1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1999
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
[LOGO]
KEYCORP
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(Exact name of registrant as specified in its
charter)
OHIO 34-6542451
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
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(Address of principal executive offices) (Zip Code)
(216) 689-6300
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Shares with a par value of $1 each 448,726,221 Shares
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(Title of class) (Outstanding at July 30, 1999)
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KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
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Consolidated Balance Sheets --
June 30, 1999, December 31, 1998 and June 30, 1998 3
Consolidated Statements of Income --
Three months and six months ended June 30, 1999 and 1998 4
Consolidated Statements of Changes in Shareholders' Equity --
Six months ended June 30, 1999 and 1998 5
Consolidated Statements of Cash Flow --
Six months ended June 30, 1999 and 1998 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 23
Item 2. Management's Discussion and Analysis of Financial Condition
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and Results of Operations 24
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Item 3. Quantitative and Qualitative Disclosure of Market Risk 47
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings 48
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Item 4 Submission of Matters to a Vote of Security Holders 48
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Item 5. Other Information 49
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Item 6. Exhibits and Reports on Form 8-K 49
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Signature 50
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KEYCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 1999 1998 1998
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(UNAUDITED) (UNAUDITED)
ASSETS
Cash and due from banks $ 3,060 $ 3,296 $ 3,050
Short-term investments 1,755 1,974 1,652
Securities available for sale 6,404 5,278 6,482
Investment securities (fair value: $985, $1,004 and $1,066) 967 976 1,038
Loans, net of unearned income of $1,507, $1,533 and $1,313 61,971 62,012 57,769
Less: Allowance for loan losses 930 900 900
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Net loans 61,041 61,112 56,869
Premises and equipment 846 902 894
Goodwill 1,446 1,430 1,028
Other intangible assets 68 79 88
Corporate owned life insurance 2,056 2,008 1,945
Other assets 3,246 2,965 2,732
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Total assets $80,889 $80,020 $75,778
======== ======== =======
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 9,058 $ 9,540 $ 8,967
Interest-bearing 31,948 32,091 31,262
Deposits in foreign office -- interest-bearing 2,010 952 1,565
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Total deposits 43,016 42,583 41,794
Federal funds purchased and securities sold under repurchase agreements 4,727 4,468 6,828
Bank notes and other short-term borrowings 7,344 9,728 7,855
Other liabilities 3,405 3,110 2,583
Long-term debt 15,168 12,967 10,196
Corporation-obligated mandatorily redeemable preferred capital securities
of subsidiary trusts holding solely debentures of the Corporation (See Note 9) 994 997 997
- --------------------------------------------------------------------------------------------------------------------------
Total liabilities 74,654 73,853 70,253
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- --
Common Shares, $1 par value; authorized 1,400,000,000 shares;
issued 491,888,780 shares 492 492 492
Capital surplus 1,413 1,412 1,284
Retained earnings 5,533 5,192 4,889
Loans to ESOP trustee (34) (34) (42)
Treasury stock, at cost (43,248,120, 39,437,183 and 51,536,469 shares) (1,062) (923) (1,126)
Accumulated other comprehensive (loss) income (107) 28 28
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Total shareholders' equity 6,235 6,167 5,525
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Total liabilities and shareholders' equity $80,889 $80,020 $75,778
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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 June 30, Six months ended June 30,
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dollars in millions, except per share amounts 1999 1998 1999 1998
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INTEREST INCOME
Loans $ 1,251 $ 1,218 $ 2,501 $ 2,383
Taxable investment securities 3 4 7 7
Tax-exempt investment securities 8 12 17 25
Securities available for sale 107 117 204 246
Short-term investments 23 21 44 38
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Total interest income 1,392 1,372 2,773 2,699
INTEREST EXPENSE
Deposits 315 346 624 693
Federal funds purchased and securities sold under repurchase agreements 63 89 117 182
Bank notes and other short-term borrowings 88 114 207 212
Long-term debt, including capital securities 229 157 443 296
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Total interest expense 695 706 1,391 1,383
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NET INTEREST INCOME 697 666 1,382 1,316
Provision for loan losses 76 72 187 149
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Net interest income after provision for loan losses 621 594 1,195 1,167
NONINTEREST INCOME
Trust and asset management income 110 80 216 157
Service charges on deposit accounts 82 75 163 153
Investment banking and capital markets income 100 50 166 97
Insurance and brokerage income 59 24 116 46
Corporate owned life insurance income 27 24 51 47
Credit card fees 21 17 31 32
Net loan securitization gains 18 -- 50 --
Net securities gains 20 2 24 4
Gains from branch divestitures -- 33 -- 39
Gains from other divestitures -- -- 148 23
Other income 89 75 170 138
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Total noninterest income 526 380 1,135 736
NONINTEREST EXPENSE
Personnel 383 302 755 596
Net occupancy 58 56 117 112
Equipment 49 45 105 88
Computer processing 59 41 113 81
Marketing 24 28 49 56
Amortization of intangibles 26 22 54 45
Professional fees 17 15 32 32
Other expense 101 93 240 178
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Total noninterest expense 717 602 1,465 1,188
INCOME BEFORE INCOME TAXES 430 372 865 715
Income taxes 150 123 292 231
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NET INCOME $ 280 $ 249 $ 573 $ 484
======== ======== ======== ========
Per Common Share:
Net income $ .63 $ 57 $ 1.28 $ 1.10
Net Income - assuming dilution .62 .56 1.27 1.09
Weighted average Common Shares outstanding (000) 448,037 440,092 448,774 439,345
Weighted average Common Shares and potential Common
Shares outstanding (000) 452,733 446,568 453,461 445,707
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See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
Accumulated
Loans to Treasury Other
dollars in millions, Common Capital Retained ESOP Stock, Comprehensive Comprehensive
except per share amounts Shares Surplus Earnings Trustee at Cost (Loss) Income Income(2)
- -------------------------------------------------------------------------------------------------------------------- -------------
BALANCE AT DECEMBER 31, 1997 $492 $1,283 $4,611 $(42) $(1,174) $11
Net income 484 $484
Other comprehensive income:
Net unrealized gains on securities
available for sale, net of income
taxes of $9(1) 17 17
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Total comprehensive income $501
====
Cash dividends on Common Shares
($.47 per share) (206)
Issuance of Common Shares under
employee benefit and dividend
reinvestment plans-2,388,481 net shares 1 52
Repurchase of Common Shares-100,000 shares (4)
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BALANCE AT JUNE 30, 1998 $492 $1,284 $4,889 $(42) $(1,126) $28
==== ====== ====== ==== ======= ===
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BALANCE AT DECEMBER 31, 1998 $492 $1,412 $5,192 $(34) $ (923) $28
Net income 573 $573
Other comprehensive losses:
Net unrealized losses on securities
available for sale, net of income
taxes of $(80)(1) (130) (130)
Foreign currency translation adjustments (5) (5)
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Total comprehensive income $438
====
Cash dividends on Common Shares
($.52 per share) (233)
Issuance of Common Shares:
Acquisition-632,183 shares 6 15
Employee benefit and dividend reinvestment
plans-1,963,304 net shares (5) 48
Repurchase of Common Shares-6,406,424 shares (202)
ESOP transactions 1
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BALANCE AT JUNE 30, 1999 $492 $1,413 $5,533 $(34) $(1,062) $(107)
==== ====== ====== ==== ======= =====
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(1) Net of reclassification adjustments.
(2) For the three months ended June 30, 1999 and 1998, comprehensive income was
$229 million and $269 million, respectively.
See Notes to Consolidated Financial Statements (Unaudited).
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KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-------------------------
in millions 1999 1998
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OPERATING ACTIVITIES
Net income $ 573 $ 484
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 187 149
Depreciation expense and software amortization 144 111
Amortization of intangibles 54 45
Net gains from divestitures (148) (62)
Net securities gains (24) (4)
Net gains from sales of loans (22) (20)
Deferred income taxes 163 154
Net increase in mortgage loans held for sale (32) (324)
Net increase in trading account assets (233) (228)
Decrease in accrued restructuring charge (1) (18)
Other operating activities, net (92) (24)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 569 263
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (3,525) (3,861)
Purchases of loans (7) (827)
Loans sold 3,044 336
Purchases of investment securities (117) (55)
Proceeds from sales of investment securities 8 43
Proceeds from prepayments and maturities of investment securities 152 232
Purchases of securities available for sale (3,780) (61)
Proceeds from sales of securities available for sale 325 43
Proceeds from prepayments and maturities of securities available for sale 2,611 1,281
Net decrease in other short-term investments 452 504
Purchases of premises and equipment (50) (27)
Proceeds from sales of premises and equipment 23 23
Proceeds from sales of other real estate owned 13 4
Net cash paid for divestitures -- (433)
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NET CASH USED IN INVESTING ACTIVITIES (851) (2,798)
FINANCING ACTIVITIES
Net increase (decrease) in deposits 433 (2,621)
Net increase (decrease)in short-term borrowings (2,145) 1,739
Net proceeds from issuance of long-term debt, including capital securities 3,756 3,495
Payments on long-term debt, including capital securities (1,592) (503)
Purchases of treasury shares (202) (4)
Net proceeds from issuance of common stock 29 34
Cash dividends (233) (206)
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NET CASH PROVIDED BY FINANCING ACTIVITIES 46 1,934
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NET DECREASE IN CASH AND DUE FROM BANKS (236) (601)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,296 3,651
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CASH AND DUE FROM BANKS AT END OF PERIOD $3,060 $3,050
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Additional disclosures relative to cash flow:
Interest paid $1,366 $1,329
Income taxes paid 85 79
Net amount received on portfolio swaps 12 10
Noncash items:
Assets sold -- $165
Liabilities sold -- 660
Reclassification of financial instruments from loans to securities
available for sale $374 --
Fair value of Concord EFS, Inc. shares received 170 --
Carrying amount of Electronic Payment Services, Inc. shares divested 36 --
Net transfer of loans to other real estate owned 13 --
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See Notes to Consolidated Financial Statements (Unaudited).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited condensed consolidated interim financial statements include the
accounts of KeyCorp (the "parent company") and its subsidiaries (collectively
referred to as "Key"). All significant intercompany accounts and transactions
have been eliminated in consolidation. In the opinion of management, the
unaudited condensed consolidated interim financial statements reflect all
adjustments of a normal recurring nature and disclosures which are necessary for
a fair presentation of the results for the interim periods presented, and should
be read in conjunction with the audited consolidated financial statements and
related notes included in Key's 1998 Annual Report to Shareholders. In addition,
certain reclassifications have been made to prior year amounts to conform to 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 1999
As of January 1, 1999, Key adopted Statement of Financial Accounting Standard
("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 to 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 securities. Since Key was in
compliance with the standard at the date of adoption, SFAS No. 134 had minimal
impact on Key's financial condition and results of operations.
As of January 1, 1999, Key adopted 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. The provisions of SOP 98-1 are substantially consistent with Key's
prior accounting policy for internally developed software. As a result, the
effect of prospective adoption did not have a material impact on Key's financial
condition or results of operations.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
In July 1999, the Financial Accounting Standards Board ("FASB") issued SFAS No.
137, "Deferral of the Effective Date of SFAS No. 133," that delays the effective
date of SFAS No. 133 until fiscal years beginning after June 15, 2000. SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," 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 either will be offset against the change in
fair value of the hedged item (which also is recognized in earnings) or will be
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. Key will adopt the provisions
of SFAS No. 133 as of January 1, 2001. Management is currently reviewing SFAS
No. 133 to determine the extent to which the statement will alter Key's use of
certain derivatives in the future and the impact on its financial condition and
results of operations.
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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 JUNE 30, SIX MONTHS ENDED JUNE 30,
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dollars in millions, except per share amounts 1999 1998 1999 1998
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NET INCOME $280 $249 $573 $484
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WEIGHTED AVERAGE COMMON SHARES
Weighted average Common Shares outstanding (000) 448,037 440,092 448,774 439,345
Potential Common Shares outstanding (000) (1) 4,696 6,476 4,687 6,362
- ------------------------------------------------------------------------------------------------------------------------------
Weighted average Common Shares and potential
Common Shares outstanding (000) 452,733 446,568 453,461 445,707
======= ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per Common Share $ .63 $ .57 $1.28 $1.10
Net income per Common Share - assuming dilution .62 .56 1.27 1.09
- ------------------------------------------------------------------------------------------------------------------------------
(1) Dilutive common stock options.
3. MERGERS, ACQUISITIONS AND DIVESTITURES
Mergers, acquisitions and divestitures completed by Key during 1998 and the
first six months of 1999 are summarized below.
COMPLETED MERGERS AND ACQUISITIONS
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, 19,337,159 Common
Shares, with a value of approximately $581 million, were issued in a transaction
structured as a tax-free merger and accounted for as a purchase. Key recorded
goodwill of $437 million, which is being amortized using the straight-line
method over a period of 25 years. In addition, Key established a retention
program for certain McDonald employees under which stock options for
approximately 3.3 million Key Common Shares were granted and will vest over a
three-year period, and approximately $30 million in cash may be paid over the
three-year period.
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 assets of approximately $1.1
billion at the time of the transaction and 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. In accordance with
a confidentiality clause in the purchase agreement, the terms, which are not
material, have not been publicly disclosed.
COMPLETED DIVESTITURES
ELECTRONIC PAYMENT SERVICES, INC.
On February 28, 1999, Electronic Payment Services, Inc. ("EPS"), an electronic
funds transfer processor in which Key held a 20% ownership interest, merged with
a wholly owned subsidiary of Concord EFS, Inc. ("Concord EFS"), a Delaware
corporation. Key received 5.9 million shares of Concord EFS and recognized a
gain of $134 million ($85 million after tax). The gain was recorded in gains
from other divestitures on the income statement. On June 17, 1999, Key sold the
Concord EFS shares and recognized a gain of $15 million ($9 million after tax).
The gain was recorded in net securities gains on the income statement.
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KEY MERCHANT SERVICES, LLC
On January 21, 1998, Key sold to NOVA Information Systems, Inc. ("NOVA") a 51%
interest in Key Merchant Services, LLC, a wholly owned subsidiary formed to
provide merchant credit card processing services to businesses. Key recognized a
$23 million gain ($14 million after tax) at the time of closing. Under the terms
of the agreement with NOVA, Key was entitled to receive additional consideration
if certain revenue-related performance targets were met. Accordingly, Key
recognized a gain of $27 million in the fourth quarter of 1998 and recorded a
final gain of $14 million during the first quarter of 1999. These gains were
recorded in gains from other divestitures on the income statement. In accordance
with a confidentiality clause in the agreement, the terms, which are not
material, have not been disclosed.
BRANCH DIVESTITURES
During 1998, Key sold 46 branch offices ("KeyCenters") with deposits of
approximately $658 million, resulting in aggregate gains of $39 million ($22
million after tax). The gains were recorded in gains from branch divestitures on
the income statement.
TRANSACTION PENDING AT JUNE 30, 1999
LONG ISLAND FRANCHISE
On May 26, 1999, Key entered into a definitive agreement for the sale of its
Long Island franchise, which includes 28 KeyCenters with approximately $1.3
billion in deposits and $415 million in loans. The franchise will be sold for a
premium of 16.25% of deposits assumed. The actual premium amount (estimated at
approximately $200 million pre-tax and net of transaction costs) will be based
on average deposits shortly before closing, which is expected to occur during
the fourth quarter of 1999, pending certain regulatory approvals.
4. LINE OF BUSINESS RESULTS
Key's four major lines of business as described below are Key Corporate Capital,
Key Consumer Finance, Key Community Bank and Key Capital Partners.
KEY CORPORATE CAPITAL
Key offers a complete range of financing, transaction processing and financial
advisory services to corporations throughout the country through Key Corporate
Capital. This line of business 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 the following specialized industry client segments: commercial real
estate, lease financing, structured finance, healthcare and
media/telecommunications. In serving these targeted segments, Key Corporate
Capital provides a number of specialized services including international
banking, corporate finance advisory services and, based on transaction volume,
is a leading provider of cash management services. Key Corporate Capital also
provides investment banking, capital markets, 401(k) and trust custody products
through Key Capital Partners.
