advisor to NSM and
was an initial purchaser in the offering. On December 24, 1998, holders of NSM
securities gave a Notice of Default alleging a number of defaults under the
terms of the securities.
In 1999, certain purchasers of the NSM securities 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 complaints in those
lawsuits were 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 were 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 was approximately $260 million. While the
relief claimed in the lawsuits has varied, generally the plaintiffs have sought
rescission of the sale of the securities, compensatory damages, punitive
damages, pre- and post- judgment interest, legal fees and expenses.
McDonald filed responses to each complaint denying liability and has been
vigorously defending these actions. McDonald has entered into settlement
agreements with the plaintiffs in seven of the nine lawsuits, pursuant to which
those plaintiffs' claims against McDonald were dismissed. The remaining two
lawsuits have also been settled and settlement documents are currently being
finalized. The terms of the settlement agreements, including the consideration
paid by McDonald, are confidential.
Key sought coverage from its insurance carriers for certain liabilities and
expenses related to the settled claims (above certain self-insurance layers that
were exhausted and expensed), which coverage was subsequently denied by the
carriers. As a result, Key and the insurance carriers filed declaratory judgment
actions against each other. In January 2002, the insurance carriers and Key
agreed to a monetary settlement of their dispute, which would have (when
aggregated with litigation reserves previously established for these lawsuits)
provided coverage for amounts paid by Key in settlement of the NSM lawsuits.
However, in the course of finalizing the settlement documentation, the insurance
carriers informed Key that in their view a settlement of all material terms was
not reached and, accordingly, the settlement agreement is not valid. Management
believes that the settlement agreement is valid, and on March 31, 2002, KeyCorp
filed a Motion to Enforce the Settlement Agreement in the United States District
Court for the Northern District of Ohio. That Motion is pending before the
Court.
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 KeyCorp or any of its subsidiaries is a party, or involving any
of their properties, that, individually or in the aggregate, will have a
material adverse effect on Key's financial condition.
22
13. OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Key, mainly through its lead bank, KeyBank National Association, is party to
various financial instruments with off-balance sheet risk. These instruments
include those related to loan securitizations, as well as derivatives and
hedging activities. The other major types of financial instruments with
off-balance sheet risk are primarily loan commitments and standby letters of
credit. These financial instruments generally help Key meet clients' financing
needs. However, they also involve credit risk not reflected on Key's balance
sheet. Key mitigates its exposure to credit risk with internal controls that
guide the way staff reviews and approves applications for credit, establishes
credit limits and, when necessary, demands collateral. In particular, Key
evaluates the credit-worthiness of each prospective borrower on a case-by-case
basis. Key does not have any significant concentrations of credit risk.
COMMITMENTS TO EXTEND CREDIT. These are agreements to provide financing on
predetermined terms, as long as the client continues to meet specified criteria.
Loan commitments generally carry variable rates of interest and have fixed
expiration dates or other termination clauses. In many cases, a client must pay
a fee to induce Key to issue a loan commitment. Since a commitment may expire
without resulting in a loan, the total amount of outstanding commitments may
exceed Key's eventual cash outlay.
STANDBY LETTERS OF CREDIT. These instruments obligate Key to pay a third-party
beneficiary when a customer fails to repay an outstanding loan or debt
instrument, or fails to perform some contractual nonfinancial obligation.
Amounts drawn under standby letters of credit are essentially loans: they bear
interest (generally at variable rates) and pose the same credit risk to Key as a
loan would.
ASSET-BACKED COMMERCIAL PAPER CONDUIT. Key serves as a referral agent to an
asset-backed commercial paper conduit ("conduit"), which is owned by a third
party and administered by an unaffiliated financial institution. In connection
with this arrangement, Key receives fees for the referral of high-grade loans
and structured assets, and for making commitments to provide liquidity and
credit enhancement. Key provides liquidity and credit enhancement to the conduit
in the form of a committed liquidity facility and credit agreement. The
commitment to provide credit enhancement specifies that in the event of default,
Key will provide financial relief to the conduit in an amount that is based on
defined criteria that consider the level of credit risk involved and other
factors. In addition to loans referred directly to the conduit, during 2001, Key
sold $434 million of federally guaranteed education loans to a qualified special
purpose entity, which issued beneficial interests that were acquired by the
conduit.
At March 31, 2002, Key's commitments to provide liquidity and credit enhancement
totaled $606 million and $200 million, respectively. There were no balances
outstanding under either of the commitment facilities at March 31, 2002.
Management periodically evaluates Key's potential exposure related to these
commitments.
The balance of assets outstanding in the conduit was $593 million at March 31,
2002. Of this amount, $154 million represents the balance of the beneficial
interests in the federally guaranteed education loans acquired by the conduit in
2001. All of the assets in the conduit were performing in accordance with their
contractual terms at March 31, 2002.
RECOURSE AGREEMENT WITH FEDERAL NATIONAL MORTGAGE ASSOCIATION. KeyBank National
Association ("KeyBank") participates as a lender in the Federal National
Mortgage Association ("FNMA") Delegated Underwriting and Servicing ("DUS")
program. As a condition to FNMA's delegation of responsibility for originating,
underwriting and servicing mortgages, KeyBank has agreed to assume a limited
portion of the risk of loss on each mortgage loan sold. Accordingly, a reserve
for such potential losses has been established and is maintained in an amount
estimated by management to be appropriate in light of the recourse risk. As of
March 31, 2002, the remaining principal balance outstanding of loans sold by
KeyBank as a participant in this program was approximately $1.0 billion.
23
RETURN GUARANTY AGREEMENT WITH LOW-INCOME HOUSING TAX CREDIT ("LIHTC")
INVESTORS. Key Affordable Housing Corporation ("KAHC"), a subsidiary of KeyBank,
offers limited partnership interests to qualified investors. Partnerships formed
by KAHC invest in low-income residential rental properties that qualify for
Federal LIHTCs under Section 42 of the Internal Revenue Code. In certain
partnerships, investors pay a fee to KAHC for a guaranteed return. The
guaranteed return is incumbent on the financial performance of the property and
the property's ability to maintain its LIHTC status throughout the fifteen-year
compliance period. Key meets its obligations pertaining to the guaranteed
returns generally through the distribution of tax credits and deductions
associated with the specific properties. At March 31, 2002, Key guaranteed
equity of $677 million plus various specified returns on that equity. KAHC has
established a reserve in an amount deemed by management to be sufficient to
cover estimated losses under the guarantees in the event that the properties do
not perform as expected.
The following table shows the contractual amount of each class of
lending-related, off-balance sheet financial instrument remaining as of the date
indicated. The table discloses Key's maximum possible accounting loss, which is
equal to the contractual amount of the various instruments. The estimated fair
values of these instruments are not material; observable liquid markets do not
exist for the majority of these instruments.
MARCH 31, DECEMBER 31, MARCH 31,
in millions 2002 2001 2001
- -----------------------------------------------------------------------------------------------------
Loan commitments:
Home equity $5,301 $4,965 $4,826
Commercial real estate and construction 2,106 2,487 2,361
Commercial and other 23,919 24,936 25,847
- -----------------------------------------------------------------------------------------------------
Total loan commitments 31,326 32,388 33,034
Other commitments:
Standby letters of credit 3,561 3,503 3,561
Commercial letters of credit 102 106 126
- -----------------------------------------------------------------------------------------------------
Total loan and other commitments $34,989 $35,997 $36,721
======= ======= =======
- -----------------------------------------------------------------------------------------------------
24
14. DERIVATIVES AND HEDGING ACTIVITIES
Key, mainly through its lead bank, KeyBank National Association, is party to
various derivative instruments. These instruments are used for asset and
liability management and trading purposes. Generally, these instruments help Key
meet clients' financing needs and manage exposure to "market risk"--the
possibility that economic value or net interest income will be adversely
affected by changes in interest rates or other economic factors. However, like
other financial instruments, these derivatives contain an element of "credit
risk"--the possibility that Key will incur a loss because a counterparty fails
to meet its contractual obligations.
The primary derivatives that Key uses are interest rate swaps, caps and futures,
and foreign exchange forward contracts. All foreign exchange forward contracts
and interest rate swaps and caps held are over-the-counter instruments.
ACCOUNTING TREATMENT AND VALUATION
Effective January 1, 2001, Key adopted SFAS No. 133, which establishes
accounting and reporting standards for derivatives and hedging activities. The
new standards are summarized in Note 1 ("Summary of Significant Accounting
Policies") under the heading "Accounting Pronouncements Adopted in 2001," on
page 61 of Key's 2001 Annual Report to Shareholders.
As a result of adopting SFAS No. 133, Key recorded cumulative after-tax losses
of $1 million in earnings and $22 million in "other comprehensive income (loss)"
as of January 1, 2001. Of the $22 million loss, an estimated $13 million was
reclassified as a charge to earnings during 2001.
At March 31, 2002, Key had $179 million of derivative assets recorded in
"accrued income and other assets" and $225 million of derivative liabilities
recorded in "accrued expense and other liabilities" on the balance sheet.
ASSET AND LIABILITY MANAGEMENT
FAIR VALUE HEDGING STRATEGIES. Key uses interest rate swap contracts known as
"receive fixed/pay variable" swaps to modify its exposure to interest rate risk.
These contracts convert specific fixed-rate deposits, short-term borrowings and
long-term debt to variable rate obligations. As a result, Key receives
fixed-rate interest payments in exchange for variable rate payments over the
lives of the contracts without exchanges of the underlying notional amounts.
During the first quarter of 2002, Key recognized a net gain of approximately $4
million related to the ineffective portion of its fair value hedging
instruments. The ineffective portion recognized is included in "other income" on
the income statement.
CASH FLOW HEDGING STRATEGIES. Key also enters into "pay fixed/receive variable"
interest rate swap contracts that effectively convert a portion of its
floating-rate debt to fixed-rate to reduce the potential adverse impact of
interest rate increases on future interest expense. These contracts allow Key to
exchange variable-rate interest payments for fixed-rate payments over the lives
of the contracts without exchanges of the underlying notional amounts.
Similarly, Key has converted certain floating-rate commercial loans to
fixed-rate loans by entering into interest rate swap contracts.
Key also uses "pay fixed/receive variable" interest rate swaps to manage the
interest rate risk associated with anticipated sales or 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 they are securitized or sold. Key's general policy is to
sell or securitize these loans within one year of their origination.
25
As a result of actions announced in May 2001, Key revised its projections of
future debt needs. 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 that Key did not
make.
During the first quarter of 2002, Key did not recognize a net gain or loss in
connection with the ineffective portion of its cash flow hedging instruments.
There was no impact on earnings during the first quarter of 2002 related to the
exclusion of portions of hedging instruments from the assessment of hedge
effectiveness. The change in "accumulated other comprehensive income (loss)"
resulting from cash flow hedges is as follows:
RECLASSIFICATION
DECEMBER 31, 2002 OF LOSSES MARCH 31,
in millions 2001 HEDGING ACTIVITY TO NET INCOME 2002
- --------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income
(loss) resulting from cash flow hedges $(2) $1 $2 $1
- ---------------------------------------------------------------------------------------------------------------
Key expects to reclassify approximately $18 million of net gains on derivative
instruments from "accumulated other comprehensive income (loss)" to earnings
during the next twelve months. Reclassifications will coincide with the income
statement impact of the hedged item through the payment of variable-rate
interest on debt, the receipt of variable-rate interest on commercial loans and
the sale or securitization of commercial real estate loans.
TRADING PORTFOLIO
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 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 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.
The following table shows trading income recognized on interest rate swap,
foreign exchange forward, and option and futures contracts.
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 2002 2001
- ------------------------------------------------------------------------------
Interest rate swap contracts $4 $3
Foreign exchange forward contracts 10 11
Option and futures contracts -- (1)
- ------------------------------------------------------------------------------
26
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 related 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 whether any collateral may
be required.
At March 31, 2002, Key was party to swaps with 39 different counterparties.
Among these were swaps entered into to offset the risk of client swaps. Key had
aggregate credit exposure of $440 million to 32 of these counterparties, with
the largest credit exposure to an individual counterparty amounting to $119
million. As of the same date, Key's aggregate credit exposure on its interest
rate caps totaled $35 million. Based on management's assessment, as of March 31,
2002, all counterparties were expected to meet their obligations.
27
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
SHAREHOLDERS AND BOARD OF DIRECTORS
KEYCORP
We have reviewed the unaudited condensed consolidated balance sheets of KeyCorp
and subsidiaries ("Key") as of March 31, 2002 and 2001, and the related
condensed consolidated statements of income, changes in shareholders' equity and
cash flow for the three-month periods then ended. These financial statements are
the responsibility of Key's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Key as of
December 31, 2001, 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 14, 2002, 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, 2001, is fairly stated, in all material respects, in relation
to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
April 12, 2002
28
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This Management's Discussion and Analysis generally reviews the financial
condition and results of operations of KeyCorp and its subsidiaries for the
first quarters of 2002 and 2001. Some tables may cover more 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 27.
