1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1998
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]
KEYCORP
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(Exact name of registrant as specified in its
charter)
Ohio 34-6542451
- ---------------------------------- -------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 Public Square, Cleveland, Ohio 44114-1306
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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 455,195,065 Shares
- ------------------------------------------- ----------------------------------
(Title of class) (Outstanding at October 31, 1998)
The number of pages of this report is 50.
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KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
-------------------- -----------
Consolidated Balance Sheets --
September 30, 1998, December 31, 1997 and September 30, 1997 3
Consolidated Statements of Income --
Three months and nine months ended September 30, 1998 and 1997 4
Consolidated Statements of Changes in Shareholders' Equity --
Nine months ended September 30, 1998 and 1997 5
Consolidated Statements of Cash Flow --
Nine months ended September 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 20
Item 2. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
And Results of Operations 21
-------------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 48
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Item 5. Other Information 48
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Item 6. Exhibits and Reports on Form 8-K 48
--------------------------------
Signature 49
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PART I. FINANCIAL INFORMATION
KEYCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31, September 30,
dollars in millions 1998 1997 1997
- ------------------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
ASSETS
Cash and due from banks $ 2,750 $ 3,651 $ 2,940
Short-term investments 2,212 1,928 1,217
Securities available for sale 5,928 7,708 7,563
Investment securities (fair value: $1,015, $1,262 and $1,378) 984 1,230 1,344
Loans, net of unearned income of $1,404, $1,197 and $1,076 59,444 53,380 53,676
Less: Allowance for loan losses 900 900 900
- ------------------------------------------------------------------------------------------------------------------------------
Net loans 58,544 52,480 52,776
Premises and equipment 876 985 993
Goodwill 1,038 1,071 1,095
Other intangible assets 83 105 112
Corporate owned life insurance 1,974 1,895 1,583
Other assets 3,302 2,646 2,454
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Total assets $ 77,691 $ 73,699 $ 72,077
======== ======== ========
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 8,732 $ 9,368 $ 8,965
Interest-bearing 31,841 32,005 32,733
Deposits in foreign offices--interest-bearing 2,024 3,700 2,172
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Total deposits 42,597 45,073 43,870
Federal funds purchased and securities sold under repurchase agreements 6,652 6,979 6,662
Bank notes and other short-term borrowings 7,576 5,967 6,053
Other liabilities 2,963 2,303 2,099
Long-term debt 11,353 7,446 7,567
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Total liabilities 71,141 67,768 66,251
Corporation-obligated mandatorily redeemable preferred capital
securities of subsidiary trusts holding solely debentures of
the Corporation (See Note 8) 997 750 750
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- --
Common Shares, $1 par value; authorized 1,400,000,000 shares;
issued 491,888,780, 491,888,780 and 245,944,390 shares 492 492 246
Capital surplus 1,283 1,283 1,531
Retained earnings 5,038 4,611 4,456
Loans to ESOP trustee (34) (42) (42)
Treasury stock, at cost (55,796,496, 53,824,950 and 26,278,189 shares) (1,267) (1,174) (1,122)
Accumulated other comprehensive income 41 11 7
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Total shareholders' equity 5,553 5,181 5,076
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Total liabilities, capital securities and shareholders' equity $ 77,691 $ 73,699 $ 72,077
======== ======== ========
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See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
dollars in millions, except per share amounts 1998 1997 1998 1997
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INTEREST INCOME
Loans $ 1,274 $ 1,191 $ 3,657 $ 3,417
Taxable investment securities 2 3 9 9
Tax-exempt investment securities 11 15 36 51
Securities available for sale 104 127 350 397
Short-term investments 24 11 62 23
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Total interest income 1,415 1,347 4,114 3,897
INTEREST EXPENSE
Deposits 339 370 1,032 1,101
Federal funds purchased and securities
sold under repurchase agreements 99 91 281 263
Bank notes and other short-term borrowings 108 73 320 194
Long-term debt 169 109 437 250
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Total interest expense 715 643 2,070 1,808
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NET INTEREST INCOME 700 704 2,044 2,089
Provision for loan losses 71 102 220 244
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Net interest income after provision for loan losses 629 602 1,824 1,845
NONINTEREST INCOME
Service charges on deposit accounts 77 77 230 222
Trust and asset management income 82 66 239 194
Investment banking and capital markets income 62 38 159 77
Credit card fees 18 25 50 73
Insurance and brokerage income 22 22 68 64
Corporate owned life insurance income 25 20 72 60
Loan securitization income 14 15 32 19
Net securities gains -- -- 4 --
Gains from sales of branches/subsidiaries -- 79 62 89
Other income 92 51 212 142
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Total noninterest income 392 393 1,128 940
NONINTEREST EXPENSE
Personnel 317 299 913 872
Net occupancy 58 54 170 164
Equipment 46 44 134 131
Amortization of intangibles 22 23 67 65
Marketing 25 22 81 65
Professional fees 14 10 46 34
Other expense 165 196 452 474
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Total noninterest expense 647 648 1,863 1,805
INCOME BEFORE INCOME TAXES 374 347 1,089 980
Income taxes 122 111 353 309
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NET INCOME $ 252 $ 236 $ 736 $ 671
======== ======== ======== ========
Per Common Share:
Net income $ .57 $ .54 $ 1.68 $ 1.53
Net income - assuming dilution .57 .53 1.65 1.51
Weighted average Common Shares outstanding (000) 438,856 436,214 439,180 439,140
Weighted average Common Shares and potential Common
Shares outstanding (000) 443,750 442,050 445,047 444,340
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See Notes to Consolidated Financial Statements (Unaudited).
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5
KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
LOANS TO TREASURY
COMMON CAPITAL RETAINED ESOP STOCK
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 $246 $1,484 $4,060 $(49) $ (854)
Net income 671
Other comprehensive income:
Adjustment related to change in accounting for
transfers of financial assets, net of deferred
tax benefit of $(25)
Net unrealized gains on securities available
for sale, net of income taxes of $32(1)
Foreign currency translation adjustments
Total comprehensive income
Cash dividends on Common Shares ($.63 per share) (275)
Issuance of Common Shares:
Acquisition - 3,336,118 shares 56 143
Employee benefit and dividend reinvestment
plans - 1,856,064 net shares (9) 82
Repurchase of Common Shares - 8,980,018 shares (493)
Loan payment from ESOP Trustee 7
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BALANCE AT SEPTEMBER 30, 1997 $246 $1,531 $4,456 $(42) $(1,122)
===== ====== ====== ===== ========
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BALANCE AT DECEMBER 31, 1997 $492 $1,283 $4,611 $(42) $(1,174)
Net income 736
Other comprehensive income:
Net unrealized gains on securities available
for sale, net of income taxes of $16(1)
Total comprehensive income
Cash dividends on Common Shares ($.705 per share) (309)
Issuance of Common Shares under employee benefit
and dividend reinvestment plans - 2,757,854 net
shares 60
Repurchase of Common Shares - 4,729,400 shares (153)
ESOP transactions 8
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BALANCE AT SEPTEMBER 30, 1998 $492 $1,283 $5,038 $(34) $(1,267)
===== ======= ======= ===== =======
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ACCUMULATED
OTHER
COMPREHENSIVE COMPREHENSIVE
dollars in millions, except per share amounts INCOME INCOME (2)
- ------------------------------------------------------------------------------------ -------------
BALANCE AT DECEMBER 31, 1996 $ (6)
Net income $671
Other comprehensive income:
Adjustment related to change in accounting for
transfers of financial assets, net of deferred
tax benefit of $(25) (43) (43)
Net unrealized gains on securities available
for sale, net of income taxes of $32(1) 57 57
Foreign currency translation adjustments (1) (1)
-----------------
Total comprehensive income $684
====
Cash dividends on Common Shares ($.63 per share)
Issuance of Common Shares:
Acquisition - 3,336,118 shares
Employee benefit and dividend reinvestment
plans - 1,856,064 net shares
Repurchase of Common Shares - 8,980,018 shares
Loan payment from ESOP Trustee
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BALANCE AT SEPTEMBER 30, 1997 $ 7
=====
- -----------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 $ 11
Net income $736
Other comprehensive income:
Net unrealized gains on securities available
for sale, net of income taxes of $16(1) 30 30
-----------------
Total comprehensive income $766
====
Cash dividends on Common Shares ($.705 per share)
Issuance of Common Shares under employee benefit
and dividend reinvestment plans - 2,757,854 net
shares
Repurchase of Common Shares - 4,729,400 shares
ESOP transactions
- -----------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1998 $ 41
=====
- -----------------------------------------------------------------------------------
1 Net of reclassification adjustments.
2 For the three months ended September 30, 1998 and 1997, comprehensive income
was $265 million and $279 million, respectively.
See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
in millions 1998 1997
- -----------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 736 $ 671
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 220 244
Depreciation expense 117 115
Amortization of intangibles 67 65
Net gains from sales of branches/subsidiaries (62) (89)
Net securities gain (4) --
Deferred income taxes 241 40
Net decrease in mortgage loans held for sales 70 132
Net increase in trading account assets (64) (530)
Decrease in accrued restructuring charge (23) (62)
Other operating activities, net (308) (494)
- -----------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 990 92
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (6,554) (5,281)
Purchases of loans (859) --
Loans sold 911 1,219
Purchases of investment securities (83) (387)
Proceeds from sales of investment securities 44 10
Proceeds from prepayments and maturities of investment securities 310 597
Purchases of securities available for sale (123) (1,535)
Proceeds from sales of securities available for sale 62 180
Proceeds from prepayments and maturities of securities available for sale 1,869 1,620
Net increase in other short-term investments (219) (162)
Purchases of premises and equipment (55) (169)
Proceeds from sales of premises and equipment 27 125
Proceeds from sales of other real estate owned 8 25
Net cash paid for sales of branches/subsidiaries (433) (241)
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NET CASH USED IN INVESTING ACTIVITIES (5,095) (3,999)
FINANCING ACTIVITIES
Net decrease in deposits (1,818) (118)
Net increase in short-term borrowings 1,284 1,800
Net proceeds from issuance of long-term debt 4,520 3,231
Payments on long-term debt (614) (1,072)
Proceeds from the issuance of capital securities 247 250
Loan payment received from ESOP trustee 8 7
Purchases of treasury shares (153) (493)
Proceeds from issuance of common stock pursuant to employee
benefit and dividend reinvestment plans 39 73
Cash dividends (309) (275)
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NET CASH PROVIDED BY FINANCING ACTIVITIES 3,204 3,403
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NET DECREASE IN CASH AND DUE FROM BANKS (901) (504)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,651 3,444
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CASH AND DUE FROM BANKS AT END OF PERIOD $ 2,750 $ 2,940
======= =======
- -----------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $ 1,965 $ 1,754
Income taxes paid 84 183
Net amount received on portfolio swaps 22 49
Noncash items:
Assets sold $ 165 $ 1,104
Liabilities sold 660 1,434
Transfer of other assets to securities available for sale -- 280
- -----------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited consolidated interim financial statements include the accounts of
KeyCorp and its subsidiaries ("Key"). All significant intercompany accounts and
transactions have been eliminated in consolidation. In the opinion of
management, the unaudited consolidated interim financial statements reflect all
adjustments of a normal recurring nature and disclosures which are necessary for
a fair presentation of the results for the interim periods presented, and should
be read in conjunction with the audited consolidated financial statements and
related notes included in Key's 1997 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.
ACCOUNTING PRONOUNCEMENTS ADOPTED IN 1998
As of January 1, 1998, Key adopted Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income." 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 new statement requires that Key's unrealized gains or losses on securities
available for sale, which prior to adoption were reported as a separate
component of shareholders' equity, and Key's foreign currency translation
adjustments be included in other comprehensive income. Since SFAS No. 130
requires only the disclosure and presentation in a prescribed format of
information customarily presented elsewhere in the financial statements, it had
no impact on Key's financial condition or results of operations. Prior year
financial statements have been reclassified to conform with the new
requirements. Comprehensive income is presented in the Consolidated Statements
of Changes in Shareholders' Equity on page 5.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
In October 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 134, "Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise." SFAS No. 134 amends SFAS No. 65, "Accounting for Certain Mortgage
Banking Activities" and SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." SFAS No. 134 requires an entity engaged in mortgage
banking activities to classify mortgage-backed securities or other retained
interests resulting from a mortgage loan securitization based on its ability and
intent to sell or hold those assets. The statement conforms the accounting for
securities and uncertificated interests retained after the securitization of
mortgage loans with the accounting for securities and uncertificated interests
retained after the securitization of other types of assets by a non-mortgage
banking enterprise. To date, Key has retained only uncertificated interests
resulting from mortgage loan securitizations. These retained interests are
classified as either available for sale or trading depending on management's
ability and intent. While SFAS No. 134 is effective for the first fiscal quarter
beginning after December 15, 1998, Key is currently in compliance with the
standard.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments including certain derivative
instruments embedded in other contracts (collectively "derivatives") and for
hedging activities. It requires that all derivatives be recognized on the
balance sheet at fair value. Changes in the fair value of all derivatives
qualifying as hedges will be recognized currently in earnings or comprehensive
income. Depending on the nature of the hedge, and the extent to which it is
effective, the changes in fair value will be either offset against the change in
fair value of the hedged item (which also is recognized in earnings); or
recorded in comprehensive income and subsequently recognized in earnings in the
period the hedged item affects earnings. The portion of a hedge that is deemed
ineffective and all changes in the fair value of derivatives not designated as
hedges will be recognized immediately in earnings. SFAS No. 133 is effective for
all fiscal quarters of all fiscal years beginning after June 15, 1999, with
earlier application permitted . Key will adopt the provisions of SFAS No. 133 as
of January 1, 2000. Key is currently reviewing SFAS No. 133 to determine the
extent to which the statement will alter its use of certain derivatives in the
future and the impact on its financial condition and results of operations.
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In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position ("SOP")
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." This SOP provides guidance on accounting for such costs,
including the characteristics to be considered in defining internal-use software
and the circumstances under which related costs should be expensed or
capitalized. SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998, with earlier adoption encouraged on a
prospective basis; restatement of financial statements for earlier periods is
not permitted. Key will adopt the provisions of SOP 98-1 as of January 1, 1999.
The provisions of SOP 98-1 are substantially consistent with Key's current
accounting practices as disclosed in Note 1, Summary of Significant Accounting
Policies, of Key's 1997 Annual Report to Shareholders. As indicated in that
note, internally developed software that is considered impaired is written down
to its fair value. Key considers potential impairment of its internally
developed software informally on a continuous basis, and a formal impairment
review of the entire internally developed software portfolio is conducted at
least annually, generally in the fourth quarter. The effect of prospective
adoption is not expected to have a material impact on Key's financial condition
or results of operations.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits." SFAS No. 132 supersedes the
disclosure requirements in SFAS No. 87, "Employers' Accounting for Pensions,"
SFAS No. 88, "Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Termination Benefits," and SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other than Pensions." The overall
objective of SFAS No. 132 is to improve and standardize disclosures about
pensions and other postretirement benefits and to make the required information
easier to prepare and more understandable. The statement addresses disclosure
issues only and does not change the measurement or recognition provisions
specified in the above statements. SFAS No. 132 is effective for fiscal years
beginning after December 15, 1997. Key will include the disclosures required by
SFAS No. 132 in its December 31, 1998, financial statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." 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. Key expects that its reportable
operating segments will be its major lines of business. 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 will include the
disclosures required by SFAS No. 131 in its December 31, 1998, financial
statements.
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2. EARNINGS PER COMMON SHARE
The computation of Key's basic and diluted earnings per Common Share is as
follows:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
dollars in millions, except per share amounts 1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
NET INCOME $ 252 $ 236 $ 736 $ 671
======== ======== ======== ========
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WEIGHTED AVERAGE COMMON SHARES
Weighted average Common Shares outstanding (000) 438,856 436,214 439,180 439,140
Potential Common Shares outstanding (000)(1) 4,894 5,836 5,867 5,200
- ---------------------------------------------------------------------------------------------------------------------
Weighted average Common Shares and potential
Common Shares outstanding (000) 443,750 442,050 445,047 444,340
======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per Common Share $ .57 $ .54 $ 1.68 $ 1.53
Net income per Common Share - assuming dilution .57 .53 1.65 1.51
- ---------------------------------------------------------------------------------------------------------------------
1 Dilutive common stock options.
3. MERGERS, ACQUISITIONS AND DIVESTITURES
COMPLETED MERGERS AND ACQUISITIONS
Business combinations completed by Key during 1997 (both of which were accounted
for as purchases) are summarized below. There were no such transactions during
the nine-month period ended September 30, 1998.
Common
dollars in millions Location Date Assets Shares Issued
- -------------------------------------------------------------------------------------------------------------------------
Champion Mortgage Co., Inc. New Jersey August 1997 $ 317 3,336,118 (1)
Leasetec Corporation Colorado July 1997 1,080 See note (2)
- -------------------------------------------------------------------------------------------------------------------------
1 Pre-split Common Shares.
2 In accordance with a confidentiality clause in the purchase agreement, the
terms, which are not material, have not been publicly disclosed.
CHAMPION MORTGAGE CO., INC.
On August 29, 1997, Key acquired Champion Mortgage Co., Inc. ("Champion"), a
home equity finance company headquartered in Parsippany, New Jersey. Under the
terms of the agreement, 3,336,118 pre-split Common Shares, with a value of
approximately $200 million, were exchanged for all of the outstanding shares of
Champion common stock in a transaction structured as a tax-free exchange and
accounted for as a purchase. 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 three-year
period following the closing. In connection with the transaction, Key recorded
goodwill of approximately $195 million, which is being amortized using the
straight-line method over a period of 25 years. At closing, Champion became a
wholly owned subsidiary of Key Bank USA, National Association ("KeyBank USA"), a
wholly owned subsidiary of the parent company.
