Back to GetFilings.com
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, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From _______ To _______
Commission File Number 0-850
[KEYCORP LOGO]
-------------------------------------------------------
(Exact name of registrant as specified in its charter)
OHIO 34-6542451
- -------------------------------------- ----------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
- --------------------------------------- ----------------------------
(Address of principal executive offices) (Zip Code)
(216) 689-6300
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicated 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 426,529,863 Shares
--------------------------------------------- ------------------------------
(Title of class) (Outstanding at July 31, 2002)
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS Page Number
------------
Consolidated Balance Sheets --
June 30, 2002, December 31, 2001 and June 30, 2001 3
Consolidated Statements of Income --
Three and six months ended June 30, 2002 and 2001 4
Consolidated Statements of Changes in Shareholders' Equity -- 5
Six months ended June 30, 2002 and 2001
Consolidated Statements of Cash Flow --
Six months ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 31
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 32
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK 65
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 65
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 65
Item 5. OTHER INFORMATION 66
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 67
Signature 68
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- -----------------------------------------------------------------------------------------------------------------------------------
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2002 2001 2001
- -----------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
ASSETS
Cash and due from banks $ 2,929 $ 2,891 $ 2,781
Short-term investments 1,471 1,898 1,961
Securities available for sale 6,349 5,346 6,706
Investment securities (fair value: $1,129, $1,128 and $1,182) 1,119 1,119 1,171
Loans, net of unearned income of $1,746, $1,778 and $1,762 63,881 63,309 66,693
Less: Allowance for loan losses 1,539 1,677 1,231
- -----------------------------------------------------------------------------------------------------------------------------------
Net loans 62,342 61,632 65,462
Premises and equipment 659 687 694
Goodwill 1,105 1,101 1,141
Corporate-owned life insurance 2,359 2,313 2,265
Accrued income and other assets 4,445 3,951 3,657
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 82,778 $ 80,938 $ 85,838
======== ======== ========
LIABILITIES
Deposits in domestic offices:
Money market deposit accounts $ 12,550 $ 12,845 $ 12,531
Savings deposits 2,025 1,918 1,952
NOW Accounts 634 616 535
Certificates of deposit ($100,0000 or more) 4,928 4,493 4,920
Other time deposits 12,995 13,657 14,048
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest bearing 33,132 33,529 33,986
Noninterest-bearing 9,095 9,667 8,376
Deposits in foreign office--interest-bearing 2,578 1,599 3,381
- -----------------------------------------------------------------------------------------------------------------------------------
Total deposits 44,805 44,795 45,743
Federal funds purchased and securities sold under repurchase agreements 5,110 3,735 5,919
Bank notes and other short-term borrowings 3,390 5,549 7,128
Accrued expense and other liabilities 4,742 4,862 4,627
Long-term debt 16,895 14,554 14,675
Corporation-obligated mandatorily redeemable preferred capital securities
of subsidiary trusts holding solely subordinated debentures of
KeyCorp (See Note 11) 1,244 1,288 1,279
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 76,186 74,783 79,371
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 1,383 1,390 1,395
Retained earnings 6,214 5,856 6,159
Loans to ESOP trustee -- -- (13)
Treasury stock, at cost (65,537,753, 67,883,724 and 66,930,892 shares) (1,530) (1,585) (1,560)
Accumulated other comprehensive income (loss) 33 2 (6)
- -----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,592 6,155 6,467
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 82,778 $ 80,938 $ 85,838
======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
3
- -----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
- -----------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------------------------------
dollars in millions, except per share amounts 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 989 $ 1,321 $ 1,974 $ 2,739
Taxable investment securities 7 8 13 15
Tax-exempt investment securities 3 4 6 9
Securities available for sale 96 115 185 235
Short-term investments 7 19 16 39
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest income 1,102 1,467 2,194 3,037
INTEREST EXPENSE
Deposits 231 388 481 848
Federal funds purchased and securities sold under
repurchase agreements 24 52 47 122
Bank notes and other short-term borrowings 20 94 47 199
Long-term debt, including capital securities 144 220 282 467
- -----------------------------------------------------------------------------------------------------------------------------------
Total interest expense 419 754 857 1,636
- -----------------------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 683 713 1,337 1,401
Provision for loan losses 135 401 271 511
- -----------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 548 312 1,066 890
NONINTEREST INCOME
Trust and investment services income 137 132 272 273
Investment banking and capital markets income 68 72 140 137
Service charges on deposit accounts 104 90 204 174
Corporate-owned life insurance income 26 27 52 54
Letter of credit and loan fees 29 30 57 59
Net securities gains 1 8 1 34
Other income 83 39 165 122
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 448 398 891 853
NONINTEREST EXPENSE
Personnel 361 345 724 709
Net occupancy 56 56 113 113
Computer processing 48 63 102 125
Equipment 36 40 70 78
Marketing 30 29 56 56
Amortization of intangibles 2 174 5 200
Professional fees 21 19 42 37
Other expense 111 132 214 238
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 665 858 1,326 1,556
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGES 331 (148) 631 187
Income taxes 85 (12) 145 105
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 246 (136) 486 82
Cumulative effect of accounting changes, net of
tax (See Note 1) -- (24) -- (25)
- -----------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 246 $ (160) $ 486 $ 57
========= ========= ========= =========
Per common share:
Income (loss) before cumulative effect of accounting changes $ .58 $ (.32) $ 1.14 $ .19
Net income (loss) .58 (.38) 1.14 .14
Income (loss) before cumulative effect of accounting
changes--assuming dilution .57 (.32) 1.13 .19
Net income (loss)-- assuming dilution .57 (.38) 1.13 .13
Weighted average common shares outstanding (000) 426,092 424,675 425,477 424,352
Weighted average common shares and potential common
shares outstanding (000) 431,935 429,760 430,983 429,838
- -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
4
- ----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------------
COMMON CAPITAL RETAINED
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 $492 $1,402 $6,352
Net income 57
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $14 (a)
Cumulative effect of change in accounting for
derivative financial instruments, net of income
taxes of ($12)
Net unrealized gains on derivative financial
instruments, net of income taxes of $3
Total comprehensive income
Cash dividends declared on common shares ($.59 per share) (250)
Issuance of common shares:
Acquisition-- 370,830 shares
Employee benefit and dividend reinvestment
plans-- 1,333,158 net shares (7)
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2001 $492 $1,395 $6,159
===== ====== ======
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 $492 $1,390 $5,856
Net income 486
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $9 (a)
Net unrealized gains on derivative financial
instruments, net of income taxes of $5
Foreign currency translation adjustments
Total comprehensive income
Cash dividends declared on common shares ($.30 per share) (128)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 2,345,971 net shares (7)
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2002 $492 $1,383 $6,214
===== ====== ======
- ----------------------------------------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
LOANS TO TREASURY OTHER
ESOP STOCK, COMPREHENSIVE
dollars in millions, except per share amounts TRUSTEE AT COST INCOME (LOSS)
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 $(13) $(1,600) $(10)
Net income
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $14 (a) 20
Cumulative effect of change in accounting for
derivative financial instruments, net of income
taxes of ($12) (22)
Net unrealized gains on derivative financial
instruments, net of income taxes of $3 6
Total comprehensive income
Cash dividends declared on common shares ($.59 per share)
Issuance of common shares:
Acquisition-- 370,830 shares 9
Employee benefit and dividend reinvestment
plans-- 1,333,158 net shares 31
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2001 $(13) $(1,560) $(6)
==== ======= ===
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 -- $(1,585) $ 2
Net income
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $9 (a) 16
Net unrealized gains on derivative financial
instruments, net of income taxes of $5 9
Foreign currency translation adjustments 6
Total comprehensive income
Cash dividends declared on common shares ($.30 per share)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 2,345,971 net shares 55
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2002 -- $(1,530) $ 33
=== ======= ====
- ----------------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
- -------------------------------------------------------------------------------
COMPREHENSIVE
dollars in millions, except per share amounts INCOME(b)
- -------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000
Net income $57
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $14 (a) 20
Cumulative effect of change in accounting for
derivative financial instruments, net of income
taxes of ($12) (22)
Net unrealized gains on derivative financial
instruments, net of income taxes of $3 6
--------
Total comprehensive income $61
===
Cash dividends declared on common shares ($.59 per share)
Issuance of common shares:
Acquisition-- 370,830 shares
Employee benefit and dividend reinvestment
plans-- 1,333,158 net shares
- -------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2001
- -------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001
Net income $486
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $9 (a) 16
Net unrealized gains on derivative financial
instruments, net of income taxes of $5 9
Foreign currency translation adjustments 6
--------
Total comprehensive income $517
=====
Cash dividends declared on common shares ($.30 per share)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 2,345,971 net shares
- -------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2002
- -------------------------------------------------------------------------------
(a) Net of reclassification adjustments.
(b) For the three months ended June 30, 2002 and 2001, comprehensive income
(loss) was $299 million and ($119) million, respectively.
See Notes to Consolidated Financial Statements (Unaudited).
5
- -------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
- -------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30,
-------------------------
in millions 2002 2001
- -------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 486 $ 57
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 271 511
Cumulative effect of accounting changes, net of tax -- 25
Depreciation expense and software amortization 116 144
Amortization of intangibles 5 200
Net securities gains (1) (34)
Net losses from venture capital investments 1 24
Net gains from loan securitizations and sales (9) (13)
Deferred income taxes 63 17
Net decrease in mortgage loans held for sale 68 68
Net increase in trading account assets (155) (288)
Net decrease in accrued restructuring charges (19) (34)
Other operating activities, net (310) (211)
- -------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 516 466
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (1,849) (1,685)
Purchases of loans -- (107)
Proceeds from loan securitizations and sales 775 1,647
Purchases of investment securities (74) (187)
Proceeds from sales of investment securities 18 22
Proceeds from prepayments and maturities of investment securities 75 185
Purchases of securities available for sale (2,803) (4,569)
Proceeds from sales of securities available for sale 292 2,049
Proceeds from prepayments and maturities of securities available for sale 1,514 3,106
Net decrease in other short-term investments 582 211
Purchases of premises and equipment (44) (48)
Proceeds from sales of premises and equipment 7 --
Proceeds from sales of other real estate owned 25 12
Cash used in acquisitions, net of cash acquired (15) (3)
- -------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (1,497) 633
FINANCING ACTIVITIES
Net increase (decrease) in deposits 2 (2,915)
Net increase (decrease) in short-term borrowings (784) 1,140
Net proceeds from issuance of long-term debt, including capital securities 3,943 2,058
Payments on long-term debt, including capital securities (1,915) (1,557)
Net proceeds from issuance of common stock 28 17
Cash dividends paid (255) (250)
- -------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,019 (1,507)
- -------------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 38 (408)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 2,891 3,189
- -------------------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 2,929 $ 2,781
======= =======
- -------------------------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $ 825 $ 1,726
Income taxes paid 159 94
Noncash items:
Derivative assets resulting from adoption of new accounting standard -- $ 120
Derivative liabilities resulting from adoption of new accounting standard -- 152
- -------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited condensed consolidated interim financial statements include the
accounts of KeyCorp and its subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation. Management believes that
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. Some
previously reported results have been reclassified to conform to current
reporting practices. The results of operations for the interim periods are not
necessarily indicative of the results of operations to be expected for the full
year. When you read these financial statements, you should also look at the
audited consolidated financial statements and related notes included in Key's
2001 Annual Report to Shareholders.
As used in these Notes, KEYCORP refers solely to the parent company and KEY
refers to the consolidated entity consisting of KeyCorp and its subsidiaries.
ACCOUNTING PRONOUNCEMENTS ADOPTED IN 2002
EXTINGUISHMENT OF DEBT. Effective April 1, 2002, Key adopted Statement of
Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical
Corrections." This new standard requires the recognition of gains and losses on
the extinguishment of debt as income or loss from continuing operations rather
than extraordinary items. Accordingly, gains or losses from extinguishments of
debt for fiscal years beginning after May 15, 2002, shall not be reported as
extraordinary items unless the extinguishment qualifies as an extraordinary item
under the provisions of Accounting Principles Board Opinion ("APBO") No. 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." In addition, this standard amends SFAS No. 13,
"Accounting for Leases," by requiring that certain modifications to capital
leases be treated as sale-leaseback transactions and modifies the accounting for
sub-leases when the original lessee remains a secondary obligor (or guarantor).
The adoption of this standard did not have any impact on Key's financial
condition and results of operations.
GOODWILL AND OTHER INTANGIBLE ASSETS. "Goodwill" represents the amount by which
the cost of net assets acquired exceeds their fair value. Key's "Other
intangibles" currently represent primarily the net present value of future
economic benefits to be derived from the purchase of core deposits.
Effective January 1, 2002, Key adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." The new standard replaces APBO No. 17, "Intangible Assets,"
and eliminates the amortization of goodwill and intangible assets deemed to have
indefinite lives. This change will reduce Key's noninterest expense and increase
its net income by approximately $80 million, or $.19 per share, for 2002.
Under the new accounting standard, goodwill and certain intangible assets are
subject to impairment testing, which must be conducted at least annually. Key
has determined that its reporting units for purposes of this impairment testing
are its major business groups consisting of Key Consumer Banking, Key Corporate
Finance and Key Capital Partners. The first step in this testing requires Key to
determine the fair value of its reporting units by using various valuation
techniques recommended by the standard. In its transitional impairment testing,
Key used a discounted cash flow methodology for determining the fair value of
its reporting units. These fair values were reviewed for reasonableness using a
relative valuation methodology. The fair value of each reporting unit is
compared with its carrying amount. If the fair value of a particular reporting
unit exceeds its carrying amount, no impairment is indicated and further testing
is not required. If the carrying amount of any reporting unit exceeds its fair
value, goodwill impairment may be indicated and the second step of this testing
is required. Key would assume that the purchase price of the reporting unit is
the fair value as determined in the first step and then allocate that purchase
price to the fair value of the assets (excluding goodwill) and liabilities of
the reporting unit. Any excess of the
7
purchase price over the fair value of the reporting unit's assets and
liabilities represents the implied fair value of goodwill. An impairment loss
would be recognized, as a charge to earnings, to the extent that the carrying
amount of the reporting unit's recorded goodwill exceeds the implied fair value
of goodwill.
Any impairment losses that result from the initial application of SFAS No. 142
would be reported as a "cumulative effect of accounting change" on the income
statement. Transitional impairment tests to determine the amount of any such
losses must be completed no later than December 31, 2002. Key completed its
transitional goodwill impairment testing during the first quarter of 2002, and
determined that no impairment existed as of January 1, 2002. The annual goodwill
impairment testing required by SFAS No. 142 will be performed in the fourth
quarter of each year beginning in 2002. Any future impairment losses would be
recorded as part of income from operations.
For additional information pertaining to Key's intangible assets and the effect
of adopting SFAS No. 142, see Note 8 ("Goodwill and Other Intangible Assets"),
on page 20.
IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. Effective January 1, 2002, Key
adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." The new standard maintains the previous accounting for the impairment
or disposal of long-lived assets, but also establishes more restrictive criteria
that have to be met to classify such an asset as "held for sale." SFAS No. 144
also increases the range of dispositions that qualify for reporting as
discontinued operations and changes the manner in which expected future
operating losses from such operations are to be reported. The adoption of this
standard did not have any impact on Key's financial condition and results of
operations.
CUMULATIVE EFFECT OF ACCOUNTING CHANGES
In 2001, Key adopted new accounting guidance on how to record interest income
and measure impairment on beneficial interests retained in a securitization
transaction accounted for as a sale under SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
As a result, Key recorded a cumulative after-tax loss of $24 million in earnings
for the second quarter of 2001.
Effective January 1, 2001, Key adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This new standard establishes the
appropriate accounting and reporting for derivative instruments and for hedging
activities. As a result of adopting SFAS No. 133, Key recorded cumulative
after-tax losses of $1 million in earnings and $22 million in "other
comprehensive income (loss)" as of January 1, 2001. More information related to
SFAS No. 140 and SFAS No. 133 is disclosed in Note 1 ("Summary of Significant
Accounting Policies"), which begins on page 58 of Key's 2001 Annual Report to
Shareholders.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
ASSET RETIREMENT OBLIGATIONS. In August 2001, the Financial Accounting Standards
Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The
new standard takes effect for fiscal years beginning after June 15, 2002. SFAS
No. 143 addresses the accounting for obligations associated with the retirement
of tangible long-lived assets and requires a liability to be recognized for the
fair value of these obligations in the period they are incurred. Related costs
are capitalized as part of the carrying amounts of the assets to be retired and
amortized over the assets' useful lives. Key will adopt SFAS No. 143 as of
January 1, 2003. Management is evaluating the extent to which it may affect
Key's financial condition and results of operations.
8
2. EARNINGS PER COMMON SHARE
Key calculates its basic and diluted earnings per common share as follows:
THREE MONTHS ENDED JUNE 30,
---------------------------
dollars in millions, except per share amounts 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
EARNINGS
Income (loss) before cumulative effect of accounting changes $246 $(136)
Net income (loss) 246 (160)
- ----------------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 426,092 424,675
Effect of dilutive common stock options (000) 5,843 5,085
- ----------------------------------------------------------------------------------------------------------------------------------
Weighted average common shares and potential
common shares outstanding (000) 431,935 429,760
======= =======
- ----------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Income (loss) per common share before cumulative effect of accounting changes $.58 $(.32)
Net income (loss) per common share .58 (.38)
Income (loss) per common share before cumulative effect of accounting changes
-- assuming dilution(a) .57 (.32)
Net income (loss) per common share--assuming dilution(a) .57 (.38)
- ----------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30,
-------------------------
dollars in millions, except per share amounts 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
EARNINGS
Income (loss) before cumulative effect of accounting changes $486 $82
Net income (loss) 486 57
- ---------------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 425,477 424,352
Effect of dilutive common stock options (000) 5,506 5,486
- ---------------------------------------------------------------------------------------------------------------------------------
Weighted average common shares and potential
common shares outstanding (000) 430,983 429,838
======= =======
- ---------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Income (loss) per common share before cumulative effect of accounting changes $1.14 $.19
Net income (loss) per common share 1.14 .14
Income (loss) per common share before cumulative effect of accounting changes
-- assuming dilution(a) 1.13 .19
Net income (loss) per common share-- assuming dilution(a) 1.13 .13
- ---------------------------------------------------------------------------------------------------------------------------------
(a) Potential common shares outstanding have been excluded from the calculation
of earnings per common share for the three months ended June 30, 2001,
since the effect would be antidilutive.
3. ACQUISITIONS AND DIVESTITURE
Business acquisitions and the divestiture that Key completed during 2001 and the
first six months of 2002 are summarized below.
ACQUISITIONS
- ------------
CONNING ASSET MANAGEMENT
On June 28, 2002, Key purchased substantially all of the mortgage loan and real
estate business of Conning Asset Management, headquartered in Hartford,
Connecticut. Conning's mortgage loan and real estate business originates,
services and securitizes multi-family, retail, industrial and office property
mortgage loans on behalf of pension fund and life insurance company investors.
The business has net assets of $17 million and services approximately $4 billion
in commercial mortgage loans through its St. Louis office. In accordance with a
confidentiality clause in the purchase agreement, the terms, which are not
material, have not been disclosed.
THE WALLACH COMPANY INC.
On January 2, 2001, Key purchased The Wallach Company, Inc., an investment
banking firm headquartered in Denver, Colorado. Key paid the purchase price of
approximately $11 million using a combination of cash and 370,830 Key common
shares. Goodwill of approximately $9 million was recorded and, through December
31, 2001, was being amortized using the straight-line method over a period of 10
years.
DIVESTITURE
- -----------
401(K) RECORDKEEPING BUSINESS
On June 12, 2002, Key sold its 401(k) recordkeeping business. Key recognized a
gain of $3 million ($2 million after tax), which is included in "other income"
on the income statement.
9
4. LINE OF BUSINESS RESULTS
Key has three major business groups that consist of 10 lines of business:
KEY CONSUMER BANKING GROUP
- --------------------------
RETAIL BANKING provides individuals with branch-based deposit, investment and
credit products and personal finance services.
SMALL BUSINESS provides small businesses with deposit, investment and credit
products and business advisory services.
INDIRECT LENDING offers automobile, marine and recreational vehicle (RV) loans
to consumers through dealers, and finances inventory for automobile, marine and
RV dealers. For students and their parents, it also provides education loans,
insurance and interest-free payment plans.
NATIONAL HOME EQUITY provides primarily prime and near-prime mortgage and home
equity loan products to individuals. It originates these products outside of
Key's retail branch system. It also works with mortgage brokers and home
improvement contractors to provide home equity and home improvement solutions.
KEY CORPORATE FINANCE GROUP
- ---------------------------
CORPORATE BANKING provides financing, cash and investment management and
business advisory services to middle-market companies and large corporations.
NATIONAL COMMERCIAL REAL ESTATE provides construction and interim lending,
permanent debt placements and servicing, and equity and investment banking
services to developers, brokers and owner-investors. This line of business deals
exclusively with nonowner-occupied properties.
NATIONAL EQUIPMENT FINANCE meets the equipment leasing needs of companies
worldwide and provides equipment manufacturers, distributors and resellers with
equipment financing options for their clients. Lease financing receivables and
related revenues are assigned to Corporate Banking or National Commercial Real
Estate if one of those businesses is principally responsible for maintaining the
relationship with the client.
KEY CAPITAL PARTNERS GROUP
- --------------------------
VICTORY CAPITAL MANAGEMENT manages or advises on investment portfolios,
nationally, for corporations, labor unions, not-for-profit organizations,
governments and individuals. These portfolios may be managed in separate
accounts, commingled funds or the Victory family of mutual funds. It also
provides administrative services for retirement plans.
HIGH NET WORTH offers financial, estate and retirement planning and asset
management services. Its solutions address the high net worth clients' banking,
brokerage, trust, portfolio management, insurance, charitable giving and related
needs.
CAPITAL MARKETS offers investment banking, capital raising, hedging strategies,
trading and financial strategies to public and privately held companies,
institutions and government organizations.
10
The table that spans pages 12 and 13 shows selected financial data for each
major business group for the three- and six-month periods ended June 30, 2002
and 2001. This table is accompanied by additional supplementary information for
each of the lines of business that comprise these groups. The financial
information was derived from the internal financial reporting system that
management uses to monitor and manage Key's financial performance. Accounting
principles generally accepted in the United States guide financial accounting,
but there is no authoritative guidance for "management accounting"--the way
management uses its judgment and experience to make reporting decisions.
Consequently, the line of business results Key reports may not be comparable
with results presented by other companies. The selected financial data are
based on internal accounting policies designed to compile results on a
consistent basis and in a manner that reflects the underlying economics of the
businesses. As such:
- - Net interest income is determined by assigning a standard cost for funds
used (or a standard credit for funds provided) to assets and liabilities
based on their maturity, prepayment and/or repricing characteristics. The
net effect of this funds transfer pricing is included in the "Other
Segments" columns.
- - Indirect expenses, such as computer servicing costs and corporate overhead,
are allocated based on assumptions of the extent to which each line
actually uses the services.
- - The provision for loan losses reflects credit quality expectations over a
normal business cycle. This "normalized provision for loan losses" does not
necessarily coincide with actual net loan charge-offs at any given point in
the cycle. The level of the consolidated provision is based upon the
methodology that management uses to estimate Key's consolidated allowance
for loan losses. This methodology is described in Note 1 ("Summary of
Significant Accounting Policies") under the heading "Allowance for Loan
Losses," on page 59 of Key's 2001 Annual Report to Shareholders.
- - Income taxes are allocated based on the statutory Federal income tax rate
of 35% (adjusted for tax-exempt interest income, income from
corporate-owned life insurance and tax credits associated with investments
in low-income housing projects) and a blended state income tax rate (net of
the Federal income tax benefit) of 2%.
- - Capital is assigned based on management's assessment of economic risk
factors (primarily credit, operating and market risk).
Developing and applying the methodologies that management uses to allocate items
among Key's lines of business is a dynamic process. Accordingly, financial
results may be revised periodically to reflect accounting enhancements, changes
in the risk profile of a particular business or changes in Key's organization
structure. The financial data reported for all periods presented in the
following tables reflect the following changes that occurred during the first
half of 2002:
- - The Small Business line of business moved from Key Corporate Finance to Key
Consumer Banking.
- - Methodologies used to allocate certain overhead costs were refined.
- - The use of revenue and expense sharing was discontinued. Under this
approach, noninterest income and expense attributable to Key Capital
Partners had been assigned to the other business groups if one of those
groups was principally responsible for maintaining the relationship with
the client that used Key Capital Partner's products and services.
