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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 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
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Shares with a par value of $1 each 424,899,883 Shares
- ------------------------------------------ ----------------------------------
(Title of class) (Outstanding at October 31, 2002)
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS Page Number
-----------
Consolidated Balance Sheets --
September 30, 2002, December 31, 2001 and September 30, 2001 3
Consolidated Statements of Income --
Three and nine months ended September 30, 2002 and 2001 4
Consolidated Statements of Changes in Shareholders' Equity --
Nine months ended September 30, 2002 and 2001 5
Consolidated Statements of Cash Flow --
Nine months ended September 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 69
Item 4. CONTROLS AND PROCEDURES 69
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 69
Item 5. OTHER INFORMATION 69
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 69
Signature 71
Management Certifications 72
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 2002 2001 2001
- --------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
ASSETS
Cash and due from banks $ 3,039 $ 2,891 $ 2,803
Short-term investments 1,190 1,898 1,792
Securities available for sale 7,349 5,346 6,471
Investment securities (fair value: $1,068, $1,128 and $1,186) 1,058 1,119 1,174
Loans, net of unearned income of $1,808, $1,778 and $1,782 62,951 63,309 64,506
Less: Allowance for loan losses 1,489 1,677 1,174
- -------------------------------------------------------------------------------------------------------------------------------
Net loans 61,462 61,632 63,332
Premises and equipment 651 687 682
Goodwill 1,105 1,101 1,121
Corporate-owned life insurance 2,384 2,313 2,289
Accrued income and other assets 5,280 3,951 4,755
- -------------------------------------------------------------------------------------------------------------------------------
Total assets $ 83,518 $ 80,938 $ 84,419
======== ======== ========
LIABILITIES
Deposits in domestic offices:
Now and money market deposit accounts $ 14,094 $ 13,461 $ 13,173
Savings deposits 1,987 1,918 1,940
Certificates of deposit($100,0000 or more) 4,807 4,493 4,900
Other time deposits 12,413 13,657 13,513
- -------------------------------------------------------------------------------------------------------------------------------
Total interest bearing 33,301 33,529 33,526
Noninterest-bearing 10,063 9,667 8,643
Deposits in foreign office-- interest-bearing 1,246 1,599 3,203
- -------------------------------------------------------------------------------------------------------------------------------
Total deposits 44,610 44,795 45,372
Federal funds purchased and securities sold under repurchase agreements 6,350 3,735 4,367
Bank notes and other short-term borrowings 2,908 5,549 6,040
Accrued expense and other liabilities 5,438 4,862 5,622
Long-term debt 16,276 14,554 15,114
Corporation-obligated mandatorily redeemable preferred capital securities
of subsidiary trusts holding solely subordinated debentures of KeyCorp
(See Note 10) 1,282 1,288 1,329
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities 76,864 74,783 77,844
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 1,382 1,390 1,393
Retained earnings 6,330 5,856 6,282
Treasury stock, at cost (67,024,459, 67,883,724 and 68,461,648 shares) (1,569) (1,585) (1,599)
Accumulated other comprehensive income 19 2 7
- -------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,654 6,155 6,575
- -------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 83,518 $ 80,938 $ 84,419
======== ======== ========
===============================================================================================================================
See Notes to Consolidated Statements (Unaudited).
3
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -----------------------
dollars in millions, except per share amounts 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 983 $ 1,240 $ 2,957 $ 3,979
Taxable investment securities 6 8 19 23
Tax-exempt investment securities 2 4 8 13
Securities available for sale 97 113 282 348
Short-term investments 7 15 23 54
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest income 1,095 1,380 3,289 4,417
INTEREST EXPENSE
Deposits 214 343 695 1,191
Federal funds purchased and securities sold under repurchase agreements 23 52 70 174
Bank notes and other short-term borrowings 18 61 65 260
Long-term debt, including capital securities 140 200 422 667
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest expense 395 656 1,252 2,292
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NET INTEREST INCOME 700 724 2,037 2,125
Provision for loan losses 135 116 406 627
- ---------------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 565 608 1,631 1,498
NONINTEREST INCOME
Trust and investment services income 151 160 467 491
Investment banking and capital markets income 34 26 130 105
Service charges on deposit accounts 102 107 306 281
Corporate-owned life insurance income 25 28 77 82
Letter of credit and loan fees 36 27 93 86
Net securities gains -- 2 1 36
Other income 84 104 249 226
- ---------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 432 454 1,323 1,307
NONINTEREST EXPENSE
Personnel 358 334 1,082 1,043
Net occupancy 57 60 170 173
Computer processing 45 62 147 187
Equipment 33 37 103 115
Marketing 33 31 89 87
Amortization of intangibles 3 22 8 222
Professional fees 21 26 63 63
Other expense 109 111 323 349
- ---------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 659 683 1,985 2,239
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGES 338 379 969 566
Income taxes 93 130 238 235
- ---------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 245 249 731 331
Cumulative effect of accounting changes, net of tax (See Note 1) -- -- -- (25)
- ---------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 245 $ 249 $ 731 $ 306
========= ========= ========= =========
Per common share:
Income before cumulative effect of accounting changes $ .57 $ .59 $ 1.72 $ .78
Net income .57 .59 1.72 .72
Income before cumulative effect of accounting changes-- assuming dilution .57 .58 1.69 .77
Net income -- assuming dilution .57 .58 1.69 .71
Weighted average common shares outstanding (000) 426,274 424,802 425,746 424,503
Weighted average common shares and potential common
shares outstanding (000) 431,326 430,346 431,098 430,009
- ---------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
ACCUMULATED
LOANS TO TREASURY OTHER
COMMON CAPITAL RETAINED ESOP STOCK, COMPREHENSIVE COMPREHENSIVE
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST INCOME (LOSS) INCOME(b)
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2000 $492 $1,402 $6,352 $(13) $(1,600) $(10)
Net income 306 $306
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $25 (a) 37 37
Cumulative effect of change in accounting for
derivative financial instruments,
net of income taxes of ($12) (22) (22)
Net unrealized losses on derivative
financial instruments, net of income
taxes of ($2) (3) (3)
Foreign currency translation adjustments 5 5
-----------
Total comprehensive income $323
=====
Cash dividends declared on common shares
($.885 per share) (376)
Issuance of common shares:
Acquisition - 370,830 shares 9
Employee benefit and dividend reinvestment
plans-- 1,491,537 net shares (9) 42
Repurchase of common shares - 2,035,600 shares (50)
ESOP transactions 13
- ---------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2001 $492 $1,393 $6,282 -- $(1,599) $ 7
==== ====== ======= ==== ======= ====
=====================================================================================================================
BALANCE AT DECEMBER 31, 2001 $492 $1,390 $5,856 -- $(1,585) $ 2
Net income 731 $731
Other comprehensive income (losses):
Net unrealized gains on securities available
for sale, net of income taxes of $10 (a) 17 17
Net unrealized losses on derivative financial
instruments, net of income taxes of ($7) (10) (10)
Foreign currency translation adjustments 10 10
-----------
Total comprehensive income $748
=====
Cash dividends declared on common shares
($.60 per share) (257)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 2,639,265 net shares (8) 62
Repurchase of common shares - 1,780,000 shares (46)
- ---------------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 2002 $492 $1,382 $6,330 -- $(1,569) $ 19
==== ====== ====== ==== ======== =====
=====================================================================================================================
(a) Net of reclassification adjustments.
(b) For the three months ended September 30, 2002 and 2001, comprehensive income
was $231 million and $262 million, respectively.
See Notes to Consolidated Financial Statements (Unaudited).
5
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
in millions 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 731 $ 306
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 406 627
Cumulative effect of accounting changes, net of tax -- 25
Depreciation expense and software amortization 169 215
Amortization of intangibles 8 222
Net securities gains (1) (36)
Net losses from principal investments 1 33
Net gains from loan securitizations and sales (34) (40)
Deferred income taxes 64 138
Net (increase) decrease in mortgage loans held for sale 10 (330)
Net increase in trading account assets (153) (101)
Net decrease in accrued restructuring charges (27) (58)
Other operating activities, net (214) (368)
- -----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 960 633
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (2,448) (1,665)
Purchases of loans -- (107)
Proceeds from loan securitizations and sales 2,224 4,061
Purchases of investment securities (85) (207)
Proceeds from sales of investment securities 37 39
Proceeds from prepayments and maturities of investment securities 101 169
Purchases of securities available for sale (4,965) (3,321)
Proceeds from sales of securities available for sale 1,004 325
Proceeds from prepayments and maturities of securities available for sale 1,928 3,843
Net decrease in other short-term investments 861 193
Purchases of premises and equipment (68) (82)
Proceeds from sales of premises and equipment 8 13
Proceeds from sales of other real estate owned 32 19
Cash used in acquisitions, net of cash acquired (15) (3)
- ------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (1,386) 3,277
FINANCING ACTIVITIES
Net decrease in deposits (229) (3,277)
Net decrease in short-term borrowings (26) (1,486)
Net proceeds from issuance of long-term debt, including capital securities 4,467 3,542
Payments on long-term debt, including capital securities (3,241) (2,687)
Loan payments received from ESOP trustee -- 13
Purchases of treasury stock (46) (50)
Net proceeds from issuance of common stock 32 25
Cash dividends paid (383) (376)
- ------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 574 (4,296)
- -----------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 148 (386)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 2,891 3,189
- -----------------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 3,039 $ 2,803
======== ========
- -----------------------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $1,199 $2,148
Income taxes paid 131 95
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.
KeyCorp evaluates whether to consolidate entities in which it has invested based
on the nature and amount of equity contributed by third parties, the
decision-making power granted to these parties and the extent of their control
over the entities' operating and financial policies. Entities that KeyCorp
controls, generally through majority ownership, are consolidated and are
considered subsidiaries.
Unconsolidated investments in entities in which KeyCorp has significant
influence over operating and financing decisions (usually defined as a voting or
economic interest of 20 to 50%) are accounted for by the equity method.
Unconsolidated investments in entities in which KeyCorp has a voting or economic
interest of less than 20% are generally carried at cost. Investments held by
KeyCorp's broker/dealer and investment company subsidiaries are carried at
estimated fair value.
KeyCorp uses special purpose entities ("SPEs"), including securitization trusts
and an asset-backed commercial paper conduit, in the normal course of business
for funding purposes and to structure capital markets activities. SPEs
established by KeyCorp as qualifying special purpose entities ("QSPEs")
under the provisions of Statement of Financial Accounting Standards ("SFAS")
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," are not consolidated. Nonqualifying SPEs are
evaluated for consolidation by KeyCorp based on the nature and amount of equity
contributed by third parties, the risks and rewards of the parties and the
control they exercise over the SPE's activities. Securitization trusts
sponsored by KeyCorp are not consolidated. Also, KeyCorp does not consolidate
an asset-backed commercial paper conduit for which it is a referral agent. The
conduit is owned by a third party and administered by an unaffiliated financial
institution. KeyCorp refers assets belonging to a number of third parties to
the conduit, to which it has made liquidity and credit enhancement commitments.
Multiple parties involved in the conduit's activities share the risks and
rewards from those activities. Additional information on SFAS No. 140 is
summarized in Note 1 ("Summary of Significant Accounting Policies") under the
heading "Loan Securitizations," on page 59 of Key's 2001 Annual Report to
Shareholders. Additional information on the conduit is summarized in Note 13
("Other Financial Instruments with Off-Balance Sheet Risk") starting on page 26
of this report.
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 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. The adoption of this standard did
not have any impact on Key's financial condition and results of operations.
7
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
its 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 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
8
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
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. In July 2002, the FASB issued
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." This new standard is effective for exit or disposal activities
initiated after December 31, 2002. SFAS No. 146 substantially changes the rules
for recognizing costs, particularly the timing of the recognition of exit or
disposal costs associated with corporate restructuring activities. This
accounting guidance generally requires costs such as lease or other contract
termination costs and one-time termination benefits associated with exit or
disposal activities to be recognized when incurred rather than at the date of a
commitment to an exit or disposal plan. Key will adopt SFAS No. 146 for
restructuring activities initiated on or after January 1, 2003. Management
expects that the adoption of SFAS No. 146 will not affect Key's financial
condition and results of operations.
ASSET RETIREMENT OBLIGATIONS. In August 2001, the FASB 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 legal 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.
SUBSEQUENT EVENT
ACCOUNTING FOR STOCK COMPENSATION. In September 2002, KeyCorp's Board of
Directors approved management's recommendation to change Key's method of
accounting for stock options granted to eligible employees and directors.
Effective January 1, 2003, Key will adopt the fair value method of accounting as
outlined in SFAS No. 123, "Accounting for Stock Compensation." Under SFAS No.
123, companies may either recognize the compensation cost associated with stock
options as expense over the respective vesting periods or disclose the pro forma
impact on earnings in their audited financial statements. Key has historically
followed the latter approach. Management believes that expensing this form of
employee compensation is in line with other actions that have been taken over
the past several quarters, such as expanding Key's line of business disclosures,
to provide investors with a clearer picture of the company's financial
performance. Management intends to apply the change in accounting prospectively
to all awards granted subsequent to the effective date. Based on the valuation
and timing of options granted in 2002, management estimates that the accounting
change will reduce Key's diluted earnings per common share by approximately $.04
in 2003. The effect on Key's earnings per common share in subsequent years will
depend on the number and timing of options granted and the related assumptions
used to estimate their fair value.
9
2. EARNINGS PER COMMON SHARE
Key calculates its basic and diluted earnings per common share as follows:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
dollars in millions, except per share amounts 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------------
EARNINGS
Income before cumulative effect of accounting changes $ 245 $ 249 $ 731 $ 331
Net income 245 249 731 306
- ------------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 426,274 424,802 425,746 424,503
Effect of dilutive common stock options (000) 5,052 5,544 5,352 5,506
- ------------------------------------------------------------------------------------------------------------------------------
Weighted average common shares and potential
common shares outstanding(000) 431,326 430,346 431,098 430,009
======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Income per common share before cumulative effect of accounting changes $ .57 $ .59 $ 1.72 $ .78
Net income per common share .57 .59 1.72 .72
Income per common share before cumulative effect of accounting changes
-- assuming dilution .57 .58 1.69 .77
Net income per common share-- assuming dilution .57 .58 1.69 .71
===============================================================================================================================
3. ACQUISITIONS AND DIVESTITURE
Business acquisitions and the divestiture that Key completed during 2001 and the
first nine 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,
securitizes and services multi-family, retail, industrial and office property
mortgage loans on behalf of pension fund and life insurance company investors.
At the date of acquisition, the business had net assets of $17 million and
serviced 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.
TRANSACTION PENDING AT SEPTEMBER 30, 2002
UNION BANKSHARES, LTD.
On September 25, 2002, Key entered into a definitive agreement to purchase Union
Bankshares, Ltd., headquartered in Denver, Colorado. The transaction, which is
subject to approval by Union Bankshares'
10
shareholders and certain regulatory agencies, is expected to close during the
fourth quarter of 2002. Under the terms of the agreement, Union Bankshares'
shareholders would receive a cash distribution of $22.63 per each Union
Bankshares' common share. Union Bankshares, Ltd. had seven branches and assets
of $454 million as of June 30, 2002.
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 and investment
products, personal finance services and loans, including residential mortgages,
home equity and various types of installment loans.
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.
OTHER SEGMENTS
Other segments consist primarily of Treasury, Principal Investing and the net
effect of funds transfer pricing.
11
RECONCILING ITEMS
Total assets included under reconciling items represent primarily the
unallocated portion of nonearning assets of corporate support functions. Charges
related to the funding of these assets are part of net interest income and are
allocated to the business segments through noninterest expense. Reconciling
items also include significant nonrecurring charges (see note b to the table on
pages 13 and 14).
The table that spans pages 13 and 14 shows selected financial data for each
major business group for the three- and nine-month periods ended September 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
nine months of 2002:
- - The Small Business line of business moved from Key Corporate Finance to
Key Consumer Banking.
- - Methodologies used to allocate certain overhead costs, management fees
and funding 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.