ACCOUNTING POLICIES
Key's business is dynamic and complex. Consequently, management must exercise
judgment in choosing and applying the most appropriate accounting policies and
methodologies in many areas. These choices are important; not only are they
necessary to ensure compliance with generally accepted accounting principles,
they also reflect the exercise of management's judgment in determining the most
appropriate manner in which to record and report Key's overall financial
performance. In management's opinion, some of these areas have a more
significant impact than others on the financial performance of Key. This is
because they apply to areas of relatively greater business importance, and/or
require a more subjective decision-making process on the part of management. For
Key, these areas include accounting for the allowance for loan losses, loan
securitizations, and contingent obligations arising from litigation. Our
accounting policies related to the first two of these three areas are disclosed
in Note 1 ("Summary of Significant Accounting Policies"), which begins on page
58 of Key's 2001 Annual Report to Shareholders. A detailed description of
contingent obligations arising from litigation is contained in Note 12 ("Legal
Proceedings"), which begins on page 21 of this report. All accounting policies
are important, and all policies contained in Note 1 of the Annual Report should
be reviewed for a greater understanding of how Key's financial performance is
recorded and reported.
Furthermore, valuation methodologies employed by management often involve a
significant degree of judgment, particularly when observable liquid markets do
not exist for the items being valued. The outcome of valuations performed by
management have a direct bearing on the carrying amounts of certain assets, such
as principal investments, residual interests retained in securitizations and
goodwill. The valuation methodology used by management for principal investments
is summarized in Note 1 ("Summary of Significant Accounting Policies") under the
heading "Securities," on page 58 of Key's 2001 Annual Report to Shareholders.
The valuation methodology used for retained interests is summarized in the same
note under the heading "Loan Securitizations" on page 59 of the Annual Report.
The valuation methodology used in the testing for goodwill impairment is
summarized in Note 1 ("Basis of Presentation") under the heading "Goodwill and
other intangible assets," on page 7 of this report.
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 business group. 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), and conduct transactions in
foreign currencies (both to accommodate clients' needs and to benefit
from fluctuations in exchange rates).
29
- - 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. All of these items can distort
results, particularly in period-to-period comparisons. Reported results
include these items as required under accounting principles generally
accepted in the United States.
- - All earnings per share data included in this discussion are presented
on a DILUTED basis, which takes into account all common shares
outstanding as well as potential common shares that could result from
the exercise of outstanding stock options. Some of the financial
information tables also include BASIC earnings per share, which takes
into account only common shares outstanding.
- - For regulatory purposes, capital is divided into two classes. Federal
regulations prescribe that at least one-half of a bank or bank holding
company's TOTAL RISK-BASED CAPITAL must qualify as TIER 1. Both total
and Tier 1 capital serve as bases for several measures of capital
adequacy, which is an important indicator of financial stability and
condition. You will find a more detailed explanation of total and Tier
1 capital and how they are calculated in the section entitled "Capital
and dividends," which begins on page 59.
- - 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.
OUR PROJECTIONS ARE NOT FOOLPROOF
This report may contain "forward-looking statements" about issues like
anticipated earnings, anticipated levels of net loan charge-offs and
nonperforming assets and anticipated improvement in profitability and
competitiveness. Forward-looking statements by their nature are subject to
assumptions, risks and uncertainties. For a variety of reasons, including the
following, actual results could differ materially from those contained in or
implied by the forward-looking statements.
- - Interest rates could change more quickly or more significantly than we
expect, which may have an adverse effect on our financial results.
- - If the economy or segments of the economy fail to rebound or decline
further, the demand for new loans and the ability of borrowers to repay
outstanding loans may decline.
- - The stock and bond markets could suffer additional disruption, which
may have an adverse 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; we may be
unable to implement certain initiatives; or the initiatives may be
unsuccessful.
- - Acquisitions and dispositions of assets, business units or affiliates
could adversely affect us in ways that management has not anticipated.
- - We may become subject to new legal obligations, or the resolution of
pending litigation may have an adverse effect on our financial
condition.
- - Terrorist activities or military actions could further disrupt the
economy and the general business climate, which may have an adverse
effect on our financial results or condition and that of our borrowers.
- - We may become subject to new accounting, tax, or regulatory practices
or requirements.
30
HIGHLIGHTS OF KEY'S FIRST QUARTER 2002 PERFORMANCE
FINANCIAL PERFORMANCE
The primary measures of Key's financial performance for the first quarters of
2002 and 2001 are summarized below.
- - Net income for the first quarter of 2002 was $240 million, or $.56 per
common share. These results compare with net income of $217 million, or
$.51 per share, for the first three months of 2001.
- - Key's return on average equity for the first quarter of 2002 was
15.53%, up from 13.28% for the year-ago quarter.
- - Key's first quarter return on average total assets was 1.20%, compared
with 1.02% for the first quarter of last year.
Despite continued softness in the economy and some intentional downsizing of the
loan portfolio, Key's taxable-equivalent net interest income rose from that
reported a year ago. A substantially improved net interest margin more than
compensated for a reduction in earning assets stemming from loan sales, slow
demand for loans and from the decision in May 2001 to scale back or discontinue
certain types of lending. In addition, noninterest expense fell by $37 million,
or $17 million, excluding the reduction associated with the adoption of new
accounting guidance for goodwill. These positive results were moderated by a
higher provision for loan losses and lower noninterest income.
Our favorable performance in terms of expense control was attributable largely
to the success of our competitiveness initiative discussed on page 32. Although
we substantially completed the initiative during the first quarter of 2002, we
will apply the discipline we learned from it to a corporate-wide continuous
improvement program. Further, as the economy recovers we stand to benefit from
decisions made last year to return to our relationship banking roots and our
conservative credit culture.
The primary reasons that Key's specific revenue and expense components changed
from those of the first quarter of 2001 are reviewed in detail in the remainder
of this discussion.
Figure 1 on page 33 summarizes Key's financial performance on a reported basis
for each of the past five quarters.
CORPORATE STRATEGY
Our objective is to achieve revenue and earnings per share growth that is
consistently above the median for stocks that make up the Standard & Poors 500
Banks Index. In order to achieve this, our strategy is comprised of the
following four primary elements:
- - STAY FOCUSED ON OUR CORE BUSINESSES. To further this objective, we
intend to focus on businesses where we can build relationships with our
clients. We will primarily focus on a business mix that comprises our
"footprint" businesses that serve individuals, particularly the
affluent, small businesses and middle market companies. Additionally,
we will focus on national businesses such as commercial real estate
lending, asset management, home equity lending and equipment leasing.
Over time, we also intend to diversify our revenue mix by emphasizing
the growth of fee income and to invest in higher-growth and
higher-return businesses.
- - PUT OUR CLIENTS FIRST. To accomplish this, we are focusing on how we
can deepen our relationship with each of our clients. We want to build
relationships with those clients who have the potential to purchase
multiple products and services or repeat business. One way in which we
are pursuing this is to emphasize deposit growth across all of our
lines of business.
31
We also want to ensure that our clients are receiving a distinctive level
of service. We are putting considerable effort into enhancing our service
quality.
- - ENHANCE OUR BUSINESS. To accomplish this objective, we will build on
the success of our competitiveness initiative via a continuous improvement
process, which will continue to focus on increasing revenues, controlling
expenses and better serving our clients. Additionally, we will continue to
leverage technology both to reduce costs and enhance the service quality
provided to our clients.
- - CULTIVATE A WORKFORCE THAT DEMONSTRATES KEY'S VALUES AND WORKS TOGETHER
FOR A COMMON purpose. Key intends to achieve this by:
--paying for performance, but only if achieved in ways that are
consistent with Key's values;
--attracting, developing and retaining a quality, high-performing and
inclusive workforce;
--developing leadership at all levels in the company; and
--creating a positive, stimulating and entrepreneurial work
environment.
STATUS OF COMPETITIVENESS INITIATIVE
Key launched a major initiative in November 1999, the first phase of which was
completed in 2000. This initiative is designed to improve Key's profitability by
reducing the costs of doing business, focusing on the most profitable growth
businesses and enhancing revenues. During the initial phase, we reduced our
operating expenses by approximately $100 million by outsourcing certain
nonstrategic support functions, consolidating sites in a number of our
businesses and reducing management layers.
As of March 31, 2002, we had substantially completed the implementation of all
projects related to the second and final phase of the initiative, referred to as
PEG (Perform, Excel, Grow). In this phase, we expect to reduce costs by an
incremental net annual rate of $200 million by:
- - simplifying Key's business structure by consolidating 22 business lines
into 10;
- - streamlining and automating business operations and processes;
- - standardizing product offerings and internal processes;
- - consolidating operating facilities and service centers; and
- - outsourcing additional noncore activities.
Management expects that Key will achieve an annual net cost savings rate of
approximately $300 million from the overall initiative when all planned actions
are fully implemented before the end of 2002. This includes approximately $60
million of savings that will have been reinvested to fund activities that are
designed to enhance Key's strategic competitive position.
Management had anticipated that the actions taken in the competitiveness
initiative would reduce Key's workforce by approximately 4,000 positions
(comprising both staffed and vacant positions) by the end of the first quarter
of 2002. At March 31, 2002, nearly 4,100 positions had been eliminated.
Since the inception of the competitiveness initiative, we have recorded related
net charges of $278 million. Note 11 ("Restructuring Charges"), on page 20,
provides more information about Key's restructuring charges.
32
FIGURE 1. SELECTED FINANCIAL DATA
2002 2001
---------- ------------------------------------------------
dollars in millions, except per share amounts FIRST FOURTH THIRD SECOND FIRST
- -----------------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $1,092 $1,210 $1,380 $1,467 $1,570
Interest expense 438 510 656 754 882
Net interest income 654 700 724 713 688
Provision for loan losses 136 723 116 401 110
Noninterest income 443 418 454 398 455
Noninterest expense 661 702 683 858 698
Income (loss) before income taxes and cumulative effect
of accounting changes 300 (307) 379 (148) 335
Income (loss) before cumulative effect of accounting changes 240 (174) 249 (136) 218
Net income (loss) 240 (174) 249 (160) 217
Net income (loss) - core 240 (174) 249 28 217
- -----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect of accounting changes $ .56 $ (.41) $ .59 $ (.32) $ .51
Income (loss) before cumulative effect of accounting changes
- assuming dilution .56 (.41) .58 (.32) .51
Net income (loss) .56 (.41) .59 (.38) .51
Net income (loss) - core .56 (.41) .59 .07 .51
Net income (loss) - assuming dilution .56 (.41) .58 (.38) .51
Net income (loss) - assuming dilution - core .56 (.41) .58 .07 .51
Cash dividends paid .30 .295 .295 .295 .295
Book value at period end 15.05 14.52 15.53 15.22 15.79
Market price:
High 27.26 24.52 28.15 26.43 27.58
Low 22.92 20.49 22.20 22.10 22.65
Close 26.65 24.34 24.14 26.05 25.80
Weighted average common shares (000) 424,855 423,596 424,802 424,675 424,024
Weighted average common shares and
potential common shares (000) 430,019 423,596 430,346 424,675 429,917
- -----------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $63,956 $63,309 $64,506 $66,693 $67,027
Earning assets 72,382 71,672 73,943 76,531 77,027
Total assets 81,359 80,938 84,419 85,838 86,457
Deposits 43,233 44,795 45,372 45,743 45,965
Long-term debt 15,256 14,554 15,114 14,675 14,495
Shareholders' equity 6,402 6,155 6,575 6,467 6,702
Full-time equivalent employees 21,076 21,230 21,297 21,742 21,882
Branches 911 911 911 926 922
- -----------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.20% (.84)% 1.16% (.75)% 1.02%
Return on average total assets - core 1.20 (.84) 1.16 .13 1.02
Return on average equity 15.53 (10.57) 15.20 (9.67) 13.28
Return on average equity - core 15.53 (10.57) 15.20 1.69 13.28
Net interest margin (taxable equivalent) 3.93 3.98 3.85 3.77 3.63
- -----------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.87% 7.60% 7.79% 7.53% 7.75%
Tangible equity to tangible assets 6.57 6.29 6.51 6.25 6.29
Tier 1 risk-based capital 7.92 7.43 7.81 7.71 7.99
Total risk-based capital 12.02 11.41 11.77 11.81 12.32
Leverage 8.13 7.65 7.90 7.68 7.79
- -----------------------------------------------------------------------------------------------------------------------------------
LINE OF BUSINESS RESULTS
This section summarizes the financial performance and related strategic
developments of each of Key's three major business groups: Key Consumer Banking,
Key Corporate Finance and Key Capital Partners. To better understand this
discussion, see Note 4 ("Line of Business Results"), which begins on page 9.
