1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1996
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From To
------- -------
Commission File Number 0-850
[KEYCORP LOGO APPEARS HERE}
KEYCORP
------------------------------------------------------
(Exact name of registrant as specified in its charter)
OHIO 34-6542451
- ---------------------------------------- -----------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
- ---------------------------------------- -----------------------------
(Address of principal executive offices) (Zip Code)
(216) 689-6300
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Shares, $1 par value 225,404,812 Shares
- --------------------------------- ---------------------------------
(Title of class) (Outstanding at October 31, 1996)
The number of pages of this report is 44.
2
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
-------------------- -----------
Consolidated Balance Sheets --
September 30, 1996, December 31, 1995, and September 30, 1995 3
Consolidated Statements of Income --
Three months and nine months ended September 30, 1996 and 1995 4
Consolidated Statements of Changes in Shareholders' Equity --
Nine months ended September 30, 1996 and 1995 5
Consolidated Statements of Cash Flow --
Nine months ended September 30, 1996 and 1995 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 17
Item 2. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations 18
-------------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 41
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Item 5 Other Information 41
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Item 6. Exhibits and Reports on Form 8-K 41
--------------------------------
Signature 42
2
3
PART I. FINANCIAL INFORMATION
KEYCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, December 31, September 30,
dollars in millions 1996 1995 1995
- ----------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (Unaudited)
ASSETS
Cash and due from banks $ 3,110 $ 3,444 $ 3,344
Short-term investments 501 682 522
Mortgage loans held for sale 82 640 659
Securities available for sale 7,113 8,060 1,596
Investment securities (fair value: $1,689, $1,738
and $9,689, respectively) 1,653 1,688 9,660
Loans 48,291 47,692 48,410
Less: Allowance for loan losses 870 876 879
- ----------------------------------------------------------------------------------------------------------------------
Net loans 47,421 46,816 47,531
Premises and equipment 1,052 1,030 1,023
Goodwill 838 899 907
Other intangible assets 144 171 174
Corporate owned life insurance 1,301 1,088 839
Other assets 2,141 1,821 1,712
- ----------------------------------------------------------------------------------------------------------------------
Total assets $ 65,356 $ 66,339 $ 67,967
======================================================================================================================
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 9,032 $ 9,281 $ 8,611
Interest-bearing 34,608 36,764 37,279
Deposits in foreign offices-- interest-bearing 883 1,237 2,015
- ----------------------------------------------------------------------------------------------------------------------
Total deposits 44,523 47,282 47,905
Federal funds purchased and securities sold
under repurchase agreements 5,592 5,544 5,908
Other short-term borrowings 3,861 2,880 3,633
Other liabilities 1,740 1,477 1,390
Long-term debt 4,664 4,003 4,048
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities 60,380 61,186 62,884
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; authorized 25,000,000 shares,
none issued -- -- --
10% Cumulative Preferred Stock Class A, $125 stated value;
authorized 1,400,000 shares, issued 1,280,000 shares in 1995 -- 160 160
Common Shares, $1 par value; authorized 900,000,000 shares;
issued 245,944,390 shares 246 246 246
Capital surplus 1,488 1,500 1,501
Retained earnings 3,994 3,633 3,514
Loans to ESOP trustee (49) (51) (64)
Net unrealized gains (losses) on securities, net of income taxes (37) 48 (25)
Treasury stock at cost (18,882,718, 12,241,569 and 8,554,987 shares) (666) (383) (249)
- ----------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 4,976 5,153 5,083
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 65,356 $ 66,339 $ 67,967
======================================================================================================================
See notes to consolidated financial statements (unaudited).
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4
KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
dollars in millions, except per share amounts 1996 1995 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 1,087 $ 1,103 $ 3,238 $ 3,229
Mortgage loans held for sale 2 4 10 12
Taxable investment securities 4 139 11 426
Tax-exempt investment securities 20 21 58 65
Securities available for sale 119 23 372 72
Short-term investments 6 9 19 39
- ---------------------------------------------------------------------------------------------------------------------------
Total interest income 1,238 1,299 3,708 3,843
INTEREST EXPENSE
Deposits 360 434 1,111 1,287
Federal funds purchased and securities
sold under repurchase agreements 72 79 218 228
Other short-term borrowings 55 52 144 158
Long-term debt 68 68 201 194
- ---------------------------------------------------------------------------------------------------------------------------
Total interest expense 555 633 1,674 1,867
- ---------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 683 666 2,034 1,976
Provision for loan losses 49 27 140 66
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 634 639 1,894 1,910
NONINTEREST INCOME
Service charges on deposit accounts 74 71 218 207
Trust and asset management income 61 58 180 170
Loan securitization income 18 3 45 9
Credit card fees 24 23 68 60
Insurance and brokerage income 18 17 52 44
Mortgage banking income 6 9 20 34
Net securities gains (losses) -- -- 1 (42)
Other income 88 54 218 147
- ---------------------------------------------------------------------------------------------------------------------------
Total noninterest income 289 235 802 629
NONINTEREST EXPENSE
Personnel 300 278 889 829
Net occupancy 55 54 163 160
Equipment 41 37 119 116
FDIC insurance assessments 20 1 25 52
Amortization of intangibles 21 19 65 55
Professional fees 18 19 47 49
Marketing 30 19 68 52
Other expense 130 134 388 377
- ---------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 615 561 1,764 1,690
- ---------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND 308 313 932 849
EXTRAORDINARY ITEM
Income taxes 101 104 300 267
- ---------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE EXTRAORDINARY ITEM 207 209 632 582
Extraordinary net gain from the sales of
subsidiaries, net of income taxes of $25 -- -- -- 36
- ---------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 207 $ 209 $ 632 $ 618
===========================================================================================================================
Net income applicable to Common Shares $ 207 $ 205 $ 624 $ 606
Per Common Share:
Income before extraordinary item $ .90 $ .90 $ 2.70 $ 2.44
Net income .90 .90 2.70 2.59
Weighted average Common Shares outstanding 229,668 228,187 231,363 234,462
===========================================================================================================================
See notes to consolidated financial statements (unaudited).
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5
KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
Net
Unrealized
Loans to Gains Treasury
Preferred Common Capital Retained ESOP (Losses) Stock
dollars in millions, except per share amounts Stock Shares Surplus Earnings Trustee on Securities at Cost
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1994 $160 $246 $1,454 $3,161 $(64) $(115) $(152)
Net income 618
Cash dividends:
Common Shares ($1.08 per share) (254)
Cumulative Preferred Stock ($9.375 per share) (12)
Issuance of Common Shares:
Acquisitions - 15,507,562 shares 54 442
Dividend reinvestment, stock option, and
purchase plans - 1,375,974 net shares (7) 39
Repurchase of Common Shares - 19,856,250 shares (578)
Change in net unrealized gains (losses) on
securities, net of deferred tax expense of $53 90
Tax benefits attributable to ESOP dividends 1
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1995 $160 $246 $1,501 $3,514 $(64) $ (25) $(249)
===================================================================================================================================
BALANCE AT DECEMBER 31, 1995 $160 $246 $1,500 $3,633 $(51) $ 48 $(383)
Net income 632
Cash dividends:
Common Shares ($1.14 per share) (263)
Cumulative Preferred Stock ($6.25 per share) (8)
Redemption of 10% Cumulative Preferred Stock (160)
Issuance of Common Shares
Acquisitions - 270,263 shares 2 9
Dividend reinvestment, stock option, and
purchase plans - 3,193,154 net shares (14) 104
Repurchase of Common Shares - 10,104,566 shares (396)
Change in net unrealized gains (losses) on
securities, net of deferred tax benefit of $(38) (85)
Loan payment from ESOP trustee 2
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1996 -- $246 $1,488 $3,994 $ (49) $ (37) $(666)
===================================================================================================================================
See notes to consolidated financial statements (unaudited).
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KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
Nine months ended September 30,
-------------------------------
in millions 1996 1995
- ----------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 632 $ 618
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 140 66
Depreciation expense 105 101
Amortization of intangibles 65 55
Net gain from sales of subsidiaries (8) (61)
Net securities (gains) losses (1) 42
Deferred income taxes 83 58
Net decrease in mortgage loans held for sale 558 706
Net increase in trading account assets (68) (43)
Other operating activities, net (193) (47)
- -----------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,313 1,495
INVESTING ACTIVITIES
Net increase in loans (2,326) (2,280)
Loans sold 876 650
Purchases of investment securities (627) (1,017)
Proceeds from sales of investment securities 9 14
Proceeds from prepayments and maturities of investment securities 620 1,757
Purchases of securities available for sale (1,608) (635)
Proceeds from sales of securities available for sale 56 1,567
Proceeds from prepayments and maturities of securities available for sale 2,372 285
Net (increase) decrease in short-term investments (125) 359
Purchases of premises and equipment (184) (121)
Proceeds from sales of premises and equipment 37 6
Proceeds from sales of other real estate owned 22 32
Purchases of corporate owned life insurance (145) (295)
Proceeds from sales of subsidiaries 140 351
Net cash used in acquisitions, net of cash acquired (12) (198)
- -----------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (895) 475
FINANCING ACTIVITIES
Net decrease in deposits (1,766) (2,378)
Net increase in short-term borrowings 1,028 577
Net proceeds from issuance of long-term debt 1,593 694
Payments on long-term debt (872) (218)
Loan payment received from ESOP trustee 2 --
Purchases of treasury shares (396) (578)
Redemption of IO% Cumulative Preferred Stock (160) --
Proceeds from issuance of common stock pursuant to employee
stock purchase, stock option and dividend reinvestment plans 90 32
Cash dividends (271) (266)
- -----------------------------------------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (752) (2,137)
- -----------------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND DUE FROM BANKS (334) (167)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,444 3,511
- -----------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 3,110 $ 3,344
=================================================================================================================
Additional disclosures relative to cash flow:
Interest paid $ 1,622 $ 1,795
Income taxes paid 120 213
Net amount received on portfolio swaps 58 82
Noncash items:
Net transfer of loans to other real estate owned $ 20 $ 12
Transfers of loans to mortgage loans held for sale -- 1,010
=================================================================================================================
See notes to consolidated financial statements (unaudited).
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7
KEYCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The unaudited consolidated interim financial statements include the accounts of
KeyCorp and its subsidiaries ("Key"). All significant intercompany accounts and
transactions have been eliminated in consolidation. In the opinion of
management, the unaudited consolidated interim financial statements reflect all
adjustments of a normal recurring nature and disclosures which are necessary for
a fair presentation of the results for the interim periods presented, and should
be read in conjunction with the audited consolidated financial statements and
related notes included in Key's 1995 Annual Report to Shareholders. In addition,
certain reclassifications have been made to prior year amounts to conform with
the current year presentation. The results of operations for the interim periods
are not necessarily indicative of the results of operations to be expected for
the full year.
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
to Be Disposed Of," SFAS No. 122, "Accounting for Mortgage Servicing Rights--an
Amendment of SFAS No. 65," and SFAS No. 123, "Accounting for Stock-Based
Compensation" were adopted by Key on January 1, 1996, and did not have a
material effect on Key's financial condition or results of operations. Under an
election available in the adoption of SFAS No. 123, Key continues to account for
stock options issued to employees in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees."
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which is
effective for transfers and servicing of financial assets and extinguishments of
liabilities occurring after December 31, 1996. SFAS No. 125 requires that the
recognition of transfers and servicing of financial assets and extinguishments
of liabilities be accounted for based on a financial components approach that
focuses on control. Under this approach, the entity that exercises control over
transferred assets recognizes those financial and servicing assets it controls
and the liabilities it has incurred. Financial assets are derecognized when
control is surrendered, and liabilities are derecognized when extinguished. In
October 1996, the FASB agreed to issue an Exposure Draft that would allow
companies to defer implementation of certain aspects of SFAS No. 125 until
January 1, 1998. The proposed Exposure Draft, which is expected to be approved
in December 1996 as a new SFAS, applies only to transfers related to securities
lending, repurchase agreements, dollar rolls or other similar secured
financings. Key expects to adopt SFAS No. 125 as of January 1, 1997; however,
the impact on future periods of the proposed Exposure Draft and the effect of
adoption of SFAS No. 125 have not yet been determined.
2. MERGERS, ACQUISITIONS AND DIVESTITURES
COMPLETED MERGERS AND ACQUISITIONS
AutoFinance Group, Inc.
On September 27, 1995, Key acquired AutoFinance Group, Inc. ("AFG"), a
Chicago-based automobile finance company operating in 28 states, in a tax-free
exchange of stock. Under the terms of the merger agreement, 9,554,003 Key Common
Shares, with a value of approximately $325 million, were exchanged for all of
the outstanding shares of AFG common stock (based on an exchange ratio of .5
shares for each share of AFG). In addition, immediately prior to the closing,
AFG completed a spin-off to its shareholders of 95.01% of its common stock
interest in Patlex Corporation, a wholly owned patent exploitation and
enforcement subsidiary. In connection with the transaction, which was accounted
for as a purchase, Key recorded goodwill of approximately $270 million, which is
being amortized using the straight-line method over a period of 25 years.
7
8
Mergers and acquisitions completed by Key during 1996 and 1995 (each of which
was accounted for as a purchase business combination) are summarized below.
COMMON
dollars in millions LOCATION DATE ASSETS SHARES ISSUED
- --------------------------------------------------------------------------------------------------------------------------
Carleton, McCreary, Holmes & Co. Ohio August 1996 $ 1 See note(1)
Knight Insurance Agency, Inc.(2) Massachusetts June 1996 8 --
AutoFinance Group, Inc. (3) Illinois September 1995 181 9,554,003
Spears, Benzak, Salomon & Farrell, Inc. New York April 1995 See note(4) 1,910,000
OMNIBANCORP Colorado February 1995 500 4,043,559
Casco Northern Bank, National Association Maine February 1995 945 --
BANKVERMONT Corporation Vermont January 1995 661 --
- -------------------------------------------------------------------------------------------------------------------------
(1) Carleton, McCreary, Holmes & Co. ("Carleton") is an investment-banking firm
specializing in mergers and acquisitions and other financial advisory
services for mid-sized and large corporations. In accordance with a
confidentiality clause in the purchase agreement, the terms, which are not
material, have not been publicly disclosed.
(2) Knight Insurance Agency, Inc. ("Knight") is an education financing company
doing business under the name "Knight College Resource Group."
(3) See the preceding text for more information regarding this transaction.
(4) Spears, Benzak, Salomon & Farrell, Inc. ("Spears Benzak") is an investment
management firm that had approximately $3.2 billion in assets under
management on the date of acquisition.
COMPLETED DIVESTITURES
Society First Federal Savings Bank
On June 1, 1996, Key sold Society First Federal Savings Bank ("SFF"), its
Florida savings association subsidiary. SFF had assets of approximately $1.2
billion at the time of the transaction. Key continues to provide private banking
services in Florida through its trust company located in Naples, Florida. An $8
million gain was realized on the SFF sale and included in other income on the
income statement.
Schaenen Wood & Associates, Inc.
On April 21, 1995, KeyCorp Asset Management Holdings, Inc., an indirect wholly
owned subsidiary of Key, sold Schaenen Wood & Associates, Inc., an asset
management subsidiary. An $11 million loss was realized in connection with the
sale ($6 million after tax, $.02 per Common Share) and recorded as an
extraordinary item in the first quarter of 1995.
KeyCorp Mortgage Inc.