11
THREE MONTHS ENDED JUNE 30, KEY CONSUMER KEY CORPORATE KEY CAPITAL
BANKING GROUP FINANCE GROUP PARTNERS GROUP
--------------------- -------------------- ------------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ 454 $ 459 $ 279 $ 274 $ 57 $ 55
Noninterest income 125 110 46 66 231 237
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) 579 569 325 340 288 292
Provision for loan losses 63 55 44 43 2 3
Depreciation and amortization expense 34 55 10 16 14 25
Noninterest expense 298 282 111 111 205 209
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) and
cumulative effect of accounting change 184 177 160 170 67 55
Allocated income taxes and taxable-equivalent adjustments 69 70 60 65 25 23
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting change 115 107 100 105 42 32
Cumulative effect of accounting change -- (24) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 115 $ 83 $ 100 $ 105 $ 42 $ 32
======== ======== ======== ======== ======== ========
Percent of consolidated net income 47% N/M 40% N/M 17% N/M
Percent of total segments net income 46 N/M 40 N/M 17 N/M
- -----------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 27,935 $ 27,992 $ 29,582 $ 31,437 $ 4,970 $ 5,486
Total assets(a) 30,094 30,781 30,785 32,907 8,325 9,197
Deposits 33,979 35,597 3,094 3,024 3,590 3,803
- -----------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs $ 73 $ 88 $ 124 $ 76 $ 6 $ 7
Return on average allocated equity 23.33% 14.34% 14.25% 15.07% 17.62% 11.97%
- -----------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, KEY CONSUMER KEY CORPORATE KEY CAPITAL
BANKING GROUP FINANCE GROUP PARTNERS GROUP
-------------------- ------------------- -----------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ 899 $ 902 $ 563 $ 535 $ 110 $ 108
Noninterest income 242 229 103 120 455 479
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) 1,141 1,131 666 655 565 587
Provision for loan losses 125 109 89 86 4 5
Depreciation and amortization expense 71 111 21 32 29 49
Noninterest expense 594 568 222 229 406 427
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) and
cumulative effect of accounting changes 351 343 334 308 126 106
Allocated income taxes and taxable-equivalent adjustments 132 136 125 118 47 44
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes 219 207 209 190 79 62
Cumulative effect of accounting changes -- (24) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 219 $ 183 $ 209 $ 190 $ 79 $ 62
======== ======== ======== ======== ======== ========
Percent of consolidated net income 45% 321% 43% 333% 16% 109%
Percent of total segments net income 45 42 42 43 16 14
- -----------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 27,628 $ 28,048 $ 29,671 $ 31,334 $ 4,875 $ 5,523
Total assets(a) 29,795 30,874 30,889 32,797 8,207 9,133
Deposits 34,145 35,863 3,112 3,040 3,631 3,853
- -----------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs $ 155 $ 155 $ 245 $ 117 $ 9 $ 8
Return on average allocated equity 22.41% 15.76% 14.99% 13.76% 16.63% 11.68%
- -----------------------------------------------------------------------------------------------------------------------------------
(a) Substantially all revenue generated by Key's major business groups is
derived from clients resident in the United States. Substantially all
long-lived assets, including premises and equipment, capitalized software
and goodwill, held by Key's major business groups are located in the United
States.
(b) "Reconciling items" include charges related to the funding of unallocated
nonearning assets of corporate support functions. These charges are part of
net interest income and are allocated to the business segments through
noninterest expense.
Noninterest income for the three- and six-month periods ended June 30,
2001, includes a $40 million ($25 million after tax) loss recorded in
connection with declines in leased vehicle residual values.
(c) The provision for loan losses for the three- and six-month periods ended
June 30, 2001, includes an additional provision of $300 million ($189
million after tax) recorded in connection with Key's decision to
discontinue certain credit-only commercial relationships.
12
OTHER SEGMENTS TOTAL SEGMENTS RECONCILING ITEMS KEY
- ------------------------ --------------------- --------------------------- ---------------------
2002 2001 2002 2001 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------
$ (47) $ (37) $ 743 $ 751 $ (22) $ (32) $ 721 $ 719
27 22 429 435 19 (37) 448 398
- -----------------------------------------------------------------------------------------------------------
(20) (15) 1,172 1,186 (3)(b) (69)(b) 1,169 1,117
1 1 110 102 25 299 (c) 135 401
-- -- 58 96 -- 151 (d) 58 247
8 7 622 609 (15) 2 607 611
- -----------------------------------------------------------------------------------------------------------
(29) (23) 382 379 (13) (521) 369 (142)
(21) (19) 133 139 (10) (145) 123 (6)
- -----------------------------------------------------------------------------------------------------------
(8) (4) 249 240 (3) (376) 246 (136)
-- -- -- (24) -- -- -- (24)
- -----------------------------------------------------------------------------------------------------------
$ (8) $ (4) $ 249 $ 216 $ (3) $ (376) $ 246 $ (160)
======== ======== ======== ======== ======== ======== ======== ========
(3)% N/M 101% N/M (1)% N/M 100% N/M
(3) N/M 100 N/M N/A N/A N/A N/A
- -----------------------------------------------------------------------------------------------------------
$ 1,312 $ 1,924 $ 63,799 $ 66,839 $ 129 $ 115 $ 63,928 $ 66,954
10,649 11,579 79,853 84,464 1,707(e) 1,523(e) 81,560 85,987
3,918 2,929 44,581 45,353 (77) (42) 44,504 45,311
- -----------------------------------------------------------------------------------------------------------
-- -- $ 203 $ 171 -- -- $ 203 $ 171
(8.34)% (3.11)% 16.28% 12.99% N/M N/M 15.16% (9.67)%
- -----------------------------------------------------------------------------------------------------------
OTHER SEGMENTS TOTAL SEGMENTS RECONCILING ITEMS KEY
- ------------------------ ------------------------- ----------------------- ---------------------
2002 2001 2002 2001 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------
$ (103) $ (71) $ 1,469 $ 1,474 $ (46) $ (60) $ 1,423 $ 1,414
60 60 860 888 31 (35) 891 853
- ---------------------------------------------------------------------------------------------------------
(43) (11) 2,329 2,362 (15)(b) (95)(b) 2,314 2,267
2 2 220 202 51 309 (c) 271 511
-- -- 121 192 -- 152 (d) 121 344
14 12 1,236 1,236 (31) (24) 1,205 1,212
- ---------------------------------------------------------------------------------------------------------
(59) (25) 752 732 (35) (532) 717 200
(43) (31) 261 267 (30) (149) 231 118
- ---------------------------------------------------------------------------------------------------------
(16) 6 491 465 (5) (383) 486 82
-- (1) -- (25) -- -- -- (25)
- ---------------------------------------------------------------------------------------------------------
$ (16) $ 5 $ 491 $ 440 $ (5) $ (383) $ 486 $ 57
======== ======== ======== ======== ======== ======== ======== ========
(3)% 9% 101% 772% (1)% (672)% 100% 100%
(3) 1 100 100 N/A N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------
$ 1,378 $ 1,982 $ 63,552 $ 66,887 $ 157 $ 106 $ 63,709 $ 66,993
10,618 11,834 79,509 84,638 1,708(e) 1,516(e) 81,217 86,154
3,432 3,291 44,320 46,047 (82) (33) 44,238 46,014
- ---------------------------------------------------------------------------------------------------------
-- -- $ 409 $ 280 -- -- $ 409 $ 280
(8.48)% 2.08% 16.14% 13.27% N/M N/M 15.34% 1.73%
- ---------------------------------------------------------------------------------------------------------
(d) Noninterest expense for the three- and six-month periods ended June 30,
2001, includes a goodwill write-down of $150 million associated with Key's
decision to downsize its automobile finance business, a $20 million ($13
million after tax) increase in litigation reserves and other nonrecurring
charges of $2 million ($1 million after tax).
(e) Total assets represent primarily the unallocated portion of nonearning
assets of corporate support functions.
N/A = Not Applicable
N/M = Not Meaningful
13
Supplementary information (Key Consumer Banking lines of business)
THREE MONTHS ENDED JUNE 30, RETAIL BANKING SMALL BUSINESS INDIRECT LENDING
--------------------------- ---------------------- ----------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 327 $ 327 $ 98 $ 98 $ 94 $ 99
Provision for loan losses 14 12 9 9 28 28
Noninterest expense 204 213 42 43 45 43
Net income (loss) 68 62 30 29 13 (7)
Net loan charge-offs 17 20 15 11 32 32
Return on average allocated equity 49.73% 41.08% 37.86% 33.49% 7.67% (2.45)%
Average full-time equivalent employees 6,016 6,320 269 267 760 807
- ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, NATIONAL HOME EQUITY
-------------------------
dollars in millions 2002 2001
- --------------------------------------------------------------------
Total revenue (taxable equivalent) $ 60 $ 45
Provision for loan losses 12 6
Noninterest expense 41 38
Net income (loss) 4 (1)
Net loan charge-offs 9 25
Return on average allocated equity 3.97% (1.77)%
Average full-time equivalent employees 1,389 1,268
- --------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, RETAIL BANKING SMALL BUSINESS INDIRECT LENDING
--------------------------- ---------------------- -------------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 641 $ 652 $ 195 $ 188 $ 185 $ 205
Provision for loan losses 27 24 18 19 56 54
Noninterest expense 402 428 83 85 93 93
Net income (loss) 132 121 59 52 22 12
Net loan charge-offs 36 33 29 20 70 74
Return on average allocated equity 49.67% 39.82% 38.23% 30.89% 6.70% 2.49%
Average full-time equivalent employees 6,027 6,338 266 273 757 807
- ------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, NATIONAL HOME EQUITY
-------------------------
dollars in millions 2002 2001
- --------------------------------------------------------------------
Total revenue (taxable equivalent) $ 120 $ 86
Provision for loan losses 24 12
Noninterest expense 87 73
Net income (loss) 6 (2)
Net loan charge-offs 20 28
Return on average allocated equity 2.59% (1.14)%
Average full-time equivalent employees 1,399 1,256
- --------------------------------------------------------------------
Supplementary information (Key Corporate Finance lines of business)
THREE MONTHS ENDED JUNE 30, CORPORATE BANKING NATIONAL COMMERCIAL REAL ESTATE
------------------------------ --------------------------------------
dollars in millions 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 177 $ 201 $ 86 $ 95
Provision for loan losses 24 24 11 11
Noninterest expense 72 76 29 27
Net income (loss) 50 62 29 36
Net loan charge-offs 117 68 -- 1
Return on average allocated equity 11.90% 14.96% 16.61% 20.16%
Average full-time equivalent employees 605 713 517 458
- ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, NATIONAL EQUIPMENT FINANCE
-----------------------------------
dollars in millions 2002 2001
- ---------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 62 $ 44
Provision for loan losses 9 8
Noninterest expense 20 24
Net income (loss) 21 7
Net loan charge-offs 7 7
Return on average allocated equity 19.97% 6.80%
Average full-time equivalent employees 606 697
- ---------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CORPORATE BANKING NATIONAL COMMERCIAL REAL ESTATE
---------------------------------------- ---------------------------------------
dollars in millions 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 365 $ 392 $ 176 $ 177
Provision for loan losses 50 48 21 21
Noninterest expense 144 159 58 54
Net income 107 115 61 63
Net loan charge-offs 221 105 3 3
Return on average allocated equity 12.73% 13.84% 17.24% 18.31%
Average full-time equivalent employees 619 730 510 470
- ---------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, NATIONAL EQUIPMENT FINANCE
--------------------------------------
dollars in millions 2002 2001
- ------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 125 $ 86
Provision for loan losses 18 17
Noninterest expense 41 48
Net income 41 12
Net loan charge-offs 21 9
Return on average allocated equity 20.36% 5.96%
Average full-time equivalent employees 607 691
- ------------------------------------------------------------------------------------
14
Supplementary information (Key Capital Partners lines of business)
THREE MONTHS ENDED JUNE 30, VICTORY CAPITAL MANAGEMENT HIGH NET WORTH
------------------------------ --------------------------------
dollars in millions 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 57 $ 60 $ 148 $ 149
Provision for loan losses -- -- 2 3
Noninterest expense 38 40 119 130
Net income 12 12 17 9
Net loan charge-offs -- -- 6 7
Return on average allocated equity 38.15% 34.26% 13.80% 6.95%
Average full-time equivalent employees 539 540 2,514 2,695
- ---------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, CAPITAL MARKETS
------------------------------
dollars in millions 2002 2001
- ------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 83 $ 83
Provision for loan losses -- --
Noninterest expense 62 64
Net income 13 11
Net loan charge-offs -- --
Return on average allocated equity 12.61% 10.68%
Average full-time equivalent employees 616 638
- ------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, VICTORY CAPITAL MANAGEMENT HIGH NET WORTH
--------------------------------- ----------------------------------
dollars in millions 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 110 $ 116 $ 293 $ 306
Provision for loan losses -- -- 4 5
Noninterest expense 77 86 240 263
Net income 21 18 31 22
Net loan charge-offs -- -- 9 8
Return on average allocated equity 32.88% 26.81% 12.42% 8.45%
Average full-time equivalent employees 542 548 2,523 2,682
- ---------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CAPITAL MARKETS
-------------------------------
dollars in millions 2002 2001
- -----------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 162 $ 165
Provision for loan losses -- --
Noninterest expense 118 127
Net income 27 22
Net loan charge-offs -- --
Return on average allocated equity 13.23% 10.46%
Average full-time equivalent employees 625 646
- -----------------------------------------------------------------------------------
15
5. SECURITIES
Key classifies its securities into three categories: trading, investment and
available for sale.
TRADING ACCOUNT SECURITIES. These are debt and equity securities that are
purchased and held by Key with the intent of selling them in the near term, and
certain interests retained in loan securitizations. All of these assets are
reported at fair value ($752 million at June 30, 2002, $597 million at December
31, 2001 and $1.0 billion at June 30, 2001) and included in "short-term
investments" on the balance sheet. Realized and unrealized gains and losses on
trading account securities are reported in "investment banking and capital
markets income" on the income statement.
INVESTMENT SECURITIES. These include debt securities that Key has the intent and
ability to hold until maturity and equity securities that do not have readily
determinable fair values. The debt securities are carried at cost, adjusted for
amortization of premiums and accretion of discounts using the interest method.
This method produces a constant rate of return on the basis of the adjusted
carrying amount.
The equity securities consist mainly of investments held in Key's Principal
Investing unit. Principal investments include direct and indirect investments
predominantly in privately held companies. These investments are carried at
estimated fair value as determined by management. Changes in estimated fair
values and actual gains and losses on sales of these investments are included in
"investment banking and capital markets income" on the income statement.
SECURITIES AVAILABLE FOR SALE. These are debt and equity securities that Key has
not classified as trading account securities or investment securities.
Securities available for sale are reported at fair value. Unrealized gains and
losses (net of income taxes) deemed temporary are recorded in shareholders'
equity as a component of "accumulated other comprehensive income (loss)." Actual
gains and losses on sales of these securities are calculated for each specific
security sold and included in "net securities gains " on the income statement.
When Key retains an interest in loans it securitizes, it bears the risk that the
loans will be prepaid (which would reduce interest income) or not paid at all.
Key accounts for these retained interests (which include both certificated and
uncertificated interests) as debt securities, classifying them as available for
sale or as trading account assets.
The amortized cost, unrealized gains and losses, and approximate fair value of
Key's investment securities and securities available for sale were as follows:
JUNE 30, 2002
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 186 $ 10 -- $ 196
Equity securities 933 -- -- 933
- ---------------------------------------------------------------------------------------------------------------
Total investment securities 1,119 $ 10 -- $1,129
====== ====== ====== ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 22 -- -- $ 22
States and political subdivisions 18 $ 1 -- 19
Collateralized mortgage obligations 5,092 99 $ 79 5,112
Other mortgage-backed securities 823 34 -- 857
Retained interests in securitizations 172 35 -- 207
Other securities 154 1 23 132
- ---------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,281 $ 170 $ 102 $6,349
====== ====== ====== ======
- ---------------------------------------------------------------------------------------------------------------
16
DECEMBER 31, 2001
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 225 $ 9 -- $ 234
Equity securities 894 -- -- 894
- ---------------------------------------------------------------------------------------------------------------
Total investment securities $1,119 $ 9 -- $1,128
====== ====== ====== ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 99 -- -- $ 99
States and political subdivisions 21 -- -- 21
Collateralized mortgage obligations 3,791 $ 86 $ 72 3,805
Other mortgage-backed securities 1,008 24 -- 1,032
Retained interests in securitizations 214 20 -- 234
Other securities 170 1 16 155
- ---------------------------------------------------------------------------------------------------------------
Total securities available for sale $5,303 $ 131 $ 88 $5,346
====== ====== ====== ======
- ---------------------------------------------------------------------------------------------------------------
JUNE 30, 2001
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 262 $ 11 -- $ 273
Equity securities 909 -- -- 909
- ---------------------------------------------------------------------------------------------------------------
Total investment securities $1,171 $ 11 -- $1,182
====== ====== ====== ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 120 $ 1 -- $ 121
States and political subdivisions 28 -- -- 28
Collateralized mortgage obligations 4,877 80 $ 62 4,895
Other mortgage-backed securities 1,192 22 2 1,212
Retained interests in securitizations 252 13 -- 265
Other securities 183 6 4 185
- ---------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,652 $ 122 $ 68 $6,706
====== ====== ====== ======
- ---------------------------------------------------------------------------------------------------------------
17
6. LOANS
Key's loans by category are summarized as follows:
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2002 2001 2001
- ----------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $18,071 $18,159 $19,812
Commercial real estate:
Commercial mortgage 6,266 6,669 6,940
Construction 5,860 5,878 5,744
- ----------------------------------------------------------------------------------------------------------------
Total commercial real estate loans 12,126 12,547 12,684
Commercial lease financing 7,216 7,357 6,930
- ----------------------------------------------------------------------------------------------------------------
Total commercial loans 37,413 38,063 39,426
Real estate-- residential mortgage 2,117 2,315 3,998
Home equity 13,379 11,184 10,666
Consumer-- direct 2,185 2,342 2,448
Consumer-- indirect:
Lease financing 1,386 2,036 2,693
Automobile 2,297 2,497 2,695
Marine 1,917 1,780 1,734
Other 912 1,036 1,142
- ----------------------------------------------------------------------------------------------------------------
Total consumer-- indirect loans 6,512 7,349 8,264
- ----------------------------------------------------------------------------------------------------------------
Total consumer loans 24,193 23,190 25,376
Loans held for sale:
Real estate-- commercial mortgage 281 252 208
Real estate-- residential mortgage 19 116 82
Education 1,975 1,688 1,601
- ----------------------------------------------------------------------------------------------------------------
Total loans held for sale 2,275 2,056 1,891
- ----------------------------------------------------------------------------------------------------------------
Total loans $63,881 $63,309 $66,693
======== ======== ========
- ----------------------------------------------------------------------------------------------------------------
Key uses interest rate swaps to manage interest rate risk; these swaps modify
the repricing and maturity characteristics of certain loans. For more
information about such swaps at June 30, 2002, see Note 14 ("Derivatives and
Hedging Activities"), which begins on page 28.
Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
in millions 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $1,607 $1,001 $1,677 $1,001
Charge-offs (236) (201) (469) (337)
Recoveries 33 30 60 57
- ---------------------------------------------------------------------------------------------------------------------------------
Net charge-offs (203) (171) (409) (280)
Allowance related to loans sold -- -- -- (1)
Provision for loan losses 135 401 271 511
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at end of period $1,539 $1,231 $1,539 $1,231
====== ====== ====== ======
- ---------------------------------------------------------------------------------------------------------------------------------
18
7. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
Impaired loans, which account for the largest portion of Key's nonperforming
assets, totaled $671 million at June 30, 2002, compared with $661 million at the
end of 2001. Impaired loans averaged $678 million for the second quarter of 2002
and $420 million for the second quarter of 2001.
Key's nonperforming assets were as follows:
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2002 2001 2001
- --------------------------------------------------------------------------------------------
Impaired loans $ 671 $ 661 $ 455
Other nonaccrual loans 286 249 342
- --------------------------------------------------------------------------------------------
Total nonperforming loans 957 910 797
Other real estate owned ("OREO") 40 38 27
Allowance for OREO losses (2) (1) (1)
- --------------------------------------------------------------------------------------------
OREO, net of allowance 38 37 26
- --------------------------------------------------------------------------------------------
Total nonperforming assets $ 995 $ 947 $ 823
===== ===== =====
- --------------------------------------------------------------------------------------------
When appropriate, an impaired loan is assigned a specific allowance. Management
calculates the extent of the impairment, which is the carrying amount of the
loan less the estimated present value of future cash flows and the fair value of
any existing collateral. When expected cash flows or collateral values do not
justify the carrying amount of the loan, the amount that management deems
uncollectible (the impaired amount) is charged against the allowance for loan
losses. Even when collateral value or other sources of repayment appear
sufficient, if management remains uncertain about whether the loan will be
repaid in full, an amount is specifically allocated in the allowance for loan
losses. At June 30, 2002, Key had $312 million of impaired loans with a
specifically allocated allowance for loan losses of $144 million, and $359
million of impaired loans that were carried at their estimated fair value
without a specifically allocated allowance. At December 31, 2001, impaired loans
included $417 million of loans with a specifically allocated allowance of $180
million, and $244 million that were carried at their estimated fair value.
Key does not perform a specific impairment valuation for smaller-balance,
homogeneous, nonaccrual loans (shown in the preceding table as "Other nonaccrual
loans"). Generally, these include residential mortgages and automobile and
marine loans. Instead, management applies historical loss experience rates to
these loans, adjusted to reflect emerging credit trends and other factors, and
then allocates a portion of the allowance for loan losses to each loan type.
19
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, Key adopted SFAS No. 142, which eliminates the
amortization of goodwill and intangible assets deemed to have indefinite lives.
Key's total amortization expense for the three-month periods ended June 30, 2002
and 2001, was $2 million and $174 million, respectively. For the six-month
periods ended June 30, 2002 and 2001, amortization expense was $5 million and
$200 million, respectively. Amortization expense for the second quarter of 2001
includes a $150 million write-down of goodwill associated with Key's decision to
downsize its automobile finance business. Estimated amortization expense for
intangible assets subject to amortization for each of the next five years is as
follows: 2002 - $11 million; 2003 - $10 million; 2004 - $6 million; 2005 -
$1 million; and 2006 - $1 million. The calculation of Key's net income and
earnings per common share, excluding goodwill amortization for the three- and
six-month periods ended June 30, 2002, is presented below.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------- ---------------------------------
dollars in millions, except per share amounts 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
EARNINGS
Net income (loss) $ 246 $ (160) $ 486 $ 57
Add: Goodwill amortization -- 171 -- 193
- --------------------------------------------------------------------------------------------------------------------------------
Adjusted net income $ 246 $ 11 $ 486 $ 250
========= ========= ========= =========
- --------------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 426,092 424,675 425,477 424,352
Weighted average common shares and potential
common shares outstanding (000) 431,935 429,760 430,983 429,838
- --------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income (loss) per common share $ .58 $ (.38) $ 1.14 $ .14
Add: Goodwill amortization -- .40 -- .45
- --------------------------------------------------------------------------------------------------------------------------------
Adjusted net income per common share $ .58 $ .02 $ 1.14 $ .59
========= ========= ========= =========
Adjusted net income per common share - assuming dilution $ .57 $ .02 $ 1.13 $ .58
========= ========= ========= =========
- --------------------------------------------------------------------------------------------------------------------------------
The following table shows the gross carrying amount and the accumulated
amortization of intangible assets that are subject to amortization.
JUNE 30, 2002 DECEMBER 31, 2001
------------------------------------------ --------------------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
in millions AMOUNT AMORTIZATION AMOUNT AMORTIZATION
- -----------------------------------------------------------------------------------------------------------------------------------
Intangible assets subject to amortization:
Core deposit intangibles $215 $192 $215 $187
Other intangible assets 8 6 9 6
- -----------------------------------------------------------------------------------------------------------------------------------
Total $223 $198 $224 $193
==== ==== ==== ====
- -----------------------------------------------------------------------------------------------------------------------------------
At June 30, 2002, the carrying amount of goodwill by major business group was as
follows: Key Consumer Banking - $446 million; Key Corporate Finance - $204
million; and Key Capital Partners - $455 million. At December 31, 2001, the
carrying amount of goodwill by major business group was as follows: Key Consumer
Banking - $446 million; Key Corporate Finance - $200 million; and Key Capital
Partners - $455 million. For additional information pertaining to the new
accounting guidance, see the section entitled "Accounting Pronouncements Adopted
in 2002" included in Note 1 ("Basis of Presentation") starting on page 7.