Note 4 includes a brief description of the products and services offered by each
of the groups, as well as more detailed financial information pertaining to the
groups and their related lines of business.
Figure 2 summarizes the contribution made by each major business group to Key's
taxable-equivalent revenue and net income for the first quarters of 2002 and
2001. The specific lines of business that comprise each of the groups are shown
in the tables that accompany the discussions that follow.
33
FIGURE 2. MAJOR BUSINESS GROUPS - TAXABLE-EQUIVALENT REVENUE AND NET INCOME
CHANGE
-------------------------------
dollars in millions 1Q02 1Q01 AMOUNT PERCENT
- -------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Key Consumer Banking $ 558 $ 561 $ (3) (.5)%
Key Corporate Finance 341 315 26 8.3
Key Capital Partners 276 296 (20) (6.8)
Other Segments (20) 5 (25) N/M
------- ------- ------- -----
Total segments 1,155 1,177 (22) (1.9)
Reconciling items (10) (27) 17 (63.0)
------- ------- ------- -----
Total $ 1,145 $ 1,150 $ (5) (.4)
======= ======= =======
Net income (loss)(a)
- ------------------
Key Consumer Banking $ 102 $ 99 $ 3 3.0%
Key Corporate Finance 109 85 24 28.2
Key Capital Partners 36 30 6 20.0
Other Segments (7) 9 (16) N/M
------- ------- ------- -----
Total segments 240 223 17 7.6
Reconciling items -- (6) 6 (100.0)
------- ------- ------- -----
Total $ 240 $ 217 $ 23 10.6
======= ======= =======
- --------------------------------------------------------------------------------
(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.
N/M = Not Meaningful
FIGURE 3. KEY CONSUMER BANKING GROUP DATA
CHANGE
------------------------
dollars in millions 1Q02 1Q01 AMOUNT PERCENT
- ---------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ------------------------------
Retail Banking $ 312 $ 325 $ (13) (4.0)%
Small Business 95 89 6 6.7
Indirect Lending 91 106 (15) (14.2)
National Home Equity 60 41 19 46.3
----- ----- ----- ----
Total $ 558 $ 561 $ (3) (.5)
===== ===== =====
Net income (loss)
- -----------------
Retail Banking $ 63 $ 59 $ 4 6.8%
Small Business 28 23 5 21.7
Indirect Lending 10 18 (8) (44.4)
National Home Equity 1 (1) 2 N/M
----- ----- ----- ----
Total $ 102 $ 99 $ 3 3.0
===== ===== =====
- ---------------------------------------------------------------------------------
N/M = Not Meaningful
Additional Key Consumer Banking Data (1Q02)
- ----------------------------------------------
Average consumer loans - direct: $1.3 billion National Home Equity average loan-to-value ratio: 77%
Average consumer loans - indirect: $7.5 billion National Home Equity first lien positions: 83%
Average core deposits: $31.2 billion 911 KeyCenters and 2,329 ATMs
450,762 on-line clients (26% penetration) 8,458 full-time equivalent employees
34
Net income for Key Consumer Banking was $102 million for the first quarter of
2002, up from $99 million in the first quarter of 2001. The increase was
attributable to a reduction in noninterest expense, offset in part by a slight
decrease in total taxable-equivalent revenue.
Taxable-equivalent net interest income was essentially unchanged from the first
quarter of 2001 as a more favorable interest rate spread on earning assets was
offset by a less favorable spread on deposits and by declines in both average
loans and deposits outstanding. Noninterest income fell by $3 million, or 3%,
due primarily to higher losses incurred on the residual values of leased
vehicles in the Indirect Lending line of business. These losses were
substantially offset by a $9 million increase in service charges on deposit
accounts contributed by the Retail Banking and Small Business lines. This growth
resulted from new pricing implemented in mid-2001 in connection with Key's
competitiveness improvement initiative. At the same time, noninterest expense
was down $8 million, or 2%, from the first three months of 2001. This
improvement reflects an approximate $9 million reduction in goodwill
amortization, which resulted from the adoption of new accounting guidance on
January 1, as well as lower costs for computer processing and software
amortization. These reductions were partially offset by higher costs related to
personnel, marketing and activities associated with a higher volume of home
equity lending.
FIGURE 4. KEY CORPORATE FINANCE GROUP DATA
CHANGE
-------------------------------
dollars in millions 1Q02 1Q01 AMOUNT PERCENT
- ---------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- -----------------------------------
Corporate Banking $188 $191 $ (3) (1.6)%
National Commercial Real Estate 91 82 9 11.0
National Equipment Finance 62 42 20 47.6
----------- ---------- -------------- --------------
Total $341 $315 $26 8.3
=========== ========== ==============
Net income
- -----------------------------------
Corporate Banking $56 $52 $ 4 7.7 %
National Commercial Real Estate 32 28 4 14.3
National Equipment Finance 21 5 16 320.0
----------- ---------- -------------- --------------
Total $109 $85 $24 28.2
=========== ========== ==============
- ---------------------------------------------------------------------------------------------
Additional Key Corporate Finance Data (1Q02)
- --------------------------------------------
Average loans and leases: $29.8 billion
Average deposits: $3.2 billion
1,750 full-time equivalent employees
Net income for Key Corporate Finance was $109 million for the first quarter of
2002, compared with $85 million for the same period last year.
The increase from the year-ago quarter was driven by substantial improvements in
both total taxable-equivalent revenue and noninterest expense. Taxable-
equivalent net interest income grew by $22 million, or 8%, due primarily to a
more favorable interest rate spread on earning assets and an increase in the
taxable-equivalent adjustment related to income derived from the equipment
leasing portfolio. Noninterest income rose by $4 million, or 8%. In the
Corporate Banking line of business, significant increases in income from service
charges on deposit accounts and from derivatives more than offset a decrease in
non-yield-related loan fees. A $12 million, or 9%, decrease in noninterest
expense was driven by lower personnel expense and an approximate $5 million
reduction in goodwill amortization resulting from the January 1 adoption of new
accounting guidance.
35
FIGURE 5. KEY CAPITAL PARTNERS GROUP DATA
CHANGE
---------------------------
dollars in millions 1Q02 1Q01 AMOUNT PERCENT
- ----------------------------------------------------------------------------------
Revenue (taxable equivalent)
- -----------------------------------
Victory Capital Management $ 53 $ 56 $ (3) (5.4)%
High Net Worth 145 159 (14) (8.8)
Capital Markets 78 81 (3) (3.7)
---- ---- ---- ----
Total $276 $296 $(20) (6.8)
==== ==== ====
Net income
- ------------------------------------
Victory Capital Management $ 8 $ 7 $ 1 14.3 %
High Net Worth 15 13 2 15.4
Capital Markets 13 10 3 30.0
---- ---- ---- ----
Total $ 36 $ 30 $ 6 20.0
==== ==== ====
- --------------------------------------------------------------------------------
Additional Key Capital Partners Data (1Q02)
- -------------------------------------------
Assets under management: $72.4 billion 831 High Net Worth sales personnel
Nonmanaged and brokerage assets: $77.8 billion 3,711 full-time equivalent employees
Net new asset inflows: $831 million
Net income for Key Capital Partners was $36 million for the first quarter of
2002, up from $30 million in the first quarter of last year. The improvement was
attributable to a substantial decrease in noninterest expense, which more than
offset a decline in total taxable-equivalent revenue.
Taxable-equivalent net interest income decreased by only $1 million, or 2%, from
the first three months of 2001, due primarily to a decline in average time
deposits outstanding in the Capital Markets line of business. Also contributing
to the reduction was a decline in average loans outstanding, which resulted from
the 2001 sale of residential mortgage loans associated with the High Net Worth
business. These factors were offset largely by the lower cost of short-term
borrowings. A $19 million, or 8%, decrease in noninterest income was
attributable mainly to decreases in income from trust and investment services in
the Victory Capital Management and High Net Worth lines of business and from
derivatives in the Capital Markets line. Noninterest expense decreased by $25
million, or 10%, from the year-ago quarter, due primarily to lower personnel
expense and an approximate $6 million reduction that resulted from the change in
accounting for goodwill.
OTHER SEGMENTS
Other Segments includes Treasury, Principal Investing and the net effect of
funds transfer pricing. In the first quarter of 2002, this segment generated a
net loss of $7 million, compared with net income of $9 million in the same
period last year.
The decrease in results from the year-ago quarter reflects net securities gains
of $25 million ($16 million after tax) recorded by the Treasury unit during the
first quarter of 2001. Those gains were partially offset by net losses of $16
million ($10 million after tax) generated by the Principal Investing unit during
the same quarter.
36
RESULTS OF OPERATIONS
NET INTEREST INCOME
Key's principal source of earnings is net interest income, which is 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 derivative 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 6, which spans pages 38 and 39, 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 first
quarter of 2002 was $702 million, compared with $695 million reported a year
ago. This growth reflected an improved net interest margin, which increased 30
basis points to 3.93%. The net interest margin is an indicator of the
profitability of the earning asset portfolio and is calculated by dividing net
interest income by average earning assets. At the same time, average earning
assets decreased by 6% to $72.0 billion, due primarily to declines in commercial
and consumer loans.
NET INTEREST MARGIN. The net interest margin improved over the past year,
primarily because:
- - we benefited from declining short-term interest rates;
- - the interest rate spread on our total loan portfolio improved as we
continued to focus on those businesses, such as home equity lending,
that typically generate higher interest rate spreads;
- - we sold loans with interest rate spreads that did not meet Key's
internal profitability standards; and
- - a greater proportion of Key's earning assets was supported by
noninterest-bearing liabilities (such as demand deposits) and
shareholders' equity.
INTEREST EARNING ASSETS. Average earning assets for the first quarter of 2002
totaled $72.0 billion, which was $4.9 billion, or 6%, lower than the first
quarter 2001 level. This decrease came principally from the loan portfolio and
was attributable to a number of factors, including weaker loan demand and Key's
decisions in May 2001 to exit or scale back certain types of lending. Another
factor was loan sales, including the September 2001 sale of $1.4 billion of
residential mortgage loans.
The size and composition of Key's loan portfolio has been affected by several
actions taken in the first quarter of 2002 and during 2001:
- - During the third quarter of 2001, we sold the aforementioned $1.4
billion of residential mortgage loans, which were generated by our
private banking and community development businesses. These loans are
originated as a customer and community accommodation and are sold
periodically because they have relatively low interest rate spreads
that do not meet Key's internal profitability standards.
- - During the second quarter of 2001, management announced that Key would
exit the automobile leasing business, de-emphasize indirect prime
automobile lending and discontinue certain nonrelationship credit-only
commercial lending. These portfolios, in the aggregate, have declined
by approximately $2.1 billion since the date of the announcement
through March 31, 2002.