On March 31, 1995, Key sold the residential mortgage servicing operations of
KeyCorp Mortgage Inc. ("KMI"), an indirect wholly owned subsidiary of Key. KMI
serviced approximately $25 billion of residential mortgage loans. A $72 million
gain was realized on the KMI sale ($42 million after tax, $.17 per Common Share)
and recorded as an extraordinary item.
3. SECURITIES AVAILABLE FOR SALE
Debt securities that Key has the positive intent and ability to hold to maturity
are classified as securities held to maturity and are carried at cost, adjusted
for amortization of premiums and accretion of discounts using the level yield
method. Securities held to maturity and equity securities that do not have
readily determinable fair values are presented as investment securities on the
balance sheet. Debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
account assets, reported at fair value ($101 million as of September 30, 1996)
and included in short-term investments on the balance sheet. Realized and
unrealized gains and losses on such assets are reported in other income on the
income statement. Debt and equity securities that Key has not classified as
investment securities or trading account assets are classified as securities
available for sale and, as such, are reported at fair value, with unrealized
gains and losses, net of deferred taxes, reported as a component of
shareholders' equity.
8
9
During the fourth quarter of 1995, the FASB granted companies a one-time
opportunity to reassess and, if appropriate, reclassify their securities from
the held-to-maturity category to the available-for-sale category without calling
into question the company's intent to hold other debt securities to maturity in
the future. This opportunity appears to have been granted in response to appeals
by the banking industry following a clarification of the position of the bank
regulatory authorities on related securities accounting matters, a position
which if known prior to the effective date of SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," would have caused Key to
classify significantly more securities as available for sale upon adoption of
SFAS No. 115. As a result, during the fourth quarter of 1995, Key reclassified
substantially all held-to-maturity debt securities, except securities of states
and political subdivisions, to the available-for-sale category. The reclassified
securities totaled approximately $8.0 billion and had an amortized cost which
approximated fair value.
At September 30, 1996, approximately $7.1 billion of securities were classified
as available for sale and shareholders' equity was reduced by $37 million,
representing the net unrealized loss on these securities, net of deferred tax
benefit.
The amortized cost, unrealized gains and losses, and approximate fair values of
securities available for sale were as follows (in millions):
SEPTEMBER 30, 1996
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
U.S. Treasury, agencies and corporations $1,135 $ 3 $ 7 $1,131
States and political subdivisions 29 -- -- 29
Collateralized mortgage obligations 2,488 1 31 2,458
Other mortgage-backed securities 3,416 34 63 3,387
Other securities 107 1 -- 108
------ --- ---- ------
Total $7,175 $39 $101 $7,113
====== === ==== ======
December 31, 1995
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
U.S. Treasury, agencies and corporations $1,176 $ 26 -- $1,202
States and political subdivisions 25 1 -- 26
Collateralized mortgage obligations 2,767 8 $24 2,751
Other mortgage-backed securities 3,850 72 22 3,900
Other securities 176 5 -- 181
------ --- ---- ------
Total $7,994 $112 $46 $8,060
====== ==== === ======
September 30, 1995
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ------
U.S. Treasury, agencies and corporations $ 663 $ 4 -- $ 667
States and political subdivisions 25 1 -- 26
Other mortgage-backed securities 860 7 $10 857
Other securities 46 -- -- 46
------ --- ---- ------
Total $1,594 $12 $10 $1,596
====== === === ======
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10
4. INVESTMENT SECURITIES
The amortized cost, unrealized gains and losses, and approximate fair values of
investment securities were as follows (in millions):
SEPTEMBER 30, 1996
--------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -----
States and political subdivisions $1,434 $37 $1 $1,470
Other securities 219 -- - 219
------ --- -- ------
Total $1,653 $37 $1 $1,689
====== === == ======
December 31, 1995
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
U.S. Treasury, agencies and corporations $ 5 -- - $ 5
States and political subdivisions 1,424 $51 $1 1,474
Other securities 259 -- - 259
------ --- -- ------
Total $1,688 $51 $1 $1,738
====== === == ======
September 30, 1995
--------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ------
U.S. Treasury, agencies and corporations $ 538 $ 6 $ 1 $ 543
States and political subdivisions 1,446 51 1 1,496
Collateralized mortgage obligations 3,495 1 68 3,428
Other mortgage-backed securities 3,764 74 32 3,806
Other securities 417 12 13 416
------ --- -- ------
Total $9,660 $144 $115 $9,689
====== ==== ==== ======
5. LOANS
Loans are summarized as follows (in millions):
SEPTEMBER 30, December 31, September 30,
1996 1995 1995
------------- ------------ -------------
Commercial, financial and agricultural $11,943 $11,535 $11,559
Real estate--construction 1,719 1,520 1,477
Real estate--commercial mortgage 7,033 7,254 7,267
Real estate--residential mortgage 11,034 12,177 12,897
Credit cards 1,669 1,564 1,415
Other consumer 9,281 8,553 8,558
Student loans held for sale 2,283 2,081 2,498
Lease financing 3,157 2,887 2,653
Foreign 172 121 86
------- ------- -------
Total $48,291 $47,692 $48,410
======= ======= =======
10
11
Changes in the allowance for loan losses are summarized as follows (in
millions):
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
1996 1995 1996 1995
---- ---- ---- ----
Balance at beginning of period $ 870 $ 867 $ 876 $ 830
Charge-offs (72) (57) (216) (149)
Recoveries 23 30 78 84
----- ----- ----- -----
Net charge-offs (49) (27) (138) (65)
Provision for loan losses 49 27 140 66
Allowance acquired/(sold), net -- 12 (8) 47
Transfer from OREO allowance -- -- -- 1
----- ----- ----- -----
Balance at end of period $ 870 $ 879 $ 870 $ 879
===== ===== ===== =====
6. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
At September 30, 1996, the recorded investment in impaired loans was $185
million. Included in this amount is $91 million of impaired loans for which the
specifically allocated allowance for loan losses is $26 million, and $94 million
of impaired loans which are carried at their estimated fair value without a
specifically allocated allowance for loan losses. At the end of the prior year,
the recorded investment in impaired loans was $205 million, of which $126
million had a specifically allocated allowance of $40 million and $79 million
were carried at their estimated fair value. The decrease in impaired loans since
the 1995 year end was due primarily to the sale of two impaired commercial loans
totaling $38 million. The average recorded investment in impaired loans for the
third quarter of 1996 was $175 million, down from $183 million for the third
quarter of last year.
Nonperforming assets were as follows (in millions):
SEPTEMBER 30, December 31, September 30,
1996 1995 1995
----- ----- -----
Impaired loans $ 185 $ 205 $ 181
Other nonaccrual loans 158 125 128
Restructured loans 1 3 4
----- ----- -----
Total nonperforming loans 344 333 313
Other real estate owned 59 56 64
Allowance for OREO losses (10) (14) (15)
----- ----- -----
Other real estate owned, net of allowance 49 42 49
Other nonperforming assets 3 4 5
===== ===== =====
Total nonperforming assets $ 396 $ 379 $ 367
===== ===== =====
Key considers all nonaccrual loans to be impaired loans, except for
smaller-balance, homogeneous nonaccrual loans (shown in the preceding table as
"Other nonaccrual loans") excluded in accordance with the provisions of SFAS No.
114, "Accounting by Creditors for Impairment of a Loan." A loan is not deemed
impaired during a period of delay in payment of 90 days or less if Key expects
to collect all amounts due, including interest accrued at the contractual
interest rate, for the period of delay.
Impaired loans are evaluated individually. Where collateral exists, the extent
of impairment is determined based on the estimated fair value of the underlying
collateral. If collateral does not exist, or is insufficient to support the
carrying value, management looks to other means of collection. Where the
estimated fair value of the collateral and the present value of the estimated
future cash flows from other means of collection do not support the carrying
value of the loan, management charges off that portion of the loan balance which
it believes will not ultimately be collected. In instances
11
12
where collateral or other sources of repayment appear sufficient, yet
uncertainty exists regarding the ultimate repayment, an allowance is
specifically allocated for in the allowance for loan losses.
Key excludes smaller-balance, homogeneous nonaccrual loans from impairment
evaluation. Generally these include loans to finance residential mortgages,
automobiles, recreational vehicles, boats and mobile homes. Key applies
historical loss experience rates to these loans, adjusted based on management's
assessment of emerging credit trends and other factors. The resulting loss
estimates are specifically allocated for by loan type in the allowance for loan
losses. In general, such loans are charged off when payment is 120-180 days past
due.
7. LONG-TERM DEBT
The components of long-term debt, presented net of unamortized discount where
applicable, were as follows (dollars in millions):
SEPTEMBER 30, December 31, September 30,
1996 1995 1995
------------- ------------ -------------
Senior medium-term notes due through 2005(1) $ 924 $ 995 $1,052
Subordinated medium-term notes due through 2005(2) 183 183 165
7.50% Subordinated notes due 2006 250 -- --
6.75% Subordinated notes due 2006 200 -- --
8.125% Subordinated notes due 2002 199 198 198
8.00 % Subordinated notes due 2004 125 125 125
8.40% Subordinated capital notes due 1999 75 75 75
8.404% Notes due 1997 through 2001 49 49 49
8.875% Notes due 1996 -- 75 75
8.255% Notes due 1996 -- 23 23
All other long-term debt 18 -- --
------ ------ ------
Total parent company 2,023 1,723 1,762
Senior medium-term bank notes due through 1998(3) 1,275 1,399 1,399
7.25% Subordinated notes due 2005 200 200 200
7.85% Subordinated notes due 2002 200 200 200
6.75% Subordinated notes due 2003 199 199 199
7.50% Subordinated notes due 2008 165 -- --
7.125% Subordinated notes due 2006 125 -- --
7.125% Subordinated notes due 2006 125 -- --
7.55% Subordinated notes due 2006 75 -- --
7.375% Subordinated notes due 2008 70 -- --
Federal Home Loan Bank Advances 193 267 273
Industrial revenue bonds 10 10 10
All other long-term debt 4 5 5
------ ------ ------
Total subsidiaries 2,641 2,280 2,286
------ ------ ------
Total $4,664 $4,003 $4,048
====== ====== ======
<FN>
(1) The weighted average rate on the senior medium-term notes due through 2005
was 6.50%, 6.62% and 6.63% at September 30, 1996, December 31, 1995, and
September 30, 1995, respectively.
(2) The weighted average rate on the subordinated medium-term notes due through
2005 was 6.81% at September 30, 1996, and 6.88% at December 31, 1995, and
September 30, 1995.
(3) The weighted average rate on the senior medium-term notes due through 1998
was 6.68% at September 30, 1996, and 6.71% at December 31, 1995, and
September 30, 1995.
</FN>
12
13
8. INCOME TAXES
The effective income tax rate (provision for income taxes as a percentage of
income before income taxes) for the 1996 third quarter was 32.8% compared with
33.1% for the third quarter of 1995. For the first nine months of 1996, the
effective income tax rate was 32.2% compared with 31.4% for the same period in
1995. The lower 1995 year-to-date effective income tax rate as compared with
that of 1996 was primarily attributable to the first quarter 1995 recognition of
one-time tax benefits totaling $16 million related to acquisitions made in years
prior to 1992. The effective income tax rate remains below the statutory Federal
rate of 35% due primarily to the impact of continued investment in
tax-advantaged assets (such as tax-exempt securities and corporate owned life
insurance) and the recognition of credits associated with investments in
low-income housing projects.
9. EXTRAORDINARY ITEM
During the first quarter of 1995, Key recorded an extraordinary net gain of $61
million ($36 million after tax, $.15 per Common Share), representing the net
effect of a gain of $72 million ($42 million after tax, $.17 per Common Share)
from the sale of the residential mortgage servicing operations of KMI, an
indirect wholly owned subsidiary of Key, and a loss of $11 million ($6 million
after tax, $.02 per Common Share) on the sale of Schaenen Wood & Associates,
Inc., an indirect wholly owned asset management subsidiary of Key. These
transactions are described in greater detail in Note 2, Mergers, Acquisitions
and Divestitures, beginning on page 7.
10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Key, mainly through its affiliate banks, is party to various financial
instruments with off-balance sheet risk. The banks use these financial
instruments in the normal course of business to meet the financing needs of
their customers and to manage their exposure to market risk effectively. Market
risk is the possibility that Key's net interest income will be adversely
affected as a result of changes in interest rates or other economic factors. The
primary financial instruments used include commitments to extend credit, standby
and commercial letters of credit, interest rate swaps, caps and floors, futures
and foreign exchange forward contracts. All of the interest rate swaps, caps and
floors, and foreign exchange forward contracts held are over-the-counter
instruments. These financial instruments may be used for lending-related, asset
and liability management or trading purposes, as discussed in the remainder of
this note. In addition to the market risks inherent in the use of these
financial instruments, each contains an element of credit risk. Credit risk is
the possibility that Key will incur a loss due to a counterparty's failure to
perform its contractual obligations.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR LENDING-RELATED PURPOSES
The following is a summary of the contractual amount of each class of
lending-related off-balance sheet financial instrument outstanding wherein Key's
maximum possible accounting loss equals the contractual amount of the
instruments (in millions):
SEPTEMBER 30, December 31, September 30,
1996 1995 1995
------- ------- -------
Loan commitments:
Credit card lines $ 7,253 $ 6,996 $ 5,874
Home equity 3,081 3,982 3,782
Commercial real estate and construction 1,527 1,554 1,636
Commercial and other 10,233 9,883 9,892
------- ------- -------
Total loan commitments 22,094 22,415 21,184
Other commitments:
Standby letters of credit 1,285 1,108 1,108
Commercial letters of credit 206 144 254
Loans sold with recourse 30 34 35
------- ------- -------
Total loan and other commitments $23,615 $23,701 $22,581
======= ======= =======
13
14
These instruments involve, to varying degrees, credit risk in excess of amounts
recognized in Key's consolidated balance sheet. Key mitigates its exposure to
credit risk through internal controls over the extension of credit. These
controls include the process of credit approval and review, the establishment of
credit limits and, when deemed necessary, securing collateral.
The banks' commitments to extend credit are agreements with customers to provide
financing at predetermined terms as long as the customer continues to meet
specified criteria. Loan commitments serve to meet the financing needs of the
banks' customers and generally carry variable rates of interest, have fixed
expiration dates or other termination clauses, and may require the payment of
fees. Since the commitments may expire without being drawn upon, the total
amount of the commitments does not necessarily represent the future cash outlay
to be made by Key. The credit-worthiness of each customer is evaluated on a
case-by-case basis. The estimated fair values of these commitments and the
standby letters of credit discussed below are not material. Key does not have
any significant concentrations of credit risk.
Standby letters of credit enhance the credit-worthiness of the banks' customers
by assuring the customers' financial performance to third parties in connection
with specified transactions. Amounts drawn under standby letters of credit
generally carry variable rates of interest, and the credit risk involved is
essentially the same as that involved in the extension of loan facilities.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES
Key manages its exposure to market risk, in part, by using off-balance sheet
instruments to modify the existing interest rate risk characteristics of its
assets and liabilities. Primary among the financial instruments used by both Key
and its affiliate banks are interest rate swap contracts. Interest rate swaps
used for this purpose are designated as portfolio swaps. The notional amount of
the interest rate swap contracts represents an agreed-upon amount on which
calculations of interest payments to be exchanged are based, and is
significantly greater than the amount at risk. Credit risk is measured as the
cost of replacing, at current market rates, contracts in an unrealized gain
position. Key deals exclusively with counterparties with high credit ratings,
enters into bilateral collateral arrangements and arranges master netting
agreements. These agreements include legal rights of setoff that provide for the
net settlement of the subject contracts with the same counterparty in the event
of default. Although Key is exposed to credit-related losses in the event of
nonperformance by the counterparties, based on management's assessment as of
September 30, 1996, all counterparties were expected to meet their obligations.