KEY CONSUMER FINANCE
Key Consumer Finance is responsible for Key's indirect, non-branch-based
consumer loan products. This line of business specializes in automobile loans
and leases, home equity loans, education loans, marine and recreational vehicle
loans and credit cards. As of December 31, 1998, based on the volume of loans
generated, Key Consumer Finance was one of the five largest education lenders 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.
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 businesses. The delivery of these products and services is accomplished
through 965 full-service banking offices ("Key Centers"), a 24-hour telephone
banking call center services group, nearly 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.
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KEY CAPITAL PARTNERS
Key Capital Partners provides clients with asset management, investment banking,
capital markets, insurance and brokerage expertise. It also plays a major role
in generating fee income through its broad range of investment choices and
customized products. This line of business 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.
Leveraging Key's corporate and community banking distribution channels and
client relationships is and will continue to be an essential factor in ensuring
Key Capital Partners' future growth and success.
Selected financial data for each major line of business for the three- and
six-month periods ended June 30, 1999 and 1998, is presented in the table
beginning on page 11. The financial information was derived from the internal
profitability reporting system used by management to monitor and manage the
financial performance of Key. The selected financial data are based on internal
management accounting policies which have been developed to ensure that results
are 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 was
allocated to the lines of business based upon their respective contributions to
net interest income. 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 primarily upon 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 a methodology designed by management to assess the adequacy
of the consolidated allowance by focusing on a number of specific factors. This
methodology and the factors which influence it are more fully discussed in the
Allowance for Loan Losses section of Note 1, Summary of Significant Accounting
Policies, beginning on page 65 of Key's 1998 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 (net of the
Federal income tax benefit) of 1.8% 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. The financial data presented in the accompanying table
for both the current and prior year reflects a number of revisions in Key's
organization structure and funds transfer pricing methodology that occurred
during the first quarter of 1999. Primary among the structural changes was the
reclassification of the public sector, retail brokerage, wealth management,
private banking and franchise trust businesses from Key Community Bank to Key
Capital Partners and the reclassification of institutional asset services from
Key Corporate Capital to Key Capital Partners. In addition, funds transfer
pricing was enhanced by refining the methodology applied to the residential
mortgage loan portfolio, certain deposit products with indeterminate maturities
and medium-term notes. 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.
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THREE MONTHS ENDED JUNE 30, KEY CORPORATE CAPITAL KEY CONSUMER FINANCE KEY COMMUNITY BANK
---------------------- ---------------------- -----------------------
dollars in millions 1999 1998 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 133 $ 114 $ 153 $ 141 $ 420 $ 427
Noninterest income 24 22 58 36 114 109
Revenue sharing--KCP(1) 12 5 1 -- 40 39
- -----------------------------------------------------------------------------------------------------------------------------
Total revenue(2) 169 141 212 177 574 575
Provision for loan losses 15 11 39 46 32 21
Depreciation and amortization expense 6 4 12 11 55 50
Other noninterest expense 37 40 81 79 279 280
Expense sharing--KCP(1) 5 2 -- -- 26 26
- -----------------------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 106 84 80 41 182 198
Allocated income taxes and TE adjustment 39 30 30 16 64 69
- -----------------------------------------------------------------------------------------------------------------------------
Net income $ 67 $ 54 $ 50 $ 25 $ 118 $ 129
======= ======= ======= ======= ======= =======
Percent of consolidated net income 24% 21% 18% 11% 42% 52%
Efficiency ratio(6) 28.40 32.62 43.87 50.85 64.98 62.13
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AVERAGE BALANCES
Loans $14,931 $12,139 $15,337 $14,188 $26,862 $26,415
Total assets(2) 15,807 12,714 16,729 15,506 36,304 36,877
Deposits 440 407 110 101 36,083 36,991
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SIX MONTHS ENDED JUNE 30, KEY CORPORATE CAPITAL KEY CONSUMER FINANCE KEY COMMUNITY BANK
---------------------- ---------------------- -----------------------
dollars in millions 1999 1998 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 254 $ 223 $ 317 $ 274 $ 833 $ 854
Noninterest income 50 40 120 71 246 237
Revenue sharing--KCP(1) 19 9 2 -- 80 76
- -----------------------------------------------------------------------------------------------------------------------------
Total revenue(2) 323 272 439 345 1,159 1,167
Provision for loan losses 21 17 94 97 63 48
Depreciation and amortization expense 11 8 27 21 112 98
Other noninterest expense 73 71 162 157 557 560
Expense sharing--KCP(1) 8 4 -- -- 53 51
- -----------------------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 210 172 156 70 374 410
Allocated income taxes and TE adjustment 76 61 58 27 127 143
- -----------------------------------------------------------------------------------------------------------------------------
Net income $ 134 $ 111 $ 98 $ 43 $ 247 $ 267
======= ======= ======= ======= ======= =======
Percent of consolidated net income 24% 23% 17% 9% 43% 55%
Efficiency ratio(6) 28.48 30.51 43.05 51.59 63.61 60.96
- -----------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $14,678 $11,843 $15,702 $13,585 $26,807 $26,274
Total assets(2) 15,471 12,401 17,091 14,891 36,171 37,164
Deposits 443 418 114 118 35,931 37,177
- -----------------------------------------------------------------------------------------------------------------------------
(1) Represents the assignment of KCP revenue and expense to the lines of
business principally responsible for maintaining the corresponding client
relationships.
(2) Substantially all revenue generated by Key's major lines of business is
derived from external clients domiciled in the United States and
substantially all long-lived assets held by such lines of business are
located in the United States. Long-lived assets include premises and
equipment, capitalized software and goodwill.
(3) Noninterest income includes $15 million ($9 million after tax) in the
second quarter of 1999, and $33 million ($18 million after tax) in the
second quarter of 1998, of gains from certain divestitures. For the
year-to-date period, gains from certain divestitures totaled $149 million
($94 million after tax) and $39 million ($22 million after tax) in 1999 and
1998, respectively. Net interest income is primarily comprised of the
funding cost related to unallocated nonearning assets of corporate support
functions.
11
12
THREE MONTHS ENDED JUNE 30, KEY CAPITAL PARTNERS KEYCORP
("KCP") TOTAL SEGMENTS RECONCILING ITEMS CONSOLIDATED
-------------------- ---------------- --------------------- -----------------
dollars in millions 1999 1998 1999 1998 1999 1998 1999 1998
- --------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 42 $ 33 $ 748 $ 715 $ (44) $ (40) $ 704 $ 675
Noninterest income 287 171 483 338 43 42 526 380
Revenue sharing--KCP(1) (53) (44) ___ ___ ___ ___ ___ ___
- --------------------------------------------------------------------------------------------------------------------------------
Total revenue(2) 276 160 1,231 1,053 (1)(3) 2(3) 1,230 1,055
Provision for loan losses 2 1 88 79 (12) (7) 76 72
Depreciation and amortization expense 21 12 94 77 5 3 99 80
Other noninterest expense 227 125 624 524 (6)(4) (2) 618 522
Expense sharing--KCP(1) (31) (28) ___ ___ ___ ___ ___ ___
- --------------------------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 57 50 425 373 12 8 437 381
Allocated income taxes and TE adjustment 20 16 153 131 4 1 157 132
- --------------------------------------------------------------------------------------------------------------------------------
Net income $ 37 $ 34 $ 272 $ 242 $ 8 $ 7 $ 280 $ 249
======= ======= ======= ======= ======= ======= ======= =======
Percent of consolidated net income 13% 13% 97% 97% 3% 3% 100% 100%
Efficiency ratio(6) 78.62 68.13 59.29 57.18 N/M N/M 59.26 59.02
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 4,256 $ 3,408 $61,386 $56,150 $ 218 $ 291 $61,604 $56,441
Total assets(2) 8,693 6,489 77,533 71,586 2,492(5) 2,480(5) 80,025 74,066
Deposits 3,327 2,764 39,960 40,263 1,821 1,088 41,781 41,351
- ------------------------------------------------------------------------------------------------------------------------------------
KEY CAPITAL PARTNERS KEYCORP
("KCP") TOTAL SEGMENTS RECONCILING ITEMS CONSOLIDATED
SIX MONTHS ENDED JUNE 30, -------------------- -------------- ---------------------- -------------------
dollars in millions 1999 1998 1999 1998 1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 81 $ 60 $ 1,485 $ 1,411 $ (88) $ (77) $ 1,397 $ 1,334
Noninterest income 525 328 941 676 194 60 1,135 736
Revenue sharing--KCP(1) (101) (85) ___ ___ ___ ___ ___ ___
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue(2) 505 303 2,426 2,087 106(3) (17(3) 2,532 2,070
Provision for loan losses 2 1 180 163 7 (14) 187 149
Depreciation and amortization expense 45 22 195 149 3 7 198 156
Other noninterest expense 439 246 1,231 1,034 36(4) (2) 1,267 1,032
Expense sharing--KCP(1) (61) (55) ___ ___ ___ ___ ___ ___
- ------------------------------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 80 89 820 741 60 (8) 880 733
Allocated income taxes and TE adjustment 27 29 288 260 19 (11) 307 249
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 53 $ 60 $ 532 $ 481 $ 41 $ 3 $ 573 $ 484
======= ======= ======= ======= ======= ======= ======= =======
Percent of consolidated net income 9% 12% 93% 99% 7% 1% 100% 100%
Efficiency ratio(6) 83.76 70.30 59.37 56.79 N/M N/M 59.73 58.61
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 4,250 $ 3,290 $61,437 $54,992 $ 211 $ 208 $61,648 $55,200
Total assets(2) 8,767 6,261 77,500 70,717 2,442(5) 2,382(5) 79,942 73,099
Deposits 3,219 2,695 39,707 40,408 1,742 1,084 41,449 41,492
- ------------------------------------------------------------------------------------------------------------------------------------
4 Noninterest expense in the second quarter of 1999 includes a $3 million ($2
million after tax) special contribution made to the Key sponsored
charitable foundation. For the first six months of 1999, noninterest
expense included a $23 million ($15 million after tax) special contribution
to the foundation and $27 million ($17 million after tax) of other
nonrecurring charges recorded in the first quarter.
5 Total assets represent primarily the unallocated portion of nonearning
assets of corporate support functions.
6 Calculated as noninterest expense (excluding certain nonrecurring charges)
divided by taxable-equivalent net interest income plus noninterest income
(excluding net securities transactions and gains from certain
divestitures).
TE=Taxable Equivalent
N/M= Not Meaningful
12
13
5. 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 (primarily equity capital investments) 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 and included in short-term investments on the balance sheet. Realized and
unrealized gains and losses on trading account 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 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 (loss) income. Gains and losses
from sales of securities available for sale are computed using the specific
identification method and included in net securities gains on the income
statement.
During the first quarter of 1999, Key reclassified approximately $374 million of
collateralized mortgage obligations from the commercial mortgage loan portfolio
to the securities available for sale portfolio.
The amortized cost, unrealized gains and losses and approximate fair value of
securities available for sale and investment securities were as follows:
JUNE 30, 1999
-----------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- --------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 152 $ 1 $ 1 $ 152
States and political subdivisions 67 1 1 67
Collateralized mortgage obligations 4,029 2 143 3,888
Other mortgage-backed securities 1,878 12 29 1,861
Retained interests in securitizations 348 -- 13 335
Other securities 96 6 1 101
- --------------------------------------------------------------------------------------------------------
Total securities available for sale $6,570 $22 $188 $6,404
====== === ==== ======
INVESTMENT SECURITIES
States and political subdivisions $515 $18 -- $533
Other securities 452 -- -- 452
- --------------------------------------------------------------------------------------------------------
Total investment securities $967 $18 -- $985
==== === ====
- --------------------------------------------------------------------------------------------------------
DECEMBER 31, 1998
-----------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- --------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 420 $ 2 -- $ 422
States and political subdivisions 65 2 -- 67
Collateralized mortgage obligations 2,191 21 $ 1 2,211
Other mortgage-backed securities 2,123 34 6 2,151
Retained interests in securitizations 345 -- 17 328
Other securities 84 16 1 99
- --------------------------------------------------------------------------------------------------------
Total securities available for sale $5,228 $75 $25 $5,278
====== === === ======
INVESTMENT SECURITIES
States and political subdivisions $631 $28 -- $ 659
Other securities 345 -- -- 345
- --------------------------------------------------------------------------------------------------------
Total investment securities $976 $28 -- $1,004
==== === ======
- --------------------------------------------------------------------------------------------------------
13
14
JUNE 30, 1998
-----------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- --------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 143 $ 2 -- $ 145
States and political subdivisions 76 1 -- 77
Collateralized mortgage obligations 3,182 20 $ 1 3,201
Other mortgage-backed securities 2,564 43 4 2,603
Retained interests in securitizations 409 -- 27 382
Other securities 61 13 -- 74
- --------------------------------------------------------------------------------------------------------
Total securities available for sale $6,435 $79 $32 $6,482
====== === === ======
INVESTMENT SECURITIES
States and political subdivisions $ 762 $28 -- $ 790
Other securities 276 -- -- 276
- --------------------------------------------------------------------------------------------------------
Total investment securities $1,038 $28 -- $1,066
======= ==== ======
- --------------------------------------------------------------------------------------------------------
Trading account assets had a fair value of $1.1 billion, $877 million and $763
million at June 30, 1999, December 31, 1998 and June 30, 1998, respectively. At
June 30, 1999, these assets included $87 million of retained interests in home
equity loan securizations.
6. LOANS
Loans are summarized as follows:
JUNE 30, DECEMBER 31, JUNE 30,
in millions 1999 1998 1998
- ------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $17,916 $17,038 $15,595
Real estate-- commercial mortgage 6,806 7,309 7,017
Real estate-- construction 4,153 3,450 2,841
Commercial lease financing 6,043 5,613 4,803
- ------------------------------------------------------------------------------------------------------
Total commercial loans 34,918 33,410 30,256
Real estate-- residential mortgage 4,330 5,083 5,508
Home equity 7,532 7,301 6,183
Credit card 1,313 1,425 1,451
Consumer--direct 2,423 2,342 2,084
Consumer--indirect lease financing 2,897 2,580 1,979
Consumer--indirect other 6,402 7,009 6,834
- ------------------------------------------------------------------------------------------------------
Total consumer loans 24,897 25,740 24,039
Loans held for sale 2,156 2,862 3,474
- ------------------------------------------------------------------------------------------------------
Total loans $61,971 $62,012 $57,769
======= ======= =======
- ------------------------------------------------------------------------------------------------------
<FN>
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 June 30, 1999, is presented in Note 10, Financial
Instruments with Off-Balance Sheet Risk, beginning on page 18.
14
15
Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
in millions 1999 1998 1999 1998
- -------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 930 $ 900 $ 900 $ 900
Charge-offs (131) (97) (238) (197)
Recoveries 55 25 81 48
- -------------------------------------------------------------------------------------------------------------------------
Net charge-offs (76) (72) (157) (149)
Provision for loan losses 76 72 187 149
- -------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 930 $ 900 $ 930 $ 900
===== ===== ====== ======
- -------------------------------------------------------------------------------------------------------------------------
7. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
At June 30, 1999, impaired loans totaled $188 million. Included in this amount
are $105 million of impaired loans for which the specifically allocated
allowance for loan losses is $51 million, and $83 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
$193 million, of which $95 million had a specifically allocated allowance of $42
million and $98 million were carried at their estimated fair value. The average
investment in impaired loans for the second quarter of 1999 and 1998 was $200
million and $181 million, respectively.