37
FIGURE 6. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
FIRST QUARTER 2002 FOURTH QUARTER 2001
------------------------------------------ ---------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a),(b)
Commercial, financial and agricultural $18,016 $ 242 5.44 % $18,462 $ 271 5.83 %
Real estate-- commercial mortgage 6,598 93 5.74 6,737 106 6.23
Real estate-- construction 5,856 72 5.01 5,971 85 5.65
Commercial lease financing 7,275 132 7.25 7,109 128 7.18
- ----------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 37,745 539 5.77 38,279 590 6.12
Real estate-- residential 2,241 41 7.21 2,384 44 7.46
Home equity 11,863 212 7.26 11,046 217 7.82
Consumer -- direct 2,289 46 8.14 2,361 52 8.66
Consumer -- indirect lease financing 1,852 41 8.74 2,210 47 8.55
Consumer -- indirect other 5,231 120 9.21 5,359 128 9.51
- ----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 23,476 460 7.89 23,360 488 8.32
Loans held for sale 2,267 32 5.70 2,113 34 6.48
- ----------------------------------------------------------------------------------------------------------------------------------
Total loans 63,488 1,031 6.55 63,752 1,112 6.94
Taxable investment securities 916 6 2.43 904 4 1.86
Tax-exempt investment securities(a) 219 5 8.52 241 6 8.69
- ----------------------------------------------------------------------------------------------------------------------------------
Total investment securities 1,135 11 3.61 1,145 10 3.30
Securities available for sale(a),(c) 5,317 89 6.76 6,120 103 6.78
Short-term investments 2,041 9 1.76 1,689 11 2.55
- ----------------------------------------------------------------------------------------------------------------------------------
Total earning assets 71,981 1,140 6.38 72,706 1,236 6.76
Allowance for loan losses (1,657) (1,159)
Accrued income and other assets 10,547 10,920
- ----------------------------------------------------------------------------------------------------------------------------------
$80,871 $82,467
======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $12,659 30 .95 $12,396 37 1.20
Savings deposits 1,947 3 .71 1,911 4 .79
NOW accounts 715 2 1.03 653 2 1.26
Certificates of deposit ($100,000 or more)(d) 4,516 57 5.10 4,788 61 5.08
Other time deposits 13,443 149 4.51 13,659 169 4.91
Deposits in foreign office 2,136 9 1.69 2,418 14 2.21
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 35,416 250 2.86 35,825 287 3.18
Federal funds purchased and securities
sold under repurchase agreements 5,584 23 1.70 4,272 24 2.20
Bank notes and other short-term borrowings(d) 4,028 27 2.68 5,563 42 2.99
Long-term debt, including capital securities(d),(e) 16,103 138 3.46 16,167 157 3.88
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 61,131 438 2.90 61,827 510 3.28
Noninterest-bearing deposits 8,553 8,750
Accrued expense and other liabilities 4,918 5,359
Common shareholders' equity 6,269 6,531
- ----------------------------------------------------------------------------------------------------------------------------------
$80,871 $82,467
======== ========
Interest rate spread (TE) 3.48 3.48
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $702 3.93% $726 3.98%
==== ======= ==== =========
Capital securities $1,298 $21 $1,333 $21
Taxable-equivalent adjustment(a) 48 26
- ----------------------------------------------------------------------------------------------------------------------------------
(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. See note 14 ("Derivatives and Hedging Activities"), which begins on
page 25, for an explanation of fair value hedges.
(e) Rate calculation excludes ESOP debt.
TE = Taxable Equivalent
38
FIGURE 6. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
(CONTINUED)
THIRD QUARTER 2001 SECOND QUARTER 2001 FIRST QUARTER 2001
------------------------------------------- ------------------------------------------- ----------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- -----------------------------------------------------------------------------------------------------------------------------------
$19,338 $ 324 6.63 % $20,030 $ 361 7.24 % $20,025 $ 406 8.22 %
6,813 123 7.20 6,837 135 7.91 6,897 147 8.63
5,859 101 6.87 5,504 108 7.81 5,273 117 9.03
6,995 117 6.68 6,990 120 6.86 7,102 125 7.07
- -----------------------------------------------------------------------------------------------------------------------------------
39,005 665 6.77 39,361 724 7.37 39,297 795 8.19
3,826 71 7.42 4,065 79 7.81 4,172 81 7.74
10,777 228 8.38 10,459 228 8.74 10,086 233 9.38
2,409 56 9.34 2,458 60 9.74 2,480 64 10.43
2,557 54 8.30 2,778 57 8.27 2,936 59 8.02
5,494 132 9.60 5,593 134 9.61 5,673 136 9.58
- -----------------------------------------------------------------------------------------------------------------------------------
25,063 541 8.58 25,353 558 8.83 25,347 573 9.10
2,130 38 7.17 2,240 43 7.69 2,389 54 9.09
- -----------------------------------------------------------------------------------------------------------------------------------
66,198 1,244 7.47 66,954 1,325 7.93 67,033 1,422 8.57
925 8 3.44 911 8 3.41 892 7 3.24
258 5 8.65 297 6 8.79 317 8 8.83
- -----------------------------------------------------------------------------------------------------------------------------------
1,183 13 4.57 1,208 14 4.74 1,209 15 4.70
6,565 114 6.99 6,572 115 6.99 7,026 120 6.87
1,741 15 3.57 1,812 19 4.19 1,604 20 5.00
- -----------------------------------------------------------------------------------------------------------------------------------
75,687 1,386 7.29 76,546 1,473 7.71 76,872 1,577 8.28
(1,204) (988) (1,006)
10,396 10,429 10,458
- -----------------------------------------------------------------------------------------------------------------------------------
$84,879 $85,987 $86,324
======= ======= =======
$12,522 55 1.72 $12,296 67 2.22 $12,070 95 3.17
1,936 5 1.01 1,969 5 1.06 1,993 7 1.34
611 2 1.41 610 3 1.50 602 2 1.54
4,800 67 5.53 5,571 81 5.85 5,994 92 6.25
13,703 184 5.33 14,479 209 5.77 15,011 224 6.06
3,399 30 3.57 2,173 23 4.27 2,869 40 5.64
- -----------------------------------------------------------------------------------------------------------------------------------
36,971 343 3.68 37,098 388 4.20 38,539 460 4.84
6,078 52 3.37 5,177 52 4.06 5,263 70 5.39
6,230 61 3.95 8,016 94 4.67 7,532 105 5.67
15,991 200 4.97 16,068 220 5.49 15,412 247 6.58
- -----------------------------------------------------------------------------------------------------------------------------------
65,270 656 3.99 66,359 754 4.56 66,746 882 5.38
8,262 8,213 8,185
4,848 4,779 4,766
6,499 6,636 6,627
- -----------------------------------------------------------------------------------------------------------------------------------
$84,879 $85,987 $86,324
======== ======== ========
3.30 3.15 2.90
- -----------------------------------------------------------------------------------------------------------------------------------
$730 3.85% $719 3.77% $695 3.63%
===== ====== ===== ====== ===== ======
$1,305 $21 $1,292 $23 $1,307 $24
6 6 7
- -----------------------------------------------------------------------------------------------------------------------------------
39
- - We sold commercial mortgage loans of $319 million during the first
quarter of 2002 and $1.7 billion during 2001. Since certain of these
loans have been sold with limited recourse, Key established a loss
reserve of an amount estimated by management to be appropriate to
reflect the recourse risk. More information about the related recourse
agreement is provided in Note 13 ("Other Financial Instruments with
Off-Balance Sheet Risk") under the section entitled "Recourse agreement
with Federal National Mortgage Association," on page 23. Our business
of originating and servicing commercial mortgage loans has grown, in
part, as a result of acquiring Newport Mortgage Company, L.P. and
National Realty Funding L.C. in 2000.
- - We sold education loans of $116 million during the first quarter of
2002 and $1.2 billion ($491 million through securitizations) during
2001.
Figure 7 shows how the changes in yields or rates and average balances from the
prior year affected net interest income. The section entitled "Financial
Condition," which begins on page 48, contains more discussion about changes in
earning assets and funding sources.
FIGURE 7. COMPONENTS OF NET INTEREST INCOME CHANGES
FROM THREE MONTHS ENDED MARCH 31, 2001
TO THREE MONTHS ENDED MARCH 31, 2002
-----------------------------------------------------------
AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE
- -----------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $(72) $(319) $(391)
Taxable investment securities -- (1) (1)
Tax-exempt investment securities (2) (1) (3)
Securities available for sale (29) (2) (31)
Short-term investments 4 (15) (11)
- ------------------------------------------------------------------------------------------------------------------
Total interest income (taxable equivalent) (99) (338) (437)
INTEREST EXPENSE
Money market deposit accounts 4 (69) (65)
Savings deposits -- (4) (4)
NOW accounts -- -- --
Certificates of deposit ($100,000 or more) (20) (15) (35)
Other time deposits (22) (53) (75)
Deposits in foreign office (8) (23) (31)
- ------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (46) (164) (210)
Federal funds purchased and securities sold
under repurchase agreements 4 (51) (47)
Bank notes and other short-term borrowings (37) (41) (78)
Long-term debt, including capital securities 11 (120) (109)
- ------------------------------------------------------------------------------------------------------------------
Total interest expense (68) (376) (444)
- ------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $(31) $ 38 $ 7
==== ==== ====
- ------------------------------------------------------------------------------------------------------------------
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.
MARKET RISK MANAGEMENT
The values of some financial instruments vary not only with changes in external
interest rates, but also with changes in foreign exchange rates, factors
influencing valuations in the equity securities markets, and other market-driven
rates or prices. For example, the value of a fixed-rate bond will decline if
market interest rates increase; the bond will become a less attractive
investment. Similarly, the value of the U.S. dollar
40
regularly fluctuates in relation to other currencies. The exposure that
instruments tied to such external factors present is called "market risk." Most
of Key's market risk is derived from interest rate fluctuations.
INTEREST RATE RISK MANAGEMENT
Key's Asset/Liability Management Policy Committee has developed a program to
measure and manage interest rate risk. This committee is also responsible for
approving Key's asset/liability management policies, overseeing the formulation
and implementation of strategies to improve balance sheet positioning and
earnings, and reviewing Key's interest rate sensitivity 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 and judgments. In this case, the assumptions relate
primarily to loan and deposit growth, asset and liability prepayments, interest
rates, and on- and off-balance sheet management strategies. Management believes
that, both individually and in the aggregate, the assumptions Key makes are
reasonable. Nevertheless, the simulation modeling process produces only a
sophisticated estimate, not a precise calculation of exposure.
Key's guidelines for risk management call for preventive measures to be taken if
the simulation modeling demonstrates that a gradual 2% increase or decrease in
short-term rates over the next twelve months would adversely affect net interest
income over the same period by more than 2%. Key is operating within these
guidelines. The low level of short-term interest rates at March 31, 2002,
necessitated a modification of Key's standard rate scenario of a gradual
decrease of 2% over twelve months to a gradual decrease of 1% over six months.
As of March 31, 2002, based on the results of our simulation model, and assuming
that management does not take action to alter the outcome, Key would expect net
interest income to decrease by approximately .98% if short-term interest rates
gradually increase by 2%. Conversely, if short-term interest rates gradually
decrease by 1% over the next six months, net interest income would be expected
to increase by approximately .46% over the next twelve months.
MEASUREMENT OF LONG-TERM INTEREST RATE EXPOSURE. Key uses an economic value of
equity model to complement short-term interest rate risk analysis. The benefit
of this model is that it measures exposure to interest rate changes over time
frames longer than two years. The economic value of Key's equity is determined
by aggregating the present value of projected future cash flows for asset,
liability and derivative positions based on the current yield curve. However,
economic value does not represent the fair values of asset, liability and
derivative positions, since it does not consider factors like credit risk and
liquidity.
Key's guidelines for risk management call for preventive measures to be taken if
an immediate 2% increase or decrease in interest rates is estimated to reduce
the economic value of equity by more than 15%. Certain short-term interest rates
were limited to reductions of less than 2% since interest rates cannot decrease
below zero in the economic value of equity model. Key is operating 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
hypothetical 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
41
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 high as the return that would have been generated had
payments been received for the duration 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 fund 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, and interest rate implications.
A brief description of interest rate swaps and caps is as follows:
- - INTEREST RATE SWAPS are contracts in 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.
- - 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").
Caps limit exposure to interest rate increases, but have no effect if
interest rates decline. Key has used interest rate caps to manage the
risk of adverse movements in interest rates on some of its debt.
For more information about how Key uses interest rate swaps and caps to manage
its balance sheet, see Note 14 ("Derivatives and Hedging Activities"), starting
on page 25.
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
proprietary trading positions in financial assets and liabilities. The fair
values of these trading portfolio items are included in "accrued income and
other assets" or "accrued expense and other liabilities" on the balance sheet.
For more information about these items, see Note 14 ("Derivatives and Hedging
Activities"), which begins on page 25.
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% probability. At March 31, 2002, Key's
aggregate daily VAR was $1.1 million, compared with $1.6 million at March 31,
2001. Aggregate daily VAR averaged $1.3 million for the first three months of
2002, compared with an average of $1.4 million for the same period last year.
VAR modeling augments other controls that Key uses to mitigate the market risk
exposure of the trading portfolio. These controls include loss and portfolio
size limits that are based on market liquidity and the level of activity and
volatility of trading products.
42
NONINTEREST INCOME
Noninterest income for the first quarter of 2002 totaled $443 million, compared
with $455 million for the comparable period last year. A $26 million decrease in
net gains from the sales of securities was the primary reason for the decline.
At the same time, noninterest income benefited from a $16 million increase in
service charges on deposit accounts, attributable largely to strategies
implemented in connection with Key's competitiveness initiative.
Figure 8 shows the major components of Key's noninterest income. The discussion
that follows provides additional information, such as the composition of certain
components and the factors that caused them to change from the first three
months of 2001.