12
KEY CONSUMER KEY CORPORATE KEY CAPITAL
THREE MONTHS ENDED SEPTEMBER 30, BANKING GROUP FINANCE GROUP PARTNERS GROUP
---------------------- ------------------- ---------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ 447 $ 462 $ 281 $ 272 $ 59 $ 52
Noninterest income 136 140 54 55 206 234
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) 583 602 335 327 265 286
Provision for loan losses 63 54 43 43 2 2
Depreciation and amortization expense 35 54 9 15 12 24
Noninterest expense 291 289 114 110 191 202
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) 194 205 169 159 60 58
Allocated income taxes and taxable-equivalent adjustments 72 80 63 61 22 24
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 122 $ 125 $ 106 $ 98 $ 38 $ 34
======== ======== ======== ======== ======== ========
Percent of consolidated net income 50% 50% 43% 39% 16% 14%
Percent of total segments net income 46 48 40 37 14 13
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 28,191 $ 27,729 $ 29,101 $ 31,137 $ 4,900 $ 5,455
Total assets(a) 30,369 30,340 30,431 32,627 8,388 9,176
Deposits 33,581 34,636 3,379 3,052 3,699 3,368
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs $ 68 $ 81 $ 115 $ 87 $ 2 $ 5
Return on average allocated equity 24.25% 23.35% 15.13% 13.86% 15.74% 13.00%
====================================================================================================================================
KEY CONSUMER KEY CORPORATE KEY CAPITAL
NINE MONTHS ENDED SEPTEMBER 30, BANKING GROUP FINANCE GROUP PARTNERS GROUP
---------------------- -------------------- --------------------
dollars in millions 2002 2001 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ 1,346 $ 1,359 $ 847 $ 806 $ 169 $ 160
Noninterest income 377 369 157 175 662 713
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) 1,723 1,728 1,004 981 831 873
Provision for loan losses 188 163 133 129 7 7
Depreciation and amortization expense 106 165 29 47 41 73
Noninterest expense 886 855 337 340 596 627
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) and
cumulative effect of accounting changes 543 545 505 465 187 166
Allocated income taxes and taxable-equivalent adjustments 203 215 189 178 70 69
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes 340 330 316 287 117 97
Cumulative effect of accounting changes -- (24) -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 340 $ 306 $ 316 $ 287 $ 117 $ 97
======== ======== ======== ======== ======== =======
Percent of consolidated net income 47% 100% 43% 94% 16% 32%
Percent of total segments net income 45 43 42 41 15 14
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 27,818 $ 27,940 $ 29,479 $ 31,268 $ 4,884 $ 5,500
Total assets(a) 29,981 30,686 30,715 32,724 8,268 9,148
Deposits 33,955 35,449 3,202 3,044 3,654 3,690
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs $ 223 $ 233 $ 360 $ 204 $ 11 $ 12
Return on average allocated equity 22.91% 18.03% 15.11% 13.78% 16.35% 12.21%
====================================================================================================================================
(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) Significant nonrecurring charges included under reconciling items for
the nine-month period ended September 30, 2001, are as follows:
- Noninterest income includes a $40 million ($25 million after
tax) second quarter loss recorded in connection with declines
in leased vehicle residual values.
- The provision for loan losses includes an additional provision
of $300 million ($189 million after tax) recorded during the
second quarter in connection with Key's decision to
discontinue certain credit-only commercial relationships.
- Noninterest expense includes a goodwill write-down of $150
million associated with Key's decision to downsize its
automobile finance business, additional litigation reserves of
$20 million ($13 million after tax) and other charges of $2
million ($1 million after tax). All of these charges were
recorded in the second quarter.
13
THREE MONTHS ENDED SEPTEMBER 30, OTHER SEGMENTS TOTAL SEGMENTS
----------------------- ---------------------
dollars in millions 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ (44) $ (28) $ 743 $ 758
Noninterest income 32 25 428 454
- --------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) (12) (3) 1,171 1,212
Provision for loan losses 1 1 109 100
Depreciation and amortization expense -- -- 56 93
Noninterest expense 6 6 602 607
- --------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) (19) (10) 404 412
Allocated income taxes and taxable-equivalent adjustments (17) (15) 140 150
- --------------------------------------------------------------------------------------------------------------
Net income (loss) $ (2) $ 5 $ 264 $ 262
======== ======== ======== ========
Percent of consolidated net income (1)% 2% 108% 105%
Percent of total segments net income -- 2 100 100
- --------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 1,209 $ 1,774 $ 63,401 $ 66,095
Total assets(a) 11,187 11,488 80,375 83,631
Deposits 4,076 4,166 44,735 45,222
- --------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs -- -- $ 185 $ 173
Return on average allocated equity N/M N/M 17.09% 16.12%
==============================================================================================================
THREE MONTHS ENDED SEPTEMBER 30, RECONCILING ITEMS KEY
----------------------- -----------------------
dollars in millions 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ (21) $ (28) $ 722 $ 730
Noninterest income 4 -- 432 454
- --------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) (17) (28) 1,154 1,184
Provision for loan losses 26 16 135 116
Depreciation and amortization expense -- -- 56 93
Noninterest expense 1 (17) 603 590
- --------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) (44) (27) 360 385
Allocated income taxes and taxable-equivalent adjustments (25) (14) 115 136
- --------------------------------------------------------------------------------------------------------------
Net income (loss) $ (19) $ (13) $ 245 $ 249
======== ======== ======== ========
Percent of consolidated net income (8)% (5)% 100% 100%
Percent of total segments net income N/A N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 85 $ 103 $ 63,486 $ 66,198
Total assets(a) 1,560 1,248 81,935 84,879
Deposits (71) 11 44,664 45,233
- --------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs -- -- $ 185 $ 173
Return on average allocated equity N/M N/M 14.74% 15.20%
==============================================================================================================
NINE MONTHS ENDED SEPTEMBER 30, OTHER SEGMENTS TOTAL SEGMENTS
--------------------- ----------------------
dollars in millions 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ (142) $ (92) $ 2,220 $ 2,233
Noninterest income 91 85 1,287 1,342
- --------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) (51) (7) 3,507 3,575
Provision for loan losses 3 3 331 302
Depreciation and amortization expense -- 1 176 286
Noninterest expense 19 17 1,838 1,839
- --------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) and
cumulative effect of accounting changes (73) (28) 1,162 1,148
Allocated income taxes and taxable-equivalent adjustments (58) (43) 404 419
- --------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes (15) 15 758 729
Cumulative effect of accounting changes -- (1) -- (25)
- --------------------------------------------------------------------------------------------------------------
Net income (loss) $ (15) $ 14 $ 758 $ 704
======== ======== ======== ========
Percent of consolidated net income (2)% 4% 104% 230%
Percent of total segments net income (2) 2 100 100
- --------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 1,321 $ 1,912 $ 63,502 $ 66,620
Total assets(a) 10,810 11,718 79,774 84,276
Deposits 3,649 3,586 44,460 45,769
- --------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs -- $ 4 $ 594 $ 453
Return on average allocated equity N/M N/M 16.53% 14.26%
==============================================================================================================
NINE MONTHS ENDED SEPTEMBER 30, RECONCILING ITEMS(b) KEY
------------------------ ---------------------
dollars in millions 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ (75) $ (89) $ 2,145 $ 2,144
Noninterest income 36 (35) 1,323 1,307
- --------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent)(a) (39) (124) 3,468 3,451
Provision for loan losses 75 325 406 627
Depreciation and amortization expense 1 151 177 437
Noninterest expense (30) (37) 1,808 1,802
- --------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) and
cumulative effect of accounting changes (85) (563) 1,077 585
Allocated income taxes and taxable-equivalent adjustments (58) (165) 346 254
- --------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes (27) (398) 731 331
Cumulative effect of accounting changes -- -- -- (25)
- --------------------------------------------------------------------------------------------------------------
Net income (loss) $ (27) $ (398) $ 731 $ 306
======== ======== ======== ========
Percent of consolidated net income (4)% (130)% 100% 100%
Percent of total segments net income N/A N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 132 $ 105 $ 63,634 $ 66,725
Total assets(a) 1,685 1,448 81,459 85,724
Deposits (78) (19) 44,382 45,750
- --------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs -- -- $ 594 $ 453
Return on average allocated equity N/M N/M 15.13% 6.21%
===============================================================================================================
N/A = Not Applicable
N/M = Not Meaningful
14
Supplementary information (Key Consumer Banking lines of business)
THREE MONTHS ENDED SEPTEMBER 30, RETAIL BANKING SMALL BUSINESS
------------------------ -------------------------
dollars in millions 2002 2001 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 333 $ 347 $102 $102
Provision for loan losses 15 13 9 9
Noninterest expense 202 213 42 44
Net income 73 74 32 30
Net loan charge-offs 15 18 16 12
Return on average allocated equity 51.08% 51.96% 39.06% 35.11%
Full-time equivalent employees 6,066 6,246 271 257
- ---------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, INDIRECT LENDING NATIONAL HOME EQUITY
------------------------ -------------------------
dollars in millions 2002 2001 2002 2001
- --------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $86 $104 $ 62 $ 49
Provision for loan losses 27 26 12 6
Noninterest expense 41 49 41 37
Net income 11 18 6 3
Net loan charge-offs 28 39 9 12
Return on average allocated equity 6.68% 9.29% 5.28% 2.64%
Full-time equivalent employees 752 768 1,170 1,192
- ---------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, RETAIL BANKING SMALL BUSINESS
------------------------ ---------------------------
dollars in millions 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 973 $ 996 $296 $290
Provision for loan losses 42 37 27 28
Noninterest expense 611 643 127 133
Net income 200 192 89 80
Net loan charge-offs 51 48 45 32
Return on average allocated equity 48.80% 43.00% 37.54% 31.09%
Full-time equivalent employees 6,066 6,246 271 257
- -----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, INDIRECT LENDING NATIONAL HOME EQUITY
------------------------ ----------------------------
dollars in millions 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $273 $308 $ 181 $ 134
Provision for loan losses 83 80 36 18
Noninterest expense 131 139 123 105
Net income 37 31 14 3
Net loan charge-offs 98 113 29 40
Return on average allocated equity 7.38% 4.65% 4.17% .92%
Full-time equivalent employees 752 768 1,170 1,192
- -----------------------------------------------------------------------------------------------------------------------------------
Supplementary information (Key Corporate Finance lines of business)
THREE MONTHS ENDED SEPTEMBER 30, CORPORATE BANKING NATIONAL COMMERCIAL REAL ESTATE
------------------------- --------------------------------
dollars in millions 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $183 $193 $ 96 $ 89
Provision for loan losses 23 24 11 11
Noninterest expense 71 75 32 30
Net income 56 58 33 30
Net loan charge-offs 98 65 2 2
Return on average allocated equity 13.59% 14.01% 18.21% 15.74%
Full-time equivalent employees 583 650 562 480
- -----------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, NATIONAL EQUIPMENT FINANCE
---------------------------
dollars in millions 2002 2001
- ------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 56 $ 45
Provision for loan losses 9 8
Noninterest expense 20 20
Net income 17 10
Net loan charge-offs 15 20
Return on average allocated equity 15.87% 9.75%
Full-time equivalent employees 597 686
- ------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, CORPORATE BANKING NATIONAL COMMERCIAL REAL ESTATE
------------------------- --------------------------------
dollars in millions 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $553 $584 $271 $264
Provision for loan losses 73 71 32 32
Noninterest expense 213 234 92 84
Net income 167 173 92 92
Net loan charge-offs 319 170 5 6
Return on average allocated equity 13.40% 14.01% 17.18% 17.16%
Full-time equivalent employees 583 650 562 480
- -----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, NATIONAL EQUIPMENT FINANCE
---------------------------
dollars in millions 2002 2001
- ------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $180 $133
Provision for loan losses 28 26
Noninterest expense 61 69
Net income 57 22
Net loan charge-offs 36 28
Return on average allocated equity 18.41% 7.05%
Full-time equivalent employees 597 686
- ------------------------------------------------------------------------------------------------------
Supplementary information (Key Capital Partners lines of business)
THREE MONTHS ENDED SEPTEMBER 30, VICTORY CAPITAL MANAGEMENT HIGH NET WORTH
---------------------------- --------------------------
dollars in millions 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 51 $ 58 $ 140 $ 153
Provision for loan losses -- -- 2 2
Noninterest expense 33 41 118 127
Net income 11 10 13 14
Net loan charge-offs -- -- 2 4
Return on average allocated equity 37.30% 30.29% 11.31% 11.02%
Full-time equivalent employees 533 579 2,336 2,560
- -----------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, CAPITAL MARKETS
---------------------
dollars in millions 2002 2001
- -----------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 74 $ 75
Provision for loan losses -- --
Noninterest expense 52 58
Net income 14 10
Net loan charge-offs -- 1
Return on average allocated equity 14.43% 9.84%
Full-time equivalent employees 678 699
- -----------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, VICTORY CAPITAL MANAGEMENT HIGH NET WORTH
---------------------------- --------------------------
dollars in millions 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $161 $174 $ 434 $ 458
Provision for loan losses -- -- 7 7
Noninterest expense 108 124 361 392
Net income 33 30 41 34
Net loan charge-offs -- -- 11 11
Return on average allocated equity 36.77% 29.93% 12.15% 8.74%
Full-time equivalent employees 533 579 2,336 2,560
- -----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, CAPITAL MARKETS
---------------------
dollars in millions 2002 2001
- -----------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $236 $241
Provision for loan losses -- --
Noninterest expense 168 184
Net income 43 33
Net loan charge-offs -- 1
Return on average allocated equity 14.89% 10.81%
Full-time equivalent employees 678 699
- -----------------------------------------------------------------------------------------
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
acquired by Key with the intent of liquidating them in the near term, and
certain interests retained in loan securitizations. All of these assets are
reported at fair value ($750 million at September 30, 2002, $597 million at
December 31, 2001 and $844 million at September 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. 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.
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 are presented in
the following tables.
16
SEPTEMBER 30, 2002
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 148 $10 -- $ 158
Equity securities 910 -- -- 910
- ---------------------------------------------------------------------------------------------------------------
Total investment securities $1,058 $10 -- $1,068
======= ==== ==== =======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 20 $ 1 -- $ 21
States and political subdivisions 17 1 -- 18
Collateralized mortgage obligations 6,156 98 $60 6,194
Other mortgage-backed securities 748 35 -- 783
Retained interests in securitizations 182 35 -- 217
Other securities 156 -- 40 116
- ---------------------------------------------------------------------------------------------------------------
Total securities available for sale $7,279 $170 $100 $7,349
======= ===== ===== =======
- ---------------------------------------------------------------------------------------------------------------
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
======= ===== ==== =======
- ---------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2001
-------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 254 $12 -- $ 266
Equity securities 920 -- -- 920
- ---------------------------------------------------------------------------------------------------------------
Total investment securities $1,174 $12 -- $1,186
======= ==== ==== =======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 268 -- -- $ 268
States and political subdivisions 23 -- -- 23
Collateralized mortgage obligations 4,562 $117 $65 4,614
Other mortgage-backed securities 1,092 39 -- 1,131
Retained interests in securitizations 246 15 -- 261
Other securities 198 1 25 174
- ---------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,389 $172 $90 $6,471
======= ===== ==== =======
- ---------------------------------------------------------------------------------------------------------------
17
6. LOANS
Key's loans by category are summarized as follows:
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 2002 2001 2001
================================================================================================================
Commercial, financial and agricultural $17,419 $18,159 $19,022
Commercial real estate:
Commercial mortgage 6,237 6,669 6,826
Construction 5,845 5,878 6,014
- ----------------------------------------------------------------------------------------------------------------
Total commercial real estate loans 12,082 12,547 12,840
Commercial lease financing 7,369 7,357 7,147
- ----------------------------------------------------------------------------------------------------------------
Total commercial loans 36,870 38,063 39,009
Real estate-- residential mortgage 2,098 2,315 2,418
Home equity 13,516 11,184 10,826
Consumer-- direct 2,167 2,342 2,388
Consumer-- indirect:
Lease financing 1,137 2,036 2,409
Automobile 2,256 2,497 2,558
Marine 2,047 1,780 1,767
Other 870 1,036 1,083
- ----------------------------------------------------------------------------------------------------------------
Total consumer-- indirect loans 6,310 7,349 7,817
- ----------------------------------------------------------------------------------------------------------------
Total consumer loans 24,091 23,190 23,449
Loans held for sale:
Real estate-- commercial mortgage 309 252 614
Real estate-- residential mortgage 49 116 74
Education 1,632 1,688 1,360
- ----------------------------------------------------------------------------------------------------------------
Total loans held for sale 1,990 2,056 2,048
- ----------------------------------------------------------------------------------------------------------------
Total loans $62,951 $63,309 $64,506
======== ======== ========
- ----------------------------------------------------------------------------------------------------------------
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 September 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 SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
in millions 2002 2001 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $1,539 $1,231 $1,677 $1,001
Charge-offs (211) (197) (680) (534)
Recoveries 26 24 86 81
- ----------------------------------------------------------------------------------------------------------------------
Net charge-offs (185) (173) (594) (453)
Allowance related to loans sold -- -- -- (1)
Provision for loan losses 135 116 406 627
- ----------------------------------------------------------------------------------------------------------------------
Balance at end of period $1,489 $1,174 $1,489 $1,174
======= ======= ======= =======
- ----------------------------------------------------------------------------------------------------------------------
18
7. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
Impaired loans, which account for the largest portion of Key's nonperforming
assets, totaled $645 million at September 30, 2002, compared with $661 million
at the end of 2001. Impaired loans averaged $658 million for the third quarter
of 2002 and $462 million for the third quarter of 2001.