Nonperforming assets were as follows:
JUNE 30, DECEMBER 31, JUNE 30,
in millions 1999 1998 1998
- -----------------------------------------------------------------------------------------------------
Impaired loans $188 $193 $200
Other nonaccrual loans 188 172 174
- -----------------------------------------------------------------------------------------------------
Total nonperforming loans 376 365 374
Other real estate owned ("OREO") 46 56 62
Allowance for OREO losses (11) (18) (23)
- -----------------------------------------------------------------------------------------------------
OREO, net of allowance 35 38 39
Other nonperforming assets 1 1 4
- -----------------------------------------------------------------------------------------------------
Total nonperforming assets $412 $404 $417
==== ==== ====
- -----------------------------------------------------------------------------------------------------
Impaired loans are evaluated individually. The fair value of any existing
collateral or an estimate of the present value of the future cash flows on the
loan is used to determine the extent of the 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.
15
16
8. LONG-TERM DEBT
The components of long-term debt, presented net of unamortized discount where
applicable, were as follows:
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 1999 1998 1998
- -------------------------------------------------------------------------------------------------------------------------
Senior medium-term notes due through 2005(1) $ 401 $ 419 $ 419
Subordinated medium-term notes due through 2005(1) 133 133 133
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
8.404% Notes due through 2001 34 34 42
8.40% Subordinated capital notes due 1999 -- 75 75
All other long-term debt(8) 5 5 12
- ---------------------------------------------------------------------------------------------------------------------------
Total parent company(9) 1,347 1,440 1,455
Senior medium-term bank notes due through 2004(3) 9,254 7,426 4,794
Senior euro medium-term bank notes due through 2007(4) 1,883 1,441 1,364
6.50 % Subordinated remarketable securities due 2027(5) 313 313 313
6.95% Subordinated notes due 2028(5) 300 300 300
7.125% Subordinated notes due 2006(5) 250 250 250
7.25% Subordinated notes due 2005(5) 200 200 200
6.75% Subordinated notes due 2003(5) 200 200 200
7.50% Subordinated notes due 2008(5) 165 165 165
7.30% Subordinated notes due 2011(5) 107 -- --
7.85% Subordinated notes due 2002(5) 93 200 200
7.55% Subordinated notes due 2006(5) 75 75 75
7.375% Subordinated notes due 2008(5) 70 70 70
Lease financing debt due through 2004(6) 571 574 508
Federal Home Loan Bank advances due through 2029(7) 239 289 263
All other long-term debt(8) 101 24 39
- -----------------------------------------------------------------------------------------------------------------------------------
Total subsidiaries(10) 13,821 11,527 8,741
- -------------------------------------------------------------------------------------------------------------------------
Total long-term debt $15,168 $12,967 $10,196
======= ======= =======
- -------------------------------------------------------------------------------------------------------------------------
Portfolio interest rate swaps, 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 June 30,
1999, is presented in Note 10, Financial Instruments with Off-Balance Sheet
Risk, beginning on page 18.
1 At June 30, 1999, December 31, 1998 and June 30, 1998, the senior
medium-term notes had weighted average interest rates of 6.41%, 6.55% and
6.70%, respectively, and the subordinated medium-term notes had a weighted
average interest rate of 7.09% at each respective date. 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 At June 30, 1999, December 31, 1998 and June 30, 1998, senior medium-term
bank notes of subsidiaries had weighted average interest rates of 5.18%,
5.30% and 5.74%, respectively. These notes had a combination of both fixed
and floating interest rates.
4 At June 30, 1999, December 31, 1998 and June 30, 1998, the senior euro
medium-term bank notes had weighted average interest rates of 5.21%, 5.52%
and 5.45%, respectively. These notes are obligations of KeyBank National
Association ("KeyBank N.A.") issued under Key's $7.0 billion Euronote
Program and had fixed and floating interest rates based on the three-month
London Interbank Offered Rate ("LIBOR"). As of June 30, 1999, the Euronote
Program had an unused capacity of $5.1 billion.
16
17
5 The subordinated notes and securities are all obligations of KeyBank N.A.,
with the exception of the 7.55% notes which are obligations of Key Bank
USA, National Association ("Key Bank USA"). These notes may not be redeemed
prior to their respective maturity dates. The 7.30% notes were issued in
exchange for a portion of the 7.85% notes during the first quarter of 1999.
6 At June 30, 1999, December 31, 1998 and June 30, 1998, lease financing debt
had weighted average interest rates of 6.66%, 6.56% and 7.27%,
respectively, and represented primarily nonrecourse debt collateralized by
lease equipment under operating, direct financing and sales type leases.
7 At June 30, 1999, December 31, 1998 and June 30, 1998, long-term advances
from the Federal Home Loan Bank ("FHLB") had weighted average interest
rates of 5.14%, 5.39% and 6.02%, respectively. These advances had a
combination of both fixed and floating interest rates. Real estate loans
and securities of $357 million, $409 million and $367 million, at June 30,
1999, December 31, 1998 and June 30, 1998, respectively, collateralize FHLB
advances.
8 Other long-term debt at June 30, 1999, December 31, 1998 and June 30, 1998,
consisted of industrial revenue bonds, capital lease obligations and
various secured and unsecured obligations of corporate subsidiaries and had
weighted average interest rates of 6.96%, 7.17% and 8.08%, respectively.
9 At June 30, 1999, unused capacity under the parent company's shelf
registration totaled $1.3 billion, including $750 million reserved for
future issuance as medium-term notes.
10 As of June 30, 1999, the Bank Note Program had an unused capacity of $13.9
billion.
9. 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 separate business trusts, all of whose common
securities are owned by the parent company. The proceeds from the issuances of
the capital securities and common securities were used to purchase debentures of
the parent company. All of the trusts hold solely junior subordinated deferrable
interest 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 (net of discount), common securities and related
debentures are summarized as follows:
PRINCIPAL INTEREST RATE MATURITY
CAPITAL AMOUNT OF OF CAPITAL OF CAPITAL
SECURITIES, COMMON DEBENTURES, SECURITIES AND SECURITIES AND
dollars in millions NET OF DISCOUNT(1) SECURITIES NET OF DISCOUNT(2) DEBENTURES(3) DEBENTURES
- ----------------------------------------------------------------------------------------------------------------------------------
June 30, 1999
KeyCorp Institutional Capital A $350 $11 $ 361 7.826% 2026
KeyCorp Institutional Capital B 150 4 154 8.250 2026
KeyCorp Capital I 247 8 255 5.740 2028
KeyCorp Capital II 247 8 255 6.875 2029
- ----------------------------------------------------------------------------------------------------------------------------------
Total $994 $31 $1,025 7.135% --
==== === ======
- ----------------------------------------------------------------------------------------------------------------------------------
December 31, 1998 $997 $31 $1,028 7.149% --
==== === ======
- ----------------------------------------------------------------------------------------------------------------------------------
June 30, 1998 $997 $31 $1,028 7.242% --
==== === ======
- ----------------------------------------------------------------------------------------------------------------------------------
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 capital securities
issued by the trusts constitute minority interests in the equity accounts
of consolidated subsidiaries and, therefore, qualify as Tier 1 capital
under Federal Reserve Board guidelines.
17
18
2 The parent company has the right to redeem the debentures purchased by
Capital A, Capital B, Capital I and Capital II: (i) in whole or in part, on
or after December 1, 2006, December 15, 2006, July 1, 2008 and March 18,
1999, respectively; and (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). If the
debentures purchased by Capital A or Capital B 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. If the
debentures purchased by Capital II are redeemed prior to maturity, the
redemption price will be equal to the greater of: (i) 100% of the principal
amount plus any accrued but unpaid interest or (ii) the sum of the present
values of principal and interest payments discounted at the Treasury Rate
(as defined in the applicable offering circular) plus 20 basis points, plus
any accrued but unpaid interest. The price of redemptions which occur in
response to tax or capital treatment events is generally slightly more
favorable than that available under other circumstances described above.
3 The interest rates for Capital A, Capital B and Capital II 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 June 30, 1999, December 31, 1998 and June
30, 1998, are weighted average rates.
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 clients 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 clients to provide
financing at predetermined terms as long as the client continues to meet
specified criteria. Loan commitments serve to meet the financing needs of
clients 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 client 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 clients by
assuring the clients' 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.
18
19
The following is a summary of the contractual amount of each class of
lending-related, off-balance sheet financial instrument outstanding wherein
Key's maximum possible accounting loss equals the contractual amount of the
instruments.
JUNE 30, DECEMBER 31, JUNE 30,
in millions 1999 1998 1998
- ---------------------------------------------------------------------------------------------------------------
Loan commitments:
Credit card lines $ 6,316 $ 6,320 $ 6,849
Home equity 4,637 4,347 4,528
Commercial real estate and construction 1,939 2,046 1,487
Commercial and other 21,891 20,995 20,751
- ---------------------------------------------------------------------------------------------------------------
Total loan commitments 34,783 33,708 33,615
Other commitments:
Standby letters of credit 1,812 1,834 1,529
Commercial letters of credit 180 138 180
Loans sold with recourse 19 21 24
- ---------------------------------------------------------------------------------------------------------------
Total loan and other commitments $36,794 $35,701 $35,348
======= ======= =======
- ---------------------------------------------------------------------------------------------------------------
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. In addition, Key uses
treasury-based interest rate locks to manage the risk associated with
anticipated loan securitizations.
The following table summarizes the notional amount, fair value, maturity,
weighted average rate received and paid, and weighted average strike rate for
the various types of portfolio swaps, caps and floors used by Key.
June 30, 1999
----------------------------------------------------------------------------
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) $ 176 $ 2 .3 7.22% 5.09% N/A
Receive fixed/pay variable-conventional 6,412 (1) 4.8 6.11 5.02 N/A
Pay fixed/receive variable-conventional 3,170 40 4.8 5.27 5.87 N/A
Pay fixed/receive variable-forward starting 618 -- 6.1 5.41 5.56 N/A
Basis swaps 6,119 (17) 1.9 5.07 5.04 N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Total 16,495 24 -- 5.55% 5.21% --
Interest rate caps, collars and corridors:
Caps purchased - one- to three-month LIBOR-based 2,775 5 .7 N/A N/A 5.88%
Collar - one- to three-month LIBOR-based 250 -- 1.6 N/A N/A 4.75 and 6.50
Collar - thirty-year U.S. Treasury-based -- -- -- N/A N/A --
1% payout corridor2 200 -- .4 N/A N/A 6.00 to 7.00
- ------------------------------------------------------------------------------------------------------------------------------------
Total 3,225 5 -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total $19,720 $29 -- -- -- --
======= ===
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, 1998
----------------------------
Notional Fair
dollars in millions Amount Value
- -------------------------------------------------------------------------------------------
Interest rate swaps:
Receive fixed/pay variable-indexed amortizing(1) $ 311 $ 4
Receive fixed/pay variable-conventional 4,325 223
Pay fixed/receive variable-conventional 4,872 (68)
Pay fixed/receive variable-forward starting 10 --
Basis swaps 2,872 19
- ---------------------------------------------------------------------------------------
Total 12,390 178
Interest rate caps, collars and corridors:
Caps purchased - one- to three-month LIBOR-based 3,175 3
Collar - one- to three-month LIBOR-based 250 (1)
Collar - thirty-year U.S. Treasury-based 250 (24)
1% payout corridor(2) 200 --
- ---------------------------------------------------------------------------------------
Total 3,875 (22)
- ---------------------------------------------------------------------------------------
Total $16,265 $156
======= ====
- ---------------------------------------------------------------------------------------
1 Maturity is based upon expected average lives rather than contractual
terms.
2 Payout is indexed to three-month LIBOR.
N/A = Not Applicable
19
20
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,
securities, 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 (a combination of simultaneously purchasing a cap at a
specified strike rate and selling a cap at a higher strike rate) 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 generally enters into
bilateral collateral and master netting arrangements. 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 June 30, 1999, Key had 39
different counterparties to portfolio swaps and swaps entered into to offset the
risk of client swaps. Key had aggregate credit exposure of $154 million to 27 of
these counterparties, with the largest credit exposure to an individual
counterparty amounting to $21 million. As of the same date, Key's aggregate
credit exposure on its interest rate caps and floors totaled $35 million. Based
on management's assessment as of June 30, 1999, 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 $4 million in the second quarter of 1999 and $9 million in
the second quarter of 1998.
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 June 30, 1999, Key was party to $86 million and $90 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 June 30, 1999, 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 34 basis
points). The aggregate fair value of $24 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.
20
21
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 six months of 1999, swaps with a
notional amount of $871 million were terminated, resulting in a deferred gain of
$7 million. During the same period last year, swaps with a notional amount of
$268 million were terminated, resulting in a net deferred loss of $1 million. At
June 30, 1999, Key had a net deferred swap gain of $17 million with a weighted
average life of 3.7 years related to the management of debt and a net deferred
loss of $1 million with a weighted average life of 7.5 years related to the
management of loans.
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
clients) and enters into other positions with third parties that are intended to
mitigate the interest rate risk of the client positions. Interest rate swap
contracts entered into with clients are typically limited to conventional swaps,
as previously described. The client 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 clients 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 June 30, 1999, 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 $431 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 $21 million, $14 million and $2 million,
respectively, for the first six months of 1999 and $32 million, $10 million and
$3 million, respectively, for the first six months of 1998.
21
22
A summary of the notional amount and the respective fair value of derivative
financial instruments held or issued for trading purposes at June 30, 1999, and
on average for the six-month period then ended, is presented below. The positive
fair values represent assets to Key and are recorded in other assets, while the
negative fair values represent liabilities and are recorded in other liabilities
on the balance sheet. The $24.6 billion notional amount of client interest rate
swaps presented in the table includes $11.5 billion of client swaps that receive
a fixed rate and pay a variable rate, $9.4 billion of client swaps that pay a
fixed rate and receive a variable rate and $3.7 billion of basis swaps. As of
June 30, 1999, the client swaps had an average expected life of 5.9 years,
carried a weighted average rate received of 5.89% and had a weighted average
rate paid of 5.80%. Also included in the table below are interest rate swaps and
caps which were executed in connection with the residual interests retained in
the securitization of certain home equity loans.
June 30, 1999 Six months ended June 30, 1999
-------------------------- ----------------------------------------
Notional Fair Average Average
in millions Amount Value Notional Amount Fair Value
- ------------------------------------------------------------------------------------------------------------------------------
Interest rate contracts - client positions:
Swap assets $14,834 $ 267 $13,308 $ 263
Swap liabilities 9,751 (200) 8,997 (187)
Caps and floors purchased 357 1 395 1
Caps and floors sold 471 (2) 520 (1)
Futures purchased 1,029 467 (1)
Futures sold 8,831 15 14,685 16
Interest rate contracts - securitization positions:
Swap assets $ 995 $ 4 $650 $ 1
Caps purchased 1,005 28 650 14
Caps sold 1,005 (28) 650 (14)
Foreign exchange forward contracts:
Assets $1,513 $ 44 $1,305 $ 43
Liabilities 1,272 (38) 1,160 (40)
Treasury-based option contracts:
Options purchased $3,546 $ 72 $3,807 $ 64
Options sold 4,198 (40) 4,820 (51)
- ------------------------------------------------------------------------------------------------------------------------------
22
23
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 June 30, 1999 and 1998, and the related condensed
consolidated statements of income for the three- and six-month periods then
ended, and the condensed consolidated statements of changes in shareholders'
equity and cash flow for the six-month periods ended June 30, 1999 and 1998.
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, 1998, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flow for the year then ended (not presented herein) and in our report
dated January 14, 1999, 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, 1998,
is fairly stated, in all material respects, in relation to the consolidated
balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
July 13, 1999
23
24
ITEM 2. 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
consolidated financial statements and notes thereto, presented on pages 3
through 22.