FIGURE 8. NONINTEREST INCOME
Noninterest Income
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------------------- --------------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
===================================================================================================================================
Trust and investment services income $135 $141 $(6) (4.3)%
Investment banking and capital markets income 72 65 7 10.8
Service charges on deposit accounts 100 84 16 19.0
Corporate-owned life insurance income 26 27 (1) (3.7)
Letter of credit and loan fees 28 29 (1) (3.4)
Net securities gains -- 26 (26) (100.0)
Other income:
Electronic banking fees 18 17 1 5.9
Insurance income 13 14 (1) (7.1)
Loan securitization servicing fees 3 4 (1) (25.0)
Net gains from loan securitizations and sales 6 5 1 20.0
Miscellaneous income 42 43 (1) (2.3)
- -----------------------------------------------------------------------------------------------------------------------------------
Total other income 82 83 (1) (1.2)
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $443 $455 $(12) (2.6)%
==== ==== ====
===================================================================================================================================
TRUST AND INVESTMENT SERVICES INCOME. Trust and investment services provide
Key's largest source of noninterest income. Its primary components are as shown
in Figure 9. The decrease in revenue derived from these services was due largely
to the effects of continued softness in the economy, leading to declines in fee
income that is based on the value of assets.
FIGURE 9. TRUST AND INVESTMENT SERVICES INCOME
THREE MONTHS ENDED MARCH 31, CHANGE
-------------------------------- ---------------------------
dollars in millions 2002 2001 Amount Percent
- -------------------------------------------------------------------------------------------------------------------------------
Personal asset management and custody fees $41 $46 $( 5) (10.9)%
Institutional asset management and custody fees 10 22 (12) (54.5)
Bond services 20 10 10 100.0
Brokerage commission income 28 26 2 7.7
All other fees 36 37 (1) (2.7)
- ----------------------------------------------------------------------------------------------------------------------------
Total trust and investment services income $135 $141 $(6) (4.3)%
==== ==== ===
- ----------------------------------------------------------------------------------------------------------------------------
At March 31, 2002, Key's bank, trust and registered investment advisory
subsidiaries had assets under management of $72.4 billion, compared with $71.4
billion at March 31, 2001. These assets are managed on behalf of both
institutions and individuals through a variety of equity, fixed income and money
market accounts. The composition of Key's assets under management is shown in
Figure 10. The value of total assets under management rose by a net 1% over the
past twelve months. This slight increase reflects the positive effect of net new
asset inflows of approximately $2.1 billion during the same period, offset in
part by a decrease in the market value of assets under management at March 31,
2001. As shown in Figure 10, more than one-half of the assets Key manages are
invested in more stable fixed income or money market
43
funds. The performance of the majority of all of Key's product types exceeded
the performance of their respective benchmarks.
FIGURE 10. ASSETS UNDER MANAGEMENT
2002 2001
------------- -------------------------------------------------------
in millions FIRST FOURTH THIRD SECOND FIRST
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS UNDER MANAGEMENT BY INVESTMENT TYPE:
Equity $34,497 $34,799 $32,067 $35,903 $34,722
Fixed income 18,536 17,326 16,929 15,363 14,683
Money market 19,413 19,957 21,223 23,177 22,032
- -----------------------------------------------------------------------------------------------------------------------------------
Total $72,446 $72,082 $70,219 $74,443 $71,437
======= ======= ======= ======= =======
Proprietary mutual funds included in assets under management:
Equity $4,080 $3,973 $3,676 $4,351 $4,045
Fixed income 1,211 1,190 1,178 1,106 1,085
Money market 13,094 13,801 14,870 14,950 15,495
- ------------------------------------------------------------------------------------------------------------------------------------
Total $18,385 $18,964 $19,724 $20,407 $20,625
======= ======= ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT BANKING AND CAPITAL MARKETS INCOME. The increase in this revenue
component reflects improved results from principal investing, offset in part by
lower income from trading activities. As shown in Figure 11, results for the
first quarter of 2002 include net gains from principal investing, compared with
net losses for the year-ago quarter. The $17 million improvement in principal
investing results is attributable to unrealized mark-to-market losses recorded
in the first three months of 2001. Principal investing income is by nature
susceptible to volatility since it is derived from investments in small to
medium-sized businesses, some of which are in their early stages of economic
development and strategy implementation, and thus more susceptible to changes in
general economic conditions. Principal investing assets are carried on the
balance sheet at fair value. The cost basis, unrealized gains (losses) and fair
value of direct and indirect investments contained in Key's principal investing
portfolio are summarized in Figure 12. Investments in technology-rich companies,
which have been particularly hard hit by the effects of the weak economy,
accounted for only $39 million, or 6%, of the fair value of Key's portfolio at
March 31, 2002.
FIGURE 11. INVESTMENT BANKING AND CAPITAL MARKETS INCOME
THREE MONTHS ENDED MARCH 31, CHANGE
------------------------------------------ ---------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- --------------------------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $40 $50 $(10) (20.0)%
Investment banking income 21 20 1 5.0
Net gains (losses) from principal investing 1 (16) 17 N/M
Foreign exchange income 10 11 (1) (9.1)
- --------------------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $72 $65 $ 7 10.8%
=== === ===
- --------------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
FIGURE 12. PRINCIPAL INVESTING PORTFOLIO
MARCH 31, 2002 COST UNREALIZED FAIR
in millions BASIS GAINS (LOSSES) VALUE
- -----------------------------------------------------------------------------------------------
Direct investments $459 $(55) $404
Indirect investments 260 (28) 232
- -----------------------------------------------------------------------------------------------
Total $719 $(83) $636
==== ==== ====
- -----------------------------------------------------------------------------------------------
December 31, 2001 $699 $(79) $620
- -----------------------------------------------------------------------------------------------
March 31, 2001 $707 $ 15 $722
- -----------------------------------------------------------------------------------------------
44
SERVICE CHARGES ON DEPOSIT ACCOUNTS. Service charges on deposit accounts
increased by $16 million, or 19%, and accounted for the largest increase in fee
income relative to the prior year. The growth of these fees is attributable
primarily to strategies implemented in connection with Key's competitiveness
initiative.
SECURITIES TRANSACTIONS. During the first quarter of 2001, Key realized $26
million of net securities gains from the sales of equity securities held in the
available-for-sale portfolio. The securities sold were primarily those issued by
financial service companies. There were no gains or losses on sales of equity
securities during the first quarter of 2002.
NONINTEREST EXPENSE
Noninterest expense for the first quarter of 2002 totaled $661 million, down $37
million, or 5%, from the comparable period last year. Approximately $20 million
of the reduction resulted from the change in accounting for goodwill. For more
information pertaining to this accounting change, see the section entitled
"Amortization of intangibles," on page 46. The remainder of the decrease was
attributable to smaller declines in most of the other major categories of
noninterest expense.
Figure 13 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 13. NONINTEREST EXPENSE
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- ------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
===============================================================================================================
Personnel $ 363 $ 364 $ (1) (.3)%
Net occupancy 57 57 -- --
Computer processing 54 62 (8) (12.9)
Equipment 34 38 (4) (10.5)
Marketing 26 27 (1) (3.7)
Amortization of intangibles 3 26 (23) (88.5)
Professional fees 21 18 3 16.7
Other expense:
Postage and delivery 15 17 (2) (11.8)
Telecommunications 8 11 (3) (27.3)
Equity- and gross receipts- based taxes 6 8 (2) (25.0)
OREO expense, net 1 2 (1) (50.0)
Miscellaneous expense 73 68 5 7.4
- ------------------------------------------------------------------------------------------------------------
Total other expense 103 106 (3) (2.8)
- ------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 661 $ 698 $ (37) (5.3)%
======= ======= =======
Full-time equivalent employees at period end 21,076 21,882 (806) (3.7)%
- ------------------------------------------------------------------------------------------------------------
PERSONNEL. Personnel expense, the largest category of Key's noninterest expense,
was essentially unchanged in total from the first quarter of 2001. This
stability is largely because of our successful competitiveness initiative.
Through this initiative we have improved efficiency and reduced the level of
personnel required to conduct our business. At March 31, 2002, the number of
full-time equivalent employees was 21,076, compared with 21,230 at the end of
2001 and 21,882 a year ago. Furthermore, in 2002, weaker economic conditions
reduced revenues on which certain incentive compensation programs, including
those related to investment banking and capital markets activities, are based.
This reduction was offset by higher costs associated with salaries and benefits.
Figure 14 shows the major components of Key's personnel expense.
FIGURE 14. PERSONNEL EXPENSE
THREE MONTHS ENDED MARCH 31, CHANGE
--------------------------- --------------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- ---------------------------------------------------------------------------------------------------
Salaries $215 $211 $ 4 1.9 %
Employee benefits 63 57 6 10.5
Incentive compensation 85 96 (11) (11.5)
- ---------------------------------------------------------------------------------------------------
Total core personnel expense $363 $364 $(1) (.3)%
==== ==== ===
- ---------------------------------------------------------------------------------------------------
45
COMPUTER PROCESSING. The $8 million, or 13%, decrease in computer processing
expense from the first three months of 2001 was due primarily to a lower level
of computer software amortization. This reduction is attributable in part to
improved software capitalization discipline instituted a few years ago.
EQUIPMENT. The $4 million, or 11%, decrease in equipment expense from the
year-ago quarter was driven by reductions in depreciation, maintenance and
rental expense stemming from cost management efforts and our competitiveness
initiative.
AMORTIZATION OF INTANGIBLES. On January 1, 2002, Key stopped amortizing
goodwill, consistent with the industry-wide adoption of new accounting guidance.
This change reduced the company's noninterest expense by approximately $20
million. In accordance with the new guidance, Key completed its transitional
goodwill impairment testing during the first quarter of 2002, and determined
that no impairment existed as of January 1, 2002. For more information
pertaining to the new accounting guidance, see the section entitled "Accounting
Pronouncements Adopted in 2002," included in Note 1 ("Basis of Presentation"),
starting on page 7.
Key continues to benefit from the expense management disciplines instituted as
part of the competitiveness initiative implemented in November 1999. As
illustrated in Figure 15, Key's core noninterest expense, adjusted for the
divestiture of the Long Island branches (October 1999) and the sale of the
credit card business (January 2000), has been stable over the past three years.
FIGURE 15. COMPETITIVENESS INITIATIVE - COST SAVINGS
In millions
[GRAPH]
1999 2000 2001 2002
Noninterest expense adjusted
for inflation $2,776(b) $2,869(c) $2,949(d) $3,020(e)
Noninterest expense (a) 2,776 2,789 2,769 2,770T
------ ------ ------ ------
Savings $ - $ 80 $ 180 $ 250
====== ====== ====== ======
(a) = Total noninterest expense less significant nonrecurring items, adjusted
for divested operations
(b) = CPI base
(c) = CPI + 3.4% (Bureau of Labor Statistics Jan-Dec 2000)
(d) = CPI + 2.8% (Bureau of Labor Statistics Jan-Nov 2001)
(e) = CPI + 2.5% (Estimate of 2.5% for 2002)
T = Target for 2002
One of management's goals is to keep noninterest expense relatively flat from
2001 to 2002, unless the growth can be attributed to incentive compensation
related to even greater increases in revenue. Figure 15 shows that Key's
noninterest expense for 2000 and 2001 was significantly lower than it would have
been had it simply grown from its 1999 base at the rate of inflation as measured
by the annual change in the consumer price index. If we are successful in
hitting our targeted expense level in 2002, management estimates that the
difference between Key's actual expense and that adjusted for inflation will
grow to approximately $250 million. The dollar amounts shown for all years in
Figure 15 are presented on a consistent basis, including the accounting for
goodwill amortization.
46
INCOME TAXES
The provision for income taxes was $60 million for the first quarter of 2002,
compared with $117 million for the first three months of 2001. The effective tax
rate (which is the provision for income taxes as a percentage of income before
income taxes) was 20.0%, compared with 34.9% for the first quarter of last year.
The decline in the effective tax rate was due primarily to the fact that
portions of our equipment leasing portfolio are now subject to a lower income
tax rate than the one previously used to calculate Key's tax accrual. As a
result of regulatory changes, we also benefited from a higher tax deduction for
dividends paid to Key's 401(k) savings plan. In addition, Key ceased amortizing
goodwill effective January 1, 2002, in accordance with new accounting guidance
specified by SFAS No. 142. Management expects that Key's effective tax rate will
rise to within the range of 25% to 28% in the second quarter and move to a
sustainable rate, which is expected to be 3% to 5% higher, in the third quarter.
The effective 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 certain leveraged lease financing receivables, tax-exempt securities
and corporate-owned life insurance), and to recognize credits associated with
investments in low-income housing projects.