Key's nonperforming assets were as follows:
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 2002 2001 2001
- ------------------------------------------------------------------------------------------------
Impaired loans $ 645 $661 $546
Other nonaccrual loans 342 249 339
- -----------------------------------------------------------------------------------------------
Total nonperforming loans 987 910 885
Other real estate owned ("OREO") 30 38 26
Allowance for OREO losses (2) (1) (1)
- ------------------------------------------------------------------------------------------------
OREO, net of allowance 28 37 25
Other nonperforming assets 2 -- 3
- ------------------------------------------------------------------------------------------------
Total nonperforming assets $1,017 $947 $913
======= ===== ====
- ------------------------------------------------------------------------------------------------
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 and/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 September 30, 2002, Key had $414 million of impaired loans with a
specifically allocated allowance for loan losses of $200 million, and $231
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"). These are typically comprised of consumer loans, including residential
mortgages, home equity and various types of installment loans. 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 September 30,
2002 and 2001, was $3 million and $22 million, respectively. For the nine-month
periods ended September 30, 2002 and 2001, amortization expense was $8 million
and $222 million, respectively. Estimated amortization expense, for intangible
assets subject to amortization, for 2002 and each of the next four 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 nine-month periods ended
September 30, 2002 and 2001, is presented below. Goodwill amortization for
the nine-month period ended September 30, 2001, as shown in the table,
excludes a $150 million second quarter write-down of goodwill associated
with Key's decision to downsize its automobile finance business.
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------- -----------------------------
dollars in millions, except per share amounts 2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------
EARNINGS
Net income $245 $249 $731 $306
Add: Goodwill amortization -- 20 -- 62
- ------------------------------------------------------------------------------------------------------------------------------
Adjusted net income $245 $269 $731 $368
===== ===== ===== =====
- ----------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 426,274 424,802 425,746 424,503
Weighted average common shares and potential
common shares outstanding (000) 431,326 430,346 431,098 430,009
-
- ----------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per common share $.57 $.59 $1.72 $.72
Add: Goodwill amortization -- .05 -- .15
- ----------------------------------------------------------------------------------------------------------------------------
Adjusted net income per common share $.57 $.64 $1.72 $.87
===== ===== ====== =====
Adjusted net income per common share - assuming dilution $.57 $.63 $1.69 $.86
===== ===== ====== =====
- ------------------------------------------------------------------------------------------------------------------------------
The following table shows the gross carrying amount and the accumulated
amortization of intangible assets that are subject to amortization.
SEPTEMBER 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 $194 $215 $187
Other intangible assets 8 6 9 6
- -----------------------------------------------------------------------------------------------------------------------------
Total $223 $200 $224 $193
==== ==== ==== ====
- -----------------------------------------------------------------------------------------------------------------------------
At September 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:
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 2002 2001 2001
- ----------------------------------------------------------------------------------------------------------------------------
Senior medium-term notes due through 2005(a) $ 1,534 $ 1,286 $ 1,171
Subordinated medium-term notes due through 2003(a) 45 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% Notes due through 2017 25 -- --
All other long-term debt(i) 36 16 22
- ----------------------------------------------------------------------------------------------------------------------------
Total parent company(j) 2,265 2,212 2,103
Senior medium-term bank notes due through 2039(d) 4,179 4,525 5,065
Senior euro medium-term bank notes due through 2007(e) 5,003 3,989 4,098
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
5.70% Subordinated notes due 2012(f) 300 -- --
Lease financing debt due through 2006(g) 467 519 545
Federal Home Loan Bank advances due through 2030(h) 1,173 762 756
All other long-term debt(i) 511 270 269
- ----------------------------------------------------------------------------------------------------------------------------
Total subsidiaries 14,011 12,342 13,011
- ----------------------------------------------------------------------------------------------------------------------------
Total long-term debt $16,276 $14,554 $15,114
======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------------
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 September 30, 2002, see
Note 14 ("Derivatives and Hedging Activities"),which begins on page 28.
(a) At September 30, 2002, December 31, 2001 and September 30,2001, the senior
medium-term notes had weighted average interest rates of 2.63%, 2.51% and
3.77%, respectively, and the subordinated medium-term notes had a weighted
average interest rate of 7.30%, 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 1.97%
at September 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 2.77%, 2.45% and 3.71%, at September 30, 2002, December 31, 2001
and September 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 1.99%,
2.58%, and 4.10%, at September 30, 2002, December 31, 2001 and September
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 7.14% at
September 30, 2002, 7.41% at December 31, 2001 and 7.93% at September 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 1.95% at September 30, 2002, 2.19% at December 31, 2001
and 3.44% at September 30, 2001. These advances, which had a combination of
fixed and floating interest rates, were secured by $1.8 billion, $1.1
billion, and $1.0 billion of real estate loans and securities at September
30, 2002, December 31, 2001 and September 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 6.53%, 6.72%, and
6.95% at September 30, 2002, December 31, 2001 and September 30, 2001,
respectively.
(j) At September 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. 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 MATURITY
CAPITAL AMOUNT OF OF CAPITAL OF CAPITAL
SECURITIES, COMMON DEBENTURES, SECURITIES AND SECURITIES AND
dollars in millions NET OF DISCOUNT(a) SECURITIES NET OF DISCOUNT (b) DEBENTURES (c) DEBENTURES
- --------------------------------------------------------------------------------------------------------------------------
September 30, 2002
KeyCorp Institutional Capital A $ 406 $11 $ 361 7.826 % 2026
KeyCorp Institutional Capital B 174 4 154 8.250 2026
KeyCorp Capital I 230 8 237 2.600 2028
KeyCorp Capital II 196 8 176 6.875 2029
KeyCorp Capital III 276 8 231 7.750 2029
- --------------------------------------------------------------------------------------------------------------------------
Total $1,282 $39 $1,159 6.784 % --
====== === =======
- --------------------------------------------------------------------------------------------------------------------------
December 31, 2001 $1,288 $39 $1,282 6.824 % --
====== === =======
- --------------------------------------------------------------------------------------------------------------------------
September 30, 2001 $1,329 $39 $1,282 7.066 % --
====== === =======
- --------------------------------------------------------------------------------------------------------------------------
(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 September 30, 2002, December 31, 2001 and
September 30, 2001, are basis adjustments of $162 million, $45 million and
$86 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.
22
(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
September 30, 2002, December 31, 2001 and September 30, 2001, are weighted
average rates.
11. 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 the March 31, 2002, target date, 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 SEPTEMBER 30,
in millions 2001 CHARGES (CREDITS) PAYMENTS 2002
- ---------------------------------------------------------------------------------------------------
Severance $27 $(8) $10 $9
Site consolidations 33 3 7 29
Equipment and other 1 (1) -- --
- ---------------------------------------------------------------------------------------------------
Total $61 $(6) $17 $38
==== ==== ==== ===
- ---------------------------------------------------------------------------------------------------
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. The market
for used cars varies.
Accordingly, the total expected loss on the portfolio for which KeyBank will
file claims cannot be determined with certainty at this time. Claims filed by
KeyBank through September 30, 2002, total approximately $230 million, and
management currently estimates that approximately $115 million of
24
additional claims may be filed through year-end 2006. As discussed above, a
number of factors could affect KeyBank's actual loss experience, which may be
higher or lower than management's current estimates.
Key is filing insurance claims for the entire amount of its losses and is
recording as a receivable on its balance sheet a portion of the amount of the
insurance claims as and when they are filed. Management believes that the amount
being recorded as a receivable due from the insurance carriers is appropriate to
reflect the collectibility risk associated with the insurance litigation;
however, litigation is inherently not without risk, and any actual recovery from
the litigation may be more or less than the receivable. While management does
not expect an adverse decision, if a court were to make an adverse final
determination, such result would cause Key to record a material one-time expense
during the period when such determination is made. An adverse determination
would not have a material effect on Key's financial condition, but could have a
material adverse effect on Key's results of operations in the quarter in
question.
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, who
alleged to have purchased approximately $260 million of NSM securities. 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). Coverage was subsequently denied by the insurance
carriers. Key and its insurance carriers filed declaratory judgment actions
against each other seeking to resolve this matter. In August 2002, Key and its
insurance carriers settled their dispute. With the settlement of the insurance
dispute, all pending NSM related litigation is concluded. Key's results of
operations for the three-month period ended September 30, 2002, were not
affected by the settlement of the NSM related litigation.
In the ordinary course of business, Key is subject to legal actions that involve
claims for substantial monetary relief. Except as discussed above, based on
information presently known to management, 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,
could reasonably be expected to have a material adverse effect on Key's
financial condition or annual results of operations.
25
13. OTHER FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Key, mainly through its lead bank, KeyBank National Association ("KBNA"), 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
unconsolidated 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 committed facilities of $1.6 billion. 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. The Federally guaranteed education loans were sold at a premium,
consistent with the terms under which similar loans have been sold to the
Student Loan Marketing Association and other secondary markets. The net gain
recognized by Key in connection with the sale was not significant.
At September 30, 2002, Key's funding requirements under the committed liquidity
and credit enhancement facilities totaled $663 million and $58 million,
respectively. However, there were no drawdowns under either of the commitment
facilities at September 30, 2002. Key's commitments to provide increased
liquidity and credit enhancement to the conduit are periodically evaluated by
management.
The balance of assets outstanding in the conduit was $452 million at September
30, 2002. Of this amount, $85 million represents the balance of the beneficial
interests in the Federally guaranteed education loans acquired by the conduit in
2001. The remaining amount represents loans and securities financed by the
conduit. All of the assets in the conduit were performing in accordance with
their contractual terms at September 30, 2002.
RECOURSE AGREEMENT WITH FEDERAL NATIONAL MORTGAGE 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
26
and is maintained in an amount estimated by management to be appropriate in
light of the recourse risk. As of September 30, 2002, the principal balance
outstanding of loans sold by KBNA as a participant in this program was
approximately $1.1 billion.
RETURN GUARANTY AGREEMENT WITH LOW-INCOME HOUSING TAX CREDIT ("LIHTC")
INVESTORS. Key Affordable Housing Corporation ("KAHC"), a subsidiary of KBNA,
offers limited partnership interests to qualified investors. Unconsolidated
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 September 30, 2002, Key
guaranteed equity of $655 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 future losses under the guarantees.
OTHER OFF-BALANCE SHEET RISK. KBNA and KeyBank 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 positions 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.
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 2002 2001 2001
- --------------------------------------------------------------------------------------------------------
Loan commitments:
Home equity $ 5,443 $ 4,965 $ 4,880
Commercial real estate and construction 2,051 2,487 2,318
Commercial and other 23,314 24,936 23,479
- --------------------------------------------------------------------------------------------------------
Total loan commitments 30,808 32,388 30,677
Other commitments:
Standby letters of credit 3,670 3,503 3,465
Commercial letters of credit 91 106 118
- --------------------------------------------------------------------------------------------------------
Total loan and other commitments $34,569 $35,997 $34,260
======== ======== ========
- --------------------------------------------------------------------------------------------------------
27
14. DERIVATIVES AND HEDGING ACTIVITIES
Key, mainly through its lead bank, KBNA, 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 September 30, 2002, Key had $721 million of derivative assets and $193
million of derivative liabilities on its balance sheet that were being used in
connection with hedging activities. As of the same date, the fair value of
derivative assets and liabilities classified as trading derivatives totaled $1.7
billion and $1.5 billion, respectively. Derivative assets and liabilities are
recorded in "accrued income and other assets" and "accrued expense and other
liabilities," respectively, 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 nine months of 2002, Key recognized a net gain of approximately
$2 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
28
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.
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 nine months of 2002, the net gain recognized by Key in
connection with the ineffective portion of its cash flow hedging instruments was
not significant. There was no impact on earnings during the first nine months 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 LOSSES SEPTEMBER 30,
in millions 2001 HEDGING ACTIVITY TO NET INCOME 2002
- -------------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income
(loss) resulting from cash flow hedges $(2) $(36) $26 $(12)
- -------------------------------------------------------------------------------------------------------------------
Key expects to reclassify approximately $36 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.
29
The following table shows net trading income recognized on interest rate swap
and foreign exchange forward contracts.
NINE MONTHS ENDED SEPTEMBER 30,
in millions 2002 2001
- ---------------------------------------------------------------------------
Interest rate swap contracts $ 8 $14
Foreign exchange forward contracts 26 31
- ---------------------------------------------------------------------------
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, Credit Administration 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 September 30, 2002, Key was party to interest rate swaps and caps with 46
different counterparties. Among these were swaps and caps entered into to offset
the risk of client exposure. Key had aggregate credit exposure of $502 million
to 26 of these counterparties, with the largest credit exposure to an individual
counterparty amounting to approximately $207 million.
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 September 30, 2002 and 2001, and the related
condensed consolidated statements of income for the three- and nine-month
periods then ended, and the condensed consolidated statements of changes in
shareholders' equity and cash flow for the nine-month periods ended September
30, 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
October 14, 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 September 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 AND ESTIMATES
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. All
accounting policies are important, and all policies contained in Note 1
("Summary of Significant Accounting Policies"), which begins on page 58 of Key's
2001 Annual Report to Shareholders, should be reviewed for a greater
understanding of how Key's financial performance is recorded and reported.
In management's opinion, some areas of accounting are likely to have a more
significant effect than others on Key's financial results and expose those
results to potentially greater volatility. This is because they apply to areas
of relatively greater business importance and/or require management to exercise
judgment in making assumptions and estimates that affect amounts reported in the
financial statements. Because these assumptions and estimates are based on
current circumstances, they may change over time or prove to be inaccurate based
on actual experience. For Key, the areas that rely most heavily on the use of
assumptions and estimates include accounting for the allowance for loan losses,
loan securitizations, contingent obligations arising from litigation and tax
exposures, and pension and other postretirement obligations. Our accounting
policies related to the first two of these four areas are disclosed in Note 1 of
Key's 2001 Annual Report.
ALLOWANCE FOR LOAN LOSSES. Historical loss rates, expected cash flows, estimated
collateral values and other factors are considered in determining the probable
losses inherent in Key's loan portfolio and in establishing an allowance for
loan losses that is sufficient to absorb such losses. Management's judgment in
determining these factors benefits from a lengthy organizational history and
experience with credit decisions and related outcomes. Nonetheless, if the
underlying assumptions prove to be inaccurate, Key's allowance for loan losses
would have to be adjusted accordingly.