LEASETEC CORPORATION
On July 1, 1997, Key acquired an 80% interest (with an option to purchase the
remaining 20%) in Leasetec Corporation ("Leasetec"), an equipment leasing
company headquartered in Boulder, Colorado, with operations in the United States
and overseas. In connection with the transaction, which was accounted for as a
purchase, Key recorded goodwill of approximately $126 million, which is being
amortized using the straight-line method over a period of 25 years. On June 26,
1998, Key acquired the remaining 20% interest in Leasetec. This resulted in
additional goodwill of approximately $26 million, which is being amortized over
the remainder of the 25-year period which began July 1, 1997.
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COMPLETED DIVESTITURES
KEY MERCHANT SERVICES, LLC
On January 21, 1998, Key sold a 51% interest in Key Merchant Services, LLC ("Key
Merchant"), a wholly owned subsidiary formed to provide merchant credit card
processing services to businesses, to NOVA Information Systems, Inc. ("NOVA"). A
$23 million gain ($14 million after tax) was recognized at the time of closing.
Under the terms of the agreement with NOVA, Key is entitled to receive
additional consideration if certain revenue-related performance targets are met.
In accordance with a confidentiality clause in the agreement, the terms, which
are not material, have not been disclosed.
KEYBANK NATIONAL ASSOCIATION (WYOMING)
On July 14, 1997, Key sold KeyBank National Association (Wyoming) ("KeyBank
Wyoming"), its 28-branch Wyoming bank subsidiary. KeyBank Wyoming had assets and
deposits of approximately $1.1 billion and $931 million, respectively, at the
time of the transaction. A $53 million ($35 million after tax) gain was realized
on the KeyBank Wyoming sale and included in gains from sales of
branches/subsidiaries on the income statement.
BRANCH DIVESTITURES
On November 26, 1996, Key announced its intention to divest approximately 140
branch offices of its subsidiary banks (including the 28 branches associated
with the sale of KeyBank Wyoming). Ultimately, 150 branch offices were sold in
this divestiture program. During the first six months of 1998, 46 such branches
with deposits of approximately $658 million were sold, resulting in aggregate
gains of $39 million ($22 million after tax) which were recorded in gains from
sales of branches/subsidiaries on the income statement. During the last three
quarters of 1997, excluding the KeyBank Wyoming transaction, 76 such branches
with deposits of approximately $1.3 billion were sold, resulting in aggregate
gains of $98 million ($62 million after tax) which were recorded in gains from
sales of branches/subsidiaries on the income statement.
TRANSACTION PENDING AT SEPTEMBER 30, 1998
MCDONALD & COMPANY INVESTMENTS, INC.
On October 23, 1998, Key acquired McDonald & Company Investments, Inc.
("McDonald"), a full-service investment banking and securities brokerage company
headquartered in Cleveland, Ohio, with assets of approximately $776 million at
the time of the transaction. Under the terms of the agreement, 19,337,617 Common
Shares, with a value of approximately $581 million, were exchanged for all of
the outstanding shares of McDonald common stock in a transaction structured as a
tax-free exchange and accounted for as a purchase. In connection with the
transaction, Key recorded approximately $420 million of goodwill, which is being
amortized using the straight line method over a period of 25 years. In addition,
Key established a retention program under which stock options for approximately
3.3 million Key Common Shares may be granted, and approximately $30 million in
cash may be paid, to certain McDonald employees over a three-year period.
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4. SECURITIES
Debt securities that Key has the positive intent and ability to hold to maturity
are classified as securities held to maturity and 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 ($599 million, $535 million and $567
million at September 30, 1998, December 31, 1997 and September 30, 1997,
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 income taxes, reported in shareholders'
equity as a component of accumulated other comprehensive income. Gains and
losses from sales of securities available for sale are computed using the
specific identification method and included in net securities gains (losses) on
the income statement.
The amortized cost, unrealized gains and losses and approximate fair value of
securities were as follows:
SEPTEMBER 30, 1998
------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- --------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 138 $ 2 -- $ 140
States and political subdivisions 75 2 -- 77
Collateralized mortgage obligations 2,743 32 $ 1 2,774
Other mortgage-backed securities 2,390 47 4 2,433
Retained interests in securitizations 421 -- 19 402
Other securities 93 9 -- 102
- --------------------------------------------------------------------------------------------------------------------
Total securities available for sale $5,860 $ 92 $ 24 $5,928
====== ====== ====== ======
INVESTMENT SECURITIES
States and political subdivisions $ 709 $ 31 -- $ 740
Other securities 275 -- -- 275
- --------------------------------------------------------------------------------------------------------------------
Total investment securities $ 984 $ 31 -- $1,015
====== ====== ====== ======
====================================================================================================================
DECEMBER 31, 1997
------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- --------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 202 $ 2 -- $ 204
States and political subdivisions 52 -- -- 52
Collateralized mortgage obligations 4,045 9 $ 3 4,051
Other mortgage-backed securities 2,908 53 10 2,951
Retained interests in securitizations 418 -- 44 374
Other securities 75 1 -- 76
- --------------------------------------------------------------------------------------------------------------------
Total securities available for sale $7,700 $ 65 $ 57 $7,708
====== ====== ====== ======
INVESTMENT SECURITIES
States and political subdivisions $ 973 $ 32 -- $1,005
Other securities 257 -- -- 257
- --------------------------------------------------------------------------------------------------------------------
Total investment securities $1,230 $ 32 -- $1,262
====== ====== ====== ======
- --------------------------------------------------------------------------------------------------------------------
11
12
SEPTEMBER 30, 1997
------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 572 $ 2 -- $ 574
States and political subdivisions 50 -- -- 50
Collateralized mortgage obligations 3,376 14 $ 8 3,382
Other mortgage-backed securities 3,130 52 17 3,165
Retained interests in securitizations 348 -- 33 315
Other securities 75 2 -- 77
- ---------------------------------------------------------------------------------------------------------------------
Total securities available for sale $7,551 $ 70 $ 58 $7,563
====== ====== ====== ======
INVESTMENT SECURITIES
States and political subdivisions $1,105 $ 34 -- $1,139
Other securities 239 -- -- 239
- ---------------------------------------------------------------------------------------------------------------------
Total investment securities $1,344 $ 34 -- $1,378
====== ====== ====== ======
- ---------------------------------------------------------------------------------------------------------------------
5. LOANS
Loans, net of unearned income, are summarized as follows:
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 1998 1997 1997
- ------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $16,352 $14,023 $13,797
Real estate-- commercial mortgage 7,168 6,952 7,109
Real estate-- construction 3,234 2,231 2,055
Commercial lease financing 5,068 4,439 4,035
- ------------------------------------------------------------------------------------------------
Total commercial loans 31,822 27,645 26,996
Real estate-- residential mortgage 5,223 6,204 6,154
Home equity 6,452 5,421 5,416
Credit card 1,398 1,521 1,476
Consumer--direct 2,073 1,739 1,848
Consumer--indirect 9,166 7,989 8,821
- ------------------------------------------------------------------------------------------------
Total consumer loans 24,312 22,874 23,715
Loans held for sale 3,310 2,861 2,965
- ------------------------------------------------------------------------------------------------
Total loans $59,444 $53,380 $53,676
======= ======= =======
- ------------------------------------------------------------------------------------------------
Portfolio interest rate swaps are used to manage interest rate risk by modifying
the repricing and maturity characteristics of certain loans. Additional
information pertaining to the notional amount, fair value and weighted average
rate of such swaps as of September 30, 1998, is presented in Note 10, Financial
Instruments with Off-Balance Sheet Risk, beginning on page 16.
12
13
Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
in millions 1998 1997 1998 1997
- -------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 900 $ 880 $ 900 $ 870
Charge-offs (91) (105) (288) (282)
Recoveries 20 20 68 65
- -------------------------------------------------------------------------------------------------------
Net charge-offs (71) (85) (220) (217)
Provision for loan losses 71 102 220 244
Allowance acquired, net --- 3 --- 3
- -------------------------------------------------------------------------------------------------------
Balance at end of period $ 900 $ 900 $ 900 $ 900
===== ===== ===== =====
- -------------------------------------------------------------------------------------------------------
6. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
At September 30, 1998, impaired loans totaled $193 million. Included in this
amount are $105 million of impaired loans for which the specifically allocated
allowance for loan losses is $41 million, and $88 million of impaired loans
which are carried at their estimated fair value without a specifically allocated
allowance for loan losses. At the end of the prior year, impaired loans totaled
$196 million, of which $91 million had a specifically allocated allowance of $26
million and $105 million were carried at their estimated fair value. The average
investment in impaired loans for the nine-month periods ended September 30, 1998
and 1997, was $194 million and $186 million, respectively.
Nonperforming assets were as follows:
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 1998 1997 1997
- ---------------------------------------------------------------------------------------
Impaired loans $ 193 $ 196 $ 184
Other nonaccrual loans 167 185 180
- ---------------------------------------------------------------------------------------
Total nonperforming loans 360 381 364
Other real estate owned ("OREO") 58 66 67
Allowance for OREO losses (19) (21) (22)
- ---------------------------------------------------------------------------------------
OREO, net of allowance 39 45 45
Other nonperforming assets 3 5 2
- ---------------------------------------------------------------------------------------
Total nonperforming assets $ 402 $ 431 $ 411
===== ===== =====
- ---------------------------------------------------------------------------------------
Impaired loans are evaluated individually. The fair value of collateral, if any,
or estimates of the present value of the estimated future cash flows on the loan
are used to determine the extent of impairment. When such amounts do not support
the carrying amount of the loan, the amount which management deems uncollectible
is charged to the allowance for loan losses. In instances where collateral or
other sources of repayment are sufficient, yet uncertainty exists regarding the
ultimate repayment, an allowance is specifically allocated for in the allowance
for loan losses.
Key excludes smaller-balance, homogeneous nonaccrual loans (shown in the
preceding table as "Other nonaccrual loans") from impairment evaluation.
Generally, this portfolio includes loans to finance residential mortgages,
automobiles, recreational vehicles, boats and mobile homes. Key applies
historical loss experience rates to these loans, adjusted based on management's
assessment of emerging credit trends and other factors. The resulting loss
estimates are specifically allocated for by loan type in the allowance for loan
losses.
13
14
7. LONG-TERM DEBT
The components of long-term debt, presented net of unamortized discount where
applicable, were as follows:
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 1998 1997 1997
- -------------------------------------------------------------------------------------------------------------------------------
Senior medium-term notes due through 2005(1) $ 419 $ 493 $ 493
Subordinated medium-term notes due through 2005(1) 133 183 183
7.50% Subordinated notes due 2006(2) 250 250 250
6.75% Subordinated notes due 2006(2) 200 200 200
8.125% Subordinated notes due 2002(2) 199 199 199
8.00% Subordinated notes due 2004(2) 125 125 125
8.40% Subordinated capital notes due 1999(3) 75 75 75
8.404% Notes due through 2001 34 42 42
All other long-term debt(9) 12 14 15
- -------------------------------------------------------------------------------------------------------------------------------
Total parent company(10) 1,447 1,581 1,582
Senior medium-term bank notes due through 2003(4) 5,984 3,103 3,202
Senior euro medium-term bank notes due through 2007(5) 1,419 840 780
6.50% Subordinated remarketable securities due 2027(6) 313 -- --
6.95% Subordinated notes due 2028(6) 300 -- --
7.25% Subordinated notes due 2005(6) 200 200 200
7.85% Subordinated notes due 2002(6) 200 200 200
6.75% Subordinated notes due 2003(6) 200 200 200
7.50% Subordinated notes due 2008(6) 165 165 165
7.125% Subordinated notes due 2006(6) 250 250 250
7.55% Subordinated notes due 2006(6) 75 75 75
7.375% Subordinated notes due 2008(6) 70 70 70
Lease financing debt due through 2003(7) 515 549 605
Federal Home Loan Bank advances due through 2028(8) 169 163 164
All other long-term debt(9) 46 50 74
- -------------------------------------------------------------------------------------------------------------------------------
Total subsidiaries(11) 9,906 5,865 5,985
- -------------------------------------------------------------------------------------------------------------------------------
Total long-term debt $11,353 $7,446 $7,567
======= ====== ======
- -------------------------------------------------------------------------------------------------------------------------------
Portfolio interest rates, caps and floors are used to manage interest rate risk
by modifying the repricing and maturity characteristics of certain long-term
debt. Additional information pertaining to the notional amount, fair value and
weighted average rate of such financial instruments as of September 30, 1998, is
presented in Note 10, Financial Instruments with Off-Balance Sheet Risk,
beginning on page 16.
1 At September 30, 1998, December 31, 1997 and September 30, 1997, the senior
medium-term notes had weighted average interest rates of 6.68%, 6.64% and
6.56%, respectively, and the subordinated medium-term notes had weighted
average interest rates of 7.09%, 6.90% and 6.85%, respectively. These notes
had a combination of both fixed and floating interest rates.
2 The 7.50%, 6.75%, 8.125% and 8.00% subordinated notes may not be redeemed
or prepaid prior to maturity.
3 The 8.40% subordinated capital notes may, at maturity, be exchanged for
common stock, preferred or other eligible securities having a market value
equal to the principal amount of the notes.
4 At September 30, 1998, December 31, 1997 and September 30, 1997, senior
medium-term bank notes of subsidiaries had weighted average interest rates
of 5.69%, 5.51% and 5.75%, respectively. These notes had a combination of
both fixed and floating interest rates.
5 At September 30, 1998, December 31, 1997 and September 30, 1997, the senior
euro medium-term bank notes had weighted average interest rates of 5.76%,
5.91%, and 5.83%, respectively. These notes are obligations of KeyBank
National Association ("KeyBank N.A.") and had fixed and floating interest
rates based on the three-month London Interbank Offered Rate ("LIBOR"). As
of September 30, 1998, the $5.0 billion Euronote Program had an unused
capacity of $3.6 billion.
14
15
6 The subordinated notes are all obligations of KeyBank N.A., with the
exception of the 7.55% note, which is an obligation of KeyBank USA. These
notes may not be redeemed prior to their respective maturity dates.
7 At September 30, 1998, December 31, 1997 and September 30, 1997, lease
financing debt had a weighted average interest rate of 7.01%, 7.12% and
7.27% , respectively, and represented primarily nonrecourse debt
collateralized by lease equipment under operating, direct financing and
sales type leases.
8 At September 30, 1998, long-term advances from the Federal Home Loan Bank
("FHLB") had adjustable and fixed interest rates ranging from $5.312% to
12.125%. Real estate loans and securities of $241 million, $218 million and
$219 million at September 30, 1998, December 31, 1997 and September 30,
1997, respectively, collateralize FHLB advances.
9 Other long-term debt at September 30, 1998, December 31, 1997 and September
30, 1997, consisted of industrial revenue bonds, capital lease obligations
and various secured and unsecured obligations of corporate subsidiaries and
had weighted average interest rates of 7.56%, 8.06% and 8.33%,
respectively.
10 At September 30, 1998, unused capacity under the parent company's shelf
registration totaled $1.3 billion, including $750 million reserved for
future issuance as medium-term notes.
11 As of September 30, 1998, the Bank Note Program had an unused capacity of
$2.9 billion.
8. CAPITAL SECURITIES
The corporation-obligated mandatorily redeemable preferred capital securities of
subsidiary trusts holding solely debentures of the Corporation ("capital
securities") were issued by four business trusts, KeyCorp Institutional Capital
A ("Capital A"), KeyCorp Institutional Capital B ("Capital B"), KeyCorp
Institutional Capital C ("Capital C") and KeyCorp Capital I ("Capital I"), all
of whose common securities are owned by the parent company. Capital A and
Capital B were formed in the fourth quarter of 1996, Capital C was formed in the
second quarter of 1997 and Capital I was formed in the second quarter of 1998.
The proceeds from the issuances of the capital securities and common securities
were used to purchase debentures of the parent company. Capital A, Capital B and
Capital I 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
the trusts; and (iii) payments due upon a voluntary or involuntary liquidation,
winding-up or termination of the trusts.
The capital securities, common securities and related debentures are summarized
as follows:
Interest Rate Maturity
Principal of Capital of Capital
Capital Common Amount of Securities and Securities and
dollars in millions Securities(1) Securities Debentures(2) Debentures(3) Debentures
- ------------------------------------------------------------------------------------------------------------------------
September 30, 1998
Capital A $350 $11 $ 361 7.826% 2026
Capital B 150 4 154 8.250 2026
Capital C 250 8 258 6.625 2029
Capital I 247 8 255 6.428 2028
- ------------------------------------------------------------------------------------------------------------------------
Total $997 $31 $1,028 7.242% --
==== === ======
- ------------------------------------------------------------------------------------------------------------------------
December 31, 1997 $750 $23 $773 7.510% --
==== === ======
- ------------------------------------------------------------------------------------------------------------------------
September 30, 1997 $750 $23 $773 7.510% --
==== === ======
- ------------------------------------------------------------------------------------------------------------------------
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 securities on the coupon adjustment date (June 1, 1999). The capital
securities issued by Capital A, Capital B and Capital I constitute minority
interests in the equity accounts of consolidated subsidiaries and, therefore,
qualify as Tier 1 capital under Federal Reserve Board Guidelines.
15
16
2 The parent company has the right to redeem the debentures purchased by Capital
A, Capital B, Capital C and Capital I: (i) in whole or in part, on or after
December 1, 2006, December 15, 2006, June 1, 2009 and July 1, 2008,
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
purchased by Capital A, Capital B or Capital C 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. If the
debentures purchased by Capital I are redeemed prior to maturity, the
redemption price will be equal to 100% of the principal amount of such
debentures, plus any accrued but unpaid interest.
3 The interest rates for Capital A, Capital B and Capital C are fixed interest
rates. The interest rate for Capital I is a floating interest rate equal to
three-month LIBOR plus 74 basis points and is repriced quarterly. The rates
shown as the total at September 30, 1998, December 31, 1997 and September 30,
1997, are weighted average rates.
9. SHAREHOLDERS' EQUITY
At the Annual Meeting of Shareholders held May 7, 1998, shareholders increased
the authorized number of Key Common Shares from 900,000,000 to 1,400,000,000
Common Shares. Additionally, on January 15, 1998, the Board voted to cancel and
retire all 1,400,000 authorized shares of Key's 10% Cumulative Preferred Stock,
Class A, none of which were outstanding.
