.
.
.
EXHIBIT 13
FINANCIAL REVIEW
MANAGEMENT'S DISCUSSION & ANALYSIS OF
FINANCIAL CONDITION & RESULTS OF OPERATIONS
Introduction 20
Highlights of Key's 2002 Performance 21
Line of Business Results 24
Results of Operations
Net Interest Income 27
Market Risk Management 30
Noninterest Income 32
Noninterest Expense 34
Income Taxes 36
Financial Condition
Loans 36
Securities 40
Asset Quality 40
Deposits and Other Sources of Funds 46
Liquidity 46
Capital 48
Fourth Quarter Results 50
REPORT OF MANAGEMENT 52
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS 52
CONSOLIDATED FINANCIAL STATEMENTS 53
19
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
INTRODUCTION
This section generally reviews the financial condition and results of operations
of KeyCorp and its subsidiaries for each of the past three years. Some tables
may cover a longer period to comply with disclosure requirements or to
illustrate trends in greater depth. When you read this discussion, you should
also refer to the consolidated financial statements and related notes that
appear on pages 53 through 88.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
Key's business is dynamic and complex. Consequently, management must exercise
judgment in choosing and applying accounting policies and methodologies in many
areas. These choices are important; not only are they necessary to comply with
accounting principles generally accepted in the United States, they also reflect
management's view of the most appropriate manner in which to record and report
Key's overall financial performance. All accounting policies are important, and
all policies described in Note 1 ("Summary of Significant Accounting Policies"),
which begins on page 57, should be reviewed for a greater understanding of how
Key's financial performance is recorded and reported.
In management's opinion, some accounting policies are more likely than others to
have a significant effect on Key's financial results and to expose those results
to potentially greater volatility. These policies apply to areas of relatively
greater business importance or require management to make assumptions and
estimates that affect amounts reported in the financial statements. Because
these assumptions and estimates are based on current circumstances, they may
change over time or prove to be inaccurate based on actual experience. For Key,
the areas that rely most heavily on the use of assumptions and estimates include
accounting for the allowance for loan losses, loan securitizations, contingent
obligations arising from litigation and tax exposures, principal investments,
goodwill, and pension and other postretirement obligations. A brief discussion
of each of these areas appears below.
ALLOWANCE FOR LOAN LOSSES. Management determines probable losses inherent in
Key's loan portfolio (which represents by far the largest category of assets on
Key's balance sheet) and establishes an allowance that is sufficient to absorb
those losses by considering factors including historical loss rates, expected
cash flows and estimated collateral values. In assessing these factors,
management benefits from a lengthy organizational history and experience with
credit decisions and related outcomes. Nonetheless, if management's underlying
assumptions prove to be inaccurate, the allowance for loan losses would have to
be adjusted. Our accounting policy related to the allowance is disclosed in Note
1 under the heading "Allowance for Loan Losses" on page 58.
LOAN SECURITIZATIONS. Key securitizes certain types of loans and accounts for
such transactions as sales when the criteria set forth in Statement of Financial
Accounting Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishment of Liabilities" are met. If future events
were to preclude accounting for such transactions as sales, the loans would have
to be placed back on Key's balance sheet. This could have a potentially adverse
effect on Key's capital ratios and other unfavorable financial implications. In
addition, determining the gain or loss resulting from securitization
transactions and the subsequent carrying amount of retained interests is
dependent on underlying assumptions made by management, the most significant of
which are described in Note 8 ("Loan Securitizations and Variable Interest
Entities"), which begins on page 70. The use of alternative ranges of possible
outcomes for these assumptions would change the amount of the initial gain or
loss recognized. It could also result in changes in the carrying amount of
retained interests, with related effects on results of operations. Our
accounting policy related to loan securitizations is disclosed in Note 1 under
the heading "Loan Securitizations" on page 59.
CONTINGENT OBLIGATIONS. A detailed description of contingent obligations arising
from litigation and their potential effects on Key's results of operations is
contained in Note 19 ("Commitments, Contingent Liabilities and Guarantees"),
which begins on page 81.
In the normal course of business, Key is routinely subject to examinations and
challenges from tax authorities regarding the amount of taxes due in connection
with investments and business activities. Currently, the Internal Revenue
Service is challenging Key's tax treatment of certain leveraged lease
investments. This and other challenges by tax authorities may result in
adjustments to the timing or amount of Key's taxable income or deductions or the
allocation of income among tax jurisdictions. Management believes these
challenges will be resolved without having any material effect on Key's
financial condition or results of operations.
VALUATION METHODOLOGIES. Valuation methodologies employed by management often
involve a significant degree of judgment, particularly when there are no
observable liquid markets for the items being valued. The outcome of valuations
performed by management have a direct bearing on the carrying amounts of certain
assets and liabilities, such as principal investments, goodwill, and pension and
other postretirement benefit obligations. To determine the values of these
assets and liabilities, as well as the extent to which related assets may be
impaired, management makes assumptions and estimates related to discount rates,
asset returns, repayment rates and other factors. The use of different discount
rates or other valuation assumptions could produce significantly different
results, which could have material positive or negative effects on Key's results
of operations.
The valuation methodology management uses for principal investments is
summarized in Note 21 ("Fair Value Disclosures of Financial Instruments") on
page 86 and the methodology used in the testing for goodwill impairment is
summarized in Note 1 under the heading "Goodwill and Other Intangible Assets" on
page 59. The primary assumptions used in determining Key's pension and other
postretirement benefit obligations and related expenses are presented in Note 16
("Employee Benefits"), which begins on page 78.
When a potential asset impairment is identified through testing, observable
changes in liquid markets or other means, management must also exercise judgment
in determining the nature of the potential impairment (i.e., whether the
impairment is temporary or other than temporary) in order to apply the
appropriate accounting treatment. For example, unrealized losses on securities
available for sale that are deemed temporary are recorded in shareholders'
equity, whereas those deemed "other than temporary" are recorded in earnings.
REVENUE RECOGNITION
In recent months, corporate improprieties related to revenue recognition have
received a great deal of attention by regulatory authorities and the news media.
Although all companies face the risk of intentional or unintentional
misstatements, such misstatements are less likely in the
20
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
financial services industry because most of the revenue (i.e., interest
accruals) recorded is driven by nondiscretionary formulas based on written
contracts, such as loan agreements.
TERMINOLOGY
This report contains some shortened names and industry-specific terms. We want
to explain some of these terms at the outset so you can better understand the
discussion that follows.
- - KEYCORP refers solely to the parent holding company.
- - KBNA refers to Key's lead bank, KeyBank National Association.
- - KEY refers to the consolidated entity consisting of KeyCorp and its
subsidiaries.
- - A KEYCENTER is one of Key's full-service retail banking facilities or
branches.
- - Key engages in CAPITAL MARKETS ACTIVITIES. These activities encompass a
variety of products and services. Among other things, we trade securities as
a dealer, enter into derivative contracts (both to accommodate clients'
financing needs and for proprietary trading purposes), and conduct
transactions in foreign currencies (both to accommodate clients' needs and
to benefit from fluctuations in exchange rates).
- - All earnings per share data included in this discussion are presented on a
DILUTED basis, which takes into account all common shares outstanding as
well as potential common shares that could result from the exercise of
outstanding stock options. Some of the financial information tables also
include BASIC earnings per share, which takes into account only common
shares outstanding.
- - For regulatory purposes, capital is divided into two classes. Federal
regulations prescribe that at least one-half of a bank or bank holding
company's TOTAL RISK-BASED CAPITAL must qualify as TIER 1. Both total and
Tier 1 capital serve as bases for several measures of capital adequacy,
which is an important indicator of financial stability and condition. You
will find a more detailed explanation of total and Tier 1 capital and how
they are calculated in the section entitled "Capital," which begins on page
48.
- - When we want to draw your attention to a particular item in Key's Notes to
Consolidated Financial Statements, we refer to NOTE ___, giving the
particular number, name and starting page number.
FORWARD-LOOKING STATEMENTS
This report may contain "forward-looking statements" about issues like
anticipated earnings, anticipated levels of net loan charge-offs and
nonperforming assets and anticipated improvement in profitability and
competitiveness. These statements usually can be identified by the use of
forward-looking language such as "our goal," "our objective," "our plan," "will
likely result," "will be," "are expected to," "as planned," "is anticipated,"
"intends to," "is projected," or similar words. Forward-looking statements by
their nature are subject to assumptions, risks and uncertainties. For a variety
of reasons, including the following, actual results could differ materially from
those contained in or implied by the forward-looking statements.
- - Interest rates could change more quickly or more significantly than we
expect, which may have an adverse effect on our financial results.
- - If the economy or segments of the economy fail to recover or, decline
further, the demand for new loans and the ability of borrowers to repay
outstanding loans may decline.
- - The stock and bond markets could suffer additional declines or disruptions,
which may have adverse effects on our financial condition and that of our
borrowers, and on our ability to raise money by issuing new securities.
- - It could take us longer than we anticipate to implement strategic
initiatives designed to increase revenues or manage expenses; we may be
unable to implement certain initiatives; or the initiatives may be
unsuccessful.
- - Acquisitions and dispositions of assets, business units or affiliates could
adversely affect us in ways that management has not anticipated.
- - We may become subject to new legal obligations, or the resolution of pending
litigation may have an adverse effect on our financial results.
- - Terrorist activities or military actions could further disrupt the economy
and the general business climate, which may have an adverse effect on our
financial results or condition and that of our borrowers.
- - We may become subject to new accounting, tax, or regulatory practices or
requirements.
HIGHLIGHTS OF KEY'S 2002 PERFORMANCE
FINANCIAL PERFORMANCE
The primary measures of Key's financial performance for 2002, 2001 and 2000 are
summarized below.
- - Net income for 2002 was $976 million, or $2.27 per common share, compared
with $132 million, or $.31 per share for 2001, and $1.0 billion, or $2.30
per share, for 2000.
- - Key's return on average equity was 14.96% for 2002. This result compares
with a return of 2.01% for 2001 and a return of 15.39% for 2000.
- - Key's 2002 return on average total assets was 1.19%. This result compares
with a return of .16% for 2001 and a return of 1.19% for 2000.
In the second and fourth quarters of 2001, we announced a series of strategic
initiatives designed to sharpen our business focus and strengthen Key's
financial performance. These included:
- - Accelerating Key's revenue growth by delivering our products and services to
customers through a seamless, integrated sales process called 1Key.
- - Achieving 100% of the savings from our competitiveness initiative discussed
on page 22.
- - Re-emphasizing our commitment to our relationship-based activities, and
committing to re-establish a conservative credit culture while
de-emphasizing high-risk, low-return businesses.
Specific actions related to these initiatives included exiting the automobile
leasing business, de-emphasizing indirect prime automobile lending,
discontinuing many credit-only relationships in the leveraged financing and
nationally syndicated lending businesses, and increasing the allowance for loan
losses.
21
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
As a result of these actions, Key recorded 2001 charges aggregating $1.1 billion
($774 million after tax) that hinder a direct comparison of financial results
over the past three years. Specifically, in the second quarter of 2001, we
recorded a $150 million write-down of goodwill associated with Key's 1995
acquisition of AutoFinance Group, Inc. This charge reflects our intention to
significantly downsize the automobile finance business. We also increased the
provision for loan losses by $300 million ($189 million after tax) to facilitate
the exiting of credits in the leveraged financing and nationally syndicated
lending businesses. Finally, we recorded a $40 million ($25 million after tax)
charge to establish a reserve for losses incurred on the residual values of
leased vehicles.
In the fourth quarter of 2001, we recorded an additional provision for loan
losses of $590 million ($372 million after tax) as a result of both the rapid
downturn in the economy and further erosion in credit quality experienced after
the events of September 11. In the same quarter, we recorded a $45 million ($28
million after tax) write-down of our principal investing portfolio and a $15
million ($9 million after tax) charge to increase our reserve for customer
derivative losses.
Results for 2001 also were adversely affected by a $39 million ($24 million
after tax) charge resulting from a prescribed change in accounting principles
generally accepted in the United States applicable to retained interests in
securitized assets and a $20 million ($13 million after tax) increase in
litigation reserves.
The charges summarized above and the primary reasons that Key's specific revenue
and expense components changed over the past three years are reviewed in greater
detail throughout the remainder of this discussion.
Figure 1 summarizes Key's financial performance for each of the past six years.
CORPORATE STRATEGY
Our goal is to achieve revenue and earnings per share growth that is
consistently above the median for stocks that make up the Standard & Poor's 500
Banks Index. Our strategy for achieving this goal comprises the following four
primary elements:
- - FOCUS ON OUR CORE BUSINESSES. We intend to focus on businesses that enable
us to build relationships with our clients. We will focus on our "footprint"
businesses that serve individuals, small businesses and middle market
companies. In addition, we intend to focus nationwide on our commercial real
estate lending, asset management, home equity lending and equipment leasing
businesses. These are businesses in which we believe we possess resources of
the scale necessary to compete nationally.
- - PUT OUR CLIENTS FIRST. We will work to deepen our relationship with our
existing clients, and to build relationships with new clients who have the
potential to purchase multiple products and services or to generate repeat
business. One way in which we are pursuing this goal is by emphasizing
deposit growth across all of our lines of business. We also want to ensure
that our clients are receiving a distinctive level of service, so we are
putting considerable effort into enhancing our service quality.
- - ENHANCE OUR BUSINESS. We intend to build on the success of our
competitiveness initiative by pursuing a continuous improvement process. We
will continue to focus on increasing revenues, controlling expenses and
better serving our clients, and we will also continue to leverage
technology -- both to reduce costs and to enhance service quality. Over
time, we also intend to diversify our revenue mix by emphasizing the growth
of fee income while investing in higher-growth and higher-return
businesses.
- - CULTIVATE A WORKFORCE THAT DEMONSTRATES KEY'S VALUES AND WORKS TOGETHER FOR
A COMMON PURPOSE. Key intends to achieve this by:
-- paying for performance, but only if achieved in ways that are consistent
with Key's values;
-- attracting, developing and retaining a quality, high-performing and
inclusive workforce;
-- developing leadership at all levels in the company; and
-- creating a positive, stimulating and entrepreneurial work environment.
STATUS OF COMPETITIVENESS INITIATIVE
Key launched a major initiative in November 1999, the first phase of which was
completed in 2000. This initiative was 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
annual operating expenses by approximately $100 million by outsourcing certain
nonstrategic support functions, consolidating sites in a number of our
businesses and reducing management layers.
During 2002, we 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 reduced our annual operating expenses by an additional
$200 million by:
- - consolidating 22 business lines into 10 to simplify Key's business
structure;
- - streamlining and automating business operations and processes;
- - standardizing product offerings and internal processes;
- - consolidating operating facilities and service centers; and
- - outsourcing additional noncore activities.
Due primarily to the success of the overall initiative, noninterest expense for
2002 was lower than it has been for any year since 1998.
Management expected the competitiveness initiative to reduce Key's workforce by
approximately 4,000 positions (comprising both staffed and vacant positions).
During 2002, Key completed its workforce reduction bringing the total number of
positions eliminated in the initiative to nearly 4,100.
Since the inception of the competitiveness initiative, we have recorded related
net charges of $270 million. The section entitled "Noninterest expense," which
begins on page 34, and Note 18 ("Restructuring Charges") on page 81 provide more
information about Key's restructuring charges.
22
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 1 SELECTED FINANCIAL DATA
COMPOUND
ANNUAL RATE
OF CHANGE
dollars in millions, except per share amounts 2002 2001 2000 1999 1998 1997 (1997-2002)
- -----------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
Interest income $ 4,366 $ 5,627 $ 6,277 $ 5,695 $ 5,525 $ 5,262 (3.7)%
Interest expense 1,617 2,802 3,547 2,908 2,841 2,517 (8.5)
Net interest income 2,749 2,825 2,730 2,787 2,684 2,745 --
Provision for loan losses 553 1,350 490 348 297 320 11.6
Noninterest income 1,769 1,725 2,194 2,315 1,600 1,315 6.1
Noninterest expense 2,653 2,941 2,917 3,070 2,508 2,395 2.1
Income before income taxes and cumulative
effect of accounting changes 1,312 259 1,517 1,684 1,479 1,345 (.5)
Income before cumulative effect
of accounting changes 976 157 1,002 1,107 996 919 1.2
Net income 976 132 1,002 1,107 996 919 1.2
- -----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income before cumulative effect
of accounting changes $ 2.29 $ .37 $ 2.32 $ 2.47 $ 2.25 $ 2.09 1.8%
Income before cumulative effect
of accounting changes--
assuming dilution 2.27 .37 2.30 2.45 2.23 2.07 1.9
Net income 2.29 .31 2.32 2.47 2.25 2.09 1.8
Net income--assuming dilution 2.27 .31 2.30 2.45 2.23 2.07 1.9
Cash dividends paid 1.20 1.18 1.12 1.04 .94 .84 7.4
Book value at year end 16.12 14.52 15.65 14.41 13.63 11.83 6.4
Market price at year end 25.14 24.34 28.00 22.13 32.00 35.41 (6.6)
Dividend payout ratio 52.40% 380.65% 48.28% 42.11% 41.78% 40.19% 5.4
Weighted average common shares (000) 425,451 424,275 432,617 448,168 441,895 439,042 (.6)
Weighted average common shares and
potential common shares (000) 430,703 429,573 435,573 452,363 447,437 444,544 (.6)
- -----------------------------------------------------------------------------------------------------------------------------------
AT DECEMBER 31,
Loans $ 62,457 $ 63,309 $ 66,905 $ 64,222 $ 62,012 $ 53,380 3.2%
Earning assets 73,635 71,672 77,316 73,733 70,240 64,246 2.8
Total assets 85,202 80,938 87,270 83,395 80,020 73,699 2.9
Deposits 49,346 44,795 48,649 43,233 42,583 45,073 1.8
Long-term debt 15,605 14,554 14,161 15,881 12,967 7,446 15.9
Shareholders' equity 6,835 6,155 6,623 6,389 6,167 5,181 5.7
Full-time equivalent employees 20,437 21,230 22,142 24,568 25,862 24,595 (3.6)
KeyCenters 910 911 922 936 968 1,015 (2.2)
- -----------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.19% .16% 1.19% 1.37% 1.32% 1.33% N/A
Return on average equity 14.96 2.01 15.39 17.68 17.97 18.89 N/A
Net interest margin (taxable equivalent) 3.97 3.81 3.69 3.93 4.08 4.54 N/A
- -----------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT DECEMBER 31,
Equity to assets 8.02% 7.60% 7.59% 7.66% 7.71% 7.03% N/A
Tangible equity to tangible assets 6.73 6.29 6.12 6.03 5.93 5.52 N/A
Tier 1 risk-based capital 8.09 7.43 7.72 7.68 7.21 6.65 N/A
Total risk-based capital 12.51 11.41 11.48 11.66 11.69 10.83 N/A
Leverage 8.15 7.65 7.71 7.77 6.95 6.40 N/A
- -----------------------------------------------------------------------------------------------------------------------------------
Key completed several acquisitions and divestitures during the six-year period
shown in this table. One or more of these transactions may have had a
significant effect on Key's results, making it difficult to compare results from
one year to the next. Note 3 ("Acquisitions and Divestitures") on page 64
contains specific information about the acquisitions and divestitures that Key
completed in the past three years to help you understand how those transactions
may have impacted Key's financial condition and results of operations.
N/A = Not Applicable
23
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
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 65.
Note 4 includes a brief description of the products and services offered by each
of the three major business groups, more detailed financial information
pertaining to the groups and their respective lines of business and brief
descriptions of "Other Segments" and "Reconciling Items" included in Figure 2.
Figure 2 summarizes the contribution made by each major business group to Key's
taxable-equivalent revenue and net income for each of the past three years.
FIGURE 2 MAJOR BUSINESS GROUPS--TAXABLE-EQUIVALENT REVENUE AND NET INCOME
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
--------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------
REVENUE (TAXABLE EQUIVALENT)
Key Consumer Banking $ 2,302 $ 2,300 $ 2,232 $ 2 .1%
Key Corporate Finance 1,361 1,351 1,264 10 .7
Key Capital Partners 1,109 1,159 1,188 (50) (4.3)
Other Segments (76) (73) 57 (3) (4.1)
- ------------------------------------------------------------------------------------------------
Total segments 4,696 4,737 4,741 (41) (.9)
Reconciling Items (58) (142)(b) 211(b) 84 59.2
- ------------------------------------------------------------------------------------------------
Total $ 4,638 $ 4,595 $ 4,952 $ 43 .9%
======= ======= ======== =======
NET INCOME (LOSS)
Key Consumer Banking $ 422 $ 358(a) $ 356 $ 64 17.9%
Key Corporate Finance 394 429 396 (35) (8.2)
Key Capital Partners 156 129 142 27 20.9
Other Segments (20) (20) 58 -- --
- ------------------------------------------------------------------------------------------------
Total segments 952 896 952 56 6.3
Reconciling Items 24 (764)(b) 50(b) 788 N/M
- ------------------------------------------------------------------------------------------------
Total $ 976 $ 132 $ 1,002 $ 844 639.4%
======= ======= ======== =======
- ------------------------------------------------------------------------------------------------
(a) Results for 2001 include a one-time cumulative charge of $39 million ($24
million after tax) resulting from a prescribed change, applicable to all
companies, in the accounting for retained interests in securitized assets.
(b) Significant items included in Reconciling Items are as follows:
Year ended December 31, 2001:
- Noninterest income includes a $40 million ($25 million after tax) charge
taken to establish a reserve for losses incurred on the residual values of
leased vehicles and a $15 million ($9 million after tax) increase in the
reserve for customer derivative losses.
- The provision for loan losses includes an additional $400 million ($252
million after tax) taken to increase the allowance for loan losses for Key's
continuing loan portfolio and an additional $490 million ($309 million after
tax) recorded primarily in connection with Key's decision to discontinue
certain credit-only commercial relationships.
- Noninterest expense includes a goodwill write-down of $150 million
associated with the downsizing of the automobile finance business and
charges of $20 million ($13 million after tax) taken to establish additional
litigation reserves.
Year ended December 31, 2000:
- Noninterest income includes a gain of $332 million ($207 million after tax)
from the sale of Key's credit card portfolio.
- The provision for loan losses includes an additional $121 million ($76
million after tax) recorded in connection with the implementation of an
enhanced methodology for assessing credit risk, particularly in the
commercial loan portfolio.
- Noninterest expense includes $127 million ($80 million after tax), primarily
restructuring charges, recorded in connection with strategic actions taken
to improve Key's operating efficiency and profitability.
N/M = Not Meaningful
KEY CONSUMER BANKING
As shown in Figure 3, net income for Key Consumer Banking was $422 million for
2002, up from $358 million for 2001 and $356 million for 2000. The improvement
in 2002 reflects the cumulative effect of the 2001 accounting change presented
in the figure, as well as an increase in noninterest income and a reduction in
noninterest expense. These positive results were partially offset by a decrease
in taxable-equivalent net interest income. The provision for loan losses was
essentially unchanged.
Taxable-equivalent net interest income decreased by $13 million, or 1%, from
2001 as a more favorable interest rate spread on average earning assets and a
21% increase in average home equity loans were more than offset by the adverse
effects of a narrower spread on deposits and a decline in average deposits
outstanding. The decrease in deposits reflected declines in time deposits
resulting from reduced rates paid for those deposits, as well as consumer
preferences for alternative investments that provide higher levels of liquidity.
At the same time, savings deposits rose in response to more aggressive pricing
implemented in mid-2002, while noninterest-bearing deposits grew significantly
as a result of intensified cross-sell efforts and the introduction of new
products, including free checking.
24
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 3 KEY CONSUMER BANKING
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
-------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 1,805 $ 1,818 $ 1,757 $ (13) (.7)%
Noninterest income 497 482 475 15 3.1
- ------------------------------------------------------------------------------------------------------------
Total revenue (TE) 2,302 2,300 2,232 2 .1
Provision for loan losses 303 300 281 3 1.0
Noninterest expense 1,324 1,366 1,356 (42) (3.1)
- ------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) and
cumulative effect of accounting change 675 634 595 41 6.5
Allocated income taxes and TE adjustments 253 252 239 1 .4
- ------------------------------------------------------------------------------------------------------------
Income before cumulative effect
of accounting change 422 382 356 40 10.5
Cumulative effect of accounting change -- (24)(a) -- 24 100.0
- ------------------------------------------------------------------------------------------------------------
Net income $ 422 $ 358 $ 356 $ 64 17.9%
======= ======= ======= =======
Percent of consolidated net income 43% 271% 36% N/A N/A
AVERAGE BALANCES
Loans $27,806 $27,673 $26,690 $ 133 .5%
Total assets 29,970 30,398 29,637 (428) (1.4)
Deposits 33,942 35,221 35,370 (1,279) (3.6)
- ------------------------------------------------------------------------------------------------------------
(a) Results for 2001 include a one-time cumulative charge of $39 million ($24
million after tax) resulting from a prescribed change, applicable to all
companies, in the accounting for retained interests in securitized assets.
TE = Taxable Equivalent, N/A = Not Applicable
ADDITIONAL KEY CONSUMER BANKING DATA
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
-------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------------------
AVERAGE DEPOSITS OUTSTANDING
Noninterest-bearing deposits $ 5,136 $ 4,802 $ 4,935 $ 334 7.0%
MMDA and other savings deposits 13,054 12,832 13,154 222 1.7
Time deposits 15,752 17,587 17,281 (1,835) (10.4)
- ----------------------------------------------------------------------------------------------------------------------
Total deposits $33,942 $35,221 $35,370 $(1,279) (3.6)%
======= ======= ======= =======
- ----------------------------------------------------------------------------------------------------------------------
RETAIL NATIONAL KEY CONSUMER
BANKING HOME EQUITY BANKING
- ----------------------------------------------------------------------------------------------------------------------------------
HOME EQUITY LOANS (2002) OTHER DATA (2002)
Average balance / % change from 2001 $6,619 / 28% $4,906 / 11% On-line clients / % penetration 575,894 / 32%
Average loan-to-value ratio 71 80 KeyCenters 910
Percent first lien positions 51 79 Automated teller machines 2,165
- ----------------------------------------------------------------------------------------------------------------------------------
Noninterest income grew by $15 million, or 3%, due primarily to a $15 million
decrease in net losses from derivatives in the National Home Equity line of
business, an aggregate $7 million increase in service charges on deposit
accounts contributed by the Retail Banking and Small Business lines and higher
fees from mortgage lending and electronic banking services. The growth in
deposit service charges resulted from new pricing implemented in mid-2001 in
connection with Key's competitiveness improvement initiative, but was moderated
by the introduction of free checking products in the third quarter of 2002.
These favorable results more than offset a $19 million increase in losses
incurred on the residual values of leased vehicles in the Indirect Lending line
of business.
Noninterest expense decreased by $42 million, or 3%, from 2001. The improvement
reflects an approximate $38 million reduction in goodwill amortization, which
resulted from the adoption of new accounting guidance, and lower costs for
software amortization. These reductions were partially offset by higher
personnel expense and an increase in marketing costs associated with the growth
in the National Home Equity line of business.
25
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
In 2001, the increase in net income reflected a $61 million, or 3%, increase in
net interest income due to an improved interest rate spread on earning assets
and a favorable change in the composition of earning assets resulting from Key's
decision to retain (rather than securitize and sell) home equity loans starting
in 2000. The growth in net interest income was substantially offset by the
effect of the 2001 accounting change mentioned on page 25.
KEY CORPORATE FINANCE
As shown in Figure 4, net income for Key Corporate Finance was $394 million for
2002, compared with $429 million for 2001 and $396 million for 2000. The
decrease from 2001 resulted from a significantly higher provision for loan
losses and lower noninterest income. These adverse results were offset in part
by moderate growth in net interest income and improvement in noninterest
expense.
FIGURE 4 KEY CORPORATE FINANCE
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
-------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 1,123 $ 1,092 $ 1,011 $ 31 2.8%
Noninterest income 238 259 253 (21) (8.1)
- ----------------------------------------------------------------------------------------------------------
Total revenue (TE) 1,361 1,351 1,264 10 .7
Provision for loan losses 236 140 125 96 68.6
Noninterest expense 495 517 497 (22) (4.3)
- ----------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 630 694 642 (64) (9.2)
Allocated income taxes and TE adjustments 236 265 246 (29) (10.9)
- ----------------------------------------------------------------------------------------------------------
Net income $ 394 $ 429 $ 396 $ (35) (8.2)%
======= ======= ======= =======
Percent of consolidated net income 41% 325% 39% N/A N/A
AVERAGE BALANCES
Loans $29,278 $31,098 $30,592 $(1,820) (5.9)%
Total assets 30,568 32,593 32,086 (2,025) (6.2)
Deposits 3,384 3,093 2,815 291 9.4
- ----------------------------------------------------------------------------------------------------------
TE = Taxable Equivalent, N/A = Not Applicable
During 2002, taxable-equivalent net interest income increased by $31 million, or
3%. The increase was due primarily to a higher taxable-equivalent adjustment
related to portions of the equipment leasing portfolio, which became subject to
a lower income tax rate in the latter half of 2001. A more favorable interest
rate spread on earning assets and the growth in average deposits also
contributed to the improvement. These positive results were partially offset by
the adverse effect of a decline in average loans outstanding.
During the same time, noninterest income decreased by $21 million, or 8%. The
decrease was due principally to losses from residual values of leased equipment
in the National Equipment Finance line of business in 2002, compared with gains
in the prior year. Lower fees generated by Corporate Banking also contributed to
the decline. These adverse results more than offset increases in
nonyield-related loan fees and loan sale gains in the National Commercial Real
Estate line and growth in service charges on deposit accounts in the Corporate
Banking line.
Noninterest expense improved by $22 million, or 4%, reflecting a $16 million
reduction in goodwill amortization following the adoption of a new accounting
standard. The provision for loan losses rose by $96 million, or 69%, due largely
to higher levels of net charge-offs in the Corporate Banking and National
Equipment Finance lines.
In 2001, an $81 million, or 8%, improvement in net interest income drove the
increase in net income relative to the prior year. This growth was attributable
largely to a more favorable interest rate spread on earning assets, as well as
loan growth in both the National Commercial Real Estate and National Equipment
Finance lines of business.
KEY CAPITAL PARTNERS
As shown in Figure 5, Key Capital Partners' net income was $156 million for
2002, compared with $129 million for 2001 and $142 million for 2000. The
improvement in 2002 was attributable to a substantial decrease in noninterest
expense and growth in taxable-equivalent net interest income. These positive
results more than offset a decline in noninterest income, while the provision
for loan losses was essentially unchanged.
Taxable-equivalent net interest income increased by $19 million, or 9%, from
2001. The growth was due primarily to a more favorable interest rate spread on
earning assets.
Noninterest income decreased by $69 million, or 7%, as market-sensitive
businesses were adversely affected by the weak economy. The reduction was
attributable mainly to an aggregate decline of $51 million in trust and
investment services income in the High Net Worth and Victory Capital Management
lines and lower income from trading activities and derivatives in the Capital
Markets line. In addition, revenue for 2001 benefited from a net gain from the
sale of residential mortgage loans associated with the private banking business.
These factors more than offset an $18 million increase in investment banking
income.
26
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 5 KEY CAPITAL PARTNERS
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
-------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 235 $ 216 $ 214 $ 19 8.8%
Noninterest income 874 943 974 (69) (7.3)
- -----------------------------------------------------------------------------------------------------
Total revenue (TE) 1,109 1,159 1,188 (50) (4.3)
Provision for loan losses 14 13 4 1 7.7
Noninterest expense 846 926 944 (80) (8.6)
- -----------------------------------------------------------------------------------------------------
Income before income taxes (TE) 249 220 240 29 13.2
Allocated income taxes and TE adjustments 93 91 98 2 2.2
- -----------------------------------------------------------------------------------------------------
Net income $ 156 $ 129 $ 142 $ 27 20.9%
====== ====== ====== ======
Percent of consolidated net income 16% 98% 14% N/A N/A
AVERAGE BALANCES
Loans $4,904 $5,266 $5,439 $ (362) (6.9)%
Total assets 8,382 8,965 8,994 (583) (6.5)
Deposits 3,924 3,679 3,480 245 6.7
- -----------------------------------------------------------------------------------------------------
TE = Taxable Equivalent, N/A = Not Applicable
ADDITIONAL KEY CAPITAL PARTNERS DATA
DECEMBER 31, 2002
dollars in millions
- --------------------------------------------------------------
Assets under management $61,694
Nonmanaged and brokerage assets 64,968
High Net Worth sales personnel 807
- --------------------------------------------------------------
Noninterest expense decreased by $80 million, or 9%, in 2002, due primarily to
an approximate $25 million reduction in amortization expense following the
prescribed change in accounting for goodwill, lower variable compensation
expense associated with revenue generation and reduced software amortization.
In 2001, net income decreased primarily as a result of a $31 million, or 3%,
reduction in noninterest income. Weak conditions in the capital markets led to a
$39 million, or 6%, decline in income from trust and investment services.
OTHER SEGMENTS
Other Segments, which consists primarily of Treasury, Principal Investing and
the net effect of funds transfer pricing, generated net losses of $20 million in
both 2002 and 2001. In 2002, net losses from principal investing activities
decreased by $64 million ($40 million after tax), or 81%. This improvement was
offset by a $55 million ($34 million after tax), or 40%, decline in net interest
income, due primarily to the change in the net effect of funds transfer pricing,
and a $23 million ($14 million after tax), or 75%, reduction in net securities
gains recorded by Treasury.
In 2001, Other Segments generated a $20 million net loss, compared with net
income of $58 million for the prior year. The decrease in results was due
primarily to net losses of $79 million ($50 million after tax) from principal
investing in 2001, compared with net gains of $70 million ($44 million after
tax) in 2000. In addition, net interest income declined by $54 million ($34
million after tax), or 64%, due largely to the change in the net effect of funds
transfer pricing. The adverse effects of these factors were partially offset by
net securities gains of $31 million ($19 million after tax) recorded by Treasury
in 2001, compared with net securities losses of $40 million ($25 million after
tax) in 2000.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Key's principal source of earnings is net interest income, which includes
interest paid to Key on earning assets such as loans and securities, as well as
loan-related fee income; less interest expense paid on deposits and borrowings.
There are several factors that affect net interest income, including:
- - the volume, pricing, mix and maturity of earning assets and interest-bearing
liabilities;
- - the use of derivative instruments to manage interest rate risk;
- - market interest rate fluctuations; and
- - asset quality.
To make it easier to compare results among several periods and the yields on
various types of earning assets, we present all net interest income on a
"taxable-equivalent basis." In other words, if we earn $100 of tax-exempt
income, we present those earnings at a higher amount (specifically, $154) that
- -- if taxed at the statutory federal income tax rate of 35% --would yield $100.
Figure 6 shows the various components of Key's balance sheet that affect
interest income and expense, and their respective yields or rates over the past
six years. Net interest income for 2002 was $2.9 billion, essentially unchanged
from the prior year as the positive effect of an improved net interest margin
was offset by the effect of a decrease in average earning assets. Key's net
interest margin rose 16 basis points to 3.97%. 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.