LOAN SECURITIZATIONS. Key securitizes certain types of loans and accounts for
such transactions as sales when the criteria set forth in SFAS No. 140 are met.
If future events were to occur that would preclude accounting for such
transactions as sales, the loans would have to be placed back on Key's balance
sheet. This could have a potentially adverse effect on Key's capital ratios and
other unfavorable financial implications. In addition, determining the gain or
loss resulting from securitization transactions and the subsequent carrying
amount of retained interests is dependent on underlying assumptions made by
management, the most significant of which are described in Note 7 ("Retained
Interests in Loan Securitizations") on page 68 of Key's 2001 Annual Report to
Shareholders. The use of alternative ranges of possible outcomes for these
assumptions would change the amount of the initial gain or loss recognized. It
could also result in subsequent changes in the carrying amount of retained
interests, with related effects on results of operations.
CONTINGENT OBLIGATIONS. A detailed description of contingent obligations arising
from litigation and their potential effects on Key's results of operations is
contained in Note 12 ("Legal Proceedings"), which begins on page 24 of this
report.
32
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.
VALUATION METHODOLOGIES. Valuation methodologies employed by management often
involve a significant degree of judgment in matters other than those described
above, 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 and liabilities, such as
principal investments, goodwill, and pension and other postretirement benefit
obligations. These valuations require the use of assumptions and estimates
related to discount rates, asset returns, repayment rates and other factors that
are used to determine the values of these assets and liabilities, as well as the
extent to which related assets may be impaired. The use of different discount
rates or other valuation assumptions could produce significantly different
results, which could have material positive or negative effects on Key's results
of operations. The valuation methodology used by management for principal
investments is summarized in Note 1 of Key's 2001 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 8 of this report. The primary assumptions used in determining
Key's pension and other postretirement benefit obligations and related expenses
are presented in Note 15 ("Employee Benefits") on pages 74 and 75 of Key's 2001
Annual Report.
REVENUE RECOGNITION. 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.
INTERNAL CONTROL. Key's management has established and maintains a comprehensive
system of internal control that is intended to protect Key's assets and the
integrity of its financial statements. While no such system is foolproof, ours
is designed to provide assurance that the financial information we publish is
accurate, complete, timely and presents our performance fairly.
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).
- - 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
33
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 67.
- - 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.
- - 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
Key's financial performance for the three- and nine-month periods ended
September 30, 2002 and 2001, was affected by a series of strategic initiatives
announced during the second quarter of 2001. These initiatives are 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. They include:
34
- - Accelerating Key's revenue growth by delivering our products and
services to customers through a seamless, integrated sales process
called 1Key.
- - Achieving 100% of the savings from our competitiveness initiative.
- - Re-emphasizing our commitment to our relationship-based activities,
while de-emphasizing high-risk, low-return businesses.
Specific actions related to these initiatives include exiting the automobile
leasing business, de-emphasizing indirect prime automobile lending,
discontinuing credit-only relationships in the leveraged financing and
nationally syndicated lending businesses, and increasing the allowance for loan
losses.
The primary measures of Key's financial performance for the third quarter and
first nine months of 2002 and 2001 are summarized below.
- - Net income for the third quarter of 2002 was $245 million, or $.57 per
common share, compared with net income of $246 million, or $.57 per
share, for the previous quarter and net income of $249 million, or $.58
per share, for the third quarter of 2001. For the first nine months of
2002, Key's net income was $731 million, or $1.69 per common share, up
from net income of $306 million, or $.71 per share for the comparable
period last year.
- - Key's return on average equity was 14.74% for the third quarter of
2002. This result compares with a return of 15.16% for the prior
quarter and a return of 15.20% for the year-ago quarter. For the first
nine months of 2002, Key's return on average equity was 15.13%,
compared with a return of 6.21% for the first nine months of 2001.
- - Key's third quarter 2002 return on average total assets was 1.19%. This
result compares with a return of 1.21% for the previous quarter and a
return of 1.16% for the third quarter of 2001. For the first nine
months of 2002, Key's return on average total assets was 1.20%, up from
a return of .48% for the comparable period in 2001.
The slight decrease in Key's earnings relative to the third quarter of 2001
reflects the ongoing effects of a challenging economic environment. Key's
taxable-equivalent net interest income decreased by $8 million from the third
quarter of 2001. A 5% reduction in average earning assets stemming from the
impact of some strategic downsizing of the loan portfolio, loan sales and weak
loan demand more than offset the positive effect of a 14 basis point improvement
in the net interest margin. At the same time, noninterest income declined by $22
million, primarily due to unfavorable trends in our market-sensitive businesses
and higher losses incurred on lease residual values. Also contributing to the
reduction in earnings was a $19 million rise in the provision for loan losses,
reflecting higher levels of net charge-offs. These unfavorable results were
offset in part by a $24 million decrease in noninterest expense, including a $20
million reduction associated with the adoption of new accounting guidance for
goodwill. Our favorable performance in terms of expense control is attributable
largely to the success of our competitiveness initiative discussed on page 37
and our ongoing efforts to drive for greater efficiency and to strengthen Key's
expense culture. Considering recent trends, we believe that Key's fourth quarter
results, including earnings per common share, are likely to be similar to those
of the third quarter.
Key's financial results for the first nine months of 2001 were adversely
affected by several significant second quarter charges recorded as a result of
the specific strategic actions discussed previously. In view of our intention to
significantly downsize the automobile finance business we recorded a $150
million write-down of goodwill associated with Key's 1995 acquisition of
AutoFinance Group, Inc. We also recorded an additional provision for loan losses
of $300 million ($189 million after tax) to facilitate the exiting of credits in
the leveraged financing and nationally syndicated lending businesses. In
addition, we recorded a $40 million ($25 million after tax) charge to establish
a reserve for losses incurred on the residual values of leased vehicles. These
charges are reviewed in greater detail throughout the remainder of this
discussion.
35
In addition, results for the second quarter and first nine months of 2001 were
adversely affected by a $39 million ($24 million after tax) charge resulting
from a prescribed change in the accounting for retained interests in securitized
assets and a $20 million ($13 million after tax) increase in litigation
reserves.
The primary reasons that Key's specific revenue and expense components changed
from those of the three- and nine-month periods ended September 30, 2001, are
reviewed in detail in the remainder of this discussion.
Figure 1 on page 38 summarizes Key's financial performance for each of the past
five quarters and the first nine 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, 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.
- - 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.
36
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 the March 31, 2002, target date, 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.
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, Key had substantially completed the implementation
of all projects related to the initiative and nearly 4,100 positions had been
eliminated.
Since the inception of the competitiveness initiative, we have recorded related
net charges of $273 million. Note 11 ("Restructuring Charges") on page 23,
provides more information about Key's restructuring charges.
37
FIGURE 1. SELECTED FINANCIAL DATA
2002
-------------------------------------------
dollars in millions, except per share amounts THIRD SECOND FIRST
- --------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $1,095 $1,102 $1,092
Interest expense 395 419 438
Net interest income 700 683 654
Provision for loan losses 135 135 136
Noninterest income 432 448 443
Noninterest expense 659 665 661
Income (loss) before income taxes and cumulative effect
of accounting changes 338 331 300
Income (loss) before cumulative effect of accounting changes 245 246 240
Net income (loss) 245 246 240
- --------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect of accounting changes $ .57 $ .58 $ .56
Income (loss) before cumulative effect of accounting changes
--- assuming dilution .57 .57 .56
Net income (loss) .57 .58 .56
Net income (loss)-- assuming dilution .57 .57 .56
Cash dividends paid .30 .30 .30
Book value at period end 15.66 15.46 15.05
Market price:
High 27.35 29.40 27.26
Low 20.96 25.95 22.92
Close 24.97 27.30 26.65
Weighted average common shares (000) 426,274 426,092 424,855
Weighted average common shares and
potential common shares (000) 431,326 431,935 430,019
- --------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $62,951 $63,881 $63,956
Earning assets 72,548 72,820 72,382
Total assets 83,518 82,778 81,359
Deposits 44,610 44,805 43,233
Long-term debt 16,276 16,895 15,256
Shareholders' equity 6,654 6,592 6,402
Full-time equivalent employees 20,522 20,929 21,076
KeyCenters 903 905 911
- --------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.19 % 1.21 % 1.20 %
Return on average equity 14.74 15.16 15.53
Net interest margin (taxable equivalent) 3.99 3.98 3.93
- --------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.97 % 7.96 % 7.87 %
Tangible equity to tangible assets 6.71 6.69 6.57
Tier 1 risk-based capital 8.34 8.23 7.92
Total risk-based capital 12.69 12.29 12.02
Leverage 8.15 8.14 8.13
- --------------------------------------------------------------------------------------------------------------------------
NINE MONTHS
2001 ENDED SEPTEMBER 30,
--------------------------- ------------------------------
dollars in millions, except per share amounts FOURTH THIRD 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
Interest income $1,210 $1,380 $3,289 $4,417
Interest expense 510 656 1,252 2,292
Net interest income 700 724 2,037 2,125
Provision for loan losses 723 116 406 627
Noninterest income 418 454 1,323 1,307
Noninterest expense 702 683 1,985 2,239
Income (loss) before income taxes and cumulative effect
of accounting changes (307) 379 969 566
Income (loss) before cumulative effect of accounting changes (174) 249 731 331
Net income (loss) (174) 249 731 306
- ----------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Income (loss) before cumulative effect of accounting changes $ (.41) $ .59 $ 1.72 $ .78
Income (loss) before cumulative effect of accounting changes
--- assuming dilution (.41) .58 1.69 .77
Net income (loss) (.41) .59 1.72 .72
Net income (loss)-- assuming dilution (.41) .58 1.69 .71
Cash dividends paid .295 .295 .90 .885
Book value at period end 14.52 15.53 15.66 15.53
Market price:
High 24.52 28.15 29.40 29.25
Low 20.49 22.20 20.96 22.10
Close 24.34 24.14 24.97 24.14
Weighted average common shares (000) 423,596 424,802 425,746 424,503
Weighted average common shares and
potential common shares (000) 428,280 430,346 431,098 430,009
- ----------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $63,309 $64,506 $62,951 $64,506
Earning assets 71,672 73,943 72,548 73,943
Total assets 80,938 84,419 83,518 84,419
Deposits 44,795 45,372 44,610 45,372
Long-term debt 14,554 15,114 16,276 15,114
Shareholders' equity 6,155 6,575 6,654 6,575
Full-time equivalent employees 21,230 21,297 20,522 21,297
KeyCenters 911 911 903 911
- ----------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets (.84)% 1.16 % 1.20 % .48 %
Return on average equity (10.57) 15.20 15.13 6.21
Net interest margin (taxable equivalent) 3.98 3.85 3.97 3.75
- ----------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.60 % 7.79 % 7.97 % 7.79 %
Tangible equity to tangible assets 6.29 6.51 6.71 6.51
Tier 1 risk-based capital 7.43 7.81 8.34 7.81
Total risk-based capital 11.41 11.77 12.69 11.77
Leverage 7.65 7.90 8.15 7.90
- ----------------------------------------------------------------------------------------------------------------------
38
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 11.
Note 4 includes a brief description of the products and services offered by each
of the three major business groups, as well as more detailed financial
information pertaining to the groups and their related lines of business. Also
included are brief descriptions of Other Segments and Reconciling Items.
Figure 2 summarizes the contribution made by each major business group to Key's
taxable-equivalent revenue and net income for the three- and nine-month periods
ended September 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 2. MAJOR BUSINESS GROUPS - TAXABLE-EQUIVALENT REVENUE AND NET INCOME
THREE MONTHS ENDED SEPTEMBER 30, CHANGE
---------------------------------------- ----------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Key Consumer Banking $ 583 $ 602 $(19) (3.2)%
Key Corporate Finance 335 327 8 2.4
Key Capital Partners 265 286 (21) (7.3)
Other Segments (12) (3) (9) (300.0)
------ ------ ------ ------
Total segments 1,171 1,212 (41) (3.4)
Reconciling items (17) (28) 11 39.3
------ ------ ------ ------
Total $1,154 $1,184 $(30) (2.5)
====== ====== ======
Net income (loss)(a)
- ----------------------------
Key Consumer Banking $ 122 $ 125 $ (3) (2.4)%
Key Corporate Finance 106 98 8 8.2
Key Capital Partners 38 34 4 11.8
Other Segments (2) 5 (7) N/M
------ ------ ------ ------
Total segments 264 262 2 .8
Reconciling items (19) (13) (6) (46.2)
------ ------ ------ ------
Total $ 245 $ 249 $ (4) (1.6)
====== ====== ======
- -----------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, CHANGE
-------------------------------------- ---------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Key Consumer Banking $1,723 $1,728 $ (5) (.3)%
Key Corporate Finance 1,004 981 23 2.3
Key Capital Partners 831 873 (42) (4.8)
Other Segments (51) (7) (44) (628.6)
------ ------ ------ ------
Total segments 3,507 3,575 (68) (1.9)
Reconciling items (39) (124)(c) 85 68.5
------ ------ ------ ------
Total $3,468 $3,451 $ 17 .5
====== ====== ======
Net income (loss)(a)
- ----------------------------
Key Consumer Banking $ 340 $306(b) $ 34 11.1%
Key Corporate Finance 316 287 29 10.1
Key Capital Partners 117 97 20 20.6
Other Segments (15) 14 (29) N/M
------ ------ ------ ------
Total segments 758 704 54 7.7
Reconciling items (27) (398)(c) 371 93.2
------ ------ ------ ------
Total $ 731 $306 $425 138.9
====== ====== ======
- -----------------------------------------------------------------------------------------------------
(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 nine-month period ended September 30, 2001, include a
second quarter 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 first nine months 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
credit-only commercial relationships, 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). All of these
charges were recorded during the second quarter. 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
39
FIGURE 3. KEY CONSUMER BANKING GROUP DATA
THREE MONTHS ENDED SEPTEMBER 30, CHANGE
---------------------------------------- -------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Retail Banking $333 $347 $(14) (4.0)%
Small Business 102 102 -- --
Indirect Lending 86 104 (18) (17.3)
National Home Equity 62 49 13 26.5
------ ------ ------ ------
Total $583 $602 $(19) (3.2)
====== ====== ======
Net income
- ----------------------------
Retail Banking $ 73 $ 74 $ (1) (1.4)%
Small Business 32 30 2 6.7
Indirect Lending 11 18 (7) (38.9)
National Home Equity 6 3 3 100.0
------ ------ ------ ------
Total $122 $125 $ (3) (2.4)
====== ====== ======
- -------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, CHANGE
----------------------------------- -----------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Retail Banking $ 973 $ 996 $ (23) (2.3)%
Small Business 296 290 6 2.1
Indirect Lending 273 308 (35) (11.4)
National Home Equity 181 134 47 35.1
------ ------ ------ -----
Total $1,723 $1,728 $ (5) (.3)
====== ====== ======
Net income
- ----------------------------
Retail Banking $ 200 $ 192 $ 8 4.2%
Small Business 89 80 9 11.3
Indirect Lending 37 31 6 19.4
National Home Equity 14 3 11 366.7
------ ------ ------ -----
Total $ 340 $ 306(a) $ 34 11.1
====== ====== ======
- -------------------------------------------------------------------------------------------------------
(a) Results for the nine-month period ended September 30, 2001, include a
second quarter 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.
ADDITIONAL KEY CONSUMER BANKING DATA (3Q02)
Average loans (including home equity loans) $28.1 billion Average core deposits: $30.6 billion
Average home equity loans: $12.2 billion 534,385 on-line clients (30% penetration)
National Home Equity average loan-to-value ratio: 76% 903 KeyCenters and 2,249 ATMs
National Home Equity first lien positions: 84% 8,259 full-time equivalent employees
Net income for Key Consumer Banking was $122 million for the third quarter of
2002, representing a $3 million decline from the year-ago quarter. Decreases in
taxable-equivalent net interest income and noninterest income, along with a
higher provision for loan losses, more than offset a reduction in noninterest
expense.