47
FINANCIAL CONDITION
LOANS
At March 31, 2002, total loans outstanding were $64.0 billion, compared with
$63.3 billion at the end of 2001 and $67.0 billion a year ago. Among the factors
that contributed to the 5% decrease in our loans over the past year are:
- - loan sales completed to improve the profitability of Key's overall
portfolio, or to accommodate our funding needs;
- - weaker loan demand stemming from the sluggish economy; and
- - our May 2001 decision to exit the automobile leasing business, de-emphasize
indirect prime automobile lending and discontinue certain nonrelationship,
credit-only commercial lending.
Over the past several years, we have used alternative funding sources like loan
sales and securitizations to allow us to continue to capitalize on our lending
opportunities. Newport Mortgage Company, L.P. and National Realty Funding L.C.,
both of which were acquired in 2000, have improved Key's ability to generate and
securitize new loans, especially in the area of commercial real estate. In
addition, over the past two years, we have sold loans and referred new business
to an asset-backed commercial paper conduit. This arrangement allows us to
generate referral revenue without having to add certain low interest rate spread
assets to the balance sheet. For more information about the conduit, see Note 13
("Other Financial Instruments with Off-Balance Sheet Risk"), starting on page
23.
Key's loans outstanding (excluding loans held for sale) would have grown by $1.4
billion, or 2%, over the past twelve months if we had not securitized and/or
sold $4.5 billion of loans during that period. Assuming no loan sales, the level
of commercial loans would have been unchanged from a year ago. Growth in our
commercial real estate and lease financing portfolios was essentially offset by
declines in other commercial portfolios, reflecting continued weakness in the
economy and our decision to eliminate nonrelationship lending in the leveraged
financing and nationally syndicated lending businesses.
At March 31, 2002, Key's commercial real estate portfolio included mortgage
loans of $6.5 billion and construction loans of $5.9 billion. The average size
of a mortgage loan was $.5 million and the largest mortgage loan had a balance
of $65 million. The average size of a construction loan was $7 million for
commercial projects and $1 million for residential projects. The largest
construction loan was $72 million. Key conducts its commercial real estate
lending business through two primary sources: a 12-state banking franchise and
National Commercial Real Estate (a national line of business that cultivates
relationships both within and beyond the branch system). At March 31, our
national line of business accounted for approximately 63% of Key's total
commercial real estate loans outstanding. Our commercial real estate business as
a whole focuses on larger real estate developers and, as shown in Figure 16, is
diversified by both industry type and geography.
48
FIGURE 16. COMMERCIAL REAL ESTATE LOANS
MARCH 31, 2002 GEOGRAPIC REGION
---------------------------------------------------------------- TOTAL PERCENT OF
dollars in millions EAST MIDWEST CENTRAL WEST AMOUNT TOTAL
- --------------------------------------------------------------------------------------------------------------------------------
Nonowner-occupied:
Multi-family properties $ 455 $ 642 $ 520 $ 741 $ 2,358 19.0%
Retail properties 306 820 102 237 1,465 11.8
Office buildings 218 248 125 232 823 6.6
Residential properties 58 132 101 354 645 5.2
Warehouses 92 266 141 195 694 5.6
Manufacturing facilities 28 29 2 11 70 .6
Hotels/Motels 8 26 1 9 44 .3
Other 543 629 130 486 1,788 14.4
- --------------------------------------------------------------------------------------------------------------------------------
1,708 2,792 1,122 2,265 7,887 63.5
Owner-occupied 631 1,812 537 1,548 4,528 36.5
- --------------------------------------------------------------------------------------------------------------------------------
Total $2,339 $4,604 $1,659 $3,813 $12,415 100.0%
====== ====== ====== ====== ======= ======
- --------------------------------------------------------------------------------------------------------------------------------
Consumer loans increased (assuming no loan sales) by $552 million, or 2%, from
the first quarter of 2001. The growth of the home equity portfolio during the
past year more than offset declines of $636 million in installment loans, $1.2
billion in automobile lease financing receivables and $482 million in
residential real estate mortgage loans. The declines in installment loans and
automobile lease financing receivables reflect our decision to de-emphasize
indirect prime automobile lending and exit the automobile leasing business. Our
home equity portfolio grew by $2.9 billion, largely as a result of lower
interest rates and our efforts to grow this business.
Key's home equity portfolio is derived from both our Retail Banking line of
business (61% of the home equity portfolio at March 31, 2002), and our National
Home Equity line of business.
The National Home Equity line of business has two components: Champion Mortgage
Company, a home equity finance company that Key acquired in August 1997; and Key
Home Equity Services, which acts as a third-party purchaser of home equity
loans. The average loan-to-value ratio at origination for a loan generated by
the National Home Equity line of business is 77%. First lien positions comprised
83% of the portfolio for this line of business at March 31, 2002.
Key Home Equity Services purchases loans in two primary ways: on a loan-by-loan
basis from an extensive network of correspondents and agents, and in bulk
portfolio acquisitions from home equity loan companies. Key intends to
discontinue the latter approach in 2002.
Figure 17 summarizes Key's home equity loan portfolio by source at the end of
each of the last five quarters, as well as certain asset quality statistics and
the yields achieved on the portfolio as a whole. The portfolio has grown by 23%
since March 31, 2001.
FIGURE 17. HOME EQUITY LOANS
2002 2001
------------- -----------------------------------------------------------
dollars in millions FIRST FOURTH THIRD SECOND FIRST
- ----------------------------------------------------------------------------------------------------------------------------
SOURCE OF LOANS OUTSTANDING AT PERIOD END
Champion Mortgage Company $2,031 $1,886 $1,608 $1,600 $1,325
Key Home Equity Services division 2,870 2,867 3,008 2,919 2,842
- ----------------------------------------------------------------------------------------------------------------------------
National Home Equity line of business 4,901 4,753 4,616 4,519 4,167
Retail KeyCenters and other sources 7,761 6,431 6,210 6,147 6,121
- ----------------------------------------------------------------------------------------------------------------------------
Total $12,662 $11,184 $10,826 $10,666 $10,288
======= ======= ======= ======= =======
- ----------------------------------------------------------------------------------------------------------------------------
Nonperforming loans at period end $ 77 $ 50 $ 77 $ 90 $ 102
Net charge-offs for the period 3 50 16 25 6
Yield for the period 7.26% 7.82% 8.38% 8.74% 9.38%
- ----------------------------------------------------------------------------------------------------------------------------
49
SALES, SECURITIZATIONS AND DIVESTITURES. During the past twelve months, Key sold
$1.7 billion of commercial real estate loans, $1.4 billion of residential
mortgage loans, $880 million of education loans ($491 million through
securitizations) and $526 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 18 summarizes Key's loan sales (including securitizations) for the first
quarter of 2002 and all of 2001.
FIGURE 18. LOANS SOLD AND DIVESTED
COMMERCIAL RESIDENTIAL HOME
in millions COMMERCIAL REAL ESTATE REAL ESTATE EQUITY EDUCATION TOTAL
- -----------------------------------------------------------------------------------------------------------------------------
2002
- -------------------------
First quarter -- $319 -- $9 $116 $444
- -----------------------------------------------------------------------------------------------------------------------------
Total -- $319 -- $9 $116 $444
== ==== == == ==== ====
2001
- -------------------------
Fourth quarter -- $678 -- $145 $ 23 $ 846
Third quarter -- 93 $1,427 269 597 2,386
Second quarter $44 577 20 59 144 844
First quarter -- 327 1 14 449 791
- -----------------------------------------------------------------------------------------------------------------------------
Total $44 $1,675 $1,448 $487 $1,213 $4,867
=== ====== ====== ==== ====== ======
- -----------------------------------------------------------------------------------------------------------------------------
Figure 19 shows loans that are either administered or serviced by Key, but not
recorded on the balance sheet. This includes loans that have been both
securitized and sold, or simply sold outright. In the event of default, Key is
subject to recourse with respect to approximately $681 million of the $17.0
billion of loans administered or serviced at March 31, 2002. Key derives income
from two sources when we sell or securitize loans but retain the right to
administer or service them. We earn noninterest income (recorded as "other
income") from servicing or administering the loans, and we earn interest income
from any securitized assets retained. The commercial real estate loans shown in
Figure 19 are serviced by National Realty Funding L.C., which was acquired by
Key in January 2000. Other financial institutions originated most of these
loans. Most of the $593 million of assets held in the asset-backed commercial
paper conduit, for which Key serves as a referral agent, are also included in
Figure 19. For more information regarding the conduit, see Note 13 ("Other
Financial Instruments with Off-Balance Sheet Risk"), starting on page 23.
FIGURE 19. LOANS ADMINISTERED OR SERVICED
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
in millions 2002 2001 2001 2001 2001
- ------------------------------------------------------------------------------------------------------------------------------
Education loans $4,258 $4,433 $4,604 $4,305 $4,428
Automobile loans 108 131 199 254 340
Home equity loans 668 768 890 965 1,085
Commercial real estate loans 11,621 10,471 9,368 9,293 8,068
Commercial loans 349 913 901 951 1,023
- ------------------------------------------------------------------------------------------------------------------------------
Total $17,004 $16,716 $15,962 $15,768 $14,944
======= ======= ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------------
50
SECURITIES
At March 31, 2002, the securities portfolio totaled $6.9 billion and
included $5.8 billion of securities available for sale and $1.1 billion of
investment securities. In comparison, the total portfolio at December 31, 2001,
was $6.5 billion, including $5.4 billion of securities available for sale and
$1.1 billion of investment securities.
The size and composition of Key's securities portfolio are dependent largely on
our needs for liquidity and the extent to which we are required or elect to hold
these assets as collateral to secure public and trust deposits. Although debt
securities are generally used for this purpose, other assets, such as securities
purchased under resale agreements, may be used temporarily when they provide
more favorable yields.
The majority of Key's securities portfolio consists of collateralized mortgage
obligations that provide a source of interest income and serve as collateral in
connection with pledging requirements. A collateralized mortgage obligation
(sometimes called a "CMO") is a debt security that is secured by a pool of
mortgages, mortgage-backed securities, U.S. government securities, corporate
debt obligations or other bonds. At March 31, 2002, Key had $5.3 billion
invested in collateralized mortgage obligations and other mortgage-backed
securities in the available-for-sale portfolio, compared with $4.8 billion at
December 31, 2001. Substantially all of these securities were issued or backed
by Federal agencies.
Figure 20 shows the composition, yields and remaining maturities of Key's
securities available for sale. Figure 21 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 13.
FIGURE 20. SECURITIES AVAILABLE FOR SALE
OTHER
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- RETAINED
AGENCIES AND POLITICAL MORTGAGE BACKED INTERESTS IN
dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(a) SECURITIES(a) SECURITIZATIONS(a)
- -------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2002
Remaining maturity:
One year or less $ 2 -- $ 889 $ 21 $ 8
After one through five years 79 $13 3,145 859 214
After five through ten years 5 7 178 16 --
After ten years 11 -- 167 27 --
- ------------------------------------------------------------------------------------------------------------------------------
Fair value $97 $20 $4,379 $923 $222
Amortized cost 97 20 4,409 900 195
Weighted average yield(b) 3.61% 4.71% 6.27% 6.96% 17.50%
Weighted average maturity 2.8 YEARS 4.8 YEARS 3.0 YEARS 2.6 YEARS 3.5 YEARS
- ------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001
Fair value $99 $21 $3,805 $1,032 $234
Amortized cost 99 21 3,791 1,008 214
- ------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2001
Fair value $220 $31 $4,708 $1,306 $287
Amortized cost 220 31 4,680 1,289 320
- ------------------------------------------------------------------------------------------------------------------------------
WEIGHTED
OTHER AVERAGE
dollars in millions SECURITIES TOTAL YIELD(b)
- ---------------------------------------------------------------------------------------
MARCH 31, 2002
Remaining maturity:
One year or less $ 7 $ 927 7.07%
After one through five years 7 4,317 6.43
After five through ten years 7 213 8.38
After ten years 133(c) 338 8.61
- -------------------------------------------------------------------------------------
Fair value $154 $5,795 --
Amortized cost 169 5,790 6.71%
Weighted average yield(b) 5.41% 6.71% --
Weighted average maturity 10.0 YEARS 3.1 YEARS --
- -------------------------------------------------------------------------------------
DECEMBER 31, 2001
Fair value $155 $5,346 --
Amortized cost 170 5,303 7.26%
- -------------------------------------------------------------------------------------
MARCH 31, 2001
Fair value $348 $6,900 --
Amortized cost 350 6,890 7.08%
- -------------------------------------------------------------------------------------
(a) Maturity is based upon expected average lives rather than contractual
terms.
(b) Weighted average yields are calculated based on amortized cost and exclude
equity securities of $136 million that have no stated yield. Such yields
have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
(c) Includes primarily marketable equity securities (including an internally
managed portfolio of bank common stock investments) with no stated
maturity.