On January 15, 1998, Key announced a two-for-one stock split effected by means
of a 100% stock dividend payable March 6, 1998, to shareholders of record as of
February 18, 1998. Except where express reference is made to Common Shares on a
pre-split basis, all relevant Common Share amounts and per Common Share data in
this report have been adjusted to reflect the split.
10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Key, mainly through its lead bank (KeyBank N. A.), is party to various financial
instruments with off-balance sheet risk. It uses these financial instruments in
the normal course of business to meet the financing needs of its customers and
to manage its exposure to market risk. Market risk includes 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 risk 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 meet 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.
Key's 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
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 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 Key's 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.
16
17
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.
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 1998 1997 1997
- -------------------------------------------------------------------------------------------------------------------
Loan commitments:
Credit card lines $ 6,756 $ 8,205 $ 7,928
Home equity 4,291 3,977 3,924
Commercial real estate and construction 1,640 1,073 1,104
Commercial and other 21,667 15,867 13,180
- -------------------------------------------------------------------------------------------------------------------
Total loan commitments 34,354 29,122 26,136
Other commitments:
Standby letters of credit 1,597 1,431 1,467
Commercial letters of credit 151 109 120
Loans sold with recourse 22 27 271
- -------------------------------------------------------------------------------------------------------------------
Total loan and other commitments $36,124 $30,689 $27,994
======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES
Key manages its exposure to interest rate risk, in part, by using off-balance
sheet financial instruments, commonly referred to as derivatives. 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 Key to manage exposure
to interest rate risk are interest rate swaps, caps and floors, otherwise
referred to as portfolio swaps, caps and floors.
The following table summarizes the notional amount, fair value, maturity,
weighted average rate received and paid, and weighted average strike price for
the various types of portfolio swaps, caps and floors used by Key.
SEPTEMBER 30, 1998
----------------------------------------------------------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR MATURITY ---------------------------------
dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY STRIKE
- ----------------------------------------------------------------------------------------------------------------------------------
Interest rate swaps:
Receive fixed/pay variable-indexed amortizing(1) $ 962 $ 5 0.4 6.79 % 5.68 % N/A
Receive fixed/pay variable-conventional 3,630 275 5.7 6.66 5.64 N/A
Pay fixed/receive variable-conventional 3,496 (87) 4.5 5.77 6.20 N/A
Pay fixed/receive variable-forward starting 533 (15) 3.1 5.69 5.97 N/A
Basis swaps 1,804 19 2.2 5.73 5.61 N/A
- ----------------------------------------------------------------------------------------------------------------------------------
Total 10,425 197 -- 6.16 % 5.84 % --
Interest rate caps, collars and corridors:
Caps purchased - one to three-month LIBOR based(2) 3,545 1 1.2 N/A N/A 5.80 %
Collars - one to three-month LIBOR based 350 (1) 3.4 N/A N/A 4.75 AND 6.50
Collar - thirty year U.S. Treasury based 250 (26) 0.7 N/A N/A 5.69 AND 7.88
1% payout corridor(3) 200 -- 1.1 N/A N/A 6.00 TO 7.00
- ----------------------------------------------------------------------------------------------------------------------------------
Total 4,345 (26) -- -- -- --
- ----------------------------------------------------------------------------------------------------------------------------------
Total $14,770 $171 -- -- -- --
======= ====
- ----------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1997
----------------------------
NOTIONAL FAIR
dollars in millions AMOUNT VALUE
- --------------------------------------------------------------------------------------
Interest rate swaps:
Receive fixed/pay variable-indexed amortizing(1) $ 3,449 $ 12
Receive fixed/pay variable-conventional 3,626 100
Pay fixed/receive variable-conventional 2,990 (7)
Pay fixed/receive variable-forward starting -- --
Basis swaps 1,110 (3)
- --------------------------------------------------------------------------------------
Total 11,175 102
Interest rate caps, collars and corridors:
Caps purchased - one to three-month LIBOR based(2) 2,845 11
Collars - one to three-month LIBOR based 100 --
Collar - thirty year U.S. Treasury based 250 (15)
1% payout corridor(3) 200 1
- --------------------------------------------------------------------------------------
Total 3,395 (3)
- --------------------------------------------------------------------------------------
Total $14,570 $ 99
======= ======
- --------------------------------------------------------------------------------------
1 Maturity is based upon expected average lives rather than contractual terms.
2 Includes $200 million and $1.0 billion of forward-starting caps as of
September 30, 1998 and December 31, 1997, respectively.
3 Payout is indexed to three-month LIBOR.
N/A = Not Applicable
Interest rate swap contracts involve the exchange of interest payments
calculated based on an agreed-upon amount (notional amount) and are generally
used to mitigate Key's exposure to interest rate risk on certain loans,
deposits, short-term borrowings and long-term debt. 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 caps, enters into collars (a
combination of simultaneously purchasing a cap and selling a floor), and enters
into corridors
17
18
(a combination of simultaneously purchasing a cap at a specified strike price
and selling a cap at a higher strike price) to manage the risk of adverse
movements in interest rates on specified long-term debt and short-term
borrowings. The notional amount associated with the execution of swaps, caps and
floors is significantly greater than the amount at risk.
Credit risk on swaps, caps and floors results from the possibility that the
counterparty will not meet the terms of the contract and is measured as the cost
of replacing, at current market rates, contracts in an unrealized gain position.
To mitigate this risk, Key deals exclusively with counterparties with high
credit ratings. With regard to its swap contracts, Key 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 Key's total credit exposure with each counterparty and
the amount of collateral required, if any, are determined. At September 30,
1998, Key had 40 different counterparties to portfolio swaps and swaps entered
into to offset the risk of customer swaps. Key had aggregate credit exposure of
$173 million to 14 of these counterparties, with the largest credit exposure to
an individual counterparty amounting to $56 million. As of the same date, Key's
aggregate credit exposure on its interest rate caps and floors totaled $5
million. Based on management's assessment as of September 30, 1998, all
counterparties were expected to meet their obligations. Portfolio swaps
(including the impact of both the spread on the swap portfolio and the
amortization of deferred gains and losses resulting from terminated swaps) and
portfolio caps and floors increased net interest income by $2 million in the
third quarter of 1998 and $12 million in the third quarter of 1997.
Conventional interest rate swap contracts involve the receipt of amounts based
on a fixed or variable rate 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 September 30, 1998, Key was party to $332 million and $630 million
of indexed amortizing swaps that used a 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.
Based on the weighted average rates in effect at September 30, 1998, the spread
on portfolio 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 32
basis points). The aggregate fair value of $197 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 gain that would be recognized if the portfolio were
to be liquidated at that date.
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 as an
adjustment to the carrying amount of the asset or liability. The deferred gain
or loss is amortized using the straight-line method over the shorter of the
projected remaining life of the related contract at its termination or the
underlying asset or liability. During the first nine months of 1998, swaps with
a notional amount of $568 million were terminated, resulting in a net deferred
loss of $1 million. During the same period last year, swaps with a notional
amount of $220 million were terminated, resulting in no deferred gain or loss.
At September 30, 1998, Key had a net deferred swap gain of $13 million with a
weighted average life of 4.8 years related to the management of debt and a net
deferred loss of $1 million with a weighted average life of 7.4 years related to
the management of loans.
In addition to interest rate swaps, caps and floors, Key uses treasury-based
interest rate locks as a component of its interest rate risk management
strategy. At September 30, 1998, the rate locks had a notional amount of $930
million, a weighted average maturity of less than one month and a negative fair
value of ($20) million.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES
Key also uses interest rate swaps, caps and floors, and futures contracts for
dealer activities (which are generally limited to the banks' commercial loan
customers) and enters into other positions with third parties that are intended
18
19
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 investment banking
and capital markets income on the income statement.
Foreign exchange forward contracts are used by Key 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 investment banking
and capital markets income on the income statement.
Key also enters into treasury options and treasury futures options for
proprietary trading purposes. Adjustments to the fair value of all such options
are included in investment banking and capital markets income on the income
statement.
At September 30, 1998, 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 $656 million. The risk of counterparties
defaulting on their obligations is monitored on an ongoing basis. Key contracts
with counterparties with high credit ratings and enters into master netting
agreements when possible in an effort to manage credit risk.
Trading income recognized on interest rate, foreign exchange forward and
treasury-based option contracts totaled $49 million, $16 million and $3 million,
respectively, for the first nine months of 1998 and $23 million, $12 million and
zero, respectively, for the first nine months of 1997.
A summary of the notional amount and the respective fair value of derivative
financial instruments held or issued for trading purposes at September 30, 1998,
and on average for the nine-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 $17.3 billion notional amount of interest
rate swaps presented in the table includes $8.1 billion of customer swaps that
receive a fixed rate and pay a variable rate, $5.7 billion of customer swaps
that pay a fixed rate and receive a variable rate and $3.2 billion of basis
swaps. As of September 30, 1998, the customer swaps had an average expected life
of 6.4 years, carried a weighted average rate received of 6.25% and had a
weighted average rate paid of 6.15%. Also included in the table are a trading
swap and cap, each with a notional amount of $300 million, which were executed
in connection with the residual interest retained in the September 1998
securization of certain home equity loans. The trading swap pays a fixed rate
and receives a variable rate. As of September 30, 1998, this swap had an
expected life of 3.4 years, carried a rate received of 5.38% and had a rate paid
of 5.06%.
SEPTEMBER 30, 1998 NINE MONTHS ENDED SEPTEMBER 30, 1998
------------------------ -------------------------------------------
NOTIONAL FAIR AVERAGE AVERAGE
in millions AMOUNT VALUE NOTIONAL AMOUNT FAIR VALUE
- --------------------------------------------------------------------------------------------------------------------
Interest rate contracts:
Swap assets $10,807 $ 449 $9,086 $ 204
Swap liabilities 6,445 (327) 4,576 (123)
Caps and floors purchased 732 3 626 1
Caps and floors sold 603 (2) 796 (1)
Futures purchased 857 23 663 5
Futures sold 10,877 (23) 8,840 (7)
Foreign exchange forward contracts:
Assets 1,209 46 1,019 29
Liabilities 1,290 (40) 969 (27)
Treasury-based option contracts:
Options purchased 5,492 135 4,248 46
Options sold 5,185 (150) 4,180 (51)
- --------------------------------------------------------------------------------------------------------------------
19
20
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
SHAREHOLDERS AND BOARD OF DIRECTORS
KEYCORP
We have reviewed the unaudited condensed consolidated balance sheets of KeyCorp
and subsidiaries ("Key") as of September 30, 1998 and 1997, and the related
condensed consolidated statements of income for the three- and nine-month
periods then ended, and the condensed consolidated statements of changes in
shareholders' equity and cash flow for the nine-month periods ended September
30, 1998 and 1997. 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 condensed 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, 1997, 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 13, 1998, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated balance sheet as of December 31, 1997,
is fairly stated, in all material respects, in relation to the consolidated
balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
October 13, 1998
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KEYCORP AND SUBSIDIARIES
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 19.
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 economy which could materially change anticipated credit quality
trends and the ability to generate loans; failure of the capital markets to
function consistent with customary levels; significant delay in or inability to
execute strategic initiatives designed to grow revenues and/or manage expenses;
consummation of significant business combinations or divestitures; unforeseen
business risks related to Year 2000 computer systems issues; and significant
changes in accounting, tax, or regulatory practices or requirements.
Key's earnings results for the third quarter of 1998 reflected strong growth in
fee income, continued growth in commercial loans and strong asset quality.
Noninterest income was up 25% from the year-ago third quarter, after excluding
1997 bank and branch divestiture gains totaling $79 million. This growth
reflected the continuation of broad-based strength with the largest increases
coming from investment banking and capital markets activities and trust and
asset management. Average outstanding commercial loans rose by 18% from the 1997
third quarter and were up an annualized 21% from the second quarter of 1998.
Contributing to the strength of Key's asset quality is its minimal emerging
markets exposure which relates predominantly to trade finance transactions. That
fact and the absence of hedge fund exposure have contributed to the stability of
Key's provision for loan losses and net charge-off levels.
During the first nine months of 1998, Key continued to evolve as a bank-based
financial services company by broadening the scope of products and services it
offers and by continuing to reallocate its resources to businesses with higher
earnings potential. During the first half of the year, these resources were made
available in part through the sales of 46 full-service banking offices
("KeyCenters"), resulting in gains of $39 million. The sales marked the
completion of the planned divestiture of KeyCenters announced in November 1996
in conjunction with Key's efforts to streamline operations and to manage
operating expenses more effectively. In total, 150 KeyCenters were sold in this
divestiture program. As a result of the decrease in core deposits associated
with these divestitures, purchased funds have been more heavily relied upon to
fund Key's earning asset growth.
Primary strategic actions taken during 1998 are as follows:
- - During the first quarter of 1998, Key entered into a joint venture with
NOVA, an Atlanta-based company which provides transaction processing and
electronic payment services to merchant clients nationwide. This joint
venture, in which Key retained a 49% interest in its proprietary merchant
credit card processing business, enables Key to participate in the same
business, but with enhanced growth prospects due to NOVA's greater presence
and ability to focus on the business as a niche specialty. Key also
capitalized on its 1997 acquisition of an 80% interest in Leasetec by
entering into an agreement to form a joint venture with Compaq Capital
Corporation to provide customized equipment leasing and financing programs
to Compaq's customers in the United Kingdom, Europe and Asia.
- - In the second quarter, Key acquired an $805 million marine/recreational
vehicle installment loan portfolio originated through another bank's dealer
distribution network. Key's marine/recreational vehicle portfolio
aggregated $3.3 billion at September 30, 1998, and is the largest such
portfolio held by any bank holding company in the United States.
- - During the third quarter, Key increased its investment in Leasetec by
purchasing the remaining 20% interest from Tokyo Leasing (U.S.A.) Inc. This
action was contemplated in the original purchase completed in July 1997 and
strengthens Key's presence as a provider of worldwide lease financing of
information technology and telecommunications equipment.
21
22
- - In October, Key completed its acquisition of McDonald, a full-service
investment banking and securities brokerage company. Leveraged by Key's
capabilities in technology, marketing and sales, the McDonald transaction
is expected to strengthen Key's product lines which provide capital
markets, investment banking and asset management expertise to business and
private clients.
The preceding items are described in greater detail in the remainder of this
discussion and in the notes to the consolidated interim financial statements.
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 September 30, 1998 and 1997. 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 19. Unless otherwise
stated, all earnings per share data included in this section and throughout the
remainder of this discussion are presented on a diluted basis.
Net income for the third quarter of 1998 reached a record high of $252 million,
or $.57 per Common Share, up from $236 million, or $.53 per Common Share in the
third quarter of 1997. This represents an 8% increase in earnings per Common
Share from the year-ago quarter. On an annualized basis, the return on average
equity for the third quarter of 1998 was 18.14%, compared with 19.41% for the
same period last year. The annualized returns on average total assets were 1.32%
and 1.34% for the third quarters of 1998 and 1997, respectively.
The increase in earnings relative to the third quarter of 1997 resulted from
strong growth in fee income and a substantial reduction in the provision for
loan losses. Noninterest income rose by $78 million, or 25%, from the year-ago
quarter, after excluding 1997 third quarter bank and branch divestiture gains
totaling $79 million. Compared with the same period, the provision for loan
losses decreased by $31 million, or 30%. These positive factors were partially
offset by a $7 million decrease in taxable-equivalent net interest income, due
to a 39 basis point decline in the net interest margin which more than offset a
$5.1 billion, or 8%, increase in average earning assets. The level of
noninterest expense was relatively unchanged from the third quarter of last
year. Included in noninterest expense in the third quarter of 1998 were $5
million ($4 million in the third quarter of 1997) of Year 2000 computer
information system compliance expenses and $19 million ($14 million in the third
quarter of 1997) of distributions on capital securities (which more closely
resemble interest payments than overhead). Noninterest expense in the year-ago
quarter also included a $50 million charge recorded in connection with efforts
to exit excess real estate resulting from Key's nationwide banking and related
centralization efforts. Excluding the above charges, noninterest expense was up
$43 million, or 7%, from the third quarter of 1997.
For the first nine months of 1998, earnings were $736 million, up 10% from $671
million for the same period last year. On a per Common Share basis, Key's 1998
year-to-date earnings were $1.65, amounting to a 9% increase from $1.51 for the
first nine months of 1997. On an annualized basis, the return on average equity
for the first nine months of 1998 was 18.29%, compared with 18.78% for the
comparable year-ago period. The annualized returns on average total assets were
1.33% and 1.32% for the first nine months of 1998 and 1997, respectively.
Affecting comparative results was a $188 million, or 20%, increase in
noninterest income (achieved despite a $50 million decrease in gains from bank
and branch divestitures) and a $24 million, or 10%, decline in the provision for
loan losses. A $58 million increase in noninterest expense and a $52 million
decrease in taxable-equivalent net interest income partially offset the positive
impact of these factors. Excluding the 1997 real estate disposition charge,
year-to date distributions on capital securities of $47 million in 1998 and $35
million in 1997, and Year 2000 computer information system compliance expenses
of $17 million and $9 million in each respective year, noninterest expense was
up $88 million, or 5%, from the first nine months of 1997.
