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 June 30, 1997
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]
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(Exact name of registrant as specified in its charter)
OHIO 34-6542451
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
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(Address of principal executive offices) (Zip Code)
(216) 689-6300
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Shares with a par value of $1 each 217,223,697 Shares
- -------------------------------------------- ------------------------------
(Title of class) (Outstanding at July 31, 1997)
The number of pages of this report is 43.
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KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
-------------------- -----------
Consolidated Balance Sheets --
June 30, 1997, December 31, 1996, and June 30, 1996 3
Consolidated Statements of Income --
Three months and six months ended June 30, 1997 and 1996 4
Consolidated Statements of Changes in Shareholders' Equity --
Six months ended June 30, 1997 and 1996 5
Consolidated Statements of Cash Flow --
Six months ended June 30, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 17
Item 2. Management's Discussion and Analysis of Financial Condition
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and Results of Operations 18
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings 40
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Item 4 Submission of Matters to a Vote of Security Holders 40
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Item 6. Exhibits and Reports on Form 8-K 41
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Signature 41
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PART I. FINANCIAL INFORMATION
KEYCORP AND SUBSIDIARIES
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CONSOLIDATED BALANCE SHEETS
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JUNE 30, December 31, June 30,
dollars in millions 1997 1996 1996
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(UNAUDITED) (Unaudited)
ASSETS
Cash and due from banks $ 2,911 $ 3,444 $ 3,061
Short-term investments 653 696 511
Securities available for sale 7,727 7,728 7,251
Investment securities (fair value: $1,516, $1,637 and $1,748) 1,484 1,601 1,714
Loans 51,644 49,235 47,928
Less: Allowance for loan losses 880 870 870
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Net loans 50,764 48,365 47,058
Premises and equipment 1,025 1,084 1,032
Goodwill 795 824 844
Other intangible assets 123 137 154
Corporate owned life insurance 1,562 1,515 1,192
Other assets 2,628 2,227 1,947
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Total assets $ 69,672 $ 67,621 $ 64,764
======== ======== ========
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 9,519 $ 9,524 $ 8,877
Interest-bearing 33,655 34,455 34,448
Deposits in foreign offices -- interest-bearing 1,452 1,338 1,092
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Total deposits 44,626 45,317 44,417
Federal funds purchased and securities sold under repurchase agreements 6,830 6,925 6,171
Other short-term borrowings 5,447 3,969 3,408
Other liabilities 2,023 1,816 1,598
Long-term debt 5,182 4,213 4,174
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Total liabilities 64,108 62,240 59,768
Corporation-obligated mandatorily redeemable preferred capital
securities of subsidiary trusts holding solely debentures of the
Corporation (See Note 8) 750 500 --
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, none issued -- -- --
Common Shares, $1 par value; authorized 900,000,000 shares;
issued 245,944,390 shares 246 246 246
Capital surplus 1,477 1,484 1,490
Retained earnings 4,311 4,060 3,874
Loans to ESOP trustee (49) (49) (49)
Net unrealized losses on securities, net of income taxes (36) (6) (70)
Treasury stock, at cost (27,564,764, 22,490,353 and 14,965,373 shares) (1,135) (854) (495)
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Total shareholders' equity 4,814 4,881 4,996
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Total liabilities, capital securities and shareholders' equity $ 69,672 $ 67,621 $ 64,764
======== ======== ========
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See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
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CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
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Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
dollars in millions, except per share amounts 1997 1996 1997 1996
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INTEREST INCOME
Loans $ 1,131 $ 1,082 $ 2,226 $ 2,159
Taxable investment securities 3 3 6 7
Tax-exempt investment securities 18 19 36 38
Securities available for sale 136 124 270 253
Short-term investments 7 6 12 13
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Total interest income 1,295 1,234 2,550 2,470
INTEREST EXPENSE
Deposits 378 367 731 751
Federal funds purchased and securities
sold under repurchase agreements 84 74 172 146
Other short-term borrowings 64 44 121 89
Long-term debt 73 67 141 133
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Total interest expense 599 552 1,165 1,119
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NET INTEREST INCOME 696 682 1,385 1,351
Provision for loan losses 75 47 142 91
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Net interest income after provision for loan losses 621 635 1,243 1,260
NONINTEREST INCOME
Service charges on deposit accounts 74 72 145 144
Trust and asset management income 64 61 128 119
Credit card fees 25 24 48 44
Insurance and brokerage income 21 16 42 34
Corporate owned life insurance income 21 15 40 27
Loan securitization income 3 14 4 27
Net securities gains -- 1 -- 1
Other income 80 61 140 117
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Total noninterest income 288 264 547 513
NONINTEREST EXPENSE
Personnel 283 298 573 589
Net occupancy 54 54 110 108
Equipment 44 40 87 78
Amortization of intangibles 21 22 42 44
Professional fees 13 13 24 29
Marketing 22 17 43 38
Other expense 145 135 278 263
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Total noninterest expense 582 579 1,157 1,149
INCOME BEFORE INCOME TAXES 327 320 633 624
Income taxes 104 103 198 199
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NET INCOME $ 223 $ 217 $ 435 $ 425
======== ======== ======== ========
Net income applicable to Common Shares $ 223 $ 213 $ 435 $ 417
Per Common Share:
Net income $ 1.02 $ .92 $ 1.98 $ 1.80
Net income - fully diluted 1.00 .91 1.94 1.77
Weighted average Common Shares outstanding (000) 218,973 231,341 220,314 232,220
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See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
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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, 1995 $160 $246 $1,500 $3,633 $(51) $ 48 $ (383)
Net income 425
Cash dividends:
Common Shares ($.76 per share) (176)
Cumulative Preferred Stock ($6.25 per share) (8)
Redemption of 10% Cumulative Preferred Stock (160)
Issuance of Common Shares under dividend
reinvestment, stock option, and purchase
plans - 2,322,196 net shares (10) 75
Repurchase of Common Shares - 5,046,000 shares (187)
Net unrealized losses on securities, net of deferred
tax benefit of $(56) (118)
Loan payment from ESOP Trustee 2
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BALANCE AT JUNE 30, 1996 -- $246 $1,490 $3,874 $(49) $ (70) $ (495)
==== ===== ======= ======= ===== ====== ======
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BALANCE AT DECEMBER 31, 1996 -- $246 $1,484 $4,060 $(49) $ (6) $ (854)
Adjustment related to change in accounting for
transfers of financial assets, net of deferred
tax benefit of $(25) (43)
Net income 435
Cash dividends on Common Shares ($.84 per share) (184)
Issuance of Common Shares under dividend
reinvestment, stock option, and purchase
plans - 1,428,289 net shares (7) 64
Repurchase of Common Shares - 6,502,700 shares (345)
Net unrealized gains on securities, net of deferred
tax expense of $7 13
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BALANCE AT JUNE 30, 1997 -- $246 $1,477 $4,311 $(49) $ (36) $(1,135)
=== ===== ======= ======= ===== ====== ========
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See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
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CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
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Six months ended June 30,
-------------------------
in millions 1997 1996
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OPERATING ACTIVITIES
Net income $ 435 $ 425
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 142 91
Depreciation expense 78 70
Amortization of intangibles 42 44
Net gain from sales of subsidiaries/branches (10) (8)
Net securities losses -- (1)
Deferred income taxes 32 33
Net (increase) decrease in mortgage loans held for sale (14) 538
Net increase in trading account assets account assets (133) --
Decrease in accrued restructuring charge (49) --
Other operating activities, net (525) (99)
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NET CASH PROVIDED BY OPERATING ACTIVITIES (2) 1,093
INVESTING ACTIVITIES
Net increase in loans (3,227) (1,252)
Loans sold 683 268
Purchases of investment securities (187) (439)
Proceeds from sales of investment securities 7 3
Proceeds from prepayments and maturities of investment securities 371 423
Purchases of securities available for sale (848) (1,279)
Proceeds from sales of securities available for sale 37 41
Proceeds from prepayments and maturities of securities available for sale 1,006 1,904
Net (increase) decrease in other short-term investments 176 (203)
Purchases of premises and equipment (89) (89)
Proceeds from sales of premises and equipment 53 14
Proceeds from sales of other real estate owned 7 19
Purchases of corporate owned life insurance -- (65)
Proceeds from sales of subsidiaries/branches (116) 137
Net cash used in acquisitions, net of cash acquired -- (12)
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NET CASH USED IN INVESTING ACTIVITIES (2,127) (530)
FINANCING ACTIVITIES
Net decrease in deposits (540) (1,868)
Net increase in short-term borrowings 1,383 1,153
Net proceeds from issuance of long-term debt 1,500 932
Payments on long-term debt (525) (699)
Proceeds from the issuance of capital securities 250 --
Loan payment received from ESOP trustee -- 2
Purchases of treasury shares (345) (187)
Redemption of 10% Cumulative Preferred Stock -- (160)
Proceeds from issuance of common stock pursuant to employee
stock purchase, stock option and dividend reinvestment plans 57 65
Cash dividends (184) (184)
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NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,596 (946)
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NET DECREASE IN CASH AND DUE FROM BANKS (533) (383)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,444 3,444
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CASH AND DUE FROM BANKS AT END OF PERIOD $ 2,911 $ 3,061
======= =======
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Additional disclosures relative to cash flow:
Interest paid $ 1,150 $ 1,122
Income taxes paid 135 107
Net amount received on portfolio swaps 41 45
Noncash items:
Transfer of loans to other real estate owned $ 16 $ 17
Transfer of other assets to securities available for sale 280 --
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See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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1. BASIS OF PRESENTATION
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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 1996 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.
On January 1, 1997, Key adopted Statement of Financial Accounting Standards
("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extingushments of Liabilities." SFAS No. 125 requires that certain assets
which are subject to prepayment and recorded in connection with a securitization
be accounted for like investments in interest-only strips. Accordingly, Key
reclassified approximately $280 million of these assets, which represent
uncertificated residual interests in securitizations, to securities available
for sale. At the time of the transfer, the carrying amount of these assets
exceeded their fair value by approximately $68 million. This difference was
recorded as a reduction to the carrying amount of the transferred assets and the
related after tax adjustment of $43 million was made to net unrealized losses on
securities in shareholders' equity. SFAS No. 125 is more fully discussed in Note
1, Summary of Significant Accounting Policies, of Key's 1996 Annual Report.
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 128, "Earnings Per Share," which specifies the computation, presentation and
disclosure requirements for earnings per share for entities with publicly held
common stock or common stock equivalents. SFAS No. 128 replaces the presentation
of primary earnings per share with the presentation of basic earnings per share.
It also requires dual presentation of basic and diluted earnings per share on
the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator of the
basic earnings per share computation to the corresponding amounts of the diluted
earnings per share computation. SFAS No. 128 is effective for both interim and
annual financial statements issued for periods ending after December 15, 1997,
with earlier adoption prohibited. All prior period earnings per share data must
be restated. Key expects to adopt SFAS No. 128 as of January 1, 1998, with no
effect on prior period data.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 130 establishes reporting and display standards for
comprehensive income and its components in a full set of general-purpose
financial statements. Comprehensive income is defined as the change in equity of
a business enterprise during a period from transactions and other events and
circumstances arising from nonowner sources. The purpose of the statement is to
provide a basis for reporting a measure of all changes in equity of an
enterprise that will result from recognized transactions and other economic
events of the period other than transactions with owners in their capacity as
owners. SFAS No. 130 is effective for both interim and annual financial
statements issued for periods beginning after December 15, 1997, and also
applies to financial statements presented for prior periods. SFAS No. 131
requires that financial and descriptive information be disclosed for each
reportable operating segment based on the management approach. The management
approach focuses on financial information that an enterprise's decision makers
use to assess performance and make decisions about resource allocation. The
statement also prescribes the enterprise-wide disclosures to be made about
products, services, geographic areas and major customers. SFAS No. 131 is
effective for annual financial statements issued for periods beginning after
December 15, 1997, and for interim financial statements in the second year of
application. Comparative information presented for earlier periods must be
restated. Key expects to adopt SFAS No. 130 and SFAS No. 131 as of January 1,
1998.
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2. MERGERS, ACQUISITIONS AND DIVESTITURES
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COMPLETED MERGERS AND ACQUISITIONS
Mergers and acquisitions completed by Key during 1996 (both of which were
accounted for as purchase business combinations) are summarized below. There
were no such transactions during the six-month period ended June 30, 1997.
COMMON
in millions LOCATION DATE ASSETS SHARES ISSUED
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Carleton, McCreary, Holmes & Co. Ohio August 1996 $1 See note(1)
Knight Insurance Agency, Inc.(2) Massachusetts June 1996 8 --
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<FN>
(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."
COMPLETED DIVESTITURE
SOCIETY FIRST FEDERAL SAVINGS BANK
On June 1, 1996, the Corporation ("parent company") 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 lead bank, KeyBank
National Association. An $8 million ($5 million after tax) gain was realized on
the SFF sale and included in other income on the income statement.
TRANSACTIONS PENDING AS OF JUNE 30, 1997
LEASETEC CORPORATION
On July 3, 1997, the parent company acquired an 80% interest (with an option to
purchase the remaining 20%) in Leasetec Corporation ("Leasetec"), a privately
held equipment leasing company headquartered in Boulder, Colorado with
operations in the United States and overseas. At June 30, 1997, Leasetec had
total assets of approximately $1.1 billion. In connection with the transaction,
which was accounted for as a purchase, Key recorded goodwill of $126 million,
which is being amortized using the straight-line method over a period of 25
years.