27
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 6 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
2002 2001 2000
YEAR ENDED DECEMBER 31, ---------------------------- ---------------------------- --------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a,b)
Commercial, financial and agricultural $ 17,767 $ 907 5.10% $ 19,459 $ 1,362 7.00% $19,369 $ 1,669 8.63%
Real estate-- commercial mortgage 6,345 373 5.87 6,821 511 7.50 6,911 628 9.10
Real estate-- construction 5,851 315 5.38 5,654 411 7.27 4,815 464 9.63
Commercial lease financing 7,263 491 6.76 7,049 490 6.95 6,821 493 7.22
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 37,226 2,086 5.60 38,983 2,774 7.12 37,916 3,254 8.59
Real estate-- residential 2,126 149 7.00 3,607 275 7.64 4,274 325 7.61
Home equity 13,028 889 6.82 10,595 906 8.55 8,857 822 9.29
Credit card -- -- -- -- -- -- -- -- --
Consumer-- direct 2,206 183 8.29 2,427 232 9.55 2,592 265 10.19
Consumer-- indirect lease financing 1,405 126 8.96 2,618 217 8.27 3,089 249 8.03
Consumer-- indirect other 5,155 471 9.15 5,529 530 9.58 6,032 570 9.44
- ------------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 23,920 1,818 7.60 24,776 2,160 8.72 24,844 2,231 8.97
Loans held for sale 2,247 123 5.52 2,217 169 7.64 2,534 230 9.05
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans 63,393 4,027 6.35 65,976 5,103 7.73 65,294 5,715 8.75
Taxable investment securities 1 -- 8.59 2 -- 8.60 2 -- 8.42
Tax-exempt investment securities(a) 180 16 8.67 277 25 8.76 391 34 8.76
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities 181 16 8.67 279 25 8.76 393 34 8.75
Securities available for sale(a,c) 6,359 389 6.14 6,625 455 6.89 6,470 448 6.80
Short-term investments 1,496 30 1.99 1,712 65 3.81 1,717 83 4.84
Other investments(c) 871 24 2.57 849 24 2.86 701 25 3.74
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 72,300 4,486 6.20 75,441 5,672 7.52 74,575 6,305 8.45
Allowance for loan losses (1,553) (1,090) (959)
Accrued income and other assets 11,034 10,552 10,419
- ------------------------------------------------------------------------------------------------------------------------------------
$ 81,781 $ 84,903 $84,035
======== ======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $ 13,197 125 .94 $ 12,323 254 2.06 $12,211 414 3.39
Savings deposits 1,986 13 .67 1,952 21 1.05 2,206 32 1.47
NOW accounts 564 6 1.02 619 9 1.43 612 10 1.59
Certificates of deposit ($100,000 or more)(d) 4,741 218 4.63 5,284 301 5.71 5,511 340 6.15
Other time deposits 12,859 496 3.86 14,208 786 5.53 13,974 805 5.76
Deposits in foreign office 2,336 39 1.67 2,715 107 3.94 2,593 167 6.45
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 35,683 897 2.52 37,101 1,478 3.98 37,107 1,768 4.76
Federal funds purchased and securities
sold under repurchase agreements 5,527 90 1.63 5,197 198 3.80 4,931 287 5.82
Bank notes and other short-term borrowings(d) 2,943 79 2.67 6,829 302 4.43 7,121 428 6.01
Long-term debt, including capital
securities(d,e) 16,961 551 3.29 15,911 824 5.20 15,707 1,064 6.78
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 61,114 1,617 2.66 65,038 2,802 4.31 64,866 3,547 5.47
Noninterest-bearing deposits 9,098 8,354 8,328
Accrued expense and other liabilities 5,045 4,939 4,329
Shareholders' equity 6,524 6,572 6,512
- ------------------------------------------------------------------------------------------------------------------------------------
$ 81,781 $ 84,903 $84,035
======== ======== =======
Interest rate spread (TE) 3.54% 3.21% 2.98%
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $2,869 3.97% $ 2,870 3.81% $ 2,758 3.69%
====== ==== ======== ==== ======== ====
Capital securities $ 1,254 $ 78 $ 1,309 $ 89 $ 1,243 $ 95
TE adjustment(a) 120 45 28
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Interest income on tax-exempt securities and loans has been adjusted to a
taxable-equivalent basis using the statutory federal income tax rate of
35%.
(b) For purposes of these computations, nonaccrual loans are included in
average loan balances.
(c) Yield is calculated on the basis of amortized cost.
(d) Rate calculation excludes basis adjustments related to fair value hedges.
See Note 20 ("Derivatives and Hedging Activities"), which begins on page
84, for an explanation of fair value hedges.
(e) Rate calculation excludes ESOP debt.
TE = Taxable Equivalent, N/M = Not Meaningful
28
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
COMPOUND
ANNUAL
RATE OF CHANGE
1999 1998 1997 (1997-2002)
- ------------------------------------ ---------------------------------- ------------------------------ -------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST
- --------------------------------------------------------------------------------------------------------------------------------
$ 17,695 $ 1,350 7.63% $ 15,413 $ 1,251 8.12% $ 12,911 $ 1,126 8.72% 6.6% (4.2)%
6,946 580 8.35 7,080 627 8.86 7,101 663 9.34 (2.2) (10.9)
4,076 343 8.42 2,866 254 8.86 1,945 188 9.67 24.6 10.9
6,092 445 7.30 4,822 359 7.45 3,310 228 6.89 17.0 16.6
- --------------------------------------------------------------------------------------------------------------------------------
34,809 2,718 7.81 30,181 2,491 8.25 25,267 2,205 8.73 8.1 (1.1)
4,479 338 7.55 5,440 422 7.76 6,192 524 8.46 (19.2) (22.2)
7,548 645 8.55 6,353 557 8.77 5,180 469 9.05 20.3 13.6
997 152 15.25 1,438 212 14.74 1,710 256 14.97 N/M N/M
2,457 238 9.69 2,139 228 10.66 2,238 246 10.99 (.3) (5.7)
2,922 236 8.08 2,024 171 8.45 1,156 99 8.56 4.0 4.9
6,584 608 9.23 6,647 603 9.07 7,023 633 9.01 (6.0) (5.7)
- --------------------------------------------------------------------------------------------------------------------------------
24,987 2,217 8.87 24,041 2,193 9.12 23,499 2,227 9.48 .4 (4.0)
2,605 228 8.75 3,200 262 8.19 2,649 198 7.47 (3.2) (9.1)
- --------------------------------------------------------------------------------------------------------------------------------
62,401 5,163 8.27 57,422 4,946 9.02 51,415 4,630 9.01 4.3 (2.8)
2 -- 12.73 3 -- 7.61 4 -- 7.86 (24.2) N/M
535 46 8.60 801 67 8.36 1,227 97 7.91 (31.9) (30.3)
- --------------------------------------------------------------------------------------------------------------------------------
537 46 8.57 804 67 8.33 1,231 97 7.87 (31.8) (30.3)
6,403 425 6.68 6,610 450 6.84 7,629 527 6.69 (3.6) (5.9)
1,873 78 4.16 1,563 84 5.37 782 40 5.12 13.9 (5.6)
442 15 3.46 279 12 4.36 243 12 4.55 29.1 14.9
- --------------------------------------------------------------------------------------------------------------------------------
71,656 5,727 7.99 66,678 5,559 8.34 61,300 5,306 8.66 3.4 (3.3)
(911) (888) (875) 12.2
10,201 9,491 8,525 5.3
- --------------------------------------------------------------------------------------------------------------------------------
$ 80,946 $75,281 $68,950 3.5
======== ======= =======
$ 12,950 390 3.01 $11,650 382 3.28 $ 10,897 333 3.06 3.9 (17.8)
2,716 44 1.62 3,225 59 1.83 4,319 94 2.18 (14.4) (32.7)
791 12 1.52 1,215 20 1.65 1,560 32 2.05 (18.4) (28.5)
4,257 223 5.24 3,520 194 5.51 3,376 190 5.63 7.0 2.8
11,969 595 4.97 12,240 654 5.34 13,273 715 5.39 (.6) (7.1)
823 41 4.98 913 50 5.48 1,812 98 5.41 5.2 (16.8)
- --------------------------------------------------------------------------------------------------------------------------------
33,506 1,305 3.89 32,763 1,359 4.15 35,237 1,462 4.15 .3 (9.3)
4,856 220 4.53 6,635 342 5.15 6,942 359 5.17 (4.5) (24.2)
7,912 426 5.38 7,975 459 5.76 4,741 283 5.97 (9.1) (22.5)
16,473 957 6.09 11,175 681 6.30 6,554 413 6.38 20.9 5.9
- --------------------------------------------------------------------------------------------------------------------------------
62,747 2,908 4.63 58,548 2,841 4.85 53,474 2,517 4.71 2.7 (8.5)
8,474 8,509 8,536 1.3
3,464 2,681 2,074 19.5
6,261 5,543 4,866 6.0
- --------------------------------------------------------------------------------------------------------------------------------
$ 80,946 $ 75,281 $ 68,950 3.5
======== ======== =========
3.36% 3.49% 3.95%
- --------------------------------------------------------------------------------------------------------------------------------
$ 2,819 3.93% $ 2,718 4.08% $ 2,789 4.54% .6%
====== ==== ======== ==== ======== ====
$ 1,162 $ 85 $ 879 $ 65 $ 648 $ 49 14.1% 9.7%
32 34 44 22.2
- --------------------------------------------------------------------------------------------------------------------------------
29
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
Average earning assets decreased by 4% to $72.3 billion, due primarily to
declines in both commercial and consumer loans (other than home equity loans).
These declines reflected weak loan demand in a challenging economic environment,
as well as the effect of management's decision to exit and/or reduce certain
lending activities. This decision is more fully discussed below in the section
entitled "Interest earning assets."
In 2001, net interest income was $2.9 billion, representing a $112 million, or
4%, increase from 2000. This growth reflected an improved net interest margin,
which increased 12 basis points to 3.81%. Average earning assets increased by 1%
to $75.4 billion, as growth in the commercial and home equity portfolios more
than offset declines in other portfolios (some of which declined due to the
strategic decision mentioned above).
NET INTEREST MARGIN. Key's net interest margin improved over the past two years,
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 2002 totaled $72.3 billion,
which was $3.1 billion, or 4%, lower than the 2001 level. This decrease came
principally from the loan portfolio and was attributable to a number of factors,
including Key's decision 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. Weak loan demand resulting from the
general economic slowdown has also contributed to the net decline in loans.
In 2001, average earning assets totaled $75.4 billion, representing an $866
million, or 1%, increase from the prior year. This improvement was driven by the
growth of Key's loan portfolio, with the largest increases occurring in the
commercial and home equity sectors. However, our decision to scale back or exit
certain types of lending, and slower demand for loans in a weak economy, led to
declines in Key's commercial and consumer loans during the second half of 2001.
The September sale of $1.4 billion of residential mortgage loans also
contributed to the decline in consumer loans.
Over the past two years, the growth and composition of Key's loan portfolio has
been affected by several actions:
- - During the third quarter of 2001, we sold $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 credit-only commercial relationships. These
portfolios, in the aggregate, have declined by approximately $3.3 billion
since the date of the announcement through December 31, 2002.
- - We sold commercial mortgage loans of $1.4 billion during 2002 and $1.7
billion during 2001. Since some of these loans have been sold with limited
recourse, Key established a loss reserve of an amount estimated by
management to be appropriate to reflect the recourse risk. More information
about the related recourse agreement is provided in Note 19 ("Commitments,
Contingent Liabilities and Guarantees") under the section entitled "Recourse
agreement with Federal National Mortgage Association" on page 83. Our
business of originating and servicing commercial mortgage loans has grown,
in part as a result of acquiring Conning Asset Management in the second
quarter of 2002 and both Newport Mortgage Company, L.P. and National Realty
Funding L.C. in 2000.
- - We sold education loans of $1.1 billion ($750 million through
securitizations) during 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 36, contains more discussion about changes in
earning assets and funding sources.
MARKET RISK MANAGEMENT
The values of some financial instruments vary not only with changes in market
interest rates, but also with changes in foreign exchange rates, factors
influencing valuations in the equity securities markets, and other market-driven
rates or prices. For example, the value of a fixed-rate bond will decline if
market interest rates increase; the bond will become a less attractive
investment to the holder. Similarly, the value of the U.S. dollar regularly
fluctuates in relation to other currencies. The exposure that instruments tied
to such external factors present is called "market risk." Most of Key's market
risk is derived from interest rate fluctuations.
Interest rate risk management
Key's Asset/Liability Management Policy Committee has developed a program to
measure and manage interest rate risk. This committee is also responsible for
approving Key's asset/liability management policies, overseeing the formulation
and implementation of strategies to improve balance sheet positioning and
earnings, and reviewing Key's interest rate sensitivity exposure.
FACTORS CONTRIBUTING TO INTEREST RATE EXPOSURE. Key uses interest rate exposure
models to quantify the potential impact on earnings and economic value of equity
arising from a variety of possible future interest rate scenarios. The many
interest rate scenarios modeled estimate the level of Key's interest rate
exposure arising from option risk, basis risk and gap risk.
- - A financial instrument presents "OPTION RISK" when one party to the
instrument can take advantage of changes in interest rates without penalty.
For example, when interest rates decline, borrowers may choose to prepay
fixed-rate loans by refinancing at a lower rate.
30
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 7 COMPONENTS OF NET INTEREST INCOME CHANGES
2002 VS 2001 2001 VS 2000
--------------------------------- ---------------------------------
AVERAGE YIELD/ NET AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE VOLUME RATE CHANGE
- -------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ (193) $ (883) $(1,076) $ 59 $ (671) $ (612)
Tax-exempt investment securities (9) -- (9) (10) 1 (9)
Securities available for sale (18) (48) (66) 10 (3) 7
Short-term investments (7) (28) (35) -- (18) (18)
Other investments 1 (1) -- 5 (6) (1)
- -------------------------------------------------------------------------------------------------------------------------
Total interest income (taxable equivalent) (226) (960) (1,186) 64 (697) (633)
INTEREST EXPENSE
Money market deposit accounts 17 (146) (129) 4 (164) (160)
Savings deposits -- (8) (8) (3) (8) (11)
NOW accounts (1) (2) (3) -- (1) (1)
Certificates of deposit ($100,000 or more) (29) (54) (83) (14) (25) (39)
Other time deposits (69) (221) (290) 13 (32) (19)
Deposits in foreign office (13) (55) (68) 8 (68) (60)
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (95) (486) (581) 8 (298) (290)
Federal funds purchased and securities sold
under repurchase agreements 12 (120) (108) 15 (104) (89)
Bank notes and other short-term borrowings (132) (91) (223) (17) (109) (126)
Long-term debt, including capital securities 51 (324) (273) 14 (254) (240)
- -------------------------------------------------------------------------------------------------------------------------
Total interest expense (164) (1,021) (1,185) 20 (765) (745)
- -------------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $ (62) $ 61 $ (1) $ 44 $ 68 $ 112
======= ======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------------
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.
Such a prepayment gives Key a return on its investment (the principal plus
some interest), but unless there is a prepayment penalty, that return may
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.
MEASUREMENT OF SHORT-TERM INTEREST RATE EXPOSURE. Key uses a net interest income
simulation model to measure interest rate risk over a short time frame. These
simulations estimate the impact that various changes in the overall level of
interest rates over one- and two-year time horizons would have on net interest
income. The results help Key develop strategies for managing exposure to
interest rate risk.
Like any forecasting technique, interest rate simulation modeling is based on a
large number of assumptions and judgments. In this case, the assumptions relate
primarily to loan and deposit growth, asset and liability prepayments, interest
rates, and on- and off-balance sheet management strategies. Management believes
that, both individually and in the aggregate, the assumptions Key makes are
reasonable. Nevertheless, the simulation modeling process produces only a
sophisticated estimate, not a precise calculation of exposure.
Key's guidelines for risk management call for preventive measures to be taken if
the simulation modeling demonstrates that a gradual 200 basis point increase or
decrease in short-term rates over the next twelve months would adversely affect
net interest income over the same period by more than 2%. Key is operating
within these guidelines. Since short-term interest rates were relatively low at
December 31, 2002, management modified Key's standard rate scenario of a gradual
decrease of 200 basis points over twelve months to a gradual decrease of 50
basis points over three months and no change over the following nine months. As
of December 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 .43% if short-term interest rates
gradually increase by 200 basis points. Conversely, if short-term interest rates
gradually decrease by 50 basis points over the next three months, net interest
income would be expected to decrease by approximately .51% over the next twelve
months.
31
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
The decline in net interest income under both of the preceding scenarios
reflects the fact that Key is currently in a liability sensitive position when
interest rates increase and an asset sensitive position when rates decrease.
Key's asset sensitive position to a decrease in interest rates stems from the
fact that short-term rates are at historically low levels. Consequently, the
results of the simulation model reflect management's assumption that deposit
rates will not decline from current levels, while interest rates on earning
assets will continue to do so. To mitigate the risk of a potentially adverse
effect on earnings, management is using interest rate contracts while
maintaining the flexibility to lower rates on deposits, if necessary.
Key has historically been in a liability sensitive position when interest rates
are rising. Management actively monitors the risk to higher rates and would
endeavor to take preventive actions to ensure that net interest income at risk
does not exceed guidelines established by the Asset/Liability Management Policy
Committee. Also, Key's lines of business have the ability to mitigate the
negative effect on net interest income from rising interest rates by growing
loans and deposits with profitable interest rate spreads.
MEASUREMENT OF LONG-TERM INTEREST RATE EXPOSURE. Key uses an economic value of
equity model to complement short-term interest rate risk analysis. The benefit
of this model is that it measures exposure to interest rate changes over time
frames longer than two years. The economic value of Key's equity is determined
by aggregating the present value of projected future cash flows for asset,
liability and derivative positions based on the current yield curve. However,
economic value does not represent the fair values of asset, liability and
derivative positions since it does not consider factors like credit risk and
liquidity.
Key's guidelines for risk management call for preventive measures to be taken if
an immediate 200 basis point increase or decrease in interest rates is estimated
to reduce the economic value of equity by more than 15%. Key is operating within
these guidelines. Certain short-term interest rates were limited to reductions
of less than 200 basis points since interest rates cannot decrease below zero in
Key's economic value of equity model.
MANAGEMENT OF INTEREST RATE EXPOSURE. Management uses the results of short-term
and long-term interest rate exposure models to formulate strategies to improve
balance sheet positioning, earnings, or both, within the bounds of Key's
interest rate risk, liquidity and capital guidelines. We manage interest rate
risk by using portfolio swaps and caps, which modify the repricing or maturity
characteristics of some of our assets and liabilities. The decision to use these
instruments rather than securities, debt or other on-balance sheet alternatives
depends on many factors, including the mix and cost of funding sources,
liquidity and capital requirements, and interest rate implications.
A brief description of interest rate swaps and caps follows.
- - INTEREST RATE SWAPS are contracts in which two parties agree to exchange
interest payment streams that are calculated based 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 under which the holder is 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 20 ("Derivatives and Hedging Activities"), which
begins on page 84.
Trading portfolio risk management
Key's trading portfolio includes interest rate swap contracts entered into to
accommodate the needs of clients, positions with third parties that are intended
to offset or mitigate the interest rate risk of client positions, foreign
exchange contracts entered into to accommodate the needs of clients, and
proprietary trading positions in financial assets and liabilities. The fair
values of these trading portfolio items are included in "accrued income and
other assets" or "accrued expense and other liabilities" on the balance sheet.
For more information about these items, see Note 20 ("Derivatives and Hedging
Activities"), which begins on page 84.
Management uses a value at risk ("VAR") model to estimate the potential adverse
effect of changes in interest and foreign exchange rates, and equity prices on
the fair value of Key's trading portfolio. Using statistical methods, this model
estimates the maximum potential one-day loss with 95% probability. At December
31, 2002, Key's aggregate daily VAR was $.9 million, compared with $1.4 million
at December 31, 2001. Aggregate daily VAR averaged $1.4 million for 2002,
compared with an average of $1.3 million during 2001. VAR modeling augments
other controls that Key uses to mitigate the market risk exposure of the trading
portfolio. These controls include loss and portfolio size limits that are based
on market liquidity and the level of activity and volatility of trading
products.
NONINTEREST INCOME
Noninterest income for 2002 was $1.8 billion, representing a $44 million, or 3%,
increase from the prior year. In 2001, noninterest income of $1.7 billion was
down $469 million, or 21%, from 2000.
The 2002 improvement in noninterest income was due primarily to an $84 million
increase in income from investment banking and capital markets activities. This
increase was attributable to strong growth in investment banking fees, but also
reflected two significant charges recorded during the fourth quarter of 2001.
These charges included a $45 million write-down of the principal investing
portfolio and a $15 million increase to the reserve for customer derivative
losses. Also contributing to the 2002 improvement was an $18 million increase in
service charges on deposit accounts and a $10 million rise in letter of credit
and nonyield-related loan fees. These positive results were offset in part by a
$42 million reduction in income from trust and investment services and a $29
million decrease in net securities gains.
In 2001, Key's noninterest income decreased principally because noninterest
income in 2000 included a $332 million gain from the sale of Key's credit card
portfolio in January 2000. For more information on this transaction, see Note 3
("Acquisitions and Divestitures") on page 64. In addition,
32
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
capital markets-sensitive revenues, particularly those generated by the asset
management, principal investing and brokerage businesses, were affected
adversely by the recessionary economy. Income from investment banking and
capital markets activities decreased by $205 million (including the $60 million
of 2001 charges discussed on page 32), while income from trust and investment
services declined by $36 million. These reductions were substantially offset by
increases in net securities gains (up $63 million), service charges on deposit
accounts (up $46 million) and letter of credit and nonyield-related loan fees
(up $17 million).
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 in 2002 and 2001.
FIGURE 8 NONINTEREST INCOME
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
---------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- --------------------------------------------------------------------------------------------------------------
Trust and investment services income $ 609 $ 651 $ 687 $ (42) (6.5)%
Service charges on deposit accounts 405 387 341 18 4.7
Investment banking and capital markets income 172 88 293 84 95.5
Letter of credit and loan fees 134 124 107 10 8.1
Corporate-owned life insurance income 108 114 109 (6) (5.3)
Electronic banking fees 79 74 68 5 6.8
Net securities gains (losses) 6 35 (28) (29) (82.9)
Gain from sale of credit card portfolio -- -- 332 -- --
Other income:
Insurance income 57 56 62 1 1.8
Net gains from loan securitizations and sales 56 49 31 7 14.3
Loan securitization servicing fees 9 16 24 (7) (43.8)
Credit card fees 9 7 11 2 28.6
Miscellaneous income 125 124 157 1 .8
- ------------------------------------------------------------------------------------------------------------
Total other income 256 252 285 4 1.6
- ------------------------------------------------------------------------------------------------------------
Total noninterest income $ 1,769 $ 1,725 $ 2,194 $ 44 2.6%
======= ======= ======= =======
- ------------------------------------------------------------------------------------------------------------
TRUST AND INVESTMENT SERVICES INCOME. Trust and investment services provide
Key's largest source of noninterest income. Its primary components are shown in
Figure 9. A significant portion of this income is based on the value of assets
under management. Thus, over the past two years, the level of revenue derived
from these services has been adversely affected by continued declines in the
equity and fixed income markets.
FIGURE 9 TRUST AND INVESTMENT SERVICES INCOME
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
-----------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------------------------------
Personal asset management and custody fees $162 $179 $189 $(17) (9.5)%
Institutional asset management and custody fees 77 86 93 (9) (10.5)
Bond services 36 41 42 (5) (12.2)
Brokerage commission income 198 202 224 (4) (2.0)
All other fees 136 143 139 (7) (4.9)
- ------------------------------------------------------------------------------------------------------------------------------
Total trust and investment services income $609 $651 $687 $(42) (6.5)%
==== ==== ==== ====
- ------------------------------------------------------------------------------------------------------------------------------
At December 31, 2002, Key's bank, trust and registered investment advisory
subsidiaries had assets under management of $61.7 billion, compared with $72.7
billion at the end of 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. In 2002, the value of total assets under management decreased by a
net 15%. This decrease reflects a decline in the market value of assets under
management, as well as net asset outflows of approximately $4.1 billion during
the year.
Approximately 60% of the outflows represent funds that have been transferred to
an outside vendor in connection with Key's decision in 2002 to sell the 401(k)
recordkeeping business. Another 20% of the outflows are attributable to funds
which clients have elected to move from money market funds under management to
an FDIC insured deposit account with Key. As shown in Figure 10, 56% of the
assets Key manages are invested in more stable fixed income or money market
funds. The performance of the majority of Key's investment products exceeded the
performance of their respective benchmarks.
33
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 10 ASSETS UNDER MANAGEMENT
DECEMBER 31,
in millions 2002 2001 2000
- ----------------------------------------------------------------
Assets under management
by investment type:
Equity $27,224 $35,798 $37,748
Fixed income 16,133 16,919 14,579
Money market 18,337 20,000 21,688
- ----------------------------------------------------------------
Total $61,694 $72,717 $74,015
======= ======= =======
Proprietary mutual funds
included in assets
under management:
Equity $ 2,878 $ 3,973 $ 4,405
Fixed income 1,215 1,190 1,042
Money market 11,457 13,801 15,307
- ----------------------------------------------------------------
Total $15,550 $18,964 $20,754
======= ======= =======
- ----------------------------------------------------------------
INVESTMENT BANKING AND CAPITAL MARKETS INCOME. As shown in Figure 11, the 2002
increase in investment banking and capital markets income was driven by improved
results from investment banking activities and from principal investing. The
improvement in principal investing reflects the $45 million charge taken for
write-downs in the fourth quarter of 2001.
Key's principal investing income is susceptible to volatility since it is
derived from investments in small to medium-sized businesses in various stages
of economic development and strategy implementation. While most of Key's
principal investments are in their mid to late stages, those that are in their
early stages are more vulnerable to changes in general economic conditions.
Principal investments consist of direct and indirect investments in
predominantly privately-held companies and are carried on the balance sheet at
fair value ($677 million at December 31, 2002, and $621 million at December 31,
2001). Thus, the net gains and losses presented in Figure 11 stem from changes
in estimated fair values, as well as actual gains and losses on sales of
principal investments. If the current weakness in the economy continues,
management anticipates there may be a further decline in the fair value of the
principal investing portfolio.
FIGURE 11 INVESTMENT BANKING AND CAPITAL MARKETS INCOME
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
---------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- ---------------------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $ 32 $ 25 $ 80 $ 7 28.0%
Investment banking income 121 102 107 19 18.6
Net gains (losses) from principal investing (14) (79) 71 65 82.3
Foreign exchange income 33 40 35 (7) (17.5)
- --------------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $172 $ 88 $293 $84 95.5%
==== ==== ==== ===
- --------------------------------------------------------------------------------------------------------------------------
SERVICE CHARGES ON DEPOSIT ACCOUNTS. In 2002, service charges on deposit
accounts rose for the second consecutive year. These fees increased over the
past two years primarily because of strategies implemented in connection with
Key's competitiveness initiative and higher levels of noninterest-bearing
deposits. The growth in these fees slowed during the second half of 2002 as free
checking products were introduced in the third quarter and rolled out to all of
Key's markets by the end of the year.
CORPORATE-OWNED LIFE INSURANCE INCOME. Income from corporate-owned life
insurance, representing a tax-deferred increase in cash surrender values and
tax-exempt death benefits, decreased by 5% in 2002, following a 5% increase in
the prior year.
SECURITIES TRANSACTIONS. During 2002, Key realized net securities gains of $6
million, compared with net gains of $35 million in 2001 and net losses of $28
million in 2000. Since the 2001 sales involved primarily equity securities, the
sales did not have a significant adverse affect on Key's net interest income in
subsequent periods. In 2000, Key's securities transactions included $50 million
of net losses that resulted from the reconfiguration of the fixed income
securities portfolio.
OTHER INCOME. Other income for 2002 increased by $4 million, or 2%, from 2001.
The $33 million decrease in 2001 compared with the prior year was due largely to
a $40 million charge (included in miscellaneous income) taken in the second
quarter to establish a reserve for losses incurred on the residual values of
leased vehicles. This charge was offset in part by an increase in net gains from
loan securitizations and sales, and higher fees from electronic banking
services. Also, traditional fee income was supplemented in the fourth quarter of
2001 by $10 million of additional revenue, representing the value of shares
received as a result of the demutualization of an insurance company in which Key
is a policyholder. Key contributed these shares to its charitable foundation,
which also increased miscellaneous expense by $10 million.
NONINTEREST EXPENSE
Noninterest expense for 2002 was $2.7 billion, representing a $288 million, or
10%, decrease from the prior year and Key's lowest level of expense for any year
since 1998. In 2001, noninterest expense of $2.9 billion was essentially
unchanged from 2000.
The 2002 reduction in noninterest expense reflected a $234 million decrease in
amortization expense related to intangibles, which resulted from two significant
events. In the second quarter of 2001, we recorded a $150 million write-down of
goodwill associated with Key's decision to downsize its automobile finance
business. In addition, a 2002 prescribed change in accounting for goodwill
reduced amortization expense by approximately $79 million. For more information
pertaining to the accounting change, see the section entitled "Amortization of
intangibles" on page 36. Other factors that contributed to the 2002 improvement
in
34
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
noninterest expense were a $60 million reduction in computer processing expense,
a $16 million decrease in equipment expense and a $20 million charge (included
in miscellaneous expense) taken in the second quarter of 2001 to increase
litigation reserves. These positive results were partially offset by a $58
million rise in personnel expense.
Noninterest expense for both 2001 and 2000 included significant items that
hinder a comparison of results between those years. In 2001, these items
included the write-down of goodwill and the additional litigation reserves
mentioned above. In 2000, these items included $127 million of restructuring and
other special charges recorded in connection with strategic actions implemented
to improve operating efficiency and profitability. More information about these
charges can be found under the heading "Restructuring and other special charges"
on page 36. Excluding these items, noninterest expense for 2001 decreased by $19
million, or 1%, from 2000. The decrease was due primarily to a $67 million
improvement in personnel expense and a $21 million decline in equipment expense.
These reductions were partially offset by increases in a number of other expense
components. Included in miscellaneous expense for 2001 is the $10 million
contribution to our charitable foundation discussed under the heading "Other
income" on page 34.
Figure 12 shows the components of Key's noninterest expense. The discussion that
follows explains the composition of certain components and the factors that
caused them to change in 2002 and 2001.
FIGURE 12 NONINTEREST EXPENSE
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
--------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------------
Personnel $ 1,436 $ 1,378 $ 1,445 $ 58 4.2%
Net occupancy 226 232 223 (6) (2.6)
Computer processing 192 252 240 (60) (23.8)
Equipment 136 152 173 (16) (10.5)
Marketing 122 112 110 10 8.9
Professional fees 92 88 89 4 4.5
Amortization of intangibles 11 245 101 (234) (95.5)
Restructuring charges (credits) -- (4) 102 4 100.0
Other expense:
Postage and delivery 59 63 65 (4) (6.3)
Telecommunications 35 44 51 (9) (20.5)
Equity- and gross receipts-based taxes 26 29 33 (3) (10.3)
OREO expense, net 7 6 7 1 16.7
Miscellaneous expense 311 344 278 (33) (9.6)
- ------------------------------------------------------------------------------------------------------------
Total other expense 438 486 434 (48) (9.9)
- ------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 2,653 $ 2,941 $ 2,917 $ (288) (9.8)%
======== ======== ======== ========
Full-time equivalent employees at year end 20,437 21,230 22,142 (793) (3.7)%
- ------------------------------------------------------------------------------------------------------------
PERSONNEL. Personnel expense, the largest category of Key's noninterest expense,
rose by $58 million, or 4%, in 2002 following decreases in each of the previous
two years. The 2002 increase was due primarily to a rise in the cost of benefits
and the effect of annual merit increases, most of which generally take effect
during the second quarter. The level of Key's personnel expense continues to
reflect the benefits derived from our successful competitiveness initiative.
Through this initiative we have improved efficiency and reduced the level of
personnel required to conduct our business. At December 31, 2002, the number of
full-time equivalent employees was 20,437, compared with 21,230 at the end of
2001 and 22,142 at the end of 2000. Figure 13 shows the major components of
Key's personnel expense.
FIGURE 13 PERSONNEL EXPENSE
YEAR ENDED DECEMBER 31, CHANGE 2002 VS 2001
-------------------
dollars in millions 2002 2001 2000 AMOUNT PERCENT
- --------------------------------------------------------------------------------
Salaries $ 867 $ 842 $ 875 $ 25 3.0%
Employee benefits 218 188 192 30 16.0
Incentive compensation 351 348 378 3 .9
- --------------------------------------------------------------------------------
Total personnel expense $1,436 $1,378 $1,445 $ 58 4.2%
====== ====== ====== ======
- --------------------------------------------------------------------------------
35
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
In September 2002, the Board of Directors approved management's recommendation
to change Key's method of accounting for stock options granted to eligible
employees and directors. Effective January 1, 2003, Key will adopt the fair
value method of accounting as outlined in SFAS No. 123, "Accounting for
Stock-Based Compensation." Additional information pertaining to this accounting
change is included in Note 1 ("Summary of Significant Accounting Policies")
under the heading "Accounting Pronouncements Pending Adoption" on page 62.
COMPUTER PROCESSING. The decrease in computer processing expense in 2002 was due
primarily to a lower level of computer software amortization. This reduction is
attributable to a decline in the number of capitalized software projects. Higher
software amortization and expenses related to software rental and maintenance
accounted for the increase in 2001.
EQUIPMENT. The decrease in equipment expense in 2002 and 2001 was driven by
reductions in depreciation 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 $79
million for 2002. 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. Key performed its
annual goodwill impairment testing as of October 1, 2002, and determined that no
impairment existed at that date as well. Additional information pertaining to
the new accounting guidance is included in Note 1 ("Summary of Significant
Accounting Policies") under the heading "Goodwill and Other Intangible Assets"
on page 59.
RESTRUCTURING AND OTHER SPECIAL CHARGES. Key recorded net charges of $127
million (including net restructuring charges of $104 million) in 2000 in
connection with strategic actions related to the competitiveness initiative. For
more information related to the actions taken, associated cost savings and
reductions to Key's workforce, see the section entitled "Status of
competitiveness initiative" on page 22. Additional information related to the
restructuring charges can be found in Note 18 ("Restructuring Charges") on page
81. Cash generated by Key's operations is expected to fund the restructuring
charge liability; none of the charges had a material impact on Key's liquidity.
INCOME TAXES
The provision for income taxes was $336 million for 2002, compared with $102
million for 2001 and $515 million for 2000. The effective tax rate, which is the
provision for income taxes as a percentage of income before income taxes, was
25.6% for 2002, compared with 39.4% for 2001 and 33.9% for 2000. In 2001, the
effective tax rate was significantly distorted by the $150 million nondeductible
write-down of goodwill recorded in the second quarter in connection with Key's
decision to downsize its automobile finance business. Excluding this charge, the
effective tax rate for 2001 was 24.9%.
The effective tax rate for 2002 and the effective tax rate for 2001 (excluding
the goodwill charge) are substantially below Key's combined statutory federal
and state rate of 37% primarily because portions of our equipment leasing
portfolio became subject to a lower income tax rate in the latter half of 2001.
Responsibility for the management of portions of Key's leasing portfolio was
transferred to a subsidiary in a lower tax jurisdiction. Since Key intends to
permanently reinvest the earnings of this subsidiary, no deferred income taxes
have been recorded on those earnings in accordance with SFAS No. 109,
"Accounting for Income Taxes." Other factors that account for the difference
between the effective and statutory tax rates in each year include tax
deductions associated with dividends paid to Key's 401(k) savings plan, income
from investments in tax-advantaged assets (such as tax-exempt securities and
corporate-owned life insurance) and credits associated with investments in
low-income housing projects.