22
23
FIGURE 1. SELECTED QUARTERLY FINANCIAL DATA
Nine months ended
1998 1997 September 30,
-------------------------------- --------------------- ------------------------
dollars in millions, except per share amounts Third Second First Fourth Third 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $ 1,415 $ 1,372 $ 1,327 $ 1,365 $ 1,347 $ 4,114 $ 3,897
Interest expense 715 692 663 660 643 2,070 1,808
Net interest income 700 680 664 705 704 2,044 2,089
Provision for loan losses 71 72 77 76 102 220 244
Noninterest income 392 380 356 366 393 1,128 940
Noninterest expense 647 616 600 630 648 1,863 1,805
Income before income taxes 374 372 343 365 347 1,089 980
Net income 252 249 235 248 236 736 671
- ------------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .57 $ .57 $ .53 $ .56 $ .54 $ 1.68 $ 1.53
Net income-assuming dilution .57 .56 .53 .56 .53 1.65 1.51
Cash dividends .235 .235 .235 .21 .21 .705 .63
Book value at period end 12.73 12.55 12.15 11.83 11.55 12.73 11.55
Market price:
High 39.50 44.88 39.25 36.59 32.72 44.88 32.72
Low 24.75 34.44 31.56 28.50 27.63 24.75 23.94
Close 28.88 35.63 37.81 35.41 31.82 28.88 31.82
Weighted average Common Shares (000) 438,856 440,092 438,589 438,746 436,214 439,180 439,140
Weighted average Common Shares and
potential Common Shares (000) 443,750 446,568 444,836 445,152 442,050 445,047 444,340
- ------------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 59,444 $ 57,769 $ 54,900 $ 53,380 $ 53,676 $ 59,444 $ 53,676
Earning assets 68,568 66,941 64,368 64,246 63,800 68,568 63,800
Total assets 77,691 75,778 73,198 73,699 72,077 77,691 72,077
Deposits 42,597 41,794 41,661 45,073 43,870 42,597 43,870
Long-term debt 11,353 10,196 9,041 7,446 7,567 11,353 7,567
Shareholders' equity 5,553 5,525 5,338 5,181 5,076 5,553 5,076
Full-time equivalent employees 24,586 24,711 24,650 24,595 25,622 24,586 25,622
Full-service banking offices 961 962 1,006 1,015 1,088 961 1,088
- ------------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.32% 1.35% 1.32% 1.38% 1.34% 1.33% 1.32%
Return on average equity 18.14 18.47 18.25 19.16 19.41 18.29 18.78
Efficiency(1) 57.09 58.22 57.39 56.81 56.75 57.56 57.75
Overhead(2) 33.33 37.30 35.36 36.17 37.76 35.31 40.81
Net interest margin (TE) 4.19 4.19 4.23 4.50 4.58 4.20 4.67
- ------------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets(3) 8.11% 8.28% 7.98% 7.71% 7.74% 8.11% 7.74%
Tangible equity to tangible assets(3) 6.76 6.91 6.51 6.21 6.16 6.76 6.16
Tier 1 risk-adjusted capital 7.01 7.15 6.81 6.65 6.73 7.01 6.73
Total risk-adjusted capital 11.61 11.86 11.38 10.83 11.10 11.61 11.10
Leverage 6.88 7.04 6.61 6.40 6.33 6.88 6.33
- ------------------------------------------------------------------------------------------------------------------------------------
The comparability of the information presented above is affected by certain
acquisitions and divestitures completed by Key in the time periods presented.
For further information concerning these transactions, refer to Note 3, Mergers,
Acquisitions and Divestitures, beginning on page 9.
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 gains from bank and branch divestitures).
2 Calculated as noninterest expense (excluding certain nonrecurring charges and
distributions on capital securities) less noninterest income (excluding net
securities transactions and gains from bank and branch divestitures) divided
by taxable-equivalent net interest income.
3 Excluding certain capital securities receiving Tier 1 treatment, these ratios
at September 30, 1998 are 7.15% and 5.79%, respectively; at June 30, 1998 are
7.29% and 5.91%, respectively; at March 31, 1998, are 7.29% and 5.81%,
respectively; at December 31, 1997, are 7.03% and 5.52%, respectively; and at
September 30, 1997 are 7.04% and 5.46%, respectively.
TE = Taxable Equivalent
23
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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 other intangibles considered
nonqualifying in regulatory capital computations, and related assets resulting
from business combinations recorded by Key under the purchase method of
accounting. Had these business combinations qualified for accounting under the
pooling of interest 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 impact Key's
liquidity and funds management activities. Cash basis financial data provide an
additional basis for measuring a company's ability to support future growth, pay
dividends and repurchase shares. Cash basis financial data, as defined above and
presented in Figure 2, have not been adjusted to exclude the impact of other
noncash items such as depreciation, the provision for loan losses, deferred
income taxes, etc. This is the only section of this report in which Key's
financial results are discussed on a cash basis.
FIGURE 2 CASH BASIS SELECTED FINANCIAL DATA
1998 1997
------------------------------------ -------------------------
dollars in millions, except per share amounts Third Second First Fourth Third
- ---------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Noninterest expense $ 627 $ 595 $ 578 $ 611 $ 628
Income before income taxes 394 393 365 384 367
Net income 270 267 254 269 253
- ---------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .61 $ .61 $ .58 $ .61 $ .58
Net income - assuming dilution .61 .60 .57 .60 .57
Weighted average Common Shares (000) 438,856 440,092 438,589 438,746 436,214
Weighted average Common Shares and potential
Common Shares (000) 443,750 446,568 444,836 445,152 442,050
- ---------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.43% 1.47% 1.45% 1.52% 1.45%
Return on average equity 24.43 25.08 25.37 27.07 26.82
Efficiency(1) 55.27 56.19 55.24 55.01 54.81
- ---------------------------------------------------------------------------------------------------------------------
GOODWILL AND NONQUALIFYING INTANGIBLES
Goodwill average balance $ 1,042 $ 1,042 $ 1,063 $ 1,083 $ 977
Nonqualifying intangibles average balance 85 96 99 108 106
Goodwill amortization (after tax) 15 15 16 18 14
Nonqualifying intangibles amortization (after tax) 3 3 3 3 3
- ---------------------------------------------------------------------------------------------------------------------
The comparability of the information presented above is affected by certain
acquisitions and divestitures completed by Key in the time periods
presented. For further information concerning these transactions, refer to Note
3, Mergers, Acquisitions and Divestitures, beginning on page 9.
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 gains from bank
and branch divestitures).
24
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LINE OF BUSINESS RESULTS
Key's four major lines of business are Key Corporate Capital, Key Consumer
Finance, Key Community Bank and Key Capital Partners ("KCP"). A summary of
financial results and significant performance measures for each major line of
business for the nine-month periods ended September 30, 1998 and 1997, is
presented in Figure 3.
FIGURE 3 LINE OF BUSINESS RESULTS
Nine months ended September 30, 1998 KEY KEY KEY KEY KEY
CORPORATE CONSUMER COMMUNITY CAPITAL SUPPORT KEYCORP
dollars in millions CAPITAL FINANCE BANK PARTNERS & ADMIN. CONSOLIDATED
- -------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 350 $ 421 $ 1,308 $ (5) $ (4) $ 2,070
Provision for loan losses 28 138 77 -- (23) 220
Noninterest income 44 115 450 475 44 1,128
Revenue sharing--KCP(1) 87 3 187 (277) -- --
Noninterest expense 106 229 1,169 311 48 1,863
Expense sharing--KCP(1) 67 -- 92 (159) -- --
- -------------------------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 280 172 607 41 15 1,115
Allocated income taxes and TE adjustment 105 68 197 16 (7) 379
- -------------------------------------------------------------------------------------------------------------------------------
Net income $ 175 $ 104 $ 410 $ 25 $ 22 $ 736
======= ======= ======= ======= ======= =======
Percent of consolidated net income 24 % 14 % 56 % 3 % 3 % 100 %
- -------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $12,488 $14,061 $29,783 -- -- $56,332
Earning assets 12,594 14,455 37,138 $ 1,551 -- 65,738
Deposits 473 1,157 39,646 4 -- 41,280
Allocated equity 894 1,325 3,002 158 $ 2 5,381
- -------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average allocated equity 26.17 % 10.49 % 18.26 % 21.16 % N/M 18.29 %
Efficiency 35.97 42.49 62.55 78.76 N/M 57.76
- -------------------------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 1997 KEY KEY KEY KEY KEY
CORPORATE CONSUMER COMMUNITY CAPITAL SUPPORT KEYCORP
dollars in millions CAPITAL FINANCE BANK PARTNERS & ADMIN. CONSOLIDATED
- -------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 273 $ 400 $ 1,438 $ 13 $ (2) $ 2,122
Provision for loan losses 5 158 81 -- -- 244
Noninterest income 36 86 406 313 99 940
Revenue sharing--KCP(1) 68 -- 122 (190) -- --
Noninterest expense 83 173 1,171 245 133 1,805
Expense sharing--KCP(1) 58 -- 78 (136) -- --
- -------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (TE) 231 155 636 27 (36) 1,013
Allocated income taxes and TE adjustment 84 60 212 11 (25) 342
- -------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 147 $ 95 $ 424 $ 16 $ (11) $ 671
======= ======= ======= ======= ======= =======
Percent of consolidated net income 22 % 14 % 63 % 2 % (1) % 100 %
- -------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 9,791 $13,026 $27,961 -- -- $50,778
Earning assets 9,795 13,270 36,785 $ 716 -- 60,566
Deposits 424 988 42,672 2 -- 44,086
Allocated equity 653 1,031 2,966 121 $ 5 4,776
- -------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average allocated equity 30.10 % 12.32 % 19.11 % 17.68 % N/M 18.78 %
Efficiency 36.60 35.60 61.75 80.15 N/M 57.75
- -------------------------------------------------------------------------------------------------------------------------------
1 Represents the assignment of KCP revenue and expense to the lines of business
principally responsible for maintaining the relevant customer relationships.
(See description of KCP on page 28).
TE = Taxable Equivalent
N/M = Not Meaningful
25
26
The financial information discussed in the remainder of this section was derived
from the internal profitability reporting system used by management to monitor
and manage the financial performance of Key. The financial results and
performance measures reported are based on internal management accounting
policies which have been developed so as to enable the results to be compiled on
a consistent basis and to reflect the underlying economics of the businesses.
These policies address the methodologies applied in connection with funds
transfer pricing as well as the allocation of certain costs and capital. Funds
transfer pricing was used in the determination of net interest income by
assigning a standard cost for funds used (or a standard credit for funds
provided) to assets and liabilities based on their maturity, prepayment and/or
repricing characteristics. The net effect of transfer pricing is included in the
Key Community Bank line of business where the securities portfolios are also
maintained. Indirect expenses were allocated based on actual volume measurements
and other criteria, as appropriate. The provision for loan losses was allocated
in an amount based upon primarily the actual net charge-offs of each respective
line of business, adjusted for loan growth and changes in risk profile. The
level of the consolidated provision for loan losses was based upon the
application of methodologies designed by management to assess the adequacy of
the consolidated allowance by focusing on a number of specific factors. These
factors are more fully discussed in the Asset Quality section of Key's 1997
Annual Report to Shareholders.
Income taxes were allocated based on the statutory Federal income tax rate of
35% (adjusted for tax-exempt income from corporate owned life insurance,
nondeductible goodwill amortization, and tax credits associated with investments
in low-income housing projects) and a blended state income tax rate of 1.8% (net
of the Federal income tax benefit) for the periods presented. Capital was
assigned to each line of business based on management's assessment of economic
risk factors (primarily credit, operating and market risk).
The development and application of these methodologies is a dynamic process.
Accordingly, financial results may be revised periodically to reflect management
accounting enhancements, changes in risk profile or changes in the
organization's structure. Further, unlike financial accounting, there is no
authoritative guidance for management accounting similar to generally accepted
accounting principles. Consequently, reported results are not necessarily
comparable with those presented by other companies. During the first quarter of
1998, Key enhanced its capital allocation process, including the adoption of a
refined methodology for estimating credit risk that applies more detailed risk
factors to loans, considering both their grades and terms. This methodology is
also reflected in the results of operations for the first nine months of 1997
presented in Figure 3.
A description of each of Key's major lines of business is presented below.
KEY CORPORATE CAPITAL
Key offers a complete range of financing, transaction processing and financial
advisory services to corporations throughout the country through its Key
Corporate Capital unit. It also operates one of the largest bank-affiliated
equipment leasing companies with operations conducted both domestically and
throughout Europe and Asia. Key Corporate Capital's business units are organized
around specialized industry client segments, inclusive of healthcare,
media/telecommunications, structured finance and commercial real estate. In
serving these targeted segments, Key Corporate Capital provides a number of
specialized services including international banking, corporate finance advisory
services, investment banking and capital markets products through Key Capital
Partners, and 401(k) and trust custody products. Based on total transaction
volume, Key Corporate Capital is also one of the leading cash management
providers in the country.
During the first nine months of 1998, Key Corporate Capital contributed
approximately 24% of Key's consolidated earnings with net income of $175
million, resulting in a return on average allocated equity of 26.17%. In the
same period last year, net income was $147 million, or approximately 22% of
Key's consolidated earnings, and the return on average allocated equity was
30.10%. The increase in earnings relative to the prior year reflected higher net
interest income resulting from a 28% increase in total average loans. This
reflected growth in all commercial portfolios (with the exception of mortgage
loans), an increase in lease financing originations, and the full-year impact of
the July 1997 acquisition of an 80% interest in Leasetec; the remaining 20%
interest was acquired at the end of the second quarter of 1998. Also
contributing to the improved earnings performance was a $27 million rise in
noninterest income, led by investment banking and capital markets activities,
and trust and asset management income. The $32 million increase in noninterest
expense compared with the first nine months of 1997 was attributable primarily
to Leasetec, which added approximately $32 million to Key Corporate Capital's
operating costs, while also adding $45 million to total revenue. The $23 million
increase in the provision for loan losses from the first nine months of 1997
occurred primarily in precautionary response to strong loan growth.
26
27
KEY CONSUMER FINANCE
Key Consumer Finance is responsible for Key's indirect, non-branch-based
consumer loan and deposit products. This line of business specializes in credit
cards, automobile loans and leases, marine and recreational vehicle loans,
education loans, home equity loans and branchless deposit-generating activities.
As of December 31, 1997, based on the volume of loans generated, Key Consumer
Finance was the third largest education lender in the nation, ranked in the top
ten in retail automobile financing and was one of the leading providers of
financing for consumer purchases of marine and recreational vehicles.
For the first nine months of 1998, Key Consumer Finance generated net income of
$104 million, or approximately 14% of Key's consolidated earnings, and a return
on average allocated equity of 10.49%. In the comparable prior year period, net
income was $95 million, representing approximately 14% of Key's consolidated
earnings, and the return on average allocated equity was 12.32%. Primary factors
affecting financial performance relative to the prior year were higher levels of
net interest income and noninterest income, and a lower provision for loan
losses resulting from improved credit quality. These positive factors were
offset in part by an increase in noninterest expense. Net interest income rose
by $21 million due to growth in loans which more than compensated for the impact
of a lower net interest margin. The growth in loans included the April 1998
acquisition of an $805 million marine/recreational vehicle installment loan
portfolio. At $3.3 million, Key's portfolio is one of the largest such
portfolios in the United States. Both loan growth and the net interest margin
were diminished by the fourth quarter 1997 securitization of $949 million of
prime credit automobile loans with low returns on equity, and the sales of the
credit card receivables discussed below. The automobile loan securitization was
consistent with Key's goal of divesting assets which do not support its return
on equity objective. The August 1997 acquisition of Champion accounted for $33
million of the $50 million increase in total revenue, and $15 million of the $32
million increase in noninterest income. The balance of the increase in
noninterest income was due primarily to increased loan sale gains and loan
securitization servicing fees. The growth in loan securitization servicing fees
reflected substantial growth in securitized loans which are serviced by Key to
$4.3 billion at September 30, 1998, from $3.6 billion a year ago. The increase
in total noninterest income was moderated, however, by a decline in credit card
fees which resulted from the sale of a total of $365 million of out-of-franchise
credit card receivables during the first and third quarters of 1997. The
acquisition of Champion also accounted for $45 million of the $56 million
increase in noninterest expense relative to the first nine months of 1997.
Adding to the level of Champion's expenses in the current year were costs
associated with expanding the home equity business. Champion is now operating in
seven states in which it was absent or only nominally present at the August 1997
date of acquisition. Champion's revenues, unlike its noninterest expenses, have
tended to fluctuate directly with new securitizations. Securitizations will
continue to be evaluated as an alternative source of funds.
Legislation adopted by Congress in 1998 provides that, effective July 1, 1998,
the interest rates that financial institutions may earn from certain Federal
government-guaranteed education loans will be based on the 91-day Treasury bill
rate plus 2.2% during in-school periods and 2.8% during repayment periods,
rather than the basis in effect prior to the scheduled change. Prior to the
change, the interest rate was based on the 91-day Treasury bill rate plus 2.5%
(during in-school periods) and 3.1% (during repayment periods). Key's Federal
government-guaranteed education loans totaled approximately $1.5 billion at
September 30, 1998, and generated approximately 2% of Key's total interest on
loans recorded during the first nine months of the year.
KEY COMMUNITY BANK
Key Community Bank is responsible for delivering a complete line of branch-based
financial products and services to small businesses, consumers, and commercial
banking and public sector businesses. The delivery of these products and
services is accomplished through 961 KeyCenters, a 24-hour telephone banking
call center services group, more than 2,600 automated teller machines ("ATMs")
that access 14 different networks and comprise one of the largest ATM networks
in the United States, and a core team of relationship management professionals.
For the first nine months of 1998, net income for Key Community Bank totaled
$410 million, or approximately 56% of Key's consolidated earnings, compared with
$424 million, or 63%, respectively, for the first nine months of 1997. Its
return on average allocated equity was 18.26% in the first nine months of 1998
and 19.11% for the same period last year. The decrease in earnings relative to
the prior year reflected a decline in net interest income and an increase in
noninterest expense, substantially offset by growth in noninterest income and a
reduction in the provision for loan losses. The $130 million decline in net
interest income resulted from a lower net interest margin which more than offset
the benefits derived from a $1.8 billion, or 7%, increase in average loan
outstandings. The lower net interest margin was due to a number of factors,
including competitive interest rate spread compression, greater reliance placed
on higher-cost
27
28
funding to support the incremental increase in loan portfolios, and the
reduction in core deposits stemming from branch divestitures. The $12 million
increase in noninterest expense was due primarily to higher incentive
compensation related to investment banking, capital markets and branch-based
activities, offset in part by lower personnel costs resulting from a decrease in
the employment base as part of Key's consolidation and expense control
initiatives. Noninterest income rose $109 million, or 21%, from the prior year
due in part to increased focus on and diversification of fee income sources. The
largest contributions to this growth came from trust and asset management
activities, investment banking and capital markets income, and service charges
on deposit accounts. Also included in 1998 noninterest income was a $23 million
gain recognized in connection with the joint venture with NOVA. The decrease in
the provision for loan losses reflected a lower level of net charge-offs.