At September 30, 1996, Key had credit exposure of an aggregate $6 million to
seven counterparties, with the largest credit exposure to an individual
counterparty amounting to $2 million.
Under conventional interest rate swap contracts, payments based on fixed or
variable rates are received based upon the notional amounts of the swaps in
exchange for payments based on variable or fixed rates. Under an indexed
amortizing swap contract, the notional amount remains constant for a specified
period of time after which, based upon the level of the index at each payment
review date, the swap contract will mature, the notional amount will begin to
amortize, or the swap will continue in effect until its contractual maturity.
Otherwise, the characteristics of these swaps are similar to those of
conventional swap contracts. At September 30, 1996, Key was party to $1.8
billion and $3.2 billion of indexed amortizing swaps that used a LIBOR (London
Interbank Offered Rates) index and a CMT (Constant Maturity Treasuries) index,
respectively, for the payment review date measurement. Under basis swap
contracts, interest payments based on different floating indices are exchanged.
The following table summarizes the notional amount, fair value, maturity and
weighted average rate received and paid for the various types of portfolio
interest rate swaps used by Key (in millions):
SEPTEMBER 30, 1996 December 31, 1995
----------------------------------------------------------------- ----------------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR MATURITY ---------------------- Notional Fair
AMOUNT VALUE (YEARS) RECEIVE PAY Amount Value
-------------------------------------------------------------------- ----------------------------
Receive fixed/pay variable -
indexed amortizing(1) $ 5,320 $(49) 2.7 6.77% 5.62% $ 6,200 $ 70
Receive fixed/pay variable -
conventional 3,517 (33) 7.4 6.74 5.62 2,497 104
Pay fixed/receive variable -
conventional 2,313 (3) 1.2 5.51 6.30 2,412 (21)
Basis swaps 400 -- .9 5.44 5.44 -- --
-------- ---- -------- -----
Total portfolio swaps $ 11,550 $(85) 3.8 6.46% 5.75% $11,109 $ 153
======== ==== ======== =====
<FN>
(1) Maturity is based upon expected average lives rather than contractual
terms.
14
15
Based on the weighted average rates in effect at September 30, 1996, the spread
on portfolio interest rate swaps, excluding the amortization of deferred gains
and losses on terminated swaps, provided a positive impact on net interest
income (since the weighted average rate received exceeded the weighted average
rate paid by 71 basis points). The aggregate negative fair value of $(85)
million at the same date was derived through the use of discounted cash flow
models, which contemplate interest rates using the applicable forward yield
curve, and represents an estimate of the unrealized loss that would be
recognized if the portfolio were to be liquidated at that date.
The following table summarizes the notional amounts, fair values and weighted
average rates of portfolio swaps by interest rate management strategy (in
millions):
SEPTEMBER 30, 1996 December 31, 1995
--------------------------------------------------------- --------------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR --------------------- Notional Fair
AMOUNT VALUE RECEIVE PAY Amount Value
------------ -------- --------- ------ --------- -------
Convert variable rate loans
to fixed $ 6,688 $(80) 6.71% 5.61% $ 7,567 $ 113
Convert variable rate deposits
and short-term borrowings
to fixed 2,033 (2) 5.53 6.26 2,275 (18)
Convert variable rate long-term
debt to fixed 280 (1) 5.38 6.58 137 (3)
Convert fixed rate long-term
debt to variable 2,149 (2) 6.91 5.65 1,130 61
Convert variable rate index of
short-term borrowings 400 -- 5.44 5.44 -- --
------- ---- ------- -----
Total portfolio swaps $11,550 $(85) 6.46% 5.75% $11,109 $ 153
======= ===== ======= =====
Portfolio interest rate swaps are used to manage interest rate risk by modifying
the repricing or maturity characteristics of specified on-balance sheet assets
and liabilities. Interest from these swaps is recognized on an accrual basis
over the lives of the respective contracts as an adjustment of the interest
income or expense of the asset or liability whose risk is being managed. Gains
and losses realized upon the termination of interest rate swaps prior to
maturity are deferred and amortized, generally using the straight-line method
over the projected remaining life of the related swap contract at its
termination and recorded as an adjustment of the yield on the respective
on-balance sheet item that was being managed. Including the impact of both the
spread on the swap portfolio and the amortization of the deferred gains and
losses resulting from terminated swaps, portfolio interest rate swaps increased
net interest income for the third quarter of 1996 by $19 million, and reduced
net interest income by $8 million for the same period in 1995. During 1995,
swaps with a notional amount of $1.4 billion were terminated, resulting in net
deferred losses of $49 million. Key recognized $38 million of swap losses during
the first quarter of 1995 in connection with the sale of the residential
mortgage loan servicing business. These recognized losses, which were direct
costs of disposing of the business, were included in the determination of the
net gain from the sale. The losses included $15 million of the $49 million of
deferred swap losses referred to above and $23 million of deferred swap losses
recorded prior to 1995. During the first nine months of 1996, swaps with a
notional amount of $800 million were terminated, resulting in a deferred gain of
$.3 million.
A summary of Key's deferred swap gains and (losses) at September 30, 1996, is as
follows (dollars in millions):
Weighted Average
Deferred Remaining
Asset/Liability Managed Gains/(Losses) Amortization (Years)
- ----------------------- -------------- --------------------
Loans $ (1) 2.1
Debt 18 6.6
------
Total $ 17
======
15
16
Key also uses interest rate caps and floors, and futures contracts to manage the
risk associated with the potential impact of adverse movements in interest
rates. Futures contracts are commitments to either purchase or sell designated
financial instruments at future dates for specified prices. Key had caps and
floors with a notional amount and fair value of $944 million and $2 million,
respectively, at September 30, 1996. There were no futures contracts outstanding
at the same date.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES
Key's affiliate banks also use interest rate swap, cap and floor contracts for
dealer activities (which are generally limited to the banks' commercial loan
customers) and enter into other positions with third parties that are intended
to mitigate the interest rate risk of the customer positions. Interest rate swap
contracts entered into with customers are typically limited to conventional
swaps, as previously described. The customer swaps, caps and floors, as well as
the third party positions, are recorded at their estimated fair values, and
adjustments to fair value are included in other income on the income statement.
Key also enters into foreign exchange forward contracts to accommodate the
business needs of its customers and for proprietary trading purposes. These
contracts provide for the delayed delivery or purchase of foreign currency. The
foreign exchange risk associated with such contracts is mitigated by entering
into other foreign exchange contracts with third parties. Adjustments to the
fair value of all such foreign exchange forward contracts are included in other
income on the income statement.
A summary of the notional amount and the respective fair value of derivative
financial instruments held or issued for trading purposes at September 30, 1996,
and on average for the nine-month period then ended, is presented below (in
millions). The positive fair values represent assets to Key and are recorded in
other assets, while the negative fair values represent liabilities and are
recorded in other liabilities on the balance sheet.
September 30, 1996 Nine months ended September 30, 1996
------------------ ------------------------------------
Notional Fair Average Average
Interest rate contracts: Amount Value Notional Amount Fair Value
-------- ----- --------------- --------------
Trading swaps:
Assets $3,265 $ 36 $ 2,183 $ 27
Liabilities 1,565 (18) 1,794 (13)
Caps and floors purchased 1,773 3 1,280 2
Caps and floors written 1,819 (3) 1,329 (2)
Foreign exchange forward contracts:(1)
Assets 394 10 502 12
Liabilities 352 (10) 491 (12)
<FN>
(1) Excludes the effect of foreign spot contracts.
At September 30, 1996, credit exposure from financial instruments held or issued
for trading purposes is limited to the aggregate fair value of each contract
with a positive fair value, or $36 million. The risk of counterparties
defaulting on their obligations is monitored on an ongoing basis. The affiliate
banks contract with counterparties of good credit standing and enter into master
netting agreements when possible in an effort to manage credit risk.
Trading income recognized on interest rate and foreign exchange forward
contracts totaled $4 million and $9 million, respectively, for the first nine
months of 1996 and $5 million and $9 million, respectively, for the first nine
months of 1995.
16
17
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
SHAREHOLDERS AND BOARD OF DIRECTORS
KEYCORP
We have reviewed the unaudited consolidated balance sheets of KeyCorp and
subsidiaries ("Key") as of September 30, 1996 and 1995, and the related
consolidated statements of income for the three and nine-month periods then
ended, and the consolidated statements of changes in shareholders' equity and
cash flow for the nine-month periods ended September 30, 1996 and 1995. These
financial statements are the responsibility of Key's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, which will be performed
for the full year with the objective of expressing an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the consolidated financial statements referred to above for them to
be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Key as of December 31, 1995, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flow for the year then ended (not presented herein) and in our report
dated January 16, 1996, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying consolidated balance sheet as of December 31, 1995, is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
October 15, 1996
17
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
This section of the report, including the highlights summarized below, provides
a discussion and analysis of the financial condition and results of operations
of Key for the periods presented. It should be read in conjunction with the
unaudited consolidated interim financial statements and notes thereto, presented
on pages 3 through 16.
This report contains forward-looking comments which are subject to numerous
assumptions, risks and uncertainties. Comments pertaining to periods subsequent
to 1996 are subject to greater uncertainty because of the increased likelihood
of changes in underlying factors and assumptions. Actual results could differ
materially from any such forward-looking comments for a variety of factors
including, in addition to those factors mentioned elsewhere in this report, the
following: sharp and/or rapid changes in interest rates; significant changes in
the economic scenario from the current anticipated scenario which could
materially change anticipated credit quality trends and the ability to generate
loans; significant delays in or changes impacting Key's ability to execute on
the strategic initiatives outlined herein to grow revenues and/or control
expenses (including Key's recently announced objective to achieve a targeted
efficiency ratio of 55% by around the end of 1997, and the initiation of a
comprehensive review of Key's branch delivery system and overall cost structure
as discussed on page 19); and significant changes in accounting, tax, or
regulatory practices or requirements.
During the first nine months of 1996, a number of actions were taken in
connection with the execution of Key's strategic plan. These actions reflect
continuing efforts to reallocate resources to businesses with higher earnings
potential and to focus on certain customer segments, while emphasizing
technology to enhance service capability. Specifically, during the first
quarter, Key launched its first small-business specialty center in Columbus,
Ohio. The opening of the specialty center is part of an overall plan to
transform the branch network into customized "KeyCenters" which target the needs
of specific customer segments. Other first quarter actions included the
formation of two new subsidiaries which provide specialized services, primarily
to corporate and institutional customers. Key Global Finance, Ltd. provides
sophisticated, asset-specific structured financing to large corporate clients,
while Key Capital Markets, Inc. ("KCMI"), a broker-dealer registered with the
National Association of Securities Dealers, Inc., provides foreign exchange,
financial risk management and financial advisory services to its institutional
clients in the public and private sector. KCMI also engages in certain
underwriting and dealing activities authorized by the Federal Reserve Board.
In the second quarter, Key acquired Knight, a Boston-based company (doing
business under the name "Knight College Resource Group") which specializes in
providing education financing programs, and now operates as a wholly owned
subsidiary of KeyBank USA, National Association. Also in the second quarter, Key
completed the sale of SFF, its Florida savings association subsidiary, but
continues to provide private banking services in Florida through its trust
company located in Naples.
In the third quarter, Key acquired Carleton, a Cleveland-based
investment-banking firm specializing in mergers and acquisitions and other
financial advisory services for mid-sized and larger corporate clients, and
merged it into KCMI. Key also announced an alliance with fourteen other North
American banks and IBM to form Integrion Financial Network with the purpose of
developing a secure, wide-ranging home banking and electronic commerce network.
Customers in selected Key markets will have access to the network in mid-1997.
Initiatives in telephone banking continued to be well-received by customers as
new loan volume generated by Key's 24-hour telebanking centers during the first
nine months of 1996 was nearly three times that produced in the same period last
year.
In addition to the above actions, during the first nine months of 1996
management continued to take certain steps to manage Key's balance sheet in
accordance with strategies developed in mid-1995 to improve returns to
shareholders, improve liquidity, enhance capital flexibility and manage credit
risk. These steps included the sale of $500 million of residential mortgage
loans, $101 million of out-of-franchise credit cards and $608 million of student
loans (of which $357 million was associated with securitizations). Other steps
included the securitization and sale of $141 million of sub-prime auto loans and
the continued, planned runoff of lower-yielding securities. An additional $354
million of student loans was securitized during the third quarter and
subsequently sold in October.
18
19
Key continued to manage its capital base proactively to optimize returns to
shareholders. During the first nine months of 1996, 10,104,566 Key Common Shares
were repurchased as part of the 12,000,000 Common Shares repurchase program
authorized by the Key Board of Directors in January 1996. The repurchase of
these shares reflected, in large part, the additional capital flexibility
achieved through loan sales and securitizations completed during 1995 and in the
first nine months of 1996. Key completed the repurchase of the remaining
authorized shares in October. In addition, on June 30, 1996, Key redeemed its
10% Cumulative Preferred Stock in accordance with approval received earlier in
the year from the Board of Directors.
In January, the merger of Key's Indiana and Michigan affiliate banks was
completed as the first step in plans to combine the affiliate banks in the Great
Lakes Region. The final stage of the Great Lakes reorganization was completed in
June as the Indiana/Michigan bank was merged with and into Society National
Bank, Key's principal bank subsidiary located in Ohio, with the resulting bank
being named KeyBank National Association. Key plans to consolidate all of its
bank subsidiaries into one national banking institution in 1997. All of Key's
bank subsidiaries now have "Key" as part of their names, facilitating the
effectiveness of a national branding marketing campaign.
In October, Key announced it had initiated a comprehensive review of its branch
delivery system and overall cost structure, with the objective of achieving a
targeted efficiency ratio of 55% by around the end of 1997. While the
comprehensive review is in its early stages, it is possible that, as a result of
that review, Key will incur a special charge relating to branch consolidations
and closings, severance costs and other matters. The amount and timing of the
charge, if any, can not yet be determined.
The above items are discussed in greater detail in the remainder of this
discussion and in the notes to the consolidated interim financial statements
referred to previously.
PERFORMANCE OVERVIEW
Figure 1 presents the primary income and expense components for the first nine
months of 1996 and 1995 expressed on a per Common Share basis. The selected
financial data set forth in Figure 2 presents certain information highlighting
Key's financial performance for each of the last five quarters and the
year-to-date periods ended September 30, 1996 and 1995. The items referred to in
this performance overview and in Figures 1 and 2 are more fully described in the
following discussion or in the notes to the unaudited consolidated interim
financial statements presented on pages 7 through 16.
FIGURE 1. COMPONENTS OF EARNINGS PER COMMON SHARE
Nine Months ended September 30, Change
------------------------------ -----------------------
1996 1995 Amount Percent
-------- ------ ------- ------
Interest income $16.03 $16.39 $ (.36) (2.2)%
Interest expense 7.24 7.96 (.72) (9.0)
------ ------ -------
Net interest income 8.79 8.43 .36 4.3
Provision for loan losses .60 .28 .32 114.3
------ ------ -------
Net interest income after provision for
loan losses 8.19 8.15 .04 .5
Noninterest income 3.47 2.69 .78 29.0
Noninterest expense 7.63 7.21 .42 5.8
------ ------ -------
Income before income taxes and
extraordinary item 4.03 3.63 .40 11.0
Income taxes 1.30 1.14 .16 14.0
Preferred dividends .03 .05 (.02) (40.0)
------ ------ -------
Earnings per Common Share
before extraordinary item 2.70 2.44 .26 10.7
Extraordinary net gain from sales of
subsidiaries, net of income taxes -- .15 (.15) (100.0)
------ ------ -------
Earnings per Common Share $ 2.70 $ 2.59 $ .11 4.2%
====== ====== =======
19
20
Net income for the third quarter of 1996 totaled $218 million, or a record $.95
per Common Share, excluding a one-time charge of $17 million ($11 million
after-tax, $.05 per Common Share) to provide for an assessment mandated by
legislation passed by Congress on September 30, 1996, to recapitalize the
Savings Association Insurance Fund ("SAIF"). Including the SAIF assessment, net
income for the third quarter of 1996 was $207 million, or $.90 per Common Share.