This report contains forward-looking statements that 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 that 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 for the second quarter of 1999 reflected the strong performance
of its fee-generating businesses, particularly those such as investment banking
and capital markets, brokerage and asset management that continue to benefit
from the October 1998 acquisition of McDonald. Core noninterest income
(noninterest income, excluding certain nonrecurring gains) was up 47% from the
year-ago quarter and comprised 42% of Key's total core revenue (net interest
income plus core noninterest income), up from 41% last quarter and 34% a year
ago. Bolstered by the McDonald acquisition and the impact of initiatives
undertaken earlier this year to strengthen the profitability of its retail
banking unit, Key made continued progress toward its long-term goal of
generating 50% of its revenue from investment advisory and other noninterest
income generating activities. At the same time, Key continues to experience
strong growth in lending, particularly in the home equity and commercial
portfolios, while maintaining a high level of asset quality. Excluding the
impact of sales, average outstanding home equity loans were up an annualized 35%
from the first quarter of 1999, while commercial loan growth exceeded 10% for
the ninth consecutive quarter. Key's asset quality has been stable over the
first six months of 1999 with modest improvement in the second quarter. During
the second quarter, declines were experienced in levels of both nonperforming
loans and net charge-offs.
Key's corporate strategy for the past several years has encompassed continued
reviews of business lines to identify opportunities to generate higher earnings
growth. This aspect of corporate strategy has led to an active program of
selling portfolios and business units that management determines to be of
low-return and/or low-growth potential. The strategy has also led to
acquisitions of businesses that Key's management believes are capable of
achieving double-digit earnings growth rates. The combination of these two
aspects of corporate strategy has resulted in an acceleration of loan growth
without any corresponding increase in deposits. As a partial response to this,
Key has used securitizations to supplement traditional sources of funding.
During the second quarter and consistent with the above strategy, Key entered
into a definitive agreement to sell its Long Island, New York, business,
including 28 KeyCenters with approximately $1.3 billion of deposits and $415
million of loans. Key's Long Island business, while profitable, was constrained
in its ability to grow due to its very small share of the market for deposits
and loans in the greater New York City-Long Island area, the competition for
which has been dominated by major New York City-based financial institutions. A
portion of the proceeds from the transaction, expected to close in the fourth
quarter, will be reinvested in KeyCenters offering a broad range of financial
services products in 25 high-growth markets in the western United States. The
first of these centers opened during July in Sandy, Utah, a suburb of Salt Lake
City. The terms of the Long Island transaction are more fully disclosed in Note
3, Mergers, Acquisitions and Divestitures, beginning on page 8.
The preceding items are reviewed in greater detail in the remainder of this
discussion and in the notes to the consolidated financial statements.
24
25
PERFORMANCE OVERVIEW
The selected financial data set forth in Figure 1 presents certain information
highlighting the financial performance of Key for each of the last five quarters
and the year-to-date periods ended June 30, 1999 and 1998. Some of the items
referred to in this performance overview and in Figure 1 are more fully
described in the following discussion or in the notes to the consolidated
financial statements presented on pages 7 through 22. Unless otherwise
indicated, 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 second quarter of 1999 was $280 million, or $.62 per Common
Share, up from $249 million, or $.56 per Common Share, in the second quarter of
1998. This improvement represents an 11% increase in per share earnings from the
year-ago quarter. On an annualized basis, the return on average equity for the
second quarter of 1999 was 18.16%, compared with 18.47% for the same period last
year. The annualized returns on average total assets were 1.40% and 1.35% for
the second quarters of 1999 and 1998, respectively.
The increase in earnings relative to the second quarter of 1998 resulted from
continued growth in fee income and an increase in taxable-equivalent net
interest income. Noninterest income for the second quarter of 1999 was $526
million, significantly higher than the $380 million recorded a year ago.
Excluding a $15 million gain from the sale of Key's interest in Concord EFS
recorded in the second quarter of 1999 and branch divestiture gains of $33
million recorded in the second quarter of last year, core noninterest income
grew by $164 million, or 47%. Compared with the same period, taxable-equivalent
net interest income rose by $29 million as a $5.1 billion, or 8%, increase in
average earning assets (primarily commercial loans) more than offset a 13 basis
point reduction in the net interest margin to 3.97%. These positive factors were
partially offset by a $115 million, or 19%, increase in noninterest expense and
a $4 million, or 6%, increase in the provision for loan losses. In the second
quarter of both 1999 and 1998, the provision was equal to the level of net loan
charge-offs. Contributing to the growth in noninterest income and expense were
the results of McDonald, acquired in October 1998.
For the first half of 1999, earnings were $573 million, up 18% from $484 million
for the same period last year. On a per Common Share basis, Key's 1999
year-to-date earnings were $1.27, representing a 17% increase from $1.09 for the
first six months of 1998. On an annualized basis, the return on average equity
for the first six months of 1999 was 18.81%, compared with 18.36% for the
comparable year-ago period. The annualized returns on average total assets were
1.45% and 1.34% for the first half of 1999 and 1998, respectively. Affecting
comparative results was a $399 million increase in noninterest income (including
a $110 million increase in nonrecurring gains). In the current year, these gains
were comprised of $15 million from the second quarter sale of Key's interest in
Concord EFS and $134 million from the sale of Key's interest in EPS in the
previous quarter. In the first six months of 1998, branch divestiture gains of
$33 million and $6 million were recorded in the second and first quarters,
respectively. Also contributing to the improvement in year-to-date earnings was
a $63 million increase in taxable-equivalent net interest income. The increase
in total revenue was moderated by a $277 million, or 23%, increase in
noninterest expense. Included in noninterest expense in the first half of 1999
was $23 million of special contributions to the Key sponsored charitable
foundation made in light of the gains realized from the sales of Concord EFS and
EPS. Excluding these contributions and $27 million of other nonrecurring
charges, noninterest expense was up $227 million, or 19%, from the first six
months of last year. The year-to-date increases in both noninterest income and
expense also reflected the impact of the McDonald acquisition. Another factor
partially offsetting the growth in revenue was a higher provision for loan
losses. In the first six months of 1999, the provision exceeded the level of net
loan charge-offs by $30 million and was $38 million higher than that of the
comparable 1998 period, when the provision matched the level of net charge-offs.
25
26
FIGURE 1. SELECTED FINANCIAL DATA
SIX MONTHS ENDED
1999 1998 JUNE 30,
----------------------- --------------------------------- ---------------------
dollars in millions, except per share amounts SECOND FIRST FOURTH THIRD SECOND 1999 1998
- ------------------------------------------------------------------------------------------------------------- --------------------
FOR THE PERIOD
Interest income $ 1,392 $ 1,381 $ 1,411 $ 1,415 $ 1,372 $ 2,773 $ 2,699
Interest expense 695 696 724 734 706 1,391 1,383
Net interest income 697 685 687 681 666 1,382 1,316
Provision for loan losses 76 111 77 71 72 187 149
Noninterest income 526 609 447 392 380 1,135 736
Noninterest expense 717 748 667 628 602 1,465 1,188
Income before income taxes 430 435 390 374 372 865 715
Net income 280 293 260 252 249 573 484
- ------------------------------------------------------------------------------------------------------------- --------------------
PER COMMON SHARE
Net income $ .63 $ .65 $ .58 $ .57 $ .57 $ 1.28 $ 1.10
Net income-assuming dilution .62 .65 .57 .57 .56 1.27 1.09
Cash dividends .26 .26 .235 .235 .235 .52 .47
Book value at period end 13.90 13.63 13.63 12.73 12.55 13.90 12.55
Market price:
High 38.13 34.19 34.06 39.50 44.88 38.13 44.88
Low 29.13 29.69 23.38 24.75 34.44 29.13 31.56
Close 32.13 30.31 32.00 28.88 35.63 32.13 35.63
Weighted average Common Shares (000) 448,037 449,520 449,949 438,856 440,092 448,774 439,345
Weighted average Common Shares and
potential Common Shares (000) 452,733 454,197 454,527 443,750 446,568 453,461 445,707
- ------------------------------------------------------------------------------------------------------------- --------------------
AT PERIOD END
Loans $ 61,971 $ 61,045 $ 62,012 $ 59,444 $ 57,769 $ 61,971 $ 57,769
Earning assets 71,097 70,458 70,240 68,568 66,941 71,097 66,941
Total assets 80,889 79,992 80,020 77,691 75,778 80,889 75,778
Deposits 43,016 41,323 42,583 42,597 41,794 43,016 41,794
Long-term debt 15,168 15,457 12,967 11,353 10,196 15,168 10,196
Shareholders' equity 6,235 6,105 6,167 5,553 5,525 6,235 5,525
Full-time equivalent employees 25,758 25,650 25,862 24,586 24,711 25,758 24,711
Full-service banking offices 965 969 968 961 962 965 962
- ------------------------------------------------------------------------------------------------------------- --------------------
PERFORMANCE RATIOS
Return on average total assets 1.40% 1.49% 1.31% 1.32% 1.35% 1.45% 1.34%
Return on average equity 18.16 19.48 17.12 18.14 18.47 18.81 18.36
Efficiency(1) 59.26 60.22 58.66 58.09 59.02 59.73 58.61
Overhead(2) 29.97 33.19 32.37 34.25 38.07 31.57 37.11
Net interest margin (TE) 3.97 3.95 3.99 4.08 4.10 3.96 4.12
- ------------------------------------------------------------------------------------------------------------- --------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.71% 7.63% 7.71% 7.15% 7.29% 7.71% 7.29%
Tangible equity to tangible assets 5.95 5.86 5.93 5.79 5.91 5.95 5.91
Tier 1 risk-adjusted capital 7.48 7.44 7.21 7.01 7.15 7.48 7.15
Total risk-adjusted capital 11.74 11.92 11.69 11.61 11.86 11.74 11.86
Leverage 7.41 7.21 6.95 6.88 7.04 7.41 7.04
- ------------------------------------------------------------------------------------------------------------- --------------------
<FN>
The comparability of the information presented above is affected by certain
mergers, acquisitions and divestitures completed by Key in the time periods
presented. For further information concerning these transactions, refer to Note
3, Mergers, Acquisitions and Divestitures, beginning on page 8.
1 Calculated as noninterest expense (excluding certain nonrecurring charges)
divided by taxable-equivalent net interest income plus noninterest income
(excluding net securities transactions and gains from certain
divestitures).
2 Calculated as noninterest expense (excluding certain nonrecurring charges)
less noninterest income (excluding net securities transactions and gains
from certain divestitures) divided by taxable-equivalent net interest
income.
TE = Taxable Equivalent
26
27
CASH BASIS FINANCIAL DATA
The selected financial data presented in Figure 2 highlights the performance of
Key on a cash basis for each of the last five quarters and the year-to-date
periods ended June 30, 1999 and 1998. The data presented has been adjusted to
exclude the amortization of goodwill and other intangibles that do not qualify
for Tier 1 capital treatment, as well as the related assets. These
non-qualifying intangibles resulted from business combinations recorded by Key
under the purchase method of accounting. Had these business combinations
qualified for accounting under the pooling of interests method, no intangible
assets would have been recorded. Since the amortization of goodwill and other
non-qualifying 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. As defined above and presented in Figure 2, cash basis financial data
have not been adjusted to exclude the impact of other noncash items such as
depreciation, the provision for loan losses and restructuring charges. 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
SIX MONTHS ENDED
1999 1998 JUNE 30,
---------------------- -------------------------------- ---------------------
dollars in millions, except per share amounts SECOND FIRST FOURTH THIRD SECOND 1999 1998
- -------------------------------------------------------------------------------------------------------------- ---------------------
FOR THE PERIOD
Noninterest expense $ 693 $ 719 $ 644 $ 608 $ 581 $ 1,412 $ 1,145
Income before income taxes 454 464 413 394 393 918 758
Net income 302 319 281 270 267 621 521
- ------------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .67 $ .71 $ .63 $ .61 $ .61 $ 1.38 $ 1.19
Net income - assuming dilution .66 .71 .62 .61 .60 1.37 1.17
Weighted average Common Shares (000) 448,037 449,520 449,949 438,856 440,092 448,774 439,345
Weighted average Common Shares and potential
Common Shares (000) 452,733 454,197 454,527 443,750 446,568 453,461 445,707
- ------------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.54% 1.65% 1.44% 1.43% 1.47% 1.60% 1.46%
Return on average equity 25.89 28.14 24.02 24.43 25.08 26.99 25.23
Efficiency(1) 57.27 57.73 56.64 56.24 56.96 57.50 56.49
- ------------------------------------------------------------------------------------------------------------------------------------
GOODWILL AND NON-QUALIFYING INTANGIBLES
Goodwill average balance $ 1,437 $ 1,428 $ 1,303 $ 1,042 $ 1,042 $ 1,432 $ 1,052
Non-qualifying intangibles average balance 69 74 81 85 96 72 99
Goodwill amortization (after tax) 20 21 18 15 15 41 31
Non-qualifying intangibles amortization (after tax) 2 5 3 3 3 7 6
- ------------------------------------------------------------------------------------------------------------------------------------
The comparability of the information presented above is affected by certain
mergers, acquisitions and divestitures completed by Key in the time periods
presented. For further information concerning these transactions, refer to Note
3, Mergers, Acquisitions and Divestitures, beginning on page 8.
(1) Calculated as noninterest expense (excluding certain nonrecurring charges
and the amortization of goodwill and non-qualifying intangibles) divided by
taxable-equivalent net interest income plus noninterest income (excluding
net securities transactions and gains from certain divestitures).
27
28
LINE OF BUSINESS RESULTS
Presented below is a summary of the comparative financial performance of each of
Key's major lines of business for the three- and six-month periods ended June
30, 1999 and 1998, as well as a summary of significant strategic developments
that occurred within those lines during the first six months of 1999. It should
be read in conjunction with Note 4, Line of Business Results, beginning on page
9. This note provides additional information pertaining to the basis of the
financial results discussed and the nature of the business conducted by each
line of business.
Key's net income by line of business for the three-and six-month periods ended
June 30, 1999 and 1998, is shown in Figure 3.
FIGURE 3 NET INCOME BY LINE OF BUSINESS
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, CHANGE JUNE 30, CHANGE
-------------------- ----------------------- ------------------- --------------------
dollars in millions 1999 1998 AMOUNT PERCENT 1999 1998 AMOUNT PERCENT
- ---------------------------------------------------------------------------------------------------------------------------------
Key Corporate Capital $ 67 $ 54 $ 13 24.1% $134 $111 $ 23 20.7%
Key Consumer Finance 50 25 25 100.0 98 43 55 127.9
Key Community Bank 118 129 (11) (8.5) 247 267 (20) (7.5)
Key Capital Partners(1) 37 34 3 8.8 53 60 (7) (11.7)
- ---------------------------------------------------------------------------------------------------------------------------------
Total segments 272 242 30 12.4 532 481 51 10.6
Reconciling items 8 7 1 N/M 41 3 38 N/M
- ---------------------------------------------------------------------------------------------------------------------------------
Total net income $280 $249 $ 31 12.4% $573 $484 $ 89 18.4%
==== ==== ==== ==== ==== ====
- ---------------------------------------------------------------------------------------------------------------------------------
(1) Prior to the assignment of income and expense to the other lines of
business, as described under the following Key Capital Partners heading,
net income was $51 million and $45 million in the second quarter of 1999
and 1998, respectively, and $80 million in the first six months of both
1999 and 1998.
N/M = Not Meaningful
KEY CORPORATE CAPITAL
During the first six months of 1999, Key Corporate Capital contributed
approximately 24% of Key's consolidated earnings with net income of $134
million. In the same period last year, net income was $111 million, or
approximately 23% of Key's consolidated earnings. The increase in earnings
relative to the prior year reflected higher net interest income resulting from a
24% increase in total average loans as growth occurred in all of Key Corporate
Capital's major business units. Also contributing to the improved earnings was a
$20 million rise in noninterest income, led by higher income from various
investment banking and capital markets activities. Letter of credit fees and
loan fees also enhanced noninterest income growth. Total revenue increased by
$51 million, partially offset by a $4 million increase in the provision for loan
losses and a $9 million increase in noninterest expense. The latter was
primarily attributable to an increase in depreciation and amortization expense,
and higher costs associated with investment banking and capital markets
activities.