20
9. LONG-TERM DEBT
The components of Key's long-term debt, presented net of unamortized discount
where applicable, were as follows:
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2002 2001 2001
- --------------------------------------------------------------------------------------------------------------
Senior medium-term notes due through 2005(a) $ 1,584 $ 1,286 $ 796
Subordinated medium-term notes due through 2003(a) 85 85 85
Senior euro medium-term notes due through 2003(b) 50 50 50
7.50% Subordinated notes due 2006(c) 250 250 250
6.75% Subordinated notes due 2006(c) 200 200 200
8.125% Subordinated notes due 2002(c) -- 200 200
8.00% Subordinated notes due 2004(c) 125 125 125
6.625% Subordinated notes due 2017(c) 25 -- --
8.404% Notes due through 2001 -- -- 13
All other long-term debt(i) 17 16 12
- --------------------------------------------------------------------------------------------------------------
Total parent company(j) 2,336 2,212 1,731
Senior medium-term bank notes due through 2039(d) 4,704 4,525 5,655
Senior euro medium-term bank notes due through 2007(e) 5,472 3,989 3,752
6.50% Subordinated remarketable securities due 2027(f) 311 311 312
6.95% Subordinated notes due 2028(f) 300 300 300
7.125% Subordinated notes due 2006(f) 250 250 250
7.25% Subordinated notes due 2005(f) 200 200 200
6.75% Subordinated notes due 2003(f) 200 200 200
7.50% Subordinated notes due 2008(f) 165 165 165
7.00% Subordinated notes due 2011(f) 607 506 506
7.30% Subordinated notes due 2011(f) 107 107 107
7.85% Subordinated notes due 2002(f) 93 93 93
7.55% Subordinated notes due 2006(f) 75 75 75
7.375% Subordinated notes due 2008(f) 70 70 70
Lease financing debt due through 2006(g) 484 519 548
Federal Home Loan Bank advances due through 2030(h) 1,168 762 506
All other long-term debt(i) 353 270 205
- --------------------------------------------------------------------------------------------------------------
Total subsidiaries 14,559 12,342 12,944
- -------------------------------------------------------------------------------------------------------------
Total long-term debt $16,895 $14,554 $14,675
======= ======= =======
- --------------------------------------------------------------------------------------------------------------
Key uses interest rate swaps and caps, which modify the repricing and maturity
characteristics of certain long-term debt, to manage interest rate risk. For
more information about such financial instruments at June 30, 2002, see Note 14
("Derivatives and Hedging Activities"),which begins on page 28.
(a) At June 30, 2002, December 31, 2001 and June 30,2002, the senior
medium-term notes had weighted average interest rates of 2.69%, 2.51% and
4.48%, respectively, and the subordinated medium-term notes had a weighted
average interest rate of 7.42%, 7.42% and 7.42% at each respective date.
These notes had a combination of fixed and floating interest rates.
(b) Senior euro medium-term notes had a weighted average interest rate of 2.11%
at June 30, 2002. These notes, which are obligations of KeyCorp, had a
floating interest rate based on the three-month London Interbank Offered
Rate (known as "LIBOR").
(c) The notes may not be redeemed or prepaid prior to maturity.
(d) Senior medium-term bank notes of subsidiaries had weighted average interest
rates of 2.73%, 2.45% and 4.30%, at June 30, 2002, December 31, 2001 and
June 30, 2001, respectively. These notes had a combination of fixed and
floating interest rates.
(e) Senior euro medium-term notes had weighted average interest rates of 2.15%,
2.58%, and 4.78%, at June 30, 2002, December 31, 2001 and June 30, 2001,
respectively. These notes, which are obligations of KeyBank National
Association, had fixed interest rates and floating interest rates based on
LIBOR.
21
(f) These notes and securities are all obligations of KeyBank National
Association, with the exception of the 7.55% notes, which are obligations
of Key Bank USA, National Association. None of the subordinated instruments
may be redeemed prior to their maturity dates.
(g) Lease financing debt had weighted average interest rates of 7.17% at June
30, 2002, 7.41% at December 31, 2001 and 7.81% at June 30, 2001. This
category of debt consists of primarily nonrecourse debt collateralized by
leased equipment under operating, direct financing and sales type leases.
(h) Long-term advances from the Federal Home Loan Bank had weighted average
interest rates of 1.97% at June 30, 2002, 2.19% at December 31, 2001 and
4.05% at June 30, 2001. These advances, which had a combination of fixed
and floating interest rates, were secured by $1.8 billion, $1.1 billion,
and $759 million of real estate loans and securities at June 30, 2002,
December 31, 2001 and June 30, 2001, respectively.
(i) Other long-term debt, consisting of industrial revenue bonds, capital lease
obligations, and various secured and unsecured obligations of corporate
subsidiaries, had weighted average interest rates of 6.77%, 6.72%, and
6.84% at June 30, 2002, December 31, 2001 and June 30, 2001, respectively.
(j) At June 30, 2002, unused capacity under KeyCorp's registration with the
Securities and Exchange Commission included $1.2 billion under a shelf
registration and $575 million allocated for the issuance of medium-term
notes.
10. RESTRUCTURING CHARGES
In November 1999, KeyCorp instituted a competitiveness initiative to improve
Key's operating efficiency and profitability.
In the first phase of the initiative, Key outsourced certain technology and
corporate support functions, consolidated sites in a number of Key's businesses
and reduced the number of management layers. This phase was completed in 2000.
As of March 31, 2002, Key had substantially completed the implementation of all
projects related to the second and final phase, which started during the second
half of 2000. This phase focused on:
- - simplifying Key's business structure by consolidating 22 business lines
into 10;
- - streamlining and automating business operations and processes;
- - standardizing product offerings and internal processes;
- - consolidating operating facilities and service centers; and
- - outsourcing certain noncore activities.
As a result of the initiative, Key estimated that it would reduce its workforce
by approximately 4,000 positions. Those reductions were to occur at all levels
throughout the organization. At March 31, 2002, nearly 4,100 positions had been
eliminated.
Changes in the components of the restructuring charge liability associated with
the above actions are as follows:
DECEMBER 31, RESTRUCTURING CASH JUNE 30,
in millions 2001 CHARGES (CREDITS) PAYMENTS 2002
- ---------------------------------------------------------------------------------------------------------
Severance $27 $(7) $ 9 $11
Site consolidations 33 2 3 32
Equipment and other 1 -- -- 1
- ---------------------------------------------------------------------------------------------------------
Total $61 $(5) $12 $44
=== === === ===
- ---------------------------------------------------------------------------------------------------------
22
11. CAPITAL SECURITIES
KeyCorp has five fully-consolidated subsidiary business trusts that have issued
corporation-obligated mandatorily redeemable preferred capital securities
("capital securities"), which are carried as liabilities on Key's balance sheet.
These securities provide an attractive source of funds since they are given Tier
I capital treatment for financial reporting purposes, but have the same tax
advantages as debt for Federal income tax purposes. As guarantor, KeyCorp
unconditionally guarantees payment of:
- - required distributions on the capital securities;
- - the redemption price when a capital security is redeemed; and
- - amounts due if a trust is liquidated or terminated.
KeyCorp owns the outstanding common stock of each of the trusts. The trusts used
the proceeds from the issuance of their capital securities and common stock to
buy debentures issued by KeyCorp. These debentures are the trusts' only assets
and the interest payments from the debentures finance the distributions paid on
the capital securities. Key's financial statements do not reflect the debentures
or the related effects on the income statement because they are eliminated in
consolidation.
The capital securities, common stock and related debentures are summarized as
follows:
PRINCIPAL INTEREST RATE
CAPITAL AMOUNT OF OF CAPITAL
SECURITIES, COMMON DEBENTURES, SECURITIES AND
dollars in millions NET OF DISCOUNT (a) SECURITIES NET OF DISCOUNT (b) DEBENTURES (c)
- ----------------------------------------------------------------------------------------------------------------------------------
June 30, 2002
KeyCorp Institutional Capital A $ 389 $11 $ 361 7.826%
KeyCorp Institutional Capital B 167 4 154 8.250
KeyCorp Capital I 237 8 244 2.778
KeyCorp Capital II 205 8 203 6.875
KeyCorp Capital III 246 8 233 7.750
- ----------------------------------------------------------------------------------------------------------------------------------
Total $1,244 $39 $1,195 6.749%
====== === ======
- ----------------------------------------------------------------------------------------------------------------------------------
December 31, 2001 $1,288 $39 $1,282 6.824%
====== === ======
- ----------------------------------------------------------------------------------------------------------------------------------
June 30, 2001 $1,279 $39 $1,282 7.263%
====== === ======
- ----------------------------------------------------------------------------------------------------------------------------------
MATURITY
OF CAPITAL
SECURITIES AND
dollars in millions DEBENTURES
- ---------------------------------------------------------------
June 30, 2002
KeyCorp Institutional Capital A 2026
KeyCorp Institutional Capital B 2026
KeyCorp Capital I 2028
KeyCorp Capital II 2029
KeyCorp Capital III 2029
- ---------------------------------------------------------------
Total --
- ---------------------------------------------------------------
December 31, 2001 --
- ---------------------------------------------------------------
June 30, 2001 --
- ---------------------------------------------------------------
(a) The capital securities must be redeemed when the related debentures mature,
or earlier if provided in the governing indenture. Each issue of capital
securities carries an interest rate identical to that of the related
debenture. The capital securities constitute minority interests in the
equity accounts of KeyCorp's consolidated subsidiaries and, therefore,
qualify as Tier 1 capital under Federal Reserve Board guidelines. Included
in certain capital securities at June 30, 2002, December 31, 2001 and June
30, 2001, are basis adjustments of $88 million, $45 million and $36
million, respectively, related to fair value hedges. See Note 14
("Derivatives and Hedging Activities"), which begins on page 28, for an
explanation of fair value hedges.
(b) KeyCorp has the right to redeem its debentures: (i) in whole or in part, on
or after December 1, 2006 (for debentures owned by Capital A), December 15,
2006 (for debentures owned by Capital B), July 1, 2008 (for debentures
owned by Capital I), March 18, 1999 (for debentures owned by Capital II),
and July 16, 1999 (for debentures owned by Capital III); and (ii) in whole
at any time within 90 days after and during the continuation of a "tax
event" or a "capital treatment event" (as defined in the applicable
offering circular). If the debentures purchased by Capital A or Capital B
are redeemed before they mature, the redemption price will be the principal
amount, plus a premium, plus any accrued but unpaid interest. If the
debentures purchased by Capital I are redeemed before they mature, the
redemption price will be the principal amount, plus any accrued but unpaid
interest. If the debentures purchased by Capital II or Capital III are
redeemed before they mature, the redemption price will be the greater of:
(a) the principal amount, plus any accrued but unpaid interest or (b) the
sum of the present values of principal and interest payments discounted at
the Treasury Rate (as defined in the applicable offering circular), plus 20
basis points (25 basis points for Capital III), plus any accrued but unpaid
interest. When debentures are redeemed in response to tax or capital
treatment events, the redemption price is generally slightly more favorable
to Key.
(c) The interest rates for Capital A, Capital B, Capital II and Capital III are
fixed. Capital I has a floating interest rate equal to three-month LIBOR
plus 74 basis points; it reprices quarterly. The rates shown as the total
at June 30, 2002, December 31, 2001 and June 30, 2001, are weighted
average rates.
23
12. LEGAL PROCEEDINGS
RESIDUAL VALUE INSURANCE LITIGATION. Key Bank USA, National Association
("KeyBank") obtained two insurance policies from Reliance Insurance Company
("Reliance") insuring the residual value of certain automobiles leased through
KeyBank. The two policies ("the Policies"), the "4011 Policy" and the "4019
Policy," together covered leases entered into during the period January 1, 1997
to January 1, 2001.
The 4019 Policy contains an endorsement stating that Swiss Reinsurance America
Corporation ("Swiss Re") will assume and reinsure 100% of Reliance's obligations
under the 4019 Policy in the event that Reliance Group Holdings' ("Reliance's
parent") so-called "claims-paying ability" were to fall below investment grade.
KeyBank also entered into an agreement with Swiss Re and Reliance whereby Swiss
Re agreed to issue to KeyBank an insurance policy on the same terms and
conditions as the 4011 Policy in the event that the financial condition of
Reliance Group Holdings fell below a certain level. Around May 2000, the
conditions under both the 4019 Policy and the Swiss Re agreement were triggered.
The 4011 Policy was canceled and replaced as of May 1, 2000, by a policy issued
by North American Specialty Insurance Company (a subsidiary or affiliate of
Swiss Re) ("the NAS Policy"). Tri-Arc Financial Services, Inc. ("Tri-Arc") acted
as agent for Reliance, Swiss Re and NAS. Since February 2000, KeyBank has been
filing claims under the Policies, but none of these claims has been paid.
In July 2000, KeyBank filed a claim for arbitration against Reliance, Swiss Re,
NAS and Tri-Arc seeking, among other things, a declaration of the scope of
coverage under the Policies and for damages. On January 8, 2001, Reliance filed
an action (litigation) against KeyBank in Federal District Court in Ohio seeking
rescission or reformation of the Policies claiming that they do not reflect the
intent of the parties with respect to the scope of coverage and how and when
claims were to be paid. Key filed an answer and counterclaim against Reliance,
Swiss Re, NAS and Tri-Arc seeking, among other things, declaratory relief as to
the scope of coverage under the Policies, damages for breach of contract,
failure to act in good faith, and punitive damages. The parties have agreed to
proceed with this court action and to dismiss the arbitration without prejudice.
On May 29, 2001, the Commonwealth Court of Pennsylvania entered an order placing
Reliance in a court supervised "rehabilitation" and purporting to stay all
litigation against Reliance. On July 23, 2001, the Federal District Court in
Ohio stayed the litigation to allow the rehabilitator to complete her task. On
October 3, 2001, the Court in Pennsylvania entered an order placing Reliance
into liquidation and canceling all Reliance insurance policies as of November 2,
2001. On November 20, 2001, the Federal District Court in Ohio entered an order
which, among other things, required Reliance to report to the Court on the
progress of the liquidation. On January 15, 2002, Reliance filed a status report
requesting the continuance of the stay for an indefinite period. On February 20,
2002, KeyBank filed a Motion for Partial Lifting of the July 23, 2001, Stay in
which it asked the Court to allow the case to proceed against the parties other
than Reliance. The Court granted KeyBank's motion on May 17, 2002.
Management believes that KeyBank has valid insurance coverage or claims for
damages relating to the residual value of automobiles leased through KeyBank
during the four-year period ending January 1, 2001. With respect to each
individual lease, however, it is not until the lease expires and the vehicle is
sold that KeyBank can determine the existence and amount of any actual loss on
the lease (i.e., the difference between the residual value provided for in the
lease agreement and the vehicle's actual market value at lease expiration).
KeyBank's actual total losses for which it will file claims will depend to a
large measure upon the viability of, and pricing within, the market for used
cars throughout the lease run-off period, which extends through 2006.
Accordingly, the total expected loss on the portfolio cannot be determined with
certainty at this time. Claims filed by KeyBank through June 30, 2002, total
approximately $202 million, and management currently estimates that
approximately $106 million of additional claims may be filed through year-end
2006. During this time frame, a number of factors could affect KeyBank's actual
loss experience, which may be higher or lower than management's current
estimates.
24
Key is recording as a receivable a portion of the amount of the claims as and
when filed estimated to be appropriate to reflect the collectibility risk
associated with the insurance litigation. Any recovery from the litigation may
be more or less than the receivable.
NSM LITIGATION. In March 1998, McDonald Investments Inc. ("McDonald"), now a
subsidiary of KeyCorp, participated in an offering to institutional investors of
approximately $452 million of debt securities and related warrants of Nakornthai
Strip Mill Public Company Ltd. ("NSM"), a Thailand public company, and certain
NSM affiliates. The offering was part of the financing of NSM's steel mini-mill
located in Chonburi, Thailand. McDonald served as a financial advisor to NSM and
was an initial purchaser in the offering. On December 24, 1998, holders of NSM
securities gave a Notice of Default alleging a number of defaults under the
terms of the securities.
In 1999, certain purchasers of the NSM securities commenced litigation against
McDonald and several other parties, claiming that McDonald, the other initial
purchasers and certain other of NSM's third party service providers violated
certain state and federal securities and other laws. Nine separate lawsuits were
brought against McDonald and others by purchasers of the NSM securities: two in
Federal court in Minnesota; two in Federal court in New York; two in California;
and one in each of Connecticut, Illinois and New Jersey. The aggregate amount of
securities alleged to have been purchased by the plaintiffs in these nine
lawsuits was approximately $260 million. While the relief claimed in the
lawsuits varied, generally the plaintiffs sought rescission of the sale of the
securities, compensatory damages, punitive damages, pre- and post- judgment
interest, legal fees and expenses.
McDonald filed responses to each complaint denying liability and has since
entered into settlement agreements with the plaintiffs in all nine lawsuits,
pursuant to which those plaintiffs' claims against McDonald were dismissed. The
terms of the settlement agreements, including the consideration paid by
McDonald, are confidential.
Key sought coverage from its insurance carriers for certain liabilities and
expenses related to the settled claims (above certain self-insurance layers that
were exhausted and expensed), which coverage was subsequently denied by the
carriers. As a result, Key and its lead insurance carrier filed declaratory
judgment actions against each other. Key's action includes claims for breach of
contract and for bad faith. In January 2002, the insurance carriers and Key
agreed to a monetary settlement of their dispute, which would have (when
aggregated with litigation reserves previously established for these lawsuits)
provided coverage for amounts paid by Key in settlement of the NSM lawsuits.
However, in the course of finalizing the settlement documentation, the insurance
carriers informed Key that in their view a settlement of all material terms was
not reached and, accordingly, the settlement agreement is not valid. Management
believes that the settlement agreement is valid, and on March 31, 2002, KeyCorp
filed a Motion to Enforce the Settlement Agreement in the United States District
Court for the Northern District of Ohio. That Motion is pending before the
Court, and a hearing is currently scheduled to take place in late August 2002.
If the settlement agreement were not to be enforced, the aggregate balance sheet
exposure for all claims relating to the coverage dispute would be approximately
$40 million. This exposure along with additional damages would then be pursued
in the underlying litigation against the carriers.
In the ordinary course of business, Key is subject to legal actions that involve
claims for substantial monetary relief. Based on information presently known to
management and Key's counsel, management does not believe there is any legal
action to which KeyCorp or any of its subsidiaries is a party, or involving any
of their properties, that, individually or in the aggregate, will have a
material adverse effect on Key's financial condition.
25
13. OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Key, mainly through its lead bank, KeyBank National Association, is party to
various financial instruments with off-balance sheet risk. These instruments
include those related to loan securitizations, as well as derivatives and
hedging activities. The other major types of financial instruments with
off-balance sheet risk are primarily loan commitments and standby letters of
credit. These financial instruments generally help Key meet clients' financing
needs. However, they also involve credit risk not reflected on Key's balance
sheet. Key mitigates its exposure to credit risk with internal controls that
guide the way applications for credit are reviewed and approved, credit limits
are established and, when necessary, demands for collateral are made. In
particular, Key evaluates the credit-worthiness of each prospective borrower on
a case-by-case basis. Key does not have any significant concentrations of credit
risk related to the financial instruments discussed in this note.
COMMITMENTS TO EXTEND CREDIT. These are agreements to provide financing on
predetermined terms, as long as the client continues to meet specified criteria.
Loan commitments generally carry variable rates of interest and have fixed
expiration dates or other termination clauses. In many cases, a client must pay
a fee to obtain a loan commitment from Key. Since a commitment may expire
without resulting in a loan, the total amount of outstanding commitments may
exceed Key's eventual cash outlay.
STANDBY LETTERS OF CREDIT. These instruments obligate Key to pay a third-party
beneficiary when a customer fails to repay an outstanding loan or debt
instrument, or fails to perform some contractual nonfinancial obligation.
Amounts drawn under standby letters of credit are essentially loans: they bear
interest (generally at variable rates) and pose the same credit risk to Key as a
loan would.
ASSET-BACKED COMMERCIAL PAPER CONDUIT. Key serves as a referral agent to an
asset-backed commercial paper conduit ("conduit"), which is owned by a third
party and administered by an unaffiliated financial institution. In connection
with this arrangement, Key receives fees for the referral of high-grade loans
and structured assets, and for making commitments to provide liquidity and
credit enhancement. Key provides liquidity and credit enhancement to the conduit
in the form of a committed liquidity facility and credit agreement. The
commitment to provide credit enhancement specifies that in the event of default,
Key will provide financial relief to the conduit in an amount that is based on
defined criteria that consider the level of credit risk involved and other
factors. In addition to loans referred directly to the conduit, during 2001, Key
sold $434 million of Federally guaranteed education loans to a qualified
special purpose entity, which issued beneficial interests that were acquired
by the conduit.
At June 30, 2002, Key's commitments to provide liquidity and credit enhancement
totaled $348 million and $34 million, respectively. There were no balances
outstanding under either of the commitment facilities at June 30, 2002.
Management periodically evaluates Key's potential exposure related to these
commitments.
The balance of assets outstanding in the conduit was $326 million at June 30,
2002. Of this amount, $140 million represents the balance of the beneficial
interests in the Federally guaranteed education loans acquired by the conduit
in 2001. The remaining amount represents primarily loans purchased by the
conduit from other financial institutions. All of the assets in the conduit
were performing in accordance with their contractual terms at June 30, 2002.
RECOURSE AGREEMENT WITH FEDERAL NATIONAL MORTGAGE ASSOCIATION. KeyBank National
Association ("KBNA") participates as a lender in the Federal National Mortgage
Association ("FNMA") Delegated Underwriting and Servicing ("DUS") program. As a
condition to FNMA's delegation of responsibility for originating, underwriting
and servicing mortgages, KBNA has agreed to assume a limited portion of the risk
of loss on each mortgage loan sold. Accordingly, a reserve for such potential
losses has been established and is maintained in an amount estimated by
management to be appropriate in light of the recourse risk. As of June 30, 2002,
the principal balance outstanding of loans sold by KBNA as a participant in this
program was approximately $1.2 billion.
26
RETURN GUARANTY AGREEMENT WITH LOW-INCOME HOUSING TAX CREDIT ("LIHTC")
INVESTORS. Key Affordable Housing Corporation ("KAHC"), a subsidiary of KeyBank,
offers limited partnership interests to qualified investors. Partnerships formed
by KAHC invest in low-income residential rental properties that qualify for
Federal LIHTCs under Section 42 of the Internal Revenue Code. In certain
partnerships, investors pay a fee to KAHC for a guaranteed return. The
guaranteed return is incumbent on the financial performance of the property and
the property's ability to maintain its LIHTC status throughout the fifteen-year
compliance period. Key meets its obligations pertaining to the guaranteed
returns generally through the distribution of tax credits and deductions
associated with the specific properties. At June 30, 2002, Key guaranteed equity
of $674 million plus various specified returns on that equity. KAHC has
established a reserve of an amount that management believes will be sufficient
to cover estimated losses under the guarantees.
OTHER OFF-BALANCE SHEET RISK. KeyBank National Association and Key Bank USA,
National Association are members of MasterCard International Inc. ("MasterCard")
and Visa U.S.A. Inc. ("Visa"). MasterCard's charter documents and bylaws state
that MasterCard has the ability to assess members for certain liabilities,
including litigation liabilities. Visa's charter documents state that Visa has
the ability to fix fees payable by members in connection with the operations of
Visa. Descriptions of pending lawsuits and MasterCard's and Visa's position
regarding the potential impact of those lawsuits on members are set forth on
MasterCard's and Visa's respective websites and in MasterCard's public filings
with the Securities and Exchange Commission. Key is not a party to any
significant litigation by third parties against MasterCard or Visa.
The following table shows the contractual amount of each class of
lending-related, off-balance sheet financial instrument remaining as of the date
indicated. The table discloses Key's maximum possible accounting loss, which is
equal to the contractual amount of the various instruments. The estimated fair
values of these instruments are not material; observable liquid markets do not
exist for the majority of these instruments.
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2002 2001 2001
- ---------------------------------------------------------------------------------------------------
Loan commitments:
Home equity $ 5,411 $ 4,965 $ 4,863
Commercial real estate and construction 2,061 2,487 2,465
Commercial and other 23,080 24,936 22,182
- ---------------------------------------------------------------------------------------------------
Total loan commitments 30,552 32,388 29,510
Other commitments:
Standby letters of credit 3,555 3,503 3,334
Commercial letters of credit 102 106 126
- ---------------------------------------------------------------------------------------------------
Total loan and other commitments $34,209 $35,997 $32,970
======= ======= =======
- ---------------------------------------------------------------------------------------------------
27
14. DERIVATIVES AND HEDGING ACTIVITIES
Key, mainly through its lead bank, KeyBank National Association, is party to
various derivative instruments. These instruments are used for asset and
liability management and trading purposes. Generally, these instruments help Key
meet clients' financing needs and manage exposure to "market risk"--the
possibility that economic value or net interest income will be adversely
affected by changes in interest rates or other economic factors. However, like
other financial instruments, these derivatives contain an element of "credit
risk"--the possibility that Key will incur a loss because a counterparty fails
to meet its contractual obligations.
The primary derivatives that Key uses are interest rate swaps, caps and futures,
and foreign exchange forward contracts. All foreign exchange forward contracts
and interest rate swaps and caps held are over-the-counter instruments.
ACCOUNTING TREATMENT AND VALUATION
Effective January 1, 2001, Key adopted SFAS No. 133, which establishes
accounting and reporting standards for derivatives and hedging activities. The
new standards are summarized in Note 1 ("Summary of Significant Accounting
Policies") under the heading "Accounting Pronouncements Adopted in 2001," on
page 61 of Key's 2001 Annual Report to Shareholders.
As a result of adopting SFAS No. 133, Key recorded cumulative after-tax losses
of $1 million in earnings and $22 million in "other comprehensive income (loss)"
as of January 1, 2001. Of the $22 million loss, an estimated $13 million was
reclassified as a charge to earnings during 2001.
At June 30, 2002, Key had $430 million of derivative assets recorded in "accrued
income and other assets" and $141 million of derivative liabilities recorded in
"accrued expense and other liabilities" on the balance sheet.