51
FIGURE 21. INVESTMENT SECURITIES
STATES AND WEIGHTED
POLITICAL OTHER AVERAGE
dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(a)
- ----------------------------------------------------------------------------------------------------------
MARCH 31, 2002
Remaining maturity:
One year or less $ 85 $ 6 $ 91 7.48%
After one through five years 94 -- 94 9.67
After five through ten years 36 58 94 6.67
After ten years 1 864(b) 865 4.73
- ---------------------------------------------------------------------------------------------------------
Amortized cost $216 $928 $1,144 7.16%
Fair value 224 928 1,152 --
Weighted average yield(a) 8.65% 4.97% 7.16% --
Weighted average maturity 2.5 YEARS 9.2 YEARS 5.2 YEARS --
- ---------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001
Amortized cost $225 $894 $1,119 7.24%
Fair value 234 894 1,128 --
- ---------------------------------------------------------------------------------------------------------
MARCH 31, 2001
Amortized cost $316 $892 $1,208 8.01%
Fair value 328 892 1,220 --
- ---------------------------------------------------------------------------------------------------------
(a) Weighted average yields are calculated based on amortized cost and exclude
equity securities of $777 million that have no stated yield. Such yields
have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
(b) Includes equity securities (primarily principal investing assets) with no
stated maturity.
ASSET QUALITY
Key has a multi-faceted program to manage asset quality. Our professionals:
- - evaluate and monitor credit quality and risk in credit-related assets;
- - develop commercial and consumer credit policies and systems;
- - monitor compliance with internal underwriting standards;
- - establish credit-related concentration limits; and
- - review the adequacy of the allowance for loan losses.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses at March 31, 2002, was
$1.6 billion, or 2.51% of loans. This compares with $1.0 billion, or 1.49% of
loans, at March 31, 2001. The allowance includes $176 million (for 2002) and
$111 million (for 2001) that is specifically allocated for impaired loans. For
more information about impaired loans, see Note 7 ("Impaired Loans and Other
Nonperforming Assets") on page 16. At March 31, 2002, the allowance for loan
losses was 165.16% of nonperforming loans, compared with 140.39% at March 31,
2001.
Management estimates the appropriate level of the allowance for loan losses on a
quarterly (and at times more frequent) basis. The methodology used is described
in Note 1 ("Summary of Significant Accounting Policies") under the heading
"Allowance for Loan Losses," on page 59 of Key's 2001 Annual Report to
Shareholders. The allowance was increased in 2001 because of continued weakness
in the economy and the related adverse effects on specific loan portfolios. As
discussed in the following section entitled "Run-off
52
Loan Portfolio," the higher allowance was also necessary to implement Key's
decision to eliminate certain types of commercial lending.
RUN-OFF LOAN PORTFOLIO. In May 2001, management segregated $300 million of Key's
allowance for loan losses in connection with the decision to eliminate
nonrelationship lending in the leveraged financing and nationally syndicated
lending businesses. An additional $190 million was added to this allowance in
the fourth quarter. The segregated allowance is being used to exit what
initially amounted to approximately $2.7 billion in related commitments
(including $1.6 billion of loans outstanding, which were moved to a separate
run-off portfolio) and for losses incurred in connection with loan sales.
Approximately $1.5 billion of these commitments (including $941 million of loans
outstanding) were remaining as of March 31. The majority of the loans are
performing in accordance with their contractual terms. As write-downs on the
run-off portfolio occur over time, we do not expect to replenish the related
allowance.
Figure 22 summarizes certain asset quality indicators, segregated between Key's
continuing and run-off loan portfolios. Additional information pertaining to the
run-off portfolio is presented in Figure 23.
FIGURE 22. ASSET QUALITY INDICATORS -- CONTINUING AND RUN-OFF LOAN PORTFOLIOS
THREE MONTHS ENDED
MARCH 31, 2002 MARCH 31, 2002
--------------------------------------------------------------- ----------------------
Allowance for Loan Losses Net Loan Charge-offs
Loans ------------------------- Nonperforming ----------------------
dollars in millions Outstanding Amount % of Loans Loans Amount % of Loans
- -----------------------------------------------------------------------------------------------------------------------------
Continuing loan portfolio $63,015 $1,402 2.22% $765 $136 .88%
Run-off loan portfolio 941 205 21.79 208 70(a) N/M
- --------------------------------------------------------------------------------------------------------------------------
Total loan portfolio $63,956 $1,607 2.51% $973 $206 1.32%
======= ====== ==== ====
- --------------------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and loans sold.
N/M = Not Meaningful
FIGURE 23. RUN-OFF LOAN PORTFOLIO
SUMMARY OF CHANGES IN COMMITMENTS
AND LOANS OUTSTANDING TOTAL LOANS
in millions COMMITMENTS OUTSTANDING
- ---------------------------------------------------------------------------
Balance at December 31, 2001 $1,694 $1,023
Charge-offs (44) (44)
Payments, expirations and
other changes, net (118) (38)
- ---------------------------------------------------------------------------
Balance at March 31, 2002 $1,532 $ 941
====== ======
- ---------------------------------------------------------------------------
SUMMARY OF CHANGES IN NONPERFORMING LOANS
AND NONREPLENISHING ALLOWANCE FOR LOAN LOSSES(a) NONPERFORMING NONREPLENISHING
in millions LOANS ALLOWANCE
- -----------------------------------------------------------------------------------------
Balance at December 31, 2001 $231 $275
Loans placed on nonaccrual status 26 N/A
Charge-offs (44) (70)
Payments (5) N/A
- -----------------------------------------------------------------------------------------
Balance at March 31, 2002 $208 $205
==== ====
- -----------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and loans sold.
N/A = Not Applicable
53
NET LOAN CHARGE-OFFS. Net loan charge-offs for the first quarter of 2002 were
$206 million, or 1.32% of average loans, compared with $109 million, or .66% of
average loans, for the first three months of last year. The composition of Key's
loan charge-offs and recoveries by type of loan is shown in Figure 25. Most of
the increase in net charge-offs occurred in the commercial loan portfolio,
reflecting the effects of continued weakness in the economy, Key's continuing
efforts to resolve credits within the commercial loan run-off portfolio and loan
sales. As shown in Figure 23, we used $70 million of Key's nonplenishing
allowance during the first quarter to absorb losses arising from the run-off
loan portfolio and loan sales. The largest contributor to Key's net charge-offs
for the first quarter of 2002 was the structured finance portfolio, which
accounted for 19% of total net charge-offs. This portfolio represents loans to
highly leveraged companies and constituted less than 3% of Key's total loans at
March 31, 2002. The structured finance portfolio is also discussed in the
section entitled "Nonperforming assets," beginning on page 55.
FIGURE 24. SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED MARCH 31,
---------------------------------
dollars in millions 2002 2001
- ------------------------------------------------------------------------------------------------------------------------
Average loans outstanding during the period $63,488 $67,033
- ------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $1,677 $1,001
Loans charged off:
Commercial, financial and agricultural 84 48
Real estate -- commercial mortgage 48 8
Commercial lease financing 20 3
- ------------------------------------------------------------------------------------------------------------------------
Total commercial loans 152 59
Real estate -- residential mortgage 1 2
Home equity 14 6
Consumer -- direct 14 12
Consumer -- indirect lease financing 7 6
Consumer -- indirect other 45 50
- ------------------------------------------------------------------------------------------------------------------------
Total consumer loans 81 76
- ------------------------------------------------------------------------------------------------------------------------
233 135
Recoveries:
Commercial, financial and agricultural 10 7
Real estate -- commercial mortgage 1 --
Commercial lease financing 1 1
- ------------------------------------------------------------------------------------------------------------------------
Total commercial loans 12 8
Real estate -- residential mortgage 1 2
Consumer -- direct 2 2
Consumer -- indirect lease financing 2 2
Consumer -- indirect other 10 12
- ------------------------------------------------------------------------------------------------------------------------
Total consumer loans 15 18
- ------------------------------------------------------------------------------------------------------------------------
27 26
- ------------------------------------------------------------------------------------------------------------------------
Net loans charged off (206) (109)
Provision for loan losses 136 110
Allowance related to loans sold, net -- (1)
- ------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $1,607 $1,001
====== ======
- ------------------------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans 1.32% .66%
Allowance for loan losses to period-end loans 2.51 1.49
Allowance for loan losses to nonperforming loans 165.16 140.39
- ------------------------------------------------------------------------------------------------------------------------
54
NONPERFORMING ASSETS. Figure 25 shows the composition of Key's nonperforming
assets. These assets totaled $1.0 billion at March 31, 2002, and represented
1.58% of loans, other real estate owned (known as "OREO") and other
nonperforming assets, compared with $947 million, or 1.49%, at December 31,
2001, and $740 million, or 1.10%, at March 31, 2001.
FIGURE 25. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
dollars in millions 2002 2001 2001 2001 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 470 $409 $399 $384 $348
Real estate -- commercial mortgage 156 187 169 128 84
Real estate -- construction 77 83 70 35 29
- -----------------------------------------------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 233 270 239 163 113
Commercial lease financing 100 94 83 83 50
- -----------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 803 773 721 630 511
Real estate -- residential mortgage 51 42 40 32 56
Home equity 77 50 77 90 102
Consumer -- direct 9 9 9 8 8
Consumer -- indirect lease financing 8 10 13 11 9
Consumer -- indirect other 25 26 25 26 27
- -----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 170 137 164 167 202
- -----------------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 973 910 885 797 713
OREO 41 38 26 27 28
Allowance for OREO losses (2) (1) (1) (1) (1)
- -----------------------------------------------------------------------------------------------------------------------------------
OREO, net of allowance 39 37 25 26 27
Other nonperforming assets -- -- 3 -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $1,012 $947 $913 $823 $740
====== ==== ==== ==== ====
- -----------------------------------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $203 $ 250 $ 332 $280 $299
Accruing loans past due 30 through 89 days 897 1,096 1,084 937 962
- -----------------------------------------------------------------------------------------------------------------------------------
Nonperforming loans to period-end loans 1.52% 1.44% 1.37% 1.20% 1.06%
Nonperforming assets to period-end loans
plus OREO and other nonperforming assets 1.58 1.49 1.41 1.23 1.10
- -----------------------------------------------------------------------------------------------------------------------------------
(a) See Figure 16 on page 49 and the accompanying discussion on page 48 for
more information related to Key's commercial real estate portfolio.
The economic slowdown can be expected to continue to impact Key's loan portfolio
in general, although the erosion in credit quality that we have experienced is
concentrated in several distinct commercial portfolios of limited size. At March
31, 2002, two portfolios, Structured Finance and Healthcare, accounted for $145
million and $132 million, respectively, of Key's nonperforming loans. Although
these two portfolios comprised less than 5% of Key's total loans, they accounted
for 28% of total nonperforming loans. At March 31, 2002, our 20 largest
nonperforming loans totaled $287 million, representing 29% of total loans on
nonperforming status. These loans include a $23 million credit in the Large
Corporate portfolio that was placed on nonaccrual status during the first
quarter. As shown in Figure 23, at March 31, 2002, the run-off loan portfolio
accounted for $208 million, or 21%, of Key's total nonperforming loans presented
in Figure 25.
Further information pertaining to the credit exposure inherent in the largest
sector of Key's loan portfolio, commercial, financial and agricultural loans, is
presented in Figure 26. The types of activity that caused the change in Key's
nonperforming loans during the last five quarters are summarized in Figure 27.
55
FIGURE 26. COMMERCIAL, FINANCIAL AND AGRICULTURAL LOANS
NONPERFORMING LOANS
--------------------------------
MARCH 31, 2002 TOTAL LOANS % OF LOANS
dollars in millions COMMITMENTS OUTSTANDING AMOUNT OUTSTANDING
- -------------------------------------------------------------------------------------------------------------
Industry classification:
Manufacturing $10,139 $4,479 $137 3.1%
Services 5,762 2,642 107 4.0
Financial services 5,456 986 6 .6
Retail trade 4,069 2,317 58 2.5
Wholesale trade 2,998 1,475 22 1.5
Property management 2,435 1,138 5 .4
Public utilities 1,419 322 -- --
Communications 1,136 608 37 6.1
Agriculture/forestry/fishing 1,204 756 23 3.0
Building contractors 1,252 582 35 6.0
Public administration 758 358 8 2.2
Transportation 677 458 7 1.5
Insurance 568 131 -- --
Mining 381 226 1 .4
Individuals 337 192 1 .5
Other 1,892 1,577 23 1.5
- -------------------------------------------------------------------------------------------------------------
Total $40,483 $18,247 $470 2.6%
======= ======= ====
- -------------------------------------------------------------------------------------------------------------
FIGURE 27. SUMMARY OF CHANGES IN NONPERFORMING LOANS
2002 2001
----------- ------------------------------------------------------------------
in millions FIRST FOURTH THIRD SECOND FIRST
- ------------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 910 $885 $797 $713 $650
Loans placed on nonaccrual status 294 407 324 455 255
Charge-offs (206) (220) (173) (170) (109)
Loans sold -- (83) (35) (137) (5)
Payments (22) (65) (20) (61) (62)
Transfers to OREO (3) (12) (8) (2) (7)
Loans returned to accrual status -- (2) -- (1) (9)
- ------------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 973 $910 $885 $797 $713
===== ==== ==== ==== ====
- ------------------------------------------------------------------------------------------------------------------------------
DEPOSITS AND OTHER SOURCES OF FUNDS
"Core deposits"--domestic deposits other than certificates of deposit of
$100,000 or more--are Key's primary source of funding. During the first quarter
of 2002, core deposits averaged $37.3 billion, and represented 52% of the funds
Key used to support earning assets, compared with $37.9 billion and 49% during
the first three months of 2001. The composition of Key's deposits is shown in
Figure 6, which spans pages 38 and 39.