CHAMPION MORTGAGE CO., INC.
On June 16, 1997, the parent company entered into a definitive agreement to
acquire Champion Mortgage Co., Inc. ("Champion"), a home equity finance company
headquartered in Parsippany, New Jersey. In accordance with the agreement, Key
will, upon closing, issue common shares valued at approximately $200 million in
a transaction structured as a tax-free exchange and to be accounted for as a
purchase. Key plans on repurchasing shares equal in number to those to be
issued. The agreement also provides an opportunity for Champion's shareholders
to receive additional consideration in the form of Key Common Shares valued at
up to $100 million in the event that certain performance targets related to
significant increases in profitability and origination volumes established at
the date of closing are achieved over the next three years. The transaction is
expected to close in the third quarter of 1997, pending necessary regulatory
approval.
KEYBANK NATIONAL ASSOCIATION (WYOMING)
On July 14, 1997, the parent company sold KeyBank National Association (Wyoming)
("KeyBank Wyoming"), its 28 branch Wyoming bank subsidiary. KeyBank Wyoming had
assets of approximately $1.1 billion at the time of the transaction. A $53
million ($35 million after tax) gain was realized on the KeyBank Wyoming sale
and will be included in other income on the income statement in the third
quarter of 1997.
BRANCH DIVESTITURES
In addition to the strategic actions announced on November 26, 1996, as part of
Key's transformation to a nationwide, bank-based financial services company, Key
announced its intention to divest approximately 140 branch offices. During the
second quarter of 1997, eight such branches were sold resulting in a gain of $10
million ($7 million after tax) which was recorded in other income on the income
statement. As of July 31, 1997, contracts had been entered into to sell a total
of 88 other branch offices (including the 28 branches associated with the sale
of KeyBank Wyoming) with deposits
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of approximately $2.1 billion at June 30, 1997. The sales of these remaining
branches under contract are expected to close in the third and fourth quarters
of 1997.
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3. SECURITIES AVAILABLE FOR SALE
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The amortized cost, unrealized gains and losses, and approximate fair values of
securities available for sale were as follows:
JUNE 30, 1997
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GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
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U.S. Treasury, agencies and corporations $ 499 $ 2 $ 3 $ 498
States and political subdivisions 48 1 1 48
Collateralized mortgage obligations 3,559 4 23 3,540
Other mortgage-backed securities 3,336 39 36 3,339
Other securities 354 1 53 302
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Total $7,796 $47 $116 $7,727
====== === ==== ======
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December 31, 1996
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Gross Gross
Amortized Unrealized Unrealized Fair
in millions Cost Gains Losses Value
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U.S. Treasury, agencies and corporations $ 857 $ 3 $ 1 $ 859
States and political subdivisions 36 -- -- 36
Collateralized mortgage obligations 3,169 3 23 3,149
Other mortgage-backed securities 3,570 44 35 3,579
Other securities 104 1 -- 105
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Total $7,736 $51 $59 $7,728
====== === === ======
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June 30, 1996
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Gross Gross
Amortized Unrealized Unrealized Fair
in millions Cost Gains Losses Value
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U.S. Treasury, agencies and corporations $1,222 $ 3 $ 7 $1,218
States and political subdivisions 20 -- -- 20
Collateralized mortgage obligations 2,419 1 46 2,374
Other mortgage-backed securities 3,542 25 90 3,477
Other securities 160 2 -- 162
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Total $7,363 $31 $143 $7,251
====== === ==== ======
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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 ($170 million and $33 million as of June
30, 1997 and 1996, respectively) 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.
At June 30, 1997, shareholders' equity was reduced by $36 million, representing
the net unrealized loss on available-for-sale securities, net of deferred tax
benefit.
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4. INVESTMENT SECURITIES
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The amortized cost, unrealized gains and losses and approximate fair values of
investment securities were as follows:
JUNE 30, 1997
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GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
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States and political subdivisions $1,209 $33 $1 $1,241
Other securities 275 -- -- 275
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Total $1,484 $33 $1 $1,516
====== === == ======
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December 31, 1996
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Gross Gross
Amortized Unrealized Unrealized Fair
in millions Cost Gains Losses Value
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States and political subdivisions $1,401 $37 $1 $1,437
Other securities 200 -- -- 200
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Total $1,601 $37 $1 $1,637
====== === == ======
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June 30, 1996
---------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
in millions Cost Gains Losses Value
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States and political subdivisions $1,450 $36 $2 $1,484
Other securities 264 -- -- 264
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Total $1,714 $36 $2 $1,748
====== === == ======
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5. LOANS
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Loans are summarized as follows:
JUNE 30, December 31, June 30,
in millions 1997 1996 1996
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Commercial, financial and agricultural $13,495 $12,309 $12,071
Real estate-- commercial mortgage 7,185 7,151 7,155
Real estate-- construction 1,935 1,666 1,561
Commercial lease financing 2,714 2,671 2,398
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Total commercial loans 25,329 23,797 23,185
Real estate-- residential mortgage 6,130 6,229 6,674
Home equity 5,274 4,793 4,320
Credit card 1,785 1,799 1,720
Consumer-- direct 2,312 2,245 1,984
Consumer-- indirect 8,147 8,062 7,629
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Total consumer loans 23,648 23,128 22,327
Loans held for sale 2,667 2,310 2,416
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Total $51,644 $49,235 $47,928
======= ======= =======
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7. LONG-TERM DEBT
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The components of long-term debt, presented net of unamortized discount where
applicable, were as follows:
JUNE 30, December 31, June 30,
dollars in millions 1997 1996 1996
- ---------------------------------------------------------------------------------------------------------------------
Senior medium-term notes due through 2005(1) $ 493 $ 584 $ 990
Subordinated medium-term notes due through 2005(2) 183 183 183
7.50% Subordinated notes due 2006 250 250 250
6.75% Subordinated notes due 2006 200 200 200
8.125% Subordinated notes due 2002 199 199 199
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
All other long-term debt 15 16 16
- ---------------------------------------------------------------------------------------------------------------------
Total parent company 1,589 1,681 2,087
Senior medium-term bank notes due through 2000(3) 2,253 1,165 1,380
7.25% Subordinated notes due 2005 200 200 200
7.85% Subordinated notes due 2002 200 200 200
6.75% Subordinated notes due 2003 200 200 199
7.50% Subordinated notes due 2008 165 165 --
7.125% Subordinated notes due 2006 125 125 --
7.125% Subordinated notes due 2006 125 125 --
7.55% Subordinated notes due 2006 75 75 --
7.375% Subordinated notes due 2008 70 70 --
Federal Home Loan Bank Advances 170 193 93
Industrial revenue bonds 10 10 10
All other long-term debt -- 4 5
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Total subsidiaries 3,593 2,532 2,087
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Total $5,182 $4,213 $4,174
====== ====== ======
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<FN>
(1) The weighted average rate on the senior medium-term notes due through 2005
was 6.63%, 6.57% and 6.46% at June 30, 1997, December 31, 1996 and June 30,
1996, respectively.
(2) The weighted average rate on the subordinated medium-term notes due through
2005 was 6.87%, 6.80% and 6.82% at June 30, 1997, December 31, 1996 and
June 30, 1996, respectively.
(3) The weighted average rate on the senior medium-term notes due through 2000
was 5.82%, 6.17% and 6.60% at June 30, 1997, December 31, 1996 and June 30,
1996, respectively.
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8. CAPITAL SECURITIES
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The corporation-obligated mandatorily redeemable preferred capital securities of
subsidiary trusts holding solely debentures of the Corporation ("capital
securities") were issued by three business trusts, KeyCorp Institutional Capital
A ("Capital A"), KeyCorp Institutional Capital B ("Capital B") and KeyCorp
Institutional Capital C ("Capital C"), all of whose common securities are owned
by the parent company. Capital A and Capital B were formed in the fourth quarter
of 1996 and Capital C was formed in the second quarter of 1997. The proceeds
from the issuances of the capital securities and common securities were used to
purchase debentures of the parent company. Capital A and Capital B hold solely
junior subordinated deferrable interest debentures of the parent company.
Capital C holds solely coupon adjusted pass-through security debentures of the
parent company. Both the debentures and related income statement effects are
eliminated in Key's financial statements.
The parent company has entered into contractual arrangements which, taken
collectively, fully and unconditionally guarantee payment of: (i) accrued and
unpaid distributions required to be paid on the capital securities; (ii) the
redemption price with respect to any capital securities called for redemption
by Capital A, Capital B or Capital C; and (iii) payments due upon a voluntary
or involuntary liquidation, winding-up or termination of Capital A, Capital B
or Capital C.
12
12
The capital securities, common securities and related debentures are summarized
as follows:
Principal
Capital Common Amount of Interest Rate Maturity of
dollars in millions Securities(1) Securities Debentures(2) of Debentures Debentures
- ---------------------------------------------------------------------------------------------------------------------------
June 30, 1997
Capital A $350 $11 $361 7.826% 2026
Capital B 150 4 154 8.250 2026
Capital C 250 8 258 6.625 2029
- ---------------------------------------------------------------------------------------------------------------------------
Total $750 $23 $773 7.510%(3) --
==== === ====
- ---------------------------------------------------------------------------------------------------------------------------
December 31, 1996 $500 $15 $515 7.953%(3) --
==== === ====
- ---------------------------------------------------------------------------------------------------------------------------
<FN>
(1) The capital securities are mandatorily redeemable upon the respective
maturity dates of the debentures or upon earlier redemption as provided in
the indenture. Each issue of capital securities carries an interest rate
identical to that of the respective debenture. The interest rate related to
the capital securities issued by Capital C may be adjusted upon the
remarketing of the capital securites on the coupon adjustment date (June 1,
1999). The capital securities issued by Capital A and Capital B qualify as
Tier I capital under Federal Reserve Board Guidelines.
(2) The parent company has the right to redeem the debentures purchased by
Capital A, Capital B and Capital C: (i) in whole or in part, on or after
December 1, 2006, December 15, 2006 and June 1, 2009, respectively, (ii) in
whole at any time within 90 days following the occurrence and during the
continuation of a tax event or a capital treatment event (as defined in the
applicable offering circular); and (iii) for Capital C, in whole or in part
on the coupon adjustment date. If the debentures are redeemed prior to
maturity, the redemption price will be expressed as a certain percentage
of, or factor added to, the principal amount, plus any accrued but unpaid
interest.
(3) Weighted average rate.
- --------------------------------------------------------------------------------
9. RESTRUCTURING CHARGE
- --------------------------------------------------------------------------------
During the fourth quarter of 1996, the parent company recorded a $100 million
($66 million after tax, $.29 per Common Share) restructuring charge in
connection with strategic actions to be taken over the next year to complete its
transformation to a nationwide, bank-based financial services company. The
primary actions taken or to be taken include: (i) the formation of a nationwide
bank from Key's current network of banks in 13 states and four regions of the
United States (Key Bank USA National Association ("KeyBank USA") did not take
part in this consolidation), (ii) the consolidation of nearly 140 of Key's
branch offices, known as KeyCenters, into other KeyCenters, and (iii) the
reduction of approximately 2,700 positions, or 10% of Key's employment base,
distributed throughout the organization at substantially all levels of
responsibility.
Included in the restructuring charge were accruals for expenses, primarily
consisting of severance payments ($54 million), consolidation costs related to
banking offices identified for closure ($18 million) and costs related to the
write-off of certain obsolete software previously developed for internal use
($28 million).
As of June 30, 1997, Key had completed the consolidation of 117 of the 140
KeyCenters identified for merger into other KeyCenters and reduced its
employment base by approximately three-quarters of the 10% projected at the
announcement date. Remaining reserves at June 30, 1997, totaled $51 million.
Changes in the restructuring reserve are summarized as follows:
Consolidation Obsolete
in millions Severance Costs Software Total
- -------------------------------------------------------------------------------------------
Balance at January 1, 1997 $ 54 $18 $ 28 $100
Cash payments (13) (1) -- (14)
Noncash charges -- (7) (28) (35)
- -------------------------------------------------------------------------------------------
Balance at June 30, 1997 $ 41 $10 -- $ 51
==== === ==== ====
- -------------------------------------------------------------------------------------------
13
13
- --------------------------------------------------------------------------------
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. 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 and 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
These instruments involve, to varying degrees, credit risk in addition to
amounts recognized in Key's 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.