KEY CONSUMER FINANCE
During the first six months of 1999, Key Consumer Finance generated net income
of $98 million, or approximately 17% of Key's consolidated earnings, up from $43
million, or approximately 9%, for the same period last year. Primary factors
contributing to improved financial performance were higher levels of net
interest income and noninterest income, as well as a slight reduction in the
provision for loan losses. These positive factors were partially offset by an
increase in noninterest expense. Net interest income increased $43 million as
average loans outstanding rose 16% from the first six months of 1998. The
increase in loans reflected the continuation of strong growth in the home equity
portfolio, as well as the April 1998 acquisition of an $805 million
marine/recreational vehicle installment loan portfolio. Growth in average loans
occurred despite the securitization and sale of an aggregate $2.5 billion of
automobile, home equity and education loans since December 31, 1997, of which
$2.2 billion occurred in 1999. Gains resulting from securitizations accounted
for virtually all of the $51 million increase in noninterest income from the
first six months of 1998. The lower provision for loan losses relative to the
prior year reflected continued improvement in consumer credit quality.
Noninterest expense rose $11 million from the 1998 year-to-date period due in
large part to increases in personnel expense, depreciation and amortization
expense associated with loan servicing, and costs incurred to expand the home
equity business.
28
29
KEY COMMUNITY BANK
Key Community Bank's primary operating units are commercial banking and retail
banking. During 1999, strategic efforts have focused on strengthening sales
generating capabilities and on improving efficiencies in branch-based delivery
costs to support a goal of achieving at least 8% earnings growth in the retail
unit of Key Community Bank. In the first half of 1999, strategies centered on
cross-selling, streamlining deposit product offerings and improving the deposit
pricing structure. Based on progress made through the first six months of the
year, the components of the retail bank initiative are on track to achieve the
targeted growth. Retail progress to date, however, has been modestly offset by
other factors, primary among which are increased commercial loan net charge-offs
and resulting increases in the provision for loan losses.
In the first half of 1999, net income for Key Community Bank totaled $247
million, or approximately 43% of Key's consolidated earnings, compared with $267
million, or 55%, respectively, for the first six months of 1998. The decrease in
earnings relative to the prior year reflected a decline in net interest income,
coupled with increases in both the provision for loan losses and noninterest
expense. These factors were partially offset by growth in noninterest income.
Net interest income declined by $21 million as a moderate increase in average
loans outstanding was more than offset by a lower net interest margin, due
largely to increased reliance on higher-cost funding. The higher cost of funds
reflected the reduction in core deposits stemming from the 1998 divestiture of
46 branch offices with average deposits of approximately $561 million during the
first six months of 1998. The provision for loan losses increased by $15 million
in response to a higher level of net charge-offs in the commercial banking unit
of Key Community Bank, while noninterest expense rose by $13 million due
primarily to an increase in depreciation and amortization expense. Noninterest
income was up $13 million from 1998 with the largest contributions coming from
service charges on deposit accounts, loan fees and investment banking and
capital markets income.
KEY CAPITAL PARTNERS
During the first six months of 1999, Key Capital Partners recorded net income of
$53 million, or approximately 9% of Key's consolidated earnings, compared with
$60 million, or approximately 12%, a year-ago. A significant portion 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 the line
of business principally responsible for maintaining the relationships with
clients who use the products and services offered by Key Capital Partners. Prior
to the aforementioned assignments, Key Capital Partner's net income totaled $80
million (representing 14% of Key's consolidated earnings) in the first six
months of 1999 and $80 million (representing 17% of Key's consolidated earnings)
in the same period last year.
During the first six months of 1999, total revenue for Key Capital Partners rose
by $202 million ($218 million prior to revenue sharing) from the same period a
year ago. This was primarily due to the October 1998 acquisition of McDonald,
but also reflected higher revenue from trust and asset management activities as
a result of new business, the repricing of certain services and the strength of
the securities markets. Weaker demand for derivative products and lower gains
from the sales of certain equity capital investments served to moderate the
overall increase in revenue relative to the prior year. Noninterest expense was
up $210 million ($216 million prior to expense sharing) from the first half of
1998, also due largely to the impact of the McDonald acquisition and the
associated increases in expenses related to personnel, depreciation and
amortization.
RECONCILING ITEMS
The impact on net income from reconciling items shown in Figure 3 is primarily
the result of certain nonrecurring items, as well as charges related to
unallocated nonearning assets of corporate support functions.
For the first half of 1999, noninterest income included a $134 million ($85
million after tax) gain from the sale of Key's 20% interest in EPS and a $15
million ($9 million after tax) gain from the sale of Key's interest in Concord
EFS. Included in noninterest income for the first six months of last year were
branch divestiture gains of $39 million ($22 million after tax). Noninterest
expense for the 1999 year-to-date period included special contributions of $23
million ($15 million after tax) made to the Key sponsored charitable foundation
and $27 million ($17 million after tax) of other nonrecurring charges.
29
30
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 18), 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 40.
In the first quarter of 1999, Key reclassified the distributions on its capital
securities (tax-advantaged preferred securities) from noninterest expense to
interest expense and restated prior quarters to conform to the current
presentation. The capital securities are more fully described in Note 9, Capital
Securities, beginning on page 17. As a result, the net interest margin for each
of the 1998 quarters presented in Figure 4 was reduced by approximately 10 basis
points from that previously reported; a corresponding reduction also occurred in
noninterest expense. As measured using the new classification, net interest
income for the second quarter of 1999 was $704 million, up $29 million, or 4%,
from the same period last year. This improvement reflected an 8% increase in
average earning assets (primarily commercial loans) to $70.9 billion, that more
than offset a 13 basis point reduction in the net interest margin to 3.97%.
Compared with the first quarter of 1999, net interest income increased by $12
million, or an annualized 7%, reflecting moderate increases in both average
earning assets and the net interest margin. 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 was primarily the result
of greater reliance placed on higher-cost funding to support the incremental
increase in loan portfolios and the repricing of core deposits in a low interest
rate environment. The improvement from the prior quarter was largely due to the
combined impact of a change in the mix and repricing of core deposits,
reflecting in part efforts made in 1999 to improve the profitability of the
retail banking unit of Key Community Bank.
Average earning assets for the second quarter totaled $70.9 billion, which was
$5.1 billion, or 8%, higher than the second quarter 1998 level and slightly
above that of the first quarter of 1999. The growth from the year-ago quarter
reflected a $5.2 billion, or 9%, increase in loans with the largest growth
coming from the commercial portfolio. The second quarter of 1999 marked the
ninth consecutive quarter in which this portfolio has achieved annualized growth
exceeding 10%. Also contributing to growth from the second quarter of 1998 were
increases in the home equity, lease financing and installment segments of the
consumer loan portfolio. The growth in earning assets relative to the prior
quarter was primarily due to a $571 million increase in securities available for
sale. The level of average total loans was relatively unchanged in the second
quarter as strong commercial and home equity loan growth was offset by the
impact of consumer loan sales and securitizations completed during the first
half of 1999. Key's strategy with respect to its loan portfolio is discussed in
greater detail in the Loans section beginning on page 40.
Key uses portfolio interest rate swaps, caps and floors (as defined in Note 10,
Financial Instruments with Off-Balance Sheet Risk, beginning on page 18) in the
management of its interest rate sensitivity position. The notional amount of
such swaps increased to $16.5 billion at June 30, 1999, from $12.4 billion at
year-end 1998. Over the same period, the notional amount of interest rate caps
and floors decreased by $650 million to $3.2 billion. For the second quarter of
1999, 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 $4 million to
net interest income and 2 basis points to the net interest margin. For the same
period last year, these instruments increased net interest income by $9 million
and the net interest margin by 6 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 Market Risk Management section.
30
31
FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
SECOND QUARTER 1999 FIRST QUARTER 1999
------------------------------------ -----------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- -------------------------------------------------------------------------------------------------------------------
ASSETS
Loans (1,2)
Commercial, financial and agricultural $17,479 $ 324 7.43% $16,994 $ 314 7.49%
Real estate-- commercial mortgage 7,007 144 8.27 7,176 148 8.36
Real estate-- construction 4,015 81 8.09 3,651 73 8.11
Commercial lease financing 5,889 109 7.39 5,723 103 7.30
- ------------------------------------------------------------------------------------------------------------------
Total commercial loans 34,390 658 7.67 33,544 638 7.71
Real estate-- residential 4,546 87 7.71 4,868 91 7.58
Credit card 1,322 49 14.93 1,377 49 14.43
Other consumer 19,232 421 8.77 19,485 432 8.99
- ------------------------------------------------------------------------------------------------------------------
Total consumer loans 25,100 557 8.90 25,730 572 9.02
Loans held for sale 2,114 39 7.35 2,419 44 7.38
- ------------------------------------------------------------------------------------------------------------------
Total loans 61,604 1,254 8.16 61,693 1,254 8.24
Taxable investment securities 424 3 3.25 375 4 4.33
Tax-exempt investment securities(1) 560 12 8.63 615 13 8.57
- ------------------------------------------------------------------------------------------------------------------
Total investment securities 984 15 6.31 990 17 6.96
Securities available for sale(1,3) 6,575 107 6.46 6,004 97 6.58
Interest-bearing deposits with banks 48 1 10.82 22 1 14.13
Federal funds sold and securities
purchased under resale agreements 445 2 1.89 749 5 2.71
Trading account assets 1,232 20 6.34 1,204 15 5.05
- ------------------------------------------------------------------------------------------------------------------
Total short-term investments 1,725 23 5.32 1,975 21 4.31
- ------------------------------------------------------------------------------------------------------------------
Total earning assets 70,888 1,399 7.91 70,662 1,389 7.97
Allowance for loan losses (919) (888)
Other assets 10,056 10,084
- -------------------------------------------------------------------------------------------------------------------
$80,025 $79,858
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $13,145 96 2.93 $12,540 94 3.04
Savings deposits 2,811 12 1.62 2,899 12 1.68
NOW accounts 743 3 1.45 1,210 4 1.34
Certificates of deposit ($100,000 or more) 3,737 47 5.07 3,646 46 5.12
Other time deposits 11,811 144 4.90 11,814 147 5.05
Deposits in foreign office 1,096 13 4.75 509 6 4.78
- ------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 33,343 315 3.79 32,618 309 3.84
Federal funds purchased and securities
sold under repurchase agreements 5,479 63 4.59 5,077 54 4.31
Bank notes and other short-term borrowings 6,786 88 5.22 9,208 119 5.24
Long-term debt, including capital securities(4) 16,530 229 5.57 15,172 214 5.73
- ------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 62,138 695 4.48 62,075 696 4.55
Noninterest-bearing deposits 8,438 8,495
Other liabilities 3,264 3,188
Common shareholders' equity 6,185 6,100
- ------------------------------------------------------------------------------------------------------------------
$80,025 $79,858
======== =======
Interest rate spread (TE) 3.43 3.42
- ------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 704 3.97% $ 693 3.95%
======== ======= ======== =========
Capital securities $1,162 $21 $1,039 $19
Taxable-equivalent adjustment(1) 7 8
- --------------------------------------------------------------------------------
(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
average loan balances.
(3) Yield is calculated on the basis of amortized cost.
(4) Rate calculation excludes ESOP debt.
TE = Taxable Equivalent
31
32
FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND
YIELDS/RATES (CONTINUED)
FOURTH QUARTER 1998 THIRD QUARTER 1998 SECOND QUARTER 1998
--------------------------- --------------------------- --------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- -------------------------------------------------------------------------------------------------------- --------------------------
ASSETS
Loans(1,2)
Commercial, financial and agricultural $ 16,711 $ 326 7.74% $ 15,815 $ 328 8.23% $ 15,026 $ 309 8.25%
Real estate-- commercial mortgage 7,394 158 8.48 7,034 160 9.02 6,944 153 8.84
Real estate-- construction 3,355 71 8.40 3,052 69 8.97 2,694 62 9.23
Commercial lease financing 5,241 100 7.57 4,933 90 7.24 4,634 86 7.44
- -----------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 32,701 655 7.95 30,834 647 8.32 29,298 610 8.35
Real estate-- residential 5,174 99 7.59 5,274 102 7.67 5,549 108 7.81
Credit card 1,388 52 14.86 1,432 53 14.68 1,449 53 14.67
Other consumer 18,682 421 8.94 17,423 399 9.09 16,742 380 9.10
- -----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 25,244 572 8.99 24,129 554 9.11 23,740 541 9.14
Loans held for sale 2,711 54 7.90 3,596 75 8.27 3,403 70 8.25
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans 60,656 1,281 8.38 58,559 1,276 8.64 56,441 1,221 8.68
Taxable investment securities 334 2 3.53 269 3 4.05 270 4 5.51
Tax-exempt investment securities(1) 668 15 8.91 726 15 8.20 871 18 8.29
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities 1,002 17 6.73 995 18 7.18 1,141 22 7.63
Securities available for sale(1,3) 6,066 99 6.47 6,175 105 6.75 6,765 117 6.94
Interest-bearing deposits with banks 25 -- 13.66 35 1 14.32 22 1 10.33
Federal funds sold and securities
purchased under resale agreements 1,102 11 3.96 951 12 5.01 790 10 4.92
Trading account assets 620 11 7.04 742 11 5.88 610 10 6.42
- ------------------------------------------------------------------------------------------------------------------------------------
Total short-term investments 1,747 22 5.00 1,728 24 5.51 1,422 21 5.92
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 69,471 1,419 8.10 67,457 1,423 8.37 65,769 1,381 8.42
Allowance for loan losses (888) (888) (888)
Other assets 10,385 9,317 9,185
- ------------------------------------------------------------------------------------------------------------------------------------
$ 78,968 $ 75,886 $ 74,066
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $ 12,152 98 3.20 $ 11,783 99 3.33 $ 11,494 95 3.32
Savings deposits 2,983 11 1.46 3,118 14 1.78 3,307 16 1.94
NOW accounts 1,205 5 1.65 1,160 5 1.71 1,250 5 1.60
Certificates of deposit ($100,000 or more) 3,816 52 5.41 3,399 47 5.49 3,502 49 5.61
Other time deposits 11,916 156 5.19 11,965 161 5.34 12,375 166 5.38
Deposits in foreign office 366 5 5.01 954 13 5.41 1,095 15 5.49
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 32,438 327 4.00 32,379 339 4.15 33,023 346 4.20
Federal funds purchased and securities
sold under repurchase agreements 5,205 61 4.65 7,456 99 5.27 6,773 89 5.27
Bank notes and other short-term borrowings 10,171 140 5.46 7,305 108 5.87 7,710 113 5.88
Long-term debt, including capital securities(4) 13,262 196 5.86 12,026 188 6.20 10,277 158 6.17
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 61,076 724 4.70 59,166 734 4.92 57,783 706 4.90
Noninterest-bearing deposits 8,810 8,485 8,328
Other liabilities 3,057 2,724 2,547
Common shareholders' equity 6,025 5,511 5,408
- ------------------------------------------------------------------------------------------------------------------------------------
$ 78,968 $ 75,886 $ 74,066
======== ======== ========
Interest rate spread (TE) 3.40 3.45 3.52
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 695 3.99% $ 689 4.08% $ 675 4.10%
====== ====== ======= ===== ======= ======
Capital securities $ 997 $ 18 $ 997 $ 19 $ 766 $ 14
Taxable-equivalent adjustment(1) 8 8 9
- ------------------------------------------------------------------------------------------------------------------------------------
32
33
FIGURE 5 COMPONENTS OF NET INTEREST INCOME CHANGES
FROM THREE MONTHS ENDED JUNE 30, 1998, FROM SIX MONTHS ENDED JUNE 30, 1998,
TO THREE MONTHS ENDED JUNE 30, 1999 TO SIX MONTHS ENDED JUNE 30, 1999
--------------------------------------------------------------------------------
AVERAGE YIELD/ NET AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE VOLUME RATE CHANGE
- ---------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 108 $ (75) $ 33 $ 268 $(149) $ 119
Taxable investment securities 2 (3) (1) 3 (3) --
Tax-exempt investment securities (7) 1 (6) (14) 2 (12)
Securities available for sale (3) (7) (10) (27) (15) (42)
Short-term investments 4 (2) 2 11 (5) 6
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest income (TE) 104 (86) 18 241 (170) 71
INTEREST EXPENSE
Money market deposit accounts 13 (12) 1 23 (18) 5
Savings deposits (2) (2) (4) (5) (5) (10)
NOW accounts (2) -- (2) (2) (1) (3)
Certificates of deposit ($100,000 or more) 3 (5) (2) 7 (9) (2)
Other time deposits (7) (15) (22) (19) (27) (46)
Deposits in foreign office -- (2) (2) (9) (4) (13)
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 5 (36) (31) (5) (64) (69)
Federal funds purchased and securities sold
under repurchase agreements (16) (10) (26) (40) (25) (65)
Bank notes and other short-term borrowings (13) (12) (25) 22 (27) (5)
Long-term debt, including capital securities 88 (17) 71 174 (27) 147
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest expense 64 (75) (11) 151 (143) 8
- ---------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) $ 40 $ (11) $ 29 $ 90 $ (27) $ 63
===== ===== ===== ===== ===== =====
- ---------------------------------------------------------------------------------------------------------------------------------
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
MARKET RISK MANAGEMENT
Market risk is the exposure to economic loss that arises from changes in the
values of certain market risk sensitive instruments. Types of market risk
include interest rate, foreign exchange and equity price risk (the risk of
economic loss related to equity securities held as assets). Foreign exchange and
equity price risk are not material to Key.