In 2002, Key attained a higher level of pre-tax income, but proportionately less
income was derived from tax-advantaged assets. This resulted in an increase from
Key's 2001 effective tax rate (excluding the goodwill charge). However, the
increase was moderated by the full-year effect of a lower tax rate on our
equipment leasing portfolio, as well as legislative changes in 2002 that
resulted in a higher tax deduction for dividends paid on Key stock held in 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, "Goodwill and Other Intangible Assets."
In 2001, the effective tax rate (excluding the goodwill charge) decreased
significantly because tax-exempt interest income, nontaxable income from
corporate-owned life insurance and tax credits accounted for a significantly
higher portion of Key's pre-tax income. Pre-tax income was substantially lower
in 2001 due to the effects of a weak economy and significant charges recorded in
the second and fourth quarters. In addition, the charitable contribution of
appreciated stock resulted in a tax benefit.
FINANCIAL CONDITION
LOANS
At December 31, 2002, total loans outstanding were $62.5 billion, compared with
$63.3 billion at the end of 2001 and $66.9 billion at the end of 2000. Among the
factors that contributed to the decrease in our loans over the past two years
are:
- - loan sales completed to improve the profitability of the overall portfolio,
or to accommodate our funding needs;
- - weakening loan demand due to the sluggish economy; and
- - our efforts to exit the automobile leasing business, de-emphasize indirect
prime automobile lending and discontinue certain credit-only commercial
relationships.
Over the past several years, we have used alternative funding sources like loan
sales and securitizations to allow us to continue to capitalize on our loan
origination capabilities. In addition, Key has completed acquisitions that have
improved our ability to generate and securitize new loans, especially in the
area of commercial real estate. These acquisitions include the purchase of
Conning Asset Management in June 2002, and both Newport Mortgage Company, L.P.
and National Realty Funding L.C. in 2000. Over the past two years, we have also
sold loans and referred new business to an asset-backed commercial paper
conduit. These sales and referrals were curtailed in 2002 to keep the loans on
Key's balance sheet. For more information about the conduit,
36
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
see Note 19 ("Commitments, Contingent Liabilities and Guarantees") under the
heading "Guarantees" on page 83.
Figure 14 shows the composition of Key's loan portfolio at December 31 for each
of the past five years.
FIGURE 14 COMPOSITION OF LOANS
DECEMBER 31, 2002 2001 2000
-------------------------- ------------------------ -------------------------
dollars in millions AMOUNT % OF TOTAL AMOUNT % OF TOTAL AMOUNT % OF TOTAL
- --------------------------------------------------------------------------------------------------------------------------------
COMMERCIAL
Commercial, financial and agricultural $ 17,425 27.9% $ 18,159 28.7% $ 20,100 30.0%
Commercial real estate (a):
Commercial mortgage 6,015 9.6 6,669 10.5 6,876 10.3
Construction 5,659 9.1 5,878 9.3 5,154 7.7
- ----------------------------------------------------------------------------------------------------------------------------
Total commercial real estate loans 11,674 18.7 12,547 19.8 12,030 18.0
Commercial lease financing 7,513 12.0 7,357 11.6 7,164 10.7
- ----------------------------------------------------------------------------------------------------------------------------
Total commercial loans 36,612 58.6 38,063 60.1 39,294 58.7
CONSUMER
Real estate -- residential mortgage 1,968 3.1 2,315 3.6 4,212 6.3
Home equity 13,804 22.1 11,184 17.7 9,908 14.8
Credit card -- -- -- -- -- --
Consumer -- direct 2,161 3.5 2,342 3.7 2,539 3.8
Consumer -- indirect:
Automobile lease financing 873 1.4 2,036 3.2 3,005 4.5
Automobile loans 2,181 3.5 2,497 4.0 2,809 4.2
Marine 2,088 3.3 1,780 2.8 1,657 2.5
Other 667 1.1 1,036 1.6 1,252 1.9
- ----------------------------------------------------------------------------------------------------------------------------
Total consumer -- indirect loans 5,809 9.3 7,349 11.6 8,723 13.1
- ----------------------------------------------------------------------------------------------------------------------------
Total consumer loans 23,742 38.0 23,190 36.6 25,382 38.0
LOANS HELD FOR SALE 2,103 3.4 2,056 3.3 2,229 3.3
- ----------------------------------------------------------------------------------------------------------------------------
Total $ 62,457 100.0% $ 63,309 100.0% $ 66,905 100.0%
========= ===== ======== ===== ======== =====
- ----------------------------------------------------------------------------------------------------------------------------
1999 1998
-------------------------- ----------------------------
AMOUNT % OF TOTAL AMOUNT % OF TOTAL
- ----------------------------------------------------------------------------------------------------
COMMERCIAL
Commercial, financial and agricultural $ 18,497 28.8% $ 17,038 27.5%
Commercial real estate(a):
Commercial mortgage 6,836 10.6 7,309 11.8
Construction 4,528 7.1 3,450 5.6
- ---------------------------------------------------------------------------------------------------
Total commercial real estate loans 11,364 17.7 10,759 17.4
Commercial lease financing 6,665 10.4 5,613 9.0
- ---------------------------------------------------------------------------------------------------
Total commercial loans 36,526 56.9 33,410 53.9
CONSUMER
Real estate-- residential mortgage 3,962 6.1 4,394 7.1
Home equity 7,973 12.4 7,990 12.9
Credit card -- -- 1,425 2.3
Consumer-- direct 2,565 4.0 2,342 3.8
Consumer-- indirect:
Automobile lease financing 3,195 5.0 2,580 4.2
Automobile loans 3,082 4.8 See note(b) See note(b)
Marine 1,716 2.7 See note(b) See note(b)
Other 1,600 2.5 7,009 11.2
- ---------------------------------------------------------------------------------------------------
Total consumer-- indirect loans 9,593 15.0 9,589 15.4
- ---------------------------------------------------------------------------------------------------
Total consumer loans 24,093 37.5 25,740 41.5
LOANS HELD FOR SALE 3,603 5.6 2,862 4.6
- ---------------------------------------------------------------------------------------------------
Total $ 64,222 100.0% $ 62,012 100.0%
========== ===== ========== =====
- ---------------------------------------------------------------------------------------------------
(a) See Figure 15 for a more detailed breakdown of Key's commercial real estate
loan portfolio at December 31, 2002.
(b) For 1998, indirect automobile and marine loans are included in other
indirect loans.
37
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
The level of Key's total loans outstanding (excluding loans held for sale) would
have decreased by $402 million, or less than 1%, over the past twelve months if
we had not sold $741 million of loans and acquired $244 million of loans during
2002. In the commercial loan portfolio, growth in lease financing receivables
was offset by a net decline in all other commercial portfolios, reflecting
continued weakness in the economy and our decision to discontinue many
credit-only relationships in the leveraged financing and nationally syndicated
lending businesses.
At December 31, 2002, Key's commercial real estate portfolio included mortgage
loans of $6.0 billion and construction loans of $5.7 billion. The average size
of a mortgage loan was $.5 million and the largest mortgage loan had a balance
of $68 million. The average size of a construction loan was $7 million. The
largest construction loan commitment was $57 million; that loan had an
outstanding balance of $31 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). This line of business deals exclusively with
nonowner-occupied properties (i.e., generally properties in which the owner
occupies less than 60% of the premises) and accounted for approximately 54% of
Key's total average commercial real estate loans during 2002. At December 31,
less than 1% of Key's nonowner-occupied portfolio was either nonperforming or
delinquent in payments. Our commercial real estate business as a whole focuses
on larger real estate developers and, as shown in Figure 15, is diversified by
both industry type and geography.
FIGURE 15 COMMERCIAL REAL ESTATE LOANS
DECEMBER 31, 2002 GEOGRAPHIC REGION
-------------------------------------------
TOTAL PERCENT OF
dollars in millions EAST MIDWEST CENTRAL WEST AMOUNT TOTAL
- -----------------------------------------------------------------------------------------------------------------------
Nonowner-occupied:
Multi-family properties $ 594 $ 561 $ 629 $ 787 $ 2,571 22.0%
Retail properties 324 565 150 226 1,265 10.8
Office buildings 171 151 154 213 689 5.9
Residential properties 46 108 135 425 714 6.1
Warehouses 51 217 98 105 471 4.0
Manufacturing facilities 36 28 6 6 76 .7
Hotels/Motels 7 9 -- 10 26 .2
Other 247 404 79 261 991 8.5
- --------------------------------------------------------------------------------------------------------------------
1,476 2,043 1,251 2,033 6,803 58.2
Owner-occupied 551 2,329 574 1,417 4,871 41.8
- --------------------------------------------------------------------------------------------------------------------
Total $ 2,027 $ 4,372 $ 1,825 $ 3,450 $11,674 100.0%
======= ======= ======= ======= ======= =====
- --------------------------------------------------------------------------------------------------------------------
Nonowner-occupied:
Nonperforming loans $ 6 $ 12 $ 2 $ 12 $ 32 N/M
Accruing loans past due 90 days or more 6 1 -- -- 7 N/M
Accruing loans past due 30 through 89 days 1 9 -- 6 16 N/M
- --------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
Consumer loans would have increased (assuming no loan sales or acquisitions) by
$1.1 billion, or 5%, during 2002. Our home equity portfolio grew by $3.0
billion, largely as a result of our focused efforts to grow this business,
facilitated by a period of lower interest rates. The growth of the home equity
portfolio more than offset declines of $418 million in installment loans, $1.2
billion in automobile lease financing receivables and $347 million in
residential real estate mortgage loans. The declines in installment loans and
automobile lease financing receivables reflect our decision to de-emphasize
indirect prime automobile lending and exit the automobile leasing business.
Key's home equity portfolio is derived from both our Retail Banking line of
business (64% of the home equity portfolio at December 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 80%. First lien positions comprised
79% of the portfolio for this line of business at December 31, 2002.
Key Home Equity Services purchases individual loans from an extensive network of
correspondents and agents. Prior to the third quarter of 2002, loans were also
purchased through bulk portfolio acquisitions from home equity loan companies.
Figure 16 summarizes Key's home equity loan portfolio at December 31 for each of
the last six years, as well as certain asset quality statistics and the yields
achieved on the portfolio as a whole.
SALES, SECURITIZATIONS AND DIVESTITURES. During 2002, Key sold $1.4 billion of
commercial real estate loans, $1.1 billion of education loans ($750 million
through a securitization) and $835 million of other types of loans. Since 1999,
Key has securitized only education loans.
Among the factors that Key considers in determining which loans to securitize
are:
- - whether the characteristics of a specific loan portfolio make it conducive
to securitization;
- - the relative cost of funds;
- - the level of credit risk; and
- - capital requirements.
38
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 16 HOME EQUITY LOANS
DECEMBER 31,
dollars in millions 2002 2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
SOURCES OF LOANS OUTSTANDING
AT PERIOD END
Retail KeyCenters and other sources $ 8,867 $ 6,431 $ 6,136 $ 5,740 $ 6,036 $ 5,210
Champion Mortgage Company 2,210 1,886 1,082 371 689 242
Key Home Equity Services division 2,727 2,867 2,690 1,862 1,265 211
- ----------------------------------------------------------------------------------------------------------------------
National Home Equity line of business 4,937 4,753 3,772 2,233 1,954 453
- ----------------------------------------------------------------------------------------------------------------------
Total $ 13,804 $ 11,184 $ 9,908 $ 7,973 $ 7,990 $ 5,663
========== ========== ========== ========== ========== ==========
- ----------------------------------------------------------------------------------------------------------------------
Nonperforming loans at year end $ 146 $ 60 $ 80 $ 50 $ 26 $ 15
Net charge-offs for the year 52 98 17 9 5 4
Yield for the year 6.82% 8.55% 9.29% 8.54% 8.77% 9.05%
- ----------------------------------------------------------------------------------------------------------------------
Figure 17 summarizes Key's loan sales (including securitizations) for 2002 and
2001.
FIGURE 17 LOANS SOLD AND DIVESTED
COMMERCIAL COMMERCIAL RESIDENTIAL HOME CONSUMER
in millions COMMERCIAL REAL ESTATE LEASE FINANCING REAL ESTATE EQUITY -- INDIRECT EDUCATION TOTAL
- -------------------------------------------------------------------------------------------------------------------------
2002
- --------------
Fourth quarter $ 93 $ 603 -- $ 65 $ 110 $ 177 $ 100 $ 1,148
Third quarter 18 352 -- 25 242 3 784 1,424
Second quarter 31 159 $ 18 20 24 -- 70 322
First quarter -- 319 -- -- 9 -- 116 444
- -------------------------------------------------------------------------------------------------------------------------
Total $ 142 $ 1,433 $ 18 $ 110 $ 385 $ 180 $ 1,070 $ 3,338
===== ======== ===== ======== ===== ===== ======== ========
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 18 shows loans that are either administered or serviced by Key, but not
recorded on the balance sheet. Included are loans that have been both
securitized and sold, or simply sold outright. In the event of default, Key is
subject to recourse with respect to approximately $227 million of the $24.8
billion of loans administered or serviced at December 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. Conning Asset Management and
National Realty Funding L.C. service the commercial real estate loans shown in
Figure 18, however, other financial institutions originated most of these loans.
Approximately $81 million of the assets held in the asset-backed commercial
paper conduit, for which Key serves as a referral agent, are also included in
Figure 18. For more information regarding the conduit, see Note 19
("Commitments, Contingent Liabilities and Guarantees") under the heading
"Guarantees" on page 83.
FIGURE 18 LOANS ADMINISTERED OR SERVICED
DECEMBER 31,
in millions 2002 2001 2000
==============================================================
Education loans $ 4,605 $ 4,433 $ 4,113
Automobile loans 54 131 422
Home equity loans 456 768 1,176
Commercial real
estate loans 19,508(a) 10,471 7,108
Commercial loans 123 983 973
Commercial lease
financing 13 -- --
- --------------------------------------------------------------
Total $ 24,759 $ 16,786 $ 13,792
========== ========== ==========
- --------------------------------------------------------------
(a) Includes $4.1 billion of serviced loans purchased in the June 28, 2002,
acquisition of Conning Asset Management.
39
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
Figure 19 shows the maturities of certain commercial and real estate loans, and
the sensitivity of those loans to changes in interest rates. As indicated, at
December 31, 2002, approximately 50% of these outstanding loans were scheduled
to mature within one year. Loans with maturities greater than one year include
$12.2 billion with floating or adjustable rates and $3.2 billion with
predetermined rates.
FIGURE 19 MATURITIES AND SENSITIVITY OF CERTAIN LOANS TO CHANGES IN INTEREST RATES
DECEMBER 31, 2002 WITHIN 1-5 OVER
in millions 1 YEAR YEARS 5 YEARS TOTAL
- --------------------------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $10,007 $4,982 $2,436 $17,425
Real estate -- construction 3,515 2,025 119 5,659
Real estate -- residential and commercial mortgage 2,131 2,139 3,713 7,983
- --------------------------------------------------------------------------------------------------------------------------------
$15,653 $9,146 $6,268 $31,067
======= ====== ====== =======
Loans with floating or adjustable interest rates(a) $7,833 $4,348
Loans with predetermined interest rates(b) 1,313 1,920
- --------------------------------------------------------------------------------------------------------------------------------
$9,146 $6,268
====== ======
- --------------------------------------------------------------------------------------------------------------------------------
(a) "Floating" and "adjustable" rates vary in relation to other interest rates
(such as the base lending rate) or a variable index that may change during
the term of the loan.
(b) "Predetermined" interest rates either are fixed or will change during the
term of the loan according to a specific formula or schedule.
SECURITIES
At December 31, 2002, the securities portfolio totaled $9.5 billion and included
$8.5 billion of securities available for sale, $120 million of investment
securities and $919 million of other investments (primarily principal
investments). In comparison, the total portfolio at December 31, 2001, was $6.5
billion, including $5.4 billion of securities available for sale, $225 million
of investment securities and $832 million of other investments.
The size and composition of Key's securities portfolio are dependent largely on
our needs for liquidity and the extent to which we are required or elect to hold
these assets as collateral to secure public and trust deposits. Although debt
securities are generally used for this purpose, other assets, such as securities
purchased under resale agreements, may be used temporarily when they provide
more favorable yields.
SECURITIES AVAILABLE FOR SALE. The majority of Key's securities available for
sale portfolio consists of collateralized mortgage obligations that provide a
source of interest income and serve as collateral in connection with pledging
requirements. A collateralized mortgage obligation (sometimes called a "CMO") is
a debt security that is secured by a pool of mortgages, mortgage-backed
securities, U.S. government securities, corporate debt obligations or other
bonds. At December 31, 2002, Key had $8.1 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.
Key invested more heavily in these securities during 2002 as opportunities to
originate loans (Key's preferred earning assets) have been adversely affected by
the weak economy. 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. For more information about retained interests in
securitizations, gross unrealized gains and losses by type of security and
securities pledged, see Note 6 ("Securities"), which begins on page 68.
INVESTMENT SECURITIES. Securities issued by states and political subdivisions
account for all of Key's investment securities. Figure 21 shows the composition,
yields and remaining maturities of these securities.
OTHER INVESTMENTS. Principal investments -- investments in equity and mezzanine
instruments made by Key's Principal Investing unit -- are carried at fair value,
which aggregated $677 million at December 31, 2002. They represent approximately
75% of other investments and include direct and indirect investments
predominately in privately-held companies. Direct investments are those made in
a particular company, while indirect investments are made through funds that
include other investors.
In addition to principal investments, other investments include securities that
do not have readily determinable fair values. These securities include certain
real estate-related investments. Neither these securities nor principal
investments have stated maturities.
ASSET QUALITY
Key has a multi-faceted program to manage asset quality. Our professionals:
- - evaluate and monitor credit quality and risk in credit-related assets;
- - develop commercial and consumer credit policies and systems;
- - monitor compliance with internal underwriting standards;
- - establish credit-related concentration limits; and
- - review the adequacy of the allowance for loan losses.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses at December 31, 2002,
was $1.5 billion, or 2.32% of loans. This compares with $1.7 billion, or 2.65%
of loans, at December 31, 2001. The allowance includes $179 million that was
specifically allocated for impaired loans of $377 million at December 31, 2002,
compared with $180 million that was allocated for impaired loans of $417 million
a year ago. For more information about impaired loans, see Note 9 ("Impaired
Loans and Other Nonperforming Assets") on page 72. At December 31, 2002, the
allowance for loan losses was 153.98% of nonperforming loans, compared with
184.29% at December 31, 2001.
40
MANAGEMENT'S DISCUSSION & ANALYSIS OF
FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 20 SECURITIES AVAILABLE FOR SALE
OTHER
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- RETAINED
AGENCIES AND POLITICAL MORTGAGE BACKED INTERESTS IN OTHER
dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(a) SECURITIES(a) SECURITIZATIONS(a) SECURITIES
- ---------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
Remaining maturity:
One year or less $ 3 $ 1 $ 852 $ 9 $ 8 $ 1
After one through five years 8 6 6,018 644 201 12
After five through ten years 5 11 185 12 -- 5
After ten years 7 17 152 187 -- 163(c)
- ---------------------------------------------------------------------------------------------------------------------------------
Fair value $ 23 $ 35 $ 7,207 $ 852 $ 209 $ 181
Amortized cost 22 35 7,143 815 166 208
Weighted average yield 5.29% 6.47% 5.26% 6.78% 22.16% 5.33%(b)
Weighted average maturity 8.4 YEARS 10.9 YEARS 2.8 YEARS 2.3 YEARS 3.6 YEARS 9.7 YEARS
- ---------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001
Fair value $ 99 $ 21 $ 3,805 $ 1,032 $ 234 $ 217
Amortized cost 99 21 3,791 1,008 214 232
- ---------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2000
Fair value $ 984 $ 33 $ 4,298 $ 1,355 $ 316 $ 398
Amortized cost 984 33 4,296 1,355 334 362
- ---------------------------------------------------------------------------------------------------------------------------------
WEIGHTED
AVERAGE
dollars in millions TOTAL YIELD(b)
- ------------------------------------------------------------------
DECEMBER 31, 2002
Remaining maturity:
One year or less $ 874 5.65%
After one through five years 6,889 5.56
After five through ten years 218 8.53
After ten years 526 9.21
- ---------------------------------------------------------------
Fair value $ 8,507 -
Amortized cost 8,389 5.76%
Weighted average yield 5.76% --
Weighted average maturity 3.0 YEARS --
- ---------------------------------------------------------------
DECEMBER 31, 2001
Fair value $ 5,408 --
Amortized cost 5,365 7.26%
- ---------------------------------------------------------------
DECEMBER 31, 2000
Fair value $ 7,384 --
Amortized cost 7,364 7.16%
- ---------------------------------------------------------------
(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 $188 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.
FIGURE 21 INVESTMENT SECURITIES
STATES AND WEIGHTED
POLITICAL AVERAGE
dollars in millions SUBDIVISIONS YIELD(a)
- ---------------------------------------------------------------------
DECEMBER 31, 2002
Remaining maturity:
One year or less $ 32 9.79%
After one through five years 69 9.54
After five through ten years 18 8.32
After ten years 1 11.22
- -------------------------------------------------------------------
Amortized cost $ 120 9.43%
Fair value 129 --
Weighted average maturity 2.8 YEARS --
- -------------------------------------------------------------------
DECEMBER 31, 2001
Amortized cost $ 225 8.71%
Fair value 234 --
- -------------------------------------------------------------------
DECEMBER 31, 2000
Amortized cost $ 323 9.18%
Fair value 333 --
- -------------------------------------------------------------------
(a) Weighted average yields are calculated based on amortized cost. Such yields
have been adjusted to a taxable-equivalent basis using the statutory federal
income tax rate of 35%.
Management estimates the appropriate level of the allowance for loan losses on a
quarterly (and at times more frequent) basis. The methodology used is described
in Note 1 ("Summary of Significant Accounting Policies") under the heading
"Allowance for Loan Losses" on page 58. Briefly, management assigns a specific
allowance to an impaired loan when the carrying amount of the loan exceeds the
estimated present value of related future cash flows and the fair value of any
existing collateral.
The allowance for loan losses arising from nonimpaired loans is determined by
applying historical loss rates to existing loans with similar risk
characteristics and by exercising judgment to assess the impact of factors such
as changes in economic conditions, credit policies or underwriting standards,
and the level of credit risk associated with specific industries and markets.
The aggregate balance of the allowance for loan losses at December 31, 2002,
represents management's best estimate of the losses inherent in the loan
portfolio at that date.
The allowance allocated for Key's impaired loans was essentially unchanged from
the prior year, reflecting Key's continued efforts to resolve problem credits,
combined with stabilizing credit quality trends in certain portfolios. During
the same period, the allowance allocated for nonimpaired loans decreased by $224
million, or 15%, due largely to slow loan growth and stabilizing credit quality
trends in certain portfolios.
Management has determined that the level of watch credits in several commercial
portfolios decreased from year-ago levels. Watch credits are loans with the
potential for further deterioration in quality based on the debtor's current
financial condition and related ability to perform in accordance with the terms
of the loan. The decline in watch credits in specific commercial portfolios was
due primarily to more conservative underwriting and slower loan growth in a
sluggish economy. The loan portfolios with the most significant decreases in
watch credits were large corporate and healthcare. Other portfolios, including
middle market, showed signs of stability or modest improvement. At the same
time, the media and commercial real estate portfolios experienced higher levels
of watch credits. These changes reflect the fluctuations that occur in loan
portfolios from quarter to quarter. Management does not believe that such
changes require any adjustment to the allowance at this time.
41
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
As shown in Figure 22, most of the 2002 decrease in Key's allowance for loan
losses was attributable to developments in the commercial loan portfolio. This
decrease reflects net charge-offs recorded in the nonreplenished allowance
discussed in the following section, stabilizing credit quality trends in certain
portfolios and slow loan growth in a weak economy.
FIGURE 22 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
DECEMBER 31, 2002 2001 2000
----------------------- ---------------------- ------------------------
PERCENT OF PERCENT OF PERCENT OF
LOAN TYPE TO LOAN TYPE TO LOAN TYPE TO
dollars in millions AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
- -------------------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $1,092 27.9% $1,289 28.7% $ 742 30.0%
Real estate -- commercial mortgage 48 9.6 45 10.5 35 10.3
Real estate -- construction 45 9.1 39 9.3 27 7.7
Commercial lease financing 74 12.0 89 11.6 45 10.7
- ---------------------------------------------------------------------------------------------------------------------
Total commercial loans 1,259 58.6 1,462 60.1 849 58.7
Real estate -- residential mortgage 2 3.1 4 3.7 2 6.3
Home equity 65 22.1 59 17.7 20 14.8
Credit card -- -- -- -- -- --
Consumer -- direct 16 3.5 24 3.7 15 3.8
Consumer -- indirect lease financing 5 1.4 8 3.2 9 4.5
Consumer -- indirect other 103 7.9 117 8.4 104 8.6
- ---------------------------------------------------------------------------------------------------------------------
Total consumer loans 191 38.0 212 36.7 150 38.0
Loans held for sale 2 3.4 3 3.2 2 3.3
Unallocated -- -- -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------
Total $1,452 100.0% $1,677 100.0% $1,001 100.0%
====== ===== ====== ===== ====== =====
- ---------------------------------------------------------------------------------------------------------------------
1999 1998
----------------------- ---------------------
PERCENT OF PERCENT OF
LOAN TYPE TO LOAN TYPE TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
- ---------------------------------------------------------------------------------------------
Commercial, financial and agricultural $509 28.8% $357 27.5%
Real estate -- commercial mortgage 34 10.6 32 11.8
Real estate -- construction 16 7.1 15 5.6
Commercial lease financing 39 10.4 49 9.0
- -----------------------------------------------------------------------------------------
Total commercial loans 598 56.9 453 53.9
Real estate -- residential mortgage 1 6.7 7 8.2
Home equity 7 11.8 5 11.8
Credit card -- -- 44 2.3
Consumer -- direct 8 4.0 15 3.8
Consumer -- indirect lease financing 6 5.0 5 4.2
Consumer -- indirect other 55 10.0 77 11.2
- -----------------------------------------------------------------------------------------
Total consumer loans 77 37.5 153 41.5
Loans held for sale 18 5.6 1 4.6
Unallocated 237 -- 293 --
- -----------------------------------------------------------------------------------------
Total $930 100.0% $900 100.0%
==== ===== ==== =====
- -----------------------------------------------------------------------------------------
RUN-OFF LOAN PORTFOLIO. In May 2001, management set apart $300 million of Key's
allowance for loan losses as part of its decision to discontinue many
credit-only relationships in the leveraged financing and nationally syndicated
lending businesses and to facilitate sales of distressed loans in other
portfolios. An additional $190 million was added to this allowance in the fourth
quarter of 2001. The resulting 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 to absorb losses incurred in connection with sales of
distressed loans in the continuing portfolio. As losses are charged to this
segregated allowance over time, we do not intend to replenish it. Within the
run-off portfolio, approximately $940 million of commitments (including $599
million of loans outstanding) remained as of December 31, 2002. Only $85 million
of these loans were nonperforming.
42
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
Figure 23 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 24.
FIGURE 23 ASSET QUALITY INDICATORS -- CONTINUING AND RUN-OFF LOAN PORTFOLIOS
DECEMBER 31, RUN-OFF LOAN PORTFOLIO AND
CONTINUING LOAN PORTFOLIO NONREPLENISHED ALLOWANCE TOTAL LOAN PORTFOLIO
------------------------- -------------------------- --------------------
in millions 2002 2001 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------
Loans outstanding $61,858 $62,286 $ 599 $ 1,023 $62,457 $63,309
Nonperforming loans 858 679 85 231 943 910
Net loan charge-offs for the year 553 458 227(a) 215(a) 780 673
Allowance for loan losses 1,404 1,402 48 275 1,452 1,677
- ----------------------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to sales of
distressed loans in the continuing portfolio.
FIGURE 24 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 (139) (139)
Payments, expirations and other changes, net (615) (285)
- ----------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 $ 940 $ 599
====== ======
- ----------------------------------------------------------------------------------------------
SUMMARY OF CHANGES IN NONPERFORMING LOANS
AND NONREPLENISHED ALLOWANCE FOR LOAN LOSSES(a)
NONPERFORMING NONREPLENISHED
in millions LOANS ALLOWANCE
- -------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 $ 231 $275
Loans placed on nonaccrual status 75 N/A
Charge-offs (139) (227)
Payments and other changes, net (82) N/A
- -------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 $ 85 $ 48
======= ====
- -------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to sales of
distressed loans in the continuing portfolio.
N/A = Not Applicable
NET LOAN CHARGE-OFFS. Net loan charge-offs for 2002 were $780 million, or 1.23%
of average loans, compared with $673 million, or 1.02% of average loans, for
2001 and $414 million, or .63% of average loans, for 2000. The composition of
Key's loan charge-offs and recoveries by type of loan is shown in Figure 25. The
increase in net charge-offs for 2002 occurred in the commercial loan portfolio,
reflecting continued weakness in the economy and Key's continuing efforts to
resolve distressed credits. As shown in Figure 24, we used $227 million of Key's
nonreplenished allowance during 2002 to absorb losses arising from the run-off
loan portfolio and from sales of distressed loans in the continuing portfolio.
Structured finance refers to a type of lending characterized by a high degree of
leverage in the borrower's financial condition and a relatively low level of
tangible loan collateral. Key has used it in extensions of credit to borrowers
in the commercial, financial and agricultural portfolio represented in Figure
25. The structured finance portfolio accounted for 23% of commercial net
charge-offs for 2002, but represented only 3% of Key's commercial loans at the
end of the year.
As shown in Figure 25, the increase in commercial loan net charge-offs was
offset in part by a decrease in the level of net charge-offs in the consumer
loan portfolio, primarily in the home equity and consumer installment segments.
The reduction in net charge-offs on installment loans reflected actions taken by
Key since May 2001 to exit the automobile leasing business and to de-emphasize
indirect prime automobile lending.
43
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 25 SUMMARY OF LOAN LOSS EXPERIENCE
YEAR ENDED DECEMBER 31,
dollars in millions 2002 2001 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------------------
Average loans outstanding during the year $ 63,393 $ 65,976 $ 65,294 $ 62,401 $ 57,422
- -------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of year $ 1,677 $ 1,001 $ 930 $ 900 $ 900
Loans charged off:
Commercial, financial and agricultural 407 313 175 112 66
Real estate -- commercial mortgage 78 18 9 2 20
Real estate -- construction 22 8 -- -- 2
- -------------------------------------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 100 26 9 2 22
Commercial lease financing 94 62 14 20 12
- -------------------------------------------------------------------------------------------------------------------------
Total commercial loans 601 401 198 134 100
Real estate -- residential mortgage 6 17 8 8 11
Home equity 56 99 19 10 6
Credit card -- 1 17 89 104
Consumer -- direct 51 47 57 41 44
Consumer -- indirect lease financing 25 27 23 13 8
Consumer -- indirect other 166 192 200 125 111
- -------------------------------------------------------------------------------------------------------------------------
Total consumer loans 304 383 324 286 284
- -------------------------------------------------------------------------------------------------------------------------
905 784 522 420 384
Recoveries:
Commercial, financial and agricultural 44 26 25 28 25
Real estate -- commercial mortgage 6 4 4 4 6
Real estate -- construction 2 -- -- 1 2
- -------------------------------------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 8 4 4 5 8
Commercial lease financing 9 5 2 3 1
- -------------------------------------------------------------------------------------------------------------------------
Total commercial loans 61 35 31 36 34
Real estate -- residential mortgage 1 8 4 4 4
Home equity 4 1 2 1 1
Credit card - 1 5 14 10
Consumer -- direct 8 8 8 8 6
Consumer -- indirect lease financing 8 9 6 3 1
Consumer -- indirect other 43 49 52 36 31
- -------------------------------------------------------------------------------------------------------------------------
Total consumer loans 64 76 77 66 53
- -------------------------------------------------------------------------------------------------------------------------
125 111 108 102 87
- -------------------------------------------------------------------------------------------------------------------------
Net loans charged off (780) (673) (414) (318) (297)
Provision for loan losses 553 1,350 490 348 297
Allowance related to loans acquired (sold), net 2 (1) (5) -- --
- -------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of year $ 1,452 $ 1,677 $ 1,001 $ 930 $ 900
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans 1.23% 1.02% .63% .51% .52%
Allowance for loan losses to year-end loans 2.32 2.65 1.50 1.45 1.45
Allowance for loan losses to nonperforming loans 153.98 184.29 154.00 208.05 234.38
- -------------------------------------------------------------------------------------------------------------------------
(a) See Figure 15 on page 38 and the accompanying discussion for more
information related to Key's commercial real estate portfolio.
NONPERFORMING ASSETS. Figure 26 shows the composition of Key's nonperforming
assets. These assets totaled $993 million at December 31, 2002, and represented
1.59% of loans, other real estate owned (known as "OREO") and other
nonperforming assets, compared with $947 million, or 1.49%, at December 31,
2001.
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
disproportionately concentrated. At December 31, 2002, two segments of the
commercial, financial and agricultural portfolio (loans to middle market clients
and loans underwritten as structured finance credits) accounted for $219 million
and $164 million, respectively, of Key's nonperforming loans. Although these two
segments comprised only 16% of Key's total loans, they accounted for 41% of
total nonperforming loans.
At December 31, 2002, our 20 largest nonperforming loans totaled $258 million,
representing 27% of total loans on nonperforming status. At December 31, 2002,
the run-off loan portfolio accounted for $85 million, or 9%, of Key's total
nonperforming loans presented in Figure 26.
44
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 26 SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
DECEMBER 31,
dollars in millions 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 448 $ 409 $ 301 $ 175 $ 144
Real estate -- commercial mortgage 157 187 90 102 79
Real estate -- construction 50 83 28 7 6
- --------------------------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 207 270 118 109 85
Commercial lease financing 69 94 48 28 29
- --------------------------------------------------------------------------------------------------------------
Total commercial loans 724 773 467 312 258
Real estate - residential mortgage 36 42 52 44 60
Home equity 146 50 80 50 26
Consumer - direct 13 9 8 6 6
Consumer - indirect lease financing 5 10 7 3 3
Consumer - indirect other 19 26 36 32 31
- --------------------------------------------------------------------------------------------------------------
Total consumer loans 219 137 183 135 126
- --------------------------------------------------------------------------------------------------------------
Total nonperforming loans 943 910 650 447 384
OREO 48 38 23 27 56
Allowance for OREO losses (3) (1) (1) (3) (18)
- --------------------------------------------------------------------------------------------------------------
OREO, net of allowance 45 37 22 24 38
Other nonperforming assets 5 -- -- 2 1
- --------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 993 $ 947 $ 672 $ 473 $ 423
======= ======= ======= ======= =======
- --------------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 198 $ 250 $ 236 $ 219 $ 159
Accruing loans past due 30 through 89 days 790 1,096 963 916 753
- --------------------------------------------------------------------------------------------------------------
Nonperforming loans to year-end loans 1.51% 1.44% .97% .70% .62%
Nonperforming assets to year-end loans
plus OREO and other nonperforming assets 1.59 1.49 1.00 .74 .68
- --------------------------------------------------------------------------------------------------------------
(a) See Figure 15 on page 38 and the accompanying discussion for more
information related to Key's commercial real estate portfolio.