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:
JUNE 30, December 31, June 30,
in millions 1997 1996 1996
- -----------------------------------------------------------------------------------------------------------------
Loan commitments:
Credit card lines $ 8,259 $ 8,078 $ 7,698
Home equity 3,538 3,239 4,184
Commercial real estate and construction 2,313 1,593 1,643
Commercial and other 11,982 10,327 10,041
- -----------------------------------------------------------------------------------------------------------------
Total loan commitments 26,092 23,237 23,566
Other commitments:
Standby letters of credit 1,440 1,385 1,236
Commercial letters of credit 130 202 205
Loans sold with recourse 202 30 32
- -----------------------------------------------------------------------------------------------------------------
Total loan and other commitments $27,864 $24,854 $25,039
======= ======= =======
- -----------------------------------------------------------------------------------------------------------------
14
14
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. Instruments used for this purpose modify the repricing or maturity
characteristics of specified on-balance sheet assets and liabilities. The
instruments must be both effective at reducing the risk associated with the
exposure being managed, and designated as a risk management transaction at the
inception of the derivative contract. In addition, to be considered effective, a
high degree of interest rate correlation must exist between the derivative and
the specified assets or liabilities being managed at inception and over the life
of the derivative contract. Primary among the financial instruments used by both
the parent company and its subsidiary banks to manage exposure to market risk
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 only 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 on these instruments 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. Key deals exclusively with counterparties with high credit ratings,
enters into bilateral collateral arrangements and generally 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. In addition, the credit risk exposure to the counterparty
on each interest rate swap is monitored by a credit committee. Based upon credit
reviews of the counterparties, limits on the total credit exposure Key may have
with each counterparty and the amount of collateral required, if any, are
determined. Although Key is exposed to credit-related losses in the event of
nonperformance by the counterparties, based on management's assessment as of
June 30, 1997, all counterparties were expected to meet their obligations. At
June 30, 1997, Key had 17 different counterparties to portfolio swaps and swaps
entered into to offset the risk of customer swaps. Key had aggregate credit
exposure of $13 million to seven of these counterparties, with the largest
credit exposure to an individual counterparty amounting to $5 million.
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 an index at each 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 June 30, 1997, Key was party to $1.4 billion and $2.8 billion of
indexed amortizing swaps that used a London Interbank Offered Rate ("LIBOR")
index and a Constant Maturity Treasuries ("CMT") index, respectively, for the
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:
JUNE 30, 1997 December 31, 1996
-------------------------------------------------------------- -------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR MATURITY ------------------------- Notional Fair
dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY Amount Value
- -----------------------------------------------------------------------------------------------------------------------
Receive fixed/pay variable--
indexed amortizing(1) $ 4,538 $ (9) 2.1 6.79% 5.81% $ 5,078 $ (8)
Receive fixed/pay variable--
conventional 3,452 (16) 6.7 6.76 5.88 3,505 21
Pay fixed/receive variable--
conventional 3,082 2 1.3 5.72 6.04 3,312 (5)
Basis swaps 600 -- .3 5.69 5.66 400 --
- -----------------------------------------------------------------------------------------------------------------------
Total portfolio swaps $11,672 $(23) 3.1 6.44% 5.88% $12,295 $ 8
======== ====== ======== ====
- -----------------------------------------------------------------------------------------------------------------------
<FN>
(1) Maturity is based upon expected average lives rather than contractual
terms.
Based on the weighted average rates in effect at June 30, 1997, the spread on
portfolio interest rate swaps, excluding the amortization of net deferred gains
on terminated swaps, provided a positive impact on net interest income (since
the weighted average rate received exceeded the weighted average rate paid by 56
basis points). The aggregate negative fair value of $(23) 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.
15
15
Interest from portfolio 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 instrument 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
second quarter of both 1997 and 1996 by $19 million. During the first six months
of 1997, swaps with a notional amount of $200 million were terminated, resulting
in no deferred gain or loss. During the same period last year, swaps with a
notional amount of $500 million were terminated, resulting in a deferred gain of
$.3 million.
A summary of Key's deferred swap gains and (losses) is as follows:
June 30, 1997
dollars in millions
- --------------------------------------------------------------------------------
Weighted Average
Deferred Remaining
Asset/Liability Managed Gains/(Losses) Amortization (Years)
- -------------------------------------------------------------------------------
Loans $(1) 1.3
Debt 16 5.9
- -------------------------------------------------------------------------------
Total $15
===
- -------------------------------------------------------------------------------
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
on specified long-term debt and other short-term borrowings. Interest rate caps
and floors involve the payment of a premium by the buyer to the seller for the
right to receive an interest differential equal to the difference between the
current interest rate and an agreed-upon interest rate ("strike rate") applied
to a notional amount. Key generally purchases or enters into net purchases (a
combination of buying and selling) of caps and floors for asset and liability
management purposes. 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 $3.4 billion (of
which $1.4 billion are forward-starting) and $23 million, respectively, at June
30, 1997. 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, and future
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, and futures, 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 had futures contracts with a notional amount
and negative fair value of $4.6 billion and $(1) million, respectively, at June
30, 1997.
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.
At June 30, 1997, credit exposure from financial instruments held or issued for
trading purposes was limited to the aggregate fair value of each contract with a
positive fair value, or $50 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 $14 million and $8 million, respectively, for the first six
months of 1997 and $9 million and $7 million, respectively, for the first six
months of 1996.
16
16
A summary of the notional amount and the respective fair value of derivative
financial instruments held or issued for trading purposes at June 30, 1997, and
on average for the six-month period then ended, is presented below. 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. The $7.1 billion notional amount of customer swaps
presented in the table includes $4.1 billion of interest rate swaps that receive
a fixed rate and pay a variable rate and $3.0 billion of interest rate swaps
that pay a fixed rate and receive a variable rate. As of June 30, 1997, these
swaps had an expected average life of 4.9 years, carried a weighted average rate
received of 6.43% and had a weighted average rate paid of 6.32%.
June 30, 1997 Six months ended June 30, 1997
---------------------------- ------------------------------------------
Notional Fair Average Average
in millions Amount Value Notional Amount Fair Value
- ------------------------------------------------------------------------------------------------------------------
Interest rate contracts:
Customer swaps:
Assets $5,016 $ 47 $4,320 $ 42
Liabilities 2,051 (21) 2,066 (21)
Caps and floors purchased 2,740 2 2,501 2
Caps and floors written 2,809 (2) 2,573 (3)
Foreign exchange forward contracts:
Assets 590 14 517 20
Liabilities 537 (13) 456 (19)
- ------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 June 30, 1997 and 1996, and the related consolidated
statements of income for the three and six-month periods then ended, and the
consolidated statements of changes in shareholders' equity and cash flow for the
six-month periods ended June 30, 1997 and 1996. 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, 1996, 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 15, 1997, 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, 1996, is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
July 15, 1997
17
17
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 17.
This report contains forward-looking statements which are subject to numerous
assumptions, risks and uncertainties. Statements pertaining to future periods
are subject to uncertainty because of the possibility of changes in underlying
factors and assumptions. Actual results could differ materially from those
contained in or implied by such forward-looking statements for a variety of
factors including: 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 delay in or inability to execute strategic
initiatives designed to grow revenues and/or control expenses, including plans
to reduce expenses to achieve a 55% efficiency ratio (exclusive of acquisitions)
by the end of 1997 and to both consolidate and divest branches; and significant
changes in accounting, tax, or regulatory practices or requirements.
Key's strong earnings performance for the second quarter of 1997 reflected
continued growth in earning assets and fee income, as well as early momentum
resulting from strategic actions being taken to complete Key's transformation to
a nationwide bank-based financial services company and to implement expense
control initiatives. These planned actions, which were announced last November,
include the consolidation of Key's bank subsidiaries (other than KeyBank USA)
into one nationwide banking institution (completed June 30, 1997, for all banks
with the exception of KeyBank National Association (New Hampshire)), the
consolidation of nearly 140 branch offices (known as KeyCenters), and a
reduction of approximately 10% of Key's employment base. The above actions have
been or will be taken throughout 1997 with the objective of improving the
efficiency ratio (exclusive of acquisitions) to the targeted level of 55%, with
further improvement thereafter. At the same time, Key also announced its plans
to divest another 140 KeyCenters. As of June 30, 1997, Key had merged 117 of the
140 KeyCenters to be consolidated and sold or reached agreements to sell 96 of
the additional 140 KeyCenters targeted for sale. The sale of KeyBank Wyoming,
Key's 28 branch Wyoming bank subsidiary, which closed in July, was included in
these agreements. The sale of eight other KeyCenters closed during the second
quarter. In addition, operations have been streamlined through a workforce
reduction of approximately three-quarters of the 10% projected at the
announcement date. As a result of the above factors, during the second quarter
Key's efficiency ratio improved 126 basis points to 57.66%, over 280 basis
points better than the 60.50% for the second quarter of 1996.
During the first six months of 1997, Key also continued its efforts to
reallocate resources (including those made available or generated by its
above-mentioned divestitures of KeyCenters in areas of low-growth potential) 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 a new subsidiary, Key
Corporate Capital Inc., to expand corporate and specialty finance businesses on
a nationwide basis. As part of Key's Corporate Banking line of business, this
new unit targets certain client segments and geographic markets, including:
media and telecommunications, healthcare, structured finance and lease
financing. In addition, Key entered into an alliance with Standard Chartered
Bank of the United Kingdom to provide expanded international banking services to
Key's clients doing business in Asia.
In the second quarter, Key moved to increase the size and scope of its leasing
business by entering into a definitive agreement to acquire Leasetec, a
privately held equipment leasing company headquartered in Boulder, Colorado,
which specializes in the leasing of information technology and
telecommunications equipment to large corporate clients. This transaction closed
in July. Key also entered into a definitive agreement to acquire Champion,
headquartered in Parsippany, New Jersey, and one of the largest home equity
finance companies in its market. The Champion transaction is expected to close
during the third quarter of 1997, pending necessary regulatory approvals.
In addition to the above actions, during the first half of 1997 management
continued to actively manage Key's balance sheet and capital. Specific steps
included the securitization and sale of $559 million of auto loans and the sale
of a $41 million out-of-franchise credit card portfolio. Management will
continue to explore opportunities for sales and/or other arrangements with
respect to its credit card and other portfolios throughout the remainder of
1997.
18
18
During the fourth quarter of 1996 and the second quarter of 1997, management
augmented its flexibility to continue its management of Key's capital through
the issuance of $500 million and $250 million, respectively, of tax-advantaged
capital securities. The securities issued in 1996 receive Tier I capital
treatment.
During the second quarter of 1997, 763,900 Key Common Shares were repurchased as
part of the 12,000,000 Common Shares repurchase program authorized by Key's
Board of Directors in November 1996. This brings the total number of shares
repurchased under that program to 8,263,900. Under a separate authorization,
858,800 Key Common Shares were repurchased during the second quarter in
connection with the anticipated closing of the Champion transaction.
The preceding 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
The selected financial data set forth in Figure 1 presents certain information
highlighting the financial performance of Key for each of the last five quarters
and the year-to-date periods ended June 30, 1997 and 1996. Each of the items
referred to in this performance overview and in Figure 1 is more fully described
in the following discussion or in the notes to the consolidated interim
financial statements presented on pages 7 through 17.
Net income for the second quarter of 1997 was $223 million, up from $217 million
in the second quarter of 1996. Earnings per Common Share rose 11% to a record
$1.02, up from $.92 reported for the 1996 second quarter. On an annualized
basis, the return on average common equity for the second quarter of 1997 was
18.85%, up from 17.15% for the same period last year. The annualized returns on
average total assets were 1.32% and 1.35% for the second quarters of 1997 and
1996, respectively.
Contributing to the increase in quarterly earnings were a $13 million increase
in taxable-equivalent net interest income and a $24 million increase in
noninterest income. These positive factors were partially offset by a $28
million rise in the provision for loan losses and a $3 million increase in
noninterest expense. Excluding the $11 million of distributions on capital
securities (which more closely resemble dividend or interest payments than
overhead expense) recorded in the second quarter of 1997, noninterest expense
was down $8 million from the comparable period a year ago. The efficiency ratio,
which measures the extent to which recurring revenues are absorbed by operating
expenses, improved to 57.66% for the second quarter of 1997 compared with 58.92%
and 60.50% for the first quarter of 1997 and the second quarter of 1996,
respectively. As discussed in the preceding Introduction, this reflected
continued progress made by Key in its restructuring efforts and implementation
of expense control initiatives.
For the first half of 1997, net income totaled $435 million, or $1.98 per Common
Share, up from $425 million, or $1.80 per Common Share for the same period last
year. On an annualized basis, the return on average common equity for the first
six months of 1997 was 18.46%, up from 16.78% for the same period last year. The
annualized returns on average total assets were 1.31% and 1.32% for the first
half of 1997 and 1996, respectively. Affecting comparative results were
increases in taxable-equivalent net interest income and noninterest income of
$31 million and $34 million, respectively, and a $4 million reduction in the
provision for income taxes (including the taxable-equivalent adjustment). The
positive impact of these factors was moderated by a $51 million increase in the
provision for loan losses and an $8 million increase in noninterest expense.
Excluding the $21 million of distributions on capital securities recorded during
the first half of 1997, noninterest expense was down $13 million from the first
six months of last year.