Asset and Liability Management
- ------------------------------
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.
Measurement of Short-term Interest Rate Exposure: The primary tool utilized 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. As of June 30, 1999, based on the results of the simulation model
using the ALCO guidelines, Key would expect its net interest income to increase
by approximately $33 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 $33 million.
33
34
Measurement of 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; the use of
estimates of cash flows is necessary 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.
Despite its limitations, the economic value of equity model does provide
management with a relatively sophisticated tool for evaluating the longer term
effect of possible interest rate movements. 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 fixed rate
interest rate swaps, caps and floors. Key has been operating well within these
guidelines.
Other Sources 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 potential 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 client (either a loan client 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 can be withdrawn on demand. Basis risk
refers to floating-rate assets and floating-rate liabilities that reprice
simultaneously, but are tied to different indices. Basis 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 or
reprice 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.
Management of Interest Rate Exposure: To manage interest rate risk, management
uses interest rate swaps, caps and floors to modify 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 on-balance sheet
alternatives 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 18. In addition, management
strategically selects the interest sensitivity structure of additions to Key's
securities portfolio, new debt issuances and loan securitizations in light of
interest rate risk management objectives.
Portfolio Swaps, Caps and Floors: As shown in Note 10, the estimated fair value
of Key's portfolio swaps, caps and floors decreased to $29 million at June 30,
1999, from a fair value of $156 million at December 31, 1998. The decrease in
fair value over the past six months reflected the combined impact of a number of
factors, including the increase in interest rates, the steepening of the implied
forward yield curve, and the fact that Key's receive fixed interest rate swap
portfolio has a slightly longer average remaining maturity than the pay fixed
portfolio. Swaps with a notional amount of $871 million were terminated during
the first half of 1999, resulting in a deferred gain of $7 million. Further
information pertaining to the balance and remaining amortization period of Key's
deferred swap gains and losses at June 30, 1999, 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. Key continues to use 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 six-month period ended
June 30, 1999, is summarized in Figure 6.
34
35
FIGURE 6 PORTFOLIO SWAPS, CAPS AND FLOORS ACTIVITY
RECEIVE FIXED
------------------------- PAY FIXED- TOTAL CAPS
INDEXED PAY FIXED- FORWARD- BASIS PORTFOLIO AND
in millions AMORTIZING CONVENTIONAL CONVENTIONAL STARTING SWAPS SWAPS FLOORS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998 $311 $4,325 $4,872 $ 10 $2,872 $12,390 $3,875 $16,265
Additions -- 2,776 152 791 3,547 7,266 -- 7,266
Maturities -- 589 1,266 -- 300 2,155 650 2,805
Terminations -- 100 605 166 -- 871 -- 871
Forward-starting becoming effective -- -- 17 (17) -- -- -- --
Amortization 135 -- -- -- -- 135 -- 135
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 1999 $176 $6,412 $3,170 $618 $6,119 $16,495 $3,225 $19,720
===== ======= ======= ===== ======= ======== ======= =======
- ------------------------------------------------------------------------------------------------------------------------------------
A summary of the notional amount and fair values of portfolio swaps, caps and
floors by interest rate management strategy is presented in Figure 7. The fair
value at any given date represents the estimated income (if positive) or cost
(if negative) that would be recognized if the 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. 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 7 PORTFOLIO SWAPS, CAPS AND FLOORS BY INTEREST RATE MANAGEMENT STRATEGY
JUNE 30, 1999 DECEMBER 31, 1998 JUNE 30, 1998
--------------------- -------------------- ---------------------
NOTIONAL FAIR NOTIONAL FAIR NOTIONAL FAIR
in millions AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE
- -----------------------------------------------------------------------------------------------------------------------------------
Convert variable rate loans to fixed $ 1,297 $ 1 $ 1,526 $ 58 $ 3,141 $ 33
Convert fixed rate loans to variable 571 6 909 (38) 592 (16)
Convert fixed rate securities to variable 322 6 -- -- -- --
Convert variable rate deposits and short-term borrowings to fixed 1,250 2 2,378 (24) 2,981 (5)
Convert fixed rate deposits and short-term borrowings to variable 635 (2) 200 -- -- --
Convert variable rate long-term debt to fixed 1,645 26 1,595 (6) 850 (2)
Convert fixed rate long-term debt to variable 4,656 2 2,910 169 2,710 108
Basis swaps - foreign currency denominated debt 321 (18) 304 19 304 (3)
Basis swaps - interest rate indices 5,798 1 2,568 -- 1,500 --
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps 16,495 24 12,390 178 12,078 115
Modify characteristics of variable rate short-term borrowings 2,825 5 3,060 2 3,430 8
Modify characteristics of variable rate long-term debt 400 -- 565 -- 565 1
Modify characteristics of capital securities remarketing -- -- 250 (24) 250 (17)
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio caps and floors 3,225 5 3,875 (22) 4,245 (8)
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $19,720 $ 29 $16,265 $ 156 $16,323 $ 107
======= ======= ======= ====== ======= ======
- -----------------------------------------------------------------------------------------------------------------------------------
The expected average maturities of the portfolio swaps, caps and floors at June
30, 1999, are summarized in Figure 8.
FIGURE 8 EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS, CAPS AND FLOORS
June 30, 1999 RECEIVE FIXED
------------------------ PAY FIXED- TOTAL CAPS
INDEXED PAY FIXED- FORWARD- BASIS PORTFOLIO AND
in millions AMORTIZING CONVENTIONAL CONVENTIONAL STARTING SWAPS SWAPS FLOORS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Mature in one year or less $ 176 $ 1,825 $ 654 -- $ 2,656 $ 5,311 $ 2,275 $ 7,586
Mature after one through five years -- 2,920 1,892 -- 3,463 8,275 950 9,225
Mature after five through ten years -- 1,317 232 $ 501 -- 2,050 -- 2,050
Mature after ten years -- 350 392 117 -- 859 -- 859
- ------------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $ 176 $ 6,412 $ 3,170 $ 618 $ 6,119 $16,495 $ 3,225 $19,720
======= ======= ======= ======= ======= ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------------------
Trading Portfolio Risk Management
- ---------------------------------
Key's trading portfolio includes interest rate swap contracts entered into to
accommodate the needs of its clients, and other positions with third parties
that are intended to mitigate the interest rate risk of the client positions,
foreign exchange contracts entered into to accommodate the needs of its clients
and financial assets and liabilities (trading positions) included in other
assets and other liabilities, respectively, on the balance sheet. Further
information pertaining to off-balance sheet contracts is included in Note 10,
Financial Instruments with Off-Balance Sheet Risk, beginning on page 18.
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36
Key uses 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 June 30, 1999, Key's aggregate
daily VAR was $1 million and averaged $1.9 million for the first six months of
1999. As of June 30, 1998, Key's aggregate daily VAR was $.9 million and
averaged $.7 million for the first six months of 1998. 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 9, noninterest income for the second quarter of 1999 totaled
$526 million, up $146 million, or 38%, from the same period last year. Included
in second quarter 1999 results was a $15 million gain (included in net
securities gains) from the sale of Key's interest in Concord EFS. Excluding this
gain and branch divestiture gains of $33 million recorded in the second quarter
of 1998, noninterest income increased by $164 million, or 47%, and comprised 42%
of total revenue for the quarter, up from 41% last quarter and 34% a year-ago.
The significant improvement over the past year reflected growth in all major
fee-based product categories with the strongest contributions coming from
investment banking and capital markets (up $50 million), insurance and brokerage
(up $35 million) and trust and asset management (up $30 million). The growth of
these three revenue components reflected the impact of the October 1998
acquisition of McDonald, as well as the strength of the securities markets and
new business. Also contributing to the improved results were second quarter 1999
net gains of $18 million recognized in connection with the securitization and
sale of $400 million of home equity loans, and a $10 million increase in letter
of credit and loan fees. Additional detail pertaining to investment banking and
capital markets income, and trust income and assets is presented in Figures 10
and 11, respectively.
For the first six months of 1999, noninterest income totaled $1.1 billion, up
$399 million, or 54%, from the comparable 1998 period. Included in 1999 results
were gains of $15 million from the second quarter sale of Key's interest in
Concord EFS and $134 million (included in gains from other divestitures) from
the sale of Key's interest in EPS in the previous quarter. Excluding these gains
and branch divestiture gains of $39 million recorded during the first half of
1998, noninterest income grew by $289 million, or 41%. The year-to-date increase
was due principally to the growth in insurance and brokerage (up $70 million),
investment banking and capital markets (up $69 million) and trust and asset
management (up $59 million) due largely to the same factors described in the
preceding paragraph. The $50 million increase in net loan securitization gains
resulted from the securitization and sale of $2.2 billion of consumer loans
during the first six months of 1999. The volume of securitizations reflected
Key's desire to diversify its funding sources and the fact that the volatility
experienced in the capital markets during the latter half of 1998 subsided,
providing a more attractive environment for securitizations. Key had delayed
some securitizations previously planned for the 1998 fourth quarter in
anticipation of a more attractive environment.
FIGURE 9 NONINTEREST INCOME
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, CHANGE JUNE 30, CHANGE
-------------------------- ------------------- ------------------ --------------------
dollars in millions 1999 1998 AMOUNT PERCENT 1999 1998 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Trust and asset management income $ 110 $ 80 $ 30 37.5% $ 216 $ 157 $ 59 37.6%
Service charges on deposit accounts 82 75 7 9.3 163 153 10 6.5
Investment banking and capital markets income 100 50 50 100.0 166 97 69 71.1
Insurance and brokerage income 59 24 35 145.8 116 46 70 152.2
Corporate owned life insurance income 27 24 3 12.5 51 47 4 8.5
Credit card fees 21 17 4 23.5 31 32 (1) (3.1)
Net loan securitization gains 18 -- 18 N/M 50 -- 50 N/M
Net securities gains 20 2 18 900.0 24 4 20 500.0
Gains from branch divestitures -- 33 (33) (100.0) -- 39 (39) (100.0)
Gains from other divestitures -- -- -- -- 148 23 125 543.5
Other income:
Letter of credit and loan fees 24 14 10 71.4 44 31 13 41.9
Electronic banking fees 14 12 2 16.7 26 21 5 23.8
Loan securitization servicing fees 8 8 -- -- 15 18 (3) (16.7)
Mortgage banking income 1 1 -- -- 2 3 (1) (33.3)
Gains from sales of loans 12 13 (1) (7.7) 22 20 2 10.0
Miscellaneous income 30 27 3 11.1 61 45 16 35.6
- ------------------------------------------------------------------------------------------------------------------------------------
Total other income 89 75 14 18.7 170 138 32 23.2
- ------------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 526 $ 380 $ 146 38.4% $1,135 $ 736 $ 399 54.2%
====== ====== ====== ====== ====== ======
- ------------------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
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37
FIGURE 10 INVESTMENT BANKING AND CAPITAL MARKETS INCOME
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, CHANGE JUNE 30, CHANGE
-------------------- -------------------- ------------------ ---------------
dollars in millions 1999 1998 AMOUNT PERCENT 1999 1998 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $ 34 $ 21 $ 13 61.9% $ 71 $ 38 $ 33 86.8%
Investment banking income 45 5 40 800.0 64 15 49 326.7
Equity capital income 15 19 (4) (21.1) 18 34 (16) (47.1)
Foreign exchange income 6 5 1 20.0 13 10 3 30.0
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $100 $ 50 $ 50 100.0% $166 $ 97 $ 69 71.1%
===== ==== ===== ==== ==== =====
- ------------------------------------------------------------------------------------------------------------------------------------
Figure 11 Trust and Asset Management
Three months ended Six months ended
June 30, Change June 30, Change
------------------- -------------------- ----------------- -------------------
dollars in millions 1999 1998 Amount Percent 1999 1998 Amount Percent
- -----------------------------------------------------------------------------------------------------------------------------------
Personal asset management and custody fees $ 45 $41 $ 4 9.8 % $ 93 $ 81 $12 14.8%
Institutional asset management and custody fees 23 22 1 4.5 48 43 5 11.6
Bond services 7 -- 7 N/M 12 -- 12 N/M
All other fees 35 17 18 105.9 63 33 30 90.9
- -----------------------------------------------------------------------------------------------------------------------------------
Total trust and asset management income $110 $80 $30 37.5 % $216 $157 $59 37.6%
==== === ==== ==== ==== ====
dollars in billions
- ---------------------------------------------------------------------------------------------
June 30,
Discretionary assets $ 69 $ 66 $3 4.5 %
Non-discretionary assets 50 49 1 2.0
- ---------------------------------------------------------------------------------------------
Total trust assets $119 $115 $4 3.5 %
==== ==== ===
- -----------------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
NONINTEREST EXPENSE
As shown in Figure 12, noninterest expense for the second quarter of 1999
totaled $717 million, compared with $602 million for the second quarter of 1998.
During the first quarter of 1999, Key reclassified the distributions on its
tax-advantaged preferred securities from noninterest expense to interest expense
and restated prior quarters to conform to the current presentation. These
distributions totaled $21 million and $14 million in the second quarter of 1999
and 1998, respectively. The increase in total noninterest expense from the
year-ago quarter came largely from the impact of the McDonald acquisition
completed in October 1998. Personnel expense grew by $81 million, reflecting the
effect of various incentive programs, as well as merit increases that took
effect on April 1, 1999, for the vast majority of Key's workforce. In addition,
computer processing expense rose by $18 million due primarily to a higher level
of computer software amortization. Additional information pertaining to the
McDonald transaction is disclosed in Note 3, Mergers, Acquisitions and
Divestitures, beginning on page 8. Included in first quarter 1999 expense was a
$20 million special contribution to the Key sponsored charitable foundation made
in light of the gain realized from the sale of EPS, as well as $27 million of
other nonrecurring charges. A related additional contribution of $3 million was
made during the second quarter. Excluding these noncore charges, noninterest
expense for the second quarter increased by $13 million, or an annualized 7%,
from the first quarter of 1999.
For the first six months of 1999, noninterest expense totaled $1.5 billion, up
$277 million, or 23%, from the same period last year. Excluding the special
contributions totaling $23 million and the $27 million of other nonrecurring
charges recorded during the first half of 1999, noninterest expense grew by $227
million, or 19%. This reflected higher costs associated with personnel expense
(up $159 million), computer processing expense (up $32 million) and equipment
expense (up $17 million).