During the first nine months of 1998, strategic developments centered around
continued efforts to reconfigure Key's delivery systems. Specific activities
included the sale of 46 branches in Maine, Idaho, Oregon and Washington,
expansion of the ATM delivery network through the installation of 666 ATMs
(representing the progress made on completing a projected total of 683
installations to occur in ARCO convenience stores in California, Nevada,
Arizona, Washington, and Oregon under terms of an agreement announced in late
1997), the completion of the merchant credit card processing joint venture with
NOVA and the opening of in-store branches in Colorado and the New England
states.
KEY CAPITAL PARTNERS
Key Capital Partners was formed at the end of 1997 to provide clients with asset
management, investment banking, capital markets, insurance and brokerage
expertise, and is expected to play a major role in developing fee income through
its broad range of investment choices and customized products. Leveraging Key's
corporate and community banking distribution channels and client relationships
will be an essential factor in ensuring Key Capital Partners' future growth and
success.
As indicated in Figure 3, a significant amount of noninterest income and expense
generated by Key Capital Partners is reported under either Key Corporate Capital
or Key Community Bank. This reflects Key's management accounting practice of
assigning such income and expense to whichever of those two lines of business is
principally responsible for maintaining the relationships with the customers who
also avail themselves of the products and services offered by Key Capital
Partners. On an all-inclusive basis (i.e., prior to the aforementioned
assignments), Key Capital Partners' net income totaled $104 million
(representing 15% of Key's consolidated earnings) in the first nine months of
1998 and $52 million (representing 8% of Key's consolidated earnings) in the
comparable prior year period. Noninterest income rose $162 million ($75 million
after revenue sharing) from the first nine months of last year. The largest
contribution to the improvement came from investment banking and capital markets
income which increased $82 million, or 107%, to $159 million, due to higher
revenues from advisory services, and dealer and trading activities, as well as
increased gains from the sales of equity capital investments. In addition,
revenues related to trust and asset management activities, which comprise the
majority of Key Capital Partners' noninterest income, rose $45 million, or 23%,
to $239 million, reflecting the strength of the stock and bond markets during
most of 1998, new business and the repricing of certain services. The increase
in noninterest income was partially offset by a $66 million ($43 million after
expense sharing) increase in noninterest expense, primarily personnel expense
which tends to rise with the growth in noninterest income due to incentive
compensation arrangements.
On October 23, 1998, Key acquired McDonald, a full-service investment banking
and securities brokerage company based in Cleveland, Ohio. The acquisition is
expected to strengthen all of the individual Key Capital Partners product lines,
including those providing capital markets, investment banking and asset
management expertise to business and private clients on a national basis. With
the addition of McDonald, Key Capital Partners will have an annual revenue base
of nearly $1 billion along with people, products and resources needed to compete
in this growing segment of the financial services industry. The new Key Capital
Partners is comprised of two major business groups. One group, operating under
the name McDonald Investments, includes retail and institutional brokerage,
equity and fixed income trading and underwriting, investment banking, capital
markets products, loan syndication and trading, public finance, and clearing
operations. The second major business group includes asset management, mutual
funds, institutional asset services, venture capital, mezzanine finance,
alliance funds, wealth management and insurance. Further information pertaining
to the terms of this transaction is included in Note 3, Mergers, Acquisitions
and Divestitures, beginning on page 9.
KEY SUPPORT AND ADMINISTRATION
Key Support and Administration includes activities that are not directly
attributable to one of the four major lines of business. Included in this
category are certain nonbanking affiliates, eliminations of certain intercompany
transactions and certain nonrecurring transactions. Also included are portions
of certain assets, capital and support functions not specifically identifiable
with the four major lines of business.
28
29
Included in year-to-date results for 1998 and 1997 were gains of $39 million and
$89 million, respectively, from the divestiture of banking offices. Also
included in 1997 results was a $50 million charge incurred in connection with
efforts to vacate and/or dispose of excess real estate. These items are more
fully described elsewhere in this management's discussion.
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 (including
off-balance sheet instruments described in Note 10, Financial Instruments with
Off-Balance Sheet Risk, beginning on page 16), interest rate fluctuations and
asset quality. To facilitate comparisons in the following discussion, net
interest income is presented on a taxable-equivalent basis, which restates
tax-exempt income to an amount that would yield the same after-tax income had
the income been subject to taxation at the statutory Federal income tax rate.
Various components of the balance sheet and their respective yields and rates
which affect interest income and expense are illustrated in Figure 4. The
information presented in Figure 5 provides a summary of the effect on net
interest income of changes in yields/rates and average balances for the
quarterly and year-to-date periods from the same periods in the prior year. A
more in-depth discussion of changes in earning assets and funding sources is
presented in the Financial Condition section beginning on page 39.
For the third quarter of 1998, net interest income was $708 million, down $7
million, or less than 1%, from the same period last year. This decrease
reflected a 39 basis point reduction in the net interest margin to 4.19%, which
more than offset an 8% increase in average earning assets (primarily loans) to
$67.5 billion. Compared with the second quarter of 1998, net interest income
increased by $19 million, or an annualized 11%, as average earning assets rose
by $1.7 billion, while the net interest margin was level with the prior quarter.
This marked the first quarter since the fourth quarter of 1996 in which Key's
net interest margin did not experience a decline. The net interest margin is
computed by dividing annualized taxable-equivalent net interest income by
average earning assets.
The decrease in the margin since the year-ago quarter resulted from a number of
factors. Primary among these are competitive interest rate spread compression,
greater reliance placed on higher-cost funding to support the incremental
increase in loan portfolios, and the reduction in core deposits stemming from
branch divestitures. Another factor contributing to the contraction of the
margin was an increase in low interest rate spread short-term investments
associated with various capital markets activities. The effects of these factors
were pronounced during an unusually (by historical standards) prolonged period
of flatness in the yield curve which has prevailed since the third quarter of
1997.
Average earning assets for the third quarter totaled $67.5 billion, which was
$5.1 billion, or 8%, higher than the third quarter 1997 level and $1.7 billion,
or an annualized 10%, above the second quarter of 1998. The growth from the
year-ago quarter reflected a $5.9 billion, or 11%, increase in loans with more
than 80% of the increase coming from the commercial portfolio. In addition,
growth from the year-ago quarter included the acquisition of an $805 million
marine/recreational vehicle installment loan portfolio in April 1998. The growth
in total loans relative to the prior quarter was due primarily to strong
commercial loan growth as well as increases in the home equity and indirect
consumer loan portfolios. Key's strategy with respect to its loan portfolio is
discussed in greater detail in the Loan section beginning on page 39.
Key uses portfolio interest rate swaps, caps and floors (as defined in Note 10)
in the management of its interest rate sensitivity position. The notional amount
of such swaps decreased to $10.4 billion at September 30, 1998, from $11.2
billion at year-end 1997. Over the same period, the notional amount of interest
rate caps and floors rose $950 million to $4.3 billion. For the third quarter of
1998, interest rate swaps (including the impact of both the spread on the swap
portfolio and the amortization of deferred gains and losses resulting from
terminated swaps) and interest rate caps and floors contributed $2 million and 1
basis point to net interest income and the net interest margin, respectively.
For the same period last year, these instruments increased net interest income
by $12 million and the net interest margin by 8 basis points. The manner in
which interest rate swaps, caps and floors are used in Key's overall program of
asset and liability management is described in the following Asset and Liability
Management section.
29
30
FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
THIRD QUARTER 1998 SECOND QUARTER 1998
------------------------------------ ----------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- -------------------------------------------------------------------------------------------------------------------------
ASSETS
Loans (1,2)
Commercial, financial and agricultural $15,815 $ 328 8.23 % $15,026 $ 309 8.25 %
Real estate-- commercial mortgage 7,034 160 9.02 6,944 153 8.84
Real estate-- construction 3,052 69 8.97 2,694 62 9.23
Commercial lease financing 4,933 90 7.24 4,634 86 7.44
- -------------------------------------------------------------------------------------------------------------------------
Total commercial loans 30,834 647 8.32 29,298 610 8.35
Real estate-- residential 5,274 102 7.67 5,549 108 7.81
Credit card 1,432 53 14.68 1,449 53 14.67
Other consumer 17,423 399 9.09 16,742 380 9.10
- -------------------------------------------------------------------------------------------------------------------------
Total consumer loans 24,129 554 9.11 23,740 541 9.14
Loans held for sale 3,596 75 8.27 3,403 70 8.25
- -------------------------------------------------------------------------------------------------------------------------
Total loans 58,559 1,276 8.64 56,441 1,221 8.68
Taxable investment securities 269 3 4.05 270 4 5.51
Tax-exempt investment securities(1) 726 15 8.20 871 18 8.29
- -------------------------------------------------------------------------------------------------------------------------
Total investment securities 995 18 7.18 1,141 22 7.63
Securities available for sale(1,3) 6,175 105 6.75 6,765 117 6.94
Interest-bearing deposits with banks 35 1 14.32 22 1 10.33
Federal funds sold and securities
purchased under resale agreements 951 12 5.01 790 10 4.92
Trading account assets 742 11 5.88 610 10 6.42
- -------------------------------------------------------------------------------------------------------------------------
Total short-term investments 1,728 24 5.51 1,422 21 5.92
- -------------------------------------------------------------------------------------------------------------------------
Total earning assets 67,457 1,423 8.37 65,769 1,381 8.42
Allowance for loan losses (888) (888)
Other assets 9,317 9,185
- -------------------------------------------------------------------------------------------------------------------------
$75,886 $74,066
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $11,783 99 3.33 $11,494 95 3.32
Savings deposits 3,118 14 1.78 3,307 16 1.94
NOW accounts 1,160 5 1.71 1,250 5 1.60
Certificates of deposit ($100,000 or more) 3,399 47 5.49 3,502 49 5.61
Other time deposits 11,965 161 5.34 12,375 166 5.38
Deposits in foreign offices 954 13 5.41 1,095 15 5.49
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 32,379 339 4.15 33,023 346 4.20
Federal funds purchased and securities
sold under repurchase agreements 7,456 99 5.27 6,773 89 5.27
Bank notes and other short-term borrowings 7,305 108 5.87 7,710 113 5.88
Long-term debt(4) 11,029 169 6.08 9,511 144 6.07
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 58,169 715 4.88 57,017 692 4.87
Noninterest-bearing deposits 8,485 8,328
Other liabilities 2,724 2,547
Capital securities 997 766
Common shareholders' equity 5,511 5,408
- -------------------------------------------------------------------------------------------------------------------------
$75,886 $74,066
======== =======
Interest rate spread (TE) 3.49 3.55
- -------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 708 4.19 % $ 689 4.19 %
======== ===== ======= =====
Taxable-equivalent adjustment(1) $8 $9
- -------------------------------------------------------------------------------------------------------------------------
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
30
31
FIRST QUARTER 1998 FOURTH QUARTER 1997 THIRD QUARTER 1997
- ---------------------------- --------------------------- ----------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- ---------------------------------------------------------------------------------------
$14,066 $ 288 8.30% $13,435 $ 290 8.56% $13,101 $ 286 8.66%
6,944 156 9.11 7,132 170 9.46 7,088 165 9.24
2,347 52 8.99 2,214 54 9.68 2,015 49 9.65
4,471 83 7.53 4,144 77 7.37 3,820 70 7.27
- -------------------------------------------------------------------------------------
27,828 579 8.44 26,925 591 8.71 26,024 570 8.69
5,773 113 7.94 6,257 140 8.88 6,161 131 8.44
1,482 54 14.78 1,487 55 14.67 1,788 68 15.09
15,771 359 9.23 15,990 373 9.25 15,926 372 9.27
- -------------------------------------------------------------------------------------
23,026 526 9.26 23,734 568 9.49 23,875 571 9.49
3,092 63 8.26 2,645 46 6.90 2,809 54 7.63
- -------------------------------------------------------------------------------------
53,946 1,168 8.78 53,304 1,205 8.97 52,708 1,195 8.99
256 3 4.53 243 3 4.90 270 3 5.88
940 19 8.20 1,027 21 8.11 1,143 22 7.64
- -------------------------------------------------------------------------------------
1,196 22 7.46 1,270 24 7.50 1,413 25 7.02
7,457 129 7.02 7,502 130 6.87 7,399 127 6.86
29 1 12.54 34 1 12.31 8 ___ 3.94
912 11 4.89 811 9 4.40 535 6 4.45
409 5 4.96 559 7 4.97 264 5 7.51
- -------------------------------------------------------------------------------------
1,350 17 5.11 1,404 17 4.80 807 11 5.41
- -------------------------------------------------------------------------------------
63,949 1,336 8.47 63,480 1,376 8.60 62,327 1,358 8.64
(889) (893) (873)
9,062 8,903 8,658
- -------------------------------------------------------------------------------------
$72,122 $71,490 $70,112
======== ======== =======
$11,159 90 3.27 $10,883 87 3.17 $10,714 82 3.04
3,499 18 2.09 3,789 20 2.09 4,161 22 2.10
1,244 5 1.63 1,370 6 1.74 1,547 8 2.05
3,362 46 5.55 3,307 47 5.64 3,166 46 5.76
12,716 171 5.45 13,084 180 5.46 13,389 183 5.42
1,245 17 5.54 1,663 21 5.01 2,065 29 5.57
- -------------------------------------------------------------------------------------
33,225 347 4.24 34,096 361 4.20 35,042 370 4.19
7,117 93 5.30 7,335 96 5.19 6,939 91 5.20
6,683 98 5.95 5,678 89 6.22 5,001 73 5.79
8,326 125 6.09 7,443 114 6.08 6,879 109 6.33
- -------------------------------------------------------------------------------------
55,351 663 4.86 54,552 660 4.80 53,861 643 4.74
8,409 8,750 8,551
2,390 2,304 2,125
750 750 750
5,222 5,134 4,825
- -------------------------------------------------------------------------------------
$72,122 $71,490 $70,112
======== ======== =======
3.61 3.80 3.90
- -------------------------------------------------------------------------------------
$ 673 4.23 % $ 716 4.50 % $ 715 4.58%
====== ===== ====== ===== ====== =====
$9 $11 $11
- -------------------------------------------------------------------------------------
31
32
FIGURE 5 COMPONENTS OF NET INTEREST INCOME CHANGES
FROM THREE MONTHS ENDED SEPTEMBER 30, 1997, FROM NINE MONTHS ENDED SEPTEMBER 30, 1997,
TO THREE MONTHS ENDED SEPTEMBER 30, 1998 TO NINE MONTHS ENDED SEPTEMBER 30, 1998
------------------------------------------- ------------------------------------------
AVERAGE YIELD/ NET AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE VOLUME RATE CHANGE
- --------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 129 $ (48) $ 81 $ 365 $(124) $ 241
Taxable investment securities -- -- -- 1 (1) --
Tax-exempt investment securities (9) 2 (7) (28) 5 (23)
Securities available for sale (21) (1) (22) (45) (2) (47)
Short-term investments 13 -- 13 38 1 39
- --------------------------------------------------------------------------------------------------------------------------------
Total interest income (TE) 112 (47) 65 331 (121) 210
INTEREST EXPENSE
Money market deposit accounts 9 8 17 14 25 39
Savings deposits (5) (3) (8) (18) (9) (27)
NOW accounts (2) (1) (3) (6) (5) (11)
Certificates of deposit ($100,000 or more) 3 (2) 1 1 (1) --
Other time deposits (19) (3) (22) (40) 2 (38)
Deposits in foreign offices (15) (1) (16) (31) (1) (32)
- --------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (29) (2) (31) (80) 11 (69)
Federal funds purchased and securities sold
under repurchase agreements 7 1 8 12 6 18
Bank notes and other short-term borrowings 34 1 35 124 2 126
Long-term debt 64 (4) 60 193 (6) 187
- --------------------------------------------------------------------------------------------------------------------------------
Total interest expense 76 (4) 72 249 13 262
- --------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) $ 36 $ (43) $ (7) $ 82 $(134) $ (52)
===== ===== ===== ===== ===== =====
- --------------------------------------------------------------------------------------------------------------------------------
The change in interest not due solely to volume or rate has been allocated in
proportion to the absolute dollar amounts of the change in each.
TE = Taxable Equivalent
ASSET AND LIABILITY MANAGEMENT
Market risk is the exposure to economic loss that may arise from changes in the
values of certain market risk sensitive instruments. Types of market risk
include interest rate, foreign exchange and equity price risk; foreign exchange
and equity price risk are not material to Key. Key manages its interest rate
risk through an active program of asset and liability management pursuant to
guidelines established by its Asset/Liability Management Policy Committee
("ALCO"). The ALCO has responsibility for approving the asset/liability
management policies of Key, overseeing the formulation and implementation of
strategies to improve balance sheet positioning and/or earnings, and reviewing
Key's interest rate sensitivity position.
Short-term Interest Rate Exposure
- ---------------------------------
The primary tool used by management to measure and manage interest rate risk 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, asset and liability prepayments, interest rates, on and off-balance
sheet management strategies 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. 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 over the same period from what net interest income would have
been if such interest rates did not change. Based on the results of the
simulation model using the ALCO guidelines, as of September 30, 1998, Key would
expect its net interest income to increase by approximately $23 million if
short-term interest rates gradually decrease. Conversely, if short-term interest
rates gradually increase, net interest income would be expected to decrease by
approximately $22 million. As shown in Figure 6, Key has been operating well
within the above guidelines.