19
19
FIGURE 1. SELECTED FINANCIAL DATA
1997 1996 SIX MONTHS ENDED JUNE 30,
---------------- ------------------------------ ---------------------------
dollars in millions, except per share amounts SECOND FIRST FOURTH THIRD SECOND 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $1,295 $1,255 $1,243 $1,238 $1,234 $2,550 $2,470
Interest expense 599 566 560 555 552 1,165 1,119
Net interest income 696 689 683 683 682 1,385 1,351
Provision for loan losses 75 67 57 49 47 142 91
Noninterest income 288 259 285 289 264 547 513
Noninterest expense 582 575 700 615 579 1,157 1,149
Income before income taxes 327 306 211 308 320 633 624
Net income 223 212 151 207 217 435 425
Net income applicable to Common Shares 223 212 151 207 213 435 417
- --------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ 1.02 $ .96 $ .67 $ .90 $ .92 $ 1.98 $ 1.80
Net income - fully diluted 1.00 .94 .65 .88 .91 1.94 1.77
Cash dividends .42 .42 .38 .38 .38 .84 .76
Book value at period end 22.04 21.29 21.84 21.91 21.63 22.04 21.63
Market price:
High 58.44 56.38 54.25 44.38 40.25 58.44 40.25
Low 47.88 48.63 43.69 36.25 36.75 47.88 33.38
Close 55.88 48.75 50.50 44.00 38.75 55.88 38.75
Weighted average Common Shares (000) 218,973 221,670 225,562 229,668 231,341 220,314 232,220
- --------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $51,644 $49,724 $49,235 $48,373 $47,928 $51,644 $47,928
Earning assets 61,508 59,825 59,260 57,640 57,404 61,508 57,404
Total assets 69,672 67,893 67,621 65,356 64,764 69,672 64,764
Deposits 44,626 44,239 45,317 44,523 44,417 44,626 44,417
Long-term debt 5,182 4,774 4,213 4,664 4,174 5,182 4,174
Common shareholders' equity 4,814 4,674 4,881 4,976 4,996 4,814 4,996
Total shareholders' equity 4,814 4,674 4,881 4,976 4,996 4,814 4,996
Full-time equivalent employees 25,882 26,603 27,689 28,337 28,319 25,882 28,319
Full-service banking offices 1,130 1,161 1,205 1,218 1,239 1,130 1,239
- --------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.32% 1.30% .92% 1.28% 1.35% 1.31% 1.32%
Return on average common equity 18.85 18.07 12.53 16.73 17.15 18.46 16.78
Return on average total equity 18.85 18.07 12.53 16.73 16.93 18.46 16.58
Efficiency(1) 57.66 58.92 60.92 60.71 60.50 58.28 60.86
Overhead (2) 41.02 43.71 44.89 44.40 45.53 42.36 46.29
Net interest margin (TE) 4.69 4.75 4.80 4.82 4.80 4.72 4.75
- --------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets (3) 6.91% 6.88% 7.22% 7.61% 7.71% 6.91% 7.71%
Tangible equity to tangible assets 3 5.67 5.58 5.88 6.20 6.27 5.67 6.27
Tier I risk-adjusted capital 7.14 7.47 7.98 7.49 7.60 7.26 7.60
Total risk-adjusted capital 11.66 12.31 13.01 12.50 11.72 11.82 11.72
Leverage 6.65 6.68 6.93 6.38 6.43 6.67 6.43
- --------------------------------------------------------------------------------------------------------------------------------
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 8.
<FN>
- ---------------------------
(1) Calculated as noninterest expense (excluding certain nonrecurring charges and distributions on capital securities) divided by
taxable-equivalent net interest income plus noninterest income (excluding net securities transactions and gain on branch
sales).
(2) Calculated as noninterest expense (excluding certain nonrecurring charges and distributions on capital securities) less
noninterest income (excluding net securities transactions and gain on branch sales) divided by taxable-equivalent net interest
income.
(3) Including capital securities, these ratios at June 30, 1997, are 7.63% and 6.39%, respectively, at March 31, 1997, are 7.62%
and 6.32%, respectively and at December 31, 1996 are 7.96% and 6.63%, respectively.
TE = Taxable Equivalent
CASH BASIS FINANCIAL DATA
The selected financial data presented in Figure 2 presents certain information
highlighting the performance of Key for each of the last five quarters, adjusted
to exclude the amortization of goodwill and nonqualifying intangibles, and
related balances resulting from business combinations recorded by Key under the
purchase method of accounting. Had these business combinations qualified for
accounting under the pooling of interests method, no intangible assets would
have been recorded. Since the amortization of goodwill and other intangibles
does not result in a cash expense, the economic value to shareholders under
either accounting method is essentially the same. Moreover, such amortization
does not
20
20
impact Key's liquidity and funds management activities. Cash basis financial
data are particularly relevant since they provide an additional basis for
measuring a company's ability to support future growth, pay dividends and
repurchase shares. They also may improve the comparability of financial results
with prior periods by removing the effect of amortization of goodwill and other
intangibles that are considered nonqualifying in regulatory capital
computations. Cash basis financial data, as defined above and presented in
Figure 2, has not been adjusted to exclude the impact of other noncash items
such as depreciation, provision for loan losses, restructuring charges, etc.
This is the only section of this report in which Key's financial results are
discussed on a cash basis.
The amortization of goodwill associated with the July acquisition of Leasetec
and the pending acquisition of Champion is expected to reduce Key's recorded net
income per common share by approximately $.06 annually.
FIGURE 2. CASH BASIS SELECTED FINANCIAL DATA
1997 1996
-------------------- --------------------------------
dollars in millions, except per share amount SECOND FIRST Fourth Third Second
- -------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Noninterest expense $563 $556 $681 $597 $560
Income before income taxes 346 325 230 326 339
Net income 239 228 167 222 233
Net income applicable to Common Shares 239 228 167 222 229
- ------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $1.09 $1.03 $.74 $.90 $.99
Net income - fully diluted 1.07 1.01 .72 .88 .98
Weighted average Common Shares (000) 218,973 221,670 225,562 229,668 231,341
- ------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.43% 1.41% 1.04% 1.39% 1.47%
Return on average common equity 25.03 24.16 17.29 22.31 23.40
Return on average total equity 25.03 24.16 17.29 22.31 22.52
Efficiency(1) 55.74 56.93 58.98 58.88 58.52
- ------------------------------------------------------------------------------------------------------
GOODWILL AND NONQUALIFYING INTANGIBLES
Goodwill average balance $803 $816 $830 $839 $861
Nonqualifying intangibles average balance 111 116 121 126 131
Goodwill amortization (after tax) 13 13 13 12 13
Nonqualifying intangibles amortization (after tax) 3 3 3 3 3
- ------------------------------------------------------------------------------------------------------
The comparability of the information presented above is affected by certain
mergers, acquisitions and divestitures completed by KeyCorp in the time periods
presented. For further information concerning these transactions, refer to Note
2, Mergers, Acquisitions and Diverstitures, beginning on page 8.
<FN>
(1) Calculated as noninterest expense (excluding certain nonrecurring charges,
the amortization of goodwill and nonqualifying intangibles and
distributions on capital securities) divided by taxable-equivalent net
interest income plus noninterest income (excluding net securities
transactions and gain on branch sales).
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.
The information presented in Figure 3 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.
Various components of the balance sheet and their respective yields and rates
which affect interest income and expense are illustrated in Figure 4. A more
in-depth discussion of changes in earning assets and funding sources is
presented in the Financial Condition section beginning on page 30.
21
21
For the second quarter of 1997, net interest income was $707 million, up $13
million, or 2%, from the same period last year. The 4% growth in average earning
assets (primarily loans) more than offset an 11 basis point decrease in the net
interest margin which continued to decline in the second quarter of 1997 and was
6 basis points lower than the prior quarter. The net interest margin is computed
by dividing annualized taxable-equivalent net interest income by average earning
assets.
Average earning assets for the second quarter totaled $60.3 billion, which was
$2.4 billion, or 4%, higher than the second quarter 1996 level and $1.3 billion,
or an annualized 8% above the first quarter of 1997. The growth from the
year-ago quarter reflected a $2.1 billion, or 4%, increase in loans and a $340
million increase in securities (including both investment securities and
securities available for sale). The higher rate of earning asset growth relative
to the prior quarter reflected strong growth in targeted loans (such as
commercial, home equity, credit card and consumer installment loans),
accompanied by a stable residential mortgage portfolio. This marked the third
consecutive quarter of earning asset growth following a period of planned
decreases in both residential mortgage loans and securities. Key's strategy with
respect to its loan portfolio is discussed in greater detail in the Loan section
beginning on page 30.
The decrease in the net interest margin as compared with the year-ago quarter
was due primarily to the growth of targeted loans at interest rate spreads lower
than the second quarter 1996 net interest margin, reflecting increased reliance
on money market funding of incremental loan growth. The negative impact of this
factor was partially offset by the favorable funding associated with the
issuance of $500 million and $250 million of capital securities in the fourth
quarter of 1996 and second quarter of 1997, respectively. The distributions
related to these tax-advantaged capital securities are classified as noninterest
expense in accordance with guidelines established by the Securities and Exchange
Commission.
Key uses portfolio interest rate swaps (as defined in Note 10, Financial
Instruments with Off-Balance Sheet Risk, beginning on page 14) in the management
of its interest rate sensitivity position. The notional amount of such swaps
decreased to $11.7 billion at June 30, 1997, from $12.3 billion at year-end
1996. For the second quarter of both 1997 and 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. 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.
FIGURE 3 COMPONENTS OF NET INTEREST INCOME CHANGES
From Three Months Ended June 30, 1996 From Six Months Ended June 30, 1996
To Three Months Ended June 30, 1997 To Six Months Ended June 30, 1997
------------------------------------- -----------------------------------
Average Yield/ Net Average Yield/ Net
in millions Volume Rate Change Volume Rate Change
- ----------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 47 $ 1 $ 48 $ 71 $ (6) $ 65
Taxable investment securities -- -- -- (1) -- (1)
Tax-exempt investment securities (1) -- (1) (2) (1) (3)
Securities available for sale 7 5 12 6 11 17
Short-term investments -- 1 1 (1) -- (1)
- ----------------------------------------------------------------------------------------------------------------------
Total interest income (TE) 53 7 60 73 4 77
INTEREST EXPENSE
Money market deposit accounts 5 (15) (10) 21 (37) (16)
Savings deposits (10) 15 5 (18) 27 9
NOW accounts (4) 1 (3) (16) 4 (12)
Certificates of deposit ($100,000 or more) 1 (3) (2) 2 (7) (5)
Other time deposits (3) 6 3 (19) 3 (16)
Deposits in foreign offices 17 1 18 21 -- 21
- ----------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 6 5 11 (9) (10) (19)
Federal funds purchased and securities sold
under repurchase agreements 7 3 10 24 2 26
Other short-term borrowings 21 (1) 20 35 (4) 31
Long-term debt 10 (4) 6 16 (8) 8
- ----------------------------------------------------------------------------------------------------------------------
Total interest expense 44 3 47 66 (20) 46
- ----------------------------------------------------------------------------------------------------------------------
Net interest income (TE) $ 9 $ 4 $ 13 $ 7 $ 24 $ 31
==== ==== ==== ==== ==== ====
- ----------------------------------------------------------------------------------------------------------------------
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
22
22
FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELD/RATES
Second Quarter 1997 First Quarter 1997
----------------------------- ---------------------------------------
Average Yield/ Average Yield/
dollars in millions Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Loans: 1, 2
Commercial, financial and agricultural $ 12,844 $ 282 8.81% $ 12,248 $ 268 8.87%
Real estate-commercial mortgage 7,121 165 9.29 7,130 163 9.27
Real estate-construction 1,853 45 9.74 1,693 40 9.58
Commercial lease financing 2,632 42 6.40 2,623 39 6.03
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 24,450 534 8.76 23,694 510 8.73
Real estate-residential 6,153 127 8.28 6,196 126 8.25
Credit card 1,781 66 14.86 1,786 67 15.21
Other consumer 15,389 356 9.28 15,070 346 9.31
- ------------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 23,323 549 9.44 23,052 539 9.48
Loans held for sale 2,600 50 7.71 2,469 48 7.88
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans 50,373 1,133 9.02 49,215 1,097 9.04
Taxable investment securities 252 3 5.79 222 3 5.48
Tax-exempt investment securities(1) 1,349 27 8.03 1,395 27 7.85
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities 1,601 30 7.52 1,617 30 7.52
Securities available for sale(1, 3) 7,822 136 7.05 7,800 134 6.99
Interest-bearing deposits with banks 17 _ 3.66 17 _ 4.11
Federal funds sold and securities
purchased under resale agreements 337 5 5.95 299 4 5.43
Trading account assets 143 2 5.61 95 1 5.63
- ------------------------------------------------------------------------------------------------------------------------------------
Total short-term investments 497 7 5.65 411 5 5.04
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 60,293 1,306 8.69 59,043 1,266 8.70
Allowance for loan losses (866) (868)
Other assets 8,351 8,179
- ------------------------------------------------------------------------------------------------------------------------------------
$ 67,778 $ 66,354
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $ 10,984 66 2.41 $ 11,008 65 2.39
Savings deposits 4,519 42 3.73 4,819 43 3.62
NOW accounts 1,644 9 2.20 1,682 9 2.17
Certificates of deposit ($100,000 or more) 3,341 47 5.64 3,699 50 5.48
Other time deposits 13,584 181 5.34 13,037 171 5.32
Deposits in foreign offices 2,361 33 5.61 1,150 15 5.31
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 36,433 378 4.16 35,395 353 4.04
Federal funds purchased and securities
sold under repurchase agreements 6,461 84 5.21 7,028 88 5.08
Other short-term borrowings 4,350 64 5.90 3,912 57 5.91
Long-term debt(4) 4,772 73 6.20 4,486 68 6.22
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 52,016 599 4.62 50,821 566 4.52
Noninterest-bearing deposits 8,432 8,408
Other liabilities 1,998 1,867
Capital securities 588 500
Preferred stock _ _
Common shareholders' equity 4,744 4,758
- ------------------------------------------------------------------------------------------------------------------------------------
$ 67,778 $ 66,354
======== ========
Interest rate spread 4.07 4.18
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 707 4.69% $ 700 4.75%
======== ==== ======== ====
Taxable-equivalent adjustment (1) $ 11 $ 11
- ------------------------------------------------------------------------------------------------------------------------------------
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
23
Fourth Quarter 1996 Third Quarter 1996 Second Quarter 1996
- ---------------------------------- ---------------------------------- --------------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
- ---------------------------------- ----------------------------------------------------------------------------
$ 12,027 $ 270 8.93% $ 11,934 $ 270 9.00% $ 12,233 $ 273 8.98%
6,978 159 9.06 7,056 162 9.13 6,993 162 9.32
1,778 44 9.84 1,671 43 10.24 1,554 40 10.35
2,514 40 6.33 2,413 37 6.10 2,302 36 6.29
- -----------------------------------------------------------------------------------------------------------------
23,297 513 8.76 23,074 512 8.83 23,082 511 8.90
6,312 131 8.26 6,481 136 8.35 7,328 158 8.67
1,712 63 14.64 1,707 62 14.45 1,659 60 14.55
14,884 346 9.25 14,293 331 9.21 13,781 306 8.93
- -----------------------------------------------------------------------------------------------------------------
22,908 540 9.38 22,481 529 9.36 22,768 524 9.26
2,114 41 7.72 2,548 51 7.96 2,442 50 8.24
- -----------------------------------------------------------------------------------------------------------------
48,319 1,094 9.01 48,103 1,092 9.03 48,292 1,085 9.04
206 3 5.79 251 4 6.34 259 3 5.64
1,409 28 7.91 1,458 29 7.91 1,414 28 7.96
- -----------------------------------------------------------------------------------------------------------------
1,615 31 7.64 1,709 33 7.68 1,673 31 7.45
7,271 121 6.62 7,152 120 6.75 7,410 124 6.73
18 1 4.49 18 _ 3.57 28 _ 2.70
600 8 5.30 385 5 5.17 418 5 5.08
60 _ 6.63 60 1 5.21 45 1 5.25
- -----------------------------------------------------------------------------------------------------------------
678 9 5.28 463 6 5.16 491 6 4.96
- -----------------------------------------------------------------------------------------------------------------
57,883 1,255 8.63 57,427 1,251 8.67 57,866 1,246 8.66
(866) (870) (877)
8,046 7,923 7,634
- -----------------------------------------------------------------------------------------------------------------
$ 65,063 $ 64,480 $ 64,623
======== ======== ==========
$ 10,979 66 2.39 $ 10,851 82 3.01 $ 10,273 76 2.98
5,110 45 3.50 5,463 33 2.40 5,832 37 2.55
1,702 9 2.10 1,733 9 2.07 2,348 12 2.06
3,448 51 5.88 3,133 45 5.71 3,267 49 6.03
13,497 177 5.22 13,338 175 5.22 13,849 178 5.17
793 10 5.02 1,189 16 5.35 1,154 15 5.23
- -----------------------------------------------------------------------------------------------------------------
35,529 358 4.01 35,707 360 4.01 36,723 367 4.02
6,087 77 5.03 5,694 72 5.03 5,899 74 5.05
3,568 53 5.91 3,669 55 5.96 2,922 44 6.06
4,567 72 6.27 4,359 68 6.28 4,152 67 6.60
- -----------------------------------------------------------------------------------------------------------------
49,751 560 4.48 49,429 555 4.47 49,696 552 4.47
8,615 8,467 8,202
1,793 1,661 1,571
111 _ _
_ _ 158
4,793 4,923 4,996
- -----------------------------------------------------------------------------------------------------------------
$ 65,063 $ 64,480 $ 64,623
======== ======== ==========
4.15 4.20 4.19
- -----------------------------------------------------------------------------------------------------------------
$ 695 4.80% $ 696 4.82% $ 694 4.80%
======== ==== ======== ==== ======== ====
$ 12 $ 13 $ 12
- -----------------------------------------------------------------------------------------------------------------
24
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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 of Key and each of its affiliate banks.