ASSET AND LIABILITY MANAGEMENT
FAIR VALUE HEDGING STRATEGIES. Key uses interest rate swap contracts known as
"receive fixed/pay variable" swaps to modify its exposure to interest rate risk.
These contracts convert specific fixed-rate deposits, short-term borrowings and
long-term debt to variable rate obligations. As a result, Key receives
fixed-rate interest payments in exchange for variable rate payments over the
lives of the contracts without exchanges of the underlying notional amounts.
During the first half of 2002, Key recognized a net gain of approximately $3
million related to the ineffective portion of its fair value hedging
instruments. The ineffective portion recognized is included in "other income" on
the income statement.
CASH FLOW HEDGING STRATEGIES. Key also enters into "pay fixed/receive variable"
interest rate swap contracts that effectively convert a portion of its
floating-rate debt to fixed-rate to reduce the potential adverse impact of
interest rate increases on future interest expense. These contracts allow Key to
exchange variable-rate interest payments for fixed-rate payments over the lives
of the contracts without exchanges of the underlying notional amounts.
Similarly, Key has converted certain floating-rate commercial loans to
fixed-rate loans by entering into interest rate swap contracts.
Key also uses "pay fixed/receive variable" interest rate swaps to manage the
interest rate risk associated with anticipated sales or securitizations of
certain commercial real estate loans. These swaps protect against a possible
short-term decline in the value of the loans that could result from changes in
interest rates between the time they are originated and the time they are
securitized or sold. Key's general policy is to sell or securitize these loans
within one year of their origination.
28
As a result of actions announced in May 2001, Key revised its projections of
future debt needs. Consequently, during the second quarter of 2001, Key
reclassified a $3 million gain from "accumulated other comprehensive income
(loss)" to "other income" on the income statement. This reclassification relates
to a cash flow hedge of a previously forecasted debt issuance that Key did not
make.
During the first half of 2002, Key recognized a net loss of approximately $1
million in connection with the ineffective portion of its cash flow hedging
instruments. There was no impact on earnings during the first half of 2002
related to the exclusion of portions of hedging instruments from the assessment
of hedge effectiveness.
The change in "accumulated other comprehensive income (loss)" resulting from
cash flow hedges is as follows:
RECLASSIFICATION
DECEMBER 31, 2002 OF GAINS JUNE 30,
in millions 2001 HEDGING ACTIVITY TO NET INCOME 2002
- ---------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income
(loss) resulting from cash flow hedges $(2) $13 $ (4 ) $7
- ---------------------------------------------------------------------------------------------------------------
Key expects to reclassify approximately $27 million of net gains on derivative
instruments from "accumulated other comprehensive income (loss)" to earnings
during the next twelve months. Reclassifications will coincide with the income
statement impact of the hedged item through the payment of variable-rate
interest on debt, the receipt of variable-rate interest on commercial loans and
the sale or securitization of commercial real estate loans.
TRADING PORTFOLIO
FUTURES CONTRACTS AND INTEREST RATE SWAPS, CAPS AND FLOORS. Key uses these
instruments for dealer activities, which are generally limited to Key's
commercial loan clients, and enters into other positions with third parties to
mitigate the interest rate risk of the client positions. The transactions
entered into with clients are generally limited to conventional interest rate
swaps. All futures contracts and interest rate swaps, caps and floors are
recorded at their estimated fair values. Adjustments to fair value are included
in "investment banking and capital markets income" on the income statement.
FOREIGN EXCHANGE FORWARD CONTRACTS. Key uses these instruments to accommodate
the business needs of clients and for proprietary trading purposes. Foreign
exchange forward contracts provide for the delayed delivery or purchase of
foreign currency. Key mitigates the associated risk by entering into other
foreign exchange contracts with third parties. Adjustments to the fair value of
all foreign exchange forward contracts are included in "investment banking and
capital markets income" on the income statement.
OPTIONS AND FUTURES. Key uses these instruments for proprietary trading
purposes. Adjustments to the fair value of options and futures are included in
"investment banking and capital markets income" on the income statement.
The following table shows net trading income recognized on interest rate swap
and foreign exchange forward contracts.
SIX MONTHS ENDED JUNE 30,
-------------------------
in millions 2002 2001
- --------------------------------------------------------------------------
Interest rate swap contracts $5 $8
Foreign exchange forward contracts 18 22
- --------------------------------------------------------------------------
29
COUNTERPARTY CREDIT RISK
Swaps and caps present credit risk because the counterparty may not meet the
terms of the contract. This risk is measured as the expected positive
replacement value of contracts. To mitigate credit risk, Key deals exclusively
with counterparties that have high credit ratings.
Key uses two additional precautions to manage exposure to credit risk on swap
contracts. First, Key generally enters into bilateral collateral and master
netting arrangements. These agreements include legal rights of setoff that
provide for the net settlement of the related contracts with the same
counterparty in the event of default. Second, a credit committee monitors credit
risk exposure to the counterparty on each interest rate swap to determine
appropriate limits on Key's total credit exposure and whether any collateral may
be required.
At June 30, 2002, Key was party to swaps with 36 different counterparties. Among
these were swaps entered into to offset the risk of client swaps. Key had
aggregate credit exposure of $261 million to 12 of these counterparties, with
the largest credit exposure to an individual counterparty amounting to
approximately $91 million. As of the same date, Key's aggregate credit exposure
on its interest rate caps totaled $33 million. Management has established a
reserve of an amount that it believes will be sufficient to cover estimated
losses related to customer derivatives.
30
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, 2002 and 2001, 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, 2002 and 2001.
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 auditing standards generally accepted in the United States,
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 accounting principles generally accepted in the
United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Key as of
December 31, 2001, 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, 2002, 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, 2001, 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 12, 2002
31
MANAGEMENT'S DISCUSSION AND ANALYSIS
INTRODUCTION
- ------------
This Management's Discussion and Analysis generally reviews the financial
condition and results of operations of KeyCorp and its subsidiaries for the
quarterly and year-to-date periods ended June 30, 2002 and 2001. Some tables may
cover more periods to comply with Securities and Exchange Commission disclosure
requirements or to illustrate trends over a longer period of time. When you read
this discussion, you should also look at the consolidated financial statements
and related notes that appear on pages 3 through 30.
ACCOUNTING POLICIES
Key's business is dynamic and complex. Consequently, management must exercise
judgment in choosing and applying accounting policies and methodologies in many
areas. These choices are important; not only are they necessary to comply with
accounting principles generally accepted in the United States, they also reflect
the exercise of management's judgment in determining the most appropriate manner
in which to record and report Key's overall financial performance. In
management's opinion, some of these areas have a more significant impact than
others on Key's financial reporting. This is because they apply to areas of
relatively greater business importance, to matters for which there is a range of
possible outcomes and/or require a more subjective decision-making process on
the part of management. For Key, these areas include accounting for the
allowance for loan losses, loan securitizations, and contingent obligations
arising from litigation and tax exposures. Our accounting policies related to
the first two of these three areas are disclosed in Note 1 ("Summary of
Significant Accounting Policies"), which begins on page 58 of Key's 2001 Annual
Report to Shareholders. A detailed description of contingent obligations arising
from litigation is contained in Note 12 ("Legal Proceedings"), which begins on
page 24 of this report. In the normal course of business, Key is routinely
subject to examinations and challenges from tax authorities regarding the amount
of taxes due in connection with investments it has made and the businesses in
which it is engaged. In connection with a current examination, the Internal
Revenue Service is challenging Key's tax treatment of certain leveraged lease
investments originated in the years under examination. This and other challenges
by tax authorities may result in adjustments to the timing or amount of taxable
income or deductions or the allocation of income among tax jurisdictions.
Management believes that these challenges will be resolved without having any
material effect on Key's financial condition and results of operations. All
accounting policies are important, and all policies contained in Note 1 of the
Annual Report should be reviewed for a greater understanding of how Key's
financial performance is recorded and reported.
Furthermore, valuation methodologies employed by management often involve a
significant degree of judgment, particularly when observable liquid markets do
not exist for the items being valued. The outcome of valuations performed by
management have a direct bearing on the carrying amounts of certain assets, such
as principal investments, residual interests retained in securitizations and
goodwill. The valuation methodology used by management for principal investments
is summarized in Note 1 ("Summary of Significant Accounting Policies") under the
heading "Securities," on page 58 of Key's 2001 Annual Report to Shareholders.
The valuation methodology used for retained interests is summarized in the same
note under the heading "Loan Securitizations" on page 59 of the Annual Report.
The valuation methodology used in the testing for goodwill impairment is
summarized in Note 1 ("Basis of Presentation") under the heading "Goodwill and
other intangible assets," on page 7 of this report.
In recent months, corporate improprieties related to revenue recognition have
received a great deal of attention in the media. Although the risk of
intentional or unintentional misstatements exists in all companies, the
likelihood of such misstatements occurring in the financial services industry is
mitigated by the fact that most of the revenue (i.e., interest accruals)
recorded is driven by nondiscretionary formulas.
In addition, Key's management has established and maintains a comprehensive
system of internal control to protect Key's assets and the integrity of its
financial statements. While no such system is foolproof, ours is designed so
that the financial information we publish is accurate, complete, timely and
presents our performance fairly.
32
TERMINOLOGY
This report contains some shortened names and industry-specific terms. We want
to explain some of these terms at the outset so you can better understand the
discussion that follows.
- - KEYCORP refers solely to the parent company.
- - KEY refers to the consolidated entity consisting of KeyCorp and its
subsidiaries.
- - A KEYCENTER is one of Key's full-service retail banking facilities or
branches.
- - Key engages in CAPITAL MARKETS ACTIVITIES, primarily through the Key
Capital Partners business group. These activities encompass a variety of
services. Among other things, we trade securities as a dealer, enter into
derivative contracts (both to accommodate clients' financing needs and for
proprietary trading purposes), and conduct transactions in foreign
currencies (both to accommodate clients' needs and to benefit from
fluctuations in exchange rates).
- - CORE FINANCIAL RESULTS exclude the effects of significant nonrecurring
items such as accounting changes, write-downs of certain assets in
connection with the implementation of strategic actions, gains from
divestitures and restructuring charges. All of these items can distort
results, particularly in period-to-period comparisons. Reported results
include these items as required under accounting principles generally
accepted in the United States. Items that account for the difference
between Key's core and reported financial results for the three- and
six-month periods ended June 30, 2001, are summarized in Figure 1 on page
35.
- - All earnings per share data included in this discussion are presented on a
DILUTED basis, which takes into account all common shares outstanding as
well as potential common shares that could result from the exercise of
outstanding stock options. Some of the financial information tables also
include BASIC earnings per share, which takes into account only common
shares outstanding.
- - For regulatory purposes, capital is divided into two classes. Federal
regulations prescribe that at least one-half of a bank or bank holding
company's TOTAL RISK-BASED CAPITAL must qualify as TIER 1. Both total and
Tier 1 capital serve as bases for several measures of capital adequacy,
which is an important indicator of financial stability and condition. You
will find a more detailed explanation of total and Tier 1 capital and how
they are calculated in the section entitled "Capital," which begins on page
63.
- - When we want to draw your attention to a particular item in Key's Notes to
Consolidated Financial Statements, we refer to NOTE ___, giving the
particular number, name and starting page number.
OUR PROJECTIONS ARE NOT FOOLPROOF
This report may contain "forward-looking statements" about issues like
anticipated earnings, anticipated levels of net loan charge-offs and
nonperforming assets and anticipated improvement in profitability and
competitiveness. Forward-looking statements by their nature are subject to
assumptions, risks and uncertainties. For a variety of reasons, including the
following, actual results could differ materially from those contained in or
implied by the forward-looking statements.
- - Interest rates could change more quickly or more significantly than we
expect, which may have an adverse effect on our financial results.
- - If the economy or segments of the economy fail to rebound or decline
further, the demand for new loans and the ability of borrowers to repay
outstanding loans may decline.
- - The stock and bond markets could suffer additional disruptions, which may
have adverse effects on our financial condition and that of our borrowers,
and on our ability to raise money by issuing new securities.
33
- - It could take us longer than we anticipate to implement strategic
initiatives designed to increase revenues or manage expenses; we may be
unable to implement certain initiatives; or the initiatives may be
unsuccessful.
- - Acquisitions and dispositions of assets, business units or affiliates could
adversely affect us in ways that management has not anticipated.
- - We may become subject to new legal obligations, or the resolution of
pending litigation may have an adverse effect on our financial condition.
- - Terrorist activities or military actions could further disrupt the economy
and the general business climate, which may have an adverse effect on our
financial results or condition and that of our borrowers.
- - We may become subject to new accounting, tax, or regulatory practices or
requirements.
HIGHLIGHTS OF KEY'S PERFORMANCE
- -------------------------------
FINANCIAL PERFORMANCE
During the second quarter of 2001, we announced a series of strategic
initiatives designed to sharpen our business focus and strengthen our financial
performance by emphasizing the importance of core relationship businesses and a
more conservative credit culture. Specific actions include exiting the
automobile leasing business, de-emphasizing indirect prime automobile lending,
discontinuing nonrelationship lending in the leveraged financing and nationally
syndicated lending businesses, and increasing the allowance for loan losses.
As a result of the above actions, we recorded several significant charges that
had an adverse effect on Key's financial performance for the second quarter of
2001. The nonrecurring charges include a noncore $150 million write-down of
goodwill, as well as two large charges included in Key's core financial results.
The core charges include an additional provision for loan losses of $300 million
($189 million after tax) and $40 million ($25 million after tax) for losses
incurred on the residual values of leased vehicles. These charges are reviewed
in greater detail throughout the remainder of this discussion.
The primary measures of Key's financial performance for the second quarter and
first six months of 2002 are summarized below. Performance measures for the same
periods in 2001 reflect the effects of the two large core charges recorded in
the second quarter, but exclude the goodwill write-down and other items
summarized in Figure 1 that are considered to be nonrecurring (or noncore).
- - Net income for the second quarter of 2002 was $246 million, or $.57 per
common share, up from net income of $240 million, or $.56 per share, for
the previous quarter and core net income of $28 million, or $.07 per share,
for the second quarter of 2001. For the first six months of the year, Key's
net income was $486 million, or $1.13 per common share, compared with core
net income of $245 million, or $.57 per share for the first half of last
year.
- - Key's return on average equity was 15.16% for the second quarter of 2002.
This result compares with a return of 15.53% for the prior quarter and a
core return of 1.69% for the year-ago quarter. For the first six months of
the year, Key's return on average equity was 15.34%, compared with a core
return of 7.45% for the first half of 2001.
- - Key's second quarter return on average total assets was 1.21%. This result
is up from a return of 1.20% for the previous quarter and a core return of
.13% for the second quarter of 2001. For the first six months of the year,
Key's return on average total assets was 1.21%, up from a core return of
.57% for the comparable period in 2001.
34
FIGURE 1. SIGNIFICANT NONRECURRING ITEMS
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ---------------------------
dollars in millions, except per share amounts 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) as reported $ 246 $ (160) $ 486 $ 57
Nonrecurring items (net of tax):
Goodwill write-down (automobile finance business) -- 150 -- 150
Cumulative effect of accounting change--EITF 99-20 -- 24 -- 24
Additional litigation reserves -- 13 -- 13
Restructuring and other special charges -- 1 -- 1
- -----------------------------------------------------------------------------------------------------------------------------------
Net income - core $ 246 $ 28 $ 486 $ 245
======= ======= ======= =======
Net income (loss) per diluted common share $ .57 $ (.38) $ 1.13 $ .13
Net income per diluted common share--core .57 .07 1.13 .57
Return on average total assets 1.21% (.75)% 1.21% .13%
Return on average total assets--core 1.21 .13 1.21 .57
Return on average equity 15.16 (9.67) 15.34 1.73
Return on average equity--core 15.16 1.69 15.34 7.45
- -----------------------------------------------------------------------------------------------------------------------------------
Relative to both the second quarter of 2001 and the first quarter of 2002, Key's
second quarter earnings reflect positive results from the actions taken last
year. Despite continued softness in the economy, Key's taxable-equivalent net
interest income rose from that reported for the second quarter of 2001. A 21
basis point improvement in net interest margin more than compensated for a 5%
reduction in average earning assets stemming from the impact of some strategic
downsizing of the loan portfolio, loan sales and weaker loan demand. Noninterest
income rose by $50 million, reflecting the $40 million charge recorded a year
ago to establish a reserve for losses incurred on the residual values of leased
vehicles. On a core basis, noninterest expense fell by $21 million, including a
$20 million reduction associated with the adoption of new accounting guidance
for goodwill. The provision for loan losses decreased by $266 million due to the
additional $300 million provision recorded in the year-ago quarter as part of
management's decision to discontinue nonrelationship lending in the leveraged
financing and nationally syndicated lending businesses and to facilitate sales
of distressed loans in other portfolios.
Relative to the first quarter of 2002, Key's second quarter earnings reflect a
moderate increase in revenue, a level of noninterest expense that was
essentially unchanged and our first quarter-to-quarter decrease in nonperforming
loans in three years. Our favorable performance in terms of expense control is
attributable largely to the success of our competitiveness initiative discussed
on page 36.
The primary reasons that Key's specific revenue and expense components changed
from those of the three- and six month periods ended June 30, 2001, are reviewed
in detail in the remainder of this discussion.
Figure 2 on page 37 summarizes Key's financial performance on a reported basis
for each of the past five quarters and the first six months of 2002 and 2001.
CORPORATE STRATEGY
Our objective is to achieve revenue and earnings per share growth that is
consistently above the median for stocks that make up the Standard & Poors 500
Banks Index. In order to achieve this, our current strategy is comprised of the
following four primary elements:
- - STAY FOCUSED ON OUR CORE BUSINESSES. To further this objective, we intend
to focus on businesses where we can build relationships with our clients.
We will primarily focus on a business mix that comprises our "footprint"
businesses that serve individuals, particularly the affluent, small
businesses and middle market companies. Additionally, we intend to focus on
national businesses such as commercial real estate lending, asset
management, home equity lending and equipment leasing.
35
- - PUT OUR CLIENTS FIRST. To accomplish this, we are focusing on how we can
deepen our relationship with each of our clients. We want to build
relationships with those clients who have the potential to purchase
multiple products and services or repeat business. One way in which we are
pursuing this is to emphasize deposit growth across all of our lines of
business.
We also want to ensure that our clients are receiving a distinctive level
of service. We are putting considerable effort into enhancing our service
quality.
- - ENHANCE OUR BUSINESS. To accomplish this objective, we intend to build on
the success of our competitiveness initiative via a continuous improvement
process, which will continue to focus on increasing revenues, controlling
expenses and better serving our clients. Additionally, we intend to
continue to leverage technology both to reduce costs and enhance the
service quality provided to our clients. Over time, we also intend to
diversify our revenue mix by emphasizing the growth of fee income and to
invest in higher-growth and higher-return businesses.
- - CULTIVATE A WORKFORCE THAT DEMONSTRATES KEY'S VALUES AND WORKS TOGETHER FOR
A COMMON PURPOSE. Key intends to achieve this by:
--paying for performance, but only if achieved in ways that are consistent
with Key's values;
--attracting, developing and retaining a quality, high-performing and
inclusive workforce;
--developing leadership at all levels in the company; and
--creating a positive, stimulating and entrepreneurial work environment.
STATUS OF COMPETITIVENESS INITIATIVE
Key launched a major initiative in November 1999, the first phase of which was
completed in 2000. This initiative was designed to improve Key's profitability
by reducing the costs of doing business, focusing on the most profitable growth
businesses and enhancing revenues. During the initial phase, we reduced our
annual operating expenses by approximately $100 million by outsourcing certain
nonstrategic support functions, consolidating sites in a number of our
businesses and reducing management layers.
As of March 31, 2002, we had substantially completed the implementation of all
projects related to the second and final phase of the initiative, referred to as
PEG (Perform, Excel, Grow). In this phase, our goal was to reduce costs by an
incremental net annual rate of $200 million by:
- - simplifying Key's business structure by consolidating 22 business lines
into 10;
- - streamlining and automating business operations and processes;
- - standardizing product offerings and internal processes;
- - consolidating operating facilities and service centers; and
- - outsourcing additional noncore activities.
Management believes that Key will achieve the anticipated annual net cost
savings from the overall initiative when all planned actions are fully
implemented before the end of 2002.
36
Management had anticipated that the actions taken in the competitiveness
initiative would reduce Key's workforce by approximately 4,000 positions
(comprising both staffed and vacant positions) by the end of the first quarter
of 2002. At March 31, 2002, nearly 4,100 positions had been eliminated.
Since the inception of the competitiveness initiative, we have recorded related
net charges of $274 million. Note 10 ("Restructuring Charges") on page 22,
provides more information about Key's restructuring charges.
FIGURE 2. SELECTED FINANCIAL DATA
2002 2001
------------------------------- ----------------------
dollars in millions, except per share amounts SECOND FIRST FOURTH
- -----------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $ 1,102 $ 1,092 $ 1,210
Interest expense 419 438 510
Net interest income 683 654 700
Provision for loan losses 135 136 723
Noninterest income 448 443 418
Noninterest expense 665 661 702
Income (loss) before income taxes and cumulative effect
of accounting changes 331 300 (307)
Income (loss) before cumulative effect of accounting changes 246 240 (174)
Net income (loss) 246 240 (174)
Net income (loss) -- core 246 240 (174)
- -----------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect of accounting changes $ .58 $ .56 $ (.41)
Income (loss) before cumulative effect of accounting changes
--- assuming dilution .57 .56 (.41)
Net income (loss) .58 .56 (.41)
Net income (loss)--core .58 .56 (.41)
Net income (loss)--assuming dilution .57 .56 (.41)
Net income (loss)--assuming dilution--core .57 .56 (.41)
Cash dividends paid .30 .30 .295
Book value at period end 15.46 15.05 14.52
Market price:
High 29.40 27.26 24.52
Low 25.95 22.92 20.49
Close 27.30 26.65 24.34
Weighted average common shares (000) 426,092 424,855 423,596
Weighted average common shares and
potential common shares (000) 431,935 430,019 428,280
- -----------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 63,881 $ 63,956 $ 63,309
Earning assets 72,820 72,382 71,672
Total assets 82,778 81,359 80,938
Deposits 44,805 43,233 44,795
Long-term debt 16,895 15,256 14,554
Shareholders' equity 6,592 6,402 6,155
Full-time equivalent employees 20,929 21,076 21,230
KeyCenters 905 911 911
- -----------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.21% 1.20% (.84)%
Return on average total assets -- core 1.21 1.20 (.84)
Return on average equity 15.16 15.53 (10.57)
Return on average equity-- core 15.16 15.53 (10.57)
Net interest margin (taxable equivalent) 3.98 3.93 3.98
- -----------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.96% 7.87% 7.60%
Tangible equity to tangible assets 6.69 6.57 6.29
Tier 1 risk-based capital 8.23 7.92 7.43
Total risk-based capital 12.29 12.02 11.41
Leverage 8.14 8.13 7.65
- -----------------------------------------------------------------------------------------------------------------------------
2001 SIX MONTHS ENDED JUNE 30,
-------------------------------- ------------------------------------
dollars in millions, except per share amounts THIRD SECOND 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $ 1,380 $ 1,467 $ 2,194 $ 3,037
Interest expense 656 754 857 1,636
Net interest income 724 713 1,337 1,401
Provision for loan losses 116 401 271 511
Noninterest income 454 398 891 853
Noninterest expense 683 858 1,326 1,556
Income (loss) before income taxes and
cumulative effect of accounting changes 379 (148) 631 187
Income (loss) before cumulative effect
of accounting changes 249 (136) 486 82
Net income (loss) 249 (160) 486 57
Net income (loss) -- core 249 28 486 245
- ----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect
of accounting changes $ .59 $ (.32) $ 1.14 $ .19
Income (loss) before cumulative effect
of accounting changes --- assuming dilution .58 (.32) 1.13 .19
Net income (loss) .59 (.38) 1.14 .14
Net income (loss) -- core .59 .07 1.14 .58
Net income (loss)-- assuming dilution .58 (.38) 1.13 .13
Net income (loss)-- assuming dilution -- core .58 .07 1.13 .57
Cash dividends paid .295 .295 .60 .59
Book value at period end 15.53 15.22 15.46 15.22
Market price:
High 28.15 26.43 29.40 29.25
Low 22.20 22.10 22.92 22.10
Close 24.14 26.05 27.30 26.05
Weighted average common shares (000) 424,802 424,675 425,477 424,352
Weighted average common shares and
potential common shares (000) 430,346 429,760 430,983 429,838
- ----------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 64,506 $ 66,693 $ 63,881 $ 66,693
Earning assets 73,943 76,531 72,820 76,531
Total assets 84,419 85,838 82,778 85,838
Deposits 45,372 45,743 44,805 45,743
Long-term debt 15,114 14,675 16,895 14,675
Shareholders' equity 6,575 6,467 6,592 6,467
Full-time equivalent employees 21,297 21,742 20,929 21,742
KeyCenters 911 926 905 926
- ----------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.16% (.75)% 1.21 % .13%
Return on average total assets -- core 1.16 .13 1.21 .57
Return on average equity 15.20 (9.67) 15.34 1.73
Return on average equity -- core 15.20 1.69 15.34 7.45
Net interest margin (taxable equivalent) 3.85 3.77 3.96 3.70
- ----------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.79% 7.53% 7.96% 7.53%
Tangible equity to tangible assets 6.51 6.25 6.69 6.25
Tier 1 risk-based capital 7.81 7.71 8.23 7.71
Total risk-based capital 11.77 11.81 12.29 11.81
Leverage 7.90 7.68 8.14 7.68
- ----------------------------------------------------------------------------------------------------------------------------------
37
LINE OF BUSINESS RESULTS
This section summarizes the financial performance and related strategic
developments of each of Key's three major business groups: Key Consumer Banking,
Key Corporate Finance and Key Capital Partners. To better understand this
discussion, see Note 4 ("Line of Business Results"), which begins on page 10.