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33
FIGURE 6 NET INTEREST INCOME AT RISK TO CHANGES IN INTEREST RATES
ESTIMATED CHANGE IN NET INTEREST INCOME
Rise Decline
---- -------
Dec-96 - 0.0128 0.0071
Mar-97 - 0.0128 0.0090
Jun-97 - 0.0113 0.0050
Sep-97 - 0.0091 0.0024
Dec-97 - 0.0107 0.0096
Mar-98 - 0.0079 0.0082
Jun-98 - 0.0072 0.0067
Sep-98 - 0.0079 0.0085
Long-term Interest Rate Exposure
- --------------------------------
Short-term interest rate risk analysis is complemented by an economic value of
equity model. This model provides the added benefit of measuring exposure to
interest rate changes outside the one- to two-year time frame 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 sheet positions do not represent the true fair values
of the positions, since they do not consider factors such as credit risk and
liquidity; estimated cash flows are required for assets and liabilities with
indeterminate maturities; 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. The
ALCO guidelines provide that an immediate 200 basis point increase or decrease
in interest rates should not result in more than a 1.75% change in the ratio of
base case economic value of equity to the sum of base case economic value of
assets and net receive fixed interest rate swaps, caps and floors. Key has been
operating well within these guidelines.
Management of Interest Rate Exposure
- ------------------------------------
Key utilizes the results of its short-term and long-term interest rate exposure
models to formulate strategies to improve balance sheet positioning and/or
earnings within interest rate risk, liquidity and capital guidelines established
by the ALCO. In addition to the interest rate exposure measured using ALCO
guidelines, the risk to earnings and economic value arising from various other
pro forma changes in the overall level of interest rates is periodically
measured. The variety of interest rate scenarios modeled, and their impact on
earnings and economic value, quantifies the level of interest rate exposure
arising from several sources, namely option risk, basis risk and gap risk.
Option risk exists in the form of options (including caps and floors) embedded
in certain products. These options permit the customer (either a loan customer
or a depositor) to take advantage of changes in interest rates without penalty.
Examples include floating-rate loans that contain an interest rate cap,
fixed-rate loans that do not contain prepayment penalties and deposits that are
withdrawable on demand. Basis risk refers to floating-rate assets and
floating-rate liabilities that reprice simultaneously, but are tied to different
indices. The risk arises when one index does not move consistently with another.
Gap risk is the risk that assets, liabilities or related interest rate swaps,
caps and floors will mature in different time frames. For example, floating-rate
loans that reprice monthly may be funded with fixed-rate certificates of deposit
that mature in one year.
To manage interest rate risk, management regularly uses Key's securities
portfolios, issues debt, and securitizes and sells certain consumer loans. In
addition, management has used interest rate swaps, caps and floors to manage
interest rate risk by modifying the repricing or maturity characteristics of
specified on-balance sheet assets and liabilities. Instruments used for this
purpose are designated as portfolio swaps, caps and floors. The decision to use
these instruments versus the on-balance sheet alternatives mentioned above
depends on various factors, including the mix and cost of funding sources,
liquidity and capital requirements. Further details pertaining to portfolio
swaps, caps and floors are included in Note 10, Financial Instruments with
Off-Balance Sheet Risk, beginning on page 16.
In addition to interest rate swaps, caps and floors, Key uses treasury-based
interest rate locks as a component of its interest rate risk management
strategy. At September 30, 1998, the rate locks had a
33
34
notional amount of $930 million, a weighted average maturity of less than one
month and a negative fair value of ($19) million.
Portfolio Swaps, Caps and Floors
- --------------------------------
As shown in Note 10, the estimated fair value of Key's portfolio swaps increased
to $197 million at September 30, 1998, from a fair value of $102 million at
December 31, 1997, while the notional amount of such swaps decreased $750
million to $10.4 billion. The increase in fair value over the past nine months
reflected the combined impact of a number of factors, including the decline in
interest rates, the flattening of the yield curve, and the fact that Key's
receive fixed interest rate swap portfolio has a longer average remaining
maturity than the pay fixed portfolio. Swaps with a notional amount of $568
million were terminated during the first nine months of 1998, resulting in a net
deferred loss of $1 million. Further information pertaining to the balance and
remaining amortization period of Key's deferred swap gains and losses at
September 30, 1998, 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 any swap contract is integrated strategically with
asset and liability management and other appropriate processes. During 1997 and
continuing through the first nine months of 1998, Key increased its use of
portfolio caps in response to heavier reliance placed on variable rate funding
to support earning asset growth. These instruments are used primarily to protect
against the adverse impact that a future rise in interest rates could have on
variable rate short-term borrowings, while having no impact in the event of a
decline in rates. Portfolio swaps, caps and floors activity for the nine-month
period ended September 30, 1998, is summarized in Figure 7.
FIGURE 7 PORTFOLIO SWAPS, CAPS AND FLOORS ACTIVITY
RECEIVE FIXED
-------------------------------- PAY FIXED-
INDEXED PAY FIXED- FORWARD- BASIS
in millions AMORTIZING CONVENTIONAL CONVENTIONAL STARTING SWAPS
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 $3,449 $3,626 $2,990 -- $1,110
Additions -- 641 1,801 $607 894
Maturities -- 337 1,369 -- 200
Terminations 268 300 -- -- --
Forward-starting becoming effective -- -- 74 (74) --
Amortization 2,219 -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1998 $ 962 $3,630 $3,496 $533 $1,804
======== ======= ======= ===== =======
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL CAPS
PORTFOLIO AND
in millions SWAPS FLOORS TOTAL
- -----------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 $11,175 $3,395 $14,570
Additions 3,943 1,050 4,993
Maturities 1,906 100 2,006
Terminations 568 -- 568
Forward-starting becoming effective -- -- --
Amortization 2,219 -- 2,219
- -----------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1998 $10,425 $4,345 $14,770
======== ======= =======
- -----------------------------------------------------------------------------------
A summary of the notional amount and fair values of portfolio swaps, caps and
floors by interest rate management strategy is presented in Figure 8. The fair
value at any given date represents the estimated income (if positive) or cost
(if negative) that would be recognized if the portfolios were to be liquidated
at that date. However, because these instruments are used to alter the repricing
or maturity characteristics of specific assets and liabilities, the net
unrealized gains and losses are not recognized in earnings. Rather, interest
from these swaps, caps and floors is recognized on an accrual basis as an
adjustment of the interest income or expense from the asset or liability being
managed.
FIGURE 8 PORTFOLIO SWAPS, CAPS AND FLOORS BY INTEREST RATE MANAGEMENT STRATEGY
SEPTEMBER 30, 1998 DECEMBER 31, 1997 SEPTEMBER 30, 1997
-------------------- ---------------------- -----------------------
NOTIONAL FAIR NOTIONAL FAIR NOTIONAL FAIR
in millions AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE
- -----------------------------------------------------------------------------------------------------------------------------------
Convert variable rate loans to fixed $ 2,182 $ 75 $ 4,630 $ 25 $ 5,430 $ 1
Convert fixed rate loans to variable 899 (52) 160 (1) 180 (1)
Convert variable rate deposits and short-term borrowings
to fixed 2,430 (37) 2,080 (4) 2,480 (3)
Convert variable rate long-term debt to fixed 700 (13) 750 (2) 600 (2)
Convert fixed rate long-term debt to variable 2,410 205 2,445 87 2,385 51
Basis swaps - foreign currency denominated debt 304 19 280 (3) -- --
Basis swaps - interest rate indices 1,500 -- 830 -- 200 --
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps 10,425 197 11,175 102 11,275 46
Modify characteristics of variable rate short-term borrowings 3,530 -- 2,580 2 2,724 17
Modify characteristics of variable rate long-term debt 565 -- 565 10 665 4
Modify characteristics of capital securities remarketing 250 (26) 250 (15) 250 (4)
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio caps and floors 4,345 (26) 3,395 (3) 3,639 17
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $14,770 $ 171 $14,570 $ 99 $14,914 $ 63
======= ======= ======= ======= ======= =======
- -----------------------------------------------------------------------------------------------------------------------------------
34
35
The expected average maturities of the portfolio swaps, caps and floors at
September 30, 1998, are summarized in Figure 9.
FIGURE 9 EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS, CAPS AND FLOORS
September 30, 1998 RECEIVE FIXED
------------------------- PAY FIXED- TOTAL
INDEXED PAY FIXED- FORWARD- BASIS PORTFOLIO
in millions AMORTIZING CONVENTIONAL CONVENTIONAL STARTING SWAPS SWAPS
- ---------------------------------------------------------------------------------------------------------------------------------
Mature in one year or less -- $ 27 $ 1,753 -- $ 930 $ 2,710
Mature after one through five years $ 962 1,165 1,004 $ 501 849 4,481
Mature after five through ten years -- 2,438 299 9 25 2,771
Mature after ten years -- -- 440 23 -- 463
- ---------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $ 962 $ 3,630 $ 3,496 $ 533 $ 1,804 $10,425
======= ======= ======= ======= ======= =======
- ---------------------------------------------------------------------------------------------------------------------------------
September 30, 1998
CAPS
AND
in millions FLOORS TOTAL
- -----------------------------------------------------------------------
Mature in one year or less $ 1,895 $ 4,605
Mature after one through five years 2,450 6,931
Mature after five through ten years -- 2,771
Mature after ten years -- 463
- -----------------------------------------------------------------------
Total portfolio swaps, caps and floors $ 4,345 $14,770
======= =======
- -----------------------------------------------------------------------
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement, which will be adopted by
Key as of January 1, 2000, establishes the accounting and reporting standards
for derivatives and requires that all such instruments be recognized on the
balance sheet at fair value. It also disqualifies the use of hedge accounting
for indexed amortizing swaps currently accounted for by Key as hedging
instruments and, therefore, will likely alter Key's use of such instruments in
the future. Key is currently reviewing SFAS No. 133 to determine the extent to
which the statement will alter its use of certain derivatives in the future and
the impact on its financial condition and results of operations.
TRADING PORTFOLIO
Key's trading portfolio includes interest rate swap contracts entered into to
accommodate the needs of its customers, and other positions with third parties
that are intended to mitigate the interest rate risk of the customer positions,
foreign exchange contracts entered into to accommodate the needs of its
customers and financial assets and liabilities (trading positions) included in
short-term investments and other liabilities, respectively, on the balance
sheet. Further information pertaining to the off-balance sheet contracts is
included in Note 10, Financial Instruments with Off-Balance Sheet Risk,
beginning on page 16.
During the second half of 1997, Key began using a value at risk ("VAR") model to
estimate the adverse effect of changes in interest and foreign exchange rates on
the fair value of its trading portfolio. VAR uses statistical methods to
estimate the maximum potential one-day loss with a 95% confidence level. At
September 30, 1998, Key's aggregate daily VAR was $.3 million and averaged $.6
million for the first nine months of 1998. As of the 1997 year end, Key's
aggregate daily VAR was less than $.8 million and averaged less than $.5 million
for the second half of 1997. VAR augments other controls used by Key to mitigate
the market risk exposure of its trading portfolio. These controls are
established by Key's Financial Markets Committee and include, in addition to
VAR, loss and position equivalent limits which are based on the level of
activity and volatility of trading products and market liquidity.
NONINTEREST INCOME
As shown in Figure 10, noninterest income for the 1998 third quarter totaled
$392 million compared with $393 million for the same period last year. Excluding
bank and branch divestiture gains totaling $79 million recorded in the third
quarter of 1997, noninterest income increased by $78 million, or 25%, and
comprised 36% of total revenue for the quarter, compared with 31% in the
year-ago quarter. The largest increases came from various investment banking and
capital markets activities (up $24 million) and trust and asset management
income (up $16 million). The increase in investment banking and capital markets
income reflected higher revenues from advisory services, and dealer and trading
activities, as well as increased gains from the sales of equity capital
investments. Growth in trust and asset management income resulted from strong
performance of both the stock and bond markets, new business and the repricing
of certain services. Additional detail pertaining to the composition of this
noninterest income component is presented in Figure 11. The $41 million
improvement in other income included increases in letter of credit and loan
fees, loan sale gains, non-yield related loan fees and gains from the sales of
low-income housing partnership interests. The latter three components are
included in the "Miscellaneous" category. The $7 million decline in credit card
fees was due primarily to the sales of $324 million of Key's credit card
receivables during the third quarter of 1997 and lower merchant credit card
processing services revenue resulting from the first quarter 1998 joint venture
with NOVA, discussed on page 36. The acquisitions of Leasetec and Champion,
completed during the third quarter of last year, contributed approximately $6
million to the increase in Key's noninterest income relative to the third
quarter of 1997.
35
36
For the first nine months of 1998, noninterest income totaled $1.1 billion, up
$188 million, or 20%, from the comparable 1997 period. Excluding gains from
sales of branches/subsidiaries of $62 million and $89 million recorded in the
first nine months of 1998 and 1997, respectively, noninterest income increased
by $215 million, or 25%. The year-to-date increase was due principally to the
growth in investment banking and capital markets income (up $82 million), trust
and asset management income (up $45 million) and other income (up $70 million)
due largely to the same factors described in the preceding paragraph. Leasetec
and Champion contributed approximately $18 million to the increase in Key's
noninterest income relative to the first nine months of last year.
Included in 1998 year-to-date gains from the sales of branches/subsidiaries was
$39 million of branch divestiture gains and a $23 million gain recognized in the
first quarter in connection with the joint venture with NOVA. The agreement with
NOVA also specifies that Key is entitled to receive additional consideration if
certain revenue-related performance targets are met. The $23 million gain was
accompanied by related reductions in both merchant credit card processing
services revenue and noninterest expense (primarily personnel). The NOVA
transaction is more fully disclosed in Note 3, Mergers, Acquisitions and
Divestitures, beginning on page 9.
FIGURE 10 NONINTEREST INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
---------------------- ------------------- ------------------- -----------------
dollars in millions 1998 1997 AMOUNT PERCENT 1998 1997 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Service charges on deposit accounts $ 77 $ 77 -- -- $ 230 $ 222 $ 8 3.6 %
Trust and asset management income 82 66 $ 16 24.2 % 239 194 45 23.2
Investment banking and capital markets income 62 38 24 63.2 159 77 82 106.5
Credit card fees 18 25 (7) (28.0) 50 73 (23) (31.5)
Insurance and brokerage income 22 22 -- -- 68 64 4 6.3
Corporate owned life insurance income 25 20 5 25.0 72 60 12 20.0
Loan securitization income 14 15 (1) (6.7) 32 19 13 68.4
Net securities gains -- -- -- -- 4 -- 4 N/M
Gains from sales of branches/subsidiaries -- 79 (79) (100.0) 62 89 (27) (30.3)
Other income:
Letter of credit and loan fees 20 12 8 66.7 51 34 17 50.0
Electronic banking fees 12 11 1 9.1 33 28 5 17.9
Mortgage banking income 1 -- 1 N/M 4 4 -- --
Miscellaneous income 59 28 31 110.7 124 76 48 63.2
- -----------------------------------------------------------------------------------------------------------------------------------
Total other income 92 51 41 80.4 212 142 70 49.3
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 392 $ 393 $ (1) (.3)% $1,128 $ 940 $ 188 20.0 %
====== ====== ====== ====== ====== ======
- ------------------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
FIGURE 11 TRUST AND ASSET MANAGEMENT
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
------------------ ------------------- ----------------- --------------------
dollars in millions 1998 1997 AMOUNT PERCENT 1998 1997 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------------------------------
Personal asset management and custody fees $ 42 $ 37 $ 5 13.5 % $123 $106 $ 17 16.0 %
Institutional asset management and custody fees 23 18 5 27.8 66 53 13 24.5
Bond services --- 1 (1) (100.0) --- 5 (5) (100.0)
All other fees 17 10 7 70.0 50 30 20 66.7
- -------------------------------------------------------------------------------------------------------------------------------
Total trust and asset management income $ 82 $ 66 $ 16 24.2 % $239 $194 $ 45 23.2 %
==== ==== ==== ==== ==== ====
dollars in billions
- -------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30,
Discretionary assets $ 63 $ 49 $ 14 28.6 %
Non-discretionary assets 44 53 (9) (17.0)
- -------------------------------------------------------------------------------------------------------------------------------
Total trust assets $107 $102 $ 5 4.9 %
==== ==== ====
- -------------------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE
As shown in Figure 12, noninterest expense for the third quarter of 1998 totaled
$647 million compared with $648 million for the third quarter of 1997. Included
in third quarter 1997 expense was a $50 million charge recorded in connection
with actions taken to sell certain properties or to alter certain leasing
arrangements in response to Key's nationwide banking and related centralization
efforts. Contributing to the increase in noninterest expense from the year-ago
quarter was a $5 million increase in distributions accrued on capital securities
(tax-advantaged preferred securities) and a $1 million increase in costs
36
37
incurred in connection with efforts being undertaken by Key to modify computer
information systems to be Year 2000 compliant. As of September 30, 1998, Key had
recognized approximately $35 million of the estimated $45 to $50 million of
expense that it expects to incur (primarily for internal and external
programmers) to substantially complete this project by the end of 1998. Further
information pertaining to the Year 2000 issue is included on page 38. The
capital securities are more fully described in Note 8, Capital Securities,
beginning on page 15. Excluding the above items, noninterest expense was $43
million, or 7%, above the year-ago quarter. The increase came largely from the
impact of the Leasetec and Champion acquisitions completed in the third quarter
of 1997 (accounting for approximately $12 million of the increase) and higher
personnel costs associated with various incentive programs, including those
related to investment banking and capital markets activities.
Noninterest expense totaled $1.9 billion for the first nine months of 1998, up
$58 million, or 3%, from the same period last year. Excluding the 1997 real
estate disposition charge and increases of $12 million and $8 million in capital
securities distributions and Year 2000 expenses, respectively, noninterest
expense was up $88 million, or 5%, from the first nine months of last year. This
reflected higher costs associated with personnel expense (up $41 million),
marketing expense (up $16 million) and professional fees (up $12 million). The
increase in marketing expense resulted from additional costs incurred by Key to
establish brand identity. Leasetec and Champion contributed approximately $51
million to the increase in Key's noninterest expense from the first nine months
of last year.