Both asset/liability management committees meet at least monthly.
SHORT-TERM INTEREST RATE EXPOSURE
The primary tool utilized by management to measure and manage interest rate
exposure is a net interest income 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 twelve-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. As shown in
Figure 5, Key has been operating well within these guidelines.
FIGURE 5 NET INTEREST INCOME AT RISK TO CHANGES IN INTEREST RATES
ESTIMATED CHANGE IN NET INTEREST INCOME
Sep-95 Dec-95 Mar-96 Jun-96 Sep-96 Dec-96 Mar-97 Jun-97
GRADUAL 200 BASIS POINT
DECREASE IN RATES OVER NEXT 12 MONTHS .23 .30 .89 .92 .60 .71 .90 .50
GRADUAL 200 BASIS POINT
INCREASE IN RATES OVER NEXT 12 MONTHS -1.20 -1.24 -1.34 -1.13 -1.23 -1.28 -1.28 -1.13
LONG-TERM INTEREST RATE EXPOSURE
Short-term interest rate analysis is complemented by an economic value of equity
model. This model provides the added benefit of measuring the exposure to
interest rate changes outside the one- to two-year time frame not measured by
the simulation model. The economic value of Key's equity is determined by
modeling the net present value of future cash flows for asset, liability, and
off-balance sheet positions based on the implied forward yield curve. Economic
value analysis has several limitations including: the economic values of asset,
liability, and off-balance positions do not represent the true fair values of
the positions, since they do not consider factors such as credit risk and
liquidity; indeterminate maturity assets and liabilities require that estimated
cash flows be developed; the future structure of the balance sheet derived from
ongoing loan and deposit activity by Key's core businesses is not factored into
present value calculations; and the analysis requires assumptions about events
that span an even longer time frame than that used in the simulation model. Key
is currently in the process of defining policy guidelines for managing long-term
interest rate risk.
RECENT MANAGEMENT ACTIONS
During 1996, a number of actions were taken in connection with the execution of
asset/liability management strategies designed to improve liquidity and reduce
longer-term interest rate exposure. These actions included the sale of
residential mortgage loans totaling $500 million and the securitization and sale
of non-prime auto loans totaling $212
25
25
million. Other actions taken during 1996 included the continued run-off of
lower-yielding securities and residential mortgage loans. During the first half
1997, Key securitized and sold an additional $559 million of auto loans.
Management will continue to evaluate strategies to securitize and/or sell loans,
taking into account the strategies' impacts on liquidity, capital and earnings.
The above actions, along with the issuance of tax-advantaged capital securities
of $500 million during the 1996 fourth quarter and $250 million in second
quarter of 1997, provided additional capital management flexibility. This was
reflected in the repurchase of 14,620,000 and 6,502,700 Common Shares during
1996 and the first six months of 1997, respectively.
As was the case throughout 1996, Key continued to utilize both portfolio
interest rate swaps, which are more fully discussed below, and interest rate
caps and floors to manage its interest rate risk. In accordance with the
previously described branch divestitures, during the month of March and in early
April strategies were executed to minimize the interest rate risk associated
with the anticipated loss of fixed rate deposits. These strategies included the
issuance of $250 million of fixed rate bank notes and the execution of $650
million of forward-starting interest rate caps and $100 million of pay fixed
swaps.
PORTFOLIO INTEREST RATE SWAP CONTRACTS
In addition to Key's securities portfolios and debt issuances, 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 or debt to manage interest rate risk depends on
various factors, including the mix and cost of funding sources, liquidity, and
capital requirements. Further details pertaining to Key's swap portfolio are
included in Note 10, Financial Instruments with Off-Balance Sheet Risk,
beginning on page 14.
As shown in Note 10, the estimated fair value of Key's portfolio interest rate
swaps decreased $31 million during the first half of 1997 from a fair value of
$8 million at December 31, 1996. The decline in fair value over the past six
months reflected the financial markets' expectations, as measured by the forward
yield curve, for a future increase in interest rates and the fact that Key's
swap portfolio is primarily in a received fixed position. Swaps with a notional
amount of $200 million were terminated during the first half of 1997, resulting
in no deferred gain or loss. A summary of Key's deferred swap gains and losses
at June 30, 1997, is also presented in Note 10. Each swap termination was made
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. Portfolio swap
activity for the six-month period ended June 30, 1997, is summarized in Figure
6.
FIGURE 6 PORTFOLIO SWAP ACTIVITY FOR THE SIX MONTHS ENDED JUNE 30, 1997
Receive Fixed
------------------------ Total
Indexed Pay Fixed- Basis Portfolio
in millions Amortizing Conventional Conventional Swaps Swaps
- ---------------------------------------------------------------------------------------------
Balance at beginning of year $ 5,078 $ 3,505 $ 3,312 $ 400 $12,295
Additions -- -- 1,150 200 1,350
Maturities -- 53 1,180 -- 1,233
Terminations -- -- 200 -- 200
Amortization 540 -- -- -- 540
- ---------------------------------------------------------------------------------------------
Balance at end of period $ 4,538 $ 3,452 $ 3,082 $ 600 $11,672
======= ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------
A summary of the notional and fair values of portfolio swaps by interest rate
management strategy 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.
26
26
FIGURE 7 PORTFOLIO SWAPS BY INTEREST RATE STRATEGY
June 30, 1997 December 31, 1996 June 30, 1996
--------------------- ------------------- ----------------------
NOTIONAL FAIR Notional Fair Notional Fair
in millions AMOUNT VALUE Amount Value Amount Value
- ----------------------------------------------------------------------------------------------------------------
Convert variable rate
loans to fixed $ 5,903 $(37) $ 6,443 $(20) $ 7,053 $(91)
Convert variable rate
deposits and short-term
borrowings to fixed 2,582 3 3,082 (4) 1,659 (2)
Convert variable rate
long-term debt to fixed 500 (1) 230 (1) 180 (2)
Convert fixed rate long-term
debt to variable 2,087 12 2,140 33 1,610 (5)
Basis swaps 600 -- 400 -- -- --
- ----------------------------------------------------------------------------------------------------------------
Total portfolio swaps $11,672 $(23) $12,295 $8 $10,502 $(100)
======= ======= ======= ======= ======= =======
- ----------------------------------------------------------------------------------------------------------------
The expected average maturities of the portfolio swaps at June 30, 1997, are
summarized in Figure 9.
FIGURE 8 EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS AT JUNE 30, 1997
Receive Fixed Total
--------------------------
Indexed Pay Fixed- Basis Portfolio
in millions Amortizing Conventional Conventional Swaps Swaps
- ------------------------------------------------------------------------------------------------------
Due in one year or less $114 $213 $900 $600 $ 1,827
Due after one through five years 4,333 305 2,182 -- 6,820
Due after five through ten years 91 2,699 -- -- 2,790
Due after ten years -- 235 -- -- 235
- -----------------------------------------------------------------------------------------------------
Total portfolio swaps $4,538 $3,452 $3,082 $600 $11,672
====== ====== ====== ==== =======
- -----------------------------------------------------------------------------------------------------
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 specific prices. Key had caps and
floors with a notional amount and fair value of $3.4 billion and $23 million,
respectively, at June 30, 1997. There were no futures contracts outstanding at
the same date.
In June 1996, the FASB issued an Exposure Draft of a proposed SFAS, "Accounting
for Derivatives and Similar Financial Instruments and for Hedging Activities."
If adopted in its present form, this SFAS would eliminate indexed amortizing
swaps as a permitted instrument for hedging activities and, therefore, would
likely alter Key's use of this instrument in the future. It is not clear whether
this SFAS will be adopted in its present form, and it is not currently
practicable to estimate the potential effects of any final standard.
CUSTOMER INTEREST RATE SWAP CONTRACTS
While not directly related to asset and liability management, 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. Further information
pertaining to these contracts, as well as caps and floors, and futures contracts
used for trading purposes is included in Note 10, Financial Instruments with
Off-Balance Sheet Risk, beginning on page 14.
NONINTEREST INCOME
As shown in Figure 9, noninterest income for the 1997 second quarter totaled
$288 million, up $24 million, or 9%, from the same period last year. Primary
contributors to the year-over-year improvement were growth in venture capital
income and miscellaneous other service and advisory fees, which led to a $19
million increase in other income. In addition, growth occurred in all major
fee-based revenues, with the exception of loan securitization income. The
largest of these increases came from income from corporate owned life insurance
(up $6 million) and insurance and brokerage income (up $5 million), while
smaller increases were experienced in service charges on deposit accounts, trust
and asset management income and credit card fees. The growth of the trust and
asset management component was moderated slightly as Key completed the transfer
of its shareholder services business to an unrelated party during the second
quarter. Shareholder services contributed approximately $11 million to Key's
revenues during all of 1996. Additional
27
27
detail pertaining to the composition of trust and asset management income is
presented in Figure 10. Included in miscellaneous other income for the second
quarter was a branch sale gain of $10 million in 1997 and an $8 million gain
from the sale of a Florida savings bank in 1996. These transactions are more
fully disclosed in Note 2, Mergers, Acquisitions and Divestitures, beginning on
page 8.
The growth in income contributed by the above categories was partially offset by
an $11 million decrease in loan securitization income, due largely to the impact
of the accounting change brought about by the January 1, 1997, adoption of SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." This new accounting standard served to reduce
loan securitization income in the second quarter by reclassifying a portion of
such revenue to interest income and by deferring an additional portion which is
expected to be recognized as interest income over the life of the respective
securitizations. SFAS No. 125 is discussed in greater detail in Note 1, Summary
of Significant Accounting Policies, in Key's 1996 Annual Report. Additional
information pertaining to the type and volume of securitized loans which are
either administered or serviced by Key and not recorded on its balance sheet is
included in the Loans section beginning on page 30. Excluding the loan
securitization component and the $10 million (branches) and $8 million (savings
bank) gains referred to previously, noninterest income in the second quarter of
1997 was up $33 million, or 14%, from the second quarter of 1996.