The slight decline in the level of Key's core deposits over the past twelve
months was due primarily to a lower level of time deposits. Time deposits
decreased by 10% because, like our competitors, Key reduced the rates paid for
them as the Federal Reserve reduced interest rates in general. At the same time,
Key's money market deposit accounts and noninterest-bearing deposits grew, since
clients view these investments as relatively liquid and stable in a weak
economy.
Purchased funds, comprising large certificates of deposit, deposits in the
foreign branch and short-term borrowings, averaged $16.3 billion during the
first quarter of 2002, compared with $21.7 billion a year ago. As shown in
Figure 6, Key has reduced its reliance on each of these funding sources. This is
attributable in part to loan sales, slow demand for loans and from the decision
made in May 2001 to scale back or discontinue certain types of lending. In
addition, Key continues to consider loan securitizations as a funding
alternative when market conditions are favorable. No securitizations were
completed during the first three months of 2002.
56
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 has sufficient liquidity
when it can pay dividends to shareholders, service its debt, and support
customary corporate operations and activities, including acquisitions, at a
reasonable cost, in a timely manner and without adverse consequences.
LIQUIDITY RISK. Management recognizes that there are circumstances that could
adversely affect Key's liquidity or materially affect the cost of funds. One
such circumstance involves the occurrence of events that are systemic in nature,
such as terrorism or war, natural disasters, political events, or the default or
bankruptcy of a major corporation, mutual fund or hedge fund. Examples of these
events are the September 11 attacks on the World Trade Center and Pentagon, and
the fall, 1998 Russian and Long-Term Capital Management defaults. Another
circumstance is a significant downgrade in the public credit rating of Key by a
rating agency due to a deterioration in asset quality, a large charge to
earnings, a significant merger or acquisition or other events. In addition,
market speculation or rumors about Key may cause normal funding sources to
withdraw credit until further information becomes available.
LIQUIDITY FOR KEY. Key's Funding and Investment Management Group monitors the
overall mix of funding sources with the objective of maintaining an appropriate
mix in light of the structure of the asset portfolios. We use several tools to
maintain sufficient liquidity.
- - We maintain portfolios of short-term money market investments and
securities available for sale, substantially all of which could be
converted to cash quickly at a small expense.
- - Key's portfolio of investment securities generates payments at maturity and
prepayments (often at a premium).
- - We try to structure the maturities of our loans so that we receive a
relatively consistent stream of payments from borrowers. We also
selectively securitize and package loans for sale.
- - Our 911 full-service KeyCenters in 12 states generate a sizable volume of
core deposits. We monitor deposit flows and use alternative pricing
structures to attract deposits when necessary. For more information about
core deposits, see the previous section entitled "Deposits and other
sources of funds."
- - Key has access to various sources of money market funding (such as Federal
funds purchased, securities sold under repurchase agreements, and bank
notes) and also can borrow from the Federal Reserve Bank to meet short-term
liquidity requirements. Key did not have any borrowings from the Federal
Reserve outstanding as of March 31, 2002.
LIQUIDITY FOR THE PARENT COMPANY. KeyCorp meets its liquidity requirements
principally through regular dividends from affiliate banks. During the first
three months of 2002, affiliate banks paid KeyCorp a total of $19 million in
dividends. As of March 31, 2002, the affiliate banks had an additional $570
million available to pay dividends to KeyCorp without prior regulatory approval.
KeyCorp 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 three months of 2002, Key's affiliate banks
raised $925 million under Key's bank note program. Of the notes issued during
the quarter, $500 million have original maturities in excess of one year and are
included in long-term debt. The remaining notes have original maturities of one
57
year or less and are included in short-term borrowings. Key's current
bank note program provides for the issuance of both long- and short-term debt of
up to $20.0 billion ($19.0 billion by KeyBank National Association and $1.0
billion by Key Bank USA, National Association), all of which was available for
future issuance at March 31, 2002.
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 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 $5.0 billion of borrowings outstanding under
this facility as of March 31, 2002, $1.0 billion of which were issued during the
first quarter. At the end of the first quarter, $4.7 billion was available for
future issuance under this program.
COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp has a commercial paper program
and a revolving credit agreement with an unaffiliated financial institution that
provide funding availability of up to $500 million and $400 million,
respectively. As of March 31, 2002, no amount was outstanding under either
facility.
PARENT COMPANY NOTE PROGRAM AND OTHER SECURITIES. KeyCorp has registered with
the Securities and Exchange Commission to provide for the issuance of up to $2.2
billion of securities, which could include long- or short-term debt, or equity
securities. At March 31, 2002, all of this capacity remained unused, including
$1.0 billion which is reserved for issuance as medium-term notes.
Key has favorable debt ratings as shown in Figure 28 below. As long as those
debt ratings are maintained, management believes that, under normal conditions
in the capital markets, any eventual offering of securities would be marketable
to investors at a competitive cost.
FIGURE 28. DEBT RATINGS
SENIOR SUBORDINATED
SHORT-TERM LONG-TERM LONG-TERM CAPITAL
MARCH 31, 2002 BORROWINGS DEBT DEBT SECURITIES
- -------------------------------------------------------------------------------------------------------------------
KEYCORP
- -------------------------------------
Standard & Poor's A-2 A- BBB+ BBB
Moody's P-1 A2 A3 "Baal"
KEYBANK NATIONAL ASSOCIATION
- -------------------------------------
Standard & Poor's A-1 A A- N/A
Moody's P-1 A1 A2 N/A
- -------------------------------------------------------------------------------------------------------------------
N/A=Not Applicable
Figure 32 on page 49 of Key's 2001 Annual Report to Shareholders summarizes
Key's significant cash obligations and contractual amounts of off-balance sheet
lending-related commitments at December 31, 2001, by the specific time periods
in which related payments are due or commitments expire. These commitments have
not changed significantly since the end of last year.
58
CAPITAL AND DIVIDENDS
SHAREHOLDERS' EQUITY. Total shareholders' equity at March 31, 2002, was $6.4
billion, up $247 million from the balance at December 31, 2001. Net income and a
reduction in treasury stock more than offset the effect of net unrealized losses
on securities available for sale in the first quarter.
SHARE REPURCHASES. In September 2000, the Board of Directors authorized the
repurchase of up to 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 three months of 2002, Key did not repurchase any of its common shares. At
March 31, 2002, a remaining balance of 16,764,400 shares may be repurchased
under the September 2000 authorization.
At March 31, 2002, Key had 66,434,962 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 quarter, Key reissued 1,448,762 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 7.87% at March 31, 2002,
compared with 7.60% at December 31, 2001, and 7.75% at March 31, 2001.
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-weighted 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-weighted assets of
4.00%, and total capital as a percent of risk-weighted assets of 8.00%. As of
March 31, 2002, Key's Tier 1 capital ratio was 7.92%, and its total capital
ratio was 12.02%.
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 3.00%. All other bank holding companies must maintain a minimum ratio of
4.00%. As of March 31, 2002, KeyCorp had a leverage ratio of 8.13%.
Federal bank regulators group FDIC-insured depository institutions into five
categories, ranging from "critically undercapitalized" to "well capitalized."
Both of Key's affiliate banks qualified as "well capitalized" at March 31, 2002,
since each exceeded the prescribed thresholds of 10.00% for total capital, 6.00%
for Tier 1 capital and 5.00% for the leverage ratio. If these provisions applied
to bank holding companies, KeyCorp would also qualify as "well capitalized" at
March 31, 2002. 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 29 presents the details of Key's regulatory capital position at March 31,
2002, December 31, 2001 and March 31, 2001.
59
FIGURE 29. CAPITAL COMPONENTS AND RISK-WEIGHTED ASSETS
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 2002 2001 2001
- --------------------------------------------------------------------------------------------------------------------------
TIER 1 CAPITAL
Common shareholders' equity(a) $6,388 $6,117 $6,730
Qualifying capital securities 1,232 1,243 1,243
Less: Goodwill 1,101 1,101 1,311
Other assets(b) 35 37 45
- --------------------------------------------------------------------------------------------------------------------------
Total Tier 1 capital 6,484 6,222 6,617
- --------------------------------------------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(c) 1,017 1,040 1,001
Net unrealized holding gains(d) -- -- 1
Qualifying long-term debt 2,338 2,286 2,587
- --------------------------------------------------------------------------------------------------------------------------
Total Tier 2 capital 3,355 3,326 3,589
- --------------------------------------------------------------------------------------------------------------------------
Total risk-based capital $ 9,839 $ 9,548 $10,206
======= ======= =======
RISK-WEIGHTED ASSETS
Risk-weighted assets on balance sheet $68,090 $67,783 $71,251
Risk-weighted off-balance sheet exposure 15,270 17,480 12,747
Less: Goodwill 1,101 1,101 1,311
Other assets(b) 35 37 45
Plus: Market risk-equivalent assets 215 217 226
Net unrealized holding gains(d) -- -- 1
- --------------------------------------------------------------------------------------------------------------------------
Gross risk-weighted assets 82,439 84,342 82,869
Less: Excess allowance for loan losses(c) 590 637 --
- --------------------------------------------------------------------------------------------------------------------------
Net risk-weighted assets $81,849 $83,705 $82,869
======= ======= =======
AVERAGE QUARTERLY TOTAL ASSETS $80,871 $82,467 $86,324
======= ======= =======
CAPITAL RATIOS
Tier 1 risk-based capital ratio 7.92% 7.43% 7.99%
Total risk-based capital ratio 12.02 11.41 12.32
Leverage ratio(e) 8.13 7.65 7.79
- --------------------------------------------------------------------------------------------------------------------------
(a) Common shareholders' equity does not include 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-weighted 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) This ratio is Tier 1 capital divided by average quarterly total assets less
goodwill and the nonqualifying intangible assets described in footnote (b).
60
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.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information presented in Note 12 ("Legal Proceedings"), beginning
on page 21, of the Notes to Consolidated Financial Statements is
incorporated herein by reference.
ITEM 5. OTHER INFORMATION
REGULATORY CAPITAL STANDARDS AND RELATED MATTERS. In late January
2002, the Federal banking agencies published their final rule on the
regulatory capital treatment of certain equity investments made by
banking organizations in companies engaged in nonfinancial activities.
The final rule becomes effective on April 1, 2002.
The final rule imposes marginal capital charges (applied by making
deductions from Tier 1 capital), which increase as the banking
organization's aggregate carrying amount of its covered equity
investments increase in relation to its Tier 1 capital. Such capital
charges range from 8% to 25% as such aggregate carrying amount
increases from 15% to 25% of the banking organization's Tier 1
capital. Management anticipates that this final rule will not have any
adverse material effect on Key's regulatory capital.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10.1) Form of Award of Restricted Stock (2002 -- 2003)
(10.2) Form of Award of Restricted Stock (2002 -- 2004)
(10.3) Award of Restricted Stock to Henry L. Meyer III (2002 -- 2003)
(10.4) Award of Restricted Stock to Henry L. Meyer III (2002 -- 2004)
(15) Acknowledgment Letter of Independent Auditors
(b) Reports on Form 8-K
January 16, 2002 - Item 5. Other Events, Item 7. Financial Statements
and Exhibits and Item 9. Regulation FD Disclosure. Reporting that on
January 16, 2002, the Registrant issued a press release announcing its
earnings results for the three-and twelve-month periods ended December
31, 2001, 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 March 31, 2002.
61
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
------------------------------------
(Registrant)
Date: May 13, 2002 /s/ Lee Irving
------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
62