Information pertaining to the credit exposure by industry classification
inherent in the largest sector of Key's loan portfolio, commercial, financial
and agricultural loans, is presented in Figure 27. Within the transportation
category, Key had approximately $270 million of exposure to the commercial
passenger airline industry at December 31, 2002. The types of activity that
caused the change in Key's nonperforming loans during 2002 are summarized in
Figure 28.
FIGURE 27 COMMERCIAL, FINANCIAL AND AGRICULTURAL LOANS
DECEMBER 31, 2002 NONPERFORMING LOANS
----------------------
TOTAL LOANS % OF LOANS
dollars in millions COMMITMENTS OUTSTANDING AMOUNT OUTSTANDING
- ----------------------------------------------------------------------------------------------
Industry classification:
Manufacturing $10,034 $ 3,931 $ 155 3.9%
Services 6,198 2,506 90 3.6
Financial services 4,061 979 5 .5
Retail trade 4,250 2,518 43 1.7
Wholesale trade 2,763 1,313 44 3.4
Property management 2,900 1,098 8 .7
Public utilities 1,728 461 1 .2
Communications 1,178 494 23 4.7
Agriculture/forestry/fishing 1,085 666 17 2.6
Building contractors 1,217 547 26 4.8
Public administration 739 245 - -
Transportation 819 440 11 2.5
Insurance 732 216 6 2.8
Mining 379 169 - -
Individuals 187 121 1 .8
Other 1,904 1,721 18 1.0
- ----------------------------------------------------------------------------------------------
Total $40,174 $17,425 $ 448 2.6%
======= ======= =======
- ----------------------------------------------------------------------------------------------
45
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 28 SUMMARY OF CHANGES IN NONPERFORMING LOANS
2002 QUARTERS
----------------------------------------------
in millions FULL YEAR FOURTH THIRD SECOND FIRST
- ---------------------------------------------------------------------------------------------------------
BALANCE AT BEGINNING OF PERIOD $ 910 $ 987 $ 957 $ 973 $ 910
Loans placed on nonaccrual status 1,168 339 281 254 294
Charge-offs (780) (186) (185) (203) (206)
Loans sold (79) (36) (25) (18) -
Payments (261) (149) (41) (49) (22)
Transfers to OREO (3) - - - (3)
Loans returned to accrual status (13) (13) - - -
Acquisition 1 1 - - -
- ---------------------------------------------------------------------------------------------------------
BALANCE AT END OF PERIOD $ 943 $ 943 $ 987 $ 957 $ 973
======= ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------
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 2002, core
deposits averaged $37.7 billion, and represented 52% of the funds Key used to
support earning assets, compared with $37.5 billion and 50% during 2001, and
$37.3 billion and 50% during 2000. The composition of Key's deposits is shown in
Figure 6, which spans pages 28 and 29.
The increase in the level of Key's core deposits during 2002 was due primarily
to higher levels of noninterest-bearing deposits and money market deposit
accounts. The growth of these deposits reflected client preferences for
investments that provide high levels of liquidity in a low interest rate
environment. Also contributing to the significant growth in noninterest-bearing
deposits were our intensified cross-sell efforts and the introduction of new
products, including free checking. A more aggressive pricing structure
implemented in mid-2002 supported the growth in savings deposits. During 2002,
time deposits decreased by 9% in part because, like our competitors, Key reduced
the rates paid for them as the Federal Reserve reduced interest rates in
general.
In 2001, the level of Key's core deposits rose from the prior year as moderate
growth of time deposits more than offset a decline in the level of savings
deposits. Time deposits grew by 2% in 2001, following an increase of 17% in
2000. The growth rate of these deposits declined largely as a result of a lower
interest rate environment.
Purchased funds, comprising large certificates of deposit, deposits in the
foreign branch and short-term borrowings, averaged $15.5 billion during 2002,
compared with $20.0 billion during 2001 and $20.2 billion in 2000. As shown in
Figure 6, both certificates of deposit and short-term borrowings have declined
as funding sources. This is attributable in part to reduced funding needs
resulting from loan sales, slow demand for loans and from our decision to scale
back or discontinue certain types of lending. In addition, Key continues to
consider loan sales and securitizations as a funding alternative when market
conditions are favorable.
Since late 1995, Key has had a program in place under which deposit balances
(above a defined threshold) in certain negotiable order of withdrawal ("NOW")
accounts and noninterest-bearing checking accounts are transferred to money
market accounts, thereby reducing the level of deposit reserves required to be
maintained with the Federal Reserve. Based on certain limitations, funds are
periodically transferred back to the checking accounts to cover checks presented
for payment or withdrawals. As a result of this program, average deposit
balances for 2002 include NOW accounts of $4.4 billion and demand deposits of
$4.9 billion that are classified as money market deposit accounts. In Figure 6,
the NOW accounts transferred are included in the money market deposit account
category, while the demand deposits continue to be reported as
noninterest-bearing checking accounts.
At December 31, 2002, Key had $8.5 billion in time deposits of $100,000 or more.
Figure 29 shows the maturity distribution of these deposits.
FIGURE 29 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE
DECEMBER 31, 2002 DOMESTIC FOREIGN
in millions OFFICES OFFICE TOTAL
- --------------------------------------------------------------
Remaining maturity:
Three months or less $1,732 $3,743 $5,475
After three through
twelve months 836 - 836
After twelve months 2,181 - 2,181
- --------------------------------------------------------------
Total $4,749 $3,743 $8,492
====== ====== ======
- --------------------------------------------------------------
LIQUIDITY
"Liquidity" measures whether an entity has sufficient cash flow to meet its
financial obligations when due. Key has sufficient liquidity when it can meet
its obligations to depositors, borrowers and creditors at a reasonable cost, on
a timely basis, and without adverse consequences. KeyCorp has sufficient
liquidity when it can pay dividends to shareholders, service its debt, and
support customary corporate operations and activities, including acquisitions,
at a reasonable cost, in a timely manner and without adverse consequences.
LIQUIDITY RISK. There are both direct and indirect circumstances that could
adversely affect Key's liquidity or materially affect the cost of funds. For
example, events unrelated to Key, such as terrorism or war, natural disasters,
political events, or the default or bankruptcy of
46
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
a major corporation, mutual fund or hedge fund, can have market-wide
consequences. A direct (but hypothetical) event would be a significant downgrade
in Key's public credit rating by a rating agency due to a deterioration in asset
quality, a large charge to earnings, a significant merger or acquisition or
other events. Similarly, market speculation or rumors about Key or the banking
industry in general may cause normal funding sources to withdraw credit until
further information becomes available.
LIQUIDITY FOR KEY. Key's Funding and Investment Management Group monitors the
overall mix of funding sources with the objective of maintaining an appropriate
mix in light of the structure of the asset portfolios. We use several tools to
maintain sufficient liquidity.
- - We maintain portfolios of short-term money market investments and securities
available for sale, substantially all of which could be converted to cash
quickly at a small expense.
- - Key's portfolio of investment securities generates prepayments (often at a
premium) and payments at maturity.
- - We try to structure the maturities of our loans so we receive a relatively
consistent stream of payments from borrowers.
- - We have a proven ability to access the securitization markets for a variety
of loan types.
- - Our 910 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 at December 31, 2002.
The Consolidated Statements of Cash Flow on page 56 summarize Key's sources and
uses of cash by type of activity for the years ended December 31, 2002, 2001 and
2000. As shown in these statements, Key's largest cash flows relate to both
investing and financing activities. Over the past three years, the primary
sources of cash from investing activities have been loan securitizations and
sales and the sales, prepayments and maturities of securities available for
sale. Investing activities that have required the greatest use of cash include
lending and the purchases of new securities.
Over the past three years, the primary source of cash from financing activities
has been the issuance of long-term debt. However, in both 2002 and 2000,
deposits were also a significant source of cash. In each of the past three
years, cash has been used to repay debt issued in prior periods and to reduce
the levels of short-term borrowings.
LIQUIDITY FOR KEYCORP. KeyCorp meets its liquidity requirements principally
through regular dividends from affiliate banks. In 2002, affiliate banks paid
KeyCorp a total of $900 million in dividends. Federal banking law limits the
amount of capital distributions that banks can make to their holding companies
without obtaining prior regulatory approval. A national bank's dividend paying
capacity is affected by several factors, including the amount of its net profits
(as defined by statute) for the two previous calendar years, and net profits for
the current year up to the date of dividend declaration. Due to this constraint,
and the restructuring charges taken by KBNA and Key Bank USA in 2001, as of
January 1, 2003, neither bank could pay dividends or make other capital
distributions to KeyCorp without prior regulatory approval.
In February 2003, KBNA obtained regulatory approval to make capital
distributions to KeyCorp of up to $365 million in the aggregate in the first and
second quarters. If KBNA were to distribute such amount, it would not have any
further dividend paying capacity until it accumulates at least $300 million of
additional net profits in 2003. Management expects this will occur during the
second quarter. Management also expects Key Bank USA to have restored dividend
paying capacity during the first quarter.
Assuming KBNA had distributed the $365 million to KeyCorp as of February 15,
2003, as of that date, KeyCorp would have had approximately $1.5 billion of cash
or short-term investments available to pay dividends on its common shares, to
service its debt and to finance its corporate operations. Management does not
expect current constraints on the subsidiary banks to pay dividends to KeyCorp
to have any material effect on the ability of KeyCorp to pay dividends to its
shareholders, to service its debt or to meet its other obligations.
ADDITIONAL SOURCES OF LIQUIDITY. Management has implemented several programs
that enable Key and KeyCorp to raise money in the public and private markets
when necessary. The proceeds from all of these programs can be used for general
corporate purposes, including acquisitions. Each of the programs is replaced or
extended from time to time as needed.
BANK NOTE PROGRAM. During 2002, Key's affiliate banks raised $2.9 billion under
Key's bank note program. Of the notes issued during the year, $2.2 billion have
original maturities in excess of one year and are included in long-term debt.
The remaining notes have original maturities of one year or less and are
included in short-term borrowings. Key's current bank note program provides for
the issuance of both long- and short-term debt of up to $20.0 billion ($19.0
billion by KBNA and $1.0 billion by Key Bank USA). At December 31, 2002, $18.1
billion was available for future issuance under this program.
EURO NOTE PROGRAM. Under Key's euro note program, KeyCorp, KBNA and Key Bank USA
may issue both long- and short-term debt of up to $10.0 billion in the
aggregate. The notes are offered exclusively to non-U.S. investors and can be
denominated in U.S. dollars and many foreign currencies. There were $1.5 billion
of borrowings issued under this program during 2002. At the end of the year,
$4.2 billion was available for future issuance.
KEYCORP MEDIUM-TERM 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. Of the amount registered, $1.0 billion has been allocated for
the issuance of medium-term notes. At December 31, 2002, unused capacity under
KeyCorp's universal shelf
47
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
registration statement totaled $1.8 billion, including $575 million allocated
for the issuance of medium-term notes.
COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp has a commercial paper program
and a revolving credit agreement with an unaffiliated financial institution that
provide funding availability of up to $500 million and $400 million,
respectively. As of December 31, 2002, there were no borrowings outstanding
under either the commercial paper program or the revolving credit agreement.
Key has favorable debt ratings as shown in Figure 30. As long as those debt
ratings are maintained, management believes that, under normal conditions in the
capital markets, future offerings of securities by KeyCorp or its affiliate
banks would be marketable to investors at a competitive cost.
FIGURE 30 DEBT RATINGS
SENIOR SUBORDINATED
SHORT-TERM LONG-TERM LONG-TERM CAPITAL
DECEMBER 31, 2002 BORROWINGS DEBT DEBT SECURITIES
- --------------------------------------------------------------------------
KEYCORP
Standard & Poor's A-2 A- BBB+ BBB
Moody's P-1 A2 A3 "Baal"
Fitch F1 A A- A
KBNA
Standard & Poor's A-1 A A- N/A
Moody's P-1 A1 A2 N/A
Fitch F1 A A- N/A
- --------------------------------------------------------------------------
N/A = Not Applicable
Figure 31 summarizes Key's significant cash obligations and contractual amounts
of off-balance sheet lending commitments at December 31, 2002, by the specific
time periods in which related payments are due or commitments expire.
FIGURE 31 CASH OBLIGATIONS AND OFF-BALANCE SHEET COMMITMENTS
DECEMBER 31, 2002 AFTER AFTER
WITHIN 1 THROUGH 3 THROUGH AFTER
in millions 1 YEAR 3 YEARS 5 YEARS 5 YEARS TOTAL
- ----------------------------------------------------------------------------------------------------------------------
Cash obligations:
Long-term debt $ 4,430 $ 5,914 $ 2,676 $ 2,585 $15,605
Noncancelable leases 125 212 170 395 902
- ----------------------------------------------------------------------------------------------------------------------
Total $ 4,555 $ 6,126 $ 2,846 $ 2,980 $16,507
======= ======= ======= ======= =======
Lending-related and other off-balance sheet commitments:
Commercial, including real estate $16,350 $ 6,970 $ 2,343 $ 1,384 $27,047
Home equity 54 127 55 5,295 5,531
Federal funds purchased and securities sold
under repurchase agreements 3,862 - - - 3,862
Principal investing 1 - 8 213 222
Commercial letters of credit 82 49 4 - 135
- ----------------------------------------------------------------------------------------------------------------------
Total $20,349 $ 7,146 $ 2,410 $ 6,892 $36,797
======= ======= ======= ======= =======
- ----------------------------------------------------------------------------------------------------------------------
CAPITAL
SHAREHOLDERS' EQUITY. Total shareholders' equity at December 31, 2002, was $6.8
billion, up $680 million from the balance at December 31, 2001. Growth in
retained earnings, net unrealized gains on securities available for sale and the
issuance of common shares out of the treasury stock account in connection with
employee stock purchase, 401(k), dividend reinvestment and stock option programs
contributed to the increase. Other factors contributing to the change in
shareholders' equity during 2002 are shown in the Consolidated Statements of
Changes in Shareholders' Equity presented on page 55.
SHARE REPURCHASES. In September 2000, the Board of Directors authorized the
repurchase of up to 25,000,000 common shares, including 3,647,200 shares
remaining at the time from an earlier repurchase program. These shares may be
repurchased in the open market or through negotiated transactions. During 2002,
Key repurchased a total of 3,000,000 of its common shares at an average price
per share of $25.58. At December 31, 2002, a remaining balance of 13,764,400
shares may be repurchased under the September 2000 authorization.
At December 31, 2002, Key had 67,945,135 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 2002, Key reissued 2,938,589 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 8.02% at December 31,
2002, and 7.60% at December 31, 2001.
48
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
Banking industry regulators prescribe minimum capital ratios for bank holding
companies and their banking subsidiaries. Note 14 ("Shareholders' Equity"),
which begins on page 76, explains the implications of failing to meet specific
capital requirements imposed by the banking regulators. Risk-based capital
guidelines require a minimum level of capital as a percent of "risk-weighted
assets," which is total assets plus certain off-balance sheet items, both
adjusted for predefined credit risk factors. Currently, banks and bank holding
companies must maintain, at a minimum, Tier 1 capital as a percent of
risk-weighted assets of 4.00%, and total capital as a percent of risk-weighted
assets of 8.00%. As of December 31, 2002, Key's Tier 1 capital ratio was 8.09%,
and its total capital ratio was 12.51%.
Another indicator of capital adequacy, the leverage ratio, is defined as Tier 1
capital as a percentage of average quarterly tangible assets. Leverage ratio
requirements vary with the condition of the financial institution. Bank holding
companies that either have the highest supervisory rating or have implemented
the Federal Reserve's risk-adjusted measure for market risk -- as KeyCorp has --
must maintain a minimum leverage ratio of 3.00%. All other bank holding
companies must maintain a minimum ratio of 4.00%. As of December 31, 2002, Key
had a leverage ratio of 8.15%.
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 December 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, Key would also qualify as "well capitalized"
at December 31, 2002. The FDIC-defined capital categories serve a limited
supervisory function. Investors should not treat them as a representation of the
overall financial condition or prospects of Key or its affiliate banks.
Figure 32 presents the details of Key's regulatory capital position at December
31, 2002 and 2001.
KeyCorp's common shares are traded on the New York Stock Exchange under the
symbol KEY. At December 31, 2002:
- - Book value per common share was $16.12, based on 423,943,645 shares
outstanding, compared with $14.52, based on 424,005,056 shares outstanding,
at December 31, 2001.
- - The closing sales price of a KeyCorp common share on the New York Stock
Exchange was $25.14. This price was 156% of year-end book value per share,
and would produce a dividend yield of 4.77%.
- - There were 40,166 holders of record of KeyCorp common shares.
In 2002, the quarterly dividend was $.30 per common share, up from $.295 per
common share in 2001. On January 16, 2003, the quarterly dividend per common
share was increased by 1.7% to $.305, effective with the March 2003 dividend
payment.
Figure 33 on page 51 shows the sales price ranges of the common shares, per
common share net income (loss) and dividends paid by quarter for each of the
last two years.
FIGURE 32 CAPITAL COMPONENTS AND RISK-WEIGHTED ASSETS
DECEMBER 31,
dollars in millions 2002 2001
- -----------------------------------------------------------------
TIER 1 CAPITAL
Common shareholders' equity(a) $ 6,738 $ 6,117
Qualifying capital securities 1,096 1,243
Less: Goodwill 1,142 1,101
Other assets(b) 60 37
- -----------------------------------------------------------------
Total Tier 1 capital 6,632 6,222
- -----------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(c) 986 1,040
Qualifying long-term debt 2,639 2,286
- -----------------------------------------------------------------
Total Tier 2 capital 3,625 3,326
- -----------------------------------------------------------------
Total risk-based capital $10,257 $ 9,548
======= =======
RISK-WEIGHTED ASSETS
Risk-weighted assets on balance sheet $67,051 $67,783
Risk-weighted off-balance sheet exposure 16,595 17,480
Less: Goodwill 1,142 1,101
Other assets(b) 251 37
Plus: Market risk-equivalent assets 192 217
- -----------------------------------------------------------------
Gross risk-weighted assets 82,445 84,342
Less: Excess allowance for loan losses(c) 466 637
- -----------------------------------------------------------------
Net risk-weighted assets $81,979 $83,705
======= =======
AVERAGE QUARTERLY
TOTAL ASSETS $82,735 $82,467
======= =======
CAPITAL RATIOS
Tier 1 risk-based capital ratio 8.09% 7.43%
Total risk-based capital ratio 12.51 11.41
Leverage ratio(d) 8.15 7.65
- -----------------------------------------------------------------
(a) Common shareholders' equity does not include net unrealized gains or losses
on securities (except for net unrealized losses on marketable equity
securities) nor net gains or losses on cash flow hedges.
(b) "Other assets" deducted from Tier 1 capital consists of intangible assets
(excluding goodwill) recorded after February 19, 1992, deductible portions
of purchased mortgage servicing rights and deductible portions of
nonfinancial equity investments.
"Other assets" deducted from risk-weighted assets consists of intangible
assets (excluding goodwill) recorded after February 19, 1992, deductible
portions of purchased mortgage servicing rights and nonfinancial equity
investments.
(c) The allowance for loan losses included in Tier 2 capital is limited by
regulation to 1.25% of gross risk-weighted assets, excluding those with
low-level recourse.
(d) This ratio is Tier 1 capital divided by average quarterly total assets less
goodwill and the nonqualifying intangible assets described in footnote (b).
49
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FOURTH QUARTER RESULTS
Some of the highlights of Key's fourth quarter results are summarized below.
Key's financial performance for each of the past eight quarters is summarized in
Figure 33.
NET INCOME (LOSS). Key had net income of $245 million, or $.57 per common share,
for the fourth quarter of 2002, compared with a net loss of $174 million, or
$.41 per share, for the same period in 2001. The improvement resulted from
growth in both net interest income and noninterest income, along with a decrease
in noninterest expense and a substantial reduction in the provision for loan
losses. Results for the fourth quarter of 2001 included charges of approximately
$410 million (after tax), or $.96 per share, taken to increase Key's allowance
for loan losses and to strengthen the balance sheet. The section entitled
"Financial performance," which begins on page 21, provides more information
about these charges.
On an annualized basis, Key's return on average total assets for the fourth
quarter of 2002 was 1.17%, compared with a return of (.84)% for the fourth
quarter of 2001. The annualized return on average equity was 14.46% for the
fourth quarter of 2002, compared with a return of (10.57)% for the year-ago
quarter.
NET INTEREST INCOME. Net interest income was $712 million for the fourth quarter
of 2002, up from $700 million for the fourth quarter of 2001. Key's net interest
margin of 3.98% for the fourth quarter of 2002 was unchanged from the fourth
quarter of 2001, while average earning assets declined by $152 million or less
than one percent. The decrease in earning assets was due primarily to Key's May
2001 decision to exit the automobile leasing business, de-emphasize indirect
prime automobile lending and discontinue certain credit-only commercial
relationships. Key's sale in September 2001 of $1.4 billion of residential
mortgage loans with low interest rate spreads also contributed to the decrease.
NONINTEREST INCOME. Key's noninterest income was $446 million for the fourth
quarter of 2002 compared with $418 million for the year-ago quarter. The
increase was due primarily to a $33 million decrease in losses from principal
investing. Noninterest income also benefited from a $6 million increase in net
gains from sales of securities. These positive results were offset in part by an
$18 million decline in income from trust and investment services and a $7
million reduction in service charges on deposit accounts.
NONINTEREST EXPENSE. Noninterest expense for the fourth quarter of 2002 totaled
$668 million, compared with $702 million for the fourth quarter of 2001. The
largest declines occurred in software amortization and the amortization of
goodwill. The January 1, 2002, adoption of new accounting guidance for goodwill
resulted in an expense reduction of approximately $20 million for each quarter
of 2002.
PROVISION FOR LOAN LOSSES. Key's provision for loan losses was $147 million for
the fourth quarter of 2002, compared with $723 million for the fourth quarter of
2001. Included in the fourth quarter 2001 amount is $400 million, which was used
to increase the allowance for loan losses for Key's continuing loan portfolio.
Another $190 million provision was added last year to the portion of the
allowance segregated in the second quarter of 2001 in connection with Key's
decision to discontinue many credit-only relationships in the leveraged
financing and nationally syndicated lending businesses and to facilitate sales
of distressed loans in other portfolios as discussed on page 42 under the
heading "Run-off loan portfolio." Net loan charge-offs totaled $186 million and
were 1.18% of average loans outstanding for the quarter, compared with $220
million and 1.37%, respectively, for the fourth quarter of 2001. For more
information about Key's allowance for loan losses, see the section entitled
"Allowance for loan losses," which begins on page 40.
50
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF
OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 33 SELECTED QUARTERLY FINANCIAL DATA
2002
---------------------------------------------------
dollars in millions, except per share amounts FOURTH THIRD SECOND FIRST
- ----------------------------------------------------------------------------------------------------
FOR THE QUARTER
Interest income $ 1,077 $ 1,095 $ 1,102 $ 1,092
Interest expense 365 395 419 438
Net interest income 712 700 683 654
Provision for loan losses 147 135 135 136
Noninterest income before net securities
gains (losses) 441 432 447 443
Net securities gains (losses) 5 -- 1 --
Noninterest expense 668 659 665 661
Income (loss) before income taxes and
cumulative effect of accounting changes 343 338 331 300
Income (loss) before cumulative effect
of accounting changes 245 245 246 240
Net income (loss) 245 245 246 240
- ----------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect
of accounting changes $ .58 $ .57 $ .58 $ .56
Income (loss) before cumulative effect
of accounting changes-- assuming dilution .57 .57 .57 .56
Net income (loss) .58 .57 .58 .56
Net income (loss)-- assuming dilution .57 .57 .57 .56
Cash dividends paid .30 .30 .30 .30
Book value at period end 16.12 15.66 15.46 15.05
Market price:
High 26.75 27.35 29.40 27.26
Low 21.25 20.96 25.95 22.92
Close 25.14 24.97 27.30 26.65
Weighted average common shares (000) 424,578 426,274 426,092 424,855
Weighted average common shares and
potential common shares (000) 429,531 431,326 431,935 430,019
- ----------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 62,457 $ 62,951 $ 63,881 $ 63,956
Earning assets 73,635 72,548 72,820 72,382
Total assets 85,202 83,518 82,778 81,359
Deposits 49,346 44,610 44,805 43,233
Long-term debt 15,605 16,276 16,895 15,256
Shareholders' equity 6,835 6,654 6,592 6,402
Full-time equivalent employees 20,437 20,522 20,929 21,076
Branches 910 903 905 911
- ----------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.17% 1.19% 1.21% 1.20%
Return on average equity 14.46 14.74 15.16 15.53
Net interest margin (taxable equivalent) 3.98 3.99 3.98 3.93
- ----------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 8.02% 7.97% 7.96% 7.87%
Tangible equity to tangible assets 6.73 6.71 6.69 6.57
Tier 1 risk-based capital 8.09 8.34 8.23 7.92
Total risk-based capital 12.51 12.69 12.29 12.02
Leverage 8.15 8.15 8.14 8.13
- ----------------------------------------------------------------------------------------------------
2001
---------------------------------------------------
dollars in millions, except per share amounts FOURTH THIRD SECOND FIRST
- ----------------------------------------------------------------------------------------------------
FOR THE QUARTER
Interest income $ 1,210 $ 1,380 $ 1,467 $ 1,570
Interest expense 510 656 754 882
Net interest income 700 724 713 688
Provision for loan losses 723 116 401 110
Noninterest income before net securities
gains (losses) 419 452 390 429
Net securities gains (losses) (1) 2 8 26
Noninterest expense 702 683 858 698
Income (loss) before income taxes and
cumulative effect of accounting changes (307) 379 (148) 335
Income (loss) before cumulative effect
of accounting changes (174) 249 (136) 218
Net income (loss) (174) 249 (160) 217
- ----------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect
of accounting changes $ (.41) $ .59 $ (.32) $ .51
Income (loss) before cumulative effect
of accounting changes-- assuming dilution (.41) .58 (.32) .51
Net income (loss) (.41) .59 (.38) .51
Net income (loss)-- assuming dilution (.41) .58 (.38) .51
Cash dividends paid .295 .295 .295 .295
Book value at period end 14.52 15.53 15.22 15.79
Market price:
High 24.52 28.15 26.43 27.58
Low 20.49 22.20 22.10 22.65
Close 24.34 24.14 26.05 25.80
Weighted average common shares (000) 423,596 424,802 424,675 424,024
Weighted average common shares and
potential common shares (000) 428,280 430,346 429,760 429,917
- ----------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 63,309 $ 64,506 $ 66,693 $ 67,027
Earning assets 71,672 73,943 76,531 77,027
Total assets 80,938 84,419 85,838 86,457
Deposits 44,795 45,372 45,743 45,965
Long-term debt 14,554 15,114 14,675 14,495
Shareholders' equity 6,155 6,575 6,467 6,702
Full-time equivalent employees 21,230 21,297 21,742 21,882
Branches 911 911 926 922
- ----------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets (.84)% 1.16% (.75)% 1.02%
Return on average equity (10.57) 15.20 (9.67) 13.28
Net interest margin (taxable equivalent) 3.98 3.85 3.77 3.63
- ----------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.60% 7.79% 7.53% 7.75%
Tangible equity to tangible assets 6.29 6.51 6.25 6.29
Tier 1 risk-based capital 7.43 7.81 7.71 7.99
Total risk-based capital 11.41 11.77 11.81 12.32
Leverage 7.65 7.90 7.68 7.79
- ----------------------------------------------------------------------------------------------------
Note 3 ("Acquisitions and Divestitures") on page 64 contains specific
information about the business combinations and divestitures that Key completed
in the past three years to help you understand how those transactions may have
impacted Key's financial condition and results of operations.
51
KEYCORP AND SUBSIDIARIES
REPORT OF MANAGEMENT
Key's management is responsible for the preparation, content and integrity of
the financial statements and other statistical data and analyses compiled for
this annual report. The financial statements and related notes have been
prepared in conformity with accounting principles generally accepted in the
United States and reflect management's best estimates and judgments. Management
believes that the financial statements and notes present fairly Key's financial
position, results of operations and cash flows, and that the financial
information presented elsewhere in this annual report is consistent with the
financial statements.
Management is responsible for establishing and maintaining a system of internal
control that is intended to protect Key's assets and the integrity of its
financial statements. This corporate-wide system of controls includes
self-monitoring mechanisms, written policies and procedures, proper delegation
of authority and organizational division of responsibility, and the careful
selection and training of qualified personnel. Management also maintains a code
of ethics that addresses conflicts of interest, compliance with laws and
regulations, and prompt reporting of any failure or circumvention of controls,
among other things.
We generally certify compliance with Key's code of ethics annually. We have
established an effective risk management function to periodically test the other
internal controls, and we endeavor to correct control deficiencies as they are
identified. Although any system of internal control can be compromised by human
error or intentional circumvention of required procedures, management believes
Key's system provides reasonable assurances that financial transactions are
recorded properly, providing an adequate basis for reliable financial
statements.
The Board of Directors discharges its responsibility for Key's financial
statements through its Audit Committee. This committee, which draws its members
exclusively from the outside directors, also hires the independent auditors. The
Audit Committee meets regularly with the independent auditors to review the
scope of their audits and audit reports and to discuss necessary action. Both
the independent and internal auditors have direct access to and interaction with
the Audit Committee.
Management has assessed Key's internal control and procedures over financial
reporting using criteria described in "Internal Control --Integrated Framework,"
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on that assessment, management believes that Key maintained an effective
system of internal control for financial reporting as of December 31, 2002.
/s/Henry L. Meyer III
Henry L. Meyer III
Chairman and Chief Executive Officer
/s/Jeffrey B. Weeden
Jeffrey B. Weeden
Senior Executive Vice President and Chief Financial Officer
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Shareholders and Board of Directors
KeyCorp
We have audited the accompanying consolidated balance sheets of KeyCorp and
subsidiaries ("Key") as of December 31, 2002 and 2001, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flow for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of Key's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Key at December
31, 2002 and 2001, and the consolidated results of their operations and their
cash flows for each of the three years in the period ended December 31, 2002, in
conformity with accounting principles generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, in 2002 Key
changed its method of accounting for goodwill.
/s/ ERNST & YOUNG LLP
Cleveland, Ohio
January 13, 2003
52
KEYCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
dollars in millions 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 3,364 $ 2,891
Short-term investments 1,632 1,898
Securities available for sale 8,507 5,408
Investment securities (fair value: $129 and $234) 120 225
Other investments 919 832
Loans, net of unearned income of $1,776 and $1,778 62,457 63,309
Less: Allowance for loan losses 1,452 1,677
- -------------------------------------------------------------------------------------------------------------------------
Net loans 61,005 61,632
Premises and equipment 644 687
Goodwill 1,142 1,103
Other intangible assets 35 31
Corporate-owned life insurance 2,414 2,313
Accrued income and other assets 5,420 3,918
- -------------------------------------------------------------------------------------------------------------------------
Total assets $ 85,202 $ 80,938
========== ==========
LIABILITIES
Deposits in domestic offices:
NOW and money market deposit accounts $ 16,249 $ 13,461
Savings deposits 2,029 1,918
Certificates of deposit ($100,000 or more) 4,749 4,493
Other time deposits 11,946 13,657
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing 34,973 33,529
Noninterest-bearing 10,630 9,667
Deposits in foreign office--interest-bearing 3,743 1,599
- -------------------------------------------------------------------------------------------------------------------------
Total deposits 49,346 44,795
Federal funds purchased and securities sold under repurchase agreements 3,862 3,735
Bank notes and other short-term borrowings 2,823 5,549
Accrued expense and other liabilities 5,471 4,862
Long-term debt 15,605 14,554
Corporation-obligated mandatorily redeemable preferred capital securities of subsidiary
trusts holding solely subordinated debentures of KeyCorp (see Note 13) 1,260 1,288
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities 78,367 74,783
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
Capital surplus 1,449 1,390
Retained earnings 6,448 5,856
Treasury stock, at cost (67,945,135 and 67,883,724 shares) (1,593) (1,585)
Accumulated other comprehensive income 39 2
- -------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,835 6,155
- -------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 85,202 $ 80,938
========== ==========
- -------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
53
KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
dollars in millions, except per share amounts 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 3,913 $ 5,067 $ 5,699
Tax-exempt investment securities 10 17 23
Securities available for sale 389 454 447
Short-term investments 30 65 83
Other investments 24 24 25
- ----------------------------------------------------------------------------------------------------------------------------
Total interest income 4,366 5,627 6,277
INTEREST EXPENSE
Deposits 897 1,478 1,768
Federal funds purchased and securities sold under repurchase agreements 90 198 287
Bank notes and other short-term borrowings 79 302 428
Long-term debt, including capital securities 551 824 1,064
- ----------------------------------------------------------------------------------------------------------------------------
Total interest expense 1,617 2,802 3,547
- ----------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 2,749 2,825 2,730
Provision for loan losses 553 1,350 490
- ----------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 2,196 1,475 2,240
NONINTEREST INCOME
Trust and investment services income 609 651 687
Service charges on deposit accounts 405 387 341
Investment banking and capital markets income 172 88 293
Letter of credit and loan fees 134 124 107
Corporate-owned life insurance income 108 114 109
Electronic banking fees 79 74 68
Net securities gains (losses) 6 35 (28)
Gain from sale of credit card portfolio -- -- 332
Other income 256 252 285
- ----------------------------------------------------------------------------------------------------------------------------
Total noninterest income 1,769 1,725 2,194
NONINTEREST EXPENSE
Personnel 1,436 1,378 1,445
Net occupancy 226 232 223
Computer processing 192 252 240
Equipment 136 152 173
Marketing 122 112 110
Professional fees 92 88 89
Amortization of intangibles 11 245 101
Restructuring charges (credits) -- (4) 102
Other expense 438 486 434
- ----------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 2,653 2,941 2,917
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGES 1,312 259 1,517
Income taxes 336 102 515
- ----------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 976 157 1,002
Cumulative effect of accounting changes, net of tax (see Note 1) -- (25) --
- ----------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 976 $ 132 $ 1,002
========== ========== ==========
Per common share:
Income before cumulative effect of accounting changes $ 2.29 $ .37 $ 2.32
Net income 2.29 .31 2.32
Income before cumulative effect of accounting changes--assuming dilution 2.27 .37 2.30
Net income--assuming dilution 2.27 .31 2.30
Weighted average common shares outstanding (000) 425,451 424,275 432,617
Weighted average common shares and potential common
shares outstanding (000) 430,703 429,573 435,573
- ----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
54
KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
ACCUMULATED
LOANS TO TREASURY OTHER
COMMON CAPITAL RETAINED ESOP STOCK, COMPREHENSIVE COMPREHENSIVE
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST INCOME (LOSS) INCOME
- --------------------------------------------------------------------------------------------------------------------- -------------
BALANCE AT DECEMBER 31, 1999 $ 492 $ 1,412 $ 5,833 $ (24) $(1,197) $ (127)
Net income 1,002 $ 1,002
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $80(a) 132 132
Foreign currency translation adjustments (15) (15)
------------
Total comprehensive income $ 1,119
===========
Cash dividends declared on common shares
($1.12 per share) (484)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 2,480,161 net shares (10) 59
Repurchase of common shares-- 22,652,800 shares (462)
ESOP transactions 1 11
- --------------------------------------------------------------------------------------------------------------------- -------------
BALANCE AT DECEMBER 31, 2000 492 1,402 6,352 (13) (1,600) (10)
Net income 132 $ 132
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $11(a) 13 13
Cumulative effect of change in accounting
for derivative financial instruments,
net of income taxes of ($12) (22) (22)
Net unrealized gains on derivative financial
instruments, net of income taxes of $12 20 20
Foreign currency translation adjustments 1 1
------------
Total comprehensive income $ 144
===========
Cash dividends declared on common shares
($1.48 per share) (628)
Issuance of common shares:
Acquisition-- 370,830 shares 9
Employee benefit and dividend reinvestment
plans-- 2,415,914 net shares (12) 56
Repurchase of common shares--2,035,600 shares (50)
ESOP transactions 13
- --------------------------------------------------------------------------------------------------------------------- -------------
BALANCE AT DECEMBER 31, 2001 492 1,390 5,856 -- (1,585) 2
Net income 976 $ 976
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $27(a) 47 47
Net unrealized gains on derivative financial
instruments, net of income taxes of $5 8 8
Foreign currency translation adjustments 7 7
Minimum pension liability adjustment,
net of income taxes of ($14) (25) (25)
------------
Total comprehensive income $ 1,013
===========
Deferred compensation obligation 68
Cash dividends declared on common shares
($.90 per share) (384)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans--2,938,589 net shares (9) 69
Repurchase of common shares-- 3,000,000 shares (77)
- ---------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 $ 492 $ 1,449 $ 6,448 -- $(1,593) $ 39
====== ======= ======== === ======= ========
- ---------------------------------------------------------------------------------------------------------------------
(a) Net of reclassification adjustments. Reclassification adjustments represent
net unrealized gains (losses) as of December 31 of the prior year on
securities available for sale that were sold during the current year. The
reclassification adjustments were $35 million ($22 million after tax) in
2002, ($5) million [($4) million after tax] in 2001 and ($11) million [($7)
million after tax] in 2000.