For the first half of 1997, noninterest income totaled $547 million, up $34
million, or 7%, from the comparable 1996 period. As shown in Figure 9, the
growth from the prior year came principally from higher levels of income from
corporate owned life insurance (up $13 million), trust and asset management
income (up $9 million), insurance and brokerage income (up $8 million) and other
income (up $23 million). The $23 million decrease in loan securitization income
relative to the prior year was due primarily to the impact of adopting SFAS No.
125, as described in the preceding paragraph. Also contributing to this decrease
was a positive $4 million adjustment to loan securitization income in the 1996
first quarter which resulted from a change in the method of recognizing
servicing income.
The $23 million increase in other income was due primarily to a $9 million
increase in ATM surcharge fees, an $8 million rise in investment banking
advisory fees, a $5 million increase in income from trading account activities
and a $3 million gain on the sale of a non-strategic affinity credit card
portfolio. The positive impact of these items was offset in part by a $10
million decline in mortgage banking income, reflecting the 1996 transition to a
telephone based method of processing loan originations.
FIGURE 9 NONINTEREST INCOME
Three Months ended June 30, Change Six Months ended June 30, Change
--------------------------- ----------------- ------------------------- ----------------
dollars in millions 1997 1996 Amount Percent 1997 1996 Amount Percent
- ----------------------------------------------------------------------------------------------------------------------------------
Service charges on deposit accounts $74 $ 72 $ 2 2.8% $145 $144 $1 .7%
Trust and asset management income 64 61 3 4.9 128 119 9 7.6
Credit card fees 25 24 1 4.2 48 44 4 9.1
Insurance and brokerage income 21 16 5 31.3 42 34 8 23.5
Corporate owned life insurance 21 15 6 40.0 40 27 13 48.1
Loan securitization income 3 14 (11) (78.6) 4 27 (23) (85.2)
Net securities gains -- 1 (1) (100.0) -- 1 (1) (100.0)
Other income:
Trading account income 7 5 2 40.0 14 9 5 55.6
Foreign exchange income 4 4 -- -- 8 7 1 14.3
Venture capital income 6 2 4 200.0 12 9 3 33.3
Letter of credit fees 5 3 2 66.7 9 7 2 28.6
Mortgage banking income 2 6 (4) (66.7) 4 14 (10) (71.4)
Miscellaneous income 56 41 15 36.6 93 71 22 31.0
- ----------------------------------------------------------------------------------------------------------------------------------
Total other income 80 61 19 31.1 140 117 23 19.7
- ----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $288 $264 $24 9.1% $547 $513 $34 6.6%
==== ==== === ==== ==== ===
- ----------------------------------------------------------------------------------------------------------------------------------
28
28
FIGURE 10 TRUST AND ASSET MANAGEMENT INCOME
Three months ended Six months ended
June 30, Change June 30, Change
---------------- -------------------- ----------------- -----------------------
dollars in millions 1997 1996 Amount Percent 1997 1996 Amount Percent
- -----------------------------------------------------------------------------------------------------------------------------
Personal asset management and
custody fees $ 35 $ 36 $ (1) (2.8)% $ 69 $ 71 $ (2) (2.8)%
Institutional asset management and
custody fees 18 16 2 12.5 35 30 5 16.7
Bond services 1 4 (3) (75.0) 4 7 (3) (42.9)
All other fees 10 5 5 (100.0) 20 11 9 81.8
- -----------------------------------------------------------------------------------------------------------------------------
Total trust and asset
management income $ 64 $ 61 $ 3 4.9% $128 $119 $ 9 7.6%
==== ==== ==== ==== ==== ====
- -----------------------------------------------------------------------------------------------------------------------------
AT JUNE 30,
dollars in billions
- -------------------------------------------------------------------------------
Discretionary $ 50 $ 48 $ 2 4.2%
Non-discretionary 51 41 10 24.4
- -------------------------------------------------------------------------------
Total trust assets $101 $ 89 $ 12 13.5%
==== ==== ====
- -------------------------------------------------------------------------------
NONINTEREST EXPENSE
As shown in Figure 11, noninterest expense for the second quarter of 1997
totaled $582 million, up $3 million, or less than 1%, from the second quarter of
1996. Included in noninterest expense for the second quarter of 1997 was $11
million of distributions accrued on capital securities (tax-advantaged preferred
securities) issued by Key during the second quarter of 1997 and the fourth
quarter of last year. These securities are more fully described in Note 8,
Capital Securities, beginning on page 12. Excluding the capital securities
distributions, noninterest expense was $8 million, or 1%, below the year-ago
quarter. This improvement was due in large part to the progress made with
respect to the restructuring efforts announced last November which center around
the formation of a single nationwide community bank (completed June 30, 1997,
for all banks with the exception of KeyBank National Association (New
Hampshire)), as well as the implementation of expense control initiatives.
Further information pertaining to specific actions taken in connection with the
restructuring and expense control initiatives is included in the Introduction
beginning on page 18.
Personnel expense, the largest category of noninterest expense, decreased $15
million, or 5%, from the second quarter of 1996, marking the lowest level for
these costs since the third quarter of 1995. Reduction in staff was a major
reason for the decrease from the prior year, as full-time equivalent employees
totaled 25,882 at June 30, 1997, down from 28,319 at June 30, 1996. This
reflected the impact of Key's restructuring and expense control initiatives
(including branch mergers), as well as the divestiture of SFF last June. The
effect of these actions on personnel expense compared with the year-ago quarter
was partially offset by the combined impact of merit increases (effective April
1 for the vast majority of Key's employees) and the acquisitions in June and
August 1996 of Knight and Carleton, respectively. The overall reduction in
noninterest expense was also moderated by increases of $5 million and $4 million
in marketing and equipment expense, respectively. In addition, during the second
quarter of 1997 Key recorded $3 million of expense in connection with efforts
being undertaken by Key and most other companies to modify their respective
computer information systems to be year 2000 compliant (properly read
date-sensitive information when the calendar year changes to 2000). As of June
30, 1997, Key had recognized approximately $6 million of the estimated $40
million of expense that it expects to incur to complete this project by the end
of 1998.
Noninterest expense totaled $1.2 billion for the first six months of 1997, up $8
million, or less than 1%, from the same period last year. Excluding $21 million
of distributions accrued on capital securities during 1997, noninterest expense
decreased $13 million, or 1%, from the comparable year-ago period. This
improvement was largely due to lower personnel expense resulting from the
factors described above. Also contributing to the control of noninterest expense
were reductions of $6 million in other expense (excluding the capital securities
distributions) and $5 million in professional fees. These positive variances
were offset in part by increases of $9 million in equipment expense and $5
million in both marketing expense and expenses incurred to become year 2000
compliant.
The efficiency ratio, which provides a measure of the extent to which recurring
revenues are used to pay operating expenses, improved to 57.66% for the second
quarter, from 58.92% in the previous quarter and 60.50% for the second quarter
of 1996. The significant 126 basis point improvement during the second quarter
of 1997 further demonstrates
29
29
the increasing benefits and effectiveness of Key's expense control strategies
and the progress made on the Company's year-long effort to reduce its efficiency
ratio.
In connection with its nationalization and related centralization efforts, Key
undertook a comprehensive review of its real estate operations and occupancy
cost structure and needs. As a result, during the third quarter of 1997 Key will
record a charge of approximately $50 million ($33 million after tax) in
connection with actions to sell certain properties or to alter certain leasing
arrangements. This charge will be included in other expense on Key's income
statement.
FIGURE 11 NONINTEREST EXPENSE
Three Months ended Six Months ended
June 30, Change June 30, Change
----------------------- ------------------------- ---------------------- ----------------------
dollars in millions 1997 1996 Amount Percent 1997 1996 Amount Percent
-----------------------------------------------------------------------------------------------------------------------------------
Personnel $ 283 $ 298 $ (15) (5.0)% $ 573 $ 589 $ (16) (2.7)%
Net occupancy 54 54 -- -- 110 108 2 1.9
Equipment 44 40 4 10.0 87 78 9 11.5
Amortization of intangibles 21 22 (1) (4.5) 42 44 (2) (4.5)
Professional fees 13 13 -- -- 24 29 (5) (17.2)
Marketing 22 17 5 29.4 43 38 5 13.2
Other expense:
Distributions on capital
securities 11 -- 11 100.0 21 -- 21 100.0
Equity and gross receipts
based taxes 8 12 (4) (33.3) 18 19 (1) (5.3)
OREO expense, net(1) 1 -- 1 100.0 2 1 1 100.0
FDIC insurance assessments 2 3 (1) (33.3) 3 5 (2) (40.0)
Miscellaneous 123 120 3 2.5 234 238 (4) (1.7)
-----------------------------------------------------------------------------------------------------------------------------------
Total other expense 145 135 10 7.4 278 263 15 5.7
-----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 582 $ 579 $ 3 .5% $ 1,157 $ 1,149 $ 8 .7%
======== ======== ======== ======== ======== ========
Full-time equivalent employees
at period end 25,882 28,319 25,882 28,319
Efficiency ratio(2) 57.66% 60.50% 58.28% 60.86%
Overhead ratio(3) 41.02 45.53 42.36 46.29
-----------------------------------------------------------------------------------------------------------------------------------
<FN>
1 OREO expense is net of income of $1 million for both the second quarter of
1997 and 1996, respectively.
2 Calculated as noninterest expense (excluding certain nonrecurring charges
and distributions on capital securities) divided by taxable-equivalent net
interest income plus noninterest income (excluding net securities
transactions and gain on branch sales).
3 Calculated as noninterest expense (excluding certain nonrecurring charges
and distributions on capital securities) less noninterest income (excluding
net securities transactions and gain on branch sales) divided by
taxable-equivalent net interest income.
INCOME TAXES
The provision for income taxes was $104 million for the three-month period ended
June 30, 1997, little changed from $103 million for the same period in 1996. The
effective tax rate (provision for income taxes as a percentage of income before
income taxes) for the 1997 second quarter was 31.8% compared with 32.2% for the
second quarter of 1996. For the first six-months of 1997, the provision for
income taxes was $198 million compared with $199 million for the first half of
last year. The effective tax rate for these periods was 31.3% and 31.9%,
respectively. Compared with the prior year, the lower effective income tax rate
for both the quarterly and year-to-date periods was primarily attributable to
increases in income from corporate owned life insurance and credits associated
with investments in low-income housing projects. The effective income tax rate
remains below the statutory Federal rate of 35% due primarily to 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.
FINANCIAL CONDITION
LOANS
At June 30, 1997, total loans outstanding were $51.6 billion, up from $49.2
billion at December 31, 1996, and $47.9 billion at June 30, 1996. 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 $3.7 billion, or 8%, increase in loans outstanding from the June 30, 1996,
level occurred despite the impact of Key's continued strategy of securitizing
and/or selling student loans, auto loans and other loans which do not meet
certain return on equity, credit or other internal standards. A summary of the
loans securitized, sold and divested during 1997 and 1996 is presented in Figure
13. Over the past year, this activity included the sale of $950 million of
student loans (of which $711 million was associated with securitizations) and
the securitization and sale of auto loans totaling $686 million (of which $182
million was classified as held for sale). Generally, Key sells or securitizes
student loans in order to reduce the credit risk that arises when a borrower
enters repayment status. Another factor moderating the increase in total loans
over the past year was the sale of $142 million of out-of-franchise credit card
receivables. Management will continue to explore opportunities for sales and/or
other arrangements with respect to its credit card and other portfolios
30
30
over the remainder of 1997. Excluding the impact of sales, loan portfolios
targeted for growth (which exclude one-to-four family mortgages and loans held
for sale) increased $4.7 billion, or 12%, since June 30, 1996, and were up $1.8
billion, or an annualized 18%, from the prior quarter. Over the past 12 months,
the largest improvement came from consumer loans which rose by $2.5 billion, and
included increases of $954 million in home equity loans and $207 million in
credit card receivables. Additionally, commercial loans contributed $2.1 billion
to the increase, due primarily to higher levels of commercial, financial and
agricultural loans (up $1.4 billion), real estate-construction loans (up $374
million) and commercial lease financings (up $316 million).
FIGURE 12 LOANS SECURITIZED AND/OR SOLD AND DIVESTED
Securitized and/or Sold Divested
-------------------------------------------------------- -------------
Mortgage Real Estate-
Student Loans Loans Held Credit Card Residential
in millions Auto Loans Held for Sale for Sale Receivables Mortgage Total
- -------------------------------------------------------------------------------------------------------------------------------
1996
- ------------
First quarter $ 38 $ 44 $500 - - $ 582
Second quarter 47 99 - - $762 908
Third quarter 56 464 - $101 - 621
Fourth quarter 71 403 - - - 474
- -------------------------------------------------------------------------------------------------------------------------------
Total $212 $1,010 $500 $101 $762 $2,585
==== ====== ==== ==== ==== ======
1997
- ------------
First quarter $456 $31 - $41 - $528
Second quarter 103 52 - - - 155
- -------------------------------------------------------------------------------------------------------------------------------
Total $559 $83 - $41 - $683
==== === === ====
- -------------------------------------------------------------------------------------------------------------------------------
The $2.4 billion increase in loans from the December 31, 1996, level reflected
strong growth in targeted loan portfolios as the aggregate annualized growth
rate of average outstanding balances in these portfolios was 11% and 7% for the
second and first quarters of 1997, respectively. Excluding the impact of sales,
targeted loans rose $2.6 billion due primarily to higher levels of commercial
loans (up $1.5 billion, including $1.2 billion of commercial, financial and
agricultural loans) and consumer loans (up $1.0 billion, including $481 million
of home equity loans). At June 30, 1997, targeted loans comprised 83% of total
loans and 62% of total assets compared with 83% of total loans and 60% of total
assets at December 31, 1996.