Included in noninterest expense for the second quarter of 1999 was $3 million
($6 million in the second quarter of 1998) of expense incurred in connection
with efforts being undertaken by Key to modify computer information systems to
be Year 2000 compliant. For the first six months of the year, these expenses
totaled $8 million ($12 million for the first six months of 1998). Further
information pertaining to the Year 2000 issue and the status of Key's efforts to
address it is included under the Year 2000 heading on page 38.
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38
The efficiency ratio, which provides a measure of the extent to which recurring
revenues are used to pay operating expenses, was 59.26% for the second quarter,
compared with 60.22% for the first quarter of 1999 and 59.02% for the second
quarter of 1998. The increase in the ratio over the past year was primarily due
to the impact of the October 1998 acquisition of McDonald. This ratio improved,
however, during the second quarter as core revenue continued to show strong
growth, while noninterest expense was held to a modest increase. Included in
other expense are equity- and gross receipts-based taxes that are assessed in
lieu of an income tax in certain states in which Key operates. These taxes,
which are shown in Figure 12, represented 74, 69 and 87 basis points of Key's
efficiency ratio for the second quarter of 1999, the first quarter of 1999 and
the second quarter of 1998, 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.
FIGURE 12 NONINTEREST EXPENSE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, CHANGE JUNE 30, CHANGE
------------------ ----------------- ---------------- -----------------
dollars in millions 1999 1998 AMOUNT PERCENT 1999 1998 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------------
Personnel $383 $302 $ 81 26.8% $ 755 $ 596 $159 26.7%
Net occupancy 58 56 2 3.6 117 112 5 4.5
Equipment 49 45 4 8.9 105 88 17 19.3
Computer processing 59 41 18 43.9 113 81 32 39.5
Marketing 24 28 (4) (14.3) 49 56 (7) (12.5)
Amortization of intangibles 26 22 4 18.2 54 45 9 20.0
Professional fees 17 15 2 13.3 32 32 -- --
Other expense:
Postage and delivery 18 19 (1) (5.3) 37 37 -- --
Telecommunications 14 14 -- -- 28 27 1 3.7
Equity- and gross receipts-
based taxes 9 9 -- -- 17 18 (1) (5.6)
Miscellaneous 60 51 9 17.6 158 96 62 64.6
- ----------------------------------------------------------------------------------------------------------------
Total other expense 101 93 8 8.6 240 178 62 34.8
- ----------------------------------------------------------------------------------------------------------------
Total noninterest expense $717 $602 $115 19.1% $1,465 $1,188 $277 23.3%
==== ==== ==== ====== ====== ====
Full-time equivalent
employees at period end 25,758 24,711 25,758 24,711
Efficiency ratio(1) 59.26% 59.02% 59.73% 58.61%
Overhead ratio(2) 29.97 38.07 31.57 37.11
- ----------------------------------------------------------------------------------------------------------------
(1) Calculated as noninterest expense (excluding certain nonrecurring charges)
divided by taxable-equivalent net interest income plus noninterest income
(excluding net securities transactions and gains from certain
divestitures).
(2) Calculated as noninterest expense (excluding certain nonrecurring charges)
less noninterest income (excluding net securities transactions and gains
from certain divestitures) divided by taxable-equivalent net interest
income.
Year 2000
- ---------
During the first six months of 1999, Key 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 in 1995, including the
formation of a team consisting of internal resources and third-party experts.
The plan 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 substantially complete. As of June 30,
1999, Key had completed all phases of Year 2000 readiness testing for its
mission critical systems and is well-along in completing the remaining steps for
which regulatory deadlines have been established.
As a financial institution, Key may experience increases in problem loans and
credit losses in the event that borrowers fail to properly respond to this
issue. In addition, financial institutions may incur higher funding costs if
consumers react to publicity about the issue by withdrawing deposits. They also
could be impacted if third parties they deal with in conducting their business,
such as foreign banks, governmental agencies, clearing houses, telephone
companies and other service providers fail to properly address this issue.
38
39
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 has been surveying significant credit clients 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
programs have been established and the adequacy of the allowance for loan losses
is being assessed on an ongoing basis. The results of the assessment will be
reflected in the assignment of an appropriate risk rating in Key's loan grading
system. On an ongoing basis, Key is also contacting other significant parties
with which it conducts business to determine the status of their Year 2000
compliance efforts.
Despite the actions taken by Key, there can be no assurance that significant
clients or other critical parties will adequately address their Year 2000
issues. Consequently, Key has developed contingency plans to help mitigate the
risks associated with potential delays in completing the renovation, validation
and implementation phases of its Year 2000 plan, as well as the potential
failure of external parties to adequately address their Year 2000 issues. In
accordance with regulatory guidelines, these plans had been completed as of June
30, 1999, and address primarily contingency solutions for Key's core systems and
the identification of alternative business partners. In addition, during the
first half of 1999, Key increased its borrowing capacity with the Federal
Reserve Bank to address the potential need for additional funding as the Year
2000 approaches. Because the Year 2000 issue has never occurred, it is not
possible to foresee or quantify the possible overall financial and operational
impact and/or to determine whether it will be material to the financial
condition or operations of Key.
As of June 30, 1999, Key had recognized approximately $47 million of its total
estimated project cost of up to $50 million. It is currently expected that the
estimated remaining cost of up to $3 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.
INCOME TAXES
The provision for income taxes was $150 million for the three-month period ended
June 30, 1999, up from $123 million for the same period in 1998. The effective
tax rate (provision for income taxes as a percentage of income before income
taxes) for the 1999 second quarter was 34.9% compared with 32.9% for the second
quarter of 1998. For the first six months of 1999, the provision for income
taxes was $292 million compared with $231 for the first six months of last year.
The effective tax rate for these periods was 33.8% and 32.3%, 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, and a second
quarter 1999 catch-up adjustment related to certain investments in low-income
housing projects. The effective income tax rate remains below the statutory
Federal rate of 35% due primarily to continued investment in tax-advantaged
assets (such as tax-exempt securities and corporate owned life insurance) and
the recognition of credits associated with investments in low-income housing
projects.
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40
FINANCIAL CONDITION
LOANS
At June 30, 1999, total loans outstanding were $62.0 billion compared with $62.0
billion at December 31, 1998, and $57.8 billion at June 30, 1998.
The $4.2 billion, or 7%, increase in loans outstanding from the June 30, 1998,
level was due primarily to internal growth, but also included the net impact of
acquisitions, sales and divestitures. The sales and divestitures which occurred
during 1999 and 1998 are summarized in Figure 13 and include the impact of
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 did not meet Key's return on equity, credit or other internal standards.
Activity since June 30, 1998, included the sales of $1.2 billion of education
loans (of which $799 million was associated with securitizations), $1.3 billion
of home equity loans (of which $1.1 billion was associated with
securitizations), $555 million of automobile loans (all of which were associated
with securitizations), $147 million of commercial real estate loans and $500
million of residential real estate loans. Securitizations are considered an
alternative funding source and the extent to which they are used is dependent
upon whether conditions in the capital markets make them more attractive as a
funding source than on-balance sheet alternatives. During the first quarter of
1999, Key benefited from a record high volume of loan securitizations ($1.8
billion) as the capital markets volatility experienced during the last half of
1998 subsided. 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.
FIGURE 13 LOANS SOLD AND DIVESTED
COMMERCIAL RESIDENTIAL BRANCH
in millions EDUCATION AUTOMOBILE HOME EQUITY REAL ESTATE REAL ESTATE DIVESTITURES TOTAL
- -----------------------------------------------------------------------------------------------------------------------------------
1999
- ---------------------
Second quarter $132 -- $442 $ 63 $292 -- $ 929
First quarter 818 $555 428 84 208 -- 2,093
- -----------------------------------------------------------------------------------------------------------------------------------
$950 $555 $870 $147 $500 -- $3,022
==== ==== ==== ==== ==== ==== ======
1998
- ---------------------
Fourth quarter $ 29 -- $ 48 -- -- -- $ 77
Third quarter 201 -- 374 -- -- -- 575
Second quarter 45 -- 53 $167 -- $124 389
First quarter 71 -- -- -- -- 20 91
- -----------------------------------------------------------------------------------------------------------------------------------
Total $346 -- $475 $167 -- $144 $1,132
==== ==== ==== ==== ======
- -----------------------------------------------------------------------------------------------------------------------------------
Excluding the net impact of acquisitions, sales and divestitures, loans (other
than one-to-four family mortgage loans and loans held for sale) increased by
$8.3 billion, or 18%, since June 30, 1998, and $3.0 billion, or an annualized
11%, from the 1998 year end. Key's policy regarding new originations of
one-to-four family mortgage loans is to originate such loans as a client 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 $4.8 billion, due
primarily to a $2.3 billion increase in commercial, financial and agricultural
loans and increases of $1.3 billion and $1.2 billion in the real
estate-construction and lease financing portfolios, respectively. Additionally,
consumer loans rose by $3.5 billion, and included increases of $2.3 billion and
$918 million in the home equity and lease financing portfolios, respectively.
The strong growth in loans over the past twelve months reflected a number of
factors, including the continued strength of the economy, improving consumer
credit, targeted efforts to increase the commercial and home equity portfolios
and Key's success in leveraging its Leasetec operation.
Loans outstanding were unchanged from the December 31, 1998, level as the volume
of loans securitized and sold during the first six months of 1999 offset the
level of new loan originations. Excluding the impact of the 1999 loan sales
shown in Figure 13, loans (other than one-to-four family mortgage loans and
loans held for sale) grew by $3.0 billion, or an annualized 11%, during the
first half of 1999. Consumer loans accounted for $1.3 billion of the increase
with the
40
41
largest growth occurring in the home equity (up $1.1 billion) and lease
financing (up $317 million) portfolios. Commercial loans contributed $1.7
billion to the year-to-date increase due to an $878 million increase in
commercial, financial and agricultural loans and increases of $703 million and
$430 million in the real estate-construction and lease financing portfolios,
respectively. On the same basis, the aggregate annualized growth rate of average
outstanding balances in the commercial loan portfolio was 10% for the second
quarter of 1999, representing the ninth consecutive quarter of double-digit
commercial loan growth.
Shown in Figure 14 are loans that 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 other 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. The
increase in these balances since the 1998 year end reflected the impact of
securitizations, offset in part by loan repayments.
FIGURE 14 LOANS SECURITIZED/SOLD AND ADMINISTERED OR SERVICED
JUNE 30, DECEMBER 31, JUNE 30,
in millions 1999 1998 1998
- --------------------------------------------------------------------------------------------
Education loans $2,785 $2,312 $2,438
Automobile loans 1,153 946 1,299
Home equity loans 1,392 744 567
- --------------------------------------------------------------------------------------------
Total $5,330 $4,002 $4,304
======= ======= ======
- --------------------------------------------------------------------------------------------
SECURITIES
At June 30, 1999, the securities portfolio totaled $7.4 billion and was
comprised of $6.4 billion of securities available for sale and $967 million of
investment securities. This compares with a total portfolio of $6.3 billion,
including $5.3 billion of securities available for sale and $976 million of
investment securities, at December 31, 1998. Certain information pertaining to
the composition, yields, and remaining maturities of the securities available
for sale and investment securities portfolios is presented in Figures 15 and 16,
respectively. Additional information pertaining to gross unrealized gains and
losses by type of security is presented in Note 5, Securities, beginning on page
13. As shown in Note 5, the increase in securities available for sale from the
December 31, 1998, level occurred as funds previously held in short-term
investments, such as Federal funds sold and securities purchased under resale
agreements, were reinvested in higher-yielding collateralized mortgage
obligations.
FIGURE 15 SECURITIES AVAILABLE FOR SALE
OTHER RETAINED
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- INTERESTS IN WEIGHTED
AGENCIES AND POLITICAL MORTGAGE BACKED SECURITI- OTHER AVERAGE
dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(1) SECURITIES(1) ZATIONS(1) SECURITIES TOTAL YIELD(2)
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 1999
Remaining maturity:
One year or less $ 24 $ 1 $ 792 $ 3 -- $ 18 $ 838 6.77%
After one through five years 101 19 2,769 1,585 $ 144 18 4,636 6.39
After five through ten years 7 45 140 237 191 11 631 7.74
After ten years 20 2 187 36 -- 54(3) 299 8.21
- ------------------------------------------------------------------------------------------------------------------------------------
Fair value $ 152 $ 67 $3,888 $1,861 $ 335 $ 101 $6,404 --
Amortized cost 152 67 4,029 1,878 348 96 6,570 6.61%
Weighted average yield 5.51% 5.88% 6.45% 6.95% 9.03% 4.30% 6.61% --
Weighted average maturity 3.9 years 6.1 years 3.7 years 5.3 years 3.3 years 8.1 years 4.3 years --
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1998
Fair value $ 422 $ 67 $2,211 $2,151 $ 328 $ 99 $5,278 --
Amortized cost 420 65 2,191 2,123 345 84 5,228 6.69%
- ------------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 1998
Fair value $ 145 $ 77 $3,201 $2,603 $ 382 $ 74 $6,482 --
Amortized cost 143 76 3,182 2,564 409 61 6,435 7.05%
- ------------------------------------------------------------------------------------------------------------------------------------
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.
41
42
FIGURE 16 INVESTMENT SECURITIES
STATES AND WEIGHTED
POLITICAL OTHER AVERAGE
dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(1)
- ----------------------------------------------------------------------------------------------------------------
JUNE 30, 1999
Remaining maturity:
One year or less $142 $ 1 $143 8.08%
After one through five years 251 98 349 8.26
After five through ten years 103 -- 103 9.56
After ten years 19 353(2) 372 3.58
- ----------------------------------------------------------------------------------------------------------------
Amortized cost $515 $452 $967 6.57%
Fair value 533 452 985 --
Weighted average yield 8.96% 3.85% 6.57% --
Weighted average maturity 3.3 years 7.9 years 5.4 years --
- ----------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1998
Amortized cost $631 $345 $ 976 7.13%
Fair value 659 345 1,004 --
- ----------------------------------------------------------------------------------------------------------------
JUNE 30, 1998
Amortized cost $762 $276 $1,038 7.98%
Fair value 790 276 1,066 --
- ----------------------------------------------------------------------------------------------------------------
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%.
2 Includes equity securities with no stated maturity.
ASSET QUALITY
Key has 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 relies upon an iterative methodology to estimate the level of the
Allowance on a quarterly and at times more frequent basis, as deemed necessary.
This methodology is described in detail in the Allowance for Loan Losses section
of Note 1, Summary of Significant Accounting Policies, beginning on page 65 of
Key's 1998 Annual Report to Shareholders.
As shown in Figure 17, net loan charge-offs for the second quarter of 1999 were
$76 million, or .49% of average loans, compared with $72 million, or .51% of
average loans, for the same period last year. Net charge-offs in the commercial
loan portfolio rose by $12 million, including increases of $10 million and $5
million in the commercial, financial and agricultural, and commercial lease
financing sectors, respectively. This reflected the significant growth that has
occurred in this portfolio over the past year, as well as the charge-off of
three specific credits aggregating $10 million during the second quarter of
1999. The increase in commercial loan net charge-offs was largely offset by a
decline in the level of net charge-offs in the consumer loan portfolio. Net
charge-offs in the credit card sector decreased by $7 million as a result of
higher recoveries, the improvement in consumer credit and a lower volume of
credit card receivables. Small improvements were also experienced in the
installment loan portfolios. At $76 million, the provision for loan losses
matched the level of net charge-offs in accordance with management's policy of
generally maintaining the provision at a level equal to or above net
charge-offs.