Note 4 includes a brief description of the products and services offered by each
of the groups, as well as more detailed financial information pertaining to the
groups and their related lines of business.
Figure 3 summarizes the contribution made by each major business group to Key's
taxable-equivalent revenue and net income for the three- and six-month periods
ended June 30, 2002 and 2001. The specific lines of business that comprise each
of the groups are shown in the tables that accompany the discussions that
follow.
FIGURE 3. MAJOR BUSINESS GROUPS - TAXABLE-EQUIVALENT REVENUE AND NET INCOME
THREE MONTHS ENDED JUNE 30, CHANGE
----------------------------------- -------------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------
REVENUE (TAXABLE EQUIVALENT)
Key Consumer Banking $ 579 $ 569 $ 10 1.8%
Key Corporate Finance 325 340 (15) (4.4)
Key Capital Partners 288 292 (4) (1.4)
Other Segments (20) (15) (5) (33.3)
---------------- ----------------- -------------- --------------
Total segments 1,172 1,186 (14) (1.2)
Reconciling items(c) (3) (69) 66 95.7
---------------- ----------------- -------------- --------------
Total $1,169 $1,117 $ 52 4.7
================ ================= ==============
NET INCOME (LOSS)(a)
Key Consumer Banking(b) $ 115 $ 107 $ 8 7.5%
Key Corporate Finance 100 105 (5) (4.8)
Key Capital Partners 42 32 10 31.3
Other Segments (8) (4) (4) (100.0)
---------------- ----------------- -------------- --------------
Total segments 249 240 9 3.8
Reconciling items(c) (3) (400) 397 99.3
---------------- ----------------- -------------- --------------
Total $ 246 $ (160) $406 N/M
================ ================= ==============
- -----------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CHANGE
-------------------------------- ------------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------
REVENUE (TAXABLE EQUIVALENT)
Key Consumer Banking $1,141 $1,131 $ 10 .9%
Key Corporate Finance 666 655 11 1.7
Key Capital Partners 565 587 (22) (3.7)
Other Segments (43) (11) (32) (290.9)
--------------- -------------- ------------- -------------
Total segments 2,329 2,362 (33) (1.4)
Reconciling items(c) (15) (95) 80 84.2
--------------- -------------- ------------- -------------
Total $2,314 $2,267 $ 47 2.1
=============== ============== =============
NET INCOME (LOSS)(a)
Key Consumer Banking(b) $ 219 $ 207 $ 12 5.8%
Key Corporate Finance 209 190 19 10.0
Key Capital Partners 79 62 17 27.4
Other Segments (16) 6 (22) (366.7)
--------------- -------------- ------------- -------------
Total segments 491 465 26 5.6
Reconciling items(c) (5) (408) 403 98.8
--------------- -------------- ------------- -------------
Total $ 486 $ 57 $ 429 752.6
=============== ============== =============
- -----------------------------------------------------------------------------------------------------
(a) Key's management accounting system utilizes a methodology for loan loss
provisioning by line of business that reflects credit quality expectations
within each line of business over a normal business cycle. The "normalized
provision for loan losses" assigned to each line as a result of this
methodology does not necessarily coincide with the level of net loan
charge-offs at any given point in the cycle.
(b) Results for the three- and six-month periods ended June 30, 2001, exclude
a one-time cumulative charge of $39 million ($24 million after tax)
resulting from a prescribed change, applicable to all companies, in the
accounting for retained interests in securitized assets (See note (c)
below).
(c) Reconciling items in the second quarter of 2001 include an additional
provision for loan losses of $300 million ($189 million after tax)
recorded in connection with Key's decision to discontinue certain
nonrelationship commercial lending, a goodwill write-down of $150 million
associated with Key's decision to downsize its automobile finance
business, a $40 million ($25 million after tax) loss recorded in
connection with declines in leased vehicle residual values, a $20 million
($13 million after tax) increase in litigation reserves and other
nonrecurring charges of $2 million ($1 million after tax). Also included
are charges related to unallocated nonearning assets of corporate support
functions and the effect of the accounting change described in note (b)
above.
N/M = Not Meaningful
38
FIGURE 4. KEY CONSUMER BANKING GROUP DATA
THREE MONTHS ENDED JUNE 30, CHANGE
----------------------------------- -----------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------------
REVENUE (TAXABLE EQUIVALENT)
Retail Banking $327 $327 -- --%
Small Business 98 98 -- --
Indirect Lending 94 99 $ (5) (5.1)
National Home Equity 60 45 15 33.3
---------------- ---------------- ------------ -------------
Total $579 $569 $ 10 1.8
================ ================ ============
NET INCOME (LOSS)(a)
Retail Banking $ 68 $ 62 $ 6 9.7%
Small Business 30 29 1 3.4
Indirect Lending 13 16 (3) (18.8)
National Home Equity 4 -- 4 N/M
---------------- ---------------- ------------ -------------
Total $115 $107 $ 8 7.5
================ ================ ============
- ----------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CHANGE
------------------------------ -----------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------
REVENUE (TAXABLE EQUIVALENT)
Retail Banking $ 641 $ 652 $(11) (1.7)%
Small Business 195 188 7 3.7
Indirect Lending 185 205 (20) (9.8)
National Home Equity 120 86 34 39.5
---------------- -------------- ------------ -------------
Total $1,141 $1,131 $ 10 .9
================ ============== ============
NET INCOME (LOSS)(a)
Retail Banking $ 132 $ 121 $ 11 9.1 %
Small Business 59 52 7 13.5
Indirect Lending 22 35 (13) (37.1)
National Home Equity 6 (1) 7 N/M
---------------- -------------- ------------ -------------
Total $ 219 $ 207 $ 12 5.8
================ ============== ============
- -------------------------------------------------------------------------------------------------------
(a) Results for the three- and six-month periods ended June 30, 2001, exclude a
one-time cumulative charge of $39 million ($24 million after tax) resulting
from a prescribed change, applicable to all companies, in the accounting
for retained interests in securitized assets.
N/M = Not Meaningful
ADDITIONAL KEY CONSUMER BANKING DATA (2Q02)
Average home equity loans: $11.9 billion National Home Equity average loan-to-value ratio: 76%
Average core deposits: $30.9 billion National Home Equity first lien positions: 83%
489,632 on-line clients (28% penetration) 905 KeyCenters and 2,284 ATMs
8,434 average full-time equivalent employees
Net income for Key Consumer Banking was $115 million for the second quarter of
2002, representing an $8 million increase from the year-ago quarter. The
improvement is attributable to an increase in noninterest income and a reduction
in noninterest expense, offset in part by a decrease in taxable-equivalent net
interest income and a higher provision for loan losses.
Taxable-equivalent net interest income decreased by $5 million, or 1%, from the
second quarter of 2001 due to a less favorable interest rate spread on deposits
and a decline in average deposits outstanding. The adverse effect of these
factors was partially offset by a more favorable spread on earning assets.
Noninterest income grew by $15 million, or 14%, due primarily to a $9 million
increase in income from service charges on deposit accounts contributed by the
Retail Banking and Small Business lines of business. This growth resulted from
new pricing implemented in mid-2001 in connection with PEG (Perform, Excel,
Grow), Key's competitiveness improvement initiative. Also contributing to the
growth in noninterest income are lower losses from retained interests in
previously securitized assets and from trading activities. Noninterest expense
was down $5 million, or 1%, from the second quarter of 2001. This improvement
reflects an approximate $9 million reduction in goodwill amortization, which
resulted from the adoption of new accounting guidance on January 1, as well as
lower costs for software amortization. These reductions were partially offset by
higher costs related to personnel, marketing and activities associated with a
higher volume of home equity lending. An $8 million, or 15%, increase in the
provision for loan losses reflects the growth in lending in the National Home
Equity line of business.
39
FIGURE 5. KEY CORPORATE FINANCE GROUP DATA
THREE MONTHS ENDED JUNE 30, CHANGE SIX MONTHS ENDED JUNE 30, CHANGE
--------------------------- ------------------- ------------------------- -------------------
dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT
- --------------------------------------------------------------------------------------------------------------------- --------
REVENUE (TAXABLE EQUIVALENT)
Corporate Banking $177 $201 $(24) (11.9)% $365 $392 $(27) (6.9)%
National Commercial Real Estate 86 95 (9) (9.5) 176 177 (1) (.6)
National Equipment Finance 62 44 18 40.9 125 86 39 45.3
---- ---- ---- ----- ---- ---- ---- -----
Total $325 $340 $(15) (4.4) $666 $655 $ 11 1.7
==== ==== ==== ==== ==== ====
NET INCOME
Corporate Banking $ 50 $ 62 $(12) (19.4)% $107 $115 $ (8) (7.0)%
National Commercial Real Estate 29 36 (7) (19.4) 61 63 (2) (3.2)
National Equipment Finance 21 7 14 200.0 41 12 29 241.7
---- ---- ---- ---- ---- ---- ---- ---
Total $100 $105 $ (5) (4.8) $209 $190 $ 19 10.0
==== ==== ==== ==== ==== ====
- --------------------------------------------------------------------------------------------------------------------- --------
ADDITIONAL KEY CORPORATE FINANCE DATA (2Q02)
Average loans and leases: $29.6 billion
Average deposits: $3.1 billion
1,728 average full-time equivalent employees
Net income for Key Corporate Finance was $100 million for the second quarter of
2002, compared with $105 million for the same period last year. The decrease is
due to a reduction in noninterest income, partially offset by an increase in
taxable-equivalent net interest income and lower noninterest expense.
Taxable-equivalent net interest income grew by $5 million, or 2%, due primarily
to a more favorable interest rate spread on earning assets and an increase in
the taxable-equivalent adjustment related to income derived from the equipment
leasing portfolio. At the same time, noninterest income decreased by $20
million, or 30%. In the Corporate Banking line of business, additional income
from a significant increase in service charges on deposit accounts was more than
offset by lower income from trading activities. The overall reduction in
noninterest income also reflects declines in gains from loan sales in the
National Commercial Real Estate line and from the residual values of leased
equipment in the National Equipment Finance line. A $6 million, or 5%, decrease
in noninterest expense was driven by an approximate $4 million reduction in
goodwill amortization resulting from the January 1 adoption of new accounting
guidance.
FIGURE 6. KEY CAPITAL PARTNERS GROUP DATA
THREE MONTHS SIX MONTHS ENDED
ENDED JUNE 30, CHANGE JUNE 30, CHANGE
------------------------ ------------------- ------------------- ----------------------
dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------------------------------
REVENUE (TAXABLE EQUIVALENT)
Victory Capital Management $ 57 $ 60 $ (3) (5.0)% $110 $116 $ (6) (5.2)%
High Net Worth 148 149 (1) (.7) 293 306 (13) (4.2)
Capital Markets 83 83 -- -- 162 165 (3) (1.8)
---- ---- ---- ---- ---- ---- ---- ----
Total $288 $292 $ (4) (1.4) $565 $587 $(22) (3.7)
==== ==== ==== ==== ==== ====
NET INCOME
Victory Capital Management $ 12 $ 12 -- -- % $ 21 $ 18 $ 3 16.7%
High Net Worth 17 9 $ 8 88.9 31 22 9 40.9
Capital Markets 13 11 2 18.2 27 22 5 22.7
---- ---- ---- ---- ---- ---- ---- ----
Total $ 42 $ 32 10 31.3 $ 79 $ 62 $ 17 27.4
==== ==== ==== ==== ==== ====
- -----------------------------------------------------------------------------------------------------------------------------------
ADDITIONAL KEY CAPITAL PARTNERS DATA (2Q02)
Assets under management: $70.7 billion 815 High Net Worth sales personnel
Nonmanaged and brokerage assets: $72.0 billion 3,669 average full-time equivalent employees
Net new asset inflows: $919 million
40
Net income for Key Capital Partners was $42 million for the second quarter of
2002, up from $32 million in the second quarter of last year. The improvement is
attributable to a substantial decrease in noninterest expense and growth in
taxable-equivalent net interest income. These positive results more than offset
a decline in noninterest income.
Taxable-equivalent net interest income increased by $2 million, or 4%, from the
second quarter of 2001, despite the $1.4 billion reduction in average loans
outstanding that resulted from the 2001 sale of residential mortgage loans
associated with the High Net Worth line of business. The increase is due
primarily to the lower cost of short-term borrowings and strong growth in home
equity lending. A $6 million, or 3%, decrease in noninterest income is
attributable mainly to lower income from derivatives and from foreign exchange
in the Capital Markets line, a decrease in income from trading activities in the
High Net Worth line and a general decline in fee income that is based on the
value of assets under management. These decreases were offset in part by a $3
million gain from the divestiture of the 401(k) business in the second quarter
of 2002. Noninterest expense decreased by $15 million, or 6%, from the year-ago
quarter, due primarily to an approximate $6 million reduction that resulted from
the change in accounting for goodwill, and to reduced software amortization.
41
RESULTS OF OPERATIONS
NET INTEREST INCOME
Key's principal source of earnings is net interest income, which is interest and
loan-related fee income less interest expense. There are several factors that
affect net interest income, including:
- - the volume, pricing, mix and maturity of earning assets and
interest-bearing liabilities;
- - the use of derivative instruments to manage interest rate risk;
- - interest rate fluctuations; and
- - asset quality.
To make it easier to compare results among different periods and the yields on
various types of earning assets, we present all net interest income on a
"taxable-equivalent basis." In other words, if we earn $100 of tax-exempt
income, we present those earnings at a higher amount (specifically, $154)
that--if taxed at the statutory Federal income tax rate of 35%--would yield
$100.
Figure 7, which spans pages 43 and 44, shows the various components of Key's
balance sheet that affect interest income and expense, and their respective
yields or rates over the past five quarters. Net interest income for the second
quarter of 2002 was $721 million, compared with $719 million reported a year
ago. This growth reflected an improved net interest margin, which increased 21
basis points to 3.98%. The net interest margin is an indicator of the
profitability of the earning asset portfolio and is calculated by dividing net
interest income by average earning assets. At the same time, average earning
assets decreased by 5% to $72.6 billion, due primarily to declines in both
commercial loans and consumer loans, other than home equity loans.
NET INTEREST MARGIN. The net interest margin improved over the past year,
primarily because:
- - we benefited from declining short-term interest rates;
- - the interest rate spread on our total loan portfolio improved as commercial
lease financing yields increased and we continued to focus on those
businesses, such as home equity lending, that typically generate higher
interest rate spreads;
- - we sold loans with interest rate spreads that did not meet Key's internal
profitability standards; and
- - a greater proportion of Key's earning assets was supported by
noninterest-bearing liabilities (such as demand deposits) and shareholders'
equity.
INTEREST EARNING ASSETS. Average earning assets for the second quarter of 2002
totaled $72.6 billion, which was $4.0 billion, or 5%, lower than the second
quarter 2001 level. This decrease came principally from the loan portfolio and
was attributable to a number of factors, including Key's decisions in May 2001
to exit or scale back certain types of lending. Another factor was loan sales,
including the September 2001 sale of $1.4 billion of residential mortgage
loans. Weak loan demand resulting from the general economic slowdown has also
contributed to the net decline in loans.
The size and composition of Key's loan portfolio has been affected by several
actions taken in the first six months of 2002 and during 2001:
- - During the third quarter of 2001, we sold the aforementioned $1.4 billion
of residential mortgage loans, which were generated by our private banking
and community development businesses. These loans are originated as a
customer and community accommodation and are sold periodically because they
have relatively low interest rate spreads that do not meet Key's internal
profitability standards.
- - During the second quarter of 2001, management announced that Key would exit
the automobile leasing business, de-emphasize indirect prime automobile
lending and discontinue certain nonrelationship credit-only commercial
lending. These portfolios, in the aggregate, have declined by approximately
$2.7 billion since the date of the announcement through June 30, 2002.
42
FIGURE 7. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
SECOND QUARTER 2002
----------------------------------------------
AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE
- ------------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a), (b)
Commercial, financial and agricultural $18,213 $ 244 5.37%
Real estate -- commercial mortgage 6,414 91 5.70
Real estate -- construction 5,870 72 4.93
Commercial lease financing 7,206 126 6.96
- ------------------------------------------------------------------------------------------------------------------
Total commercial loans 37,703 533 5.66
Real estate -- residential 2,148 38 7.04
Home equity 13,072 229 7.03
Consumer -- direct 2,210 45 8.21
Consumer -- indirect lease financing 1,514 33 8.84
Consumer -- indirect other 5,131 118 9.19
- ------------------------------------------------------------------------------------------------------------------
Total consumer loans 24,075 463 7.71
Loans held for sale 2,150 30 5.58
- ------------------------------------------------------------------------------------------------------------------
Total loans 63,928 1,026 6.43
Taxable investment securities 934 7 3.20
Tax-exempt investment securities(a) 205 4 8.31
- ------------------------------------------------------------------------------------------------------------------
Total investment securities 1,139 11 4.12
Securities available for sale(a),(c) 5,951 95 6.45
Short-term investments 1,561 8 1.97
- ------------------------------------------------------------------------------------------------------------------
Total earning assets 72,579 1,140 6.30
Allowance for loan losses (1,579)
Accrued income and other assets 10,560
- ------------------------------------------------------------------------------------------------------------------
$81,560
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $12,535 27 .87
Savings deposits 2,014 3 .67
NOW accounts 697 2 1.02
Certificates of deposit ($100,000 or more) (d) 4,816 56 4.69
Other time deposits 13,085 131 4.02
Deposits in foreign office 2,638 12 1.76
- ------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 35,785 231 2.59
Federal funds purchased and securities
sold under repurchase agreements 5,541 24 1.71
Bank notes and other short-term borrowings(d) 2,995 20 2.73
Long-term debt, including capital securities(d),(e) 17,230 144 3.37
- ------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 61,551 419 2.73
Noninterest-bearing deposits 8,719
Accrued expense and other liabilities 4,783
Common shareholders' equity 6,507
- ------------------------------------------------------------------------------------------------------------------
$81,560
=======
Interest rate spread (TE) 3.57%
- ------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $721 3.98%
---- =====
Capital securities $1,236 $20
Taxable-equivalent adjustment(a) 38
- ------------------------------------------------------------------------------------------------------------------
FIRST QUARTER 2002
---------------------------------------------
AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE
- -----------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a), (b)
Commercial, financial and agricultural $18,016 $ 242 5.44%
Real estate -- commercial mortgage 6,598 93 5.74
Real estate -- construction 5,856 72 5.01
Commercial lease financing 7,275 132 7.25
- -----------------------------------------------------------------------------------------------------------------
Total commercial loans 37,745 539 5.77
Real estate -- residential 2,241 41 7.21
Home equity 11,863 212 7.26
Consumer -- direct 2,289 46 8.14
Consumer -- indirect lease financing 1,852 41 8.74
Consumer -- indirect other 5,231 120 9.21
- -----------------------------------------------------------------------------------------------------------------
Total consumer loans 23,476 460 7.89
Loans held for sale 2,267 32 5.70
- -----------------------------------------------------------------------------------------------------------------
Total loans 63,488 1,031 6.55
Taxable investment securities 916 6 2.43
Tax-exempt investment securities(a) 219 5 8.52
- -----------------------------------------------------------------------------------------------------------------
Total investment securities 1,135 11 3.61
Securities available for sale(a),(c) 5,317 89 6.76
Short-term investments 2,041 9 1.76
- -----------------------------------------------------------------------------------------------------------------
Total earning assets 71,981 1,140 6.38
Allowance for loan losses (1,657)
Accrued income and other assets 10,547
- -----------------------------------------------------------------------------------------------------------------
$80,871
========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $12,659 30 .95
Savings deposits 1,947 3 .71
NOW accounts 715 2 1.03
Certificates of deposit ($100,000 or more)(d) 4,516 57 5.10
Other time deposits 13,443 149 4.51
Deposits in foreign office 2,136 9 1.69
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 35,416 250 2.86
Federal funds purchased and securities
sold under repurchase agreements 5,584 23 1.70
Bank notes and other short-term borrowings(d) 4,028 27 2.68
Long-term debt, including capital securities(d),(e) 16,103 138 3.46
- -----------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 61,131 438 2.90
Noninterest-bearing deposits 8,553
Accrued expense and other liabilities 4,918
Common shareholders' equity 6,269
- -----------------------------------------------------------------------------------------------------------------
$80,871
========
Interest rate spread (TE) 3.48%
- -----------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $702 3.93%
---- ====
Capital securities $ 1,298 $ 21
Taxable-equivalent adjustment(a) 48
- -----------------------------------------------------------------------------------------------------------------
(a) Interest income on tax-exempt securities and loans has been adjusted to a
taxable-equivalent basis using the statutory Federal income tax rate of
35%.
(b) For purposes of these computations, nonaccrual loans are included in
average loan balances.
(c) Yield is calculated on the basis of amortized cost.
(d) Rate calculation excludes basis adjustments related to fair value hedges.
See Note 14 ("Derivatives and Hedging Activities"), which begins on page
28, for an explanation of fair value hedges.
(e) Rate calculation excludes ESOP debt.
TE = Taxable Equivalent
43
FIGURE 7. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
(CONTINUED)
FOURTH QUARTER 2001 THIRD QUARTER 2001 SECOND QUARTER 2001
- -------------------------------------- -------------------------------------------- -------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- -------------------------------------------------------------------------------------- -------------------------------------
$18,462 $ 271 5.83% $19,338 $ 324 6.63 % $20,030 $ 361 7.24%
6,737 106 6.23 6,813 123 7.20 6,837 135 7.91
5,971 85 5.65 5,859 101 6.87 5,504 108 7.81
7,109 128 7.18 6,995 117 6.68 6,990 120 6.86
- ------------------------------------------------------------------------------------------------------------------------------------
38,279 590 6.12 39,005 665 6.77 39,361 724 7.37
2,384 44 7.46 3,826 71 7.42 4,065 79 7.81
11,046 217 7.82 10,777 228 8.38 10,459 228 8.74
2,361 52 8.66 2,409 56 9.34 2,458 60 9.74
2,210 47 8.55 2,557 54 8.30 2,778 57 8.27
5,359 128 9.51 5,494 132 9.60 5,593 134 9.61
- ------------------------------------------------------------------------------------------------------------------------------------
23,360 488 8.32 25,063 541 8.58 25,353 558 8.83
2,113 34 6.48 2,130 38 7.17 2,240 43 7.69
- ------------------------------------------------------------------------------------------------------------------------------------
63,752 1,112 6.94 66,198 1,244 7.47 66,954 1,325 7.93
904 4 1.86 925 8 3.44 911 8 3.41
241 6 8.69 258 5 8.65 297 6 8.79
- ------------------------------------------------------------------------------------------------------------------------------------
1,145 10 3.30 1,183 13 4.57 1,208 14 4.74
6,120 103 6.78 6,565 114 6.99 6,572 115 6.99
1,689 11 2.55 1,741 15 3.57 1,812 19 4.19
- ------------------------------------------------------------------------------------------------------------------------------------
72,706 1,236 6.76 75,687 1,386 7.29 76,546 1,473 7.71
(1,159) (1,204) (988)
10,920 10,396 10,429
- ------------------------------------------------------------------------------------------------------------------------------------
$82,467 $84,879 $85,987
======= ======= =======
$12,396 37 1.20 $12,522 55 1.72 $12,296 67 2.22
1,911 4 .79 1,936 5 1.01 1,969 5 1.06
653 2 1.26 611 2 1.41 610 3 1.50
4,788 61 5.08 4,800 67 5.53 5,571 81 5.85
13,659 169 4.91 13,703 184 5.33 14,479 209 5.77
2,418 14 2.21 3,399 30 3.57 2,173 23 4.27
- ------------------------------------------------------------------------------------------------------------------------------------
35,825 287 3.18 36,971 343 3.68 37,098 388 4.20
4,272 24 2.20 6,078 52 3.37 5,177 52 4.06
5,563 42 2.99 6,230 61 3.95 8,016 94 4.67
16,167 157 3.88 15,991 200 4.97 16,068 220 5.49
- ------------------------------------------------------------------------------------------------------------------------------------
61,827 510 3.28 65,270 656 3.99 66,359 754 4.56
8,750 8,262 8,213
5,359 4,848 4,779
6,531 6,499 6,636
- ------------------------------------------------------------------------------------------------------------------------------------
$82,467 $84,879 $85,987
======= ======= =======
3.48% 3.30% 3.15%
- ------------------------------------------------------------------------------------------------------------------------------------
$726 3.98% $730 3.85% $719 3.77%
==== ==== ==== ==== ==== =====
$1,333 $21 $1,305 $21 $1,292 $23
26 6 6
- ------------------------------------------------------------------------------------------------------------------------------------
44
- - We sold commercial mortgage loans of $478 million during the first half of
2002 and $1.7 billion during 2001. Since certain of these loans have been
sold with limited recourse, Key established a loss reserve of an amount
estimated by management to be appropriate to reflect the recourse risk.