Taxable-equivalent net interest income decreased by $15 million, or 3%, from the
third quarter of 2001 due to a less favorable interest rate spread on deposits,
a decline in average deposits outstanding and an $11 million write-down of the
unamortized premium associated with purchased home equity loans. The adverse
effect of these factors was partially offset by a more favorable spread on
earning assets. Noninterest income decreased by $4 million, or 3%, due primarily
to a $9 million increase in losses incurred on the residual values of leased
vehicles in the Indirect Lending line of business. Noninterest expense was down
$17 million, or 5%, from the third quarter of 2001. This improvement includes an
approximate $9 million reduction in goodwill amortization, which resulted from
the adoption of a new accounting standard on January 1, as well as lower costs
for software amortization and a decline in the level of fraud losses. These
reductions were partially offset by higher personnel expense. A $9 million, or
17%, increase in the provision for loan losses reflects the growth in lending in
the National Home Equity line of business.
40
FIGURE 4. KEY CORPORATE FINANCE GROUP DATA
THREE MONTHS ENDED SEPTEMBER 30, CHANGE
------------------------------------ ---------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Corporate Banking $183 $193 $(10) (5.2)%
National Commercial Real Estate 96 89 7 7.9
National Equipment Finance 56 45 11 24.4
------ ----- ----- -----
Total $335 $327 $ 8 2.4
====== ===== =====
Net income
- ----------------------------
Corporate Banking $ 56 $ 58 $ (2) (3.4)%
National Commercial Real Estate 33 30 3 10.0
National Equipment Finance 17 10 7 70.0
------ ----- ----- -----
Total $106 $ 98 $ 8 8.2
====== ===== =====
- ------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, CHANGE
----------------------------------- ------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Corporate Banking $ 553 $584 $(31) (5.3)%
National Commercial Real Estate 271 264 7 2.7
National Equipment Finance 180 133 47 35.3
------ ------ ------ -----
Total $1,004 $981 $ 23 2.3
====== ====== =====
Net income
- ----------------------------
Corporate Banking $ 167 $173 $ (6) (3.5)%
National Commercial Real Estate 92 92 -- --
National Equipment Finance 57 22 35 159.1
------ ------ ------ -----
Total $ 316 $287 $ 29 10.1
====== ====== =====
- ------------------------------------------------------------------------------------------------------------
ADDITIONAL KEY CORPORATE FINANCE DATA (3Q02)
Average loans and leases: $29.1 billion
Average deposits: $3.4 billion
1,742 full-time equivalent employees
Net income for Key Corporate Finance was $106 million for the third quarter of
2002, compared with $98 million for the same period last year. The improvement
was attributable to an increase in taxable-equivalent net interest income, as
changes in other major components of the income statement were not significant.
Taxable-equivalent net interest income grew by $9 million, or 3%, 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, the level of noninterest income was
essentially unchanged, reflecting a number of offsetting factors. Increases in
non-yield-related loan fees and loan sale gains in the National Commercial Real
Estate line of business and in income from trading activities in the Corporate
Banking line were offset by declines in gains from the residual values of leased
equipment in the National Equipment Finance line and by lower fees generated by
Corporate Banking. A $2 million, or 2%, decrease in noninterest expense was
driven by an approximate $4 million reduction in goodwill amortization resulting
from the January 1 adoption of a new accounting standard.
41
FIGURE 5. KEY CAPITAL PARTNERS GROUP DATA
THREE MONTHS ENDED SEPTEMBER 30, CHANGE
------------------------------------ ----------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- --------------------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Victory Capital Management $ 51 $ 58 $ (7) (12.1)%
High Net Worth 140 153 (13) (8.5)
Capital Markets 74 75 (1) (1.3)
------ ------ ------ ------
Total $265 $286 $(21) (7.3)
====== ====== ======
Net income
- ----------------------------
Victory Capital Management $ 11 $ 10 $ 1 10.0%
High Net Worth 13 14 (1) (7.1)
Capital Markets 14 10 4 40.0
------ ------ ------ ------
Total $ 38 $ 34 $ 4 11.8
====== ====== ======
- ----------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, CHANGE
----------------------------------- ----------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- --------------------------------------------------------------------------------------------------------------
Revenue (taxable equivalent)
- ----------------------------
Victory Capital Management $161 $174 $(13) (7.5)%
High Net Worth 434 458 (24) (5.2)
Capital Markets 236 241 (5) (2.1)
------ ------ ------ ------
Total $831 $873 $(42) (4.8)
====== ====== ======
Net income
- ----------------------------
Victory Capital Management $ 33 $ 30 $ 3 10.0%
High Net Worth 41 34 7 20.6
Capital Markets 43 33 10 30.3
------ ----- ----- -----
Total $117 $ 97 $ 20 20.6
====== ===== =====
- -------------------------------------------------------------------------------------------------------------
ADDITIONAL KEY CAPITAL PARTNERS DATA (3Q02)
Assets under management: $62.4 billion 809 High Net Worth sales personnel
Nonmanaged and brokerage assets: $67.2 billion 3,547 full-time equivalent employees
Net asset outflows: $3.5 billion
Net income for Key Capital Partners was $38 million for the third quarter of
2002, up from $34 million in the third 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 $7 million, or 13%, from the
third quarter of 2001, despite the reduction in average loans outstanding that
resulted from the 2001 sale of residential mortgage loans associated with the
High Net Worth line of business. A primary reason for this growth is a more
favorable interest rate spread on short-term borrowings. Noninterest income
decreased by $28 million, or 12%, as market-sensitive businesses were adversely
affected by the weak economy. The decrease is attributable mainly to declines in
trust and investment services income in both the High Net Worth and Victory
Capital Management lines and lower income from trading activities and
derivatives in the Capital Markets line. Additionally, gains from loan sales in
the High Net Worth line totaled $1 million in the current quarter, compared with
$7 million a year ago. Noninterest expense decreased by $23 million, or 10%,
from the year-ago quarter, due primarily to an approximate $6 million reduction
that resulted from the change in accounting for goodwill, lower variable
compensation expense associated with revenue generation and reduced software
amortization.
42
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 6, which spans pages 44 and 45, 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 third
quarter of 2002 was $722 million, compared with $730 million a year ago. This
decrease reflects a lower level of average earning assets, which declined by 5%
to $72.1 billion, due primarily to decreases in both commercial loans and
consumer loans, other than those in the home equity portfolio. During the same
period, the net interest margin rose by 14 basis points to 3.99%. This marks the
highest level reached by the margin since 1998 and the third consecutive quarter
of improvement. 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.
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 third quarter of 2002
totaled $72.1 billion, which was $3.6 billion, or 5%, lower than the third
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 nine months of 2002 and during 2001:
- - During the third quarter of 2001, we sold $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.
43
FIGURE 6. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
THIRD QUARTER 2002 SECOND QUARTER 2002
--------------------------------- ---------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- -----------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a),(b)
Commercial, financial and agricultural $ 17,485 $ 225 5.11% $ 18,213 $ 232 5.11%
Real estate-- commercial mortgage 6,207 93 5.92 6,414 95 5.94
Real estate-- construction 5,822 79 5.37 5,870 79 5.40
Commercial lease financing 7,215 121 6.72 7,206 126 6.96
- -------------------------------------------------------------------------------------------------------------------
Total commercial loans 36,729 518 5.60 37,703 532 5.65
Real estate-- residential 2,089 37 7.00 2,148 38 7.04
Home equity 13,505 222 6.52 13,072 229 7.03
Consumer -- direct 2,172 46 8.32 2,210 46 8.37
Consumer -- indirect lease financing 1,264 28 8.98 1,514 33 8.84
Consumer -- indirect other 5,143 117 9.13 5,131 118 9.19
- -------------------------------------------------------------------------------------------------------------------
Total consumer loans 24,173 450 7.41 24,075 464 7.73
Loans held for sale 2,584 35 5.48 2,150 30 5.58
- -------------------------------------------------------------------------------------------------------------------
Total loans 63,486 1,003 6.29 63,928 1,026 6.43
Taxable investment securities 918 6 2.51 934 7 3.20
Tax-exempt investment securities(a) 166 4 8.76 205 4 8.31
- -------------------------------------------------------------------------------------------------------------------
Total investment securities 1,084 10 3.47 1,139 11 4.12
Securities available for sale(a),(c) 6,362 98 6.17 5,951 95 6.45
Short-term investments 1,151 6 2.28 1,561 8 1.97
- -------------------------------------------------------------------------------------------------------------------
Total earning assets 72,083 1,117 6.17 72,579 1,140 6.30
Allowance for loan losses (1,509) (1,579)
Accrued income and other assets 11,361 10,560
- -------------------------------------------------------------------------------------------------------------------
$ 81,935 $ 81,560
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $ 12,733 29 .91 $ 12,535 27 .87
Savings deposits 2,002 3 .67 2,014 3 .67
NOW accounts 560 1 .95 697 2 1.02
Certificates of deposit ($100,000 or more)(d) 4,886 54 4.45 4,816 56 4.69
Other time deposits 12,713 115 3.57 13,085 131 4.02
Deposits in foreign office 2,593 12 1.76 2,638 12 1.76
- -------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 35,487 214 2.40 35,785 231 2.59
Federal funds purchased and securities
sold under repurchase agreements 5,483 23 1.69 5,541 24 1.71
Bank notes and other short-term borrowings(d) 2,581 18 2.73 2,995 20 2.73
Long-term debt, including capital securities(d) 17,455 140 3.25 17,230 144 3.37
- -------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 61,006 395 2.59 61,551 419 2.73
Noninterest-bearing deposits 9,177 8,719
Accrued expense and other liabilities 5,159 4,783
Common shareholders' equity 6,593 6,507
- -------------------------------------------------------------------------------------------------------------------
$ 81,935 $ 81,560
======== ========
Interest rate spread (TE) 3.58% 3.57%
- -------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 722 3.99% $ 721 3.98%
-------- ==== -------- ====
Capital securities $ 1,249 $ 19 $ 1,236 $ 20
Taxable-equivalent adjustment(a) 22 38
- --------------------------------------------------------------------------------
(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.
TE = Taxable Equivalent
44
FIGURE 6. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
(CONTINUED)
FIRST QUARTER 2002 FOURTH QUARTER 2001
----------------------------- ----------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- --------------------------------------------------------------------------------------------------------------------
ASSETS
Loans(a),(b)
Commercial, financial and agricultural $ 18,016 $ 230 5.18% $ 18,462 $ 271 5.83%
Real estate-- commercial mortgage 6,598 97 5.97 6,737 106 6.23
Real estate-- construction 5,856 79 5.49 5,971 85 5.65
Commercial lease financing 7,275 132 7.25 7,109 128 7.18
- --------------------------------------------------------------------------------------------------------------------
Total commercial loans 37,745 538 5.76 38,279 590 6.12
Real estate-- residential 2,241 41 7.21 2,384 44 7.46
Home equity 11,863 212 7.26 11,046 217 7.82
Consumer -- direct 2,289 47 8.30 2,361 52 8.66
Consumer -- indirect lease financing 1,852 41 8.74 2,210 47 8.55
Consumer -- indirect other 5,231 120 9.21 5,359 128 9.51
- --------------------------------------------------------------------------------------------------------------------
Total consumer loans 23,476 461 7.91 23,360 488 8.32
Loans held for sale 2,267 32 5.70 2,113 34 6.48
- --------------------------------------------------------------------------------------------------------------------
Total loans 63,488 1,031 6.55 63,752 1,112 6.94
Taxable investment securities 916 6 2.43 904 4 1.86
Tax-exempt investment securities(a) 219 5 8.52 241 6 8.69
- --------------------------------------------------------------------------------------------------------------------
Total investment securities 1,135 11 3.61 1,145 10 3.30
Securities available for sale(a),(c) 5,317 89 6.76 6,120 103 6.78
Short-term investments 2,041 9 1.76 1,689 11 2.55
- --------------------------------------------------------------------------------------------------------------------
Total earning assets 71,981 1,140 6.38 72,706 1,236 6.76
Allowance for loan losses (1,657) (1,159)
Accrued income and other assets 10,547 10,920
- --------------------------------------------------------------------------------------------------------------------
$ 80,871 $ 82,467
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $ 12,659 30 .95 $ 12,396 37 1.20
Savings deposits 1,947 3 .71 1,911 4 .79
NOW accounts 715 2 1.03 653 2 1.26
Certificates of deposit ($100,000 or more)(d) 4,516 57 5.10 4,788 61 5.08
Other time deposits 13,443 149 4.51 13,659 169 4.91
Deposits in foreign office 2,136 9 1.69 2,418 14 2.21
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 35,416 250 2.86 35,825 287 3.18
Federal funds purchased and securities
sold under repurchase agreements 5,584 23 1.70 4,272 24 2.20
Bank notes and other short-term borrowings(d) 4,028 27 2.68 5,563 42 2.99
Long-term debt, including capital securities(d) 16,103 138 3.46 16,167 157 3.88
- --------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 61,131 438 2.90 61,827 510 3.28
Noninterest-bearing deposits 8,553 8,750
Accrued expense and other liabilities 4,918 5,359
Common shareholders' equity 6,269 6,531
- --------------------------------------------------------------------------------------------------------------------
$ 80,871 $ 82,467
======== ========
Interest rate spread (TE) 3.48% 3.48%
- --------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 702 3.93% $ 726 3.98%
-------- ===== -------- =====
Capital securities $ 1,298 $ 21 $ 1,333 $ 21
Taxable-equivalent adjustment(a) 48 26
- --------------------------------------------------------------------------------------------------------------------
THIRD QUARTER 2001
--------------------------------
AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE
- -------------------------------------------------------------------------------
ASSETS
Loans(a),(b)
Commercial, financial and agricultural $19,338 $ 324 6.63%
Real estate-- commercial mortgage 6,813 123 7.20
Real estate-- construction 5,859 101 6.87
Commercial lease financing 6,995 117 6.68
- -------------------------------------------------------------------------------
Total commercial loans 39,005 665 6.77
Real estate-- residential 3,826 71 7.42
Home equity 10,777 228 8.38
Consumer -- direct 2,409 56 9.34
Consumer -- indirect lease financing 2,557 54 8.30
Consumer -- indirect other 5,494 132 9.60
- -------------------------------------------------------------------------------
Total consumer loans 25,063 541 8.58
Loans held for sale 2,130 38 7.17
- -------------------------------------------------------------------------------
Total loans 66,198 1,244 7.47
Taxable investment securities 925 8 3.44
Tax-exempt investment securities(a) 258 5 8.65
- -------------------------------------------------------------------------------
Total investment securities 1,183 13 4.57
Securities available for sale(a),(c) 6,565 114 6.99
Short-term investments 1,741 15 3.57
- -------------------------------------------------------------------------------
Total earning assets 75,687 1,386 7.29
Allowance for loan losses (1,204)
Accrued income and other assets 10,396
- -------------------------------------------------------------------------------
$84,879
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $12,522 55 1.72
Savings deposits 1,936 5 1.01
NOW accounts 611 2 1.41
Certificates of deposit ($100,000 or more)(d) 4,800 67 5.53
Other time deposits 13,703 184 5.33
Deposits in foreign office 3,399 30 3.57
- -------------------------------------------------------------------------------
Total interest-bearing deposits 36,971 343 3.68
Federal funds purchased and securities
sold under repurchase agreements 6,078 52 3.37
Bank notes and other short-term borrowings(d) 6,230 61 3.95
Long-term debt, including capital securities(d) 15,991 200 4.97
- -------------------------------------------------------------------------------
Total interest-bearing liabilities 65,270 656 3.99
Noninterest-bearing deposits 8,262
Accrued expense and other liabilities 4,848
Common shareholders' equity 6,499
- -------------------------------------------------------------------------------
$84,879
=======
Interest rate spread (TE) 3.30%
- -------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 730 3.85%
------- ====
Capital securities $1,305 $ 21
Taxable-equivalent adjustment(a) 6
- -------------------------------------------------------------------------------
45
- - 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 credit-only commercial
relationships. These portfolios, in the aggregate, have declined by
approximately $3.2 billion since the date of the announcement through
September 30, 2002.