FIGURE 12 NONINTEREST EXPENSE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
------------------ ------------------ ----------------- ----------------------
dollars in millions 1998 1997 AMOUNT PERCENT 1998 1997 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Personnel $ 317 $ 299 $ 18 6.0 % $ 913 $ 872 $ 41 4.7 %
Net occupancy 58 54 4 7.4 170 164 6 3.7
Equipment 46 44 2 4.5 134 131 3 2.3
Amortization of intangibles 22 23 (1) (4.3) 67 65 2 3.1
Marketing 25 22 3 13.6 81 65 16 24.6
Professional fees 14 10 4 40.0 46 34 12 35.3
Other expense:
Distributions on capital securities 19 14 5 35.7 47 35 12 34.3
Equity-and gross receipts-based taxes 9 10 (1) (10.0) 27 28 (1) (3.6)
OREO expense, net(1) 2 (3) 5 N/M 4 (1) 5 N/M
FDIC insurance assessments 2 1 1 100.0 5 4 1 25.0
Real estate disposition reserve -- 50 (50) (100.0) -- 50 (50) (100.0)
Year 2000 expense 5 4 1 25.0 17 9 8 88.9
Miscellaneous 128 120 8 6.7 352 349 3 .9
- ------------------------------------------------------------------------------------------------------------------------------------
Total other expense 165 196 (31) (15.8) 452 474 (22) (4.6)
- ------------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 647 $ 648 $ (1) (.2) % $1,863 $1,805 $ 58 3.2 %
===== ===== ===== ====== ====== =====
Full-time equivalent employees at period end 24,586 25,662 24,586 25,662
Efficiency ratio(2) 57.09 % 56.75 % 57.56 % 57.75 %
Overhead ratio(3) 33.33 37.76 35.31 40.81
- ------------------------------------------------------------------------------------------------------------------------------------
1 OREO expense is net of income of $1 million for both the third quarter of 1998
and 1997.
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 gains from bank and branch divestitures).
3 Calculated as noninterest expense (excluding certain nonrecurring charges and
distributions on capital securities) less noninterest income (excluding net
securities transactions and gains from bank and branch divestitures) divided
by taxable-equivalent net interest income.
N/M = Not Meaningful
The efficiency ratio, which provides a measure of the extent to which recurring
revenues are used to pay operating expenses, was 57.09% for the third quarter
compared with 56.75% in the third quarter of 1997 and 58.22% for the prior
quarter. The slight improvement from the second quarter of 1998 resulted from
the proportionately greater increase in Key's recurring revenues relative to the
increase in Key's noninterest expense. Included in other expense are equity-and
gross receipts-based taxes which are assessed in lieu of an income tax in
certain states in which Key operates. These taxes, which are shown in Figure 12,
represented 82, 87 and 97 basis points of Key's efficiency ratio for the third
quarter of 1998, the second quarter of 1998 and the third quarter of 1997,
respectively. The extent to which such taxes impact the level of noninterest
expense will vary among companies based on the geographic locations in which
they conduct their business.
37
38
Year 2000
- ---------
During the first nine months of 1998, Key has continued its efforts to prepare
its systems to be Year 2000 compliant. The Year 2000 issue refers to the fact
that many computer systems were originally programmed using two digits rather
than four digits to identify the applicable year. Therefore, when the year 2000
occurs, these systems could interpret the year as 1900 rather than 2000. Unless
hardware, system software and applications are corrected to be Year 2000
compliant, computers and the devices they control could generate miscalculations
and create operational problems. Various systems could be affected ranging from
complex computer systems to telephone systems, ATMs and elevators.
To address this issue, Key developed an extensive plan, including the formation
of a team consisting of internal resources and third-party experts. The plan,
originally developed in 1995, has been in implementation since that time and
consists of five major phases: awareness-ensuring a common understanding of the
issue throughout Key; assessment-identifying and prioritizing the systems and
third parties with whom Key has exposure to Year 2000 issues;
renovation-enhancing, replacing or retiring hardware, software and systems
applications; validation-testing modifications made; and
implementation-certifying Year 2000 compliance and user understanding and
acceptance. The awareness and assessment phases have been completed and the
remaining phases are expected to be substantially complete by the end of 1998,
allowing 1999 as a year of final testing and refinement. In conjunction with the
assessment phase, Key prioritized the various operating systems (including those
maintained by its business suppliers) that could be affected by the Year 2000,
and efforts to ensure compliance of core systems deemed critical to the
continuation of Key's operations have been accelerated. As of September 30,
1998, compliance efforts had been completed for approximately 55% of the core
systems identified.
In addition, financial institutions may experience increases in problem loans
and credit losses in the event that borrowers fail to properly respond to this
issue, and higher funding costs may come about if consumers react to publicity
about the issue by withdrawing deposits. Key also could be impacted if third
parties it deals with in conducting its business, such as foreign banks,
governmental agencies, clearing houses, telephone companies, and other service
providers, fail to properly address this issue. Accordingly, Key has formed a
separate internal team charged with the task of identifying critical business
interfaces; assessing potential problems relating to credit, liquidity and
counterparty risk; and where appropriate, developing contingency plans. This
team is conducting a survey of significant credit customers to determine their
Year 2000 readiness and to evaluate the level of potential credit risk to Key.
Based on the information obtained, specific follow-up policies will be
established and the adequacy of the allowance for loan losses will be assessed.
On an ongoing basis, Key is also contacting significant third parties with whom
it conducts business to determine the status of their Year 2000 compliance
efforts. Notwithstanding these actions, there can be no assurance that
significant customers or critical third parties will adequately address their
Year 2000 issues. Consequently, Key is developing contingency plans to help
mitigate the risks associated with potential delays in completing the
renovation, validation and implementation phases of its Year 2000 plan; and the
failure of external parties to adequately address their Year 2000 issues. These
plans are expected to be well underway by the 1998 year end and address
primarily back-up solutions for Key's core systems and the identification of
alternative business partners. Because the Year 2000 issue has never previously
occurred, it is not possible to foresee or quantify the overall financial and
operational impact and/or to determine whether it will be material to the
financial condition or operations of Key.
The cost of the project (currently estimated to be $45 to $50 million) and
timing of its implementation are based on management's best estimates, which
were derived using numerous assumptions about future events, including the
continued availability of certain resources and other factors. However, there
can be no guarantee that these estimates will be achieved, and actual results
could differ materially from those anticipated. It is currently expected that
approximately $4 million of additional cost will be incurred during the fourth
quarter of 1998 and that the estimated remaining cost of $6 to $11 million will
be recognized in 1999 and the first half of 2000. The total cost of the project
is being funded through operating cash flows.
Euro Conversion
- ---------------
Eleven of the fifteen member countries of the European Economic & Monetary Union
have agreed to establish fixed conversion rates between their existing sovereign
currencies and the "euro" and to adopt the euro as their common legal currency
effective January 1, 1999. The existing sovereign currencies will remain legal
tender in the participating countries as denominations of the euro until January
1, 2002, at which time new euro-denominated bills and coins will be introduced.
By July 1, 2002, the participating countries will withdraw all bills and coins
denominated in sovereign currencies and the euro will become the only currency
and the only official legal tender in such countries.
38
39
The euro conversion will impact companies that conduct business in or use the
currencies of any of the eleven participating countries. In addition, the euro
will create more efficient foreign exchange markets and reduce arbitrage
opportunities. Similar to the Year 2000 issue, euro preparations will require
conversion of various operating and processing systems to avoid interruption in
Key's ongoing business activities. To address this issue, Key is in the process
of installing and testing new systems that will allow its foreign exchange
operation to accommodate the new currency, as well as simultaneous trading in
the existing national currencies during the transition period. These actions
reflect the efforts of a task force established in 1998 to assess the impact of
the euro conversion on Key's operations and to oversee the implementation of
required changes. This task force has made a number of recommendations
(including the selection of clearing firms in Europe) which will enable Key to
be euro-ready by the January 1, 1999, conversion date. The business conducted by
Key in the participating countries is not material to its earnings. Furthermore,
substantially all of Key's derivatives are based on either domestic interest
rates or U.S. dollar LIBOR. Key continues to evaluate the potential loss of
revenue and increase in costs associated with the euro conversion and work
closely with its customers, counterparties and the regulatory agencies to
mitigate its financial risk. While Key does not expect that the impact of the
conversion will be material to its financial condition or operations, it can not
be assured that third parties on whom it relies will be fully prepared. However,
Key currently believes that the risk associated with such third parties will not
be material.
INCOME TAXES
The provision for income taxes was $122 million for the three-month period ended
September 30, 1998, up from $111 million for the same period in 1997. The
effective tax rate (provision for income taxes as a percentage of income before
income taxes) for the 1998 third quarter was 32.6% compared with 32.0% for the
third quarter of 1997. For the first nine months of 1998, the provision for
income taxes was $353 million compared with $309 for the first nine months of
last year. The effective tax rates for these periods were 32.4% and 31.5 %,
respectively. Primary factors contributing to the increase in the effective tax
rate for both the quarterly and year-to-date periods were a lower proportion of
tax-exempt income and tax credits to pretax earnings in the current year. The
increase in the year-to-date effective tax rate also reflected the write-off of
nondeductible goodwill in connection with the 1998 branch divestitures. 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 September 30, 1998, total loans outstanding were $59.4 billion, up from $53.4
billion at December 31, 1997, and $53.7 billion at September 30, 1997. 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 12.
The $5.7 billion, or 11%, increase in loans outstanding from the September 30,
1997, level was due primarily to internal growth, but also included the net
impact of acquisitions, sales and divestitures. During the second quarter of
1998, Key acquired an $805 million marine/recreational vehicle installment loan
portfolio. The sales and divestitures which occurred during 1998 and 1997 are
summarized in Figure 13 and included the impact of planned bank and branch
divestitures, as well as the securitization and/or sale of education loans,
automobile loans, certain non-prime home equity loans and other loans which do
not meet Key's return on equity, credit or other internal standards. Key
generally sells or securitizes education loans when a borrower enters repayment
status. In addition, home equity loans originated by Champion and all non-prime
automobile loans were targeted for securitization in 1997. In addition to bank
and branch divestitures, activity since September 30, 1997, included the sales
of $1.2 billion of education loans (of which $744 million was associated with
securitizations), $1.0 billion of automobile loans, $471 million of home equity
loans and $167 million of commercial real estate loans. All of the automobile
loan sales and $300 million of the home equity loan sales were associated with
securitizations. Included in the automobile loan sales was $949 million of prime
credit loans with low returns on equity. This particular portfolio was sold
during the fourth quarter of 1997 in keeping with Key's strategy of divesting
assets which do not support its return on equity objective. Management will
continue to explore opportunities for sales and/or other arrangements with
respect to certain loan portfolios, consistent with prudent asset/liability
management practices. Securitizations in particular will also be considered as
an alternative source of funds.
39
40
Excluding the net impact of acquisitions, sales and divestitures, loan
portfolios (other than one-to-four family mortgages and loans held for sale)
increased $6.8 billion, or 15%, since September 30, 1997, and were up $5.9
billion, or an annualized 18% from the 1997 year end. Key's policy since 1994
regarding new originations of one-to-four family mortgage loans is to originate
such loans as a customer and community accommodation, but to retain few of such
loans on the balance sheet due to their marginal returns. Over the past year,
the largest growth in Key's loan portfolio came from commercial loans which rose
by $4.9 billion, due primarily to higher levels of commercial, financial and
agricultural loans (up $2.6 billion), real estate-construction loans (up $1.2
billion) and lease financing receivables (up $1.0 billion). Additionally,
consumer loans rose by $1.8 billion, and included increases of $1.1 billion in
home equity loans and $779 million in installment loans.
FIGURE 13 LOANS SOLD AND DIVESTED
COMMERCIAL CREDIT CARD
in millions EDUCATION AUTOMOBILE HOME EQUITY REAL ESTATE RECEIVABLES ALL OTHER TOTAL
- ---------------------------------------------------------------------------------------------------------------------------------
1998
- -----------------------
Third quarter $201 -- $374 -- -- -- $ 575
Second quarter 45 -- 53 $167 -- $124(1) 389
First quarter 71 -- -- -- -- 20(1) 91
- ---------------------------------------------------------------------------------------------------------------------------------
$317 -- $427 $167 -- $144 $1,055
===== ===== ===== ===== ======
1997
- -----------------------
Fourth quarter $ 879 $1,046 $ 44 -- -- $147(1) $2,116
Third quarter 100 112 205 -- $324 491(1) 1,232
Second quarter 52 103 -- -- -- -- 155
First quarter 31 456 -- -- 41 -- 528
- ---------------------------------------------------------------------------------------------------------------------------------
Total $1,062 $1,717 $249 -- $365 $638 $4,031
======= ======= ===== ===== ===== ======
- ---------------------------------------------------------------------------------------------------------------------------------
1 Part of branch divestitures, including the sale of KeyBank Wyoming in the
third quarter of 1997.
The $6.0 billion increase in loans from the December 31, 1997, level also
reflected strong growth in loan portfolios other than one-to-four family
mortgages and loans held for sale. Excluding the second quarter 1998 acquisition
of the marine/recreational installment loan portfolio and the impact of 1998
loan sales and branch divestitures shown in Figure 13, such loans increased $5.9
billion, or an annualized 18%, during the first nine months of 1998. Commercial
loans accounted for $4.2 billion of the increase with the largest growth coming
from commercial, financial and agricultural loans (up $2.4 billion) and
construction loans (up $1.0 billion). On the same basis, the aggregate
annualized growth rate of average outstanding balances in the commercial loan
portfolio was 21% for the third quarter of 1998 and has exceeded 12% for every
quarter since the second quarter of 1997. Consumer loans contributed $1.7
billion to the year-to-date increase in loans, due principally to growth in the
home equity portfolio.
Shown in Figure 14 are loans which have been securitized/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 retained in
connection with securitizations and accounted for like investments in
interest-only strip securities, is recorded as interest income on securities
available for sale.
40
41
FIGURE 14 LOANS SECURITIZED/SOLD AND ADMINISTERED OR SERVICED
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 1998 1997 1997
- --------------------------------------------------------------------------------------------
Education loans $2,363 $2,611 $1,908
Automobile loans 1,099 1,601 847
Home equity loans 813 735 869
- --------------------------------------------------------------------------------------------
Total $4,275 $4,947 $3,624
======= ======= ======
- --------------------------------------------------------------------------------------------
SECURITIES
At September 30, 1998, the securities portfolio totaled $6.9 billion, consisting
of $5.9 billion of securities available for sale and $1.0 billion of investment
securities. This compares with a total portfolio of $8.9 billion, comprised of
$7.7 billion of securities available for sale and $1.2 billion of investment
securities, at December 31, 1997. The composition of the two securities
portfolios by type of security, as of each of these respective dates, is
presented in Note 4, Securities, beginning on page 11. The decrease in
collateralized mortgage obligations and other mortgage backed securities since
the 1997 year end was due primarily to scheduled amortization, as well as
prepayments which occurred in connection with refinancings completed in the
continued low interest rate environment. 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
OTHER OTHER
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- RETAINED
AGENCIES AND POLITICAL MORTGAGE BACKED INTERESTS IN OTHER
dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(1) SECURITIES(1) SECURITIZATIONS SECURITIES
- --------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1998
Maturity:
One year or less $ 82 $ 1 $ 937 $ 14 --- $ 14
After one through five years 21 55 1,784 1,492 $184 9
After five through ten years 16 19 53 883 218 2
After ten years 21 2 --- 44 --- 77(3)
- --------------------------------------------------------------------------------------------------------------------------------
Fair value $140 $77 $2,774 $2,433 $402 $102
Amortized cost 138 75 2,743 2,390 421 93
Weighted average yield 7.11% 6.09% 6.76% 7.19% 8.84% 5.31%
Weighted average maturity 4.1 YEARS 5.6 YEARS 1.8 YEARS 4.1 YEARS 3.2 YEARS 9.0 YEARS
- --------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1997
Fair Value $204 $52 $4,051 $2,951 $374 $76
Amortized cost 202 52 4,045 2,908 418 75
- --------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1997
Fair Value $574 $50 $3,382 $3,165 $315 $77
Amortized cost 572 50 3,376 3,130 348 75
- --------------------------------------------------------------------------------------------------------------------------------
WEIGHTED
AVERAGE
dollars in millions TOTAL YIELD(2)
- ----------------------------------------------------
SEPTEMBER 30, 1998
Maturity:
One year or less $ 1,048 6.74 %
After one through five years 3,545 7.10
After five through ten years 1,191 7.34
After ten years 144 6.15
- ----------------------------------------------------
Fair value $5,928 ---
Amortized cost 5,860 7.06 %
Weighted average yield 7.06% ---
Weighted average maturity 3.1 YEARS ---
- ----------------------------------------------------
DECEMBER 31, 1997
Fair Value $7,708 ---
Amortized cost 7.19 %
7,700
- ----------------------------------------------------
SEPTEMBER 30, 1997
Fair Value $7,563 ---
Amortized cost 6.70 %
7,551
- ----------------------------------------------------
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.