This compared with $209 million, or $.90 per Common Share, for the third quarter
of 1995. On an annualized basis, the return on average total equity for the
third quarter of 1996 was 16.73%, down from 17.79% for the same period last
year. The annualized returns on average total assets for the third quarters of
1996 and 1995 were 1.28% and 1.25%, respectively. Primary factors affecting the
comparative earnings were a $16 million increase in taxable-equivalent net
interest income and a $54 million increase in noninterest income, offset in part
by a $22 million increase in the provision for loan losses and a $37 million
increase in noninterest expense, excluding the SAIF assessment. The efficiency
ratio, which measures the extent to which recurring revenues are used to pay
operating expenses, was 60.71% compared with 60.50% and 61.27% for the second
quarter of 1996 and the third quarter of 1995, respectively.
Net income for the first nine months of 1996 was $632 million, or $2.70 per
Common Share, up from $618 million, or $2.59 per Common Share, for the same
period last year. On an annualized basis, the return on average total equity for
the first nine months of 1996 was 16.62% compared with 17.46% for the same
period a year ago. The annualized returns on average total assets for the first
nine months of 1996 and 1995 were 1.30% and 1.24%, respectively.
As previously discussed, 1996 results included a one-time SAIF assessment of $17
million ($11 million after tax, $.05 per Common Share) recorded during the third
quarter. Included in 1995 year-to-date results was the effect of several
significant nonrecurring items recorded during the first quarter. An
extraordinary net gain of $61 million ($36 million after tax, $.15 per Common
Share) was recorded in connection with the sales of certain subsidiaries. This
net gain included a gain of $72 million ($42 million after tax, $.17 per Common
Share) from the sale of the residential mortgage loan servicing business and a
loss of $11 million ($6 million after tax, $.02 per Common Share) incurred in
connection with the sale of Schaenen Wood & Associates, Inc., an asset
management subsidiary. Efforts to reconfigure the balance sheet in order to
reduce exposure to changes in interest rates resulted in net losses of $49
million ($31 million after tax, $.13 per Common Share) from the sales of
securities. In addition, Key recorded one-time tax benefits of $16 million, or
$.07 per Common Share, which related to acquisitions completed in prior years.
In the aggregate, these nonrecurring items increased 1995 year-to-date earnings
by $21 million, or $.09 per Common Share.
Excluding the impact of the 1996 and 1995 nonrecurring items, earnings for the
first nine months of 1996 were up $46 million, or 8%, from the same period a
year ago. Affecting the comparative results were a $52 million increase in
taxable-equivalent net interest income and a $173 million increase in
noninterest income. These positive factors were partially offset by increases of
$74 million and $57 million in the provision for loan losses and noninterest
expense, respectively. The efficiency ratio improved to 60.81% for the first
nine months of 1996 from 62.79% for the same period a year ago.
20
21
Figure 2. Selected Quarterly Financial Data
Nine months ended
1996 1995 September 30,
----------------------------- ------------------ ---------------------
dollars in millions, except per share amounts THIRD Second First Fourth Third 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $ 1,238 $ 1,234 $ 1,236 $ 1,278 $ 1,299 $ 3,708 $ 3,843
Interest expense 555 552 567 618 633 1,674 1,867
Net interest income 683 682 669 660 666 2,034 1,976
Provision for loan losses 49 47 44 34 27 140 66
Noninterest income 289 264 249 304 235 802 629
Noninterest expense 615 579 570 622 561 1,764 1,690
Income before income taxes and extraordinary item 308 320 304 308 313 932 849
Income before extraordinary item 207 217 208 207 209 632 582
Net income 207 217 208 207 209 632 618
Net income applicable to Common Shares 207 213 204 203 205 624 606
- ---------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income before extraordinary item $ .90 $ .92 $ .88 $ .86 $ .90 $ 2.70 $ 2.44
Net income .90 .92 .88 .86 .90 2.70 2.59
Cash dividends .38 .38 .38 .36 .36 1.14 1.08
Book value at period end 21.91 21.63 21.43 21.36 20.74 21.91 20.74
Market price:
High 44.38 40.25 39.13 37.25 35.13 44.38 35.13
Low 36.25 36.75 33.38 33.25 30.38 33.38 24.50
Close 44.00 38.75 38.63 36.25 34.25 44.00 34.25
Weighted average Common Shares (000) 229,668 231,341 233,100 235,753 228,187 231,363 234,462
- ---------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 48,291 $ 47,826 $ 48,161 $ 47,692 $ 48,410 $ 48,291 $ 48,410
Earning assets 57,640 57,404 57,941 58,762 60,847 57,640 60,847
Total assets 65,356 64,764 65,052 66,339 67,967 65,356 67,967
Deposits 44,523 44,417 45,401 47,282 47,905 44,523 47,905
Long-term debt 4,664 4,174 4,266 4,003 4,048 4,664 4,048
Common shareholders' equity 4,976 4,996 4,964 4,993 4,923 4,976 4,923
Total shareholders' equity 4,976 4,996 5,124 5,153 5,083 4,976 5,083
- ---------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.28% 1.35% 1.28% 1.23% 1.25% 1.30% 1.24%
Return on average common equity 16.73 17.15 16.42 16.31 18.07 16.76 17.72
Return on average total equity 16.73 16.93 16.22 16.11 17.79 16.62 17.46
Efficiency(1) 60.71 60.50 61.22 63.67 61.27 60.81 62.79
Overhead(2) 44.40 45.53 47.07 47.36 47.89 45.66 50.43
Net interest margin (TE) 4.82 4.80 4.70 4.53 4.50 4.78 4.46
- ---------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.61% 7.71% 7.88% 7.77% 7.48% 7.61% 7.48%
Tangible equity to tangible assets 6.20 6.27 6.38 6.25 5.98 6.20 5.98
Tier I risk-adjusted capital 7.49 7.60 7.71 7.53 7.55 7.49 7.55
Total risk-adjusted capital 12.50 11.72 11.45 10.85 10.84 12.50 10.84
Leverage 6.38 6.43 6.43 6.20 6.19 6.38 6.19
<FN>
The comparability of the information presented above is affected by certain
mergers, acquisitions and divestitures completed by Key in the time periods
presented. For further information concerning these transactions, refer to Note
2, Mergers, Acquisitions and Divestitures, beginning on page 7.
(1) Calculated as noninterest expense (excluding certain nonrecurring charges)
divided by taxable-equivalent net interest income plus noninterest income
(excluding net securities transactions).
(2) Calculated as noninterest expense (excluding certain nonrecurring charges)
less noninterest income (excluding net securities transactions) divided by
taxable-equivalent net interest income.
TE = Taxable Equivalent
21
22
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income, which is comprised of interest and loan-related fee income
less interest expense, is the principal source of earnings for Key. Net interest
income is affected by a number of factors including the level, pricing, mix and
maturity of earning assets and interest-bearing liabilities (both on and
off-balance sheet), interest rate fluctuations and asset quality. To facilitate
comparisons in the following discussion, net interest income is presented on a
taxable-equivalent basis, which restates tax-exempt income to an amount that
would yield the same after-tax income had the income been subject to taxation at
the statutory Federal income tax rate.
Various components of the balance sheet and their respective yields and rates
which affect interest income and expense are illustrated in Figure 3. The
information presented in Figure 4 provides a summary of the effect on net
interest income of changes in yields/rates and average balances for the
quarterly and year-to-date periods from the same periods in the prior year. A
more in-depth discussion of changes in earning assets and funding sources is
presented in the Financial Condition section beginning on page 32.
For the third quarter of 1996, net interest income reached a record high of $696
million, up $16 million, or 2%, from the same period last year. This increase
resulted from a net interest margin which rose by 32 basis points to 4.82%, the
highest level achieved since the second quarter of 1994. The impact of the
improved margin more than offset the effect of a managed decrease of $2.9
billion, or 5%, in average earning assets. The net interest margin is computed
by dividing annualized taxable-equivalent net interest income by average earning
assets.
The increase in the net interest margin as compared with the year ago quarter
reflected the origination of new loans with wider interest rate spreads as well
as the impact of continued actions taken to reconfigure the balance sheet.
Primary among these actions were loan securitizations and sales completed since
the third quarter of last year and fourth quarter 1995 securities sales. These
actions are more fully described in the following Asset and Liability Management
section. Other factors which contributed to the improved margin were the
completion during the first quarter of 1996 of the amortization of deferred
losses resulting from the 1994/1995 swap terminations related to the balance
sheet reconfiguration, the investment of funds from maturing securities into
higher-yielding loans and the replacement of maturing bank notes and pay fixed
swaps with similar instruments having lower interest rates during the fourth
quarter of last year. The positive impact of these factors was moderated
somewhat by the effect of the funding costs associated with the Common Share
repurchase program. Swap terminations are discussed in greater detail in Note
10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 13.
During the third quarter, Key's net interest margin continued to improve,
increasing two basis points from the prior quarter and marking the sixth
consecutive quarter of increases.
Average earning assets for the third quarter totaled $57.4 billion, which was
$2.9 billion, or 5%, lower than the third quarter 1995 level. This decrease was
due primarily to a $2.4 billion, or 21%, decline in securities (including both
investment securities and securities available for sale) and a $203 million, or
30%, decline in short-term investments. The planned reduction in securities is
part of Key's overall asset/liability management strategy, which is discussed
under Recent Management Actions in the following Asset and Liability Management
section.
Key uses portfolio interest rate swaps (as defined in Note 10, Financial
Instruments with Off-Balance Sheet Risk, beginning on page 13) in the management
of its interest rate sensitivity position. The notional amount of such swaps
increased to $11.6 billion at September 30, 1996, from $11.1 billion at year-end
1995. For the third quarter of 1996, interest rate swaps contributed $19 million
and 13 basis points to net interest income and the net interest margin,
respectively, including the impact of both the spread on the swap portfolio and
the amortization of deferred gains and losses resulting from terminated swaps.
During the same period in 1995, interest rate swaps reduced net interest income
by $8 million and the net interest margin by 5 basis points. The manner in which
interest rate swaps are used in Key's overall program of asset and liability
management is described in the following Asset and Liability Management section.
22
23
FIGURE 3. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
THIRD QUARTER 1996 Second Quarter 1996
------------------------------ ---------------------------
AVERAGE YIELD/ Average Yield/
dollars in millions BALANCE INTEREST RATE Balance Interest Rate
- -------------------------------------------------------------------------------------------------------
ASSETS
Loans: (1), (2)
Commercial, financial and agricultural $11,785 $267 9.01 % $12,134 $271 8.98 %
Real estate 19,757 442 8.90 20,155 449 8.96
Consumer 10,798 277 10.21 10,490 264 10.12
Student loans held for sale 2,463 51 8.24 2,343 48 8.24
Lease financing 3,065 50 6.49 2,971 49 6.63
Foreign 149 3 8.03 99 2 7.93
- -------------------------------------------------------------------------------------------------------
Total loans 48,017 1,090 9.03 48,192 1,083 9.04
Mortgage loans held for sale 86 2 8.34 100 2 8.04
Taxable investment securities 251 4 6.34 259 3 5.64
Tax-exempt investment securities (1) 1,458 29 7.91 1,414 28 7.96
- -------------------------------------------------------------------------------------------------------
Total investment securities 1,709 33 7.68 1,673 31 7.45
Securities available for sale (1), (3) 7,152 120 6.75 7,410 124 6.73
Interest-bearing deposits with banks 18 --- 3.57 28 --- 2.70
Federal funds sold and securities
purchased under resale agreements 385 5 5.17 418 5 5.08
Trading account assets 60 1 5.21 45 1 5.25
- -------------------------------------------------------------------------------------------------------
Total short-term investments 463 6 5.16 491 6 4.96
- -------------------------------------------------------------------------------------------------------
Total earning assets 57,427 1,251 8.67 57,866 1,246 8.66
Allowance for loan losses (870) (877)
Other assets 7,923 7,634
- -------------------------------------------------------------------------------------------------------
$64,480 $64,623
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $10,851 82 3.01 $10,273 76 2.98
Savings deposits 5,463 33 2.40 5,832 37 2.55
NOW accounts 1,733 9 2.07 2,348 12 2.06
Certificates of deposit ($100,000 or more) 3,133 45 5.71 3,267 49 6.03
Other time deposits 13,338 175 5.22 13,849 178 5.17
Deposits in foreign offices 1,189 16 5.35 1,154 15 5.23
- -------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 35,707 360 4.01 36,723 367 4.02
Federal funds purchased and securities
sold under repurchase agreements 5,694 72 5.03 5,899 74 5.05
Other short-term borrowings 3,669 55 5.96 2,922 44 6.06
Long-term debt (4) 4,359 68 6.28 4,152 67 6.60
- -------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 49,429 555 4.47 49,696 552 4.47
Noninterest-bearing deposits 8,467 8,202
Other liabilities 1,661 1,571
Preferred stock --- 158
Common shareholders' equity 4,923 4,996
- -------------------------------------------------------------------------------------------------------
$64,480 $64,623
======= =======
Interest rate spread 4.20 4.19
- -------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $696 4.82 % $694 4.80 %
==== ====== ==== ======
Taxable-equivalent adjustment (1) $ 13 $12
- -------------------------------------------------------------------------------------------------------
<FN>
(1) 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%
(2) For purposes of these computations, nonaccrual loans are included in the
average loan balances.
(3) Yield is calculated on the basis of amortized cost.
(4) Rate calculation excludes ESOP debt.