See Notes to Consolidated Financial Statements.
55
KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 976 $ 132 $ 1,002
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 553 1,350 490
Cumulative effect of accounting changes, net of tax -- 25 --
Depreciation expense and software amortization 215 285 281
Amortization of intangibles 11 245 101
Net gain from sale of credit card portfolio -- -- (332)
Net securities (gains) losses (6) (35) 28
Net (gains) losses from principal investing 14 79 (71)
Net gains from loan securitizations and sales (56) (49) (31)
Deferred income taxes 155 (139) 335
Net (increase) decrease in mortgage loans held for sale 118 (10) (164)
Net (increase) decrease in trading account assets (204) 146 26
Net increase (decrease) in accrued restructuring charges (35) (64) 31
Other operating activities, net (282) (271) (113)
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,459 1,694 1,583
INVESTING ACTIVITIES
Cash used in acquisitions, net of cash acquired (63) (3) (375)
Net (increase) decrease in other short-term investments 485 (160) (49)
Purchases of securities available for sale (6,744) (4,290) (6,855)
Proceeds from sales of securities available for sale 1,552 349 2,450
Proceeds from prepayments and maturities of securities available for sale 2,317 5,859 3,859
Purchases of investment securities (18) (46) (30)
Proceeds from prepayments and maturities of investment securities 95 144 155
Purchases of other investments (167) (225) (374)
Proceeds from sales of other investments 45 56 129
Proceeds from prepayments and maturities of other investments 57 106 56
Net increase in loans, excluding acquisitions, sales and divestitures (3,184) (1,876) (7,215)
Purchases of loans -- (107) --
Proceeds from loan securitizations and sales 3,393 4,916 4,978
Purchases of premises and equipment (90) (121) (103)
Proceeds from sales of premises and equipment 9 15 22
Proceeds from sales of other real estate owned 40 27 28
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (2,273) 4,644 (3,324)
FINANCING ACTIVITIES
Net increase (decrease) in deposits 4,128 (3,854) 5,416
Net decrease in short-term borrowings (2,611) (2,609) (696)
Net proceeds from issuance of long-term debt, including capital securities 4,739 3,864 4,286
Payments on long-term debt, including capital securities (4,418) (3,532) (5,985)
Loan payments received from ESOP trustee -- 13 11
Purchases of treasury shares (77) (50) (462)
Net proceeds from issuance of common stock 37 33 28
Cash dividends paid (511) (501) (484)
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,287 (6,636) 2,114
- ----------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 473 (298) 373
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 2,891 3,189 2,816
- ----------------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF YEAR $ 3,364 $ 2,891 $ 3,189
========== ========== ==========
- ----------------------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $ 1,549 $ 2,626 $ 3,572
Income taxes paid 173 115 92
Noncash items:
Derivative assets resulting from adoption of new accounting standard -- $ 120 --
Derivative liabilities resulting from adoption of new accounting standard -- 152 --
Cash dividends declared, but not paid -- 127 --
Transfer of investment securities to other investments $ 847 832 $ 820
Transfer of investment securities to securities available for sale 62 62 55
Assets acquired 475 -- --
Liabilities assumed 450 -- --
- ----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
KeyCorp, an Ohio corporation and bank holding company headquartered in
Cleveland, Ohio, is one of the nation's largest bank-based financial services
companies. KeyCorp's subsidiaries provide retail and commercial banking,
commercial leasing, investment management, consumer finance and investment
banking products and services to individual, corporate and institutional clients
through three major business groups: Key Consumer Banking, Key Corporate
Finance and Key Capital Partners. As of December 31, 2002, KeyCorp's banking
subsidiaries operated 910 full-service branches, a telephone banking call center
services group and 2,165 ATMs in 17 states.
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.
USE OF ESTIMATES
Key's accounting policies conform to accounting principles generally accepted in
the United States and prevailing practices within the financial services
industry. Management must make certain estimates and judgments when determining
the amounts presented in Key's consolidated financial statements and the related
notes. If these estimates prove to be inaccurate, actual results could differ
from those reported.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of KeyCorp and its
subsidiaries. All significant intercompany accounts and transactions have been
eliminated in consolidation. Some previously reported results have been
reclassified to conform to current reporting practices.
KeyCorp evaluates whether to consolidate entities in which it has invested based
on the nature and amount of equity contributed by third parties, the
decision-making power granted to those parties and the extent of their control
over the entity's operating and financial policies. Entities that KeyCorp
controls, generally through majority ownership, are consolidated and are
considered subsidiaries.
Unconsolidated investments in entities in which KeyCorp has significant
influence over operating and financing decisions (usually defined as a voting or
economic interest of 20 to 50%) are accounted for by the equity method.
Unconsolidated investments in entities in which KeyCorp has a voting or economic
interest of less than 20% are generally carried at cost. Investments held by
KeyCorp's broker/dealer and investment company subsidiaries (principal
investments) are carried at estimated fair value.
KeyCorp uses special purpose entities ("SPEs"), including securitization trusts,
in the normal course of business for funding purposes. SPEs established by
KeyCorp as qualifying special purpose entities under the provisions of SFAS No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities,"are not consolidated. Nonqualifying SPEs are
evaluated for consolidation by KeyCorp based on the nature and amount of equity
contributed by third parties, the risks and rewards the parties assume and the
control the respective parties exercise over the SPE's activities.
Securitization trusts sponsored by KeyCorp are not consolidated since they are
qualifying SPEs.
KeyCorp also does not consolidate an asset-backed commercial paper conduit for
which it is a referral agent. The conduit is owned by a third party and
administered by an unaffiliated financial institution. KeyCorp shares the risks
and rewards of the conduit's activities with multiple third parties.
Additional information on SFAS No. 140 is summarized in this note under the
heading "Loan Securitizations" on page 59. Additional information on the conduit
is summarized in Note 19 ("Commitments, Contingent Liabilities and
Guarantees"),which begins on page 81. The "Accounting Pronouncements Pending
Adoption" section of this note, which begins on page 62, and Note 8 ("Loan
Securitizations and Variable Interest Entities"), which begins on page 70,
summarize guidance issued by the Financial Accounting Standards Board ("FASB")
in January 2003 that changes the methods for evaluating when to consolidate
entities and may affect Key's decision as to which entities to consolidate in
the future.
BUSINESS COMBINATIONS
Key accounts for its business combinations using the purchase method of
accounting. Under this method of accounting, the acquired company's net assets
are recorded at fair value at the date of acquisition and the results of
operations of the acquired company are combined with Key's results from that
date forward. Purchase premiums and discounts, including intangible assets, are
amortized over the remaining useful lives of the related assets or liabilities.
The difference between the purchase price and the fair value of the net assets
acquired is recorded as goodwill. Key's accounting policy for intangible assets
is summarized in this note under the heading "Goodwill and Other Intangible
Assets"on page 59.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," which
eliminated the pooling-of-interests method of accounting for business
combinations initiated after June 30, 2001. Since that date, Key has not
initiated any business combinations that would have qualified for the
pooling-of-interests method of accounting under previous accounting standards.
The last business combination that Key accounted for using the
pooling-of-interests method occurred in December 1994.
STATEMENTS OF CASH FLOW
Cash and due from banks are considered "cash and cash equivalents" for financial
reporting purposes.
SECURITIES
Key classifies its securities into four categories: trading, available for sale,
investment and other investments.
TRADING ACCOUNT SECURITIES. These are debt and equity securities that are
purchased and held by Key with the intent of selling them in the near term, and
certain interests retained in loan securitizations. All of these assets are
reported at fair value ($801 million at December 31, 2002, and $597 million at
December 31, 2001) and are included in "short-term investments" on the balance
sheet. Realized and unrealized gains and
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
losses on trading account securities are reported in "investment banking and
capital markets income" on the income statement.
SECURITIES AVAILABLE FOR SALE. These include securities that Key intends to hold
for an indefinite period of time and that may be sold in response to changes in
interest rates, prepayment risk, liquidity needs or other factors. Securities
available for sale are reported at fair value and include debt and marketable
equity securities with readily determinable fair values. Unrealized gains and
losses (net of income taxes) deemed temporary are recorded in shareholders'
equity as a component of "accumulated other comprehensive income (loss)."
Unrealized gains and losses on specific securities deemed to be "other than
temporary" are included in "net securities gains (losses)" on the income
statement. Also included in "net securities gains (losses)" are actual gains and
losses resulting from sales of specific securities.
INVESTMENT SECURITIES. These are debt securities that Key has the intent and
ability to hold until maturity. Debt securities are carried at cost, adjusted
for amortization of premiums and accretion of discounts using the interest
method. This method produces a constant rate of return on the basis of the
adjusted carrying amount.
OTHER INVESTMENTS. Principal investments -- investments in equity and mezzanine
instruments made by Key's Principal Investing unit -- represent the majority of
other investments and are carried at fair value. They include direct and
indirect investments predominately in privately-held companies. Direct
investments are those made in a particular company, while indirect investments
are made through funds that include other investors. Changes in estimated fair
values and actual gains and losses on sales of Principal Investments are
included in "investment banking and capital markets income" on the income
statement.
In addition to principal investments, other investments include securities that
do not have readily determinable fair values. These securities include certain
real estate-related investments that are carried at estimated fair value, as
well as other types of securities that are generally carried at cost. The
carrying amount of the securities carried at cost is adjusted for declines in
value that are considered to be "other than temporary." These adjustments are
included in "net securities gains (losses)" on the income statement.
LOANS
Loans are carried at the principal amount outstanding, net of unearned income,
including net deferred loan fees and costs. Key defers certain nonrefundable
loan origination and commitment fees and the direct costs of originating or
acquiring loans. The net deferred amount is amortized over the estimated lives
of the related loans as an adjustment to the yield.
At December 31, 2002, loans held for sale include commercial, mortgage and
education loans. These loans are carried at the lower of aggregate cost or fair
value. Fair value is determined based on prevailing market prices for loans with
similar characteristics. When a loan is placed in the held for sale category,
amortization of the related deferred fees and costs is discontinued. The
remaining unamortized fees and costs are recognized as part of the cost basis of
the loan at the time it is sold.
Direct financing leases are carried at the aggregate of lease payments
receivable plus estimated residual values, less unearned income. Unearned income
on direct financing leases is amortized over the lease terms using methods that
approximate the interest method. This method amortizes unearned income to
produce a constant rate of return on the lease. Net gains or losses on sales of
lease residuals are included in "other income" on the income statement.
IMPAIRED AND OTHER NONACCRUAL LOANS
Key will generally stop accruing interest on a loan (i.e., designate the loan
"nonaccrual") when payment is 90 days or more past due, unless the loan is
well-secured and in the process of collection. Loans are also placed on
nonaccrual status when payment is not past due but management has serious doubts
as to the ability of the borrower to comply with existing loan repayment terms.
Once a loan is designated as nonaccrual, the interest accrued but not collected
is generally charged against the allowance for loan losses, and payments
subsequently received are generally applied to principal. However, if management
believes that all principal and interest on a nonaccrual loan ultimately are
collectible, interest income may be recognized as received.
Nonaccrual loans, other than smaller-balance homogeneous loans (i.e., loans to
finance residential mortgages, automobiles, etc.), are designated "impaired."
Impaired loans and other nonaccrual loans are returned to accrual status when
management determines that the borrower's performance has improved and that both
principal and interest are collectible. This generally requires a sustained
period of timely principal and interest payments.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents management's estimate of probable
credit losses inherent in the loan portfolio at the balance sheet date. Key
determines and maintains an appropriate allowance for loan losses based on an
analysis of the quality of the loan portfolio. This analysis is conducted at
least quarterly, and more often if deemed necessary.
ALLOWANCE FOR IMPAIRED LOANS. When expected cash flows or collateral values do
not justify the carrying amount of an impaired loan, the loan is assigned a
specific allowance. Management calculates the extent of the impairment, which is
the carrying amount of the loan less the estimated present value of future cash
flows and the fair value of any existing collateral. The amount that management
deems uncollectible (the impaired amount) is charged against the allowance for
loan losses. Even when collateral value or other sources of repayment appear
sufficient, if management remains uncertain about whether the loan will be
repaid in full, an amount is specifically allocated in the allowance for loan
losses.
ALLOWANCE FOR NONIMPAIRED LOANS AND BINDING COMMITMENTS.
Management establishes an allowance for nonimpaired loans and legally binding
commitments by applying historical loss rates to existing loans with similar
risk characteristics. The portion of this allowance that was related to legally
binding commitments was $72 million at December 31, 2002, compared with $71
million at December 31, 2001. The loss rates used to establish the allowance may
be adjusted to reflect management's current assessment of the following factors:
- - changes in national and local economic and business conditions;
- - changes in experience, ability and depth of lending management and staff,
in lending policies or in the mix and volume of the loan portfolio;
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
- - the trend of the volume of past due, nonaccrual and other loans; and
- - external forces, such as competition, legal developments and regulatory
guidelines.
LOAN SECURITIZATIONS
Key sells education and certain other types of loans in securitizations. A
securitization involves the sale of a pool of loan receivables to investors
through either a public or private issuance (generally by a SPE) of asset-backed
securities. Securitized loans are removed from the balance sheet and a net gain
or loss is recorded when the combined net sales proceeds and, if applicable,
residual interests differ from the loans' allocated carrying amount. Net gains
and losses resulting from securitizations are recorded in "other income" on the
income statement. A servicing asset may also be recorded if Key either purchases
or retains the right to service these loans and receives related fees that
exceed the going market rate. Income earned under servicing or administration
arrangements also is recorded in "other income."
Key adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities," which took effect for all
transactions entered into after March 31, 2001. SFAS No. 140 added three
significant rules to practices already in effect. These rules:
- - prescribe the test that determines whether a SPE is a "qualifying" SPE, and
prescribe the amount and type of derivative instruments a qualifying SPE can
hold and the activities it may pursue;
- - provide more restrictive guidance regarding the circumstances under which a
company that transfers assets to a qualifying SPE will be deemed to have
relinquished control of such assets and may account for the transaction as a
sale; and
- - require extensive disclosures about collateral, assets securitized and
accounted for as a sale, and retained interests in securitized assets.
In some cases, Key retains a residual interest in securitized loans that may
take the form of an interest-only strip, a residual asset, a servicing asset
and/or a security. The accounting for these retained interests is subject to the
rules contained in SFAS No. 140. Under these rules, the previous carrying amount
of the assets sold is allocated between the retained interests and the assets
sold based on their relative fair values at the date of transfer. Fair value is
determined by computing the present value of estimated cash flows, using a
discount rate that reflects the risks associated with the cash flows and the
dates that Key expects to receive such cash flows. Other assumptions used in the
determination of fair value are disclosed in Note 8 ("Loan Securitizations and
Variable Interest Entities"), which begins on page 70.
In July 2000, the Emerging Issues Task Force ("EITF"), a standard-setting group
working under the auspices of the FASB, issued EITF 99-20. This guidance
specifies how to record interest income and measure impairment on beneficial
interests retained in a securitization transaction accounted for as a sale under
SFAS No. 140, and on purchased beneficial interests in securitized financial
assets. Assets subject to this accounting guidance are presented on the balance
sheet as securities available for sale [see Note 6 ("Securities"), which begins
on page 68] or as trading account assets. This guidance became effective for
fiscal quarters beginning after March 15, 2001, causing Key to record a
cumulative after-tax loss of $24 million in earnings for the second quarter of
2001. This loss is presented on Key's income statement as a "cumulative effect
of accounting change."
Key conducts a review to determine whether all retained interests are valued
appropriately in the financial statements on a quarterly basis. Management
reviews the historical performance of each retained interest and the assumptions
used to project future cash flows. Assumptions are revised if past performance
and future expectations dictate, and the present values of cash flows are
recalculated based on the revised assumptions.
The present value of these cash flows is referred to as the "retained interest
fair value." For retained interests classified as trading account assets, any
increase or decrease in the asset's fair value is recognized in "other income"
on the income statement. Generally, if the carrying amount of a retained
interest classified as securities available for sale exceeds its fair value,
impairment is indicated and recognized in earnings. Conversely, if the fair
value of the retained interest exceeds its carrying amount, the write-up to fair
value is recorded in equity as a component of "accumulated other comprehensive
income (loss)," and the yield on the retained interest is adjusted
prospectively.
SERVICING ASSETS
Servicing assets purchased or retained by Key in a sale or securitization of
loans are reported at the lower of amortized cost or fair value ($99 million at
December 31, 2002, and $73 million at December 31, 2001) and included in
"accrued income and other assets" on the balance sheet. Fair value is initially
measured by allocating the previous carrying amount of the assets sold or
securitized to the retained interests and the assets sold based on their
relative fair values at the date of transfer. Fair value is determined by
estimating the present value of future cash flows associated with the serviced
loans. The estimate is based on a number of assumptions, including the cost of
servicing, discount rate, prepayment rate and default rate. The amortization of
servicing assets is determined in proportion to, and over the period of, the
estimated net servicing income and is recorded in "other income" on the income
statement.
PREMISES AND EQUIPMENT
Premises and equipment, including leasehold improvements, are stated at cost
less accumulated depreciation and amortization. Management determines
depreciation of premises and equipment using the straight-line method over the
estimated useful lives of the particular assets. Leasehold improvements are
amortized using the straight-line method over the terms of the leases.
Accumulated depreciation and amortization on premises and equipment totaled $1.1
billion at December 31, 2002 and 2001.
GOODWILL AND OTHER INTANGIBLE ASSETS
"Goodwill" represents the amount by which the cost of net assets acquired in a
business combination exceeds their fair value. "Other intangibles" represent
primarily the net present value of the future economic benefits to be derived
from the purchase of core deposits. Other intangibles are amortized on either an
accelerated or straight-line basis over periods ranging from 7 to 30 years.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
Effective January 1, 2002, Key adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," which replaced Accounting Principles Board Opinion No.
17,"Intangible Assets." Under the new accounting standard, companies are no
longer permitted to amortize goodwill and other intangible assets deemed to have
indefinite lives. This change reduced Key's noninterest expense and increased
net income by approximately $79 million, or $.18 per common share, for 2002.
Under SFAS No. 142, goodwill and certain intangible assets are subject to
impairment testing, which must be conducted at least annually. Key has
determined that its reporting units for purposes of this testing are its major
business groups: Key Consumer Banking, Key Corporate Finance and Key Capital
Partners.
The first step in this testing requires that the fair value of each reporting
unit be determined. If the carrying amount of any reporting unit exceeds its
fair value, goodwill impairment may be indicated and a second step of impairment
testing is required. If such were the case, Key would assume that the purchase
price of the reporting unit is equal to its fair value as determined in the
first step and then allocate that purchase price to the fair value of the unit's
assets (excluding goodwill) and liabilities. Any excess of the assumed 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 the carrying amount of the
reporting unit's goodwill exceeds the implied fair value of goodwill. Any
impairment losses resulting from the initial application of SFAS No. 142 must be
reported as a "cumulative effect of accounting change" on the income statement.
Key was required to perform a transitional impairment test of goodwill as of
January 1, 2002. In conducting this testing, Key used a discounted cash flow
methodology to determine the fair value of its reporting units and a relative
valuation methodology to review the fair values for reasonableness. Then, Key
compared the fair value of each reporting unit with its carrying amount. Under
SFAS No. 142, if the fair value of a particular reporting unit exceeds its
carrying amount, no impairment is indicated and further testing is not required.
Key completed its transitional goodwill impairment testing during the first
quarter of 2002, and determined that no impairment existed as of January 1,
2002.
The annual goodwill impairment testing required by SFAS No. 142 will be
performed by Key in the fourth quarter of each year beginning in 2002. Any
future impairment losses would be charged against income from operations. Key's
annual goodwill impairment testing was performed as of October 1, 2002, and it
was determined that no impairment existed at that date.
Prior to the adoption of SFAS No. 142, goodwill was amortized using the
straight-line method over the period (up to 40 years) that management expected
the acquired assets to have value. Accumulated amortization on goodwill and
other intangible assets was $919 million at December 31, 2002, and $908 million
at December 31, 2001. Before January 1, 2002, Key reviewed goodwill and other
intangibles for impairment when impairment indicators, such as significant
changes in market conditions, changes in product mix or management focus, or a
potential sale or disposition, arose. In most instances, Key used the
undiscounted cash flow method in testing for impairment. In May 2001, Key
recorded a goodwill impairment charge of $150 million as a result of
management's decision to downsize the automobile finance business.
INTERNALLY DEVELOPED SOFTWARE
Key relies on both company personnel and independent contractors to plan,
develop, install, customize and enhance computer systems applications that
support corporate and administrative operations. Software development costs,
such as those related to program coding, testing, configuration and
installation, are capitalized and included in "accrued income and other assets"
on the balance sheet. The resulting asset ($105 million at December 31, 2002,
and $134 million at December 31, 2001) is amortized using the straight-line
method over its expected useful life (not to exceed five years). Costs incurred
during both the planning and the post-development phases of an internal software
project are expensed as incurred.
Software that is considered impaired is written down to its fair value. Software
that is no longer used is written off to earnings immediately. When management
decides to replace unimpaired software, amortization of such software is
accelerated to the expected replacement date.
DERIVATIVES USED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES
Key uses derivatives known as interest rate swaps and caps to hedge interest
rate risk. These instruments modify the repricing or maturity characteristics of
specified on-balance sheet assets and liabilities. For example, an interest rate
cap tied to variable rate debt would effectively prevent the interest rate on
that debt from rising above a specified point.
Key's accounting policies related to such derivatives reflect the accounting
guidance in SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which became effective for Key as of January 1, 2001. This
standard established the appropriate accounting and reporting for derivative
instruments and for hedging activities. SFAS No. 133 requires that all
derivatives be recognized as either assets or liabilities on the balance sheet
at fair value. The accounting for changes in the fair value (i.e., gains or
losses) of derivatives depends on whether they have been designated and qualify
as part of a hedging relationship, and further, on the type of hedging
relationship. For derivatives that are not designated as hedging instruments,
the gain or loss is recognized immediately in earnings.
A derivative that is designated and qualifies as a hedging instrument must be
designated either a fair value hedge, a cash flow hedge or a hedge of a net
investment in a foreign operation. Key does not have any derivatives that hedge
net investments in foreign operations.
A fair value hedge is used to hedge changes in the fair value of existing
assets, liabilities and firm commitments against changes in interest rates or
other economic factors. Key recognizes the gain or loss on the derivative, as
well as the related gain or loss on the hedged item underlying the hedged risk,
in earnings during the period in which the fair value changes. Thus, if a hedge
is perfectly effective, the change in the fair value of the hedged item will be
offset, resulting in no net effect on earnings.
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
A cash flow hedge is used to hedge the variability of future cash flows against
changes in interest rates or other economic factors. The effective portion of a
gain or loss on any cash flow hedge is reported as a component of "other
comprehensive income (loss)" and reclassified into earnings in the same period
or periods that the hedged transaction affects earnings. Any ineffective portion
of the derivative gain or loss is recognized in earnings during the current
period.
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. The cumulative loss included in earnings represented the
fair value at January 1, 2001, of all derivatives that were then designated as
fair value hedges and the unrealized gain or loss on the related hedged assets
and liabilities. The cumulative loss included in "other comprehensive income
(loss)" represented the effective portion of the fair value of all derivatives
designated as cash flow hedges.
Prior to the effective date of SFAS No. 133, to qualify for hedge accounting
treatment, a derivative had to be effective at reducing the risk associated with
the exposure being managed and had to be designated as a risk management
transaction at the inception of the derivative contract. An instrument
effectively reduced risk if there was a high degree of interest rate correlation
between the derivative and the asset or liability being managed, both at
inception and over the life of the derivative contract.
There were several rules that governed the hedge accounting treatment of
derivatives prior to SFAS No. 133:
- - Changes in fair value of a derivative were not included in the financial
statements.
- - The net interest income or expense associated with a derivative was accrued
and recognized as an adjustment to the interest income or interest expense
of the asset or liability being managed.
- - The interest receivable or payable from a derivative contract was recorded
in "other assets" or "other liabilities" on the balance sheet.
- - Premiums paid for a derivative were amortized as an adjustment to the
interest income or expense of the asset or liability being managed.
- - Realized gains and losses resulting from the early termination of a
derivative contract were deferred as an adjustment to the carrying amount of
the related asset or liability. Such gains or losses were amortized using
the straight-line method over the shorter of the projected remaining life of
the derivative contract on the date of termination or the projected
remaining life of the underlying asset or liability on that date.
DERIVATIVES USED FOR TRADING PURPOSES
Derivatives that are not used for asset and liability management purposes are
used for trading purposes. Key enters into contracts for such derivatives either
to make a market for clients or for proprietary trading purposes. Derivatives
used for trading purposes typically include financial futures, foreign exchange
forward and spot contracts, written and purchased options (including currency
options), and interest rate swaps, caps and floors.
All derivatives used for trading purposes are recorded at fair value. Fair value
is determined by estimating the present value of future cash flows. Derivatives
with a positive fair value are included in "accrued income and other assets" on
the balance sheet, and derivatives with a negative fair value are included in
"accrued expense and other liabilities." Changes in fair value (including
payments and receipts) are recorded in "investment banking and capital markets
income" on the income statement.
EMPLOYEE STOCK OPTIONS
Through December 31, 2002, Key accounted for stock options issued to employees
using the intrinsic value method. This method requires that compensation expense
be recognized to the extent that the fair value of the stock exceeds the
exercise price of the option at the grant date. Key's employee stock options
generally have fixed terms and exercise prices that are equal to or greater than
the fair value of Key's common shares at the grant date, so Key generally does
not recognize compensation expense related to stock options.
In September 2002, KeyCorp's Board of Directors approved management's
recommendation to change Key's method of accounting for stock options granted to
eligible employees and directors. Effective January 1, 2003, Key will adopt the
fair value method of accounting as outlined in SFAS No. 123, "Accounting for
Stock-Based Compensation." Additional information pertaining to this accounting
change is summarized under the heading "Accounting Pronouncements Pending
Adoption" on page 62.
SFAS No. 123 requires companies like Key that use the intrinsic value method to
account for employee stock options to provide pro forma disclosures of the net
income and earnings per share effect of stock options using the fair value
method. Management estimates the fair value of options granted using the
Black-Scholes option-pricing model. This model was originally developed to
estimate the fair value of exchange-traded equity options, which (unlike
employee stock options) have no vesting period or transferability restrictions.
As a result, the Black-Scholes model is not a perfect indicator of the value of
an option, but it is commonly used for this purpose.
The Black-Scholes model requires several assumptions, which management developed
based on historical trends and current market observations. These assumptions
include:
- - an average option life of 4.1 years in 2002, 3.9 years in 2001 and 4.7 years
in 2000;
- - a future dividend yield of 4.84% in 2002, 4.22% in 2001 and 5.83% in 2000;
- - share price volatility of .264 in 2002, .330 in 2001 and .267 in 2000; and
- - a weighted average risk-free interest rate of 3.9% in 2002, 5.0% in 2001 and
6.6% in 2000.
The level of accuracy achieved in deriving the estimated fair values is directly
related to the accuracy of the underlying assumptions.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
The model assumes that the estimated fair value of an option is amortized over
the option's vesting period and would be included in personnel expense on the
income statement. The pro forma effect of applying the fair value method of
accounting for the years shown in the following table may not be indicative of
the effect in future years.
YEAR ENDED DECEMBER 31,
in millions, except per share amounts 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
Net income $ 976 $ 132 $ 1,002
Less: Stock-based employee compensation expense determined
under fair value method, net of tax 20 25 17
- ----------------------------------------------------------------------------------------------------------------------------
Net income-- pro forma $ 956 $ 107 $ 985
========== ========== ==========
Per common share:
Net income $ 2.29 $ .31 $ 2.32
Net income--pro forma 2.25 .25 2.28
Net income assuming dilution 2.27 .31 2.30
Net income assuming dilution--pro forma 2.23 .25 2.24
- ----------------------------------------------------------------------------------------------------------------------------
MARKETING COSTS
Key expenses all marketing-related costs, including advertising costs, as
incurred.
RESTRUCTURING CHARGES
Key may record restructuring charges in connection with certain events or
transactions, including business combinations, changes in Key's strategic plan,
changes in business conditions that may result in a decrease in or exit from
affected businesses, or other factors. Such charges typically result from
consolidating or relocating operations, or disposing of or abandoning operations
or productive assets. Any of these events could result in a significant
downsizing of the workforce.
To qualify as restructuring charges, costs must be incremental and incurred as a
direct result of a restructuring event or transaction. Restructuring charges do
not include costs that are associated with or incurred to benefit future
periods. Among the costs typically included in restructuring charges are those
related to:
- - employee severance and termination benefits;
- - the consolidation of operations facilities; and
- - losses resulting from the impairment or disposal of assets.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." Additional information pertaining to this new
accounting guidance is summarized under the heading "Accounting Pronouncements
Pending Adoption."
ACCOUNTING PRONOUNCEMENTS ADOPTED IN 2002
ACQUISITIONS OF CERTAIN FINANCIAL INSTITUTIONS. Effective October 1, 2002, Key
adopted SFAS No. 147, "Acquisitions of Certain Financial Institutions." SFAS No.
147 addresses the financial accounting and reporting for the acquisition of all
or part of a financial institution and also provides guidance on the accounting
for the impairment or disposal of acquired long-term customer relationship
intangible assets. The adoption of this standard did not have any effect on
Key's financial condition or results of operations.
EXTINGUISHMENT OF DEBT. Effective April 1, 2002, Key adopted SFAS No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13 and Technical Corrections." Under this new standard, gains and losses on
the extinguishment of debt must be recognized as income or loss from continuing
operations rather than extraordinary items. The adoption of this standard did
not have any effect on Key's financial condition or results of operations.
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." This new standard maintains the previous accounting for the impairment
or disposal of long-lived assets, but imposes more conditions on the
classification of 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. The adoption of this standard did not have any
effect on Key's financial condition or results of operations.
GOODWILL AND OTHER INTANGIBLE ASSETS. Effective January 1, 2002, Key adopted
SFAS No. 142, "Goodwill and Other Intangible Assets." Additional information
pertaining to this new accounting guidance is summarized under the heading
"Goodwill and Other Intangible Assets" on page 59.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
CONSOLIDATION OF VARIABLE INTEREST ENTITIES. In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities," which
significantly changes how Key and other companies determine when to consolidate
other entities. Under this guidance, entities are classified as either voting
interest entities or variable interest entities ("VIEs"). A voting interest
entity is evaluated for consolidation under existing accounting standards, which
focus on the equity owner with voting control, while a VIE is consolidated by
its primary beneficiary. The primary beneficiary is the party that holds
variable interests that expose it to a majority of the entity's expected losses
and/or residual returns. Variable interests include equity interests,
subordinated debt, derivative
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
contracts, leases, service agreements, guarantees, standby letters of credit,
loan commitments and other instruments.
Interpretation No. 46 was effective immediately for entities created or obtained
after January 31, 2003, and applies to previously existing entities in quarters
beginning after June 15, 2003. It requires additional disclosures by primary
beneficiaries and other significant variable interest holders. Management is
currently evaluating Key's involvement with entities created before February 1,
2003, to identify those that must be consolidated or only disclosed in
accordance with this guidance. The most significant impact of this new guidance
will be on Key's balance sheet since consolidating additional entities will
increase assets and liabilities and change leverage and capital ratios, as well
as asset concentrations. Additional information is summarized in Note 8 ("Loan
Securitizations and Variable Interest Entities"), which begins on page 70 and in
Note 19 ("Commitments, Contingent Liabilities and Guarantees"), which begins on
page 81.
ACCOUNTING FOR AND DISCLOSURE OF GUARANTEES. In November 2002, the FASB issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others." This
Interpretation requires a guarantor to recognize, at the inception of a
guarantee, a liability for the fair value of obligations undertaken. The
liability that must be recognized is specifically related to the obligation to
stand ready to perform over the term of the guarantee. The initial recognition
and measurement provisions of this guidance are effective on a prospective basis
for guarantees issued or modified on or after January 1, 2003.
This new accounting guidance also expands the disclosures that a guarantor must
make about its obligations under certain guarantees. These disclosure
requirements are effective for financial statements of interim or annual periods
ending after October 15, 2002. The required disclosures for Key are provided in
Note 19 ("Commitments, Contingent Liabilities and Guarantees"), which begins on
page 81.
Management expects that the adoption of Interpretation No. 45 will not have any
material effect on Key's financial condition or results of operations.
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. In July 2002, the FASB issued
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." This new standard is effective for exit or disposal activities
(e.g., activities related to ceasing a line of business, relocating operations,
etc.) initiated after December 31, 2002. SFAS No. 146 substantially changes the
rules for recognizing costs, such as lease or other contract termination costs
and one-time employee termination benefits associated with exit or disposal
activities arising from corporate restructurings. Generally, these costs must be
recognized when incurred. Previously, those costs could be recognized earlier,
for example, when a company committed to an exit or disposal plan. Key will
adopt SFAS No. 146 for restructuring activities initiated on or after January 1,
2003. Management expects that the adoption of SFAS No. 146 will not
significantly affect Key's financial condition or results of operations.
ASSET RETIREMENT OBLIGATIONS. In August 2001, the FASB issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." The new standard takes effect for
fiscal years beginning after June 15, 2002. SFAS No. 143 addresses the
accounting for legal obligations associated with the retirement of tangible
long-lived assets and requires a liability to be recognized for the fair value
of these obligations in the period they are incurred. Related costs are
capitalized as part of the carrying amounts of the assets to be retired and are
amortized over the assets' useful lives. Key will adopt SFAS No. 143 as of
January 1, 2003. Management has determined that the adoption of this accounting
guidance will not affect Key's financial condition or results of operations.
ACCOUNTING FOR STOCK COMPENSATION. Under SFAS No. 123, "Accounting for
Stock-Based Compensation," companies may either recognize the compensation cost
associated with stock options as expense over the respective vesting periods or
disclose the pro forma impact on earnings in their audited financial statements.