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FIGURE 16 INVESTMENT SECURITIES
STATES AND WEIGHTED
POLITICAL OTHER AVERAGE
dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(1)
- ----------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1998
Maturity:
One year or less $206 $ 10 $216 7.89 %
After one through five years 337 83 420 8.31
After five through ten years 136 --- 136 9.83
After ten years 30 182 212 5.93
- ----------------------------------------------------------------------------------------------------
Amortized cost $709 $275 $984 7.50 %
Fair value 740 275 1,015 ---
Weighted average yield 8.81 % 5.60 % 7.50 % ---
Weighted average maturity 3.3 YEARS 7.0 YEARS 4.1 YEARS ---
- ----------------------------------------------------------------------------------------------------
DECEMBER 31, 1997
Amortized cost $ 973 $257 $1,230 7.59 %
Fair value 1,005 257 1,262 ---
- ----------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1997
Amortized cost $1,105 $239 $1,344 8.42 %
Fair value 1,139 239 1,378 ---
- ----------------------------------------------------------------------------------------------------
1 Weighted average yields are calculated on the basis of amortized cost. Such
yields have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
ASSET QUALITY
Key has established groups dedicated to evaluating and monitoring the level of
risk in its credit-related assets; formulating underwriting standards and
guidelines for line management; developing commercial and consumer credit
policies and systems; establishing credit-related concentration limits;
reviewing loans, leases and other corporate assets to evaluate credit quality;
and reviewing 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 third quarter of 1998 were
$71 million, or .48% of average loans, compared with $85 million, or .64% of
average loans, for the same period last year. The reduction in net charge-offs
was concentrated in the installment segment of the consumer loan portfolio and
reflects the improvement in credit quality. Net charge-offs in this segment of
the loan portfolio have decreased in each of the last four quarters. Overall,
the level of Key's quarterly net loan charge-offs has been fairly consistent for
almost two years and has benefited from the fourth quarter 1997 sale of $949
million of prime credit automobile loans. At $71 million, the provision for loan
losses for the third quarter of 1998 was at the lowest level since the first
quarter of last year. The provision for loan losses matched the level of net
charge-offs in accordance with management's long-standing policy of maintaining
the provision at a level equal to or above net charge-offs.
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FIGURE 17 SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
dollars in millions 1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------------------------------
Average loans outstanding during the period $ 58,559 $ 52,708 $ 56,332 $ 50,778
- ------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $ 900 $ 880 $ 900 $ 870
Loans charged off:
Commercial, financial and agricultural 18 17 53 39
Real estate--commercial mortgage 5 8 12 13
Real estate--construction -- -- 2 2
Commercial lease financing 4 2 6 5
- ------------------------------------------------------------------------------------------------------------------------
Total commercial loans 27 27 73 59
Real estate--residential mortgage 3 3 8 8
Home equity 1 2 5 3
Credit card 25 25 79 86
Consumer--direct 9 9 32 27
Consumer--indirect 26 39 91 99
- ------------------------------------------------------------------------------------------------------------------------
Total consumer loans 64 78 215 223
- ------------------------------------------------------------------------------------------------------------------------
91 105 288 282
Recoveries:
Commercial, financial and agricultural 5 7 20 23
Real estate--commercial mortgage 2 2 4 7
Real estate--construction 1 2 3 2
Commercial lease financing -- -- 1 --
- ------------------------------------------------------------------------------------------------------------------------
Total commercial loans 8 11 28 32
Real estate--residential mortgage 1 -- 3 2
Credit card 2 2 7 6
Consumer--direct 2 1 5 5
Consumer--indirect 7 6 25 20
- ------------------------------------------------------------------------------------------------------------------------
Total consumer loans 12 9 40 33
- ------------------------------------------------------------------------------------------------------------------------
20 20 68 65
- ------------------------------------------------------------------------------------------------------------------------
Net loans charged off (71) (85) (220) (217)
Provision for loan losses 71 102 220 244
Allowance acquired/sold, net -- 3 -- 3
- ------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $ 900 $ 900 $ 900 $ 900
======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans .48 % .64 % .52 % .57 %
Allowance for loan losses to period end loans 1.51 1.68 1.51 1.68
Allowance for loan losses to nonperforming loans 250.00 247.25 250.00 247.25
- ------------------------------------------------------------------------------------------------------------------------
The Allowance at September 30, 1998, was $900 million, or 1.51% of loans,
compared with $900 million, or 1.68% of loans, at September 30, 1997. Included
in the 1998 and 1997 Allowance was $41 million and $21 million, respectively,
which was specifically allocated for impaired loans. For a further discussion of
impaired loans see Note 6, Impaired Loans and Other Nonperforming Assets, on
page 13. At September 30, 1998, the Allowance was 250.00% of nonperforming
loans, compared with 236.22% at December 31, 1997, and 247.25% at September 30,
1997. There have been no significant changes in the allocation of the Allowance
since the 1997 year end.
The composition of nonperforming assets is shown in Figure 18. These assets
totaled $402 million at September 30, 1998, and represented .68% of loans, OREO
and other nonperforming assets compared with $431 million, or .81%, at year end
1997 and $411 million, or .77%, at September 30, 1997. The level of
nonperforming assets has remained consistent over the past seven quarters,
ranging from a high of $433 million at June 30, 1997, to a low of $402 million
at September 30, 1998.
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FIGURE 18 SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 1998 1997 1997
- ------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 132 $ 162 $ 162
Real estate--commercial mortgage 97 88 77
Real estate--construction 5 21 24
Commercial lease financing 22 5 3
Real estate--residential mortgage 70 58 56
Consumer 34 47 42
- -----------------------------------------------------------------------------------------------------------
Total nonperforming loans(1) 360 381 364
OREO 58 66 67
Allowance for OREO losses (19) (21) (22)
- -----------------------------------------------------------------------------------------------------------
OREO, net of allowance 39 45 45
Other nonperforming assets 3 5 2
- -----------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 402 $ 431 $ 411
===== ===== =====
- -----------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 167 $ 132 $ 138
- -----------------------------------------------------------------------------------------------------------
Nonperforming loans to period end loans .61 % .71 % .68 %
Nonperforming assets to period end loans plus
OREO and other nonperforming assets .68 .81 .77
- -----------------------------------------------------------------------------------------------------------
1 Includes impaired loans of $193 million, $196 million and $184 million at
September 30, 1998, December 31, 1997, and September 30, 1997, respectively.
DEPOSITS AND OTHER SOURCES OF FUNDS
Core deposits, defined as domestic deposits other than certificates of deposit
of $100,000 or more, are Key's primary source of funding. During the third
quarter of 1998, these deposits averaged $36.5 billion and represented 54% of
Key's funds supporting earning assets, compared with $38.4 billion and 62%,
respectively, during the third quarter of 1997. The decrease in core deposits
was due primarily to declines in the levels of savings deposits, NOW accounts
and time deposits. This resulted from primarily the sale of KeyBank Wyoming in
July 1997 and the divestiture of 122 other branch offices since mid-1997. The
divested branches (including KeyBank Wyoming) had deposits of approximately $3.0
billion. Also contributing to both the decrease and change in the mix of core
deposits were investment alternatives pursued by customers in response to the
strength of the stock and bond markets. The increase in money market deposit
accounts over the past four quarters reflects these customer preferences as well
as actions taken by management to reprice such deposits.
Purchased funds, which are comprised of large certificates of deposit, deposits
in foreign offices and short-term borrowings, averaged $19.1 billion during the
third quarter of 1998, up $1.9 billion, or 11%, from the comparable prior year
period. As illustrated in Figure 4, the increase was attributable primarily to
short-term borrowings which rose by $2.8 billion. Purchased funds have been more
heavily relied upon to offset declines in the volume of core deposits and to
fund earning asset growth.
FIGURE 19 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE
September 30, 1998 DOMESTIC FOREIGN
in millions OFFICES OFFICES TOTAL
- ---------------------------------------------------------------------------------------
Time remaining to maturity:
Three months or less $1,782 $2,024 $3,806
Over three through six months 729 -- 729
Over six through twelve months 620 -- 620
Over twelve months 559 -- 559
- ---------------------------------------------------------------------------------------
Total $3,690 $2,024 $5,714
======= ======= ======
- ---------------------------------------------------------------------------------------
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45
LIQUIDITY
Key actively analyzes and manages its liquidity, which 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
maintains liquidity in the form of short-term money market investments,
securities available for sale, anticipated prepayments and maturities on
securities, the maturity structure of its 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 961
full-service KeyCenters in 13 states. Key monitors deposit flows and evaluates
alternate pricing structures with respect to its deposit base. This process is
managed by Key's Funds & Investment Management Group, which monitors the overall
mix of funding sources in conjunction with deposit pricing and in response to
the structure of the earning assets portfolio. In addition, Key has 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. In addition, KeyBank USA, has a line of credit with the Federal Reserve,
which provides for overnight borrowings of up to $944 million and is secured by
$1.4 billion of KeyBank USA's credit card receivables at September 30, 1998.
There were no borrowings outstanding under this line of credit as of September
30, 1998.
During the first nine months of 1998, Key's affiliate banks raised $9.4 billion
under Key's Bank Note Program. Of the notes issued during 1998, $3.8 billion
have original maturities in excess of one year and are included in long-term
debt, while $5.6 billion have original maturities of one year or less and are
included in short-term borrowings. On October 27, 1998, Key commenced a new Bank
Note Program which provides for the issuance of up to $20 billion ($19 billion
by KeyBank N.A. and $1 billion by KeyBank USA).
Under Key's Euronote Program, the parent company, KeyBank N.A. and KeyBank USA
may issue both long- and short-term debt of up to $5 billion in the aggregate.
The notes are offered exclusively to non-U.S. investors and can be denominated
in dollars and most European currencies. There was $1.4 billion of borrowings
outstanding under this facility as of September 30, 1998, $579 million of which
was issued during the current year.
The parent company has a commercial paper program and a four-year revolving
credit agreement; each facility provides funding availability of up to $500
million. The proceeds from these facilities may be used for general corporate
purposes. As of September 30, 1998, $10 million of borrowings was outstanding
under these facilities, all of which was issued under the commercial paper
program.
The parent company also has a universal shelf registration statement on file
with the SEC, which provides for the possible issuance of up to $1.3 billion of
debt and equity securities. At September 30, 1998, unused capacity under the
shelf registration totaled $1.3 billion, including $750 million 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. In addition, the parent company has access to the
capital markets as a result of its favorable debt ratings which, at September
30, 1998, were as follows:
Senior Subordinated
Commercial Long-Term Long-Term
Paper Debt Debt
------------------- ------------------- -------------------
Duff & Phelps D-1 A+ 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
nine-month periods ended September 30, 1998 and 1997, is presented in the
Consolidated Statements of Cash Flow on page 6.
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46
CAPITAL AND DIVIDENDS
Total shareholders' equity at September 30, 1998, was $5.6 billion, up $372
million, or 7%, from the December 31, 1997, balance and $477 million, or 9%,
from the end of the third quarter of last year. The increase from the end of the
prior year and from the year-ago quarter was due primarily to retained net
income and net unrealized gains on securities available for sale. In each of
these periods the increase was offset in part by a net increase in treasury
stock, resulting from the share repurchases discussed below. Other factors
contributing to the change in shareholders' equity during the first nine months
of 1998 are shown in the Statement of Changes in Shareholders' Equity presented
on page 5.
In January 1998, the Board of Directors approved a share repurchase program
which authorized the repurchase from that date of up to 5,000,000 Common Shares
(10,000,000 shares on a post-split basis), with no expiration date for the
authority. Under the program, shares may be repurchased from time to time in the
open market or through negotiated transactions. No shares were repurchased under
this program during the first nine months of 1998. Under a separate
authorization, Key plans on repurchasing up to one-half of the 19,337,617 shares
issued in October 1998 in connection with the acquisition of McDonald. During
the first nine months of 1998, under this separate authorization Key repurchased
4,729,400 shares at an average price per share of $32.46. The 55,796,496 shares
held in treasury at September 30, 1998, 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, such as the McDonald
acquisition. During the first nine months of 1998, Key reissued 2,757,854
Treasury Shares for employee benefit and dividend reinvestment plans.
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 8.11% at September 30, 1998,
compared with 7.71% at December 31, 1997, and 7.74% at September 30, 1997.
Excluding certain capital securities receiving Tier 1 treatment, these ratios
are 7.15%, 7.03% and 7.04%, respectively.
Banking industry regulators define minimum capital ratios for bank holding
companies and their banking subsidiaries. Based on risk-adjusted capital rules
and definitions prescribed by the banking regulators, Key's Tier 1 and total
risk-adjusted capital ratios at September 30, 1998, were 7.01% and 11.61%,
respectively, compared with minimum regulatory requirements of 4.0% for Tier 1
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
September 30, 1998, Key's leverage ratio was 6.88%. Figure 20 presents the
details of Key's regulatory capital position at September 30, 1998, December 31,
1997, and September 30, 1997.
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47
FIGURE 20 CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 1998 1997 1997
- --------------------------------------------------------------------------------------------------
TIER 1 CAPITAL
Common shareholders' equity(1) $ 5,512 $ 5,170 $ 5,068
Qualifying capital securities 747 500 500
Less: Goodwill (1,038) (1,071) (1,095)
Other intangible assets(2) (74) (95) (108)
- --------------------------------------------------------------------------------------------------
Total Tier 1 capital 5,147 4,504 4,365
- --------------------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(3) 900 847 812
Qualifying long-term debt 2,474 1,982 2,022
- --------------------------------------------------------------------------------------------------
Total Tier 2 capital 3,374 2,829 2,834
- --------------------------------------------------------------------------------------------------
Total capital $ 8,521 $ 7,333 $ 7,199
======== ======== ========
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $ 62,422 $ 58,412 $ 57,181
Risk-adjusted off-balance sheet exposure 12,025 10,501 8,990
Less: Goodwill (1,038) (1,071) (1,095)
Other intangible assets(2) (74) (95) (108)
Plus: Market risk-equivalent assets 76
- --------------------------------------------------------------------------------------------------
Gross risk-adjusted assets 73,411 67,747 64,968
Less: Excess allowance for loan losses(3) -- (53) (88)
- --------------------------------------------------------------------------------------------------
Net risk-adjusted assets $ 73,411 $ 67,694 $ 64,880
======== ======== ========
AVERAGE QUARTERLY TOTAL ASSETS $ 75,886 $ 71,490 $ 70,112
======== ======== ========
CAPITAL RATIOS
Tier 1 risk-adjusted capital ratio 7.01 % 6.65 % 6.73 %
Total risk-adjusted capital ratio 11.61 10.83 11.10
Leverage ratio(4) 6.88 6.40 6.33
- --------------------------------------------------------------------------------------------------
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 2 capital is limited to 1.25%
of gross risk-adjusted assets.
4 Tier 1 capital as a percentage of average quarterly assets, less goodwill and
other non-qualifying intangible assets as defined in 2 above.
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." Both of Key's affiliate banks qualify as "well
capitalized" at September 30, 1998, since they exceeded the well-capitalized
thresholds of 10%, 6% and 5% for the total capital, Tier 1 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 also
qualify as "well capitalized" at September 30, 1998. The FDIC-defined capital
categories may not constitute an accurate representation of the overall
financial condition or prospects of Key or its affiliate banks.
On January 15, 1998, Key announced a two-for-one stock split effected by means
of a 100% stock dividend payable March 6, 1998, to shareholders of record as of
February 18, 1998. Except where express reference is made to Common Shares on a
pre-split basis, all relevant Common Share amounts and per share data in this
report have been adjusted to reflect the split.
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48
At the Annual Meeting of Shareholders held May 7, 1998, shareholders increased
the authorized number of Key Common Shares from 900,000,000 to 1,400,000,000
Common Shares. Additionally, on January 15, 1998, the Board voted to cancel and
retire all 1,400,000 authorized shares of Key's 10% Cumulative Preferred Stock,
Class A, none of which were outstanding.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
In the ordinary course of business, Key is subject to legal actions
which involve claims for substantial monetary relief. Based on
information presently available to management and Key's counsel,
management does not believe that any legal actions, individually or in
the aggregate, will have a material adverse effect on the consolidated
financial condition of Key.
Item 5. Other Information
-----------------
As stated in the Proxy Statement for KeyCorp's 1998 Annual Meeting of
Shareholders, the deadline for the submission to KeyCorp of certain
proposals for consideration at its 1999 Annual Meeting of Shareholders
is December 8, 1998. That deadline applies to proposals submitted for
inclusion in KeyCorp's Proxy Statement for the 1999 Annual Meeting
under the provisions of Rule 14a-8 of the Proxy Rules of the Securities
and Exchange Commission under the Securities Exchange Act of 1934 (the
"Proxy Rules"). In addition, proxies solicited by KeyCorp for the 1999
Annual Meeting will confer discretionary authority on KeyCorp to vote
on other proposals submitted by shareholders for consideration at the
1999 Annual Meeting unless (a) the proposal has been given in writing
to the Secretary of KeyCorp, delivered to, or mailed and received at
KeyCorp's principal executive offices, not less than 60 nor more than
90 days prior to the shareholders' meeting (KeyCorp intends to, at
least 75 days prior to the annual meeting, make a public disclosure of
the date of the annual meeting), (b) the shareholder submitting the
proposal has complied with the additional requirements set forth in
Article 1, Section 7, of KeyCorp's Amended and Restated Regulations,
and (c) the shareholder has also complied with the further requirements
regarding the proposal under Rule 14a-4(c)(2)(i) through (iii) of the
Proxy Rules. The date of the 1999 Annual Meeting of Shareholders has
not yet been established by KeyCorp's Board of Directors, but is
tentatively scheduled for May 20, 1999. If that tentative date is, in
fact, fixed by the Board of Directors as the Annual Meeting date, a
proposal under (a) above must be received not later than March 22,
1999, and not earlier than February 19, 1999. February 19, 1999.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(3) Amended and Restated Articles of Incorporation
(10) KeyCorp Director Deferred Compensation Plan (May 6, 1998,
Restatement)
(15) Acknowledgment Letter of Independent Auditors
(27) Financial Data Schedule (filed electronically only)
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49
(b) Reports on Form 8-K
July 17, 1998 - Item 5. Other Events and Item 7. Financial Statements
and Exhibits. Reporting that on July 16, 1998, the Registrant issued a
press release announcing its earnings results for the three-month
period ended June 30, 1998.
September 23, 1998 - Item 5. Other Events. Reporting that KeyCorp
intends to repurchase prior to, or within 90 days following, the
closing of the McDonald acquisition an amount of KeyCorp Common Shares
which is approximately equivalent to the value of up to one-half of the
shares to be issued in connection with the transaction. KeyCorp also
reported that it intends to purchase shares of McDonald, within
regulatory limits, prior to closing.
No other reports on Form 8-K were filed during the three-month period
ended September 30, 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
-------------------------------------
(Registrant)
Date: November 13, 1998 /s/ Lee Irving
-------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
49