TE= Taxable Equivalent
23
24
First Quarter 1996 Fourth Quarter 1995 Third Quarter 1995
- -------------------------- --------------------------- ---------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
- ----------------------------------------------------------------------------------------
$11,578 $256 8.89 % $11,455 $253 8.75 % $11,391 $268 9.33 %
20,734 459 8.90 21,542 489 9.01 22,166 495 8.86
10,227 263 10.34 9,992 259 10.30 9,720 248 10.14
2,257 46 8.20 1,848 40 8.48 2,355 51 8.56
2,895 48 6.67 2,715 48 6.99 2,490 43 6.95
109 2 7.38 88 1 6.40 74 1 5.06
- ----------------------------------------------------------------------------------------
47,800 1,074 9.04 47,640 1,090 9.08 48,196 1,106 9.11
352 6 6.86 398 7 6.97 168 4 8.75
267 4 6.03 5,736 95 6.58 8,275 139 6.68
1,418 29 8.23 1,275 27 8.49 1,532 32 8.29
- ----------------------------------------------------------------------------------------
1,685 33 7.88 7,011 122 6.93 9,807 171 6.93
7,864 129 6.60 3,890 64 6.53 1,457 23 6.15
32 -- 2.89 53 1 4.37 41 -- 4.06
448 7 5.39 417 6 5.89 481 7 5.83
27 -- 5.30 70 1 5.60 144 2 5.75
- ----------------------------------------------------------------------------------------
507 7 5.35 540 8 5.71 666 9 5.71
- ----------------------------------------------------------------------------------------
58,208 1,249 8.63 59,479 1,291 8.62 60,294 1,313 8.63
(875) (879) (870)
7,778 7,943 7,192
- ----------------------------------------------------------------------------------------
$65,111 $66,543 $66,616
======= ======= =======
$8,725 71 3.27 $7,285 66 3.59 $7,154 66 3.67
6,018 39 2.61 6,201 41 2.65 6,289 42 2.65
3,984 18 1.82 5,389 27 2.00 5,408 27 2.00
3,661 54 5.93 3,735 58 6.14 4,070 58 5.69
14,215 190 5.38 14,623 203 5.50 14,496 206 5.63
848 12 5.69 1,048 23 8.53 1,867 35 7.42
- ----------------------------------------------------------------------------------------
37,451 384 4.12 38,281 418 4.33 39,284 434 4.39
5,691 72 5.09 6,269 87 5.48 5,672 79 5.55
2,950 45 6.14 3,089 46 5.92 3,375 52 6.00
4,102 66 6.59 4,042 67 6.58 4,046 68 6.83
- ----------------------------------------------------------------------------------------
50,194 567 4.54 51,681 618 4.74 52,377 633 4.80
8,208 8,392 8,157
1,551 1,379 1,407
160 160 160
4,998 4,931 4,515
- ----------------------------------------------------------------------------------------
$65,111 $66,543 $66,616
======= ======= =======
4.09 3.88 3.83
- ----------------------------------------------------------------------------------------
$682 4.70 % $673 4.53 % $680 4.50 %
==== ==== ==== ==== ==== ====
$13 $13 $14
- ----------------------------------------------------------------------------------------
24
25
FIGURE 4. COMPONENTS OF NET INTEREST INCOME CHANGES
in millions
From Three Months Ended From Nine Months Ended
September 30, 1995 September 30, 1995
To Three Months Ended To Nine Months Ended
September 30, 1996 September 30, 1996
------------------------------ -----------------------------
Average Yield/ Net Average Yield/ Net
Volume Rate Change Volume Rate Change
------------------------------ -----------------------------
INTEREST INCOME
Loans $ (4) $(12) $ (16) $ 14 $ (7) $ 7
Mortgage loans held for sale (2) -- (2) (1) (1) (2)
Taxable investment securities (128) (7) (135) (359) (56) (415)
Tax-exempt investment securities (2) (1) (3) (7) (5) (12)
Securities available for sale 95 2 97 298 3 301
Short-term investments (3) -- (3) (16) (4) (20)
----- ---- ----- ----- ----- -----
Total interest income (TE) (44) (18) (62) (71) (70) (141)
INTEREST EXPENSE
Money market deposit accounts 27 (26) 1 64 (65) (1)
Savings deposits (6) 12 6 (18) 29 11
NOW accounts (19) 1 (18) (40) (4) (44)
Certificates of deposit ($100,000 or more) (13) -- (13) (13) 3 (16)
Other time deposits (16) (15) (31) (24) (12) (36)
Deposits in foreign offices (11) (8) (19) (65) (25) (90)
----- ---- ----- ----- ----- -----
Total interest-bearing deposits (38) (36) (74) (96) (80) (176)
Federal funds purchased and securities
sold under repurchase agreements -- (7) (7) 14 (24) (10)
Other short-term borrowings 4 (1) 3 (12) (2) (14)
Long-term debt 5 (5) -- 18 (11) 7
----- ---- ----- ----- ----- -----
Total interest expense (29) (49) (78) (76) (117) (193)
----- ---- ----- ----- ----- -----
Net interest income (TE) $ (15) $ 31 $ 16 $ 5 $ 47 $ 52
===== ==== ===== ===== ===== =====
<FN>
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.
TE = Taxable Equivalent
ASSET AND LIABILITY MANAGEMENT
Asset/Liability Management Committees
Key manages its exposure to economic loss from fluctuations in interest rates
through an active program of asset and liability management pursuant to
guidelines established by its Asset/Liability Management Policy Committee, and
strategies formulated and implemented by the Asset/Liability Strategy Committee
(collectively, "ALCO"). The ALCO has the responsibility for approving the
asset/liability management policies of Key, formulating and implementing
strategies to improve balance sheet positioning and/or earnings, and reviewing
the interest rate sensitivity positions and liquidity profiles of Key and each
of its affiliate banks. Both asset/liability management committees meet at least
monthly.
The primary tool utilized by management to measure and manage interest rate
exposure is a simulation model. Use of the model to perform simulations of
changes in interest rates over one- and two-year time horizons has enabled
management to develop strategies for managing exposure to interest rate risk. In
its simulations, management estimates the impact on net interest income of
various pro forma changes in the overall level of interest rates. These
estimates are based on a large number of assumptions related to loan and deposit
growth, prepayments, interest rates, and other factors. Management believes that
both individually and in the aggregate these assumptions are reasonable, but the
complexity of the simulation modeling process results in a sophisticated
estimate, not a precise calculation of exposure. For example, estimates of
future cash flows must be made for instruments without contractual repayment
schedules. The ALCO guidelines provide that a gradual 200 basis point increase
or decrease in short-term rates over the next 12-month period should not result
in more than a 2% impact on net interest income from what net interest income
would have been if interest rates did not change. Key remains well within these
guidelines.
Recent Management Actions
During the latter half of 1995, a number of actions were taken in connection
with the execution of asset/liability management strategies designed to fund
loan growth, improve liquidity, reduce longer-term interest rate exposure and
enhance capital management flexibility. These actions included the
securitization and sale of low margin prime auto
25
26
loans (in the amount of $299 million), the sale of approximately $1.0 billion of
residential mortgage loans, the reclassification of approximately $8.0 billion
of securities from the investment securities to the securities
available-for-sale portfolio in connection with a one-time opportunity provided
by the FASB (discussed in greater detail in Note 3, Securities Available for
Sale, beginning on page 8), the sale of $1.3 billion of securities and the
execution of $1.0 billion of indexed amortizing receive fixed swaps and $1.0
billion of pay fixed swaps. During the same period, Key repurchased 5,813,450 of
its Common Shares. In the first nine months of 1996, Key sold residential
mortgage loans totaling $500 million and securitized and sold sub-prime auto
loans totaling $141 million. Key expects to securitize another $70 million to
$80 million of sub-prime auto loans during the remainder of the fourth quarter.
Other actions taken during the nine-month period included the repurchase of
10,104,566 Common Shares and the continued run-off of lower-yielding securities.
In response to targeted loan growth and Key's objective of maintaining an
interest rate risk position within ALCO guidelines, $1.1 billion of pay fixed
swaps were executed during the third quarter to replace maturing pay fixed swaps
and fixed-rate borrowings. Management will continue to evaluate strategies to
securitize and/or sell loans, taking into account the strategies' impacts on
liquidity, capital and earnings.
Interest Rate Swap Contracts
Key's core lending and deposit-gathering businesses have generated more
fixed-rate deposits than fixed-rate loans. Left unaddressed, this would result
in an asset-sensitive position and place Key's earnings at risk to declining
interest rates as interest-earning assets would reprice faster than would
interest-bearing liabilities. In addition to Key's primarily fixed-rate
securities portfolio, management has utilized interest rate swaps to manage
interest rate risk by modifying the repricing or maturity characteristics of
specified on-balance sheet assets and liabilities. Interest rate swaps used for
this purpose are designated as portfolio swaps. The decision to use portfolio
interest rate swaps versus on-balance sheet securities to manage interest rate
risk has depended on various factors, including funding costs, liquidity and
capital requirements. As summarized in Figure 5, Key's portfolio swaps totaled
$11.6 billion at September 30, 1996, and consisted principally of contracts
wherein Key receives a fixed rate of interest while paying a variable rate.
FIGURE 5. INTEREST RATE SWAP PORTFOLIO
dollars in millions
SEPTEMBER 30, 1996 December 31, 1995
------------------------------------------------------------------------ -----------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR MATURITY ------------------------- Notional Fair
AMOUNT VALUE (YEARS) RECEIVE PAY Amount Value
----------------------------------------------------------------------- -----------------------
Receive fixed/pay variable -
indexed amortizing(1) $ 5,320 $(49) 2.7 6.77% 5.62% $ 6,200 $ 70
Receive fixed/pay variable -
conventional 3,517 (33) 7.4 6.74 5.62 2,497 104
Pay fixed/receive variable -
conventional 2,313 (3) 1.2 5.51 6.30 2,412 (21)
Basis swaps 400 -- .9 5.44 5.44 -- --
------- ---- ------- ----
Total portfolio swaps 11,550 (85) 3.8 6.46 5.75 11,109 153
Customer swaps 4,830 18 4.7 6.23 6.30 2,844 11
------- ---- ------- ----
Total interest rate swaps $16,380 $(67) 4.0 6.39% 5.91% $13,953 $164
======= ==== ======= ====
<FN>
(1) Maturity is based upon expected average lives rather than contractual terms.
Conventional interest rate swap contracts involve the receipt of amounts based
on fixed or variable rates in exchange for payments based on variable or fixed
rates, without an exchange of the underlying notional amount. Under an indexed
amortizing swap contract, the notional amount remains constant for a specified
period of time after which, based upon the level of the index at each payment
review date, the swap contract will mature, the notional amount will amortize,
or the swap will continue in effect until its contractual maturity. Otherwise,
the characteristics of these swaps are similar to those of conventional swap
contracts. Under basis swap contracts, interest payments based on different
floating indices are exchanged.
In addition to portfolio swaps, Key has entered into interest rate swap
contracts to accommodate the needs of its customers, typically commercial loan
customers, and other positions with third parties that are intended to mitigate
the interest rate risk of the customer positions. Adjustments to the fair values
of such swaps are included in other income on the income statement. The $4.8
billion notional amount of customer swaps presented in Figure 5 includes $2.4
billion of interest rate swaps that receive a fixed rate and pay a variable rate
and $2.4 billion of interest rate swaps that pay a fixed rate and receive a
variable rate.
26
27
The total notional amount of all interest rate swap contracts outstanding was
$16.4 billion at September 30, 1996, $14.0 billion at December 31, 1995, and
$11.9 billion at September 30, 1995. The weighted average rates presented in
Figure 5 are those in effect at September 30, 1996. Portfolio interest rate
swaps increased net interest income and the net interest margin by $19 million
and by 13 basis points, respectively, during the third quarter of 1996. These
increases reflected the impact of a positive spread on the third quarter 1996
swap portfolio, which more than offset the amortization of deferred losses from
swaps terminated in prior periods. As of September 30, 1996, the spread on
portfolio interest rate swaps, which excludes the amortization of deferred swap
gains and losses, provided a positive impact on net interest income (since the
weighted average rate received exceeded the weighted average rate paid by 71
basis points). The portfolio had an aggregate negative fair value of $(85)
million at the same date. The aggregate fair value was estimated through the use
of discounted cash flow models which contemplate interest rates using the
applicable forward yield curve. As shown in Figure 5, the estimated fair value
of Key's total interest rate swap portfolio decreased during the first nine
months of 1996 from a fair value of $164 million at December 31, 1995. The
decline in fair value over the past nine months reflected the financial markets'
expectations, as measured by the forward yield curve, for a future increase in
interest rates. In addition, during 1995, swaps with an aggregate notional
amount of $1.4 billion were terminated prior to their maturities, resulting in
net deferred losses of $49 million. Swaps with a notional amount of $800 million
were also terminated during the current year, resulting in a deferred gain of
$.3 million. Such gains and losses are amortized, generally, over the projected
remaining life of the related swap contract at its termination, and recorded as
an adjustment of the yield on the respective on-balance sheet item that was
being managed. A summary of Key's deferred swap gains and losses at September
30, 1996, is presented in Note 10, Financial Instruments with Off-Balance Sheet
Risk, beginning on page 13. Each swap termination was in response to a unique
set of circumstances and for various reasons; however, the decision to terminate
a swap contract is integrated strategically with asset and liability management
and other appropriate processes. These terminations as well as other portfolio
swap activity for the nine-month period ended September 30, 1996, are summarized
in Figure 6.
FIGURE 6. PORTFOLIO SWAP ACTIVITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
in millions
Receive Fixed
--------------------------------- Total
Indexed Pay Fixed- Basis Portfolio
Amortizing Conventional Conventional Swaps Swaps
-------------- ---------------- ---------------- ---------------- ----------------
Balance at beginning of year $6,200 $2,497 $2,412 -- $11,109
Additions -- 1,341 1,152 $400 2,893
Maturities -- (121) (651) -- (772)
Terminations -- (200) (600) -- (800)
Amortization (880) -- -- -- (880)
------ ------ ------ ---- -------
Balance at end of period $5,320 $3,517 $2,313 $400 $11,550
====== ====== ====== ==== =======
A summary of the notional and fair values of portfolio swaps by interest rate
management strategy at September 30, 1996, is presented in Figure 7. The fair
value at any given date represents the estimated income (if positive) or cost
(if negative) that would be recognized if the portfolio were to be liquidated at
that date. However, because the portfolio interest rate swaps are used to alter
the repricing or maturity characteristics of specific assets and liabilities,
the net unrealized gains and losses related to the swaps are not recognized in
earnings. Rather, interest from these swaps is recognized on an accrual basis as
an adjustment of the interest income or expense from the asset or liability
being managed.
The notional amount of the interest rate swap contracts represents only an
agreed upon amount on which calculations of interest payments to be exchanged
are based. It does not represent the potential for gain or loss on such
positions. Similarly, the notional amount is not indicative of the market risk
or the credit risk of the positions held. Credit risk is the possibility that
the counterparty will not meet the terms of the swap contract and is measured as
the cost of replacing, at current market rates, contracts in an unrealized gain
position. The credit risk exposure to the counterparty on each interest rate
swap is monitored by an appropriate credit committee. Based upon detailed credit
reviews of the counterparties, limits on the total credit exposure Key may have
with each counterparty, and whether collateral is required, are determined.
27
28
FIGURE 7. PORTFOLIO SWAPS BY INTEREST RATE MANAGEMENT STRATEGY
in millions
SEPTEMBER 30, 1996 December 31, 1995 September 30, 1995
-------------------------- ------------------------- -------------------------
NOTIONAL FAIR Notional Fair Notional Fair
AMOUNT VALUE Amount Value Amount Value
--------------- --------- ------------ ----------- ----------- ------------
Convert variable rate loans
to fixed $ 6,688 $(80) $ 7,567 $113 $5,704 $(28)
Convert variable rate deposits
and short-term borrowings
to fixed 2,033 (2) 2,275 (18) 2,487 (23)
Convert variable rate long-term
debt to fixed 280 (1) 137 (3) -- --
Convert fixed rate long-term
debt to variable 2,149 (2) 1,130 61 1,616 37
Convert variable rate index of
short-term borrowings 400 -- -- -- -- --
------- ---- ------- ---- ------ ----
Total portfolio swaps $11,550 $(85) $11,109 $153 $9,807 $(14)
======= ==== ======= ==== ====== ====
At September 30, 1996, Key had 17 different counterparties to portfolio swaps
and swaps entered into to offset the risk of customer swaps. Of these
counterparties, Key had an aggregate credit exposure of $6 million to seven,
with the largest credit exposure to an individual counterparty amounting to $2
million. Although Key is exposed to credit-related losses in the event of
nonperformance by the counterparties, based on management's assessment, as of
September 30, 1996, all counterparties were expected to meet their obligations.
The expected average maturities of the portfolio swaps at September 30, 1996,
are summarized in Figure 8.