Key has historically followed the latter approach, but in September 2002,
KeyCorp's Board of Directors approved management's recommendation to recognize
the compensation cost for stock options. Effective January 1, 2003, Key will
adopt the fair value method of accounting as outlined in SFAS No. 123.
Management intends to apply the change in accounting prospectively (prospective
method) to all awards as permitted under the transition provisions in SFAS No.
148, "Accounting for Stock-Based Compensation Transition and Disclosure," which
was issued in December 2002. SFAS No. 148 amends SFAS No. 123 to provide
alternative methods of transition for an entity that voluntarily changes to the
fair value method of accounting for stock compensation. These alternative
methods include the: (i) prospective method; (ii) modified prospective method;
and, (iii) retroactive restatement method. This accounting guidance also amends
the disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock compensation and the effect of the method used on reported financial
results. The required disclosures for Key are provided under the heading
"Employee Stock Options" on page 61 and in Note 15 ("Stock Options"), which
begins on page 77.
Based on the valuation and timing of options granted in 2002 and projected to be
granted in 2003, management estimates that the accounting change will reduce
Key's diluted earnings per common share by up to $.04 in 2003. The effect on
Key's earnings per common share in subsequent years will depend on the number
and timing of options granted and the assumptions used to estimate their fair
value.
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
2. EARNINGS PER COMMON SHARE
Key calculates its basic and diluted earnings per common share as follows:
YEAR ENDED DECEMBER 31,
dollars in millions, except per share amounts 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
EARNINGS
Income before cumulative effect of accounting changes $ 976 $ 157 $ 1,002
Net income 976 132 1,002
- ----------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 425,451 424,275 432,617
Effect of dilutive common stock options (000) 5,252 5,298 2,956
- ----------------------------------------------------------------------------------------------------------------------------
Weighted average common shares and potential
common shares outstanding (000) 430,703 429,573 435,573
========== ========== ==========
- ----------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Income per common share before cumulative effect of accounting changes $ 2.29 $ .37 $ 2.32
Net income per common share 2.29 .31 2.32
Income per common share before cumulative effect of accounting changes--
assuming dilution 2.27 .37 2.30
Net income per common share-- assuming dilution 2.27 .31 2.30
- ----------------------------------------------------------------------------------------------------------------------------
3. ACQUISITIONS AND DIVESTITURES
Key completed the following acquisitions and divestitures during the past three
years.
ACQUISITIONS
UNION BANKSHARES, LTD.
On December 12, 2002, Key purchased Union Bankshares, Ltd., the holding company
for Union Bank & Trust, a seven-branch bank headquartered in Denver, Colorado.
Key paid $22.63 per Union Bankshares common share for a total cash consideration
of $66 million. Goodwill of approximately $34 million and core deposit
intangibles of $13 million were recorded. Union Bankshares, Ltd. had assets of
$475 million at the date of acquisition. On January 17, 2003, Union Bank & Trust
was merged into KBNA.
CONNING ASSET MANAGEMENT
On June 28, 2002, Key purchased substantially all of the mortgage loan and real
estate business of Conning Asset Management, headquartered in Hartford,
Connecticut. Conning's mortgage loan and real estate business originates,
securitizes and services multi-family, retail, industrial and office property
mortgage loans on behalf of pension fund and life insurance company investors.
At the date of acquisition, Conning had net assets of $17 million and serviced
approximately $4 billion in commercial mortgage loans. In accordance with a
confidentiality clause in the purchase agreement, the terms, which are not
material, have not been disclosed.
THE WALLACH COMPANY, INC.
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, prior to the
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," on January 1,
2002, was being amortized using the straight-line method over a period of 10
years.
NEWPORT MORTGAGE COMPANY, L.P.
On September 30, 2000, Key purchased certain net assets of Newport Mortgage
Company, L.P., a commercial mortgage company headquartered in Dallas, Texas, for
$22 million in cash. Goodwill of approximately $10 million was recorded and,
prior to the adoption of SFAS No. 142, was being amortized using the
straight-line method over a period of 10 years.
NATIONAL REALTY FUNDING L.C.
On January 31, 2000, Key purchased certain net assets of National Realty Funding
L.C., a commercial finance company headquartered in Kansas City, Missouri, for
$359 million in cash. Goodwill of approximately $10 million was recorded and,
prior to the adoption of SFAS No. 142, was being amortized using the
straight-line method over a period of 15 years.
DIVESTITURES
401(K) RECORDKEEPING BUSINESS
On June 12, 2002, Key sold its 401(k) recordkeeping business. Key recognized a
gain of $3 million ($2 million after tax), which is included in "other income"
on the income statement.
CREDIT CARD PORTFOLIO
On January 31, 2000, Key sold its credit card portfolio of $1.3 billion in
receivables and nearly 600,000 active VISA and MasterCard accounts to Associates
National Bank (Delaware). Key recognized a gain of $332 million ($207 million
after tax), which is included in "gain from sale of credit card portfolio" on
the income statement.
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
4. LINE OF BUSINESS RESULTS
Key has three major business groups that consist of 10 lines of business:
KEY CONSUMER BANKING
RETAIL BANKING provides individuals with branch-based deposit and investment
products, personal finance services and loans, including residential mortgages,
home equity and various types of installment loans.
SMALL BUSINESS provides businesses that have annual sales revenues of $10
million or less with deposit, investment and credit products, and business
advisory services.
INDIRECT LENDING offers automobile, marine and recreational vehicle (RV) loans
to consumers through dealers, and finances inventory for automobile, marine and
RV dealers. This line of business also provides education loans, insurance and
interest-free payment plans for students and their parents.
NATIONAL HOME EQUITY provides primarily nonprime mortgage and home equity loan
products to individuals. These products originate outside of Key's retail branch
system. This line of business also works with mortgage brokers and home
improvement contractors to provide home equity and home improvement solutions.
KEY CORPORATE FINANCE
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. This line of business deals
exclusively with nonowner-occupied properties (i.e., generally properties in
which the owner occupies less than 60% of the premises).
NATIONAL EQUIPMENT FINANCE meets the equipment leasing needs of companies
worldwide and provides equipment manufacturers, distributors and resellers with
financing options for their clients. Lease financing receivables and related
revenues are assigned to Corporate Banking or National Commercial Real Estate if
one of those businesses is principally responsible for maintaining the
relationship with the client.
KEY CAPITAL PARTNERS
VICTORY CAPITAL MANAGEMENT manages or gives advice regarding investment
portfolios for a national client base, including corporations, labor unions,
not-for-profit organizations, governments and individuals. These portfolios may
be managed in separate accounts, commingled funds or the Victory family of
mutual funds. This line of business also provides administrative services for
retirement plans.
HIGH NET WORTH offers financial, estate and retirement planning and asset
management services to assist high-net-worth clients with their banking,
brokerage, trust, portfolio management, insurance, charitable giving and related
needs.
CAPITAL MARKETS offers investment banking, capital raising, hedging strategies,
trading and financial strategies to public and privately-held companies,
institutions and government organizations.
OTHER SEGMENTS
Other segments consists primarily of Treasury, Principal Investing and the net
effect of funds transfer pricing.
RECONCILING ITEMS
Total assets included under "Reconciling Items" represent primarily the
unallocated portion of nonearning assets of corporate support functions. Charges
related to the funding of these assets are part of net interest income and are
allocated to the business segments through noninterest expense. Reconciling
Items also include significant items (see note b to the table on pages 66 and
67). These items are not allocated to the business segments because they are not
reflective of their normal operations.
The table that spans pages 66 and 67 shows selected financial data for each
major business group for the years ended December 31, 2002, 2001 and 2000. This
table is accompanied by additional supplementary information for each of the
lines of business that comprise these groups. The information was derived from
the internal financial reporting system that management uses to monitor and
manage Key's financial performance. Accounting principles generally accepted in
the United States guide financial accounting, but there is no authoritative
guidance for "management accounting" -- the way management uses its judgment and
experience to make reporting decisions. Consequently, the line of business
results Key reports may not be comparable with results presented by other
companies.
The selected financial data are based on internal accounting policies designed
to compile results on a consistent basis and in a manner that reflects the
underlying economics of the businesses. As such:
- - Net interest income is determined by assigning a standard cost for funds
used to assets or a standard credit for funds provided to liabilities based
on their maturity, prepayment and/or repricing characteristics. The net
effect of this funds transfer pricing is included in the "Other Segments"
columns.
- - Indirect expenses, such as computer servicing costs and corporate overhead,
are allocated based on assumptions of the extent to which each line actually
uses the services.
- - Key's consolidated provision for loan losses is allocated among the lines of
business based primarily on their actual net charge-offs (excluding those in
the run-off portfolio discussed on page 43), adjusted for loan growth and
changes in risk profile. The level of the consolidated provision is based on
the methodology that management uses to estimate Key's consolidated
allowance for loan losses. This methodology is described in Note 1 ("Summary
of Significant Accounting Policies") under the heading "Allowance for Loan
Losses" on page 58.
- - Income taxes are allocated based on the statutory federal income tax rate of
35% (adjusted for tax-exempt interest income, income from corporate-owned
life insurance and tax credits associated with investments in low-income
housing projects) and a blended state income tax rate (net of the federal
income tax benefit) of 2%.
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
YEAR ENDED DECEMBER 31, KEY CONSUMER BANKING KEY CORPORATE FINANCE
--------------------------------------- --------------------------------------
dollars in millions 2002 2001 2000 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 1,805 $ 1,818 $ 1,757 $ 1,123 $ 1,092 $ 1,011
Noninterest income 497 482 475 238 259 253
- ---------------------------------------------------------------------------------------------------------------------------------
Total revenue (TE)(a) 2,302 2,300 2,232 1,361 1,351 1,264
Provision for loan losses 303 300 281 236 140 125
Depreciation and amortization expense 137 216 224 39 64 62
Other noninterest expense 1,187 1,150 1,132 456 453 435
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (TE)and
cumulative effect of accounting changes 675 634 595 630 694 642
Allocated income taxes and TE adjustments 253 252 239 236 265 246
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect
of accounting changes 422 382 356 394 429 396
Cumulative effect of accounting changes -- (24) -- -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 422 $ 358 $ 356 $ 394 $ 429 $ 396
========== ========== ========== ========== ========== ==========
Percent of consolidated net income 43% 271% 36% 41% 325% 39%
Percent of total segments net income 44 40 37 41 48 42
- ---------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 27,806 $ 27,673 $ 26,690 $ 29,278 $ 31,098 $ 30,592
Total assets(a) 29,970 30,398 29,637 30,568 32,593 32,086
Deposits 33,942 35,221 35,370 3,384 3,093 2,815
- ---------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Expenditures for additions to long-lived
assets(a) $ 74 $ 51 $ 48 $ 14 $ 19 $ 24
Net loan charge-offs 303 350 281 462 305 126
Return on average allocated equity 21.14% 16.13% 14.64% 14.12% 15.42% 15.06%
Full-time equivalent employees 8,299 8,523 8,769 1,789 1,770 2,034
- ---------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, KEY CAPITAL PARTNERS
--------------------------------------
dollars in millions 2002 2001 2000
- --------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 235 $ 216 $ 214
Noninterest income 874 943 974
- --------------------------------------------------------------------------------------
Total revenue (TE)(a) 1,109 1,159 1,188
Provision for loan losses 14 13 4
Depreciation and amortization expense 53 97 93
Other noninterest expense 793 829 851
- --------------------------------------------------------------------------------------
Income (loss) before income taxes (TE)and
cumulative effect of accounting changes 249 220 240
Allocated income taxes and TE adjustments 93 91 98
- --------------------------------------------------------------------------------------
Income (loss) before cumulative effect
of accounting changes 156 129 142
Cumulative effect of accounting changes -- -- --
- --------------------------------------------------------------------------------------
Net income (loss) $ 156 $ 129 $ 142
========== ========== ==========
Percent of consolidated net income 16% 98% 14%
Percent of total segments net income 16 14 15
- --------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 4,904 $ 5,266 $ 5,439
Total assets(a) 8,382 8,965 8,994
Deposits 3,924 3,679 3,480
- --------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Expenditures for additions to long-lived
assets(a) $ 11 $ 18 $ 21
Net loan charge-offs 14 13 4
Return on average allocated equity 16.25% 12.33% 12.49%
Full-time equivalent employees 3,474 3,749 3,916
- --------------------------------------------------------------------------------------
(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) Significant items included under Reconciling Items are as follows:
Year ended December 31, 2001:
- Noninterest income includes a $40 million ($25 million after tax) charge
taken to establish a reserve for losses incurred on the residual values
of leased vehicles and a $15 million ($9 million after tax) increase in
the reserve for customer derivative losses.
- The provision for loan losses includes an additional $400 million ($252
million after tax) taken to increase the allowance for loan losses for
Key's continuing loan portfolio and an additional $490 million ($309
million after tax) recorded primarily in connection with Key's decision
to discontinue certain credit-only commercial relationships.
- Depreciation and amortization expense includes a goodwill write-down of
$150 million associated with the downsizing of the automobile finance
business, and other noninterest expense includes charges of $20 million
($13 million after tax) taken to establish additional litigation
reserves.
Year ended December 31, 2000:
- Noninterest income includes a gain of $332 million ($207 million after
tax) from the sale of Key's credit card portfolio.
- The provision for loan losses includes an additional $121 million ($76
million after tax) recorded in connection with the implementation of an
enhanced methodology for assessing credit risk, particularly in the
commercial loan portfolio.
- Noninterest expense includes $127 million ($80 million after tax),
primarily restructuring charges, recorded in connection with strategic
actions taken to improve Key's operating efficiency and profitability.
TE = Taxable Equivalent, N/A = Not Applicable, N/M = Not Meaningful
- - Capital is assigned based on management's assessment of economic risk
factors (primarily credit, operating and market risk).
Developing and applying the methodologies that management uses to allocate items
among Key's lines of business is a dynamic process. Accordingly, financial
results may be revised periodically to reflect accounting enhancements, changes
in the risk profile of a particular business or changes in Key's organization
structure. The financial data reported for all periods presented in the
tables reflect a number of changes, which occurred during 2002:
- - The Small Business line of business moved from Key Corporate Finance to Key
Consumer Banking.
- - Methodologies used to allocate certain overhead costs, management fees and
funding costs were refined.
- - In previous years, noninterest income and expense attributable to Key
Capital Partners was 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 Partners' products and services. That revenue
and expense sharing has been discontinued.
- - The methodology used to assign a provision for loan losses to each line of
business was changed from one based on the credit quality expectations
within each line over a normal business cycle to one based primarily upon
actual net charge-offs (excluding those in the run-off portfolio), adjusted
for loan growth and changes in risk profile.
66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
OTHER SEGMENTS TOTAL SEGMENTS
- ----------------------------------------- -----------------------------------------
2002 2001 2000 2002 2001 2000
- ------------------------------------------------------------------------------------
$ (194) $ (139) $ (85) $ 2,969 $ 2,987 $ 2,897
118 66 142 1,727 1,750 1,844
- ------------------------------------------------------------------------------------
(76) (73) 57 4,696 4,737 4,741
1 5 3 554 458 413
-- 1 1 229 378 380
24 23 30 2,460 2,455 2,448
- ------------------------------------------------------------------------------------
(101) (102) 23 1,453 1,446 1,500
(81) (83) (35) 501 525 548
- ------------------------------------------------------------------------------------
(20) (19) 58 952 921 952
-- (1) -- -- (25) --
- ------------------------------------------------------------------------------------
$ (20) $ (20) $ 58 $ 952 $ 896 $ 952
========== ========== ========== ========== ========== ==========
(2)% (15)% 6% 98% 679% 95%
(1) (2) 6 100 100 100
- ------------------------------------------------------------------------------------
$ 1,262 $ 1,833 $ 2,280 $ 63,250 $ 65,870 $ 65,001
11,210 11,585 11,511 80,130 83,541 82,228
3,606 3,492 3,773 44,856 45,485 45,438
- ------------------------------------------------------------------------------------
-- -- -- $ 99 $ 88 $ 93
$ 1 $ 5 $ 3 780 673 414
N/M N/M N/M 15.52% 13.72% 14.44%
35 31 36 13,597 14,073 14,755
- ------------------------------------------------------------------------------------
RECONCILING ITEMS(B) KEY
- ----------------------------------------- -----------------------------------------
2002 2001 2000 2002 2001 2000
- ------------------------------------------------------------------------------------
$ (100) $ (117) $ (139) $ 2,869 $ 2,870 $ 2,758
42 (25) 350 1,769 1,725 2,194
- ------------------------------------------------------------------------------------
(58) (142) 211 4,638 4,595 4,952
(1) 892 77 553 1,350 490
1 152 2 230 530 382
(37) (44) 87 2,423 2,411 2,535
- ------------------------------------------------------------------------------------
(21) (1,142) 45 1,432 304 1,545
(45) (378) (5) 456 147 543
- ------------------------------------------------------------------------------------
24 (764) 50 976 157 1,002
-- -- -- -- (25) --
- ------------------------------------------------------------------------------------
$ 24 $ (764) $ 50 $ 976 $ 132 $ 1,002
========== ========== ========== ========== ========== ==========
2% (579)% 5% 100% 100% 100%
N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------
$ 143 $ 106 $ 293 $ 63,393 $ 65,976 $ 65,294
1,651 1,362 1,807 81,781 84,903 84,035
(75) (30) (3) 44,781 45,455 45,435
- ------------------------------------------------------------------------------------
$ 95 $ 111 $ 107 $ 194 $ 199 $ 200
-- -- -- 780 673 414
N/M N/M N/M 14.96% 2.01% 15.39%
6,840 7,157 7,387 20,437 21,230 22,142
- ------------------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION (KEY CONSUMER BANKING LINES OF BUSINESS)
YEAR ENDED DECEMBER 31, RETAIL BANKING SMALL BUSINESS
------------------------------------- --------------------------------------
dollars in millions 2002 2001 2000 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 1,301 $ 1,324 $ 1,304 $ 398 $ 391 $ 367
Provision for loan losses 71 62 124 60 44 33
Noninterest expense 814 855 872 170 179 170
Net income 260 247 185 105 104 101
Average loans 8,784 7,675 7,654 4,272 4,409 4,065
Average deposits 29,890 31,486 31,615 3,723 3,555 3,613
Net loan charge-offs 71 62 124 60 44 33
Return on average allocated equity 46.93% 42.15% 27.13% 32.92% 30.59% 31.08%
Full-time equivalent employees 6,053 6,191 6,606 295 258 253
- ---------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, INDIRECT LENDING NATIONAL HOME EQUITY
-------------------------------------- ---------------------------------------
dollars in millions 2002 2001 2000 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 355 $ 401 $ 425 $ 248 $ 184 $ 136
Provision for loan losses 132 158 115 40 36 9
Noninterest expense 175 187 182 165 145 132
Net income 30 10 76 27 (3) (6)
Average loans 9,630 10,949 11,895 5,120 4,640 3,076
Average deposits 317 171 138 12 9 4
Net loan charge-offs 132 158 115 40 86 9
Return on average allocated equity 4.52% 1.17% 7.60% 5.87% (.68)% (1.42)%
Full-time equivalent employees 747 776 829 1,204 1,298 1,081
- ---------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTARY INFORMATION (KEY CORPORATE FINANCE LINES OF BUSINESS)
YEAR ENDED DECEMBER 31, CORPORATE BANKING NATIONAL COMMERCIAL REAL ESTATE
------------------------------------- --------------------------------------
dollars in millions 2002 2001 2000 2002 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 738 $ 787 $ 773 $ 390 $ 377 $ 316
Provision for loan losses 167 98 112 7 10 2
Noninterest expense 283 313 327 131 118 98
Net income 179 233 207 158 155 135
Average loans 15,687 17,945 18,454 7,782 7,931 7,227
Average deposits 2,776 2,561 2,478 599 525 328
Net loan charge-offs 393 239 113 7 10 2
Return on average allocated equity 10.86% 14.26% 12.71% 21.88% 21.15% 24.19%
Full-time equivalent employees 569 650 866 614 499 493
- ---------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, NATIONAL EQUIPMENT FINANCE
-------------------------------------
dollars in millions 2002 2001 2000
- ---------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 233 $ 187 $ 175
Provision for loan losses 62 32 11
Noninterest expense 81 86 72
Net income 57 41 54
Average loans 5,809 5,222 4,911
Average deposits 9 7 9
Net loan charge-offs 62 56 11
Return on average allocated equity 13.57% 9.86% 12.22%
Full-time equivalent employees 606 621 675
- ---------------------------------------------------------------------------------
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
SUPPLEMENTARY INFORMATION (KEY CAPITAL PARTNERS LINES OF BUSINESS)
YEAR ENDED DECEMBER 31, VICTORY CAPITAL MANAGEMENT HIGH NET WORTH
-------------------------------------- -------------------------------------
dollars in millions 2002 2001 2000 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 205 $ 227 $ 235 $ 583 $ 619 $ 652
Provision for loan losses -- -- -- 14 13 4
Noninterest expense 146 164 169 473 521 533
Net income 36 38 40 61 50 69
Average loans 13 26 29 4,204 4,633 4,825
Average deposits 59 75 85 2,246 2,067 1,896
Net loan charge-offs -- -- -- 14 13 4
Return on average allocated equity 30.51% 28.57% 27.03% 13.47% 9.84% 12.34%
Full-time equivalent employees 429 579 623 2,347 2,483 2,586
- --------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, CAPITAL MARKETS
-------------------------------------
dollars in millions 2002 2001 2000
- --------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 321 $ 313 $ 301
Provision for loan losses -- -- --
Noninterest expense 227 241 242
Net income 59 41 33
Average loans 687 607 585
Average deposits 1,619 1,537 1,499
Net loan charge-offs -- -- --
Return on average allocated equity 15.17% 10.12% 7.67%
Full-time equivalent employees 698 687 707
- --------------------------------------------------------------------------------
5. RESTRICTIONS ON CASH, DIVIDENDS AND LENDING ACTIVITIES
Federal law requires depository institutions to maintain a prescribed amount of
cash or noninterest-bearing balances with the Federal Reserve Bank. KeyCorp's
bank subsidiaries maintained average reserve balances aggregating $336
million in 2002 to fulfill these requirements.
KeyCorp's principal source of cash flow to pay dividends on its common shares,
to service its debt and to finance its corporate operations is capital
distributions from KBNA and its other subsidiaries. Federal banking law limits
the amount of capital distributions that national banks can make to their
holding companies without obtaining prior regulatory approval. A national bank's
dividend paying capacity is affected by several factors, including the amount of
its net profits (as defined by statute) for the two previous calendar years, and
net profits for the current year up to the date of dividend declaration. Due to
this constraint, and the restructuring charges taken by KBNA and Key Bank USA in
2001, as of January 1, 2003, neither bank could pay dividends or make other
capital distributions to KeyCorp without prior regulatory approval.
In February 2003, KBNA obtained regulatory approval to make capital
distributions to KeyCorp of up to $365 million in the aggregate in the first and
second quarters. If KBNA were to distribute such amount, it would not have any
further dividend paying capacity until it accumulates at least $300 million of
additional net profits in 2003. Management expects this will occur during the
second quarter. Management also expects Key Bank USA to have restored dividend
paying capacity during the first quarter.
Assuming KBNA had distributed the $365 million to KeyCorp as of February 15,
2003, as of that date, KeyCorp would have had approximately $1.5 billion of cash
or short-term investments available to pay dividends on its common shares, to
service its debt and to finance its corporate operations. Management does not
expect current constraints on the subsidiary banks to pay dividends to KeyCorp
to have any material effect on the ability of KeyCorp to pay dividends to its
shareholders, to service its debt or to meet its other obligations.
Federal law also restricts loans and advances from bank subsidiaries to their
parent companies (and to nonbank subsidiaries of their parent companies), and
requires those transactions to be secured.
6. SECURITIES
The amortized cost, unrealized gains and losses, and approximate fair value of
Key's investment securities, securities available for sale and other investments
were as follows:
DECEMBER 31, 2002
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- --------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 120 $ 9 -- $ 129
- --------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 22 $ 1 -- $ 23
States and political subdivisions 35 -- -- 35
Collateralized mortgage obligations 7,143 129 $ 65 7,207
Other mortgage-backed securities 815 37 -- 852
Retained interests in securitizations 166 43 -- 209
Other securities 208 -- 27 181
- --------------------------------------------------------------------------------------------
Total securities available for sale $ 8,389 $ 210 $ 92 $ 8,507
========== ========== ========== ==========
- --------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Principal investments $ 702 $ 36 $ 61 $ 677
Other securities 242 -- -- 242
- --------------------------------------------------------------------------------------------
Total other investments $ 944 $ 36 $ 61 $ 919
========== ========== ========== ==========
- --------------------------------------------------------------------------------------------
DECEMBER 31, 2001
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- --------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 225 $ 9 -- $ 234
- --------------------------------------------------------------------------------------------
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 232 1 16 217
- --------------------------------------------------------------------------------------------
Total securities available for sale $ 5,365 $ 131 $ 88 $ 5,408
========== ========== ========== ==========
- --------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Principal investments $ 699 -- $ 78 $ 621
Other securities 211 -- -- 211
- --------------------------------------------------------------------------------------------
Total other investments $ 910 -- $ 78 $ 832
========== ========== ========== ==========
- --------------------------------------------------------------------------------------------
68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
When Key retains an interest in loans it securitizes, it bears risk that the
loans will be prepaid (which would reduce expected interest income) or not paid
at all. Key accounts for these retained interests (which include both
certificated and uncertificated interests) as debt securities, classifying them
as available for sale or as trading account assets.
"Other securities" held in the available for sale portfolio primarily are
marketable equity securities, including an internally managed portfolio of bank
common stock investments. "Other securities" held in the other investments
portfolio are equity securities that do not have readily determinable fair
values.
Realized gains and losses related to securities available for sale were as
follows:
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- ------------------------------------------------------------------
Realized gains $ 34 $ 40 $ 59
Realized losses 28 5 87
- ------------------------------------------------------------------
Net securities gains (losses) $ 6 $ 35 $(28)
==== ==== ====
- ------------------------------------------------------------------
At December 31, 2002, securities available for sale and investment securities
with an aggregate amortized cost of approximately $6.0 billion were pledged to
secure public and trust deposits, securities sold under repurchase agreements,
and for other purposes required or permitted by law.
The following table shows securities available for sale and investment
securities by remaining contractual maturity. Included in securities available
for sale are collateralized mortgage obligations, other mortgage- backed
securities and retained interests in securitizations. All of these securities
are presented based on their expected average lives. Other investments do not
have stated maturities and are not included in the table.
SECURITIES INVESTMENT
AVAILABLE FOR SALE SECURITIES
------------------- -------------------
DECEMBER 31, 2002 AMORTIZED FAIR AMORTIZED FAIR
in millions COST VALUE COST VALUE
- --------------------------------------------------------------------------------
Due in one year or less $ 861 $ 874 $ 32 $ 32
Due after one through five years 6,718 6,889 69 76
Due after five through ten years 234 218 18 20
Due after ten years 576 526 1 1
- --------------------------------------------------------------------------------
Total $8,389 $8,507 $ 120 $ 129
====== ====== ====== ======
- -------------------------------------------------------------------------------=
7. LOANS
Key's loans by category are summarized as follows:
DECEMBER 31,
in millions 2002 2001
- ----------------------------------------------------------------------
Commercial, financial and agricultural $ 17,425 $ 18,159
Commercial real estate:
Commercial mortgage 6,015 6,669
Construction 5,659 5,878
- ----------------------------------------------------------------------
Total commercial real estate loans 11,674 12,547
Commercial lease financing 7,513 7,357
- ----------------------------------------------------------------------
Total commercial loans 36,612 38,063
Real estate--residential mortgage 1,968 2,315
Home equity 13,804 11,184
Consumer--direct 2,161 2,342
Consumer--indirect:
Automobile lease financing 873 2,036
Automobile loans 2,181 2,497
Marine 2,088 1,780
Other 667 1,036
- ----------------------------------------------------------------------
Total consumer--indirect loans 5,809 7,349
- ----------------------------------------------------------------------
Total consumer loans 23,742 23,190
Loans held for sale:
Commercial, financial and agricultural 41 --
Real estate--commercial mortgage 193 252
Real estate--residential mortgage 57 116
Education 1,812 1,688
- ----------------------------------------------------------------------
Total loans held for sale 2,103 2,056
- ----------------------------------------------------------------------
Total loans $ 62,457 $ 63,309
========= =========
- ----------------------------------------------------------------------
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 December 31, 2002, see Note 20 ("Derivatives and
Hedging Activities"), which begins on page 84.
Commercial and consumer lease financing receivables in the preceding table
primarily are direct financing leases, but also include leveraged leases and
operating leases. The composition of the net investment in direct financing
leases is as follows:
DECEMBER 31,
in millions 2002 2001
- --------------------------------------------------------------------------
Direct financing lease receivable $ 5,384 $ 6,785
Unearned income (639) (888)
Unguaranteed residual value 637 716
Deferred fees and costs 38 38
- --------------------------------------------------------------------------
Net investment in direct financing leases $ 5,420 $ 6,651
======= =======
- --------------------------------------------------------------------------
Minimum future lease payments to be received at December 31, 2002, are as
follows: 2003--$1.0 billion; 2004--$980 million; 2005--$1.1 billion;
2006--$793 million; 2007--$749 million; and all subsequent years--$807
million.
Changes in the allowance for loan losses are summarized as follows:
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- -------------------------------------------------------------------------------
Balance at beginning of year $ 1,677 $ 1,001 $ 930
Charge-offs (905) (784) (522)
Recoveries 125 111 108
- -------------------------------------------------------------------------------
Net charge-offs (780) (673) (414)
Provision for loan losses 553 1,350 490
Allowance related to loans
acquired (sold), net 2 (1) (5)
- -------------------------------------------------------------------------------
Balance at end of year $ 1,452 $ 1,677 $ 1,001
======= ======= =======
- -------------------------------------------------------------------------------
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
8. LOAN SECURITIZATIONS AND VARIABLE INTEREST ENTITIES
RETAINED INTERESTS IN LOAN SECURITIZATIONS
Key sells certain types of loans in securitizations. A securitization involves
the sale of a pool of loan receivables to investors through either a public or
private issuance of asset-backed securities. Generally, the assets are
transferred to a trust that sells interests in the form of certificates of
ownership. In some cases, Key retains an interest in the securitized loans.
Certain assumptions and estimates are used to determine the fair value allocated
to these retained interests at the date of transfer and at subsequent
measurement dates. These assumptions and estimates include loan repayment rates,
projected charge-offs and discount rates commensurate with the risks involved.
Additional information pertaining to Key's residual interests is disclosed in
Note 1 ("Summary of Significant Accounting Policies") under the heading "Loan
Securitizations" on page 59.
Key securitized and sold $792 million of education loans (including accrued
interest) in 2002 and $523 million in 2001. The securitizations resulted in an
aggregate gain of $7 million in 2002 (from gross cash proceeds of $799 million)
and $11 million in 2001 (from gross cash proceeds of $534 million). In these
transactions, Key retained residual interests in the form of servicing assets
and interest-only strips. During 2002, Key retained servicing assets of $6
million and interest-only strips of $26 million. During 2001, Key retained
servicing assets of $4 million and interest-only strips of $16 million.
Primary economic assumptions used to measure the fair value of Key's retained
interests and the sensitivity of the current fair value of residual cash flows
to immediate adverse changes in those assumptions are as follows:
DECEMBER 31, 2002 EDUCATION HOME EQUITY AUTOMOBILE
dollars in millions LOANS LOANS LOANS
- -----------------------------------------------------------------------------------------------------------------------------
Carrying amount (fair value) of retained interests $209 $76 $ 8
Weighted-average life (years) 1.1 -- 5.3 1.9 -- 2.8 .5
- -----------------------------------------------------------------------------------------------------------------------------
PREPAYMENT SPEED ASSUMPTIONS (ANNUAL RATE) 7.99% -- 16.32% 23.89% -- 27.10% 1.59%
Impact on fair value of 1% CPR (education and home equity)
and .10% ABS (automobile) adverse change $ (6) $(1) --
Impact on fair value of 2% CPR (education and home equity)
and .20% ABS (automobile) adverse change (11) (2) --
- -----------------------------------------------------------------------------------------------------------------------------
EXPECTED CREDIT LOSSES (STATIC RATE) .01% -- 1.58% 1.27% -- 2.59% 5.51%
Impact on fair value of .10% (education)
and .25% (home equity and automobile) adverse change $ (7) $(5) $(1)
Impact on fair value of .20% (education)
and .50% (home equity and automobile) adverse change (14) (9) (2)
- -----------------------------------------------------------------------------------------------------------------------------
RESIDUAL CASH FLOWS DISCOUNT RATE (ANNUAL RATE) 8.50% -- 12.00% 7.50% -- 10.75% 9.00%
Impact on fair value of 1% adverse change $ (6) $(1) --
Impact on fair value of 2% adverse change (12) (2) --
- -----------------------------------------------------------------------------------------------------------------------------
EXPECTED STATIC DEFAULT (STATIC RATE) 10.46% -- 16.04% N/A N/A
Impact on fair value of 1% (education loans) adverse change $ (8) N/A N/A
Impact on fair value of 2% (education loans) adverse change (16) N/A N/A
- -----------------------------------------------------------------------------------------------------------------------------
VARIABLE RETURNS TO TRANSFEREES (a) (b) (c)
- -----------------------------------------------------------------------------------------------------------------------------
These sensitivities are hypothetical and should be relied upon with caution.
Sensitivity analysis for each asset type is based on the nature of the asset,
the seasoning (i.e., age and payment history) of the portfolio and the results
experienced. Changes in fair value based on a 1% variation in assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the change in fair value may not be linear. Also, the effect of a
variation in a particular assumption on the fair value of the retained interest
is calculated without changing any other assumption; in reality, changes in one
factor may cause changes in another. For example, increases in market interest
rates may result in lower prepayments and increased credit losses, which might
magnify or counteract the sensitivities.
(a) Forward London Interbank Offered Rate (known as "LIBOR") plus contractual
spread over LIBOR ranging from .06% to .75%, or Treasury plus contractual
spread over Treasury ranging from .65% to 1.00% or fixed rate yield.
(b) Forward LIBOR plus contractual spread over LIBOR ranging from .23% to .40%,
or Treasury plus contractual spread over Treasury ranging from 2.40% to
2.95% or fixed rate yield.
(c) Fixed rate yield.
CPR = Constant Prepayment Rate, ABS = Absolute Prepayment Speed, N/A = Not
Applicable
70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
Information about the components of Key's managed loans (i.e., loans held in
portfolio and securitized loans), as well as related delinquencies and net
credit losses is as follows:
DECEMBER 31,
--------------------------------------
LOANS PAST DUE NET CREDIT LOSSES
LOAN PRINCIPAL 60 DAYS OR MORE DURING THE YEAR
------------------- --------------- ------------------
in millions 2002 2001 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------
Education loans $ 6,336 $ 5,964 $166 $161 $ 19 $ 13
Home equity loans 14,242 11,925 237 200 58 104
Automobile loans 2,235 2,628 24 41 84 106
- --------------------------------------------------------------------------------------------------------
Total loans managed 22,813 20,517 427 402 161 223
Less:
Loans securitized 5,016 5,148 209 238 16 20
Loans held for sale or securitization 1,812 1,688 -- -- -- --
- --------------------------------------------------------------------------------------------------------
Loans held in portfolio $15,985 $13,681 $218 $164 $ 145 $203
======= ======= ==== ==== ====== ====
- --------------------------------------------------------------------------------------------------------
VARIABLE INTEREST ENTITIES
A variable interest entity ("VIE") is a partnership, limited liability company,
trust or other legal entity that is not controlled through a voting equity
interest and/or does not have enough equity at risk invested to finance its
activities without subordinated financial support from another party. FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities," addresses
the consolidation of VIEs. This interpretation is summarized in Note 1 ("Summary
of Significant Accounting Policies") under the heading "Accounting
Pronouncements Pending Adoption" on page 62. Under Interpretation No. 46, VIEs
are consolidated by the party (the primary beneficiary) who is exposed to the
majority of the VIE's expected losses and/or residual returns.