42
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FIGURE 17 SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
dollars in millions 1999 1998 1999 1998
- --------------------------------------------------------------------------------------------------------------
Average loans outstanding during the period $61,604 $56,441 $61,648 $55,200
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $930 $900 $900 $900
Loans charged off:
Commercial, financial and agricultural 36 19 58 35
Real estate-commercial mortgage 1 4 1 8
Real estate-construction -- 1 -- 1
Commercial lease financing 7 1 9 2
- --------------------------------------------------------------------------------------------------------------
Total commercial loans 44 25 68 46
Real estate-residential mortgage 4 1 6 5
Home equity 2 1 5 3
Credit card 25 27 51 54
Consumer-direct 12 12 24 23
Consumer-indirect 44 31 84 66
- --------------------------------------------------------------------------------------------------------------
Total consumer loans 87 72 170 151
- --------------------------------------------------------------------------------------------------------------
131 97 238 197
Recoveries:
Commercial, financial and agricultural 15 8 23 14
Real estate-commercial mortgage 2 3 4 5
Commercial lease financing 1 -- 1 --
- --------------------------------------------------------------------------------------------------------------
Total commercial loans 18 11 28 19
Real estate-residential mortgage 3 1 4 2
Credit card 8 3 11 5
Consumer-direct 4 2 5 4
Consumer-indirect 22 8 33 18
- --------------------------------------------------------------------------------------------------------------
Total consumer loans 37 14 53 29
- --------------------------------------------------------------------------------------------------------------
55 25 81 48
- --------------------------------------------------------------------------------------------------------------
Net loans charged off (76) (72) (157) (149)
Provision for loan losses 76 72 187 149
- --------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $930 $900 $930 $900
==== ==== ==== ====
- --------------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans .49% .51% .51% .54%
Allowance for loan losses to period end loans 1.50 1.56 1.50 1.56
Allowance for loan losses to nonperforming loans 247.34 240.64 247.34 240.64
- --------------------------------------------------------------------------------------------------------------
The Allowance at June 30, 1999, was $930 million, or 1.50% of loans, compared
with $900 million, or 1.56% of loans, at June 30, 1998. Included in the 1999 and
1998 Allowance was $51 million and $23 million, respectively, which was
specifically allocated for impaired loans. For a further discussion of impaired
loans see Note 7, Impaired Loans and Other Nonperforming Assets, on page 15. At
June 30, 1999, the Allowance was 247.34% of nonperforming loans, compared with
240.64% at June 30, 1998.
The composition of nonperforming assets is shown in Figure 18. These assets
totaled $412 million at June 30, 1999, and represented .66% of loans, OREO and
other nonperforming assets compared with $404 million, or .65%, at December 31,
1998. The $8 million rise in the level of nonperforming assets since the 1998
year end reflected an $11 million increase in nonperforming loans, offset in
part by a $3 million decrease in OREO. Over the past two years, the level of
nonperforming assets has ranged from a quarterly 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
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 1999 1998 1998
- -------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 146 $ 144 $ 139
Real estate--commercial mortgage 99 79 93
Real estate--construction 2 6 18
Commercial lease financing 38 29 20
Real estate--residential mortgage 53 60 63
Consumer 38 47 41
- -------------------------------------------------------------------------------------------------------
Total nonperforming loans(1) 376 365 374
OREO 46 56 62
Allowance for OREO losses (11) (18) (23)
- -------------------------------------------------------------------------------------------------------
OREO, net of allowance 35 38 39
Other nonperforming assets 1 1 4
- -------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 412 $ 404 $ 417
===== ===== =====
- -------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 198 $ 178 $ 156
- -------------------------------------------------------------------------------------------------------
Nonperforming loans to period end loans .61% .59% .65%
Nonperforming assets to period end loans plus
OREO and other nonperforming assets .66 .65 .72
- -------------------------------------------------------------------------------------------------------
1 Includes impaired loans of $188 million, $193 million and $200 million at
June 30, 1999, December 31, 1998 and June 30, 1998, 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 second
quarter of 1999, these deposits averaged $36.9 billion and represented 52% of
Key's funds supporting earning assets, compared with $36.8 billion and 56%,
respectively, during the second quarter of 1998. As shown in Figure 4 beginning
on page 31, the mix of core deposits changed over the course of the past year as
decreases in the levels of savings and time deposits were largely offset by
substantial growth in money market deposit accounts. The consistent level and
change in the mix of core deposits reflected the 1998 divestiture of 46 branches
with deposits of approximately $658 million, and investment alternatives pursued
by clients in response to the strength of the securities markets. The increase
in money market deposit accounts that has now occurred over seven consecutive
quarters reflects these client preferences as well as actions taken by
management in 1998 to reprice such deposits.
Purchased funds, which are comprised of large certificates of deposit, deposits
in the foreign office and short-term borrowings, averaged $17.1 billion during
second quarter of 1999, compared with $18.4 billion during the prior quarter and
$19.1 billion a year-ago. As shown in Figure 4, long-term debt, including
capital securities, has been more heavily relied upon to fund earning asset
growth and increased substantially during the second quarter of 1999. This trend
is expected to continue over the remainder of the year. In addition, Key
continues to consider loan securitizations as a funding alternative, provided
capital market conditions are conducive to such activity. During the first six
months of 1999, Key securitized and sold $2.2 billion of consumer loans,
including $400 million of home equity loans during the second quarter.
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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 965
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 Funding and 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 Bank for short-term liquidity requirements
should the need arise. During the second quarter of 1999, KeyBank N.A. increased
its overnight borrowing capacity at the Federal Reserve Bank Discount Window to
approximately $11.0 billion at June 30, 1999, by pledging approximately $10.0
billion of commercial loans as additional collateral. This action was taken as a
precautionary measure in connection with Key's Year 2000 contingency planning
process. In addition, KeyBank USA has overnight borrowing capacity at the
Federal Reserve Bank Discount Window which provides for borrowings of up to $893
million and is secured by $1.3 billion of KeyBank USA's credit card receivables
at June 30, 1999. Neither bank had borrowings outstanding under these facilities
as of June 30, 1999.
During the first six months of 1999, Key's affiliate banks raised $4.5 billion
under Key's Bank Note Program, which provides for the issuance of both long- and
short-term debt of up to $20.0 billion ($19.0 billion by KeyBank N.A. and $1.0
billion by KeyBank USA) in the aggregate. Of the notes issued during the first
half of 1999, $3.0 billion have original maturities in excess of one year and
are included in long-term debt, while $1.5 billion have original maturities of
one year or less and are included in short-term borrowings. At June 30, 1999,
the program had an unused capacity of $13.9 billion.
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 $7.0 billion in the aggregate.
The borrowing capacity under this program was increased from $5.0 billion during
the second quarter of 1999. The notes are offered exclusively to non-U.S.
investors and can be denominated in dollars and/or most European currencies.
There were $1.9 billion of borrowings outstanding under this facility as of June
30, 1999, $440 million of which were 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 June 30, 1999, $336 million of borrowings were outstanding under
the commercial paper program.
The parent company also has a universal shelf registration statement on file
with the Securities and Exchange Commission, which provides for the possible
issuance of up to $1.3 billion of debt and equity securities. At June 30, 1999,
unused capacity under the shelf registration totaled $1.3 billion, including
$750 million reserved for 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 June 30,
1999, 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
six-month periods ended June 30, 1999 and 1998, is presented in the Consolidated
Statements of Cash Flow on page 6.
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46
CAPITAL AND DIVIDENDS
Total shareholders' equity at June 30, 1999, was $6.2 billion, up slightly from
the balance at December 31, 1998, and $710 million, or 13%, from June 30, 1998.
During the first six months of 1999, the increase provided by retained net
income was offset by a net increase in treasury stock, resulting from the share
repurchases discussed below, and net unrealized losses on securities available
for sale. The increase from the June 30, 1998, balance was due primarily to
retained net income and the net decrease in treasury stock resulting from the
shares issued in the McDonald acquisition, also discussed below. Other factors
contributing to the change in shareholders' equity during the first six months
of 1999 are shown in the Consolidated Statements of Changes in Shareholders'
Equity presented on page 5.
During the first half of 1999, Key repurchased 6,406,424 of its Common Shares at
an average price per share of $31.51. This included the repurchase of 3,869,761
shares remaining under the authorization by the Board of Directors to repurchase
up to 60% of the 19,337,159 shares issued in the October 1998 acquisition of
McDonald. The other 2,536,663 shares were repurchased under a separate
repurchase program authorized in January 1998. That authority provides for the
repurchase of up to 10,000,000 shares in open market or negotiated transactions
and has no expiration date. At June 30, 1999, the number of shares remaining
under that authority was 7,463,337. The 43,248,120 shares held in treasury at
June 30, 1999, 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. During the first six months of 1999, Key reissued
1,963,304 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 7.71% at June 30, 1999, and
December 31, 1998, and 7.29% at June 30, 1998.
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 June 30, 1999, were 7.48% and 11.74%,
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% for bank holding companies (such as Key) that either have
the highest supervisory rating or have implemented the Federal Reserve Board's
risk-based capital measure for market risk. All other bank holding companies
must maintain a minimum leverage ratio of at least 4%. At June 30, 1999, Key's
leverage ratio was 7.41%, substantially higher than the minimum requirement.
Figure 19 presents the details of Key's regulatory capital position at June 30,
1999, December 31, 1998, and June 30, 1998.
Under the Federal Deposit Insurance Act, Federal bank regulators group
FDIC-insured depository institutions into the following five categories based on
certain capital ratios: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." Both of Key's affiliate banks qualify as "well capitalized"
at June 30, 1999, 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 bank holding companies,
Key would also qualify as "well capitalized" at June 30, 1999, if the same
provisions were applied. The FDIC-defined capital categories may not constitute
an accurate representation of the overall financial condition or prospects of
Key or its affiliates.
46
47
FIGURE 19 CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 1999 1998 1998
- ------------------------------------------------------------------------------------------------------------------
TIER 1 CAPITAL
Common shareholders' equity(1) $ 6,335 $ 6,137 $ 5,497
Qualifying capital securities 994 747 747
Less: Goodwill (1,446) (1,430) (1,028)
Other intangible assets(2) (64) (71) (79)
- ------------------------------------------------------------------------------------------------------------------
Total Tier 1 capital 5,819 5,383 5,137
- ------------------------------------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(3) 930 900 898
Net unrealized holding gains(4) -- 3 --
Qualifying long-term debt 2,383 2,445 2,487
- ------------------------------------------------------------------------------------------------------------------
Total Tier 2 capital 3,313 3,348 3,385
- ------------------------------------------------------------------------------------------------------------------
Total capital $ 9,132 $ 8,731 $ 8,522
======== ======== ========
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $ 65,923 $ 63,721 $ 60,533
Risk-adjusted off-balance sheet exposure 13,004 12,198 12,267
Less: Goodwill (1,446) (1,430) (1,028)
Other intangible assets(2) (64) (71) (79)
Plus: Market risk-equivalent assets 392 242 171
Net unrealized holding gains(4) -- 3 --
- ------------------------------------------------------------------------------------------------------------------
Gross risk-adjusted assets 77,809 74,663 71,864
Less: Excess allowance for loan losses(3) -- -- (2)
- ------------------------------------------------------------------------------------------------------------------
Net risk-adjusted assets $ 77,809 $ 74,663 $ 71,862
======== ======== ========
AVERAGE QUARTERLY TOTAL ASSETS $ 80,025 $ 78,968 $ 74,066
======== ======== ========
CAPITAL RATIOS
Tier 1 risk-adjusted capital ratio 7.48% 7.21% 7.15%
Total risk-adjusted capital ratio 11.74 11.69 11.86
Leverage ratio(5) 7.41 6.95 7.04
- ------------------------------------------------------------------------------------------------------------------
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) 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 Net unrealized holding gains included in Tier 2 capital are limited to 45% of
net unrealized holding gains on available for sale equity securities with
readily determinable fair values.
5 Tier 1 capital as a percentage of average quarterly total assets, less
goodwill and other non-qualifying intangible assets as defined in 2 above.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information included in the Market Risk Management section beginning on page
33 of the Management's Discussion and Analysis of Financial Condition and
Results of Operations is incorporated herein by reference.
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48
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 known to management and Key's counsel, management
does not believe that there exists any legal action to which KeyCorp or
any of its subsidiaries is a party, or of which their properties are
the subject, that, individually or in the aggregate, will have a
material adverse effect on the financial condition of Key.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the 1999 Annual Meeting of Shareholders of KeyCorp held on May 20,
1999, six directors were elected for three-year terms expiring in 2002,
and shareholders adopted a resolution to ratify the appointment by the
Board of Directors of Ernst & Young LLP as independent auditors for
KeyCorp for the fiscal year ending December 31, 1999. Shareholders
defeated a shareholder proposal requesting necessary steps to cause
annual election of all directors. Director nominees for terms expiring
in 2002 were: Albert C. Bersticker, Edward P. Campbell, Kenneth M.
Curtis, Charles R. Hogan, Bill R. Sanford and Dennis W. Sullivan.
Directors whose term in office as a director continued after the Annual
Meeting of Shareholders were: Cecil D. Andrus, William G. Bares, Dr.
Carol A. Cartwright, Thomas A. Commes, Robert W. Gillespie, Stephen R.
Hardis, Henry S. Hemingway, Douglas J. McGregor, Henry L. Meyer III,
Steven A. Minter, Ronald B. Stafford and Peter G. Ten Eyck, II.
The vote on each issue was as follows:
For Against Abstain
---------------------------------------------------
Election of Directors:
Albert C. Bersticker 372,437,671 * 8,760,300
Edward P. Campbell 372,793,506 * 8,404,465
Kenneth M. Curtis 369,717,337 * 11,480,634
Charles R. Hogan 372,699,637 * 8,482,709
Bill R. Sanford 372,699,037 * 8,489,335
Dennis W. Sullivan 372,879,809 * 8,318,163
Ratification of Ernst & Young as
independent auditors of KeyCorp 374,681,821 4,816,103 1,700,047
Shareholder proposal requesting
necessary steps to cause
annual election of all Directors 165,323,520 166,393,378 5,601,707
*Proxies provide that shareholders may either cast a vote for, or
abstain from voting for, directors.
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ITEM 5. OTHER INFORMATION
On February 10, 1999, the Federal banking agencies published their
final Uniform Retail Credit Classification and Account Management
Policy (the "Retail Credit Policy"), which revises their 1980 Uniform
Policy for Classification of Consumer Installment Credit Based on
Delinquency Status. The Retail Credit Policy applies to all financial
institutions which file call reports or thrift financial reports with a
Federal banking agency.
In general, the Retail Credit Policy establishes a uniform charge-off
policy at 120 and 180 days delinquency for closed-end and open-end
credit, respectively, provides uniform guidance for loans affected by
bankruptcy, fraud, and death, establishes guidelines for re-aging,
extending, deferring, or rewriting past due accounts, classifies
certain delinquent residential mortgage and home equity loans, and
broadens recognition of partial payments that qualify as full payments.
Changes made by the Retail Credit Policy which involve manual
adjustments to an institution's policies and procedures were required
to be implemented by June 30, 1999, while changes involving programming
resources are required to be implemented by December 31, 2000. Key was
not impacted by any changes involving manual adjustments to its
policies and procedures at June 30, 1999. The definitive financial
impact on Key from implementing the Retail Credit Policy will not be
known until December 31, 2000. However, based upon its estimate of
the impact of applying the Retail Credit Policy against Key's existing
retail portfolio, management anticipates that implementing the Retail
Credit Policy at December 31, 2000, will not have a material adverse
effect on Key's financial condition and results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10) KeyCorp 1997 Stock Option Plan for Directors as amended on
April 21, 1999.
(15) Acknowledgment Letter of Independent Auditors
(27) Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
April 16, 1999 - Item 5. Other Events and Item 7. Financial Statements
and Exhibits. Reporting that on April 15, 1999, the Registrant issued a
press release announcing its earnings results for the three-month
period ended March 31, 1999.
No other reports on Form 8-K were filed during the three-month period
ended June 30, 1999.
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50
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
-------------------------------------
(Registrant)
Date: August 12, 1999 /s/ Lee Irving
-------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
50