As shown in Figure 13, new loan volume during the first half of 1997 was largely
attributable to activity in the Great Lakes Region and the Consumer Finance
companies. The Consumer Finance companies include KeyBank USA, a nationally
chartered bank formed from Key's existing Community Banking franchise during the
third quarter of 1995, which serves as the national platform for prime auto
lending, credit card receivables, student loans, mortgage loan originations and
all nonbranch consumer finance business. The majority of new loan volume
generated by these companies is either participated to Key's other banks or
securitized and sold.
FIGURE 13 PERIOD END LOAN GROWTH BY REGION
Net Intercompany
December 31, Originations/ Participations/ Acquired/ June 30, Percent
dollars in millions 1996 (Repayments) (Sales) (Sold) 1997 Change
- --------------------------------------------------------------------------------------------------------------------------
Northeast Region $14,111 $ (390) $ 406 $ (26) $14,101 (.1)%
Great Lakes Region 20,089 676 1,603 - 22,368 11.3
Rocky Mountain Region 3,833 (203) 40 (2) 3,668 (4.3)
Northwest Region 9,707 117 250 (8) 10,066 3.7
Consumer Finance companies 2,768 2,938 (2,299) (647) 2,760 (.3)
Eliminations/other (1,273) (46) - - (1,319) N/M
- --------------------------------------------------------------------------------------------------------------------------
Total $49,235 $3,092 - $ (683) $51,644 4.9%
======= ====== ===== ======= =======
- --------------------------------------------------------------------------------------------------------------------------
N/M = NOT MEANINGFUL
31
31
Shown in Figure 14 are loans which have been securitized and sold and are either
administered or serviced by Key, but not recorded on its balance sheet. Income
recognized in connection with such transactions is derived from two sources.
Noninterest income earned from servicing or administering the loans is recorded
as loan securitization income; while income earned on assets subject to
prepayment, recorded in connection with securitizations and accounted for like
investments in interest-only strips, is recorded as interest income on
securities available for sale.
FIGURE 14 LOANS SECURITIZED/SOLD AND ADMINISTERED OR SERVICED
JUNE 30, December 31, June 30,
in millions 1997 1996 1996
- ----------------------------------------------------------------------
Student loans $1,959 $2,089 $1,481
Auto loans 846 386 378
- ----------------------------------------------------------------------
Total $2,805 $2,475 $1,859
====== ====== ======
- ----------------------------------------------------------------------
SECURITIES
At June 30, 1997, the securities portfolio totaled $9.2 billion, consisting of
$7.7 billion of securities available for sale and $1.5 billion of investment
securities. This compares with a total portfolio of $9.3 billion, comprised of
$7.7 billion of securities available for sale and $1.6 billion of investment
securities, at December 31, 1996. The composition of the two securities
portfolios by type of security, as of each of these respective dates, is
presented in Note 3, Securities Available for Sale, and Note 4, Investment
Securities, presented on pages 9 and 10, respectively. The stability of the
overall level of securities during the past six months is indicative that the
planned runoff of lower-yielding securities pursuant to balance sheet management
strategies developed in 1995 has come to an end. The increase in collateralized
mortgage obligations since year end 1996 is in part the result of programs
instituted in the fourth quarter of 1996 to better manage securities used to
meet the collateral requirements of the affiliate banks. Previously,
lower-yielding securities with shorter maturities had been relied upon for this
purpose. Certain information pertaining to the composition, yields, and
maturities of the securities available for sale and investment securities
portfolios is presented in Figures 15 and 16, respectively.
FIGURE 15 SECURITIES AVAILABLE FOR SALE AT JUNE 30, 1997
Other
U.S. Treasury, States and Collateralized Mortgage- Weighted
Agencies and Political Mortgage Backed Other Average
dollars in millions Corporations Subdivisions Obligations(1) Securities(1) Securities Total Yield(2)
- ------------------------------------------------------------------------------------------------------------------------------------
Maturity:
One year or less $247 $1 $335 $12 $1 $596 5.99%
After one through five years 127 11 3,205 1,063 19 4,425 6.97
After five through ten years 13 31 -- 1,866 11 1,921 7.04
After ten years 111 5 -- 398 271 785(3) 4.75
- -----------------------------------------------------------------------------------------------------------------------------------
Fair value $498 $48 $3,540 $3,339 $302 $7,727 --
Amortized cost 490 48 3,559 3,336 354 7,796 6.69%
Weighted average yield 6.37% 5.98% 6.67% 7.28% 1.04% 6.69% --
Weighted average maturity 6.1 years 7.6 years 2.5 years 6.5 years 3.4 years 4.5 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%.
3 Includes equity securities with no stated maturity.
32
32
FIGURE 16 INVESTMENT SECURITIES AT JUNE 30, 1997
States and Weighted
Political Other Average
dollars in millions Subdivisions Securities Total Yield (1)
- ----------------------------------------------------------------------------------
Maturity:
One year or less $ 457 -- $ 457 7.00%
After one through five years 513 $ 108 621 9.87
After five through ten years 181 -- 181 9.93
After ten years 58 167 225 2.38
- ----------------------------------------------------------------------------------
Amortized cost $1,209 $ 275 $1,484 7.86%
Fair value 1,241 275 1,516 --
Weighted average yield 8.23% 6.27% 7.86% --
Weighted average maturity 3.0 years 2.9 years 3.0 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
Through its Credit Policy, Credit Administration and Loan Review Groups, Key
evaluates and monitors the level of risk in its credit-related assets;
formulates underwriting standards and guidelines for line management; develops
commercial and consumer credit policies and systems; establishes credit-related
concentration limits; reviews loans, leases and other corporate assets to
evaluate credit quality; and reviews the adequacy of the allowance for loan
losses ("Allowance"). Geographic diversity throughout Key is a significant
factor in managing credit risk.
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 17, net loan charge-offs for the second quarter of 1997 were
$65 million, or .52% of average loans, compared with $46 million, or .38% of
average loans, for the same period last year. The higher level of net
charge-offs was concentrated in the credit card and consumer-indirect portfolios
and was partially offset by a lower level of commercial, financial and
agricultural net charge-offs. The $14 million increase in consumer-indirect net
charge-offs (primarily indirect auto loans) reflected the impact of a strategy
adopted by Key in 1996 to expand its consumer customer base to include various
credit risk profiles. This strategy also includes risk-adjusted pricing to
address the relative credit risk of various strata of the customer base. In
addition, Key's consumer portfolio was impacted by the continuing widespread
nationwide deterioration in consumer credit quality, as indicated by an
increasingly high number of bankruptcies. Key has a relatively small credit card
portfolio which comprises less than 4% of its total average loans outstanding.
As a result of the higher level of net charge-offs, the provision for loan
losses was increased to $75 million for the second quarter of 1997 from $67
million for the prior quarter and $47 million for the second 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.
On a year-to-date basis, net charge-offs were $132 million, or .54% of average
loans, for the first half of 1997 compared with $89 million, or .37% of average
loans, for the same period last year. The provision for loan losses for the
first six months of 1997 was $142 million compared with $91 million for the
first six months of 1996. Similar to the increase for the quarter, the rise in
net charge-offs for the year-to-date period was attributable to increases of $27
million and $22 million in the credit card and consumer-indirect portfolios,
respectively.
33
33
FIGURE 17 SUMMARY OF LOAN LOSS EXPERIENCE
Three months ended June 30, Six months ended June 30,
--------------------------- --------------------------
dollars in millions 1997 1996 1997 1996
- --------------------------------------------------------------------------------------------------------------
Average loans outstanding during
the period $ 50,373 $ 48,292 $ 49,797 $ 48,222
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses at
beginning of period $ 870 $ 875 $ 870 $ 876
Loans charged off:
Commercial, financial and agricultural 10 21 22 39
Real estate-commercial mortgage 2 3 5 7
Real estate-construction 1 -- 2 --
Commercial lease financing -- 3 3 4
- --------------------------------------------------------------------------------------------------------------
Total commercial loans 13 27 32 50
Real estate-residential mortgage 2 2 5 4
Home equity -- 1 1 1
Credit card 32 20 61 36
Consumer-direct 10 7 18 14
Consumer-indirect 31 17 60 39
- --------------------------------------------------------------------------------------------------------------
Total consumer loans 75 47 145 94
- --------------------------------------------------------------------------------------------------------------
88 74 177 144
Recoveries:
Commercial, financial and agricultural 8 12 16 23
Real estate-commercial mortgage 2 2 5 4
Commercial lease financing -- -- -- 1
- --------------------------------------------------------------------------------------------------------------
Total commercial loans 10 14 21 28
Real estate-residential mortgage 1 1 2 2
Credit card 2 3 4 6
Consumer-direct 2 2 4 4
Consumer-indirect 8 8 14 15
- --------------------------------------------------------------------------------------------------------------
Total consumer loans 13 14 24 27
- --------------------------------------------------------------------------------------------------------------
23 28 45 55
- --------------------------------------------------------------------------------------------------------------
Net loans charged off (65) (46) (132) (89)
Provision for loan losses 75 47 142 91
Allowance acquired/sold, net -- (6) -- (8)
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $ 880 $ 870 $ 880 $ 870
======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans .52% .38% .54% .37%
Allowance for loan losses to period end loans 1.70 1.82 1.70 1.82
Allowance for loan losses to nonperforming loans 236.56 266.87 236.56 266.87
- --------------------------------------------------------------------------------------------------------------
The Allowance at June 30, 1997, was $880 million, or 1.70% of loans, up $10
million from $870 million, or 1.77% of loans, at December 31, 1996, and $870
million, or 1.82% of loans, at June 30, 1996. At June 30, 1997, the Allowance
was 236.56% of nonperforming loans, compared with 249.28% at December 31, 1996
and 266.87% at June 30, 1996. Although this percentage is not a 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 18. These assets
totaled $433 million at June 30, 1997, and represented .84% of loans, OREO and
other nonperforming assets compared with $400 million, or .81%, at year end 1996
and $371 million, or .77%, at June 30, 1996. The $23 million increase in
nonperforming loans since year end 1996 was geographically broad based and
spread across a number of product types in the commercial (up $33 million) and
consumer (up $12 million) loan portfolios. These increases were partially offset
by a $21 million decline in the level of nonperforming residential real estate
loans. Additional information pertaining to changes in impaired and other
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 19 and 20, respectively.
34
34
FIGURE 18 SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
JUNE 30, December 31, June 30,
dollars in millions 1997 1996 1996
- ------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 160 $ 120 $ 128
Real estate-commercial mortgage 82 84 95
Real estate-construction 9 19 8
Commercial lease financing 13 8 1
Real estate-residential mortgage 59 80 68
Consumer 49 37 25
- ------------------------------------------------------------------------------------------------
Total nonaccrual loans 372 348 325
Restructured loans -- 1 1
- ------------------------------------------------------------------------------------------------
Total nonperforming loans 372 349 326
Other real estate owned 68 56 53
Allowance for OREO losses (9) (8) (11)
- ------------------------------------------------------------------------------------------------
Other real estate owned, net of allowance 59 48 42
Other nonperforming assets 2 3 3
- ------------------------------------------------------------------------------------------------
Total nonperforming assets $ 433 $ 400 $ 371
===== ===== =====
- ------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 128 $ 103 $ 80
- ------------------------------------------------------------------------------------------------
Nonperforming loans to period end loans .72% .71% .68%
Nonperforming assets to period end loans plus other
real estate owned and other nonperforming assets .84 .81 .77
- ------------------------------------------------------------------------------------------------
FIGURE 19 SUMMARY OF CHANGES IN IMPAIRED AND OTHER NONACCRUAL LOANS
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
in millions 1997 1996 1997 1996
- -----------------------------------------------------------------------------------------------
Balance at beginning of period $ 371 $ 338 $ 348 $ 330
Loans placed on nonaccrual 55 88 120 169
Charge-offs(1) (15) (25) (27) (44)
Payments (23) (45) (47) (66)
Loans sold -- (18) -- (38)
Transfers to OREO (13) (5) (16) (13)
Loans returned to accrual (3) (8) (6) (13)
- -----------------------------------------------------------------------------------------------
Balance at end of period $ 372 $ 325 $ 372 $ 325
===== ===== ===== =====
- -----------------------------------------------------------------------------------------------
1 Represents the gross charge-offs taken against nonaccrual loans; excluded
are charge-offs taken against accruing loans, credit card receivables, and
interest reversals.