The securitization trusts referred to in the "Retained Interests in Loan
Securitizations" section of this note are VIEs; however, as qualifying special
purpose entities under SFAS 140, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," they are exempt from
consolidation under Interpretation No. 46.
As required by Interpretation No. 46, Key is assessing its relationships and
arrangements with legal entities formed prior to February 1, 2003, to identify
VIEs in which Key holds a significant variable interest and to determine if Key
is the primary beneficiary of these entities and should therefore consolidate
them.
Based on the review performed to date, it is reasonably possible that Key will
have to consolidate (if primary beneficiary) or only disclose significant
variable interests in the following entities, as currently structured, when
Interpretation No. 46 becomes effective on July 1, 2003.
COMMERCIAL PAPER CONDUITS. Key, among others, refers third party assets and
borrowers and provides liquidity and credit enhancement to an unconsolidated
asset-backed commercial paper conduit. The conduit had assets of $423 million at
December 31, 2002.
In addition, Key holds a subordinated note in and provides referral services and
liquidity to one program, also unconsolidated, within another asset-backed
commercial paper conduit. This program had assets of $79 million at December 31,
2002. These assets are expected to decrease over time since this conduit program
is in the process of being liquidated.
At December 31, 2002, Key's maximum exposure to loss from its interests in these
conduits totaled $79 million, which represents a $68 million committed credit
enhancement facility and an $11 million subordinated note.
Additional information pertaining to Key's involvement with conduits is
summarized in Note 1 ("Summary of Significant Accounting Policies") under the
heading "Basis of Presentation" on page 57 and in Note 19 ("Commitments,
Contingent Liabilities and Guarantees") under the heading "Guarantees" on page
83 and the heading "Other Off-Balance Sheet Risk" on page 84.
LOW-INCOME HOUSING TAX CREDIT ("LIHTC") GUARANTEED FUNDS. Key Affordable Housing
Corporation ("KAHC") forms unconsolidated limited partnerships (funds) which
invest in LIHTC projects. Interests in these funds are offered to qualified
investors, who pay a fee to KAHC for a guaranteed return. Key also earns
syndication and asset management fees from these funds. At December 31, 2002,
the guaranteed funds had unamortized equity of $676 million. Additional
information on the return guaranty agreement with LIHTC investors is summarized
in Note 19 ("Commitments, Contingent Liabilities and Guarantees") under the
heading "Guarantees" on page 83.
Key's maximum exposure to loss from its relationships with the above entities
was $851 million at December 31, 2002, which represents undiscounted future
payments due to investors for the return on and of their investments. KAHC has
established a reserve in the amount of $35 million at December 31, 2002, which
management believes will be sufficient to absorb future estimated losses under
the guarantees.
LIHTC INVESTMENTS. Key makes investments directly in LIHTC projects through the
Retail Banking line of business. As a limited partner in these unconsolidated
projects, Key is allocated tax credits and deductions associated with the
underlying properties. At December 31, 2002, Key's investments in these projects
totaled $298 million. Key has not yet completed its analysis of these entities
under Interpretation No. 46.
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
COMMERCIAL REAL ESTATE INVESTMENTS. Through the National Commercial Real Estate
line of business, Key provides real estate financing for new construction,
acquisition and rehabilitation projects. In certain of these unconsolidated
projects, Key has provided or committed funds through limited partnership
interests, mezzanine investments or standby letters of credit. At December 31,
2002, these investments and facilities totaled $131 million. Key has not yet
completed its analysis of these investments under Interpretation No. 46.
Key is continuing to evaluate its relationships with, and investments in, these
entities as well as others to assess whether it is reasonably possible that
consolidation or disclosure of significant interests in such entities will be
necessary when the guidance provided under Interpretation No. 46 becomes
effective for existing VIEs on July 1, 2003.
9. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
Impaired loans, which account for the largest portion of Key's nonperforming
assets, totaled $610 million at December 31, 2002, compared with $661 million at
December 31, 2001. Impaired loans averaged $653 million for 2002 and $535
million for 2001.
Key's nonperforming assets were as follows:
DECEMBER 31,
in millions 2002 2001
- --------------------------------------------------------------
Impaired loans $610 $661
Other nonaccrual loans 333 249
- --------------------------------------------------------------
Total nonperforming loans 943 910
Other real estate owned (OREO) 48 38
Allowance for OREO losses (3) (1)
- --------------------------------------------------------------
OREO, net of allowance 45 37
Other nonperforming assets 5 --
- --------------------------------------------------------------
Total nonperforming assets $993 $947
==== ====
- --------------------------------------------------------------
At December 31, 2002, Key did not have any significant commitments to lend
additional funds to borrowers with loans on nonperforming status.
Key evaluates most impaired loans individually using the process described in
Note 1 ("Summary of Significant Accounting Policies") under the heading
"Allowance for Loan Losses" on page 58. At December 31, 2002, Key had $377
million of impaired loans with a specifically allocated allowance for loan
losses of $179 million, and $233 million of impaired loans that were carried at
their estimated fair value without a specifically allocated allowance. At
December 31, 2001, impaired loans included $417 million of loans with a
specifically allocated allowance of $180 million, and $244 million that were
carried at their estimated fair value.
Key does not perform a specific impairment valuation for smaller-balance,
homogeneous, nonaccrual loans (shown in the preceding table as "Other nonaccrual
loans"). These typically are consumer loans, including residential mortgages,
home equity loans and various types of installment loans. Management applies
historical loss experience rates to these loans, adjusted to reflect emerging
credit trends and other factors, and then allocates a portion of the allowance
for loan losses to each loan type.
The following table shows the amount by which loans classified as nonperforming
at December 31 reduced Key's expected interest income.
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- --------------------------------------------------------------
Interest income receivable under
original terms $50 $52 $62
Less: Interest income recorded
during the year 20 21 25
- --------------------------------------------------------------
Net reduction to interest income $30 $31 $37
=== === ===
- --------------------------------------------------------------
10. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, Key adopted SFAS No. 142, "Goodwill and Other
Intangible Assets," which eliminates the amortization of goodwill and intangible
assets deemed to have indefinite lives. Key's total amortization expense was $11
million for 2002, $245 million for 2001 and $101 million for 2000. Estimated
amortization expense for intangible assets subject to amortization for each of
the next five years is as follows: 2003 -- $12 million; 2004 -- $8 million; 2005
- -- $3 million; 2006 -- $3 million; and 2007 -- $3 million.
72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
The calculation of Key's net income and earnings per common share, excluding
goodwill amortization, is presented below.
YEAR ENDED DECEMBER 31,
dollars in millions, except per share amounts 2002 2001 2000
- -------------------------------------------------------------------------------------------------
EARNINGS
Net income $ 976 $ 132 $ 1,002
Add: Goodwill amortization -- 82(a) 86
- -------------------------------------------------------------------------------------------------
Adjusted net income $ 976 $ 214 $ 1,088
======== ======== ========
- -------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 425,451 424,275 432,617
Weighted average common shares and potential
common shares outstanding (000) 430,703 429,573 435,573
- -------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per common share $ 2.29 $ .31 $ 2.32
Add: Goodwill amortization -- .19(a) .20
- -------------------------------------------------------------------------------------------------
Adjusted net income per common share $ 2.29 $ .50 $ 2.52
======== ======== ========
Adjusted net income per common share--assuming dilution $ 2.27 $ .50 $ 2.50
======== ======== ========
- -------------------------------------------------------------------------------------------------
(a) Goodwill amortization for 2001 excludes a $150 million write-down
(equivalent to $.35 per both basic and diluted common share) associated
with Key's decision to downsize the automobile finance business.
The following table shows the gross carrying amount and the accumulated
amortization of intangible assets that are subject to amortization.
DECEMBER 31, 2002 2001
-------------------------------- -------------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
in millions AMOUNT AMORTIZATION AMOUNT AMORTIZATION
- ----------------------------------------------------------------------------------------------------------------
Intangible assets subject to amortization:
Core deposit intangibles $227 $197 $215 $187
Other intangible assets 11 6 9 6
- ----------------------------------------------------------------------------------------------------------------
Total $238 $203 $224 $193
==== ==== ==== ====
- ----------------------------------------------------------------------------------------------------------------
During 2002, core deposit intangibles with a fair value of $13 million were
acquired in conjunction with the purchase of Union Bankshares and are being
amortized using the straight-line method over seven years. Additional
information pertaining to this acquisition is discussed in Note 3 ("Acquisitions
and Divestitures") on page 64.
During 2002, Key performed transitional impairment testing of goodwill at
January 1, 2002, that was completed during the first quarter and annual
impairment testing of goodwill at October 1, 2002, that was completed during
the fourth quarter. Both tests determined that no impairment of Key's goodwill
existed at either of those dates.
Additional information pertaining to the new accounting guidance is included in
Note 1 ("Summary of Significant Accounting Policies") under the heading
"Goodwill and Other Intangible Assets" on page 59.
Changes in the carrying amount of goodwill by major business group are as
follows:
KEY CONSUMER KEY CORPORATE KEY CAPITAL
in millions BANKING FINANCE PARTNERS TOTAL
- -------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 $446 $202 $455 $1,103
Additional goodwill:
Union Bankshares acquisition 34 -- -- 34
Conning Asset Management acquisition -- 5 -- 5
- -------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 $480 $207 $455 $1,142
==== ==== ==== ======
- -------------------------------------------------------------------------------------------------
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
11. SHORT-TERM BORROWINGS
Selected financial information pertaining to the components of Key's short-term
borrowings is as follows:
dollars in millions 2002 2001 2000
- ------------------------------------------------------------------------------
FEDERAL FUNDS PURCHASED
Balance at year end $2,147 $2,591 $3,267
Average during the year 3,984 3,575 2,991
Maximum month-end balance 5,983 5,034 4,693
Weighted average rate during the year 1.71% 4.00% 6.42%
Weighted average rate at December 31 1.19 1.72 6.68
- ------------------------------------------------------------------------------
SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
Balance at year end $1,715 $1,144 $1,669
Average during the year 1,543 1,622 1,940
Maximum month-end balance 2,313 1,807 2,447
Weighted average rate during the year 1.49% 3.39% 4.90%
Weighted average rate at December 31 1.26 1.80 6.01
- ------------------------------------------------------------------------------
SHORT-TERM BANK NOTES
Balance at year end $ 575 $3,748 $4,345
Average during the year 1,700 4,649 5,021
Maximum month-end balance 3,048 6,098 6,834
Weighted average rate during the year 1.94% 5.01% 7.35%
Weighted average rate at December 31 2.05 2.16 8.28
- ------------------------------------------------------------------------------
OTHER SHORT-TERM BORROWINGS
Balance at year end $2,248 $1,801 $2,612
Average during the year 1,243 2,179 2,100
Maximum month-end balance 2,248 2,841 2,326
Weighted average rate during the year 1.29% 2.39% 3.10%
Weighted average rate at December 31 .83 2.18 3.31
- ------------------------------------------------------------------------------
Key uses interest rate swaps and caps, which modify the repricing and maturity
characteristics of certain short-term borrowings, to manage interest rate risk.
For more information about such financial instruments at December 31, 2002, see
Note 20 ("Derivatives and Hedging Activities"),which begins on page 84.
Key has several programs that support short-term financing needs.
BANK NOTE PROGRAM. This program provides for the issuance of up to $20.0 billion
[$19.0 billion by KeyBank National Association ("KBNA") and $1.0 billion by Key
Bank USA, National Association ("Key Bank USA")] of bank notes with original
maturities ranging from 30 days to 30 years. At December 31, 2002, $18.1 billion
was available for future issuance under this program.
EURO NOTE PROGRAM. KeyCorp, KBNA and Key Bank USA may issue both long- and
short-term debt of up to $10.0 billion to non-U.S. investors. This facility had
$4.2 billion available for future issuance as of December 31, 2002.
KEYCORP MEDIUM-TERM 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. Of the amount registered, $1.0 billion has been allocated for
the issuance of medium-term notes. At December 31, 2002, unused capacity under
KeyCorp's universal shelf registration statement totaled $1.8 billion, including
$575 million allocated for the issuance of medium-term notes.
COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp's commercial paper program and a
revolving credit agreement provide funding availability of up to $500 million
and $400 million, respectively. There were no borrowings outstanding under the
commercial paper program at December 31, 2002. Borrowings outstanding under the
commercial paper program totaled $25 million at December 31, 2001. There were no
borrowings outstanding under the revolving credit agreement at December 31, 2002
and 2001. The revolving credit agreement serves as a back-up facility for the
commercial paper program.
LINE OF CREDIT. KBNA has overnight borrowing capacity at the Federal Reserve
Bank. At December 31, 2002, this capacity was approximately $17.5 billion and
was secured by approximately $22.5 billion of loans, primarily those in the
commercial portfolio. There were no borrowings outstanding under this facility
at December 31, 2002 or 2001.
74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
12. LONG-TERM DEBT
The components of Key's long-term debt, presented net of unamortized discount
where applicable, were as follows:
DECEMBER 31,
dollars in millions 2002 2001
- -----------------------------------------------------------------------
Senior medium-term notes due through 2005(a) $ 1,445 $ 1,286
Subordinated medium-term notes
due through 2003(a) 45 85
Senior euro medium-term notes
due through 2003(b) 50 50
7.50% Subordinated notes due 2006(c) 250 250
6.75% Subordinated notes due 2006(c) 200 200
8.125% Subordinated notes due 2002(c) -- 200
8.00% Subordinated notes due 2004(c) 125 125
6.625% Subordinated notes due 2017(c) 24 --
All other long-term debt(i) 36 16
- -----------------------------------------------------------------------
Total parent company(j) 2,175 2,212
Senior medium-term bank notes
due through 2039(d) 3,854 4,525
Senior euro medium-term bank notes
due through 2007(e) 4,792 3,989
6.50% Subordinated remarketable notes
due 2027(f) 311 311
6.95% Subordinated notes due 2028(f) 300 300
7.125% Subordinated notes due 2006(f) 250 250
7.25% Subordinated notes due 2005(f) 200 200
6.75% Subordinated notes due 2003(f) 200 200
7.50% Subordinated notes due 2008(f) 165 165
7.00% Subordinated notes due 2011(f) 607 506
7.30% Subordinated notes due 2011(f) 107 107
7.85% Subordinated notes due 2002(f) -- 93
7.55% Subordinated notes due 2006(f) 75 75
7.375% Subordinated notes due 2008(f) 70 70
5.70% Subordinated notes due 2012(f) 300 --
5.70% Subordinated notes due 2017(f) 200 --
Lease financing debt due through 2006(g) 435 519
Federal Home Loan Bank advances
due through 2033(h) 1,018 762
All other long-term debt(i) 546 270
- -----------------------------------------------------------------------
Total subsidiaries 13,430 12,342
- -----------------------------------------------------------------------
Total long-term debt $15,605 $14,554
======= =======
- -----------------------------------------------------------------------
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 December 31, 2002, see Note
20 ("Derivatives and Hedging Activities"), which begins on page 84.
(a) At December 31, 2002, the senior medium-term notes had a weighted average
interest rate of 2.54%, and the subordinated medium-term notes had a
weighted average interest rate of 7.30%. At December 31, 2001, the senior
medium-term notes had a weighted average interest rate of 2.51%, and the
subordinated medium-term notes had a weighted average interest rate of
7.42%. These notes had a combination of fixed and floating interest rates.
(b) Senior euro medium-term notes had a weighted average interest rate of 1.62%
at December 31, 2002, and 2.33% at December 31, 2001. These notes had a
floating interest rate based on the three-month LIBOR.
(c) These notes may not be redeemed or prepaid prior to maturity.
(d) Senior medium-term bank notes of subsidiaries had weighted average interest
rates of 2.59% at December 31, 2002, and 2.45% at December 31, 2001. These
notes had a combination of fixed and floating interest rates.
(e) Senior euro medium-term notes had weighted average interest rates of 1.79%
at December 31, 2002, and 2.58% at December 31, 2001. These notes, which
are obligations of KBNA, had a combination of fixed interest rates and
floating interest rates based on LIBOR.
(f) These notes are all obligations of KBNA, with the exception of the 7.55%
notes, which are obligations of Key Bank USA. None of the subordinated
notes may be redeemed prior to their maturity dates.
(g) Lease financing debt had weighted average interest rates of 7.14% at
December 31, 2002, and 7.41% at December 31, 2001. This category of debt
consists of primarily nonrecourse debt collateralized by leased equipment
under operating, direct financing and sales type leases.
(h) Long-term advances from the Federal Home Loan Bank had weighted average
interest rates of 1.71% at December 31, 2002, and 2.19% at December 31,
2001. These advances, which had a combination of fixed and floating
interest rates, were secured by real estate loans and securities totaling
$1.4 billion at December 31, 2002, and $1.1 billion at December 31, 2001.
(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 6.29% at December 31,
2002, and 6.72% at December 31, 2001.
(j) At December 31, 2002, unused capacity under KeyCorp's universal shelf
registration statement filed with the Securities and Exchange Commission
totaled $1.8 billion, including $575 million which was allocated for the
issuance of medium-term notes.
Scheduled principal payments on long-term debt over the next five years are as
follows:
in millions PARENT SUBSIDIARIES TOTAL
- -------------------------------------------------
2003 $773 $3,657 $4,430
2004 490 3,112 3,602
2005 403 1,909 2,312
2006 450 785 1,235
2007 -- 1,441 1,441
- -------------------------------------------------
13. CAPITAL SECURITIES
KeyCorp has six fully-consolidated subsidiary business trusts that have issued
corporation-obligated mandatorily redeemable preferred capital securities
("capital securities"). These securities are carried as liabilities on Key's
balance sheet. They provide an attractive source of funds since they constitute
Tier I capital for regulatory reporting purposes, but have the same tax
advantages as debt for federal income tax purposes. As guarantor, KeyCorp
unconditionally guarantees payment of:
- - required distributions on the capital securities;
- - the redemption price when a capital security is redeemed; and
- - amounts due if a trust is liquidated or terminated.
KeyCorp owns the outstanding common stock of each of the trusts. The trusts used
the proceeds from the issuance of their capital securities and common stock to
buy debentures issued by their respective parent company: KeyCorp in the case of
the Key trusts, and Union Bankshares, Ltd. in the case of the Union trust. These
debentures are the trusts' only assets; the interest payments from the
debentures finance the distributions paid on the capital securities. Key's
financial statements do not reflect the debentures or the related effects on the
income statement because they are eliminated in consolidation.
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
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) STOCK NET OF DISCOUNT(b) DEBENTURES(c) DEBENTURES
- -----------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
KeyCorp Institutional Capital A $ 413 $11 $ 361 7.826% 2026
KeyCorp Institutional Capital B 177 4 154 8.250 2026
KeyCorp Capital I 230 8 237 2.546 2028
KeyCorp Capital II 182 8 165 6.875 2029
KeyCorp Capital III 248 8 208 7.750 2029
Union Bankshares Capital Trust I(d) 10 1 11 9.000 2028
- -----------------------------------------------------------------------------------------------------------------------------------
Total $1,260 $40 $1,136 6.779% --
====== === ======
- -----------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001 $1,288 $39 $1,282 6.824% --
====== === ======
- -----------------------------------------------------------------------------------------------------------------------------------
(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 December 31, 2002 and 2001, are basis
adjustments of $164 million and $45 million, respectively, related to fair
value hedges. See Note 20 ("Derivatives and Hedging Activities"), which
begins on page 84, for an explanation of fair value hedges.
(b) KeyCorp has the right to redeem its debentures: (i) in whole or in part, on
or after December 1, 2006 (for debentures owned by Capital A), December 15,
2006 (for debentures owned by Capital B), July 1, 2008 (for debentures
owned by Capital I), March 18, 1999 (for debentures owned by Capital II),
July 16, 1999 (for debentures owned by Capital III), and December 17, 2003
(for debentures owned by Union Bankshares Capital Trust I); and (ii) in
whole at any time within 90 days after and during the continuation of a
"tax event" or a "capital treatment event" (as defined in the applicable
offering circular). If the debentures purchased by Capital A or Capital B
are redeemed before they mature, the redemption price will be the principal
amount, plus a premium, plus any accrued but unpaid interest. If the
debentures purchased by Capital I or Union Bankshares Capital Trust I are
redeemed before they mature, the redemption price will be the principal
amount, plus any accrued but unpaid interest. If the debentures purchased
by Capital II or Capital III are redeemed before they mature, the
redemption price will be the greater of: (a) the principal amount, plus any
accrued but unpaid interest or (b) the sum of the present values of
principal and interest payments discounted at the Treasury Rate (as defined
in the applicable offering circular), plus 20 basis points (25 basis points
for Capital III), plus any accrued but unpaid interest. When debentures are
redeemed in response to tax or capital treatment events, the redemption
price generally is slightly more favorable to Key.
(c) The interest rates for Capital A, Capital B, Capital II, Capital III and
Union Bankshares Capital Trust I are fixed. Capital I has a floating
interest rate equal to three-month LIBOR plus 74 basis points; it reprices
quarterly. The rates shown as the total at December 31, 2002 and 2001, are
weighted average rates.
(d) On December 12, 2002, KeyCorp acquired Union Bankshares, Ltd., the owner of
all the common stock of Union Bankshares Capital Trust I and the guarantor
of all the trust's obligations under its capital securities. On January 16,
2003, Union Bankshares, Ltd. merged into KeyCorp. As a result of this
merger, KeyCorp became the owner of the common stock of the trust and the
guarantor of all the trust's obligations under its capital securities.
During 2002, the subsidiary business trusts repurchased an aggregate $159
million of their outstanding capital securities and KeyCorp repurchased a like
amount of the related debentures. Management intends to replace the capital
securities at some future date with capital securities that will yield a lower
cost.
14. SHAREHOLDERS' EQUITY
SHAREHOLDER RIGHTS PLAN
KeyCorp has a shareholder rights plan, which was first adopted in 1989 and has
since been amended. Under the plan, each shareholder received one Right --
representing the right to purchase a common share for $82.50 -- for each KeyCorp
common share owned. All of the Rights expire on May 14, 2007, but KeyCorp may
redeem Rights earlier for $.005 apiece, subject to certain limitations.
Rights will become exercisable if a person or group acquires 15% or more of
KeyCorp's outstanding shares. Until that time, the Rights will trade with the
common shares; any transfer of a common share will also constitute a transfer of
the associated Right. If the Rights become exercisable, they will begin to trade
apart from the common shares. If one of a number of "flip-in events" occurs,
each Right will entitle the holder to purchase a KeyCorp common share for $1.00
(the par value per share), and the Rights held by a 15% or more shareholder will
become void.
CAPITAL ADEQUACY
KeyCorp and its banking subsidiaries must meet specific capital requirements
imposed by federal banking regulators. Sanctions for failure to meet applicable
capital requirements may include regulatory enforcement actions that restrict
dividend payments, require the adoption of remedial measures to increase
capital, terminate Federal Deposit Insurance Corporation ("FDIC") deposit
insurance, and mandate the appointment of a conservator or receiver in severe
cases. As of December 31, 2002, KeyCorp and its bank subsidiaries met all
capital requirements.
Federal bank regulators apply certain capital ratios to assign FDIC- insured
depository institutions to one of five categories: "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized"
and "critically undercapitalized." At December 31, 2002 and 2001, the most
recent regulatory notification classified each of KeyCorp's subsidiary banks as
"well capitalized." Management does not believe there have been any changes in
condition or events since those notifications that would cause the banks'
classifications to change.
Unlike bank subsidiaries, bank holding companies are not classified by capital
adequacy. However, Key satisfied the criteria for a "well capitalized"
institution at December 31, 2002 and 2001. The FDIC- defined capital categories
serve a limited regulatory function and may not accurately represent the overall
financial condition or prospects of Key or its affiliates.
76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
The following table presents Key's, KBNA's and Key Bank USA's actual capital
amounts and ratios, minimum capital amounts and ratios prescribed by regulatory
guidelines, and capital amounts and ratios required to qualify as "well
capitalized" under the Federal Deposit Insurance Act.
TO QUALIFY AS
TO MEET MINIMUM WELL CAPITALIZED
CAPITAL ADEQUACY UNDER FEDERAL DEPOSIT
ACTUAL REQUIREMENTS INSURANCE ACT
---------------------- --------------------- -----------------------
dollars in millions AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- ----------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
TOTAL CAPITAL TO NET RISK-WEIGHTED ASSETS
Key $10,257 12.51% $6,558 8.00% N/A N/A
KBNA 8,248 11.19 5,899 8.00 $7,374 10.00%
Key Bank USA 837 12.04 556 8.00 695 10.00
TIER 1 CAPITAL TO NET RISK-WEIGHTED ASSETS
Key $ 6,632 8.09% $3,279 4.00% N/A N/A
KBNA 5,054 6.85 2,949 4.00 $4,424 6.00%
Key Bank USA 713 10.25 278 4.00 417 6.00
TIER 1 CAPITAL TO AVERAGE ASSETS
Key $ 6,632 8.15% $2,440 3.00% N/A N/A
KBNA 5,054 6.93 2,915 4.00 $3,644 5.00%
Key Bank USA 713 8.50 335 4.00 419 5.00
- ----------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001
TOTAL CAPITAL TO NET RISK-WEIGHTED ASSETS
Key $ 9,548 11.41% $6,696 8.00% N/A N/A
KBNA 7,970 10.63 5,993 8.00 $7,492 10.00%
Key Bank USA 746 11.48 520 8.00 650 10.00
TIER 1 CAPITAL TO NET RISK-WEIGHTED ASSETS
Key $ 6,222 7.43% $3,348 4.00% N/A N/A
KBNA 5,170 6.90 2,997 4.00 $4,495 6.00%
Key Bank USA 618 9.51 260 4.00 390 6.00
TIER 1 CAPITAL TO AVERAGE ASSETS
Key $ 6,222 7.65% $2,440 3.00% N/A N/A
KBNA 5,170 7.13 2,897 4.00 $3,622 5.00%
Key Bank USA 618 8.53 290 4.00 362 5.00
- ----------------------------------------------------------------------------------------------------------------------------
N/A = Not Applicable
DEFERRED COMPENSATION OBLIGATION
Key maintains various deferred compensation plans, under which employees and
directors can defer a portion of their compensation for future distribution. All
or a portion of such deferrals will be distributed in the form of KeyCorp common
shares. Effective December 31, 2002, Key reclassified its $68 million obligation
relating to the portion of deferred compensation payable in KeyCorp common
shares from "other liabilities" to "capital surplus" in accordance with EITF
97-14,"Accounting for Deferred Compensation Arrangements Where Amounts Earned
Are Held in a Rabbi Trust and Invested." Among other things, EITF 97-14, which
became effective March 19, 1998, for deferrals after that date, requires that
the deferred compensation obligation to be settled by the delivery of shares be
classified in equity without any subsequent expense recognition for changes in
the market value of the underlying shares. Key did not reclassify its obligation
in prior years because it was not material.
15. STOCK OPTIONS
Key's compensation plans allow for the granting of stock options, stock
appreciation rights, limited stock appreciation rights, restricted stock and
performance shares to eligible employees and directors. Under all of the option
plans, exercise prices cannot be less than the fair value of Key's common stock
on the grant date. Generally, options become exercisable at the rate of 33% per
year beginning one year from their grant date and expire no later than 10 years
from their grant date.
At December 31, 2002, KeyCorp had 1,680,959 common shares available for future
grant, compared with 3,569,750 at December 31, 2001.
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
The following table summarizes activity, pricing and other information about
Key's stock options.
2002 2001
-------------------------------- ----------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
OPTIONS PRICE PER OPTION OPTIONS PRICE PER OPTION
- -------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 34,246,323 $ 24.66 34,291,153 $ 23.72
Granted 7,918,780 24.85 7,377,680 28.02
Exercised 2,346,983 16.08 2,212,746 14.96
Lapsed or canceled 2,142,189 26.54 5,209,764 27.27
- -------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 37,675,931 $ 25.14 34,246,323 $ 24.66
- -------------------------------------------------------------------------------------------------------------------------
Exercisable at end of year 16,368,542 $ 26.45 19,501,856 $ 24.80
- -------------------------------------------------------------------------------------------------------------------------
Weighted average fair value of options
granted during the year $ 3.95 $ 6.26
- -------------------------------------------------------------------------------------------------------------------------
The following table summarizes the range of exercise prices and other related
information pertaining to Key's stock options at December 31, 2002.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ----------------------------------------------------------------------------------- --------------------------------
RANGE OF WEIGHTED WEIGHTED AVERAGE WEIGHTED
EXERCISE NUMBER OF AVERAGE PRICE REMAINING OPTIONS AVERAGE
PRICES OPTIONS PER OPTION LIFE (YEARS) EXERCISABLE PRICE
- -------------------------------------------------------------------------------------------------------------------------
$8.94-$14.99 2,350,269 $ 14.14 1.7 2,350,269 $ 14.14
15.00-19.99 5,655,710 17.55 5.5 2,175,367 17.26
20.00-24.99 10,463,784 23.50 8.3 194,475 22.44
25.00-29.99 9,760,542 27.52 7.5 2,202,805 26.15
30.00-34.99 9,128,126 31.37 5.6 9,128,126 31.37
35.00-50.00 317,500 43.48 5.8 317,500 43.48
- -------------------------------------------------------------------------------------------------------------------------
Total 37,675,931 $ 25.14 6.6 16,368,542 $ 26.45
- -------------------------------------------------------------------------------------------------------------------------
Information pertaining to Key's method of accounting for employee stock options,
including pro forma disclosures of the net income and earnings per share effect
of stock options using the "fair value method," are included in Note 1 ("Summary
of Significant Accounting Policies") under the heading "Employee Stock Options"
on page 61.
16. EMPLOYEE BENEFITS
PENSION PLANS
Net periodic and total net pension cost (income) for all funded and unfunded
plans include the following components.
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- -------------------------------------------------------------------------
Service cost of benefits earned $ 40 $ 37 $ 37
Interest cost on projected
benefit obligation 54 53 53
Expected return on plan assets (91) (95) (90)
Amortization of unrecognized
net transition asset -- (2) (5)
Amortization of prior service cost -- 1 2
Amortization of losses 3 1 1
- -------------------------------------------------------------------------
Net periodic pension cost (income) 6 (5) (2)
Curtailment gain -- -- (2)
- -------------------------------------------------------------------------
Total net pension cost (income) $ 6 $ (5) $ (4)
==== ==== ====
- -------------------------------------------------------------------------
The curtailment gain in the above table resulted from Key's competitiveness
initiative and related reduction in workforce.
Changes in the projected benefit obligation ("PBO") related to Key's pension
plans are summarized as follows:
YEAR ENDED DECEMBER 31,
in millions 2002 2001
- -------------------------------------------------
PBO at beginning of year $ 787 $ 715
Service cost 40 37
Interest cost 54 53
Actuarial losses 31 57
Plan amendments 3 --
Benefit payments (69) (75)
- -------------------------------------------------
PBO at end of year $ 846 $ 787
===== =====
- -------------------------------------------------
Changes in the fair value of pension plan assets ("FVA") are summarized as
follows:
YEAR ENDED DECEMBER 31,
in millions 2002 2001
- -------------------------------------------------------
FVA at beginning of year $ 875 $ 1,062
Actual loss on plan assets (101) (121)
Employer contributions 12 9
Benefit payments (69) (75)
- -------------------------------------------------------
FVA at end of year $ 717 $ 875
======= =======
- -------------------------------------------------------
78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
The funded status of the pension plans at September 30 (the actuarial
measurement date), reconciled to the amounts recognized in the consolidated
balance sheets at December 31, 2002 and 2001, is as follows:
DECEMBER 31,
in millions 2002 2001
- --------------------------------------------------------------------
Funded status(a) $(129) $ 88
Unrecognized net loss 375 156
Unrecognized prior service benefit (1) (4)
Benefits paid subsequent to
measurement date 3 3
- --------------------------------------------------------------------
Net prepaid pension cost $ 248 $ 243
===== =====
- --------------------------------------------------------------------
Net prepaid pension cost consists of:
Prepaid benefit cost $ 342 $ 332
Accrued benefit liability (136) (89)
Deferred tax asset 14 --
Intangible asset 3 --
Accumulated other comprehensive loss 25 --
- --------------------------------------------------------------------
Net prepaid pension cost $ 248 $ 243
===== =====
- --------------------------------------------------------------------
(a) The excess (shortfall) of the fair value of plan assets over the projected
benefit obligation.
Included in the above table are the effects of certain nonqualified supplemental
executive retirement programs ("SERPs") that are unfunded. At December 31, 2002,
the projected benefit obligation for these unfunded plans was $148 million
(compared with $132 million at the end of 2001), and the accumulated benefit
obligation ("ABO") was $139 million (compared with $128 million at the end of
2001). The amount of accrued benefit liability for these plans was $136 million
at December 31, 2002, and $89 million at December 31, 2001.
Effective December 31, 2002, Key recorded an additional minimum liability
("AML") of $42 million for its SERPs. SFAS No. 87, "Employers' Accounting for
Pensions,"requires the recognition of an AML to the extent of any excess of the
unfunded ABO over the liability already recognized as unfunded accrued pension
cost. The after-tax effect of recording of the AML was a $25 million reduction
to "comprehensive income" in 2002. Key did not record an AML in prior years
because it was not material.
In order to determine the actuarial present value of benefit obligations and net
pension cost (income), management assumed the following weighted average rates:
YEAR ENDED DECEMBER 31, 2002 2001 2000
- ----------------------------------------------------------------
Discount rate 6.50% 7.25% 7.75%
Compensation increase rate 4.00 4.00 4.00
Expected return on plan assets 9.75 9.75 9.75
- ----------------------------------------------------------------
Management estimates that Key's net pension cost will be $38 million for 2003,
compared with cost of $6 million for 2002 and income of $5 million for 2001. The
substantial increase in cost for 2003 is due primarily to a decline in the fair
value of plan assets, reflecting continued weakness in the capital markets. The
higher cost also reflects an expected return of 9.00% on plan assets, compared
with expected returns of 9.75% in 2002 and 2001.
Management determines Key's expected return on plan assets by considering a
number of factors. Primary among these are:
- - Historical returns on Key's plan assets.
- - Historical returns that a portfolio with an investment mix similar to Key's
would have earned.
- - Management's expectations for returns on plan assets over the long term,
weighted for the investment mix of the assets. In accordance with Key's
current investment policy, plan assets include equity securities, which
comprise 65% to 85% of the portfolio; fixed income securities, which
comprise 15% to 30% of the portfolio; and convertible securities, which
comprise up to 15% of the portfolio.
Management estimates that a 25 basis point decrease (increase) in the expected
return on plan assets would increase (decrease) Key's net pension cost for 2003
by approximately $2 million.