More information about the related recourse agreement is provided in Note
13 ("Other Financial Instruments with Off-Balance Sheet Risk") under the
section entitled "Recourse agreement with Federal National Mortgage
Association," on page 26. Our business of originating and servicing
commercial mortgage loans has grown, in part, as a result of acquiring
Conning Asset Management in the second quarter of 2002 and both Newport
Mortgage Company, L.P. and National Realty Funding L.C. in 2000.
- - We sold education loans of $186 million during the first six months of 2002
and $1.2 billion ($491 million through securitizations) during 2001.
Figure 8 shows how the changes in yields or rates and average balances from the
prior year affected net interest income. The section entitled "Financial
Condition," which begins on page 52, contains more discussion about changes in
earning assets and funding sources.
FIGURE 8. COMPONENTS OF NET INTEREST INCOME CHANGES
FROM THREE MONTHS ENDED JUNE 30, 2001
IN THREE MONTHS ENDED JUNE 30, 2002
-----------------------------------------------------------
AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE
- -----------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $(58) $(241) $(299)
Taxable investment securities -- (1) (1)
Tax-exempt investment securities (2) -- (2)
Securities available for sale (10) (10) (20)
Short-term investments (2) (9) (11)
- -----------------------------------------------------------------------------------------------------------------------
Total interest income (taxable equivalent) (72) (261) (333)
INTEREST EXPENSE
Money market deposit accounts 1 (41) (40)
Savings deposits -- (2) (2)
NOW accounts -- (1) (1)
Certificates of deposit ($100,000 or more) (10) (15) (25)
Other time deposits (19) (59) (78)
Deposits in foreign office 4 (15) (11)
- -----------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (24) (133) (157)
Federal funds purchased and securities sold
under repurchase agreements 3 (31) (28)
Bank notes and other short-term borrowings (44) (30) (74)
Long-term debt, including capital securities 15 (91) (76)
- -----------------------------------------------------------------------------------------------------------------------
Total interest expense (50) (285) (335)
- -----------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $(22) $ 24 $ 2
===== ===== ====
- -----------------------------------------------------------------------------------------------------------------------
FROM SIX MONTHS ENDED JUNE 30, 2001
TO SIX MONTHS ENDED JUNE 30, 2002
------------------------------------------------------------
AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE
- -------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $(129) $(561) $(690)
Taxable investment securities -- (2) (2)
Tax-exempt investment securities (4) (1) (5)
Securities available for sale (39) (11) (50)
Short-term investments 2 (25) (23)
- -------------------------------------------------------------------------------------------------------------------
Total interest income (taxable equivalent) (170) (600) (770)
INTEREST EXPENSE
Money market deposit accounts 5 (110) (105)
Savings deposits -- (9) (9)
NOW accounts 1 1 2
Certificates of deposit ($100,000 or more) (30) (30) (60)
Other time deposits (40) (112) (152)
Deposits in foreign office (3) (40) (43)
- -------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (67) (300) (367)
Federal funds purchased and securities sold
under repurchase agreements 8 (83) (75)
Bank notes and other short-term borrowings (81) (71) (152)
Long-term debt, including capital securities 26 (211) (185)
- -------------------------------------------------------------------------------------------------------------------
Total interest expense (114) (665) (779)
- -------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $(56) $ 65 $ 9
===== ===== ====
- -------------------------------------------------------------------------------------------------------------------
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.
MARKET RISK MANAGEMENT
The values of some financial instruments vary not only with changes in external
interest rates, but also with changes in foreign exchange rates, factors
influencing valuations in the equity securities markets, and other market-driven
rates or prices. For example, the value of a fixed-rate bond will decline if
market interest rates increase; the bond will become a less attractive
investment. Similarly, the value of the U.S. dollar regularly fluctuates in
relation to other currencies. The exposure that instruments tied to such
external factors present is called "market risk." Most of Key's market risk is
derived from interest rate fluctuations.
INTEREST RATE RISK MANAGEMENT
Key's Asset/Liability Management Policy Committee has developed a program to
measure and manage interest rate risk. This committee is also responsible for
approving Key's asset/liability management policies, overseeing the formulation
and implementation of strategies to improve balance sheet positioning and
earnings, and reviewing Key's interest rate sensitivity exposure.
45
FACTORS CONTRIBUTING TO INTEREST RATE EXPOSURE. Key uses interest rate exposure
models to quantify the potential impact on earnings and economic value of equity
arising from a variety of future interest rate scenarios. The many interest rate
scenarios modeled quantify the level of Key's interest rate exposure arising
from option risk, basis risk and gap risk.
- - A financial instrument presents "OPTION RISK" when one party can take -
advantage of changes in interest rates without penalty. For example, when
interest rates decline, borrowers may choose to prepay fixed-rate loans by
refinancing at a lower rate. Such a prepayment gives Key a return on its
investment (the principal plus some interest), but unless there is a
prepayment penalty, that return will not be as high as the return that
would have been generated had payments been received for the duration
originally scheduled. Floating-rate loans that are capped against potential
interest rate increases and deposits that can be withdrawn on demand also
present option risk.
- - One approach that Key follows to manage interest rate risk is to use
floating-rate liabilities (such as borrowings) to fund floating-rate assets
(such as loans). That way, as our interest expense increases, so will our
interest income. We face "BASIS RISK" when our floating-rate assets and
floating-rate liabilities reprice in response to different market factors
or indices. Under those circumstances, even if equal amounts of assets and
liabilities are repricing at the same time, interest expense and interest
income may not change by the same amount.
- - We often use an interest-bearing liability to fund an interest-earning
asset. For example, Key may sell certificates of deposit and use the
proceeds to make loans. That strategy presents "GAP RISK" if the related
liabilities and assets do not mature or reprice at the same time.
MEASUREMENT OF SHORT-TERM INTEREST RATE EXPOSURE. The primary tool that
management uses to measure interest rate risk is a net interest income
simulation model. These simulations estimate the impact that various changes in
the overall level of interest rates over one- and two-year time horizons would
have on net interest income. The results help Key develop strategies for
managing exposure to interest rate risk.
Like any forecasting technique, interest rate simulation modeling is based on a
large number of assumptions and judgments. In this case, the assumptions relate
primarily to loan and deposit growth, asset and liability prepayments, interest
rates, and on- and off-balance sheet management strategies. Management believes
that, both individually and in the aggregate, the assumptions Key makes are
reasonable. Nevertheless, the simulation modeling process produces only a
sophisticated estimate, not a precise calculation of exposure.
Key's guidelines for risk management call for preventive measures to be taken if
the simulation modeling demonstrates that a gradual 2% increase or decrease in
short-term rates over the next twelve months would adversely affect net interest
income over the same period by more than 2%. Key is operating within these
guidelines. The low level of short-term interest rates at June 30, 2002,
necessitated a modification of Key's standard rate scenario of a gradual
decrease of 2% over twelve months to a gradual decrease of 1% over six months
and no change over the following six months. As of June 30, 2002, based on the
results of our simulation model, and assuming that management does not take
action to alter the outcome, Key would expect net interest income to decrease by
approximately .39% if short-term interest rates gradually increase by 2%.
Conversely, if short-term interest rates gradually decrease by 1% over the next
six months, net interest income would be expected to increase by approximately
..82% over the next twelve months.
MEASUREMENT OF LONG-TERM INTEREST RATE EXPOSURE. Key uses an economic value of
equity model to complement short-term interest rate risk analysis. The benefit
of this model is that it measures exposure to interest rate changes over time
frames longer than two years. The economic value of Key's equity is determined
by aggregating the present value of projected future cash flows for asset,
liability and derivative positions based on the current yield curve. However,
economic value does not represent the fair values of asset, liability and
derivative positions, since it does not consider factors like credit risk and
liquidity.
Key's guidelines for risk management call for preventive measures to be taken if
an immediate 2% increase or decrease in interest rates is estimated to reduce
the economic value of equity by more than 15%. Certain
46
short-term interest rates were limited to reductions of less than 2% since
interest rates cannot decrease below zero in the economic value of equity model.
Key is operating within these guidelines.
MANAGEMENT OF INTEREST RATE EXPOSURE. Management uses the results of short-term
and long-term interest rate exposure models to formulate strategies to improve
balance sheet positioning, earnings, or both, within the bounds of Key's
interest rate risk, liquidity and capital guidelines. We manage interest rate
risk by using portfolio swaps and caps, which modify the repricing or maturity
characteristics of some of our assets and liabilities. The decision to use these
instruments rather than securities, debt or other on-balance sheet alternatives
depends on many factors, including the mix and cost of funding sources,
liquidity and capital requirements, and interest rate implications.
A brief description of interest rate swaps and caps is as follows:
- - INTEREST RATE SWAPS are contracts in which two parties agree to exchange
interest payment streams that are calculated based on agreed-upon amounts
(known as "notional amounts"). For example, party A will pay interest at a
fixed rate to, and receive interest at a variable rate from, party B. Key
generally uses interest rate swaps to mitigate its exposure to interest
rate risk on certain loans, securities, deposits, short-term borrowings and
long-term debt.
- - INTEREST RATE CAPS are contracts that provide for the holder to be
compensated based on an agreed-upon notional amount when a benchmark
interest rate exceeds a specified level (known as the "strike rate"). Caps
limit exposure to interest rate increases, but have no effect if interest
rates decline. Key has used interest rate caps to manage the risk of
adverse movements in interest rates on some of its debt.
For more information about how Key uses interest rate swaps and caps to manage
its balance sheet, see Note 14 ("Derivatives and Hedging Activities"), starting
on page 28.
TRADING PORTFOLIO RISK MANAGEMENT
Key's trading portfolio includes interest rate swap contracts entered into to
accommodate the needs of clients, other positions with third parties that are
intended to mitigate the interest rate risk of client positions, foreign
exchange contracts entered into to accommodate the needs of clients, and
proprietary trading positions in financial assets and liabilities. The fair
values of these trading portfolio items are included in "accrued income and
other assets" or "accrued expense and other liabilities" on the balance sheet.
For more information about these items, see Note 14 ("Derivatives and Hedging
Activities"), which begins on page 28.
Management uses a value at risk ("VAR") model to estimate the potential adverse
effect of changes in interest and foreign exchange rates on the fair value of
Key's trading portfolio. Using statistical methods, this model estimates the
maximum potential one-day loss with 95% probability. At June 30, 2002, Key's
aggregate daily VAR was $1.8 million, compared with $1.4 million at June 30,
2001. Aggregate daily VAR averaged $1.6 million for the first six months of
2002, compared with an average of $1.3 million for the same period last year.
VAR modeling augments other controls that Key uses to mitigate the market risk
exposure of the trading portfolio. These controls include loss and portfolio
size limits that are based on market liquidity and the level of activity and
volatility of trading products.
NONINTEREST INCOME
Noninterest income for the second quarter of 2002 totaled $448 million, up $50
million, or 13%, from the same period last year. For the first six months of the
year, noninterest income was $891 million, representing an increase of $38
million, or 4%, from the first half of 2001.
47
Key's noninterest income for the second quarter of 2001 includes a $40 million
charge (included in miscellaneous income) to establish a reserve for losses
incurred on the residual values of leased vehicles. Excluding this strategic
charge, noninterest income for the second quarter of 2002 grew by $10 million,
or 2%, from the year-ago quarter. The improvement is due primarily to a $14
million increase in service charges on deposit accounts, attributable largely to
new pricing implemented in mid-2001 in connection with Key's competitiveness
initiative. Noninterest income also benefited from a $5 million increase in
trust and investment services income. These favorable results were offset in
part by a $7 million reduction in net securities gains.
Adjusting for the $40 million charge discussed above, Key's noninterest income
for the first six months of 2002 was essentially unchanged from the amount for
the comparable period last year. A $30 million increase in service charges on
deposit accounts was more than offset by a $33 million decline in net securities
gains.
Figure 9 shows the major components of Key's noninterest income. The discussion
that follows provides additional information, such as the composition of certain
components and the factors that caused them to change from the prior year.
FIGURE 9. NONINTEREST INCOME
THREE MONTHS SIX MONTHS
ENDED JUNE 30, CHANGE ENDED JUNE 30, CHANGE
--------------- ------------------ ----------------- -------------------
dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------- -------------------
Trust and investment services income $137 $132 $5 3.8% $272 $273 $(1) (.4)%
Investment banking and capital markets income 68 72 (4) (5.6) 140 137 3 2.2
Service charges on deposit accounts 104 90 14 15.6 204 174 30 17.2
Corporate-owned life insurance income 26 27 (1) (3.7) 52 54 (2) (3.7)
Letter of credit and loan fees 29 30 (1) (3.3) 57 59 (2) (3.4)
Net securities gains 1 8 (7) (87.5) 1 34 (33) (97.1)
Other income:
Electronic banking fees 20 18 2 11.1 38 35 3 8.6
Insurance income 15 12 3 25.0 28 26 2 7.7
Loan securitization servicing fees 2 5 (3) (60.0) 5 9 (4) (44.4)
Net gains from loan securitizations and sales 3 8 (5) (62.5) 9 13 (4) (30.8)
Miscellaneous income 43 (4) 47 N/M 85 39 46 117.9
- -----------------------------------------------------------------------------------------------------------------------------------
Total other income 83 39 44 112.8 165 122 43 35.2
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $448 $398 $50 12.6% $891 $853 $38 4.5 %
==== ==== === ==== ==== ===
- -----------------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful
TRUST AND INVESTMENT SERVICES INCOME. Trust and investment services provide
Key's largest source of noninterest income. Its primary components are as shown
in Figure 10. In 2002, the level of revenue derived from these services has been
adversely affected by continued softness in the economy, since a significant
portion of this income is based on the value of assets under management.
FIGURE 10. TRUST AND INVESTMENT SERVICES INCOME
THREE MONTHS SIX MONTHS
ENDED JUNE 30, CHANGE ENDED JUNE 30, CHANGE
------------------ -------------------- ---------------- -------------------
dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------------------------------
Personal asset management and custody fees $41 $44 $(3) (6.8)% $81 $90 $(9) (10.0)%
Institutional asset management and custody fees 20 22 (2) (9.1) 40 44 (4) (9.1)
Bond services 10 9 1 11.1 20 19 1 5.3
Brokerage commission income 29 21 8 38.1 57 47 10 21.3
All other fees 37 36 1 2.8 74 73 1 1.4
- -----------------------------------------------------------------------------------------------------------------------------------
Total trust and investment services income $137 $132 $ 5 3.8 % $272 $273 $(1) (.4)%
==== ==== ==== ==== ==== ====
- -----------------------------------------------------------------------------------------------------------------------------------
At June 30, 2002, Key's bank, trust and registered investment advisory
subsidiaries had assets under management of $70.7 billion, compared with $74.4
billion at June 30, 2001. These assets are managed on behalf of both
institutions and individuals through a variety of equity, fixed income and money
market accounts. The composition of Key's assets under management is shown in
Figure 11. The value of total assets under management decreased by a net 5% over
the past twelve months. This decrease reflects the adverse effect of a decline
in the market value of assets under management at June 30, 2002, offset in part
by the positive effect of net new asset inflows of approximately $296 million
during the same period. As shown in Figure 11, more than one-half of the assets
Key manages are invested in more stable fixed income or money market funds. The
performance of the majority of Key's product types exceeded the performance of
their respective benchmarks.
48
FIGURE 11. ASSETS UNDER MANAGEMENT
2002 2001
------------------------- -----------------------------------------
in millions Second First Fourth Third Second
- ------------------------------------------------------------------------------------------------------------------------------------
Assets under management by investment type:
Equity $31,064 $34,497 $34,799 $32,067 $35,903
Fixed income 18,905 18,536 17,326 16,929 15,363
Money market 20,756 19,413 19,957 21,223 23,177
- ------------------------------------------------------------------------------------------------------------------------------------
Total $70,725 $72,446 $72,082 $70,219 $74,443
======= ======= ======= ======= =======
Proprietary mutual funds included in assets under management:
Equity $3,709 $4,080 $3,973 $3,676 $4,351
Fixed income 1,262 1,211 1,190 1,178 1,106
Money market 12,568 13,094 13,801 14,870 14,950
- ------------------------------------------------------------------------------------------------------------------------------------
Total $17,539 $18,385 $18,964 $19,724 $20,407
======= ======= ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT BANKING AND CAPITAL MARKETS INCOME. As shown in Figure 12, income
derived from dealer trading and derivatives decreased significantly, while both
investment banking and principal investing results showed considerable
improvement from the prior year. Principal investing income is by nature
susceptible to volatility since it is derived from investments in small to
medium-sized businesses, some of which are in their early stages of economic
development and strategy implementation, and thus more susceptible to changes in
general economic conditions. Principal investing assets are carried on the
balance sheet at fair value. The cost basis, unrealized gains (losses) and fair
value of direct and indirect investments contained in Key's principal investing
portfolio are summarized in Figure 13. Investments in technology-rich companies,
which have been particularly hard hit by the effects of the weak economy,
accounted for only $40 million, or 6%, of the fair value of Key's portfolio at
June 30, 2002.
FIGURE 12. INVESTMENT BANKING AND CAPITAL MARKETS INCOME
Three months Six months
ended June 30, Change ended June 30, Change
---------------- ------------------- -------------- -----------------
dollars in millions 2002 2001 Amount Percent 2002 2001 Amount Percent
- ----------------------------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $28 $41 $(13) (31.7)% $ 68 $91 $(23) (25.3)%
Investment banking income 34 28 6 21.4 55 48 7 14.6
Net losses from principal investing (2) (8) 6 75.0 (1) (24) 23 95.8
Foreign exchange income 8 11 (3) (27.3) 18 22 (4) (18.2)
- ----------------------------------------------------------------------------------------------------------------------------------
Total investment banking and capital
markets income $68 $72 $(4) (5.6)% $140 $137 $ 3 2.2%
=== === === ==== ==== ===
- ----------------------------------------------------------------------------------------------------------------------------------
FIGURE 13. PRINCIPAL INVESTING PORTFOLIO
JUNE 30, 2002 ORIGINAL UNREALIZED FAIR
in millions INVESTMENT LOSSES VALUE
- -----------------------------------------------------------------------------
Direct investments $443 $22 $421
Indirect investments 264 34 230
- -----------------------------------------------------------------------------
Total $707 $56 $651
==== === ====
- -----------------------------------------------------------------------------
December 31, 2001 $699 $79 $620
- -----------------------------------------------------------------------------
June 30, 2001 $700 $8 $692
- -----------------------------------------------------------------------------
SERVICE CHARGES ON DEPOSIT ACCOUNTS. Service charges on deposits account for the
largest increase in fee income relative to the prior year. The growth of these
fees is attributable primarily to strategies implemented in connection with
Key's competitiveness initiative.
SECURITIES TRANSACTIONS. During the first half of 2001, Key realized $34 million
of net securities gains from the sales of securities held in the
available-for-sale portfolio. The securities sold were primarily equity
securities issued by financial service companies. Net gains from the sales of
securities during the first half of 2002 were not significant.
49
NONINTEREST EXPENSE
Noninterest expense for the second quarter of 2002 totaled $665 million, down
$193 million, or 22%, from the second quarter of 2001. For the first six months
of the year, noninterest expense was $1.3 billion, representing a decrease of
$230 million, or 15%, from the first half of last year. As shown in Figure 14,
noninterest expense for the second quarter of 2001 includes a number of
significant nonrecurring items that hinder the comparison of results between
reporting periods. These items include a $150 million write-down of goodwill
associated with Key's decision to downsize its automobile finance business and
additional litigation reserves of $20 million.
Core noninterest expense, which excludes significant nonrecurring items,
decreased by $21 million, or 3%, from the year-ago quarter. Lower costs
associated with computer processing (down $15 million) and the amortization of
intangibles (down $22 million, including approximately $20 million related to
the change in accounting for goodwill) more than offset a $16 million increase
in personnel expense.
For the year-to-date period, core noninterest expense improved by $58 million,
or 4%, reflecting a decrease in amortization expense related to intangibles
(down $45 million, including approximately $40 million related to the change in
accounting for goodwill) and a reduction in computer processing expense (down
$23 million). These positive results were partially offset by a $15 million rise
in personnel expense. For more information pertaining to the accounting change
for goodwill, see the section entitled "Amortization of intangibles," on page
51.
Figure 14 shows the components of Key's noninterest expense. The discussion that
follows explains the composition of certain components and the factors that
caused them to change from the prior year.
FIGURE 14. NONINTEREST EXPENSE
Three months Six months
ended June 30, Change ended June 30, Change
---------------- -------------------- ------------------ -------------------
dollars in millions 2002 2001 Amount Percent 2002 2001 Amount Percent
- -----------------------------------------------------------------------------------------------------------------------------------
Personnel $361 $345 $ 16 4.6 % $724 $709 $ 15 2.1 %
Net occupancy 56 56 - - 113 113 - -
Computer processing 48 63 (15) (23.8) 102 125 (23) (18.4)
Equipment 36 40 (4) (10.0) 70 78 (8) (10.3)
Marketing 30 29 1 3.4 56 56 - -
Amortization of intangibles 2 24 (22) (91.7) 5 50 (45) (90.0)
Professional fees 21 19 2 10.5 42 37 5 13.5
Other expense:
Postage and delivery 14 16 (2) (12.5) 29 33 (4) (12.1)
Telecommunications 9 12 (3) (25.0) 17 23 (6) (26.1)
Equity- and gross receipts-based taxes 7 7 - - 13 15 (2) (13.3)
OREO expense, net 2 2 - - 3 4 (1) (25.0)
Miscellaneous expense 79 73 6 8.2 152 141 11 7.8
- -----------------------------------------------------------------------------------------------------------------------------------
Total other expense 111 110 1 .9 214 216 (2) (.9)
- -----------------------------------------------------------------------------------------------------------------------------------
Total core noninterest expense 665 686 (21) (3.1) 1,326 1,384 (58) (4.2)
Goodwill write-down
(automobile finance business) - 150 (150) (100.0) - 150 (150) (100.0)
Additional litigation reserves - 20 (20) (100.0) - 20 (20) (100.0)
Restructuring and other special charges - 2 (2) (100.0) - 2 (2) (100.0)
- -----------------------------------------------------------------------------------------------------------------------------------
Total significant nonrecurring items - 172 (172) (100.0) - 172 (172) (100.0)
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $665 $858 $(193) (22.5)% $1,326 $1,556 $(230) (14.8)%
==== ==== ===== ====== ====== =====
Full-time equivalent employees at period end 20,929 21,742 (813) (3.7)% 20,929 21,742 (813) (3.7)%
- -----------------------------------------------------------------------------------------------------------------------------------
PERSONNEL. Personnel expense, the largest category of Key's noninterest expense,
rose by a modest $15 million, or 2%, from the first six months of 2001.
Essentially all of the increase occurred in the second quarter and is due
primarily to a rise in the cost of benefits, the effect of annual merit
increases and higher incentive compensation related to certain revenue producing
activities. The level of Key's personnel expense continues to reflect the
benefits derived from our successful competitiveness initiative. Through this
initiative we have improved efficiency and reduced the level of personnel
required to conduct our
50
business. At June 30, 2002, the number of full-time equivalent employees was
20,929, compared with 21,230 at the end of 2001 and 21,742 a year ago. Figure 15
shows the major components of Key's personnel expense.
FIGURE 15. PERSONNEL EXPENSE
Three months Six months
ended June 30, Change ended June 30, Change
---------------- -------------------- ------------------- ---------------------
dollars in millions 2002 2001 Amount Percent 2002 2001 Amount Percent
- -------------------------------------------------------------------------------------------------------------------------------
Salaries $215 $214 $1 .5% $431 $425 $6 1.4%
Employee benefits 55 45 10 22.2 118 102 16 15.7
Incentive compensation 91 86 5 5.8 175 182 (7) (3.8)
- -------------------------------------------------------------------------------------------------------------------------------
Total core personnel expense $361 $345 $16 4.6% $724 $709 $15 2.1%
==== ==== === ==== ==== ===
- -------------------------------------------------------------------------------------------------------------------------------
COMPUTER PROCESSING. The decrease in computer processing expense for both the
quarterly and year-to-date periods is due primarily to a lower level of computer
software amortization. This reduction is attributable in part to improved
software capitalization discipline instituted a few years ago.
AMORTIZATION OF INTANGIBLES. On January 1, 2002, Key stopped amortizing
goodwill, consistent with the industry-wide adoption of new accounting guidance.
This change reduced the company's noninterest expense by approximately $40
million for the first six months of 2002. In accordance with the new guidance,
Key completed its transitional goodwill impairment testing during the first
quarter of 2002, and determined that no impairment existed as of January 1,
2002. For more information pertaining to the new accounting guidance, see the
section entitled "Accounting Pronouncements Adopted in 2002," included in Note 1
("Basis of Presentation"), starting on page 7.