FIGURE 20 PERCENTAGE OF NONPERFORMING LOANS TO PERIOD END LOANS
BY TYPE AT JUNE 30, 1997
Commercial, Real Estate- Commercial Real Estate-
Financial and Commercial Real Estate- Lease Residential
Agricultural Mortgage Construction Financing Mortgage Consumer(1) Total
- ---------------------------------------------------------------------------------------------------------------
Northeast Region 1.82% 2.11% .43% .02 1.49% .27% 1.20%
Great Lakes Region .38 .57 .40 .17% .71 .25 .35
Rocky Mountain Region 2.46 1.23 .06 .07 1.58 .68 1.32
Northwest Region .57 .64 .86 2.45 .62 .28 .56
Financial Services -- -- -- -- -- .31 .06
- ---------------------------------------------------------------------------------------------------------------
Total 1.18% 1.14% .47% .49% .95% .31% .72%
===============================================================================================================
1 Excludes credit card receivables.
35
35
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 second
quarter of 1997, these deposits averaged $39.2 billion and represented 65% of
Key's funds supporting earning assets compared with $40.5 billion and 70%,
respectively, for the second quarter of 1996. As shown in Figure 4 beginning on
page 23, over the past year the mix of core deposits has changed significantly.
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. A major factor contributing to the change in mix
is a program started during the fourth quarter of 1995 under which 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 six months of
1997, demand deposits and NOW account balances averaging $1.7 billion and $3.6
billion, respectively, were transferred to the money market deposit account
category, compared with the transfer of balances averaging $1.2 billion and $2.3
billion, respectively, for the same period last year. In Figure 4, 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, this program was
implemented in the last of Key's four banking regions.
Purchased funds, which are comprised of large certificates of deposit, deposits
in foreign offices and short-term borrowings, averaged $16.5 billion for the
second quarter of 1997, up $3.3 billion, or 25%, from the comparable prior year
period. As illustrated in Figure 4, the increase was attributable primarily to
higher levels of short-term borrowings and deposits in foreign offices which
rose by $2.0 billion and $1.2 billion, respectively. Purchased funds have been
more heavily relied upon to offset declines in the volume of core deposits and
to fund earning asset growth. This trend is expected to continue through the
remainder of 1997 due in large part to the impact of the planned branch
divestitures.
FIGURE 21 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE AT
JUNE 30, 1997
Domestic Foreign
in millions Offices Offices Total
- ------------------------------------------------------------------------
Time remaining to maturity:
Three months or less $1,463 $1,452 $2,915
Over three through six months 533 -- 533
Over six through twelve months 474 -- 474
Over twelve months 634 -- 634
- ------------------------------------------------------------------------
Total $3,104 $1,452 $4,556
====== ====== ======
- ------------------------------------------------------------------------
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 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 1,100 full-service banking offices in 14 states. The
affiliate banks 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 & Investment Management Group. This group
monitors the overall mix of funding sources in conjunction with the affiliate
banks' deposit pricing and in response to the structure of the earning assets
portfolio. In addition, the affiliate banks have access to various sources of
money market funding (such as Federal funds purchased, securities sold under
repurchase agreements and bank notes) and borrowings from the Federal Reserve
system for short-term liquidity requirements should the need arise. One of the
affiliate banks, KeyBank USA, has a line of credit with the Federal Reserve
which provides for overnight borrowings of up to $1.3 billion and is secured by
$1.7 billion of KeyBank USA's credit card receivables at June 30, 1997. There
were no borrowings outstanding under this line of credit as of June 30, 1997.
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During the first half of 1997, Key's affiliate banks raised $3.1 billion under
Key's Bank Note Program. As of June 30, 1997, the program had unused capacity of
$4.2 billion. Of the notes issued during the first half of 1997, $1.5 billion
have original maturities in excess of one year and are included in long-term
debt, while $1.6 billion have original maturities of one year or less and are
included in other short-term borrowings.
During the second quarter of 1997, Key diversified its funding sources by
establishing a Euronote Program under which the parent company, KeyBank National
Association and KeyBank USA may issue both long and short-term debt of up to $5
billion in the aggregate. The notes will be offered exclusively to non-U.S.
investors and can be denominated in dollars and most European currencies. There
were no borrowings outstanding under this facility as of June 30, 1997.
The parent company's Commercial Paper/Note Program 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, and have been used to fund
AutoFinance Group, Inc.'s lending activities in conjunction with securitizations
of its auto loans. The parent company also has a revolving credit agreement with
several unaffiliated banks under which the banks have agreed to lend
collectively up to $500 million to the parent company. This credit agreement 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 June 30, 1997.
During the third quarter of 1996, the parent company filed a universal shelf
registration statement with the SEC to provide for the possible issuance of up
to $1.2 billion of debt and equity securities in addition to the unused capacity
under a previous shelf registration. Accordingly, at June 30, 1997, unused
capacity under the 1996 shelf registration totaled $1.3 billion, of which $750
million is reserved for future issuance as medium-term notes. The proceeds from
the issuances under the shelf registration, the Bank Note Program and the
Euronote Program described above may be used for general corporate purposes,
including 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 June 30, 1997, 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
Further information pertaining to Key's sources and uses of cash for the
six-month periods ended June 30, 1997 and 1996, is presented in the Consolidated
Statements of Cash Flow on page 6.
CAPITAL AND DIVIDENDS
Total shareholders' equity at June 30, 1997, was $4.8 billion, down $67 million,
or 1%, from the December 31, 1996, balance and $182 million, or 4%, from the end
of the second quarter of 1996. 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 from current period net income. Also
contributing to the decrease from the 1996 year end were net unrealized losses
on securities. As of June 30, 1997, cumulative net unrealized securities losses
totaled $36 million and were recorded in connection with SFAS No. 115,
"Accounting for Investments in Certain Debt and Equity Securities." This amount
compares with losses of $6 million and $70 million at December 31, 1996, and
June 30, 1996, respectively. The increase in net unrealized losses which
occurred during the first half of 1997 reflected the impact of adopting SFAS No.
125 as disclosed in Note 1, Basis of Presentation, on page 7. Other factors
contributing to the change in shareholders' equity during the first six months
of 1997 are shown in the Statement of Changes in Shareholders' Equity presented
on page 5.
In November 1996, the Board of Directors approved a share repurchase program
which authorized the repurchase from that date of up to 12,000,000 Common
Shares by the end of 1997. Under the program, shares will be repurchased from
time to time in the open market or through negotiated transactions. During the
first half of 1997, Key repurchased 5,643,900 shares at a total cost of $296
million (an average of $52.45 per share) and reissued 1,428,289 Treasury
Shares for dividend
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reinvestment and employee benefit plans. Coupled with the 2,620,000 shares
repurchased in the fourth quarter of 1996, this brings the total number of
shares repurchased under the 1997 program to 8,263,900. Under a separate
authorization, an additional 858,800 Key Common Shares were repurchased during
the second quarter of 1997 in connection with the anticipated closing of the
Champion acquisition. The 27,564,764 Treasury Shares at June 30, 1997, 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 6.91% at June 30, 1997, compared
with 7.22% at December 31, 1996, and 7.71% at June 30, 1996. Including the
capital securities issued in the fourth quarter of 1996 and the second quarter
of 1997, the ratio of total shareholders' equity to total assets at June 30,
1997, and December 31, 1996, is 7.63% and 7.96%, respectively.
Banking industry regulators define minimum capital ratios for bank holding
companies and their banking subsidiaries. Based on the risk-adjusted capital
rules and definitions prescribed by the banking regulators, Key's Tier I and
total risk-adjusted capital ratios at June 30, 1997, were 7.14% and 11.66%,
respectively. These compare favorably with the minimum requirements of 4.0% for
Tier I and 8.0% for total capital. The regulatory 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 June 30, 1997, Key's leverage ratio was 6.65%, substantially higher
than the minimum requirement. Figure 22 presents the details of Key's regulatory
capital position at June 30, 1997, December 31, 1996, and June 30, 1996.
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 qualify as "well
capitalized" at June 30, 1997, since 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
Key under existing laws and regulations, based upon its ratios Key would qualify
as "well capitalized" at June 30, 1997. 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 22 CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
JUNE 30, December 31, June 30,
dollars in millions 1997 1996 1996
- ---------------------------------------------------------------------------------------------
TIER I CAPITAL
Common shareholders' equity(1) $ 4,850 $ 4,887 $ 5,066
Qualifying capital securities 500 500 --
Less: Goodwill (795) (824) (844)
Other intangible assets(2) (108) (121) (130)
- ---------------------------------------------------------------------------------------------
Total Tier I capital 4,447 4,442 4,092
- ---------------------------------------------------------------------------------------------
TIER II CAPITAL
Allowance for loan losses(3) 779 698 675
Qualifying long-term debt 2,032 2,103 1,542
- ---------------------------------------------------------------------------------------------
Total Tier II capital 2,811 2,801 2,217
- ---------------------------------------------------------------------------------------------
Total capital $ 7,258 $ 7,243 $ 6,309
======== ======== ========
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $ 55,304 $ 52,228 $ 49,940
Risk-adjusted off-balance sheet exposure 7,949 4,541 5,043
Less: Goodwill (795) (824) (844)
Other intangible assets(2) (108) (121) (130)
- ---------------------------------------------------------------------------------------------
Gross risk-adjusted assets 62,350 55,824 54,009
Less: Excess allowance for loan losses(3) (101) (172) (195)
- ---------------------------------------------------------------------------------------------
Net risk-adjusted assets $ 62,249 $ 55,652 $ 53,814
======== ======== ========
AVERAGE QUARTERLY TOTAL ASSETS $ 67,778 $ 65,063 $ 64,623
======== ======== ========
CAPITAL RATIOS(5)
Tier I risk-adjusted capital ratio 7.14% 7.98% 7.60%
Total risk-adjusted capital ratio 11.66 13.01 11.72
Leverage ratio(4) 6.65 6.93 6.43
- ---------------------------------------------------------------------------------------------
<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.
5 Excluding the assets and off-balance sheet financial instruments of Key's
securities subsidiary, Key Capital Markets, Inc., as well as the required
portion of Key's investment in such subsidiary, the Tier I, Total and
Leverage ratios at June 30, 1997, are 7.03%, 11.42% and 6.56%,
respectively.
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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 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
At the 1997 Annual Meeting of Shareholders of KeyCorp, held on May 15,
1997, seven directors were elected for three-year terms expiring in
2000 and shareholders adopted resolutions to: (a) amend KeyCorp's
Regulations to reduce the size of the Board of Directors to between 17
and 20 members, (b) amend and restate KeyCorp's Regulations to remove
certain provisions relating to the merger of the former KeyCorp with
Society Corporation in 1994, and (c) ratify the appointment of Ernst &
Young LLP by the Board of Directors as independent auditors for 1997.
Shareholders also defeated two shareholder proposals. These proposals
were to: (a) eliminate management's ability to vote unmarked proxies
and (b) request that the Board of Directors take steps to provide for
the annual election of all directors and thereby eliminate the
classification of KeyCorp's Board of Directors.
The vote on each issue was as follows:
For Against Abstain
-------------- --------------- -------------
Election of directors:
William G. Bares 188,393,007 * 2,473,786
Dr. Carol A. Cartwright 188,140,708 * 2,726,085
Robert W. Gillespie 187,973,095 * 2,893,698
Henry S. Hemingway 188,234,792 * 2,632,001
Henry L. Meyer III 188,151,454 * 2,715,339
Steven A. Minter 188,262,191 * 2,604,602
Ronald B. Stafford 188,217,768 * 2,649,025
Resolution amending KeyCorp's Regulations to reduce
the size of the Board of Directors to between 17 and
20 members 186,995,491 2,250,313 1,620,985
Resolution amending and restating KeyCorp's Regulations
to remove certain provisions relating to the merger of the
former KeyCorp with Society Corporation 165,867,449 1,804,296 2,872,012
Ratification of independent auditors 188,012,731 1,818,164 1,035,898
Proposal regarding discretionary voting of proxy cards 29,156,330 134,543,314 6,683,861
Proposal regarding annual election of directors 62,230,927 104,242,552 3,910,026
<FN>
* Proxies provide that shareholders may either cast a vote for, or
abstain from voting for, directors.
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Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(3) Amended and Restated Regulations of KeyCorp effective May 15,
1997. Filed as Exhibit 2 to Form 8-A/A filed on June 19,
1997, and incorporated herein by reference.
(4) Restated Rights Agreement between KeyCorp and KeyBank
National Association as Rights Agent, dated as of May 15,
1997. Filed as Exhibit 1 to Form 8-A filed on June 19, 1997,
and incorporated herein by reference.
(10.1) Employment Agreement between KeyCorp and Henry L. Meyer III,
dated as of May 15, 1997.
(10.2) Trust Agreement for certain amounts that may become payable
to certain executives and directors of KeyCorp, dated as of
April 1, 1997.
(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
April 11, 1997 - Item 5. Other Events. Reporting that the Registrant
issued a press release announcing it had signed a definitive agreement
to acquire Leasetec Corporation.
April 18, 1997 - Item 5. Other Events and Item 7. Financial
Statements, Pro Forma Financial Statements and Exhibits. Reporting
that the Registrant issued a press release on April 17, 1997,
announcing its earnings results for the three-month period ended March
31, 1997.
June 16, 1997 - Item 5. Other Events. Reporting that the Registrant
issued a press release announcing it had signed a definitive agreement
to acquire Champion Mortgage Co. Inc.
No other reports on Form 8-K were filed during the three-month period
ended June 30, 1997.
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: August 13, 1997 /s/ Lee Irving
--------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
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