Additionally, pension cost is affected by an assumed discount rate and an
assumed compensation increase rate. Management estimates that a 25 basis point
change in either or both of these assumed rates would change net pension cost
for 2003 by less than $1 million.
Despite the 2002 decline in the fair value of plan assets, at December 31, Key's
qualified plan was sufficiently funded under the Employee Retirement Income
Security Act of 1974, which outlines pension-funding laws. Consequently, no
minimum contributions to the plan were required at that time.
OTHER POSTRETIREMENT BENEFIT PLANS
Key sponsors a contributory postretirement healthcare plan. Retirees'
contributions are adjusted annually to reflect certain cost-sharing provisions
and benefit limitations. Key also sponsors life insurance plans covering certain
grandfathered employees. These plans are principally noncontributory.
Net periodic and total net postretirement benefit cost includes the following
components.
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- ---------------------------------------------------------------------------------
Service cost of benefits earned $ 3 $ 3 $ 3
Interest cost on accumulated
postretirement benefit obligation 8 8 7
Expected return on plan assets (2) (2) (2)
Amortization of transition obligation 1 4 5
- ---------------------------------------------------------------------------------
Net postretirement benefit cost 10 13 13
Curtailment (gain) loss -- (1) 5
- ---------------------------------------------------------------------------------
Total net postretirement
benefit cost $ 10 $ 12 $ 18
==== ==== ====
- ---------------------------------------------------------------------------------
The curtailment activity in the above table resulted from the previously
mentioned competitiveness initiative and workforce reduction.
Changes in the accumulated postretirement benefit obligation ("APBO") are
summarized as follows:
YEAR ENDED DECEMBER 31,
in millions 2002 2001
- ---------------------------------------------------------------
APBO at beginning of year $ 114 $ 106
Service cost 3 3
Interest cost 8 8
Plan participants' contributions 5 4
Actuarial losses 17 9
Benefit payments (19) (16)
- ---------------------------------------------------------------
APBO at end of year $ 128 $ 114
===== =====
- ---------------------------------------------------------------
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
Changes in the fair value of postretirement plan assets are summarized as
follows:
YEAR ENDED DECEMBER 31,
in millions 2002 2001
- -------------------------------------------------------------
FVA at beginning of year $ 39 $ 38
Employer contributions 18 19
Plan participants' contributions 5 4
Benefit payments (19) (16)
Actual loss on plan assets (4) (6)
- -------------------------------------------------------------
FVA at end of year $ 39 $ 39
==== ====
- -------------------------------------------------------------
The funded status of the postretirement plans at September 30 (the actuarial
measurement date), reconciled to the amounts recognized in the consolidated
balance sheets at December 31, 2002 and 2001, is as follows:
YEAR ENDED DECEMBER 31,
in millions 2002 2001
- -------------------------------------------------------------------
Funded status(a) $(89) $(76)
Unrecognized net loss 35 12
Unrecognized prior service cost 2 3
Unrecognized transition obligation 40 44
Contributions/benefits paid subsequent
to measurement date 10 9
- -------------------------------------------------------------------
Accrued postretirement benefit cost $ (2) $ (8)
==== ====
- -------------------------------------------------------------------
(a) The excess of the accumulated postretirement benefit obligation over the
fair value of plan assets.
The assumed weighted average healthcare cost trend rate for 2003 is 10.0% for
both Medicare-eligible retirees and non-Medicare-eligible retirees. The rate is
assumed to decrease gradually to 5.0% by the year 2013 and remain constant
thereafter. Increasing or decreasing the assumed healthcare cost trend rate by
one percentage point each future year would not have a material impact on net
postretirement benefit cost or obligations since the postretirement plans have
cost-sharing provisions and benefit limitations.
To determine the accumulated postretirement benefit obligation and the net
postretirement benefit cost, management assumed the following weighted average
rates:
YEAR ENDED DECEMBER 31, 2002 2001 2000
- ----------------------------------------------------------------
Discount rate 6.50% 7.25% 7.75%
Expected return on plan assets 5.73 5.71 5.71
- ----------------------------------------------------------------
EMPLOYEE 401(K) SAVINGS PLAN
A substantial majority of Key's employees are covered under a savings plan that
is qualified under Section 401(k) of the Internal Revenue Code. Key's plan
permits employees to contribute from 1% to 16% (1% to 10% prior to January 1,
2002) of eligible compensation, with up to 6% being eligible for matching
contributions in the form of Key common shares. The plan also permits Key to
distribute a discretionary profit-sharing component. Total expense associated
with the plan was $54 million in 2002, $42 million in 2001 and $51 million in
2000.
17. INCOME TAXES
Income taxes included in the consolidated statements of income are summarized
below. Key files a consolidated federal income tax return.
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- ------------------------------------------------------------------------
Currently payable:
Federal $ 150 $ 222 $ 147
State 31 19 33
- ------------------------------------------------------------------------
181 241 180
Deferred:
Federal 150 (133) 307
State 5 (6) 28
- ------------------------------------------------------------------------
155 (139) 335
- ------------------------------------------------------------------------
Total income tax expense(a) $ 336 $ 102 $ 515
===== ===== =====
- ------------------------------------------------------------------------
(a) Income tax expense (benefit) on securities transactions totaled $2 million
in 2002, $14 million in 2001 and ($10) million in 2000. Income tax expense
in the above table excludes equity- and gross receipts-based taxes, which
are assessed in lieu of an income tax in certain states in which Key
operates. These taxes are recorded in noninterest expense on the income
statement and totaled $26 million in 2002, $29 million in 2001 and $33
million in 2000.
Significant components of Key's deferred tax assets and liabilities are as
follows:
DECEMBER 31,
in millions 2002 2001
- ---------------------------------------------------------------------------
Provision for loan losses $ 477 $ 604
Restructuring charges 10 22
Write-down of OREO 4 5
Other 268 294
- ---------------------------------------------------------------------------
Total deferred tax assets 759 925
Leasing income reported using the operating
method for tax purposes 2,104 1,853
Net unrealized securities gains 57 18
Depreciation 12 --
Other 388 606
- ---------------------------------------------------------------------------
Total deferred tax liabilities 2,561 2,477
- ---------------------------------------------------------------------------
Net deferred tax liabilities $1,802 $1,552
====== ======
- ---------------------------------------------------------------------------
80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
The following table shows how Key arrived at total income tax expense and the
effective tax rate.
YEAR ENDED DECEMBER 31, 2002 2001 2000
-------------- ----------------- ------------------
dollars in millions AMOUNT RATE AMOUNT RATE AMOUNT RATE
- ------------------------------------------------------------------------------------------------------------------------------
Income before income taxes times 35% statutory federal tax rate $459 35.0% $ 90 35.0% $ 531 35.0%
State income tax, net of federal tax benefit 23 1.8 9 3.4 40 2.6
Amortization of nondeductible intangibles -- -- 78 30.1 27 1.8
Tax-exempt interest income (13) (1.0) (15) (5.9) (18) (1.2)
Corporate-owned life insurance income (39) (3.0) (42) (16.3) (40) (2.7)
Tax credits (37) (2.8) (42) (16.1) (36) (2.4)
Reduced tax rate on lease income (61) (4.7) (13) (5.1) -- --
Other 4 .3 37 14.3 11 .8
- ------------------------------------------------------------------------------------------------------------------------------
Total income tax expense $336 25.6% $ 102 39.4% $ 515 33.9%
==== ==== ===== ==== ===== ====
- ------------------------------------------------------------------------------------------------------------------------------
18. 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 businesses and
reduced the number of management layers. This phase was completed in 2000.
During 2002, Key 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:
- - consolidating 22 business lines into 10 to simplify Key's business
structure;
- - streamlining and automating business operations and processes;
- - standardizing product offerings and internal processes;
- - consolidating operating facilities and service centers; and
- - outsourcing certain noncore activities.
Management expected the initiative to reduce Key's workforce by approximately
4,000 positions. Those reductions were to occur at all levels throughout the
organization. During 2002, Key completed its workforce reduction, bringing the
total number of positions eliminated in the initiative to nearly 4,100.
Changes in the components of the restructuring charge liability associated with
the actions taken are as follows:
DECEMBER 31, RESTRUCTURING CASH DECEMBER 31,
in millions 2001 CHARGES (CREDITS) PAYMENTS 2002
- -----------------------------------------------------------------------------------------
Severance $ 27 $(11) $ 13 $ 3
Site consolidations 33 3 9 27
Equipment and other 1 (1) -- --
- -----------------------------------------------------------------------------------------
Total $ 61 $ (9) $ 22 $ 30
==== ==== ==== ====
- -----------------------------------------------------------------------------------------
19. COMMITMENTS, CONTINGENT LIABILITIES AND GUARANTEES
OBLIGATIONS UNDER NONCANCELABLE LEASES
Key is obligated under various noncancelable leases for land, buildings and
other property, consisting principally of data processing equipment. Rental
expense under all operating leases totaled $132 million in 2002, $132 million in
2001 and $136 million in 2000. Minimum future rental payments under
noncancelable leases at December 31, 2002, are as follows: 2003 -- $125 million;
2004 -- $113 million; 2005 -- $99 million; 2006 -- $91 million; 2007 -- $79
million; all subsequent years -- $395 million.
COMMITMENTS TO EXTEND CREDIT OR FUNDING
Loan commitments 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 applications
for credit are reviewed and approved, credit limits are established and, when
necessary, demands for collateral are made. 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 related to commitments to
extend credit.
Loan commitments provide for financing on predetermined terms as long as the
client continues to meet specified criteria. These agreements 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 obtain a loan commitment from
Key. Since a commitment may expire without resulting in a loan, the total amount
of outstanding commitments may significantly exceed Key's eventual cash outlay.
The table on page 82 shows the remaining contractual amount of each class of
commitments to extend credit or funding as of the date indicated.
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
This amount also represents Key's maximum possible accounting loss. The
estimated fair values of these instruments are not material; there are no
observable liquid markets for the majority of these instruments.
DECEMBER 31,
in millions 2002 2001
- ---------------------------------------------------------------------
Loan commitments:
Home equity $ 5,531 $ 4,965
Commercial real estate and construction 2,042 2,487
Commercial and other 25,005 24,936
- ---------------------------------------------------------------------
Total loan commitments 32,578 32,388
Principal investing commitments 222 191
Commercial letters of credit 135 106
- ---------------------------------------------------------------------
Total loan and other commitments $32,935 $32,685
======= =======
- ---------------------------------------------------------------------
LEGAL PROCEEDINGS
RESIDUAL VALUE INSURANCE LITIGATION. Key Bank USA obtained two insurance
policies from Reliance Insurance Company ("Reliance") insuring the residual
value of certain automobiles leased through Key Bank USA. The two policies ("the
Policies"), the "4011 Policy" and the "4019 Policy," together covered leases
entered into during the period from January 1, 1997 to January 1, 2001.
The 4019 Policy contains an endorsement stating that Swiss Reinsurance America
Corporation ("Swiss Re") will assume and reinsure 100% of Reliance's obligations
under the 4019 Policy in the event Reliance Group Holdings' ("Reliance's
parent") so-called "claims-paying ability" were to fall below investment grade.
Key Bank USA also entered into an agreement with Swiss Re and Reliance whereby
Swiss Re agreed to issue to Key Bank USA an insurance policy on the same terms
and conditions as the 4011 Policy in the event the financial condition of
Reliance Group Holdings fell below a certain level. Around May 2000, the
conditions under both the 4019 Policy and the Swiss Re agreement were triggered.
The 4011 Policy was canceled and replaced as of May 1, 2000, by a policy issued
by North American Specialty Insurance Company (a subsidiary or affiliate of
Swiss Re) ("the NAS Policy"). Tri-Arc Financial Services, Inc. ("Tri-Arc") acted
as agent for Reliance, Swiss Re and NAS. Since February 2000, Key Bank USA has
been filing claims under the Policies, but none of these claims has been paid.
In July 2000, Key Bank USA filed a claim for arbitration against Reliance, Swiss
Re, NAS and Tri-Arc seeking, among other things, a declaration of the scope of
coverage under the Policies and for damages. On January 8, 2001, Reliance filed
an action (litigation) against Key Bank USA in Federal District Court in Ohio
seeking rescission or reformation of the Policies because they allegedly do not
reflect the intent of the parties with respect to the scope of coverage and how
and when claims were to be paid. Key filed an answer and counterclaim against
Reliance, Swiss Re, NAS and Tri-Arc seeking, among other things, declaratory
relief as to the scope of coverage under the Policies, damages for breach of
contract and failure to act in good faith, and punitive damages. The parties
agreed to proceed with this court action and to dismiss the arbitration without
prejudice.
On May 29, 2001, the Commonwealth Court of Pennsylvania entered an order placing
Reliance in a court supervised "rehabilitation" and purporting to stay all
litigation against Reliance. On July 23, 2001, the Federal District Court in
Ohio stayed the litigation to allow the rehabilitator to complete her task. On
October 3, 2001, the Court in Pennsylvania entered an order placing Reliance
into liquidation and canceling all Reliance insurance policies as of November 2,
2001. On November 20, 2001, the Federal District Court in Ohio entered an order
that, among other things, required Reliance to report to the Court on the
progress of the liquidation. On January 15, 2002, Reliance filed a status report
requesting the continuance of the stay for an indefinite period. On February 20,
2002, Key Bank USA filed a Motion for Partial Lifting of the July 23, 2001, Stay
in which it asked the Court to allow the case to proceed against the parties
other than Reliance. The Court granted Key Bank USA's motion on May 17, 2002.
Management believes that Key Bank USA has valid insurance coverage or claims for
damages relating to the residual value of automobiles leased through Key Bank
USA during the four-year period ending January 1, 2001. With respect to each
individual lease, however, it is not until the lease expires and the vehicle is
sold that Key Bank USA can determine the existence and amount of any actual loss
(i.e., the difference between the residual value provided for in the lease
agreement and the vehicle's actual market value at lease expiration). Key Bank
USA's actual total losses for which it will file claims will depend to a large
measure upon the viability of, and pricing within, the market for used cars
throughout the lease run- off period, which extends through 2006. The market for
used cars varies.
Accordingly, the total expected loss on the portfolio for which Key Bank USA
will file claims cannot be determined with certainty at this time. Claims filed
by Key Bank USA through December 31, 2002, total approximately $259 million, and
management currently estimates that approximately $102 million of additional
claims may be filed through year-end 2006. As discussed above, a number of
factors could affect Key Bank USA's actual loss experience, which may be higher
or lower than management's current estimates.
Key is filing insurance claims for the entire amount of its losses and is
recording as a receivable on its balance sheet a portion of the amount of the
insurance claims as and when they are filed. Management believes the amount
being recorded as a receivable due from the insurance carriers is appropriate to
reflect the collectibility risk associated with the insurance litigation;
however, litigation is inherently not without risk, and any actual recovery from
the litigation may be more or less than the receivable. While management does
not expect an adverse decision, if a court were to make an adverse final
determination, such result would cause Key to record a material one-time expense
during the period when such determination is made. An adverse determination
would not have a material effect on Key's financial condition, but could have a
material adverse effect on Key's results of operations in the quarter it occurs.
OTHER LITIGATION. In the ordinary course of business, Key is subject to legal
actions that involve claims for substantial monetary relief. Based on
information presently known to management, management does not believe there is
any legal action to which KeyCorp or any of its subsidiaries is a party, or
involving any of their properties, that, individually or in the aggregate, could
reasonably be expected to have a material adverse effect on Key's financial
condition or annual results of operations.
82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
GUARANTEES
Key is a guarantor in various agreements with third parties. In accordance with
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others,"certain
guarantees issued or modified on or after January 1, 2003, will require the
recognition of a liability on Key's balance sheet for the "stand ready"
obligation associated with such guarantees. The accounting for guarantees
existing at December 31, 2002, was not revised. Thus, the stand ready obligation
related to the majority of Key's guarantees was not recorded on the balance
sheet at December 31, 2002. Additional information pertaining to Interpretation
No. 45 is summarized in Note 1 ("Summary of Significant Accounting Policies")
under the heading "Accounting Pronouncements Pending Adoption" on page 62. The
following table shows the types of guarantees (as defined by Interpretation No.
45) that Key had outstanding at December 31, 2002.
MAXIMUM POTENTIAL
UNDISCOUNTED LIABILITY
in millions FUTURE PAYMENTS RECORDED
- ----------------------------------------------------------------------------
Financial guarantees:
Standby letters of credit $4,325 --
Credit enhancement for
asset-backed commercial
paper conduit 68 $ 1
Recourse agreement with FNMA 227 4
Return guaranty agreement
with LIHTC investors 851 35
Default guarantees 140 2
Written interest rate caps(a) 43 24
- ----------------------------------------------------------------------------
Total $5,654 $ 66
====== ======
- ----------------------------------------------------------------------------
(a) As of December 31, 2002, the weighted average interest rate of written
interest rate caps was 1.5%. Maximum potential undiscounted future payments
were calculated assuming a 10% interest rate.
STANDBY LETTERS OF CREDIT. These instruments obligate Key to pay a third- party
beneficiary when a customer fails to repay an outstanding loan or debt
instrument, or fails to perform some contractual nonfinancial obligation.
Standby letters of credit are issued by many of Key's lines of business to
address clients' financing needs. If amounts are drawn under standby letters of
credit, such amounts are treated as loans; they bear interest (generally at
variable rates) and pose the same credit risk to Key as a loan would. At
December 31, 2002, Key's standby letters of credit had a remaining weighted
average life of approximately 2 years, with remaining actual lives ranging from
less than 1 to 16 years.
CREDIT ENHANCEMENT FOR ASSET-BACKED COMMERCIAL PAPER CONDUIT. Key provides
credit enhancement in the form of a committed facility to ensure the continuing
operations of an asset-backed commercial paper conduit, which is owned by a
third party and administered by an unaffiliated financial institution. The
commitment to provide credit enhancement extends until September 26, 2003, and
specifies that in the event of default by certain borrowers whose loans are held
by the conduit, Key will provide financial relief to the conduit in an amount
that is based on defined criteria that consider the level of credit risk
involved and other factors.
At December 31, 2002, Key's funding requirement under the credit enhancement
facility totaled $59 million. However, there were no drawdowns under the
facility during or at the end of the year. Key has no recourse or other
collateral available to offset any amounts that may be funded under this credit
enhancement facility. Key's commitments to provide increased credit enhancement
to the conduit are periodically evaluated by management.
RECOURSE AGREEMENT WITH FEDERAL NATIONAL MORTGAGE ASSOCIATION. KBNA participates
as a lender in the Federal National Mortgage Association ("FNMA") Delegated
Underwriting and Servicing ("DUS") program. As a condition to FNMA's delegation
of responsibility for originating, underwriting and servicing mortgages, KBNA
has agreed to assume a limited portion of the risk of loss during the remaining
term on each commercial mortgage loan sold. Accordingly, a reserve for such
potential losses has been established and is maintained in an amount estimated
by management to approximate the fair value of the liability undertaken by KBNA.
The outstanding commercial mortgage loans in this program had a weighted average
remaining term of 10 years at December 31, 2002. At December 31, 2002, the
unpaid principal balance outstanding of loans sold by KBNA as a participant in
this program was approximately $1.1 billion. The maximum potential amount of
undiscounted future payments that may be required under this program is equal to
20% of the principal balance of loans outstanding at December 31, 2002. If
payment is required under this program, Key would have an interest in the
collateral underlying the commercial mortgage loan on which the loss occurred.
RETURN GUARANTEE AGREEMENT WITH LOW-INCOME HOUSING TAX CREDIT ("LIHTC")
INVESTORS. Key Affordable Housing Corporation ("KAHC"), a subsidiary of KBNA,
offers limited partnership interests to qualified investors. Unconsolidated
partnerships formed by KAHC invest in low-income residential rental properties
that qualify for federal LIHTCs under Section 42 of the Internal Revenue Code.
In certain partnerships, investors pay a fee to KAHC for a guaranteed return
that is dependent on the financial performance of the property and the
property's ability to maintain its LIHTC status throughout the fifteen-year
compliance period. If these two conditions are not achieved, Key is obligated to
make any necessary payments to investors to provide the guaranteed return. KAHC
has the ability to affect changes in the management of the properties to improve
performance. However, other than the underlying income stream from the
properties, no recourse or collateral would be available to offset the guarantee
obligation. These guarantees have expiration dates that extend through 2018. Key
meets its obligations pertaining to the guaranteed returns generally through the
distribution of tax credits and deductions associated with the specific
properties.
As shown in the preceding table, KAHC had established a reserve in the amount of
$35 million at December 31, 2002, which management believes will be sufficient
to cover estimated future obligations under the guarantees. However, in
accordance with Interpretation No. 45, for any return guarantee agreements
entered into or modified with LIHTC investors on or after January 1, 2003, all
fees received in consideration for the guarantee will be established as the fair
value liability.
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
VARIOUS TYPES OF DEFAULT GUARANTEES. Some lines of business provide or
participate in guarantees that obligate Key to perform if the debtor fails to
pay all or a portion of the subject indebtedness and/or related interest. These
guarantees are generally undertaken when Key is supporting or protecting its
underlying investment or where the risk profile of the debtor should provide an
investment return. The terms of these default guarantees range from 1 year to as
many as 19 years. Although no collateral is held, Key would have recourse
against the debtors for any payments made under these default guarantees.
WRITTEN INTEREST RATE CAPS. In the ordinary course of business, Key writes
interest rate caps for commercial loan clients that have variable rate loans
with Key. These caps are purchased by clients to limit their exposure to
interest rate increases.
Key is obligated to pay the interest rate counterparty if the applicable
benchmark interest rate exceeds a specified level (known as the "strike rate")
over a weighted average life of approximately 8.3 years. These instruments are
accounted for as derivatives with the fair market value liability recorded in
"other liabilities" on the balance sheet. Key's potential amount of future
payments under these obligations is mitigated by the fact that the company
enters into offsetting positions with third parties.
OTHER OFF-BALANCE SHEET RISK
Other off-balance sheet risk stems from financial instruments that do not meet
the definition of a guarantee as specified in Interpretation No. 45 and from
other relationships.
LIQUIDITY FACILITIES THAT SUPPORT ASSET-BACKED COMMERCIAL PAPER CONDUITS. Key
provides liquidity to all or a portion of two separate asset- backed commercial
paper conduits that are owned by third parties and administered by unaffiliated
financial institutions. These liquidity facilities obligate Key through February
15, 2005, to provide funding if such is required as a result of a disruption in
the markets or other factors. Additional information about these asset-backed
commercial paper conduits is summarized in Note 1 ("Summary of Significant
Accounting Policies") under the heading "Basis of Presentation" on page 57 and
in Note 8 ("Loan Securitizations and Variable Interest Entities") under the
heading "Variable Interest Entities" on page 71.
Key provides liquidity to the conduits in the form of committed facilities of
$1.7 billion. The amount available to be drawn on these facilities was $712
million at December 31, 2002. However, there were no drawdowns under either of
the committed facilities at that time. Of the $1.7 billion of liquidity facility
commitments, $108 million is associated with a conduit program that is in the
process of being liquidated. Therefore, Key's commitment will decrease as the
assets in this conduit program decrease. Key's commitments to provide liquidity
are periodically evaluated by management.
INDEMNIFICATIONS PROVIDED IN THE ORDINARY COURSE OF BUSINESS. Key provides
certain indemnifications primarily through representations and warranties in
contracts that are entered into in the ordinary course of business in connection
with purchases and sales of businesses, loan sales and other ongoing activities.
Management's past experience with these indemnifications has been that the
amounts paid, if any, have not had a significant effect on Key's financial
condition or results of operations.
INTERCOMPANY GUARANTEES. KeyCorp and primarily KBNA are parties to various
guarantees that are undertaken to facilitate the ongoing business activities of
other Key affiliates. These business activities encompass debt issuance, certain
lease and insurance obligations, investments and securities, and certain leasing
transactions involving clients.
RELATIONSHIP WITH MASTERCARD INTERNATIONAL INC. AND VISA U.S.A. INC. KBNA and
Key Bank USA are members of MasterCard International Inc. and Visa U.S.A. Inc.
MasterCard's charter documents and bylaws state that MasterCard may assess
members for certain liabilities, including litigation liabilities. Visa's
charter documents state that Visa may fix fees payable by members in connection
with Visa's operations. Descriptions of pending lawsuits and MasterCard's and
Visa's positions regarding the potential impact of those lawsuits on members are
set forth on MasterCard's and Visa's respective websites and in MasterCard's
public filings with the Securities and Exchange Commission. Key is not a party
to any significant litigation by third parties against MasterCard or Visa.
20. DERIVATIVES AND HEDGING ACTIVITIES
Key, mainly through its lead bank, KBNA, is party to various derivative
instruments. These instruments are used for asset and liability management and
trading purposes. Generally, these instruments help Key meet clients' financing
needs and manage exposure to "market risk" -- the possibility that economic
value or net interest income will be adversely affected by changes in interest
rates or other economic factors. However, like other financial instruments,
these derivatives contain an element of "credit risk" -- the possibility that
Key will incur a loss because a counterparty fails to meet its contractual
obligations.
The primary derivatives that Key uses are interest rate swaps, caps and futures,
and foreign exchange forward contracts. All foreign exchange forward contracts
and interest rate swaps and caps held are over-the-counter instruments.
ACCOUNTING TREATMENT AND VALUATION
Effective January 1, 2001, Key adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," 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 "Derivatives Used for Asset and Liability Management Purposes" on page
60.
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.
84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
At December 31, 2002, Key had $849 million of derivative assets and $151 million
of derivative liabilities on its balance sheet that were being used in
connection with hedging activities. As of the same date, the fair value of
derivative assets and liabilities classified as trading derivatives totaled $1.6
billion and $1.5 billion, respectively. Derivative assets and liabilities are
recorded in "accrued income and other assets" and "accrued expense and other
liabilities," respectively, on the balance sheet.
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 into 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 2002, Key recognized a net gain of approximately $3 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 into fixed-rate debt 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 that could result from changes in
interest rates 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.
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
consolidated income statement. This reclassification relates to a cash flow
hedge of a previously forecasted debt issuance that Key did not make.
During 2002, the net gain recognized by Key in connection with the ineffective
portion of its cash flow hedging instruments was not significant. The exclusion
of portions of hedging instruments from the assessment of hedge effectiveness
had no effect on earnings during 2002.
The change in "accumulated other comprehensive income (loss)" resulting from
cash flow hedges is as follows:
RECLASSIFICATION
DECEMBER 31, 2002 OF LOSSES DECEMBER 31,
in millions 2001 HEDGING ACTIVITY TO NET INCOME 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income
(loss) resulting from cash flow hedges $(2) $(29) $37 $6
- ----------------------------------------------------------------------------------------------------------------------------------
Key expects to reclassify an estimated $47 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 Key's
commercial loan clients, and enters into positions with third parties that are
intended to offset or mitigate the interest rate risk of the client positions.
The transactions entered into with clients are generally limited to conventional
interest rate 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 and futures 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.
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- -------------------------------------------------------------------
Interest rate contracts $10 $17 $32
Foreign exchange forward contracts 33 40 35
Option and futures contracts -- -- 3
- -------------------------------------------------------------------
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
COUNTERPARTY CREDIT RISK
Swaps and caps present credit risk because the counterparty may not meet the
terms of the contract. This risk is measured as the expected positive
replacement value of contracts. To mitigate credit risk, Key deals exclusively
with counterparties that have high credit ratings.
Key uses two additional precautions to manage exposure to credit risk on swap
contracts. First, Key generally enters into bilateral collateral and master
netting arrangements. These agreements include legal rights of setoff that
provide for the net settlement of the related contracts with the same
counterparty in the event of default. Second, Credit Administration monitors
credit risk exposure to the counterparty on each interest rate swap to determine
appropriate limits on Key's total credit exposure and whether it is advisable to
demand collateral.
At December 31, 2002, Key was party to interest rate swaps and caps with 51
different counterparties. Among these were swaps and caps entered into to offset
the risk of client exposure. Key had aggregate credit exposure of $631 million
to 31 of these counterparties, with the largest credit exposure to an individual
counterparty amounting to approximately $277 million.
21. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS
The carrying amount and estimated fair value of Key's financial instruments are
shown below in accordance with the requirements of SFAS No. 107, "Disclosures
About Fair Value of Financial Instruments."
DECEMBER 31, 2002 2001
---------------------- -----------------------
CARRYING FAIR CARRYING FAIR
in millions AMOUNT VALUE AMOUNT VALUE
- ---------------------------------------------------------------------------------------------
ASSETS
Cash and short-term investments(a) $ 4,996 $ 4,996 $ 4,789 $ 4,789
Securities available for sale(b) 8,507 8,507 5,408 5,408
Investment securities(b) 120 129 225 234
Other investments(c) 919 919 832 832
Loans, net of allowance(d) 61,005 62,703 61,632 62,938
Servicing assets(a) 99 99 73 73
Derivative assets(f) 2,477 2,477 1,107 1,107
LIABILITIES
Deposits with no stated maturity(a) $28,908 $28,908 $25,047 $25,047
Time deposits(e) 20,438 21,021 19,748 20,067
Short-term borrowings(a) 6,685 6,685 9,284 9,284
Long-term debt(e) 15,605 15,712 14,554 14,268
Derivative liabilities(f) 1,628 1,628 899 899
CAPITAL SECURITIES(c) 1,260 1,129 1,288 1,157
- ---------------------------------------------------------------------------------------------
Valuation Methods and Assumptions:
(a) Fair value equals or approximates carrying amount.
(b) Fair values of securities available for sale and investment securities
generally were based on quoted market prices. Where quoted market prices
were not available, fair values were based on quoted market prices of
similar instruments.
(c) Fair values of most other investments were estimated based on the issuer's
financial condition and results of operations, prospects, values of public
companies in comparable businesses, market liquidity, and the nature and
duration of resale restrictions. Where fair values were not readily
determinable, they were based on fair values of similar instruments, or the
investments were included at their carrying amounts.
(d) Fair values of most loans were estimated using discounted cash flow models.
Lease financing receivables and loans held for sale were included at their
carrying amounts in the estimated fair value of loans.
(e) Fair values of time deposits, long-term debt and capital securities were
estimated based on discounted cash flows.
(f) Fair values of interest rate swaps and caps were based on discounted cash
flow models. Foreign exchange forward contracts were valued based on quoted
market prices and had a fair value that approximated their carrying amount.
Residential real estate mortgage loans with carrying amounts of $2.0 billion at
December 31, 2002, and $2.3 billion at December 31, 2001, are included in the
amount shown for "Loans, net of allowance." The estimated fair values of
residential real estate mortgage loans and deposits do not take into account the
fair values of long-term client relationships, which are integral parts of the
related financial instruments. The estimated fair values of these instruments
would be significantly higher if they included the fair values of these
relationships.
For financial instruments with a remaining average life to maturity of less than
six months, carrying amounts were used as an approximation of fair values.
If management used different assumptions (related to discount rates and cash
flow) and estimation methods, the estimated fair values shown in the table could
change significantly. Accordingly, these estimates do not necessarily reflect
the amounts Key's financial instruments would command in a current market
exchange. Similarly, because SFAS No. 107 excludes certain financial instruments
and all nonfinancial instruments from its disclosure requirements, the fair
value amounts shown in the table do not, by themselves, represent the underlying
value of Key as a whole.
86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
22. CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY
CONDENSED BALANCE SHEETS
DECEMBER 31,
in millions 2002 2001
- ------------------------------------------------------------------------
ASSETS
Interest-bearing deposits with KBNA $ 1,406 $ 1,054
Loans and advances to subsidiaries:
Banks 77 99
Nonbank subsidiaries 693 669
- ------------------------------------------------------------------------
770 768
Investment in subsidiaries:
Banks 5,884 5,744
Nonbank subsidiaries 1,993 2,004
- ------------------------------------------------------------------------
7,877 7,748
Accrued income and other assets 881 780
- ------------------------------------------------------------------------
Total assets $10,934 $10,350
======= =======
LIABILITIES
Accrued expense and other liabilities $ 595 $ 580
Short-term borrowings 187 121
Long-term debt:
Subsidiary trusts 1,142 1,282
Unaffiliated companies 2,175 2,212
- ------------------------------------------------------------------------
3,317 3,494
- ------------------------------------------------------------------------
Total liabilities 4,099 4,195
SHAREHOLDERS' EQUITY(a) 6,835 6,155
- ------------------------------------------------------------------------
Total liabilities and shareholders' equity $10,934 $10,350
======= =======
- ------------------------------------------------------------------------
(a) See page 55 for KeyCorp's Consolidated Statements of Changes in
Shareholders' Equity.
CONDENSED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- ----------------------------------------------------------------------------------------------------
INCOME
Dividends from subsidiaries:
Banks $ 900 $ 500 $ 1,440
Nonbank subsidiaries 200 107 57
Interest income from subsidiaries 54 77 62
Other income 3 49 46
- ----------------------------------------------------------------------------------------------------
1,157 733 1,605
EXPENSES
Interest on long-term debt with subsidiary trusts 80 92 98
Interest on other borrowed funds 33 132 133
Restructuring charges (credits) -- (4) 102
Personnel and other expense 58 56 59
- ----------------------------------------------------------------------------------------------------
171 276 392
Income before income tax benefit and equity in
net income less dividends from subsidiaries 986 457 1,213
Income tax benefit 53 28 103
- ----------------------------------------------------------------------------------------------------
1,039 485 1,316
Equity in net income less dividends from subsidiaries (63) (353) (314)
- ----------------------------------------------------------------------------------------------------
NET INCOME $ 976 $ 132 $ 1,002
======= ======= =======
- ----------------------------------------------------------------------------------------------------
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
CONDENSED STATEMENTS OF CASH FLOW
YEAR ENDED DECEMBER 31,
in millions 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 976 $ 132 $ 1,002
Adjustments to reconcile net income to net cash provided by operating
activities:
Amortization of intangibles -- 20 24
Net securities gains (losses) 16 (28) (7)
Deferred income taxes (21) (20) 10
Equity in net income less dividends from subsidiaries 63 353 314
Net increase in other assets (113) (69) (213)
Net increase in other liabilities 244 125 133
Net increase (decrease) in accrued restructuring charges (32) (68) 33
Other operating activities, net 11 39 (35)
- ------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,144 484 1,261
INVESTING ACTIVITIES
Cash used in acquisition, net of cash acquired (66) -- --
Net (increase) decrease in interest-bearing deposits (352) (507) 136
Purchases of securities available for sale (8) (50) (192)
Proceeds from prepayments and maturities of securities available for sale 25 195 10
Net increase in loans and advances to subsidiaries (1,648) (136) (83)
(Increase) decrease in investments in subsidiaries 1,604 670 (846)
- ------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (445) 172 (975)
FINANCING ACTIVITIES
Net increase (decrease) in short-term borrowings 66 (1,063) 665
Net proceeds from issuance of long-term debt 423 1,142 290
Payments on long-term debt (637) (230) (334)
Loan payment received from ESOP trustee -- 13 11
Purchases of treasury shares (77) (50) (462)
Proceeds from issuance of common stock pursuant to employee
benefit and dividend reinvestment plans 37 33 28
Cash dividends paid (511) (501) (484)
- ------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (699) (656) (286)
- ------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS -- -- --
CASH AND DUE FROM BANKS AT BEGINNING OF YEAR -- -- --
- ------------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF YEAR -- -- --
======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------
KeyCorp paid interest on borrowed funds amounting to $113 million in 2002, $224
million in 2001 and $231 million in 2000.
88