INCOME TAXES
The provision for income taxes was $85 million for the second quarter of 2002,
compared with a tax benefit of $12 million for the comparable period in 2001.
The effective tax rate (which is the provision or benefit for income taxes as a
percentage of the respective income or loss, before income taxes) was 25.7% for
the second quarter of 2002 compared with 8.1% for the second quarter of 2001.
The tax benefit recorded a year ago is largely attributable to several
significant nonrecurring charges, which resulted in a loss for the quarter. Most
of these charges (including a $150 million write-down of nondeductible goodwill)
are associated with the implementation of strategic actions announced in May
2001. Because Key recorded a pretax loss in the second quarter of 2001, the
effect of the goodwill write-down was to reduce the overall tax benefit and
thereby decrease the effective tax rate by 36%. The effective tax rate for the
second quarter of 2002 is substantially below Key's combined statutory Federal
and state rate of 37% due primarily to portions of our equipment leasing
portfolio that are subject to a lower income tax rate. Other factors that
account for the difference between the effective and statutory tax rates include
tax deductions associated with dividends paid to Key's 401(k) savings plan,
income from investments in tax-advantaged assets (such as tax-exempt securities
and corporate-owned life insurance) and credits associated with investments in
low-income housing projects.
For the first six months of 2002, the provision for income taxes was $145
million compared with $105 million for the first half of last year. The
effective tax rates for these periods were 23.0% and 56.1%, respectively.
Excluding the $150 million write-down of nondeductible goodwill, the effective
tax rate for the first six months of 2001 was approximately 31.2%. The decline
from the adjusted effective tax rate is attributable to the portions of our
equipment leasing portfolio that are now subject to a lower tax rate, as well as
legislative changes in 2002 that resulted in a higher tax deduction for
dividends paid to Key's 401(k) savings plan. In addition, Key ceased amortizing
goodwill effective January 1, 2002, in accordance with new accounting guidance
specified by SFAS No.142.
51
FINANCIAL CONDITION
LOANS
At June 30, 2002, total loans outstanding were $63.9 billion, compared with
$63.3 billion at the end of 2001 and $66.7 billion a year ago. Among the factors
that contributed to the 4% decrease in our loans over the past year are:
- - loan sales completed to improve the profitability of Key's overall
portfolio, or to accommodate our funding needs;
- - weaker loan demand stemming from the sluggish economy; and
- - our May 2001 decision to exit the automobile leasing business,
de-emphasize indirect prime automobile lending and discontinue certain
credit-only commercial relationships.
Over the past several years, we have used alternative funding sources like loan
sales and securitizations to allow us to continue to capitalize on our loan
origination capabilities. In addition, Key has completed several acquisitions,
which have improved its ability to generate and securitize new loans, especially
in the area of commercial real estate. These acquisitions include the purchase
of Conning Asset Management in June 2002, and both Newport Mortgage Company,
L.P. and National Realty Funding L.C. in 2000. Over the past two years, we have
also sold loans and referred new business to an asset-backed commercial paper
conduit. These sales and referrals have been curtailed in 2002 in favor of
funding on Key's balance sheet. The conduit arrangement allows us to generate
referral revenue when the loans are not funded on the balance sheet. For more
information about the conduit, see Note 13 ("Other Financial Instruments with
Off-Balance Sheet Risk"), starting on page 26.
The level of Key's loans outstanding (excluding loans held for sale) would have
been unchanged over the past twelve months if we had not securitized and/or sold
$4.0 billion of loans during that period. On the commercial side, growth in our
real estate and lease financing portfolios was more than offset by a net decline
in all other commercial portfolios, reflecting continued weakness in the economy
and our decision to discontinue nonrelationship lending in the leveraged
financing and nationally syndicated lending businesses.
At June 30, 2002, Key's commercial real estate portfolio included mortgage loans
of $6.3 billion and construction loans of $5.9 billion. The average size of a
mortgage loan was $.5 million and the largest mortgage loan had a balance of $65
million. The average size of a construction loan was $8 million. The largest
construction loan was $37 million. Key conducts its commercial real estate
lending business through two primary sources: a 12-state banking franchise and
National Commercial Real Estate (a national line of business that cultivates
relationships both within and beyond the branch system). At June 30, our
national line of business accounted for approximately 64% of Key's total
commercial real estate loans outstanding. Our commercial real estate business
as a whole focuses on larger real estate developers and, as shown in Figure
16, is diversified by both industry type and geography.
52
FIGURE 16. COMMERCIAL REAL ESTATE LOANS
JUNE 30, 2002 GEOGRAPIC REGION
-----------------------------------------------------
TOTAL PERCENT OF
dollars in millions EAST MIDWEST CENTRAL WEST AMOUNT TOTAL
- --------------------------------------------------------------------------------------------------------------------------------
Nonowner-occupied:
Multi-family properties $ 504 $ 619 $ 535 $ 750 $ 2,408 19.9%
Retail properties 306 806 154 212 1,478 12.2
Office buildings 185 207 167 234 793 6.5
Residential properties 67 117 123 403 710 5.9
Warehouses 78 270 127 170 645 5.3
Manufacturing facilities 29 37 5 7 78 .6
Hotels/Motels 8 14 1 9 32 .3
Other 415 716 92 549 1,772 14.6
- --------------------------------------------------------------------------------------------------------------------------------
1,592 2,786 1,204 2,334 7,916 65.3
Owner-occupied 544 1,774 509 1,383 4,210 34.7
- --------------------------------------------------------------------------------------------------------------------------------
Total $2,136 $4,560 $1,713 $3,717 $12,126 100.0%
====== ====== ====== ====== ======= ======
- --------------------------------------------------------------------------------------------------------------------------------
Consumer loans increased (assuming no loan sales) by $691 million, or 3%, from
the second quarter of 2001. The growth of the home equity portfolio during the
past year more than offset declines of $708 million in installment loans, $1.3
billion in automobile lease financing receivables and $454 million in
residential real estate mortgage loans. The declines in installment loans and
automobile lease financing receivables reflect our decision to de-emphasize
indirect prime automobile lending and exit the automobile leasing business. Our
home equity portfolio grew by $3.2 billion, largely as a result of our focused
efforts to grow this business, facilitated by a period of lower interest rates.
Key's home equity portfolio is derived from both our Retail Banking line of
business (62% of the home equity portfolio at June 30, 2002), and our National
Home Equity line of business.
The National Home Equity line of business has two components: Champion Mortgage
Company, a home equity finance company that Key acquired in August 1997; and Key
Home Equity Services, which acts as a third-party purchaser of home equity
loans. The average loan-to-value ratio at origination for a loan generated by
the National Home Equity line of business is 76%. First lien positions comprised
83% of the portfolio for this line of business at June 30, 2002.
Key Home Equity Services purchases loans in two primary ways: on a loan-by-loan
basis from an extensive network of correspondents and agents, and in bulk
portfolio acquisitions from home equity loan companies. Key intends to
discontinue the latter approach in the second half of 2002.
Figure 17 summarizes Key's home equity loan portfolio by source at the end of
each of the last five quarters, as well as certain asset quality statistics and
the yields achieved on the portfolio as a whole. The portfolio has grown by 25%
since June 30, 2001. Loans generated by the Retail KeyCenters channel have grown
by 36%, while loans generated by the National Home Equity line of business have
grown by 11%.
FIGURE 17. HOME EQUITY LOANS
2002 2001
---------------------------- ---------------------------------------------
dollars in millions SECOND FIRST FOURTH THIRD SECOND
- -------------------------------------------------------------------------------------------------------------------------------
SOURCE OF LOANS OUTSTANDING AT PERIOD END
Champion Mortgage Company $2,153 $2,031 $1,886 $1,608 $1,600
Key Home Equity Services division 2,845 2,870 2,867 3,008 2,919
- -------------------------------------------------------------------------------------------------------------------------------
National Home Equity line of business 4,998 4,901 4,753 4,616 4,519
Retail KeyCenters and other sources 8,381 7,761 6,431 6,210 6,147
- -------------------------------------------------------------------------------------------------------------------------------
Total $13,379 $12,662 $11,184 $10,826 $10,666
======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------------------
Nonperforming loans at period end $ 107 $ 95 $ 60 $ 93 $ 98
Net charge-offs for the period 13 14 50 16 25
Yield for the period 7.03% 7.26% 7.82% 8.38% 8.74%
- -------------------------------------------------------------------------------------------------------------------------------
53
SALES, SECURITIZATIONS AND DIVESTITURES. During the past twelve months, Key sold
$1.4 billion of residential mortgage loans, $1.2 billion of commercial real
estate loans, $806 million of education loans ($491 million through
securitizations) and $496 million of other types of loans. Since 1999, only
education loans have been securitized by Key.
Among the factors that Key considers in determining which loans to securitize
are:
- whether the characteristics of a specific loan portfolio make it
conducive to securitization;
- the relative cost of funds;
- the level of credit risk; and
- capital requirements.
Figure 18 summarizes Key's loan sales (including securitizations) for the first
six months of 2002 and all of 2001.
FIGURE 18. LOANS SOLD AND DIVESTED
COMMERCIAL COMMERCIAL RESIDENTIAL HOME
in millions COMMERCIAL REAL ESTATE LEASE FINANCING REAL ESTATE EQUITY EDUCATION TOTAL
- ----------------------------------------------------------------------------------------------------------------------------------
2002
- ------------------
Second quarter $31 $159 $18 $20 $24 $70 $322
First quarter -- 319 -- -- 9 116 444
- ----------------------------------------------------------------------------------------------------------------------------------
Total $31 $478 $18 $20 $33 $186 $766
=== ==== === === === ==== ====
2001
- ------------------
Fourth quarter -- $678 -- -- $145 $ 23 $ 846
Third quarter -- 93 -- $1,427 269 597 2,386
Second quarter $44 577 -- 20 59 144 844
First quarter -- 327 -- 1 14 449 791
- ----------------------------------------------------------------------------------------------------------------------------------
Total $44 $1,675 -- $1,448 $487 $1,213 $4,867
=== ===== === ===== ==== ====== ======
- ----------------------------------------------------------------------------------------------------------------------------------
Figure 19 shows loans that are either administered or serviced by Key, but not
recorded on the balance sheet. This includes loans that have been both
securitized and sold, or simply sold outright. In the event of default, Key is
subject to recourse with respect to approximately $497 million of the $21.3
billion of loans administered or serviced at June 30, 2002. Key derives income
from two sources when we sell or securitize loans but retain the right to
administer or service them. We earn noninterest income (recorded as "other
income") from servicing or administering the loans, and we earn interest income
from any securitized assets retained. The commercial real estate loans shown in
Figure 19 are serviced by Conning Asset Management and National Realty Funding
L.C. Other financial institutions originated most of these loans. Approximately
$145 million of the assets held in the asset-backed commercial paper conduit,
for which Key serves as a referral agent, are also included in Figure 19. For
more information regarding the conduit, see Note 13 ("Other Financial
Instruments with Off-Balance Sheet Risk"), starting on page 26.
FIGURE 19. LOANS ADMINISTERED OR SERVICED
JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30,
in millions 2002 2002 2001 2001 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Education loans $4,095 $4,258 $4,433 $4,604 $4,305
Automobile loans 87 108 131 199 254
Home equity loans 596 668 768 890 965
Commercial real estate loans 16,483(a) 11,621 10,471 9,368 9,293
Commercial loans 5 349 913 901 951
- ---------------------------------------------------------------------------------------------------------------------------------
Total securitized $21,266 $17,004 $16,716 $15,962 $15,768
======== ======== ======== ======== ========
- ---------------------------------------------------------------------------------------------------------------------------------
(a) Includes $4.1 billion of servicing assets purchased in the June 28, 2002,
acquisition of Conning Asset Management.
54
SECURITIES
At June 30, 2002, the securities portfolio totaled $7.4 billion and included
$6.3 billion of securities available for sale and $1.1 billion of investment
securities. In comparison, the total portfolio at December 31, 2001, was $6.5
billion, including $5.4 billion of securities available for sale and $1.1
billion of investment securities.
The size and composition of Key's securities portfolio are dependent largely on
our needs for liquidity and the extent to which we are required or elect to hold
these assets as collateral to secure public and trust deposits. Although debt
securities are generally used for this purpose, other assets, such as securities
purchased under resale agreements, may be used temporarily when they provide
more favorable yields.
SECURITIES AVAILABLE FOR SALE. The majority of Key's securities available for
sale portfolio consists of collateralized mortgage obligations that provide a
source of interest income and serve as collateral in connection with pledging
requirements. A collateralized mortgage obligation (sometimes called a "CMO") is
a debt security that is secured by a pool of mortgages, mortgage-backed
securities, U.S. government securities, corporate debt obligations or other
bonds. At June 30, 2002, Key had $6.0 billion invested in collateralized
mortgage obligations and other mortgage-backed securities in the
available-for-sale portfolio, compared with $4.8 billion at December 31, 2001.
Substantially all of these securities were issued or backed by Federal agencies.
Figure 20 shows the composition, yields and remaining maturities of Key's
securities available for sale. For more information about retained interests in
securitizations, and gross unrealized gains and losses by type of security, see
Note 5 ("Securities"), which begins on page 16.
FIGURE 20. SECURITIES AVAILABLE FOR SALE
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- RETAINED
AGENCIES AND POLITICAL MORTGAGE BACKED INTERESTS IN
dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(a) SECURITIES(a) SECURITIZATIONS(a)
- ------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2002
Remaining maturity:
One year or less $ 2 -- $ 661 $ 16 --
After one through five years 6 $13 3,307 793 $207
After five through ten years 5 6 981 21 --
After ten years 9 -- 163 27 --
- ------------------------------------------------------------------------------------------------------------------------------
Fair value $22 $19 $5,112 $857 $207
Amortized cost 22 18 5,092 823 172
Weighted average yield 5.50% 4.72% 6.07% 6.95% 20.14%
Weighted average maturity 5.6 YEARS 4.5 YEARS 3.6 YEARS 2.7 YEARS 3.9 YEARS
- ------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001
Fair value $99 $21 $3,805 $1,032 $234
Amortized cost 99 21 3,791 1,008 214
- ------------------------------------------------------------------------------------------------------------------------------
JUNE 30, 2001
Fair value $121 $28 $4,895 $1,212 $265
Amortized cost 120 28 4,877 1,192 252
- ------------------------------------------------------------------------------------------------------------------------------
WEIGHTED
OTHER AVERAGE
dollars in millions SECURITIES TOTAL YIELD(b)
- -------------------------------------------------------------------------------------
JUNE 30, 2002
Remaining maturity:
One year or less $ 5 $ 684 6.98%
After one through five years 10 4,336 6.38
After five through ten years 6 1,019 6.53
After ten years 111(c) 310 8.79
- -------------------------------------------------------------------------------------
Fair value $132 $6,349 --
Amortized cost 154 6,281 6.57%
Weighted average yield 5.10(b)% 6.57% --
Weighted average maturity 9.3 YEARS 3.6 YEARS --
- -------------------------------------------------------------------------------------
DECEMBER 31, 2001
Fair value $155 $5,346 --
Amortized cost 170 5,303 7.26%
- -------------------------------------------------------------------------------------
JUNE 30, 2001
Fair value $185 $6,706 --
Amortized cost 183 $6,652 7.20%
- -------------------------------------------------------------------------------------
(a) Maturity is based upon expected average lives rather than contractual
terms.
(b) Weighted average yields are calculated based on amortized cost and exclude
equity securities of $131 million that have no stated yield. Such yields
have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
(c) Includes primarily marketable equity securities (including an internally
managed portfolio of investments in the common stocks of financial services
companies) with no stated maturity.
55
INVESTMENT SECURITIES. Equity securities (including principal investing assets)
accounted for more than 75% of Key's investment securities portfolio at June 30,
2002, and December 31, 2001. Figure 21 shows the composition, yields and
remaining maturities of Key's investment securities.
FIGURE 21. INVESTMENT SECURITIES
STATES AND WEIGHTED
POLITICAL EQUITY AVERAGE
dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(a)
- -----------------------------------------------------------------------------------------------------------
JUNE 30, 2002
Remaining maturity:
One year or less $73 -- $ 73 7.54%
After one through five years 79 -- 79 9.61
After five through ten years 33 -- 33 8.41
After ten years 1 $933(b) 934 5.54
- -----------------------------------------------------------------------------------------------------------
Amortized cost $186 $933 $1,119 7.44%
Fair value 196 933 1,129 --
Weighted average yield 8.59% 5.50(a)% 7.44% --
Weighted average maturity 2.6 YEARS 10.0 YEARS 8.8 YEARS --
- -----------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001
Amortized cost $225 $894 $1,119 7.24%
Fair value 234 894 1,128 --
- -----------------------------------------------------------------------------------------------------------
JUNE 30, 2001
Amortized cost $262 $909 $1,171 7.92%
Fair value 273 909 1,182 --
- -----------------------------------------------------------------------------------------------------------
(a) Weighted average yields are calculated based on amortized cost and exclude
equity securities of $823 million that have no stated yield. Such yields
have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
(b) Includes primarily principal investing assets with no stated maturity.
ASSET QUALITY
Key has a multi-faceted program to manage asset quality. Our professionals:
- - evaluate and monitor credit quality and risk in credit-related assets;
- - develop commercial and consumer credit policies and systems;
- - monitor compliance with internal underwriting standards;
- - establish credit-related concentration limits; and
- - review the adequacy of the allowance for loan losses.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses at June 30, 2002, was
$1.5 billion, or 2.41% of loans. This compares with $1.2 billion, or 1.85% of
loans, at June 30, 2001. The allowance includes $144 million (for 2002) and $129
million (for 2001) that is specifically allocated for impaired loans. For more
information about impaired loans, see Note 7 ("Impaired Loans and Other
Nonperforming Assets") on page 19. At June 30, 2002, the allowance for loan
losses was 160.82% of nonperforming loans, compared with 154.45% at June 30,
2001.
Management estimates the appropriate level of the allowance for loan losses on a
quarterly (and at times more frequent) basis. The methodology used is described
in Note 1 ("Summary of Significant Accounting Policies") under the heading
"Allowance for Loan Losses," on page 59 of Key's 2001 Annual Report to
56
Shareholders. The allowance was increased in 2001 because of continued weakness
in the economy and the related adverse effects on specific loan portfolios. As
discussed in the following section entitled "Run-off Loan Portfolio," the higher
allowance also facilitated the implementation of Key's decision to discontinue
certain types of commercial lending.
RUN-OFF LOAN PORTFOLIO. In May 2001, management set apart $300 million of Key's
allowance for loan losses as part of its decision to discontinue nonrelationship
lending in the leveraged financing and nationally syndicated lending businesses
and to facilitate sales of distressed loans in other portfolios. An additional
$190 million was added to this allowance in the fourth quarter. The resulting
segregated allowance is being used to exit what initially amounted to
approximately $2.7 billion in related commitments (including $1.6 billion of
loans outstanding), which were moved to a separate run-off portfolio, and for
losses incurred in connection with the sales of distressed loans in the
continuing portfolio. As losses are charged to this segregated allowance over
time, we do not intend to replenish it. Within the run-off portfolio,
approximately $1.1 billion of commitments (including $724 million of loans
outstanding) remained as of June 30. The majority of the loans are performing in
accordance with their contractual terms.
Figure 22 summarizes certain asset quality indicators, segregated between Key's
continuing and run-off loan portfolios. Additional information pertaining to the
run-off portfolio is presented in Figure 23.
FIGURE 22. ASSET QUALITY INDICATORS -- CONTINUING AND RUN-OFF LOAN PORTFOLIOS
THREE MONTHS ENDED
JUNE 30, 2002 JUNE 30, 2002
-------------------------------------------------------------- ----------------------------
Allowance for Loan Losses Net Loan Charge-offs
Loans ------------------------- Nonperforming -----------------------------
dollars in millions Outstanding Amount % of Loans Loans Amount % of Loans
- ------------------------------------------------------------------------------------------------------------------------------------
Continuing loan portfolio $63,157 $1,402 2.22% $825 $135 .86%
Run-off loan portfolio 724 137 18.91 132 68(a) N/M
- ------------------------------------------------------------------------------------------------------------------------------------
Total loan portfolio $63,881 $1,539 2.41% $957 $203 1.27%
======= ====== ==== ====
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to the sales of
distressed loans in the continuing portfolio.
N/M = Not Meaningful
FIGURE 23. RUN-OFF LOAN PORTFOLIO
SUMMARY OF CHANGES IN COMMITMENTS
AND LOANS OUTSTANDING TOTAL LOANS
in millions COMMITMENTS OUTSTANDING
- ----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $1,694 $1,023
Charge-offs (102) (102)
Payments, expirations and other changes, net (449) (197)
- ----------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 $1,143 $ 724
====== =====
- ----------------------------------------------------------------------------------------------------------------
SUMMARY OF CHANGES IN NONPERFORMING LOANS
AND NONREPLENISHING ALLOWANCE FOR LOAN LOSSES(a) NONPERFORMING NONREPLENISHING
in millions LOANS ALLOWANCE
- ----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $ 231 $ 275
Loans placed on nonaccrual status 39 N/A
Charge-offs (102) (138)
Payments and other changes, net (36) N/A
- ----------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 $ 132 $ 137
===== =====
- ----------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to the sales of
distressed loans in the continuing portfolio.
N/A = Not Applicable
57
NET LOAN CHARGE-OFFS. Net loan charge-offs for the second quarter of 2002 were
$203 million, or 1.27% of average loans, compared with $171 million, or 1.02% of
average loans, for the same period last year. For the first six months of 2002,
net loan charge-offs totaled $409 million, or 1.29% of average loans, compared
with $280 million, or .84%, for the first half of 2001. The composition of Key's
loan charge-offs and recoveries by type of loan is shown in Figure 24. The
increase in net charge-offs for both the quarterly and year-to-date periods
occurred in the commercial loan portfolio, reflecting the effects of continued
weakness in the economy and Key's continuing efforts to resolve distressed
credits. As shown in Figure 23, we used $138 million of Key's nonplenishing
allowance during the first half of 2002 ($68 million during the second quarter)
to absorb losses arising from the run-off loan portfolio and from sales of
distressed loans in the continuing portfolio. In the aggregate, the middle
market, structured finance and healthcare portfolios account for approximately
one-half of total net charge-offs for the second quarter, but represented only
19% of Key's total loans at June 30, 2002. The structured finance and healthcare
portfolios are also discussed in the section entitled "Nonperforming assets,"
beginning on page 59.
FIGURE 24. SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
----------------------------------------------------------------------
dollars in millions 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
Average loans outstanding during the period $63,928 $66,954 $63,709 $66,993
- ------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $1,607 $1,001 $1,677 $1,001
Loans charged off:
Commercial, financial and agricultural 114 91 211 144
Real estate -- commercial mortgage 13 5 48 8
Real estate -- construction 12 2 12 2
- ------------------------------------------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 25 7 60 10
Commercial lease financing 18 10 38 13
- ------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 157 108 309 167
Real estate -- residential mortgage(a) 2 5 3 7
Home equity 15 26 29 32
Consumer -- direct 13 12 27 24
Consumer -- indirect lease financing 6 7 13 13
Consumer -- indirect other 43 44 88 94
- ------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 79 94 160 170
- ------------------------------------------------------------------------------------------------------------------------------
236 202 469 337
Recoveries:
Commercial, financial and agricultural 9 7 19 14
Real estate -- commercial mortgage(a) 2 2 3 2
Commercial lease financing 3 3 4 4
- ------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 14 12 26 20
Real estate -- residential mortgage -- 1 1 3
Home equity 2 1 2 1
Consumer -- direct 2 2 4 4
Consumer -- indirect lease financing 2 2 4 4
Consumer -- indirect other 13 13 23 25
- ------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 19 19 34 37
- ------------------------------------------------------------------------------------------------------------------------------
33 31 60 57
- ------------------------------------------------------------------------------------------------------------------------------
Net loans charged off (203) (171) (409) (280)
Provision for loan losses 135 401 271 511
Allowance related to loans sold, net -- -- -- (1)
- ------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $1,539 $1,231 $1,539 $1,231
====== ====== ====== ======
- ------------------------------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans 1.27% 1.02% 1.29% .84%
Allowance for loan losses to period-end loans 2.41 1.85 2.41 1.85
Allowance for loan losses to nonperforming loans 160.82 154.45 160.82 154.45
- ------------------------------------------------------------------------------------------------------------------------------
(a) See Figure 16 on page 53 and the accompanying discussion on page 52 for
more information related to Key's commercial real estate portfolio.
58
NONPERFORMING ASSETS. Figure 25 shows the composition of Key's nonperforming
assets. These assets totaled $995 million at June 30, 2002, and represented
1.56% of loans, other real estate owned (known as "OREO") and other
nonperforming assets, compared with $947 million, or 1.49%, at December 31,
2001, and $823 million, or 1.23%, at June 30, 2001.