- - We sold commercial mortgage loans of $830 million during the first nine
months 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," starting 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 $970 million ($750 million through
securitizations) during the first nine months of 2002 and $1.2 billion
($491 million through securitizations) during 2001.
Figure 7 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 54, contains more discussion about changes in
earning assets and funding sources.
FIGURE 7. COMPONENTS OF NET INTEREST INCOME CHANGES
FROM THREE MONTHS ENDED SEPTEMBER 30, 2001 FROM NINE MONTHS ENDED SEPTEMBER 30, 2001
TO THREE MONTHS ENDED SEPTEMBER 30, 2002 TO NINE MONTHS ENDED SEPTEMBER 30, 2002
------------------------------------------ ----------------------------------------
AVERAGE YIELD/ NET AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE VOLUME RATE CHANGE
- -----------------------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ (49) $ (192) $ (241) $ (178) $ (752) $ (930)
Taxable investment securities -- (2) (2) -- (4) (4)
Tax-exempt investment securities (2) 1 (1) (6) (1) (7)
Securities available for sale (3) (13) (16) (42) (25) (67)
Short-term investments (4) (5) (9) (4) (27) (31)
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest income (taxable equivalent) (58) (211) (269) (230) (809) (1,039)
INTEREST EXPENSE
Money market deposit accounts 1 (27) (26) 6 (137) (131)
Savings deposits -- (2) (2) -- (7) (7)
NOW accounts -- (1) (1) 1 (3) (2)
Certificates of deposit ($100,000 or more) 1 (14) (13) (29) (44) (73)
Other time deposits (13) (56) (69) (52) (170) (222)
Deposits in foreign office (6) (12) (18) (11) (50) (61)
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (17) (112) (129) (85) (411) (496)
Federal funds purchased and securities sold
under repurchase agreements (5) (24) (29) 1 (105) (104)
Bank notes and other short-term borrowings (29) (14) (43) (110) (85) (195)
Long-term debt, including capital securities 17 (77) (60) 44 (289) (245)
- ----------------------------------------------------------------------------------------------------------------------------------
Total interest expense (34) (227) (261) (150) (890) (1,040)
- ----------------------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $ (24) $ 16 $ (8) $ (80) $ 81 $ 1
======= ======= ======= ======= ======= =======
==================================================================================================================================
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 to the holder. 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.
46
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.
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 may 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 200 basis point 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 September
30, 2002, necessitated a modification of Key's standard rate scenario of a
gradual decrease of 200 basis points over twelve months to a gradual decrease of
100 basis points over six months and no change over the following six months. As
of September 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 .53% if short-term
interest rates gradually increase by 200 basis points. Conversely, if short-term
interest rates gradually decrease by 100 basis points over the next six months,
net interest income would be expected to increase by approximately .22% over the
next twelve months.
47
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 200 basis point increase or decrease in interest rates is estimated
to reduce the economic value of equity by more than 15%. Certain short-term
interest rates were limited to reductions of less than 200 basis points 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, and equity prices 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 September
30, 2002, Key's aggregate daily VAR was $1.1 million, compared with $1.3 million
at September 30, 2001. Aggregate daily VAR averaged $1.4 million for the first
nine 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.
48
NONINTEREST INCOME
Noninterest income for the third quarter of 2002 totaled $432 million, down $22
million, or 5%, from the same period last year. For the first nine months of the
year, noninterest income was $1.3 billion, representing an increase of $16
million, or 1%, from the first nine months of 2001.
The decrease in noninterest income from the year-ago quarter is due primarily to
lower income from trust and investment services (down $9 million), service
charges on deposit accounts (down $5 million) and a $17 million increase in
losses incurred on lease residual values. These adverse results were offset in
part by a $7 million increase in non-yield-related loan fees and a $9 million
decrease in net losses from principal investing.
Key's noninterest income for the first nine months of 2001 includes a second
quarter charge of $40 million (included in miscellaneous income) to establish a
reserve for losses incurred on the residual values of leased vehicles. Excluding
this charge, noninterest income for the first nine months of 2002 decreased by
$24 million, or 2%, from the same period last year. The decrease is largely
attributable to a $35 million decline in net securities gains, a $24 million
reduction in trust and investment services income and a $21 million increase in
losses incurred on lease residual values. These reductions were substantially
offset by a $25 million increase in service charges on deposit accounts and a
$32 million decrease in net losses from principal investing.
Figure 8 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 8. NONINTEREST INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
---------------- ----------------- ---------------- -------------------
dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------------------------------
Trust and investment services income(a) $ 151 $ 160 $ (9) (5.6)% $ 467 $ 491 $ (24) (4.9)%
Investment banking and capital markets income(a) 34 26 8 30.8 130 105 25 23.8
Service charges on deposit accounts 102 107 (5) (4.7) 306 281 25 8.9
Corporate-owned life insurance income 25 28 (3) (10.7) 77 82 (5) (6.1)
Letter of credit and loan fees 36 27 9 33.3 93 86 7 8.1
Net securities gains -- 2 (2) (100.0) 1 36 (35) (97.2)
Other income:
Electronic banking fees 21 20 1 5.0 59 55 4 7.3
Insurance income 14 14 -- -- 42 40 2 5.0
Loan securitization servicing fees 2 4 (2) (50.0) 7 13 (6) (46.2)
Net gains from loan securitizations
and sales 25 27 (2) (7.4) 34 40 (6) (15.0)
Miscellaneous income 22 39 (17) (43.6) 107 78 29 37.2
- -----------------------------------------------------------------------------------------------------------------------------------
Total other income 84 104 (20) (19.2) 249 226 23 10.2
- -----------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 432 $ 454 $ (22) (4.8)% $1,323 $1,307 $ 16 1.2 %
====== ====== ====== ====== ====== ======
===================================================================================================================================
(a) During the third quarter of 2002, brokerage commissions resulting from
principal trades were reclassified from investment banking and capital
markets income to trust and investment services income for all periods
presented.
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 9. In 2002, the level of revenue derived from these services has been
adversely affected by continued declines in the equity and fixed income markets,
since a significant portion of this income is based on the value of assets under
management.
FIGURE 9. TRUST AND INVESTMENT SERVICES INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
------------- ---------------- ------------- ------------------
dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------------------
Personal asset management and custody fees $ 38 $ 44 $ (6) (13.6)% $120 $135 $(15) (11.1)%
Institutional asset management and custody fees 20 21 (1) (4.8) 60 65 (5) (7.7)
Bond services 9 10 (1) (10.0) 29 29 -- --
Brokerage commission income 48 46 2 4.3 149 151 (2) (1.3)
All other fees 36 39 (3) (7.7) 109 111 (2) (1.8)
- -----------------------------------------------------------------------------------------------------------------------
Total trust and investment services income $151 $160 $ (9) (5.6)% $467 $491 $(24) (4.9)%
==== ==== ==== ==== ==== ==== ====
=======================================================================================================================
49
At September 30, 2002, Key's bank, trust and registered investment advisory
subsidiaries had assets under management of $62.4 billion, compared with $70.2
billion at September 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 10. The value of total assets under management decreased by a net 11%
over the past twelve months. This decrease reflects the adverse effects of a
decline in the market value of assets under management at September 30, 2002, as
well as net asset outflows of approximately $3.0 billion during the period. As
shown in Figure 10, nearly 60% 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.
FIGURE 10. ASSETS UNDER MANAGEMENT
2002 2001
------------------------------------------ -----------------------
in millions THIRD SECOND FIRST FOURTH THIRD
- ------------------------------------------------------------------------------------------------------------------------------------
Assets under management by investment type:
Equity $25,422 $31,064 $34,497 $34,799 $32,067
Fixed income 17,588 18,905 18,536 17,326 16,929
Money market 19,364 20,756 19,413 19,957 21,223
- ------------------------------------------------------------------------------------------------------------------------------------
Total $62,374 $70,725 $72,446 $72,082 $70,219
======= ======= ======= ======= =======
Proprietary mutual funds included in assets under management:
Equity $2,965 $3,709 $4,080 $3,973 $3,676
Fixed income 1,377 1,262 1,211 1,190 1,178
Money market 12,129 12,568 13,094 13,801 14,870
- ------------------------------------------------------------------------------------------------------------------------------------
Total $16,471 $17,539 $18,385 $18,964 $19,724
======= ======= ======= ======= =======
====================================================================================================================================
INVESTMENT BANKING AND CAPITAL MARKETS INCOME. As shown in Figure 11, the
increase in investment banking and capital markets income was driven by improved
results from principal investing. 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 original investment, unrealized losses and fair
value of direct and indirect investments contained in Key's principal investing
portfolio are summarized in Figure 12. Investments in technology-rich companies,
which have been particularly hard hit by the effects of the weak economy,
accounted for only $39 million, or 6%, of the fair value of Key's portfolio at
September 30, 2002. If the current weakness in the economy continues, management
anticipates that some decline in the fair value of the principal investing
portfolio could occur.
FIGURE 11. INVESTMENT BANKING AND CAPITAL MARKETS INCOME
THREE MONTHS ENDED
SEPTEMBER 30, CHANGE
--------------------------- ------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $3 $3 -- --
Investment banking income 23 23 -- --
Net losses from principal investing -- (9) $ 9 100.0 %
Foreign exchange income 8 9 (1) (11.1)
- -------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $34 $26 $ 8 30.8 %
==== ==== ====
===================================================================================================================
NINE MONTHS ENDED
SEPTEMBER 30, CHANGE
---------------------------- ------------------------
dollars in millions 2002 2001 AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------
Dealer trading and derivatives income $27 $36 $(9) (25.0)%
Investment banking income 78 71 7 9.9
Net losses from principal investing (1) (33) 32 97.0
Foreign exchange income 26 31 (5) (16.1)
- ------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $130 $105 $25 23.8%
===== ===== ====
=====================================================================================================================
50
FIGURE 12. PRINCIPAL INVESTING PORTFOLIO
SEPTEMBER 30, 2002 ORIGINAL UNREALIZED FAIR
in millions INVESTMENT LOSSES VALUE
- -----------------------------------------------------------------------------------------------
Direct investments $436 $22 $414
Indirect investments 257 41 216
- -----------------------------------------------------------------------------------------------
Total $693 $63 $630
===== ==== =====
- -----------------------------------------------------------------------------------------------
DECEMBER 31, 2001 $699 $79 $620
- -----------------------------------------------------------------------------------------------
SEPTEMBER 30, 2001 $716 $23 $693
===============================================================================================
SERVICE CHARGES ON DEPOSIT ACCOUNTS. Service charges on deposit accounts account
for one of the two largest increases in Key's year-to-date 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 nine months of 2001, Key realized $36
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 nine months of 2002 were not significant.
51
NONINTEREST EXPENSE
Noninterest expense for the third quarter of 2002 totaled $659 million, down $24
million, or 4%, from the third quarter of 2001. For the first nine months of the
year, noninterest expense was $2.0 billion, representing a decrease of $254
million, or 11%, from the same period last year.
The quarterly improvement was attributable largely to lower costs associated
with the amortization of intangibles (down $19 million, reflecting the change in
accounting for goodwill) and computer processing (down $17 million). These
reductions more than offset a $24 million increase in personnel expense.
Noninterest expense for the first nine months of 2001 includes two significant
items recorded during the second quarter that hinder the comparison of results
between reporting periods. These items are 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. Excluding these items,
noninterest expense decreased by $84 million, or 4%, from the year-ago quarter.
This improvement reflects a decrease in amortization expense related to
intangibles (down $64 million, including approximately $60 million related to
the change in accounting for goodwill), a reduction in computer processing
expense (down $40 million) and lower equipment expense (down $12 million). These
positive results were partially offset by a $39 million rise in personnel
expense. For more information pertaining to the accounting change for goodwill,
see the section entitled "Amortization of intangibles," on page 53.
Figure 13 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 13. NONINTEREST EXPENSE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
----------------------- -------------------- ---------------------- -----------------
dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT
- --------------------------------------------------------------------------------------------------------------------------------
Personnel $358 $334 $ 24 7.2 % $1,082 $1,043 $ 39 3.7 %
Net occupancy 57 60 (3) (5.0) 170 173 (3) (1.7)
Computer processing 45 62 (17) (27.4) 147 187 (40) (21.4)
Equipment 33 37 (4) (10.8) 103 115 (12) (10.4)
Marketing 33 31 2 6.5 89 87 2 2.3
Amortization of intangibles 3 22 (19) (86.4) 8 222 (214) (96.4)
Professional fees 21 26 (5) (19.2) 63 63 -- --
Other expense:
Postage and delivery 15 16 (1) (6.3) 44 49 (5) (10.2)
Telecommunications 9 10 (1) (10.0) 26 33 (7) (21.2)
Equity- and gross receipts-
based taxes 7 7 -- -- 20 22 (2) (9.1)
OREO expense, net 1 2 (1) (50.0) 4 6 (2) (33.3)
Miscellaneous expense 77 76 1 1.3 229 239 (10) (4.2)
- --------------------------------------------------------------------------------------------------------------------------------
Total other expense 109 111 (2) (1.8) 323 349 (26) (7.4)
- --------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $659 $683 $(24) (3.5)% $1,985 $2,239 $(254) (11.3)%
===== ===== ==== ======= ======= =====
Full-time equivalent employees
at period end 20,522 21,297 (775) (3.6)% 20,522 21,297 (775) (3.6)%
- ------------------------------------------------------------------------------------------------------------------------------------
PERSONNEL. Personnel expense, the largest category of Key's noninterest expense,
rose by $39 million, or 4%, from the first nine months of 2001. The increase is
due primarily to a rise in the cost of benefits and the effect of annual merit
increases, most of which generally take effect during the second quarter. 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
business. At September 30, 2002, the number of full-time equivalent employees
was 20,522, compared with 21,230 at the end of 2001 and 21,297 a year ago.
Figure 14 shows the major components of Key's personnel expense.
In September 2002, the Board of Directors approved management's recommendation
to change Key's method of accounting for stock options granted to eligible
employees and directors. Effective January 1, 2003, Key will adopt the fair
value method of accounting as outlined in SFAS No. 123. For more information
pertaining to this accounting change and its anticipated effect on Key's results
of operations for 2003, see the section entitled "Subsequent Event," included in
Note 1 ("Basis of Presentation") starting on page 7.
52
FIGURE 14. PERSONNEL EXPENSE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
------------------------ ----------------- ----------------------------------------------------
dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT
- ----------------------------------------------------------------------------------------------------------------------------------
Salaries $219 $212 $7 3.3 % $ 650 $ 637 $13 2.0 %
Employee benefits 53 42 11 26.2 171 144 27 18.8
Incentive compensation 86 80 6 7.5 261 262 (1) (.4)
- ---------------------------------------------------------------------------------------------------------------------------------
Total personnel expense $358 $334 $24 7.2 % $1,082 $1,043 $39 3.7 %
===== ==== ==== ======= ====== ====
- --------------------------------------------------------------------------------------------------------------------------------
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 $60
million for the first nine 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 $93 million for the third quarter of 2002,
compared with $130 million for the comparable period in 2001. The effective tax
rate, which is the provision for income taxes as a percentage of income before
income taxes, was 27.5% for the third quarter of 2002 compared with 34.3% for
the third quarter of 2001. The effective tax rate for the third 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 now
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 nine months of 2002, the provision for income taxes was $238
million compared with $235 million for the first nine months of last year. The
effective tax rates for these periods were 24.6% and 41.5%, respectively. The
effective tax rate for 2001 was significantly distorted by the $150 million
nondeductible write-down of goodwill recorded in the second quarter in
connection with Key's decision to downsize its automobile finance business.
Excluding this charge, the effective tax rate for the first nine months of 2001
was 32.8%. 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.