FIGURE 8. EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS AT SEPTEMBER 30, 1996
in millions
Receive Fixed
------------------------------- Total
Indexed Pay Fixed- Basis Portfolio
Amortizing Conventional Conventional Swaps Swaps
------------- ---------------- ---------------- ---------------- ------------
Due in one year or less $ 75 $ 2 $1,361 $400 $ 1,838
Due after one through five years 5,058 340 950 -- 6,348
Due after five through ten years 187 2,940 2 -- 3,129
Due after ten years -- 235 -- -- 235
============= ================ ================ ================ ============
Total portfolio swaps $5,320 $3,517 $2,313 $400 $11,550
============= ================ ================ ================ ============
NONINTEREST INCOME
As shown in Figure 9, noninterest income totaled $289 million for the third
quarter of 1996, up $54 million, or 23%, from the same period last year. The
improvement in noninterest income reflected growth in all major fee-based
revenues, with the exception of mortgage banking income, and included the impact
of the AFG and Knight acquisitions completed in September 1995 and June 1996,
respectively. The largest increases from the prior year came from a $15 million
increase in loan securitization income and a $34 million increase in other
income. As shown in Figure 10, the increase in loan securitization income in the
third quarter was due primarily to gains on the sales of student and auto loans.
The increase in other income reflected a number of items, including an $8
million increase in venture capital income, an $11 million gain on the sale of a
$101 million out-of-franchise credit card portfolio and a $6 million increase in
income from corporate owned life insurance. Also contributing to the favorable
comparison with the prior year quarter were increases of $3 million in both
service charges on deposit accounts and trust and asset management income. The
repricing of fees by certain affiliate banks, the introduction of certain
services to new markets in 1995 and enhanced collection efforts were the primary
factors contributing to the growth in service charges on deposit accounts, while
the increase in trust and asset management income resulted from continued strong
performance of both the stock and bond markets, new business and an array of new
products. The positive factors contributing to the increase in trust and asset
management income were partially offset, however, by the impact of the December
1995 sale of Key's bond servicing business. Additional detail pertaining to the
composition of the trust and asset management income component is
28
29
presented in Figure 11. The acquisitions referred to above are more fully
disclosed in Note 2, Mergers, Acquisitions and Divestitures, beginning on page
7.
Noninterest income totaled $802 million for the first nine months of 1996, up
$173 million, or 28%, from the comparable 1995 period. Included in 1995 results
were net securities losses of $49 million recorded in the first quarter in
connection with efforts to reconfigure the balance sheet in order to reduce
interest rate risk. Excluding these and all other securities transactions for
comparative purposes, noninterest income was up $130 million, or 19%, from the
first nine months of 1995 and reflected the impact of seven acquisitions
completed during 1995 and 1996. As shown in Figure 9, the growth from the prior
year came principally from higher levels of loan securitization income (up $36
million), service charges on deposit accounts (up $11 million), trust and asset
management income (up $10 million), credit card fees (up $8 million), insurance
and brokerage income (up $8 million) and other income (up $71 million). Included
in the increase in other income was a $22 million increase in income from
corporate owned life insurance, a $13 million increase in venture capital
income, an $11 million gain on the August 1996 sale of the credit card portfolio
previously referred to and the $8 million gain on the June 1996 sale of SFF. The
positive effect of the above items was partially offset by a $14 million
decrease in mortgage banking income, resulting from the March 1995 sale of the
residential mortgage loan servicing business. This transaction as well as the
acquisitions and the divestiture of SFF referred to above are more fully
disclosed in Note 2, referred to in the preceding paragraph.
FIGURE 9. NONINTEREST INCOME
dollars in millions
Three Months Nine Months
ended ended
September 30, Change September 30, Change
------------- -------------------- --------------- -----------------
1996 1995 Amount Percent 1996 1995 Amount Percent
------ ----- -------- ---------- ----- ------- ------- -------
Service charges on deposit accounts $ 74 $ 71 $ 3 4.2% $218 $ 207 $ 11 5.3%
Trust and asset management income 61 58 3 5.2 180 170 10 5.9
Loan securitization income 18 3 15 N/M 45 9 36 N/M
Credit card fees 24 23 1 4.3 68 60 8 13.3
Insurance and brokerage income 18 17 1 5.9 52 44 8 18.2
Mortgage banking income 6 9 (3) (33.3) 20 34 (14) (41.2)
Net securities gains (losses) -- -- -- -- 1 (42) 43 N/M
Other income:
Corporate owned life insurance 15 9 6 66.7 42 20 22 110.0
Venture capital income 14 6 8 133.3 23 10 13 130.0
Letter of credit fees 4 6 (2) (33.3) 11 15 (4) (26.7)
Miscellaneous income 55 33 22 66.7 142 102 40 39.2
---- ---- ---- ---- ----- -----
Total other income 88 54 34 63.0 218 147 71 48.3
---- ---- ---- ---- ----- -----
Total noninterest income $289 $235 $ 54 23.0% $802 $ 629 $ 173 27.5%
==== ==== ==== ==== ===== =====
N/M = Not Meaningful
FIGURE 10. LOAN SECURITIZATIONS
dollars in millions
Three Months ended Nine Months ended
September 30, September 30,
-------------------- -----------------
1996 1995 1996 1995
-------- --------- ------- ------
Servicing fees $ 5 $1 $20 $1
Gains on sales of securitized loans 13 2 24 8
Miscellaneous income -- -- 1 --
-------- --------- ------- ------
Total loan securitization income $18 $3 $45 $9
======== ========= ======= ======
- ----------------------------------------------------------------------------------
AT SEPTEMBER 30,
Student loans securitized $1,778 $ 920
Auto loans securitized 375 260
-------- ---------
Total securitized loans $2,153 $1,180
======== =========
29
30
FIGURE 11. TRUST AND ASSET MANAGEMENT
dollars in millions
Three months ended Nine months ended
September 30, Change September 30, Change
--------------- ---------------- -------------- ----------------
1996 1995 Amount Percent 1996 1995 Amount Percent
---- ---- ------ ------- ---- ----- ------ -------
Personal asset management and
custody fees $36 $35 $ 1 2.9% $107 $100 $ 7 7.0%
Institutional asset management and
custody fees 17 14 3 21.4 47 42 5 11.9
Bond services 3 4 (1) (25.0) 10 14 (4) (28.6)
All other fees 5 5 -- -- 16 14 2 14.3
---- ----- ---- ---- ---- ----
Total trust and asset
management income $61 $58 $ 3 5.2% $180 $170 $ 10 5.9%
==== ===== ==== ==== ==== ====
- ------------------------------------------------------------------------------------------------------------
AT SEPTEMBER 30,
dollars in billions
Discretionary $49 $48 $ 1 2.1%
Non-discretionary 44 34 10 29.4
---- ---- ----
Total trust assets $93 $82 $ 11 13.4%
==== ==== ====
NONINTEREST EXPENSE
As shown in Figure 12, noninterest expense for the third quarter of 1996 totaled
$615 million, up $54 million, or 10%, from the third quarter of 1995. Included
in noninterest expense for the third quarter of 1996 was a one-time charge of
$17 million to provide for an assessment mandated by legislation passed by
Congress on September 30, 1996, to recapitalize the SAIF. Excluding the impact
of this one-time charge, noninterest expense was up $37 million, or 7%, relative
to the prior year quarter. This increase was due principally to higher levels of
personnel expense and marketing expense which rose by $22 million and $11
million, respectively. The increase in personnel expense, the largest category
of noninterest expense, reflected the impact of normal annual merit increases
(which take effect in April for the majority of Key's employees), an increase in
employee benefits expense, higher costs associated with various incentive
programs (including commissions related to the venture capital income discussed
previously in the Noninterest Income section) and the overall impact of
additional costs associated with the implementation of strategic initiatives.
The growth in marketing expense was due largely to incremental costs related to
continued strategic efforts aimed at strengthening consumer identification of
the KeyBank brand name as well as other marketing activities. Marketing expenses
are expected to be at a somewhat lower level in the fourth quarter. The
acquisitions of AFG and Knight in September 1995 and June 1996, respectively,
also contributed to the year-over-year increase in noninterest expense. However,
their impact was substantially offset by the effect of the June 1996 sale of
SFF.
Noninterest expense totaled $1.8 billion for the first nine months of 1996, up
$74 million, or 4%, from the same period last year. This increase reflected
growth in personnel expense (up $60 million), marketing expense (up $16
million), the amortization of intangibles (up $10 million), and other expense
(up $11 million). Excluding the one-time SAIF assessment referred to above,
noninterest expense for the year-to-date period was up $57 million, or 3%, from
the prior year. The variances in personnel expense and marketing expense were
attributable to the same factors which accounted for the quarterly variances
discussed previously. The higher level of amortization related to intangibles
was a direct result of the goodwill recorded in connection with the AFG
acquisition, while the growth in other expense reflected increases in a number
of categories of operating expense. The overall increase in noninterest expense
relative to the prior year was offset, in part, by the effect of the elimination
of the Bank Insurance Fund assessment rate which took effect as of January 1,
1996. During the latter half of 1995, the assessment rate for well-capitalized
banks (including all of Key's banks) was reduced from $.23 per $100 of insured
deposits to $.04 per $100 for the period June through December 1995. As a result
of these actions, after excluding the impact of the one-time SAIF assessment,
the cost of insurance assessments during the first nine months of 1996 decreased
$44 million, or 85%, from the comparable 1995 period. In general, the increases
summarized above also reflected the impact of seven acquisitions completed
during 1995 and 1996, offset in part by the overall reduction in costs
(primarily personnel) resulting from the 1995 sales of both KMI and Schaenen
Wood & Associates, Inc. and the June 1996 sale of SFF. The acquisitions and
sales are more fully disclosed in Note 2, Mergers, Acquisitions and
Divestitures, beginning on page 7.
30
31
The efficiency ratio, which measures the extent to which recurring revenues are
used to pay operating expenses, improved to 60.71% for the third quarter, from
61.27% for the third quarter of 1995. The improvement in the efficiency ratio
relative to the third quarter of last year reflected faster growth in
taxable-equivalent net interest income and noninterest income than in
noninterest expense. In October, Key announced it had initiated a comprehensive
review of its branch delivery system and overall cost structure, with the
objective of achieving a targeted efficiency ratio of 55% by around the end of
1997. While the comprehensive review is in its early stages, it is possible
that, as a result of that review, Key will incur a special charge relating to
branch consolidations and closings, severance costs and other matters. The
amount and timing of the charge, if any, can not yet be determined.
FIGURE 12. NONINTEREST EXPENSE
(dollars in millions)
Three Months ended Nine Months ended
September 30, Change September 30, Change
--------------------------- ------------------------ --------------------- ---------------------
1996 1995 Amount Percent 1996 1995 Amount Percent
------------ ------------ --------- ---------- -------- -------- ---------- ---------
Personnel $ 300 $ 278 $ 22 7.9% $ 889 $ 829 $ 60 7.2%
Net occupancy 55 54 1 1.9 163 160 3 1.9
Equipment 41 37 4 10.8 119 116 3 2.6
FDIC insurance assessments 20 1 19 N/M 25 52 (27) (51.9)
Amortization of intangibles 21 19 2 10.5 65 55 10 18.2
Professional fees 18 19 (1) (5.3) 47 49 (2) (4.1)
Marketing 30 19 11 57.9 68 52 16 30.8
Other expense:
OREO expense, net(1) 2 (1) 3 N/M 3 -- 3 N/M
Miscellaneous expense 128 135 (7) (5.2) 385 377 8 2.1
-------- --------- -------- --------- -------- --------
Total other expense 130 134 (4) (3.0) 388 377 11 2.9
-------- --------- -------- --------- -------- --------
Total noninterest expense $ 615 $ 561 $ 54 9.6% $ 1,764 $ 1,690 $ 74 4.4%
======== ========= ======== ========= ======== ========
Full-time equivalent employees
at period end 28,337 29,560 28,337 29,560
Efficiency ratio(2) 60.71% 61.27% 60.81% 62.79%
Overhead ratio(3) 44.40 47.89 45.66 50.43
<FN>
(1) OREO expense is net of income of $1 million and $2 million for the
third quarter of 1996 and 1995, respectively, and $3 million and $4
million for the 1996 and 1995 year -to-date period, respectively
(2) Calculated as noninterest expense (excluding certain nonrecurring charges)
divided by taxable-equivalent net interest income plus noninterest income
(excluding net securities transactions).
(3) Calculated as noninterest expense (excluding certain nonrecurring charges)
less noninterest income (excluding net securities transactions) divided by
taxable-equivalent net interest income.
</FN>
N/M = Not Meaningful
INCOME TAXES
The provision for income taxes was $101 million for the three month period ended
September 30, 1996, as compared with $104 million for the same period in 1995.
The effective income tax rate (provision for income taxes as a percentage of
income before income taxes) for the 1996 third quarter was 32.8% compared with
33.1% for the third quarter of 1995. For the first nine months of 1996, the
provision for income taxes was $300 million compared with $267 million (before
the extraordinary net gain resulting from the sales of KMI and Schaenen Wood &
Associates, Inc.) for the first nine months of 1995. The effective income tax
rate in these periods was 32.2% and 31.4%, respectively. The lower 1995
year-to-date effective income tax rate as compared with 1996 was primarily
attributable to the first quarter 1995 recognition of one-time tax benefits
totaling $16 million related to acquisitions made in years prior to 1992. The
effective income tax rate remains below the statutory Federal rate of 35% due
primarily to the impact of continued investment in tax-advantaged assets (such
as tax-exempt securities and corporate owned life insurance) and the recognition
of credits associated with investments in low-income housing projects.
31
32
FINANCIAL CONDITION
LOANS
At September 30, 1996, total loans outstanding were $48.3 billion, compared with
$47.7 billion at December 31, 1995, and $48.4 billion at September 30, 1995. The
composition of the loan portfolio by loan type, as of each of these respective
dates, is presented in Note 5, Loans, beginning on page 10.
The slight decrease in loans outstanding from September 30, 1995, reflected the
impact of Key's continued strategy of securitizing and/or selling sub-prime
loans, student loans and other loans with lower spreads which do not meet
certain return on equity, credit or other internal standards. This activity
included the sale of $1.0 billion of residential mortgage loans, $1.4 billion of
student loans (of which $1.1 billion was associated with securitizations) and
the securitization and sale of auto loans totaling $237 million. Since $500
million of the mortgage loans sold were transferred to the held for sale
portfolio prior to September 30, 1995, they did not contribute to the reduction
in loans outstanding over the past year. Similarly, an additional $354 million
of student loans, which were securitized during the third quarter of 1996, did
not affect year-over year comparisons since they were sold in the fourth quarter
of 1995. Generally, Key sells or securitizes student loans in order to reduce
the credit risk that arises when a borrower enters repayment status. Other
factors contributing to the decrease in total loans over the past year were the
August 1996 sale of a $101 million out-of-franchise credit card portfolio and
the sale of $763 million of loans (primarily residential real estate) in
conjunction with the June 1996 divestiture of SFF. This latter transaction is
described in greater detail in Note 2, Mergers, Acquisitions and Divestitures,
beginning on page 7. Excluding the impact of the above sales, loan portfolios
targeted for growth (which exclude one-to-four family mortgages) increased $3.5
billion with the largest advances coming from consumer loans (up $1.3 billion,
including an increase of $355 million in credit card outstandings), student
loans (up $1.2 billion), lease financing (up $504 million) and commercial loans
(up $384 million).