FIGURE 25. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30,
dollars in millions 2002 2002 2001 2001 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $471 $ 470 $409 $399 $384
Real estate-- commercial mortgage 179 156 187 169 128
Real estate-- construction 61 77 83 70 35
- ---------------------------------------------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 240 233 270 239 163
Commercial lease financing 76 100 94 83 83
- ---------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 787 803 773 721 630
Real estate-- residential mortgage 34 33 32 24 24
Home equity 107 95 60 93 98
Consumer-- direct 6 9 9 9 8
Consumer-- indirect lease financing 7 8 10 13 11
Consumer-- indirect other 16 25 26 25 26
- ---------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 170 170 137 164 167
- ---------------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 957 973 910 885 797
OREO 40 41 38 26 27
Allowance for OREO losses (2) (2) (1) (1) (1)
- ---------------------------------------------------------------------------------------------------------------------------------
OREO, net of allowance 38 39 37 25 26
Other nonperforming assets -- -- -- 3 --
- ---------------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $995 $1,012 $947 $913 $823
==== ====== ==== ==== ====
- ---------------------------------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $186 $203 $ 250 $ 332 $280
Accruing loans past due 30 through 89 days 780 897 1,096 1,084 937
- ---------------------------------------------------------------------------------------------------------------------------------
Nonperforming loans to period-end loans 1.50% 1.52% 1.44% 1.37% 1.20%
Nonperforming assets to period-end loans
plus OREO and other nonperforming assets 1.56 1.58 1.49 1.41 1.23
- ---------------------------------------------------------------------------------------------------------------------------------
(a) See Figure 16 on page 53 and the accompanying discussion on page 52 for
more information related to Key's commercial real estate portfolio.
The economic slowdown can be expected to continue to impact Key's loan portfolio
in general, although the erosion in credit quality that we have experienced is
disproportionately concentrated in several distinct commercial portfolios of
limited size. At June 30, 2002, two portfolios, structured finance and
healthcare, accounted for $138 million and $117 million, respectively, of Key's
nonperforming loans. Although these two portfolios comprised less than 5% of
Key's total loans, they accounted for 27% of total nonperforming loans.
At June 30, 2002, our 20 largest nonperforming loans totaled $298 million,
representing 31% of total loans on nonperforming status. As shown in Figure 23,
at June 30, 2002, the run-off loan portfolio accounted for $132 million, or 14%,
of Key's total nonperforming loans presented in Figure 25. Key's nonperforming
loans decreased from the first quarter of 2002, representing the first
quarter-to-quarter decline in three years. The second quarter sale of $18
million of nonperforming commercial loans contributed to this decline.
Further information pertaining to the credit exposure inherent in the largest
sector of Key's loan portfolio, commercial, financial and agricultural loans, is
presented in Figure 26. The types of activity that caused the change in Key's
nonperforming loans during the last five quarters are summarized in Figure 27.
59
FIGURE 26. COMMERCIAL, FINANCIAL AND AGRICULTURAL LOANS
NONPERFORMING LOANS
---------------------------------
JUNE 30, 2002 TOTAL LOANS % OF LOANS
dollars in millions COMMITMENTS OUTSTANDING AMOUNT OUTSTANDING
- ---------------------------------------------------------------------------------------------------------------
Industry classification:
Manufacturing $9,899 $4,320 $183 4.2%
Services 5,898 2,626 97 3.7
Financial services 4,175 966 11 1.1
Retail trade 4,116 2,360 51 2.2
Wholesale trade 2,937 1,470 15 1.0
Property management 2,487 1,082 5 .5
Public utilities 1,540 373 1 .3
Communications 1,191 615 33 5.4
Agriculture/forestry/fishing 1,147 706 18 2.5
Building contractors 1,204 554 29 5.2
Public administration 746 280 -- --
Transportation 685 447 5 1.1
Insurance 553 156 -- --
Mining 333 221 1 .5
Individuals 200 120 1 .8
Other 2,119 1,775 21 1.2
- ---------------------------------------------------------------------------------------------------------------
Total $39,230 $18,071 $471 2.6%
======= ======= ====
- ---------------------------------------------------------------------------------------------------------------
FIGURE 27. SUMMARY OF CHANGES IN NONPERFORMING LOANS
2002 2001
---------------------- -------------------------------------------
in millions SECOND FIRST FOURTH THIRD SECOND
- -----------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 973 $ 910 $885 $797 $713
Loans placed on nonaccrual status 254 294 407 324 455
Charge-offs (203) (206) (220) (173) (170)
Loans sold (18) -- (83) (35) (137)
Payments (49) (22) (65) (20) (61)
Transfers to OREO -- (3) (12) (8) (2)
Loans returned to accrual status -- -- (2) -- (1)
- -----------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 957 $ 973 $910 $885 $797
===== ===== ==== ==== ====
- -----------------------------------------------------------------------------------------------------------------------------
DEPOSITS AND OTHER SOURCES OF FUNDS
"Core deposits"--domestic deposits other than certificates of deposit of
$100,000 or more--are Key's primary source of funding. During the second quarter
of 2002, core deposits averaged $37.1 billion, and represented 51% of the funds
Key used to support earning assets, compared with $37.6 billion and 49% during
the same period last year. The composition of Key's deposits is shown in Figure
7, which spans pages 43 and 44.
The slight decline in the level of Key's core deposits over the past twelve
months is due primarily to a lower level of time deposits. Time deposits
decreased by 10% because, like our competitors, Key reduced the rates paid for
them as the Federal Reserve reduced interest rates in general. At the same time,
Key's money market deposit accounts and noninterest-bearing deposits grew,
reflecting client preferences for investments that provide high levels of
liquidity in a low interest rate environment.
60
Purchased funds, comprising large certificates of deposit, deposits in the
foreign branch and short-term borrowings, averaged $16.0 billion during the
second quarter of 2002, compared with $20.9 billion a year ago. As shown in
Figure 7, Key has reduced its reliance on both certificates of deposit and
short-term borrowings as funding sources. This is attributable in part to loan
sales, slow demand for loans and from the decision made in May 2001 to scale
back or discontinue certain types of lending. In addition, Key continues to
consider loan securitizations as a funding alternative when market conditions
are favorable. No securitizations were completed during the first half of 2002.
LIQUIDITY
"Liquidity" measures whether an entity has sufficient cash flow to meet
its financial obligations when due. Key has sufficient liquidity when it can
meet the needs of depositors, borrowers and creditors at a reasonable cost, on a
timely basis, and without adverse consequences. KeyCorp has sufficient liquidity
when it can pay dividends to shareholders, service its debt, and support
customary corporate operations and activities, including acquisitions, at a
reasonable cost, in a timely manner and without adverse consequences.
LIQUIDITY RISK. Management recognizes that there are circumstances that could
adversely affect Key's liquidity or materially affect the cost of funds. One
such circumstance involves the occurrence of events that are systemic in nature,
such as terrorism or war, natural disasters, political events, or the default or
bankruptcy of a major corporation, mutual fund or hedge fund. Examples of these
events are the September 11 attacks on the World Trade Center and Pentagon, and
the fall, 1998 Russian and Long-Term Capital Management defaults. Another
hypothetical circumstance may be a significant downgrade in the public credit
rating of Key by a rating agency due to a deterioration in asset quality, a
large charge to earnings, a significant merger or acquisition or other events.
In addition, market speculation or rumors about Key may cause normal funding
sources to withdraw credit until further information becomes available.
LIQUIDITY FOR KEY. Key's Funding and Investment Management Group monitors the
overall mix of funding sources with the objective of maintaining an appropriate
mix in light of the structure of the asset portfolios. We use several tools to
maintain sufficient liquidity.
- - We maintain portfolios of short-term money market investments and
securities available for sale, substantially all of which could be
converted to cash quickly at a small expense.
- - Key's portfolio of investment securities generates payments at maturity and
prepayments (often at a premium).
- - We try to structure the maturities of our loans so that we receive a
relatively consistent stream of payments from borrowers. We also
selectively securitize and package loans for sale.
- - We have a proven ability to access the securitization markets for a variety
of loan types.
- - Our 905 full-service KeyCenters in 12 states generate a sizable volume of
core deposits. We monitor deposit flows and use alternative pricing
structures to attract deposits when necessary. For more information about
core deposits, see the previous section entitled "Deposits and other
sources of funds."
- - Key has access to various sources of money market funding (such as Federal
funds purchased, securities sold under repurchase agreements, and bank
notes) and also can borrow from the Federal Reserve Bank to meet short-term
liquidity requirements. Key did not have any borrowings from the Federal
Reserve outstanding as of June 30, 2002.
LIQUIDITY FOR THE PARENT COMPANY. KeyCorp meets its liquidity requirements
principally through regular dividends from affiliate banks. During the first
half of 2002, affiliate banks paid KeyCorp a total of $387 million in dividends.
As of June 30, 2002, the affiliate banks had an additional $557 million
available to
61
pay dividends to KeyCorp without prior regulatory approval. KeyCorp generally
maintains excess funds in short-term investments.
ADDITIONAL SOURCES OF LIQUIDITY. Management has implemented several programs
that enable Key and KeyCorp to raise money in the public and private markets
when necessary. The proceeds from all of these programs can be used for general
corporate purposes, including acquisitions.
BANK NOTE PROGRAM. During the first six months of 2002, Key's affiliate banks
raised $2.1 billion under Key's bank note program. Of these notes issued during
the year, $1.6 billion have original maturities in excess of one year and are
included in long-term debt. The remaining notes have original maturities of one
year or less and are included in short-term borrowings. Key's current bank note
program provides for the issuance of both long- and short-term debt of up to
$20.0 billion ($19.0 billion by KeyBank National Association and $1.0 billion by
Key Bank USA, National Association). At June 30, 2002, $18.9 billion was
available for future issuance under this program.
EURO NOTE PROGRAM. Under Key's euro note program, KeyCorp, KeyBank National
Association and Key Bank USA, National Association may issue both long- and
short-term debt of up to $10.0 billion in the aggregate. The notes are offered
exclusively to non-U.S. investors and can be denominated in U.S. dollars and
many foreign currencies. There were $5.5 billion of borrowings outstanding under
this facility as of June 30, 2002, $1.4 billion of which were issued during the
current year. At the end of the second quarter, $4.3 billion was available for
future issuance under this program.
COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp has a commercial paper program
and a revolving credit agreement with unaffiliated financial institutions that
provide funding availability of up to $500 million and $400 million,
respectively. As of June 30, 2002, no amount was outstanding under either
facility.
PARENT COMPANY NOTE PROGRAM AND OTHER SECURITIES. KeyCorp has registered with
the Securities and Exchange Commission to provide for the issuance of up to $2.2
billion of securities, which could include long- or short-term debt, or equity
securities. Of the amount registered, $1.0 billion has been allocated for the
issuance of medium-term notes. At June 30, 2002, unused capacity under the shelf
registration totaled $1.2 billion and $575 million of the amount allocated for
medium-term notes was available for future issuance.
Key has favorable debt ratings as shown in Figure 28 below. As long as those
debt ratings are maintained, management believes that, under normal conditions
in the capital markets, any eventual offering of securities would be marketable
to investors at a competitive cost.
FIGURE 28. DEBT RATINGS
SENIOR SUBORDINATED
SHORT-TERM LONG-TERM LONG-TERM CAPITAL
JUNE 30, 2002 BORROWINGS DEBT DEBT SECURITIES
- -------------------------------------------------------------------------------------------------------------------
KEYCORP
- -------------------------------------
Standard & Poor's A-2 A- BBB+ BBB
Moody's P-1 A2 A3 Baa1
KEYBANK NATIONAL ASSOCIATION
- -------------------------------------
Standard & Poor's A-1 A A- N/A
Moody's P-1 A1 A2 N/A
- -------------------------------------------------------------------------------------------------------------------
N/A=Not Applicable
Figure 32 on page 49 of Key's 2001 Annual Report to Shareholders summarizes
Key's significant cash obligations and contractual amounts of off-balance sheet
lending-related commitments at December 31, 2001, by the specific time periods
in which related payments are due or commitments expire. These commitments have
not changed significantly since the end of last year.
62
CAPITAL
SHAREHOLDERS' EQUITY. Total shareholders' equity at June 30, 2002, was $6.6
billion, up $437 million from the balance at December 31, 2001. Growth in
retained earnings and the issuance of common shares out of the treasury stock
account in connection with employee stock purchase, 401(k), dividend
reinvestment and stock option programs are responsible for the increase.
SHARE REPURCHASES. In September 2000, the Board of Directors authorized the
repurchase of up to 25,000,000 common shares, including the 3,647,200 shares
remaining at the time from an earlier repurchase program. These shares may be
repurchased in the open market or through negotiated transactions. During the
first six months of 2002, Key did not repurchase any of its common shares. At
June 30, 2002, a remaining balance of 16,764,400 shares may be repurchased under
the September 2000 authorization.
At June 30, 2002, Key had 65,537,753 treasury shares. Management expects to
reissue those shares over time to support the employee stock purchase, 401(k),
stock option and dividend reinvestment plans, and for other corporate purposes.
During the first half of 2002, Key reissued 2,345,971 treasury shares for
employee benefit and dividend reinvestment plans.
CAPITAL ADEQUACY. Capital adequacy is an important indicator of financial
stability and performance. Overall, Key's capital position remains strong: the
ratio of total shareholders' equity to total assets was 7.96% at June 30, 2002,
compared with 7.60% at December 31, 2001, and 7.53% at June 30, 2001.
Banking industry regulators prescribe minimum capital ratios for bank holding
companies and their banking subsidiaries. Risk-based capital guidelines require
a minimum level of capital as a percent of "risk-weighted assets," which is
total assets plus certain off-balance sheet items that are adjusted for
predefined credit risk factors. Currently, banks and bank holding companies must
maintain, at a minimum, Tier 1 capital as a percent of risk-weighted assets of
4.00%, and total capital as a percent of risk-weighted assets of 8.00%. As of
June 30, 2002, Key's Tier 1 capital ratio was 8.23%, and its total capital ratio
was 12.29%.
The leverage ratio is Tier 1 capital as a percentage of average quarterly
tangible assets. Leverage ratio requirements vary with the condition of the
financial institution. Bank holding companies that either have the highest
supervisory rating or have implemented the Federal Reserve's risk-adjusted
measure for market risk--as KeyCorp has--must maintain a minimum leverage ratio
of 3.00%. All other bank holding companies must maintain a minimum ratio of
4.00%. As of June 30, 2002, KeyCorp had a leverage ratio of 8.14%.
Federal bank regulators group FDIC-insured depository institutions into five
categories, ranging from "critically undercapitalized" to "well capitalized."
Both of Key's affiliate banks qualified as "well capitalized" at June 30, 2002,
since each exceeded the prescribed thresholds of 10.00% for total capital, 6.00%
for Tier 1 capital and 5.00% for the leverage ratio. If these provisions applied
to bank holding companies, KeyCorp would also qualify as "well capitalized" at
June 30, 2002. The FDIC-defined capital categories serve a limited regulatory
function. Investors should not treat them as a representation of the overall
financial condition or prospects of Key or its affiliates.
Figure 29 presents the details of Key's regulatory capital position at June 30,
2002, December 31, 2001 and June 30, 2001.
63
FIGURE 29. CAPITAL COMPONENTS AND RISK-WEIGHTED ASSETS
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2002 2001 2001
- ---------------------------------------------------------------------------------------------------------------------------
TIER 1 CAPITAL
Common shareholders' equity(a) $6,527 $6,117 $6,451
Qualifying capital securities 1,156 1,243 1,243
Less: Goodwill 1,105 1,101 1,141
Other assets(b) 49 37 42
- ---------------------------------------------------------------------------------------------------------------------------
Total Tier 1 capital 6,529 6,222 6,511
- ---------------------------------------------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(c) 987 1,040 1,051
Net unrealized holding gains(d) -- -- 1
Qualifying long-term debt 2,233 2,286 2,402
- ---------------------------------------------------------------------------------------------------------------------------
Total Tier 2 capital 3,220 3,326 3,454
- ---------------------------------------------------------------------------------------------------------------------------
Total risk-based capital $9,749 $9,548 $9,965
====== ====== ======
RISK-WEIGHTED ASSETS
Risk-weighted assets on balance sheet $68,273 $67,783 $70,899
Risk-weighted off-balance sheet exposure 12,611 17,480 14,645
Less: Goodwill 1,105 1,101 1,141
Other assets(b) 248 37 42
Plus: Market risk-equivalent assets 312 217 215
Net unrealized holding gains(d) -- -- 1
- ---------------------------------------------------------------------------------------------------------------------------
Gross risk-weighted assets 79,843 84,342 84,577
Less: Excess allowance for loan losses(c) 552 637 180
- ---------------------------------------------------------------------------------------------------------------------------
Net risk-weighted assets $79,291 $83,705 $84,397
======= ======= =======
AVERAGE QUARTERLY TOTAL ASSETS $81,560 $82,467 $85,987
======= ======= =======
CAPITAL RATIOS
Tier 1 risk-based capital ratio 8.23% 7.43% 7.71%
Total risk-based capital ratio 12.29 11.41 11.81
Leverage ratio(e) 8.14 7.65 7.68
- ---------------------------------------------------------------------------------------------------------------------------
(a) Common shareholders' equity does not include net unrealized gains or losses
on securities (except for net unrealized losses on marketable equity
securities) and net gains or losses on cash flow hedges.
(b) "Other assets" deducted from Tier 1 capital consist of intangible assets
(excluding goodwill) recorded after February 19, 1992, and deductible
portions of purchased mortgage servicing rights and of nonfinancial
equity investments.
"Other assets" deducted from risk-weighted assets consist of intangible
assets (excluding goodwill) recorded after February 19, 1992, deductible
portions of purchased mortgage servicing rights and nonfinancial equity
investments.
(c) The allowance for loan losses included in Tier 2 capital is limited by
regulation to 1.25% of gross risk-weighted assets, excluding those with
low-level recourse.
(d) Net unrealized holding gains included in Tier 2 capital are limited by
regulation to 45% of net unrealized holding gains on available-for-sale
equity securities with readily determinable fair values.
(e) This ratio is Tier 1 capital divided by average quarterly total assets less
goodwill and the nonqualifying intangible assets described in footnote (b).
64
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information presented in the Market Risk Management section beginning on
page 45 of the Management's Discussion and Analysis of Financial Condition and
Results of Operations is incorporated herein by reference.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information presented in Note 12 ("Legal Proceedings"), beginning
on page 24, of the Notes to Consolidated Financial Statements is
incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the 2002 Annual Meeting of Shareholders of KeyCorp held on May 23,
2002, five directors were elected for three-year terms expiring in
2005, and shareholders adopted resolutions to amend KeyCorp's
Regulations to reduce the size of KeyCorp's Board of Directors to no
fewer than 14 and no more than 17 directors and to permit electronic
communications and provide for other recent changes in Ohio
Corporation Law, and 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, 2002. The shareholders rejected a
proposed amendment to KeyCorp's Regulations to require the annual
election of all directors. Director nominees for terms expiring in
2005 were: Edward P. Campbell, Charles R. Hogan, Dr. Shirley A.
Jackson, 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, Alexander M. Cutler, Henry S. Hemingway, Douglas J.
McGregor, Henry L. Meyer III, Steven A. Minter, Ronald B. Stafford,
Thomas C. Stevens, and Peter G. Ten Eyck. On July 18, 2002, the Board
of Directors elected Eduardo R. Menasce as a Director effective July
19, 2002.
The vote on each issue was as follows:
FOR AGAINST ABSTAIN
----------------------------------------------
Election of Directors:
Edward P. Campbell 366,113,383 * 11,481,400
Charles R. Hogan 365,394,453 * 12,200,330
Dr. Shirley A. Jackson 361,390,943 * 16,203,840
Bill R. Sanford 363,109,707 * 14,485,076
Dennis W. Sullivan 364,101,221 * 13,493,562
Amendment to Regulations to 367,949,602 7,195,997 2,449,185
reduce the size of the Board of
Directors to no fewer than 14
and no more than 17 directors
Amendment to Regulations to 366,947,678 7,583,715 3,063,391
permit electronic communications
and provide for other recent
changes in Ohio Corporation Law
Amendment to Regulations to 158,262,012 143,537,457 6,491,890***
require annual election of all
directors**
65
Ratification of Ernst & Young as 362,076,221 13,152,730 2,365,833
independent auditors of KeyCorp
* Proxies provide that shareholders may either cast a vote for, or
abstain from voting for, directors.
** This matter required the affirmative vote of holders of shares
entitled to exercise three-quarters of the voting power of
KeyCorp. The matter did not receive the requisite vote.
***In addition, there were 69,303,425 broker non-votes on this matter.
ITEM 5. OTHER INFORMATION
REGULATORY CAPITAL STANDARDS AND RELATED MATTERS. On April 1, 2002, a
final rule regarding the regulatory capital treatment of certain
equity investments made by banking organizations in companies engaged
in nonfinancial activities became effective. It imposes marginal
capital charges (applied by making deductions from Tier 1 capital)
that increase as the banking organization's aggregate carrying amount
of its covered equity investments increase in relation to its Tier 1
capital. Such capital charges range from 8% to 25% as such aggregate
carrying amount increases from 15% to 25% of the banking
organization's Tier 1 capital. Implementation of this new rule did not
have any material adverse effect on Key's regulatory capital during
the second quarter of 2002.
FDIC DEPOSIT INSURANCE AND FINANCING CORPORATION BOND ASSESSMENTS. In
May 2002, the House of Representatives passed H.R. 3717, the Federal
Deposit Insurance Reform Act of 2002. This legislation is currently
pending in the Senate Committee on Banking, Housing, and Urban
Affairs. Under this legislation: (i) the Bank Insurance Fund ("BIF")
and the Savings Association Insurance Fund ("SAIF") would merge into a
single Deposit Insurance Fund ("DIF"), (ii) DIF coverage limits would
significantly increase with an inflation adjustment index for future
increases in coverage, (iii) a designated reserve ratio within a range
of 1.15% to 1.40% would apply to DIF replacing the 1.25% designated
reserve ratio applicable under current law to BIF and SAIF, with the
Federal Deposit Insurance Corporation ("FDIC") determining at least
annually the designated reserve ratio within the range that will apply
to DIF, (iv) current deposit insurance assessments would be set in an
amount the FDIC determines to be appropriate (including a maximum base
assessment of $.01 per $100 of assessable deposits for insured
depository institutions in the lowest risk category, so long as the
DIF reserve ratio does not fall below 1.15%), (v) a one-time credit
predicated upon the December 31, 1996, assessment base of eligible
insured depository institutions would be available (with the amount of
such credit being limited for institutions exhibiting financial,
operational, or compliance weakness, including undercapitalization),
(vi) the payment of dividends to insured depository institutions would
be required whenever the DIF reserve ratio equals or exceeds specified
percentages, (vii) an on-going system of credits to be applied against
future assessments would be established on the same basis as the
payment of dividends, and (viii) restoration plans for DIF would be
required to be established and implemented by the FDIC whenever DIF's
reserve ratio falls (or is projected to fall) below its then
applicable designated reserve ratio.
FINANCIAL MODERNIZATION LEGISLATION. Effective in May 2001, the
Gramm-Leach-Bliley Act repealed the blanket exception of banks and
savings associations from the definitions of "broker" and "dealer"
under the Securities Exchange Act of 1934, and replaced this full
exception with functional exceptions. Under the statute, these
institutions that engage in securities activities either must conduct
those activities through a broker-dealer or conform their securities
activities to those which qualify for functional exceptions. The
Securities and Exchange Commission ("SEC") issued interim final rules
in May 2001 which include a temporary exemption for banks from the
definitions of "broker" and "dealer." Because the SEC has given notice
that it expects to amend its interim final regulations, the SEC has
twice extended this temporary exemption. As a result of the
66
SEC's most recent extension in May 2002, banks are exempt from the
definition of "broker" until May 2003 and from the definition of
"dealer" until November 2002. The SEC does not expect banks to develop
compliance systems to bring their operations into compliance with the
interim final rules until the SEC has amended them.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(3.2) Amended and Restated Regulations of KeyCorp effective May 23,
2002
(10.1) Form of Award of Restricted Stock (2002 __ 2003)
(10.2) Form of Award of Restricted Stock (2002 __ 2004)
(10.3) Award of Restricted Stock to Henry L. Meyer III (2002 __ 2003)
(10.4) Award of Restricted Stock to Henry L. Meyer III (2002 __ 2004)
(10.5) Form of Change of Control Agreement between KeyCorp and Certain
Executive Officers of KeyCorp, effective January 17, 2002
(10.6) Amended Employment Agreement between KeyCorp and Henry L. Meyer
III, dated July 18, 2002
(15) Acknowledgment Letter of Independent Auditors
(99.1) Certification of Chief Executive Officer pursuant to section
906 of the Sarbanes-Oxley Act of 2002
(99.2) Certification of Chief Financial Officer pursuant to section
906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
April 17, 2002 - Item 5. Other Events, Item 7. Financial Statements
and Exhibits and Item 9. Regulation FD Disclosure. Reporting that on
April 17, 2002, the Registrant issued a press release announcing its
earnings results for the three-month period ended March 31, 2002, and
providing a slide presentation reviewed in the related conference
call/webcast.
No other reports on Form 8-K were filed during the three-month period
ended June 30, 2002.
67
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
------------------------------------
(Registrant)
Date: August 13, 2002 /s/ Lee Irving
------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
68