53
FINANCIAL CONDITION
LOANS
At September 30, 2002, total loans outstanding were $63.0 billion, compared with
$63.3 billion at the end of 2001 and $64.5 billion a year ago. Among the factors
that contributed to the 2% 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. 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
$2.0 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 credit-only relationships in the leveraged
financing and nationally syndicated lending businesses.
At September 30, 2002, Key's commercial real estate portfolio included mortgage
loans of $6.2 billion and construction loans of $5.8 billion. The average size
of a mortgage loan was $.5 million and the largest mortgage loan had a balance
of $64 million. The average size of a construction loan was $7 million. The
largest construction loan commitment was $57 million, including an outstanding
loan balance of $26 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 September 30, our
national line of business accounted for approximately 65% 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
15, is diversified by both industry type and geography.
54
FIGURE 15. COMMERCIAL REAL ESTATE LOANS
GEOGRAPIC REGION
SEPTEMBER 30, 2002 -------------------------------------------- TOTAL PERCENT OF
dollars in millions EAST MIDWEST CENTRAL WEST AMOUNT TOTAL
- ----------------------------------------------------------------------------------------------------
Nonowner-occupied:
Multi-family properties $ 588 $ 623 $ 633 $ 768 $ 2,612 21.6%
Retail properties 294 714 162 202 1,372 11.4
Office buildings 198 202 157 215 772 6.4
Residential properties 55 110 131 471 767 6.3
Warehouses 41 221 108 162 532 4.4
Manufacturing facilities 33 33 2 5 73 .6
Hotels/Motels 6 10 1 8 25 .2
Other 214 399 51 227 891 7.4
- ---------------------------------------------------------------------------------------------------
1,429 2,312 1,245 2,058 7,044 58.3
Owner-occupied 536 2,440 605 1,457 5,038 41.7
- ---------------------------------------------------------------------------------------------------
Total $ 1,965 $ 4,752 $ 1,850 $ 3,515 $12,082 100.0%
======= ======= ======= ======= ======= =====
======================================================================================================
Consumer loans increased (assuming no loan sales) by $1.1 billion, or 5%, from
the third quarter of 2001. The growth of the home equity portfolio during the
past year more than offset declines of $453 million in installment loans, $1.3
billion in automobile lease financing receivables and $320 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 $3.1 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 (64% of the home equity portfolio at September 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
84% of the portfolio for this line of business at September 30, 2002.
Key Home Equity Services purchases loans on a loan-by-loan basis from an
extensive network of correspondents and agents. Prior to the third quarter of
2002, loans were also purchased through bulk portfolio acquisitions from home
equity loan companies.
Figure 16 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.
FIGURE 16. HOME EQUITY LOANS
2002 2001
---------------------------------------------- ---------------------------
dollars in millions THIRD SECOND FIRST FOURTH THIRD
- -----------------------------------------------------------------------------------------------------------------------------
SOURCE OF LOANS OUTSTANDING AT PERIOD END
Retail KeyCenters and other sources $8,680 $8,381 $7,761 $6,431 $6,210
Champion Mortgage Company 2,109 2,153 2,031 1,886 1,608
Key Home Equity Services division 2,727 2,845 2,870 2,867 3,008
- -----------------------------------------------------------------------------------------------------------------------------
National Home Equity line of business 4,836 4,998 4,901 4,753 4,616
- -----------------------------------------------------------------------------------------------------------------------------
Total $13,516 $13,379 $12,662 $11,184 $10,826
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------------
Nonperforming loans at period end $125 $107 $95 $60 $93
Net charge-offs for the period 12 13 14 50 16
Yield for the period 6.52 % 7.03 % 7.26 % 7.82 % 8.38 %
- -----------------------------------------------------------------------------------------------------------------------------
55
SALES, SECURITIZATIONS AND DIVESTITURES. During the past twelve months, Key sold
$1.5 billion of commercial real estate loans, $993 million of education loans
($750 million through securitizations) and $535 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 17 summarizes Key's loan sales (including securitizations) for the first
nine months of 2002 and all of 2001.
FIGURE 17. LOANS SOLD AND DIVESTED
COMMERCIAL COMMERCIAL RESIDENTIAL HOME CONSUMER
in millions COMMERCIAL REAL ESTATE LEASE FINANCING REAL ESTATE EQUITY --INDIRECT EDUCATION TOTAL
========================================================================================================================
2002
- -----------------
Third quarter $ 18 $ 352 -- $ 25 $ 242 $ 3 $ 784 $1,424
Second quarter 31 159 $ 18 20 24 -- 70 322
First quarter -- 319 -- -- 9 -- 116 444
- ----------------------------------------------------------------------------------------------------------------------
Total $ 49 $ 830 $ 18 $ 45 $ 275 $ 3 $ 970 $2,190
====== ====== ====== ====== ====== ====== ====== ======
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 18 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 $521 million of the $22.6
billion of loans administered or serviced at September 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 18 are serviced by Conning Asset Management and National Realty Funding
L.C. Other financial institutions originated most of these loans. Approximately
$85 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 18. For more
information regarding the conduit, see Note 13 ("Other Financial Instruments
with Off-Balance Sheet Risk") starting on page 26.
FIGURE 18. LOANS ADMINISTERED OR SERVICED
SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
in millions 2002 2002 2002 2001 2001
- --------------------------------------------------------------------------------------------------------------------------------
Education loans $4,756 $4,095 $4,258 $4,433 $4,604
Automobile loans 69 87 108 131 199
Home equity loans 519 596 668 768 890
Commercial real estate loans 17,002 16,483(a) 11,621 10,471 9,368
Commercial loans 110 103 446 983 954
Commercial lease financing 111 140 174 -- --
- --------------------------------------------------------------------------------------------------------------------------------
Total $22,567 $21,504 $17,275 $16,786 $16,015
======== ======== ======== ======== ========
- --------------------------------------------------------------------------------------------------------------------------------
(a) Includes $4.1 billion of servicing assets purchased in the June 28, 2002,
acquisition of Conning Asset Management.
56
SECURITIES
At September 30, 2002, the securities portfolio totaled $8.4 billion
and included $7.3 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 September 30, 2002, Key had $7.0 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.
Key has invested more heavily in these securities during 2002 as opportunities
to originate loans (Key's preferred earning assets) have been adversely affected
by the weak economy. Substantially all of these securities were issued or backed
by Federal agencies.
Figure 19 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 19. SECURITIES AVAILABLE FOR SALE
OTHER
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)
- -----------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002
Remaining maturity:
One year or less $ 2 $ 1 $ 89 $ 12 $ 8
After one through five years 6 11 5,748 733 209
After five through ten years 6 6 189 12 --
After ten years 7 -- 168 26 --
- -----------------------------------------------------------------------------------------------------------------------------------
Fair value $21 $18 $6,194 $783 $217
Amortized cost 20 17 6,156 748 182
Weighted average yield 5.44% 4.70% 5.46% 6.94% 18.97%
Weighted average maturity 8.5 YEARS 4.1 YEARS 2.8 YEARS 2.8 YEARS 3.4 YEARS
- -----------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001
Fair value $99 $21 $3,805 $1,032 $234
Amortized cost 99 21 3,791 1,008 214
- -----------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2001
Fair value $268 $23 $4,614 $1,131 $261
Amortized cost 268 23 4,562 1,092 246
- -----------------------------------------------------------------------------------------------------------------------------------
WEIGHTED
OTHER AVERAGE
dollars in millions SECURITIES TOTAL YIELD (b)
- --------------------------------------------------------------------------------
SEPTEMBER 30, 2002
Remaining maturity:
One year or less $ 4 $ 116 6.75 %
After one through five years 11 6,718 5.76
After five through ten years 5 218 8.68
After ten years 96(c) 297 8.92
- --------------------------------------------------------------------------------
Fair value $116 $7,349 --
Amortized cost 156 7,279 5.96 %
Weighted average yield 4.86(b)% 5.96 % --
Weighted average maturity 9.5 YEARS 3.0 YEARS --
- --------------------------------------------------------------------------------
DECEMBER 31, 2001
Fair value $155 $5,346 --
Amortized cost 170 5,303 7.26 %
- --------------------------------------------------------------------------------
SEPTEMBER 30, 2001
Fair value $174 $6,471 --
Amortized cost 198 $6,389 7.07 %
- --------------------------------------------------------------------------------
(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 $134 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.
57
INVESTMENT SECURITIES. Equity securities (including principal investing assets)
accounted for more than 85% of Key's investment securities portfolio at
September 30, 2002. Figure 20 shows the composition, yields and remaining
maturities of Key's investment securities.
FIGURE 20. INVESTMENT SECURITIES
STATES AND WEIGHTED
POLITICAL EQUITY AVERAGE
dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD (a)
- -----------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2002
Remaining maturity:
One year or less $44 -- $ 44 9.41%
After one through five years 74 -- 74 9.63
After five through ten years 29 -- 29 8.39
After ten years 1 $910(b) 911 5.52
- -----------------------------------------------------------------------------------------------------------
Amortized cost $148 $910 $1,058 7.69%
Fair value 158 910 1,068 --
Weighted average yield 9.33% 5.49(a)% 7.69% --
Weighted average maturity 2.8 YEARS 10.0 YEARS 9.0 YEARS --
- -----------------------------------------------------------------------------------------------------------
DECEMBER 31, 2001
Amortized cost $225 $894 $1,119 7.24%
Fair value 234 894 1,128 --
- -----------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2001
Amortized cost $254 $920 $1,174 7.67%
Fair value 266 920 1,186 --
- -----------------------------------------------------------------------------------------------------------
(a) Weighted average yields are calculated based on amortized cost and exclude
equity securities of $800 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.
58
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 September 30, 2002,
was $1.5 billion, or 2.37% of loans. This compares with $1.2 billion, or 1.82%
of loans, at September 30, 2001. The allowance includes $200 million that was
specifically allocated for impaired loans of $645 million at September 30, 2002,
compared with $135 million that was allocated to impaired loans of $546 million
a year ago. For more information about impaired loans, see Note 7 ("Impaired
Loans and Other Nonperforming Assets") on page 19. At September 30, 2002, the
allowance for loan losses was 150.86% of nonperforming loans, compared with
132.66% at September 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
Shareholders. Briefly, management assigns a specific allowance to an impaired
loan when the carrying amount of the loan exceeds the estimated present value of
related future cash flows and the fair value of any existing collateral. The
allowance for loan losses arising from nonimpaired loans is determined by
applying historical loss rates to existing loans with similar risk
characteristics and by exercising judgment to assess the impact of factors such
as changes in economic conditions, credit policies or underwriting standards,
and the level of credit risk associated with specific industries and markets.
The aggregate balance of the allowance for loan losses at September 30, 2002,
represents management's best estimate of the losses inherent in the loan
portfolio at that date.
The allowance allocated for Key's impaired loans rose by $65 million, or 48%,
over the past year due largely to the adverse effects of continued economic
weakness on certain commercial loans, particularly those acquired through
syndicated purchases. During the same period, the allowance allocated for
nonimpaired loans rose by $250 million, or 24%. By applying the process
described in the preceding paragraph, management has determined that the level
of watch credits in all commercial portfolios increased from year-ago levels.
Watch credits are loans that possess the potential for further deterioration in
quality based on the debtors' current financial condition and related ability
to perform in accordance with the terms of the loan. The increases in
commercial watch credits were due primarily to sluggish economic
conditions, specifically in the Midwest, and volatility in certain industries,
such as the automotive and other manufacturing sectors. Loan portfolios in
which the increases in watch credits were the most significant include middle
market, large corporate, and structured finance. Compounding the effect of the
weak economy was the minimization of the capital markets as a source of
liquidity, which adversely affected the structured finance and large corporate
portfolios. In addition, overcapacity in the assisted living facility market
adversely affected the healthcare portfolio.
A comparison of September 30, 2002, loans with those at June 30, 2002, reveals
signs of stability in certain portfolios. The level of watch credits in the
large corporate and healthcare portfolios declined, while watch credits in the
media and commercial real estate portfolios increased modestly. These changes
reflect the fluctuations that occur in loan portfolios from quarter to quarter.
Management does not believe that such changes require any adjustment to the
allowance at this time.
59
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 credit-only
relationships 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 $1.0 billion of commitments (including $662 million of loans
outstanding) remained as of September 30. Only $91 million of these loans were
nonperforming at September 30, 2002.
Figure 21 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 22.
FIGURE 21. ASSET QUALITY INDICATORS -- CONTINUING AND RUN-OFF LOAN PORTFOLIOS
RUN-OFF LOAN PORTFOLIO AND
CONTINUING LOAN PORTFOLIO NONREPLENISHED ALLOWANCE TOTAL LOAN PORTFOLIO
------------------------- ------------------------- ----------------------
dollars in millions 3Q02 3Q01 3Q02 3Q01 3Q02 3Q01
- -----------------------------------------------------------------------------------------------------------------------------
Loans outstanding at period end $62,289 $63,330 $ 662 $ 1,176 $62,951 $64,506
Nonperforming loans at period end 896 652 91 233 987 885
Net loan charge-offs 135 116 50(a) 57(a) 185 173
Allowance for loan losses at period end 1,402 1,002 87 172 1,489 1,174
- ----------------------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to the sales of
distressed loans in the continuing portfolio.
FIGURE 22. 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 (138) (138)
Payments, expirations and other changes, net (551) (223)
- ---------------------------------------------------------------------------------------------------
Balance at September 30, 2002 $1,005 $ 662
======= ======
- ---------------------------------------------------------------------------------------------------
SUMMARY OF CHANGES IN NONPERFORMING LOANS
AND NONREPLENISHED ALLOWANCE FOR LOAN LOSSES(a) NONPERFORMING NONREPLENISHED
in millions LOANS ALLOWANCE
- ---------------------------------------------------------------------------------------------------
Balance at December 31, 2001 $ 231 $ 275
Loans placed on nonaccrual status 49 N/A
Charge-offs (138) (188)
Payments and other changes, net (51) N/A
- ---------------------------------------------------------------------------------------------------
Balance at September 30, 2002 $ 91 $ 87
===== =====
- ---------------------------------------------------------------------------------------------------
(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
60
NET LOAN CHARGE-OFFS. Net loan charge-offs for the third quarter of 2002 were
$185 million, or 1.16% of average loans, compared with $173 million, or 1.04% of
average loans, for the same period last year. For the first nine months of 2002,
net loan charge-offs totaled $594 million, or 1.25% of average loans, compared
with $453 million, or .91%, for the first nine months of 2001. The composition
of Key's loan charge-offs and recoveries by type of loan is shown in Figure 23.
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 22, we used $188 million of Key's nonreplenished
allowance during the first nine months of 2002 ($50 million during the third
quarter) to absorb losses arising from the run-off loan portfolio and from sales
of distressed loans in the continuing portfolio. The structured finance
portfolio accounted for 25% of commercial net charge-offs for the third quarter,
but represented only 4% of Key's commercial loans at September 30, 2002.