The $599 million increase in loans from the December 31, 1995, level reflected
strong growth in targeted loan portfolios as the aggregate annualized growth
rate of average outstanding balances in these portfolios was approximately 10%
for each of the past three quarters. Excluding the impact of sales, the $2.6
billion increase in targeted loans was primarily due to higher levels of
consumer loans (up $1.1 billion, including an increase in of $206 million credit
card outstandings), student loans (up $810 million) and commercial loans (up
$408 million). This growth was substantially offset, however, by the sale of
$608 million of student loans (of which $357 million was associated with
securitizations), $141 million of sub-prime auto loans and the sale of the $101
million out-of-franchise credit card portfolio. In addition, during the first
nine months of 1996, residential mortgage loans decreased by $1.1 billion,
reflecting primarily the divestiture of SFF. Although Key sold $500 million of
residential mortgage loans during the same period, this sale did not contribute
to the change in the level of loans outstanding, since these loans had been
transferred to the held for sale portfolio prior to 1996. Key expects to
securitize and sell an additional $70 million to $80 million of sub-prime auto
loans in the fourth quarter.
As shown in Figure 13, new loan volume during the first nine months of 1996 was
attributable to Consumer Finance companies, which include Key Bank USA, National
Association ("KeyBank USA") and AFG. KeyBank USA, a nationally chartered bank
formed during the third quarter of 1995, serves as the national platform for
credit card lending, student loans, mortgage loan originations and all
non-branch consumer finance business, while AFG, acquired during the third
quarter of 1995, is one of the nation's leading sub-prime automobile finance
companies. The majority of new loan volume generated by Consumer Finance
companies is either participated to Key's other banks or securitized and sold.
FIGURE 13. PERIOD-END LOAN GROWTH BY REGION FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1996
dollars in millions
Net Intercompany
December 31, Originations/ Participations Acquired/ SEPTEMBER 30, Percent
1995 (Repayments) (Sales) (Sold) 1996 Change
------------ ------------ -------------- -------- -------- -----
Northeast Region $ 13,718 $ (521) $ 959 $ (143) $ 14,013 2.2%
Great Lakes Region 19,211 (1,131) 1,658 (27) 19,711 2.6
Rocky Mountain Region 3,817 (26) 43 (10) 3,824 .2
Northwest Region 9,008 (145) 593 (13) 9,443 4.8
Consumer Finance companies 2,108 4,257 (3,046) (683) 2,636 25.0
Eliminations/other(1) (170) (196) (207) (763) (1,336) N/M
-------- -------- -------- -------- -------
Total $ 47,692 $ 2,238 -- $ (1,639) $ 48,291 1.3%
======== ======== ======== ======== ========
<FN>
(1) Eliminations/other includes loans sold in connection with the
SFF divestiture.
32
33
SECURITIES
At September 30, 1996, the securities portfolio totaled $8.8 billion, consisting
of $7.1 billion of securities available for sale and $1.7 billion of investment
securities. This compares with a total portfolio of $9.7 billion, comprised of
$8.0 billion of securities available for sale and $1.7 billion of investment
securities, at December 31, 1995. The reduction in the overall portfolio since
yearend 1995 reflects the planned runoff of lower-yielding securities pursuant
to balance sheet management strategies developed in mid-1995. These strategies
are more fully discussed in the Asset and Liability Management section beginning
on page 25. Certain information pertaining to the composition, yields and
maturities of the securities available for sale and investment securities
portfolios is presented in Figures 14 and 15, respectively.
FIGURE 14. SECURITIES AVAILABLE FOR SALE AT SEPTEMBER 30, 1996
dollars in millions
Other
U.S. Treasury, States and Collateralized Mortgage- Weighted
Agencies and Political Mortgage Backed Other Average
Corporations Subdivisions Obligations(1) Securities(1) Securities Total Yield(2)
--------------- ------------- -------------- ------------- ----------- --------- ----------
Maturity:
One year or less $ 262 $ 3 $ 340 $ 22 $ 22 $ 649 6.17%
After one through five years 488 13 2,117 1,087 48 3,753 6.84
After five through ten years 178 10 1 2,006 31 2,226 6.99
After ten years 203 3 -- 272 7 485 6.74
--------------- -------------- ------------- ---------- ---------- -----------
Fair value $1,131 $29 $2,458 $3,387 $108 $7,113 6.84%
=============== ============== ============= ========== ========== ===========
Amortized cost $1,135 $29 $2,488 $3,416 $107 $7,175
Weighted average yield 6.40% 8.20% 6.25% 7.34% 6.82% 6.84%
Weighted average maturity 8.6 years 6.0 years 2.2 years 6.2 years 5.7 years 4.4 years
<FN>
1 Maturity is based upon expected average lives rather than contractual terms.
2 Weighted average yields are calculated on the basis of amortized cost. Such
yields have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
FIGURE 15. INVESTMENT SECURITIES AT SEPTEMBER 30, 1996
dollars in millions
States and Weighted
Political Other Average
Subdivisions Securities Total Yield(1)
------------- ----------- ---------- ---------
Maturity:
One year or less $ 626 $ 67 $ 693 6.79%
After one through five years 550 121 671 8.26
After five through ten years 199 23 222 10.17
After ten years 59 8 67 9.68
============= =========== ==========
Amortized cost $1,434 $219 $1,653 7.96%
============= =========== ==========
Fair value $1,470 $219 $1,689
Weighted average yield 8.09% 4.53% 7.96%
Weighted average maturity 2.8 years 4.0 years 2.8 years
<FN>
1 Weighted average yields are calculated on the basis of amortized cost. Such
yields have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
ASSET QUALITY
Key's Credit Risk Management Group evaluates and monitors the level of risk in
Key's credit-related assets, and formulates underwriting standards and
guidelines for line management. Geographic diversification throughout Key is a
significant factor in managing credit risk. The Credit Risk Management Group is
also responsible for reviewing the adequacy of the allowance for loan losses
("Allowance"). Furthermore, Key's Credit Policy/Risk Management Group reviews
corporate assets other than loans, leases and other real estate owned ("OREO")
to evaluate the credit quality and risk inherent in such assets. This group is
also responsible for commercial and consumer credit policy development,
concentration management and credit systems development.
33
34
Management has developed methodologies designed to assess the adequacy of the
Allowance. The Allowance allocation methodologies applied at Key focus on
changes in the size and character of the loan portfolio, changes in the levels
of impaired and other nonperforming and past due loans, the risk inherent in
specific loans, concentrations of loans to specific borrowers or industries,
existing and prospective economic conditions and historical losses on a
portfolio basis. In addition, indirect risk in the form of off-balance sheet
exposure for unfunded commitments is taken into consideration. Management
continues to target and maintain an Allowance equal to the allocated requirement
plus an unallocated portion, as appropriate. Management believes this is an
appropriate posture in light of current and expected economic conditions and
trends, the geographic and industry mix of the loan portfolio and similar
risk-related matters.
As shown in Figure 16, net loan charge-offs for the third quarter of 1996 were
$49 million, or .41% of average loans, compared with $27 million, or .23% of
average loans, for the same period last year. The increase in net charge-offs
was attributable to a continued increase from historically low net charge-off
levels in the commercial and indirect auto areas, as well as continued increases
in the credit card area. The $10 million increase in commercial loan net
charge-offs reflected a lower level of recoveries relative to the prior year.
Net charge-offs in the commercial portfolio continue to be well below historical
levels and are anticipated to increase to more normalized levels. Credit cards,
representing 3% of the total loan portfolio, experienced a $6 million increase
in net charge-offs, which was in line with industry experience as well as
management's expectations. As a result of the higher level of net charge-offs,
the provision for loan losses was increased to $49 million for the third quarter
of 1996 from $47 million for the prior quarter and $27 million for the third
quarter of last year. This increase reflected management's intention to continue
to maintain the provision for loan losses at a level equal to or above net
charge-offs.
FIGURE 16. SUMMARY OF LOAN LOSS EXPERIENCE
dollars in millions
Three months ended Nine months ended
September 30, September 30,
---------------------------- -----------------------------
1996 1995 1996 1995
------------ ------------ ------------- -------------
Average loans outstanding during the period $ 48,017 $ 48,196 $ 48,003 $ 47,801
Allowance for loan losses at beginning of period $ 870 $ 867 $ 876 $ 830
Loans charged off:
Commercial, financial and agricultural 14 11 53 31
Real estate--construction 2 1 2 2
Real estate--commercial and residential mortgage 7 12 19 26
Credit cards 21 14 57 38
Other consumer 27 18 80 49
Lease financing 1 1 5 3
-------- -------- -------- --------
72 57 216 149
Recoveries:
Commercial, financial and agricultural 8 15 31 42
Real estate--construction 1 3 1 3
Real estate--commercial and residential mortgage 3 4 9 11
Credit cards 4 3 10 9
Other consumer 7 5 26 18
Lease financing -- -- 1 1
-------- -------- -------- --------
23 30 78 84
-------- -------- -------- --------
Net loans charged off (49) (27) (138) (65)
Provision for loan losses 49 27 140 66
Allowance acquired/(sold), net -- 12 (8) 47
Transfer from OREO allowance -- -- -- 1
-------- -------- -------- --------
Allowance for loan losses at end of period $ 870 $ 879 $ 870 $ 879
======== ======== ======== ========
Net loan charge-offs to average loans .41% .23% .38% .18%
Allowance for loan losses to period-end loans 1.80 1.82 1.80 1.82
Allowance for loan losses to nonperforming loans 252.91 280.53 252.91 280.53
34
35
On a year-to-date-basis, net charge offs were $138 million, or .38% of average
loans, for 1996 compared with $65 million, or .18% of average loans for the same
period last year. The provision for loan losses for the first nine months of
1996 was $140 million compared with $66 million for the first nine months of
1995. Similar to the increase for the quarter, the increase in net charge-offs
for the year-to-date period was primarily attributable to increased charge-offs
in the commercial, credit card and indirect auto areas and reduced recoveries,
primarily in the commercial area. The increase in commercial loan net
charge-offs reflected two large credits totaling $17 million that were
charged-off in the first half of 1996.
The Allowance at September 30, 1996, was $870 million, or 1.80% of loans,
compared with $876 million, or 1.84% of loans, at December 31, 1995 and $879
million, or 1.82% of loans, at September 30, 1995. At September 30, 1996, the
Allowance was 252.91% of nonperforming loans, compared with 263.15% at December
31, 1995 and 280.53% at September 30, 1995. Although this percentage is not the
primary factor used by management in determining the adequacy of the Allowance,
it has general short to medium-term relevance. There have been no significant
changes in the allocation of the Allowance since year end.
The composition of nonperforming assets is shown in Figure 17. These assets
totaled $396 million at September 30, 1996, and represented .82% of loans, OREO
and other nonperforming assets compared with $379 million, or .79%, at year-end
1995 and $367 million, or .76%, at September 30, 1995. The $11 million increase
in nonperforming loans since year-end 1995 reflected the placement of an
additional $244 million of loans on nonaccrual status, partially offset by loan
charge-offs of $59 million, payments received totaling $98 million and the sale
of two nonaccrual commercial loans totaling $38 million. Additional information
pertaining to changes in nonaccrual loans and the percentage of nonperforming
loans to period-end loans by type within Key's geographically dispersed banking
regions is presented in Figures 18 and 19, respectively.
FIGURE 17. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
(dollars in millions)
SEPTEMBER 30, December 31, September 30,
1996 1995 1995
------------ ------------ -------------
Commercial, financial and agricultural $ 131 $ 145 $ 121
Real estate--construction 14 10 12
Real estate--commercial mortgage 82 90 99
Real estate--residential mortgage 75 62 60
Consumer 25 20 14
Lease financing 16 3 3
----- ----- -----
Total nonaccrual loans 343 330 309
Restructured loans 1 3 4
----- ----- -----
Total nonperforming loans 344 333 313
Other real estate owned 59 56 64
Allowance for OREO losses (10) (14) (15)
----- ----- -----
Other real estate owned, net of allowance 49 42 49
Other nonperforming assets 3 4 5
----- ----- -----
Total nonperforming assets $ 396 $ 379 $ 367
===== ===== =====
Accruing loans past due 90 days or more $ 105 $ 97 $ 79
Nonperforming loans to period-end loans .71% .70% .65%
Nonperforming assets to period-end loans plus other
real estate owned and other nonperforming assets .82 .79 .76
35
36
FIGURE 18. SUMMARY OF CHANGES IN NONACCRUAL LOANS
in millions
Three months ended September 30, Nine months ended September 30,
---------------------------------------- --------------------------------
1996 1995 1996 1995
----- ------ ------- -----
Balance at beginning of period $ 325 $ 310 $ 330 $ 255
Loans placed on nonaccrual 75 66 244 228
Charge-offs(1) (15) (17) (59) (50)
Payments (32) (29) (98) (99)
Loans sold -- -- (38) --
Transfers to OREO (6) (7) (19) (19)
Loans returned to accrual status (4) (14) (17) (46)
Acquisitions -- -- -- 20
Transfers from OREO(2) -- -- -- 20
----- ----- ----- -----
Balance at end of period $ 343 $ 309 $ 343 $ 309
===== ===== ===== =====
<FN>
1 Represents the gross charge-offs taken against nonaccrual loans; excluded
are charge-offs taken against accruing loans and credit card receivables,
and interest reversals.
2 Represents transfers related to the adoption of SFAS No. 114.
FIGURE 19. PERCENTAGE OF NONPERFORMING LOANS TO PERIOD-END LOANS BY TYPE AT
SEPTEMBER 30, 1996
Commercial, Real Estate- Real Estate-
Financial and Real Estate- Commercial Residential
Agricultural Construction Morgage Morgage Consumer Total
------------- ------------ ------------ ------------ -------- -----
Northeast Region 1.58% .57% 2.03% .96% .23% 1.12%
Great Lakes Region .63 1.23 .75 .53 .14 .53
Rocky Mountian Region 1.75 .06 .95 .35 .62 .98
Northwest Region .53 .75 .63 .65 .33 .54
Consumer Finance
companies -- -- -- -- .01 .01
------------- ------------ ------------ ------------ -------- -----
Total .98% .81% 1.17% .68% .19% .71%
============= ============ ============ ============ ======== =====
DEPOSITS AND OTHER SOURCES OF FUNDS
Core deposits, defined as domestic deposits other than certificates of deposit
of $100,000 or more, are Key's primary source of funding. During the third
quarter of 1996, these deposits averaged $39.9 billion and represented 69% of
Key's funds supporting earning assets compared with $41.5 billion and 69%,
respectively, for the third quarter of 1995. As shown in Figure 3 beginning on
page 23, over the past year the mix of core deposits has changed significantly.
Primary among the factors contributing to this change is a new program started
during the fourth quarter of 1995. Deposit balances (above a defined threshold)
in certain NOW and noninterest-bearing checking accounts are transferred to
money market deposit 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,
during the first nine months of 1996, demand deposits and NOW account balances
averaging $1.3 billion and $2.7 billion, respectively, were transferred to the
money market deposit account category and a pre-tax cost savings of
approximately $13 million was realized. In Figure 3, the demand deposits
transferred continue to be reported as noninterest-bearing deposits, while the
NOW accounts transferred are included in the money market deposit account
category. During the second quarter of 1996, the implementation of this program
was completed in the last of Key's four banking regions. Contributing to the
overall decrease in core deposits relative to the prior year was the impact of
investment alternatives pursued by customers in response to the continued
strength of the stock and bond markets, and the impact of the SFF divestiture
early in June 1996.