FIGURE 23. SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- --------------------
dollars in millions 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------
Average loans outstanding during the period $ 63,486 $ 66,198 $ 63,634 $ 66,725
- -----------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $ 1,539 $ 1,231 $ 1,677 $ 1,001
Loans charged off:
Commercial, financial and agricultural 110 66 321 210
Real estate -- commercial mortgage 11 25 59 33
Real estate -- construction 5 -- 17 2
- -----------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 16 25 76 35
Commercial lease financing 18 20 56 33
- -----------------------------------------------------------------------------------------------
Total commercial loans 144 111 453 278
Real estate -- residential mortgage 1 5 4 12
Home equity 13 16 42 48
Consumer -- direct 11 12 38 36
Consumer -- indirect lease financing 6 7 19 20
Consumer -- indirect other 36 46 124 140
- -----------------------------------------------------------------------------------------------
Total consumer loans 67 86 227 256
- -----------------------------------------------------------------------------------------------
211 197 680 534
Recoveries:
Commercial, financial and agricultural 6 5 25 19
Real estate -- commercial mortgage -- 1 3 3
Real estate -- construction 2 -- 2 --
- -----------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 2 1 5 3
Commercial lease financing 2 -- 6 4
- -----------------------------------------------------------------------------------------------
Total commercial loans 10 6 36 26
Real estate -- residential mortgage -- 1 1 4
Home equity 1 -- 3 1
Consumer -- direct 2 2 6 6
Consumer -- indirect lease financing 2 3 6 7
Consumer -- indirect other 11 12 34 37
- -----------------------------------------------------------------------------------------------
Total consumer loans 16 18 50 55
- -----------------------------------------------------------------------------------------------
26 24 86 81
- -----------------------------------------------------------------------------------------------
Net loans charged off (185) (173) (594) (453)
Provision for loan losses 135 116 406 627
Allowance related to loans sold, net -- -- -- (1)
- -----------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $ 1,489 $ 1,174 $ 1,489 $ 1,174
======== ======== ======== ========
- -----------------------------------------------------------------------------------------------
Net loan charge-offs to average loans 1.16 % 1.04 % 1.25 % .91 %
Allowance for loan losses to period-end loans 2.37 1.82 2.37 1.82
Allowance for loan losses to nonperforming loans 150.86 132.66 150.86 132.66
================================================================================================
(a) See Figure 15 on page 55 and the accompanying discussion on page 54 for more
information related to Key's commercial real estate portfolio.
61
NONPERFORMING ASSETS. Figure 24 shows the composition of Key's nonperforming
assets. These assets totaled $1.0 billion at September 30, 2002, and represented
1.61% 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 $913 million, or 1.41%, at September 30, 2001.
FIGURE 24. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
SEPTEMBER 30, JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30,
dollars in millions 2002 2002 2002 2001 2001
- --------------------------------------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 484 $ 471 $ 470 $ 409 $ 399
Real estate-- commercial mortgage 149 179 156 187 169
Real estate-- construction 79 61 77 83 70
- ------------------------------------------------------------------------------------------------------------------
Total commercial real estate loans(a) 228 240 233 270 239
Commercial lease financing 88 76 100 94 83
- ------------------------------------------------------------------------------------------------------------------
Total commercial loans 800 787 803 773 721
Real estate-- residential mortgage 34 34 33 32 24
Home equity 124 107 95 60 93
Consumer-- direct 6 6 9 9 9
Consumer-- indirect lease financing 6 7 8 10 13
Consumer-- indirect other 17 16 25 26 25
- ------------------------------------------------------------------------------------------------------------------
Total consumer loans 187 170 170 137 164
- ------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 987 957 973 910 885
OREO 30 40 41 38 26
Allowance for OREO losses (2) (2) (2) (1) (1)
- ------------------------------------------------------------------------------------------------------------------
OREO, net of allowance 28 38 39 37 25
Other nonperforming assets 2 -- -- -- 3
- ------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 1,017 $ 995 $ 1,012 $ 947 $ 913
======= ======= ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 208 $ 186 $ 203 $ 250 $ 332
Accruing loans past due 30 through 89 days 787 780 897 1,096 1,084
- ------------------------------------------------------------------------------------------------------------------
Nonperforming loans to period-end loans 1.57 % 1.50 % 1.52 % 1.44 % 1.37
Nonperforming assets to period-end loans
plus OREO and other nonperforming assets 1.61 1.56 1.58 1.49 1.41
==================================================================================================================
(a) See Figure 15 on page 55 and the accompanying discussion on page 54 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 portfolios. At September 30,
2002, two portfolios, middle market and structured finance, accounted for $205
million and $151 million, respectively, of Key's nonperforming loans. Although
these two portfolios comprised only 16% of Key's total loans, they accounted for
36% of total nonperforming loans.
At September 30, 2002, our 20 largest nonperforming loans totaled $315 million,
representing 32% of total loans on nonperforming status. As shown in Figure 22,
at September 30, 2002, the run-off loan portfolio accounted for $91 million, or
9%, of Key's total nonperforming loans presented in Figure 24.
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 25. The types of activity that caused the change in Key's
nonperforming loans during the last five quarters are summarized in Figure 26.
62
FIGURE 25. COMMERCIAL, FINANCIAL AND AGRICULTURAL LOANS
NONPERFORMING LOANS
--------------------------------
SEPTEMBER 30, 2002 TOTAL LOANS % OF LOANS
dollars in millions COMMITMENTS OUTSTANDING AMOUNT OUTSTANDING
- -------------------------------------------------------------------------------------------------------------
Industry classification:
Manufacturing $9,736 $4,088 $213 5.2 %
Services 6,005 2,582 81 3.1
Financial services 4,195 899 7 .8
Retail trade 4,152 2,233 59 2.6
Wholesale trade 2,795 1,429 20 1.4
Property management 2,766 1,158 7 .6
Public utilities 1,501 402 -- --
Communications 1,129 533 29 5.4
Agriculture/forestry/fishing 1,105 670 23 3.4
Building contractors 1,183 540 18 3.3
Public administration 772 299 -- --
Transportation 729 448 5 1.1
Insurance 588 153 -- --
Mining 433 220 -- --
Individuals 183 114 1 .9
Other 1,948 1,651 21 1.3
- -------------------------------------------------------------------------------------------------------------
Total $39,220 $17,419 $484 2.8 %
======== ======== =====
- -------------------------------------------------------------------------------------------------------------
FIGURE 26. SUMMARY OF CHANGES IN NONPERFORMING LOANS
2002 2001
--------------------------------------- -----------------------
in millions THIRD SECOND FIRST FOURTH THIRD
- --------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 957 $ 973 $ 910 $ 885 $ 797
Loans placed on nonaccrual status 281 254 294 407 324
Charge-offs (185) (203) (206) (220) (173)
Loans sold (25) (18) -- (83) (35)
Payments (41) (49) (22) (65) (20)
Transfers to OREO -- -- (3) (12) (8)
Loans returned to accrual status -- -- -- (2) --
- --------------------------------------------------------------------------------------------------------------
Balance at end of period $ 987 $ 957 $ 973 $ 910 $ 885
===== ===== ===== ===== =====
- --------------------------------------------------------------------------------------------------------------
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 third quarter
of 2002, core deposits averaged $37.2 billion, and represented 52% of the funds
Key used to support earning assets, compared with $37.0 billion and 49% during
the same period last year. The composition of Key's deposits is shown in Figure
6, which spans pages 44 and 45.
The slight increase in the level of Key's core deposits over the past twelve
months is due primarily to higher levels of noninterest-bearing deposits and
money market deposit accounts. The growth of these deposits reflects client
preferences for investments that provide high levels of liquidity in a low
interest rate environment. During the same period, time deposits decreased by 7%
because, like our competitors, Key reduced the rates paid for them as the
Federal Reserve reduced interest rates in general.
63
Purchased funds, comprising large certificates of deposit, deposits in the
foreign branch and short-term borrowings, averaged $15.5 billion during the
third quarter of 2002, compared with $16.5 billion a year ago. As shown in
Figure 6, both certificates of deposit and short-term borrowings have declined
as funding sources. This is attributable in part to reduced funding needs
resulting from 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. During the first nine months of 2002, Key securitized
and sold $750 million of education loans, all of which occurred in the third
quarter.
Since late 1995, Key has had a program in place under which deposit balances
(above a defined threshold) in certain NOW accounts and noninterest-bearing
checking accounts are transferred to money market accounts, thereby reducing the
level of deposit reserves required to be maintained with the Federal Reserve.
Based on certain limitations, funds are periodically transferred back to the
checking accounts to cover checks presented for payment or withdrawals. As a
result of this program, average deposit balances for the third quarter of 2002
include NOW accounts of $4.2 billion and demand deposits of $4.9 billion that
are classified as money market deposit accounts. In Figure 6, the NOW accounts
transferred are included in the money market deposit account category, while the
demand deposits continue to be reported as noninterest-bearing checking
accounts.
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 have a proven ability to access the securitization markets for a
variety of loan types.
- - Our 903 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
64
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 September 30, 2002.
The consolidated Statements of Cash Flow on page 6 of this report summarize
Key's sources and uses of cash by type of activity for the nine-month periods
ended September 30, 2002 and 2001. As shown in these statements, Key's largest
cash flows relate to both investing and financing activities. Over the past two
years, the primary sources of cash from investing activities have been loan
securitizations and sales; and the sales, prepayments and maturities of
securities available for sale. Investing activities that have required the
greatest use of cash include lending and the purchases of new securities.
During the same periods, the primary source of cash from financing activities
has been the issuance of long-term debt. At the same time, cash has also been
used to repay debt issued in prior periods. During the first nine months of
2001, significant outflows of cash also resulted from reductions in the levels
of deposits and short-term borrowings.
LIQUIDITY FOR THE PARENT COMPANY. KeyCorp meets its liquidity requirements
principally through regular dividends from affiliate banks. During the first
nine months of 2002, affiliate banks paid KeyCorp a total of $806 million in
dividends. As of September 30, 2002, the affiliate banks had an additional $353
million available to 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 nine months of 2002, Key's affiliate banks
raised $2.5 billion under Key's bank note program. Of these notes issued during
the year, $1.9 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 KBNA and $1.0 billion by KeyBank). At
September 30, 2002, $18.5 billion was available for future issuance under this
program.
EURO NOTE PROGRAM. Under Key's euro note program, KeyCorp, KBNA and KeyBank 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 $5.0 billion of
borrowings outstanding under this facility as of September 30, 2002, $1.5
billion of which were issued during the current year. At the end of the third
quarter, $4.2 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 September 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 September 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.
65
Key has favorable debt ratings as shown in Figure 27 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 27. DEBT RATINGS
SENIOR SUBORDINATED
SHORT-TERM LONG-TERM LONG-TERM CAPITAL
SEPTEMBER 30, 2002 BORROWINGS DEBT DEBT SECURITIES
- -------------------------------------------------------------------------------------------------------------------
KEYCORP
- ---------------------
Standard & Poor's A-2 A- BBB+ BBB
Moody's P-1 A2 A3 Baa1
KBNA
- ---------------------------
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.
66
CAPITAL
SHAREHOLDERS' EQUITY. Total shareholders' equity at September 30, 2002, was
$6.7 billion, up $499 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 nine months of 2002, Key repurchased 1,780,000 of its common shares. At
September 30, 2002, a remaining balance of 14,984,400 shares may be repurchased
under the September 2000 authorization.
At September 30, 2002, Key had 67,024,459 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 nine months of 2002, Key reissued 2,639,265 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 7.97% at September 30,
2002, compared with 7.60% at December 31, 2001, and 7.79% at September 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
September 30, 2002, Key's Tier 1 capital ratio was 8.34%, and its total capital
ratio was 12.69%.
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 September 30, 2002, KeyCorp had a leverage ratio of 8.15%.
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 September 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 September 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 28 presents the details of Key's regulatory capital position at September
30, 2002, December 31, 2001 and September 30, 2001.
67
FIGURE 28. CAPITAL COMPONENTS AND RISK-WEIGHTED ASSETS
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 2002 2001 2001
- -----------------------------------------------------------------------------------
TIER 1 CAPITAL
Common shareholders' equity(a) $ 6,597 $ 6,117 $ 6,533
Qualifying capital securities 1,121 1,243 1,243
Less: Goodwill 1,105 1,101 1,121
Other assets(b) 46 37 39
- --------------------------------------------------------------------------------
Total Tier 1 capital 6,567 6,222 6,616
- --------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(c) 977 1,040 1,053
Qualifying long-term debt 2,441 2,286 2,305
- --------------------------------------------------------------------------------
Total Tier 2 capital 3,418 3,326 3,358
- --------------------------------------------------------------------------------
Total risk-based capital $ 9,985 $ 9,548 $ 9,974
======= ======= =======
RISK-WEIGHTED ASSETS
Risk-weighted assets on balance sheet $67,734 $67,783 $70,177
Risk-weighted off-balance sheet exposure 12,595 17,480 15,616
Less: Goodwill 1,105 1,101 1,121
Other assets(b) 218 37 39
Plus: Market risk-equivalent assets 214 217 236
- --------------------------------------------------------------------------------
Gross risk-weighted assets 79,220 84,342 84,869
Less: Excess allowance for loan losses(c) 512 637 121
- --------------------------------------------------------------------------------
Net risk-weighted assets $78,708 $83,705 $84,748
======= ======= =======
AVERAGE QUARTERLY TOTAL ASSETS $81,935 $82,467 $84,879
======= ======= =======
CAPITAL RATIOS
Tier 1 risk-based capital ratio 8.34 % 7.43 % 7.81 %
Total risk-based capital ratio 12.69 11.41 11.77
Leverage ratio(d) 8.15 7.65 7.90
================================================================================
(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, deductible portions
of purchased mortgage servicing rights and deductible portions 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) This ratio is Tier 1 capital divided by average quarterly total assets
less goodwill and the nonqualifying intangible assets described in
footnote (b).
68
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information presented in the Market Risk Management section beginning on
page 46 of the Management's Discussion and Analysis of Financial Condition and
Results of Operations is incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2002, an evaluation was performed under the supervision and
with the participation of Key's management, including the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of Key's disclosure controls and procedures. Based on that evaluation,
Key's management, including the Chief Executive Officer and Chief Financial
Officer, concluded that Key's disclosure controls and procedures were effective
as of September 30, 2002. There have been no significant changes in Key's
internal controls or in other factors that could significantly affect internal
controls subsequent to September 30, 2002.
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 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 has not had any material adverse effect
on Key's regulatory capital.
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." Since that time, the SEC has extended this
temporary extension. The most recent extension provides that banks are exempt
from the definition of "broker" until May 2003 and from the definition of
"dealer" until February 2003. The SEC has also indicated that it expects to
amend the interim final rules, and that it does not expect banks to develop
compliance systems to bring their operations into compliance with the interim
final rules until they have been amended. The SEC has not yet amended the
interim final rules.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10) Amended Employment Agreement among KeyCorp, Robert T.
Clutterbuck and McDonald Investments Inc., dated September 16,
2002
69
(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
July 16, 2002 - Item 5. Other Events, Item 7. Financial Statements and
Exhibits and Item 9. Regulation FD Disclosure. Reporting that on July
16, 2002, the Registrant issued a press release announcing its earnings
results for the three-and six-month period ended June 30, 2002, and
providing a slide presentation reviewed in the related conference
call/webcast.
August 8, 2002 - Item 5. Other Events and Item 7. Financial Statements
and Exhibits. Reporting that on August 8, 2002, the Registrant issued a
press release announcing the retirement of Robert T. Clutterbuck and
the appointment of Robert G. Jones as Chief Executive Officer of
McDonald Investments, Inc.
August 13, 2002 - Item 9. Regulation FD Disclosure. Reporting that on
August 13, 2002, the Registrant issued a press release announcing that
it had submitted to the Securities and Exchange Commission the sworn
statements in accordance with Order No. 4-460 of the Securities and
Exchange Commission and with 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act 0f 2002.
September 26, 2002 - Item 5. Other Events and Item 7. Financial
Statements and Exhibits. Reporting that on September 26, 2002, the
Registrant issued a press release announcing the appointment of Jeffrey
B. Weeden as Chief Financial Officer effective September 30, 2002.
No other reports on Form 8-K were filed during the three-month period
ended September 30, 2002.
70
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
------------------------------------
(Registrant)
Date: November 12, 2002 /s/ Lee Irving
------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
71
CERTIFICATION OF DISCLOSURES
PURSUANT TO RULE 13a-14
OF THE EXCHANGE ACT OF 1934
I, Henry L. Meyer III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of KeyCorp;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 12, 2002 /s/ Henry L. Meyer III
---------------------------------
Henry L. Meyer III
Chairman, President and
Chief Executive Officer
72
CERTIFICATION OF DISCLOSURES
PURSUANT TO RULE 13a-14
OF THE EXCHANGE ACT OF 1934
I, Jeffrey B. Weeden, certify that:
1. I have reviewed this quarterly report on Form 10-Q of KeyCorp;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 12, 2002 /s/ Jeffrey B. Weeden
----------------------------
Jeffrey B. Weeden
Chief Financial Officer
73