Purchased funds, which are comprised of large certificates of deposit, deposits
in foreign offices and short-term borrowings, averaged $13.7 billion for the
third quarter of 1996, down $1.3 billion, or 9%, from the comparable prior year
period. As illustrated in Figure 3, the decrease was attributable to reductions
in certificates of deposit ($100,000 or more) and deposits in foreign offices of
$937 million and $678 million, respectively, as less expensive sources were used
to fund earning assets.
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FIGURE 20. MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE AT
SEPTEMBER 30, 1996
in millions
Domestic Foreign
Offices Offices Total
-------- -------- -------
Time remaining to maturity:
Three months or less $1,974 $881 $2,855
Over three through six months 454 2 456
Over six through twelve months 434 -- 434
Over twelve months 582 -- 582
======== ======= ======
Total $3,444 $883 $4,327
======== ======= ======
LIQUIDITY
Liquidity represents the availability of funding to meet the needs of
depositors, borrowers and creditors at a reasonable cost on a timely basis and
without adverse consequences. Key's ALCO actively analyzes and manages Key's
liquidity in coordination with similar committees at each affiliate bank. The
affiliate banks individually maintain liquidity in the form of short-term money
market investments, securities available for sale, anticipated prepayments and
maturities on securities, the maturity structure of their loan portfolios and
the ability to securitize and package loans for sale. Liquidity is also enhanced
by a sizable concentration of core deposits, previously discussed, which are
generated by more than 1,200 full-service banking offices in 13 states. The
affiliate banks individually monitor deposit flows and evaluate alternate
pricing structures with respect to their deposit base. This process is supported
by a Central Funding Unit within Key's Funds Management Group which monitors
deposit outflows and assists the banks in converting the pricing of deposits
from fixed to floating rates or vice versa as specific needs are determined. In
addition, the affiliate banks have access to various sources of non-core market
funding (such as borrowings from the Federal Reserve system) for short-term
liquidity requirements should the need arise.
Key's Commercial Paper/Note Program established in 1995 provides for the
availability of up to $500 million of additional short-term funding. The
proceeds from this program may be used for general corporate purposes, including
future acquisitions, and the funding of AFG's lending activities in conjunction
with quarterly securitizations of its auto loans. In 1995, the parent company
also entered into a four-year, $500 million revolving credit agreement with
several banks under which the banks have agreed to lend collectively up to $500
million to Key. The line of credit is used primarily as a backup source of
liquidity for the Commercial Paper/Note Program. There were no borrowings
outstanding under either of these facilities as of September 30, 1996.
During the first nine months of 1996, Key's affiliate banks raised $3.8 billion
under Key's Bank Note Program which allows for the issuance of up to $12.3
billion, covering twelve affiliate banks. Of the notes issued during this
period, $282 million have original maturities in excess of one year and are
included in long-term debt, while $3.6 billion have original maturities of one
year or less and are included in other short-term borrowings. As of September
30, 1996, the program had an unused capacity of $8.7 billion.
Medium-term notes and subordinated debt issued by the parent company during the
first nine months of 1996 totaled $100 million and $450 million, respectively,
and have original maturities of more than one year. During the third quarter of
1996, Key amended its existing universal shelf registration statement on file
with the Securities and Exchange Commission to provide for the possible issuance
of up to $1.2 billion of debt and equity securities by the parent company in
addition to the unused capacity under the previous shelf registration.
Accordingly, at September 30, 1996, unused capacity under the 1996 shelf
registration totaled approximately $1.3 billion, of which $750 million is
reserved for future issuance as medium-term notes. The proceeds from issuances
under the shelf registration and the Bank Note Program discussed above may be
used for general corporate purposes, including future acquisitions.
The liquidity requirements of the parent company, primarily for dividends to
shareholders, servicing of debt and other corporate purposes are principally met
through regular dividends from affiliate banks. Excess funds are maintained in
short-term investments. The parent company has ready access to the capital
markets as a result of its favorable debt ratings which, at September 30, 1996,
were as follows:
Senior Subordinated
Commercial Long-Term Long-Term
Paper Debt Debt
--------------- --------------- ---------------
Duff & Phelps D-1+ AA- A+
Standard & Poor's A-2 A- BBB+
Moody's P-1 A1 A2
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Further information pertaining to Key's sources and uses of cash for the
nine-month periods ended September 30, 1996 and 1995, is presented in the
Consolidated Statements of Cash Flow on page 6.
CAPITAL AND DIVIDENDS
Total shareholders' equity at September 30, 1996, was $5.0 billion, down $177
million, or 3%, from the December 31, 1995, balance and $107 million, or 2%,
from the end of the third quarter of 1995. The decrease from the end of the
prior year and from the year-ago quarter was due primarily to the share
repurchases discussed below and dividends paid to shareholders. Other factors
contributing to the change in shareholders' equity during the first nine months
of 1996 are shown in the Statement of Changes in Shareholders' Equity presented
on page 5. Included in these changes are the redemption of all $160 million of
Key's 10% Cumulative Preferred Stock as of June 30, 1996, and net unrealized
losses of $85 million on securities. These securities losses resulted in
cumulative net unrealized securities losses of $37 million as of September 30,
1996, and were recorded in connection with SFAS No. 115, "Accounting for
Investments in Certain Debt and Equity Securities."
In January 1996, the Board of Directors approved a new share repurchase program
which authorized the repurchase of up to 12,000,000 Common Shares in 1996. Under
the new program, shares will be repurchased from time to time in the open market
or through negotiated transactions. During the first nine months of 1996, Key
repurchased 10,104,566 shares (of which 5,058,566 shares were repurchased in the
third quarter) at a total cost of $396 million (an average of $39.23 per share).
The remaining 1,895,434 shares were repurchased in October. The repurchased
shares were placed in Treasury, from which 270,263 Treasury Shares were reissued
in connection with an acquisition and 3,193,154 shares were reissued for
employee benefit plans. The 18,882,718 Treasury Shares at September 30, 1996,
are expected to be reissued over time in connection with employee stock
purchase, 401(k), stock option and dividend reinvestment plans and for other
corporate purposes.
Capital adequacy is an important indicator of financial stability and
performance. Overall, Key's capital position remains strong with a ratio of
total shareholders' equity to total assets of 7.61% at September 30, 1996,
compared with 7.77% at December 31, 1995, and 7.48% at September 30, 1995.
Banking industry regulators define minimum capital ratios for bank holding
companies and their banking and savings association subsidiaries. Based on the
risk-adjusted capital rules and definitions prescribed by the banking
regulators, Key's Tier I and total capital to net risk-adjusted assets ratios at
September 30, 1996, were 7.49% and 12.50%, respectively. These compare favorably
with the minimum requirements of 4.0% for Tier I and 8.0% for total capital. The
regulatory Tier I leverage ratio standard prescribes a minimum ratio of 3.0%,
although most banking organizations are expected to maintain ratios of at least
100 to 200 basis points above the minimum. At September 30, 1996, Key's leverage
ratio was 6.38%, substantially higher than the minimum requirement. Figure 21
presents the details of Key's regulatory capital position at September 30, 1996,
December 31, 1995, and September 30, 1995.
Failure to meet applicable capital guidelines could result in enforcement
remedies available to the banking industry regulators, including a limitation on
the ability to pay dividends, the issuance of a directive to increase capital,
the termination of deposit insurance by the Federal Deposit Insurance
Corporation ("FDIC"), and (in severe cases) the appointment of a conservator or
receiver. Management believes that as of September 30, 1996, the parent company
and its banking subsidiaries meet all capital adequacy guidelines to which they
are subject.
Under the Federal Deposit Insurance Act, the Federal bank regulators group
FDIC-insured depository institutions into five broad categories based on certain
capital ratios. The five categories are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." All of Key's affiliate banks qualified as
"well-capitalized" at September 30, 1996, as they exceeded the well-capitalized
thresholds of 10%, 6% and 5% for the total capital, Tier I capital and leverage
ratios, respectively. Although these provisions are not directly applicable to
the parent company under existing laws and regulations, based upon its ratios
the parent company would qualify as "well capitalized" at September 30, 1996.
The FDIC-defined capital categories may not constitute an accurate
representation of the overall financial condition or prospects of Key or its
affiliate banks.
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FIGURE 21. CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
dollars in millions
SEPTEMBER 30, December 31, September 30,
1996 1995 1995
-------------- ------------- -------------
TIER I CAPITAL
Common shareholders' equity(1) $5,013 $4,945 $4,948
Qualifying preferred stock -- 160 160
Less: Goodwill (838) (899) (907)
Other intangible assets(2) (124) (143) (141)
-------------- ----------- -------------
Total Tier I capital 4,051 4,063 4,060
-------------- ----------- -------------
TIER II CAPITAL
Allowance for loan losses(3) 678 677 675
Qualifying long-term debt 2,026 1,114 1,097
--------------
----------- -------------
Total Tier II capital 2,704 1,791 1,772
-------------- ----------- -------------
Total capital $6,755 $5,854 $5,832
============== =========== =============
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $50,805 $49,555 $49,390
Risk-adjusted off-balance sheet exposure 4,403 5,619 5,663
Less: Goodwill (838) (899) (907)
Other intangible assets(2) (124) (143) (142)
-------------- ----------- -------------
Gross risk-adjusted assets 54,246 54,132 54,004
Less: Excess allowance for loan losses(3) (192) (199) (204)
-------------- ----------- -------------
Net risk-adjusted assets $54,054 $53,933 $53,800
============== =========== =============
AVERAGE QUARTERLY TOTAL ASSETS $64,480 $66,543 $66,616
============== =========== =============
CAPITAL RATIOS
Tier I capital to net risk-adjusted assets 7.49% 7.53% 7.55%
Total capital to net risk-adjusted assets 12.50 10.85 10.84
Leverage(4) 6.38 6.20 6.19
<FN>
1 Common shareholders' equity excludes the impact of net unrealized gains or
losses on securities, except for net unrealized losses on marketable equity
securities.
2 Intangible assets (excluding goodwill and portions of purchased credit card
relationships) recorded after February 19, 1992, and deductible portions of
purchased mortgage servicing rights.
3 The allowance for loan losses included in Tier II capital is limited to 1.25%
of gross risk-adjusted assets.
4 Tier I capital as a percentage of average quarterly assets, less goodwill and
other non-qualifying intangible assets as defined in 2 above.
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FIGURE 22. BANKING SERVICES DATA BY REGION
dollars in millions
Northeast Region
----------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------------- --------------------------
1996 1995 1996 1995
-------- ------- ------- ---------
ASSET QUALITY RATIOS
Nonperforming loans to
period-end loans 1.12% .93% 1.12% .93%
Allowance for loan losses to
period-end loans 1.48 1.39 1.48 1.39
Net loan charge-offs to average loans .38 .48 .39 .37
AVERAGE BALANCES
Loans $13,899 $13,901 $13,896 $13,553
Earning assets 17,440 17,761 17,446 17,690
Total assets 19,005 19,251 18,997 19,050
Deposits 13,920 14,810 13,990 14,802
Great lakes Region
----------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------------- --------------------------
1996 1995 1996 1995
-------- ------- ------- ---------
ASSET QUALITY RATIOS
Nonperforming loans to
period-end loans .53% .52% .53% .52%
Allowance for loan losses to
period-end loans 2.15 2.26 2.15 2.26
Net loan charge-offs to average loans .13 (.05) .12 .04
AVERAGE BALANCES
Loans $19,698 $20,020 $19,651 $20,095
Earning assets 24,082 25,339 24,007 25,898
Total assets 26,679 27,942 26,623 28,305
Deposits 16,995 18,331 17,052 19,060
Rocky Mountain Region
----------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------------- --------------------------
1996 1995 1996 1995
-------- ------- ------- ------- -
ASSET QUALITY RATIOS
Nonperforming loans to
period-end loans .98% .73% .98% .73%
Allowance for loan losses to
period-end loans 1.35 1.25 1.35 1.25
Net loan charge-offs to average loans .58 .46 .52 .30
AVERAGE BALANCES
Loans $3,854 $3,772 $3,831 $3,618
Earning assets 4,738 4,777 4,719 4,624
Total assets 5,242 5,181 5,168 5,036
Deposits 3,919 4,027 3,970 3,906
Northwest Region
----------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------------- --------------------------
1996 1995 1996 1995
-------- ------- ------- ------- -
ASSET QUALITY RATIOS
Nonperforming loans to
period-end loans .54% .48% .54% .48%
Allowance for loan losses to
period-end loans 1.38 1.34 1.38 1.34
Net loan charge-offs to average loans .22 .21 .18 .13
AVERAGE BALANCES
Loans $ 9,299 $ 9,135 $ 9,150 $ 9,331
Earning assets 10,680 10,954 10,641 11,100
Total assets 11,833 11,886 11,748 12,042
Deposits 9,043 9,354 9,069 9,306
Consumer Finance companies
----------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------------- --------------------------
1996 1995 1996 1995
-------- ------- ------- ------- -
ASSET QUALITY RATIOS
Nonperforming loans to
period-end loans .01% -- .01% --
Allowance for loan losses to
period-end loans 1.73 2.09% 1.73 2.09%
Net loan charge-offs to average loans 2.84 3.21 2.88 2.81
AVERAGE BALANCES
Loans $2,575 $458 $2,343 $183
Earning assets 2,586 549 2,359 213
Total assets 3,085 576 2,792 229
Deposits 767 165 697 56
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
In the ordinary course of business, Key is subject to legal actions
which involve claims for substantial monetary relief. Based on
information presently available to management and Key's counsel,
management does not believe that any legal actions, individually or in
the aggregate, will have a material adverse effect on the consolidated
financial condition of Key.
Item 5. Other Information
------------------
(a) Regulatory Capital Standards and Related Matters
Capital Guidelines -- On September 17, 1996, the Board of Governors of
the Federal Reserve System, Office of the Comptroller of the Currency
and FDIC issued a final rule amending their respective risk-based
capital requirements to incorporate a measure of market risk to cover
all positions in an institution's trading account and all foreign
exchange and commodity positions. Under the final rule, bank holding
companies, such as Key, and banks, such as Key's bank subsidiaries,
with significant exposure to market risk must measure that risk using
their own internal "value at risk" model, subject to the parameters of
the final rule, and adjust their risk-based capital ratios accordingly.
Institutions must also measure their specific risk for debt and equity
positions in their trading accounts with risk measurement techniques
developed by banking supervisory authorities and hold the appropriate
level of capital in accordance with the results of that measurement.
The final rule is effective January 1, 1997, with mandatory compliance
required by January 1, 1998. Key has not yet assessed whether or not
its market risk exposure is at a level that would require compliance
with this rule, nor has it assessed the possible impact of this rule,
if any, on its operations, including the effect, if any, on its levels
of required capital should compliance be necessary.
(b) Interstate Banking and Other Legislation
Key continues to review periodically the consolidation opportunities
which may become available to it under applicable law. Key has
consolidated the banks within its Great Lakes Region and plans to
consolidate all of its bank subsidiaries into one national banking
institution in 1997.
Item 6. Exhibits and Reports on Form 8-K
---------------------------------
(a) Exhibits
(11) Computation of Net Income Per Common Share
(15) Acknowledgment Letter of Independent Auditors
(27) Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
July 18, 1996 - Item 5. Other Events and Item 7. Financial Statements,
Pro Forma Financial Statements and Exhibits. Reporting that the
Registrant issued a press release on July 18, 1996, announcing its
earnings results for the three-month period ended June 30, 1996.
No other reports on Form 8-K were filed during the three-month period
ended September 30, 1996.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
--------------------------------------
(Registrant)
Date: November 12, 1996 /s/ Lee Irving
--------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
42