<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 1997
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ______ To ______
Commission File Number 0-850
[KEYCORP LOGO]
------------------------------------------------------
(Exact name of registrant as specified in its charter)
OHIO 34-6542451
- ----------------------------------------- ------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
- ----------------------------------------- --------------------------------
(Address of principal executive offices) (Zip Code)
(216) 689-6300
------------------------------------------------------
(Registrant's telephone number, including area code)
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, $1 par value 218,916,755 Shares
- --------------------------------- -------------------------------
(Title of class) (Outstanding at April 30, 1997)
The number of pages of this report is 41.
<PAGE> 2
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
-------------------- -----------
Consolidated Balance Sheets --
March 31, 1997, December 31, 1996, and March 31, 1996 3
Consolidated Statements of Income --
Three months ended March 31, 1997 and 1996 4
Consolidated Statements of Changes in Shareholders' Equity --
Three months ended March 31, 1997 and 1996 5
Consolidated Statements of Cash Flow --
Three months ended March 31, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 17
Item 2. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations 18
-------------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 38
-----------------
Item 6. Exhibits and Reports on Form 8-K 38
--------------------------------
Signature 39
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
KEYCORP AND SUBSIDIARIES
Consolidated Balance Sheets
<TABLE>
<CAPTION>
March 31, December 31, March 31,
dollars in millions 1997 1996 1996
- ----------------------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
<S> <C> <C> <C>
ASSETS
Cash and due from banks $ 3,242 $ 3,444 $ 2,975
Short-term investments 502 696 507
Securities available for sale 7,971 7,728 7,482
Investment securities (fair value: $1,657, $1,637 and $1,714) 1,628 1,601 1,679
Loans 49,724 49,235 48,273
Less: Allowance for loan losses 870 870 875
- ----------------------------------------------------------------------------------------------------------------------------------
Net loans 48,854 48,365 47,398
Premises and equipment 1,057 1,084 1,032
Goodwill 811 824 881
Other intangible assets 130 137 160
Corporate owned life insurance 1,535 1,515 1,177
Other assets 2,163 2,227 1,761
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets $67,893 $67,621 $65,052
======= ======= =======
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 8,986 $ 9,524 $ 8,571
Interest-bearing 34,318 34,455 36,451
Deposits in foreign offices -- interest-bearing 935 1,338 379
- ----------------------------------------------------------------------------------------------------------------------------------
Total deposits 44,239 45,317 45,401
Federal funds purchased and securities sold under repurchase agreements 7,509 6,925 5,820
Other short-term borrowings 4,261 3,969 2,952
Other liabilities 1,936 1,816 1,489
Long-term debt 4,774 4,213 4,266
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 62,719 62,240 59,928
Corporation-obligated mandatorily redeemable capital securities
of subsidiary trusts holding solely junior subordinated
deferrable interest debentures of the Corporation 500 500 --
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- --
10% Cumulative Preferred Stock Class A, $125 stated value;
authorized 1,400,000 shares, issued 1,280,000 shares in 1996 -- -- 160
Common Shares, $1 par value; authorized 900,000,000 shares;
issued 245,944,390 shares 246 246 246
Capital surplus 1,479 1,484 1,496
Retained earnings 4,180 4,060 3,749
Loans to ESOP trustee (49) (49) (49)
Net unrealized losses on securities, net of income taxes (117) (6) (15)
Treasury stock, at cost (26,362,727, 22,490,353 and 14,274,479 shares) (1,065) (854) (463)
- ----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 4,674 4,881 5,124
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities, corporation-obligated mandatorily redeemable capital
securities and shareholders' equity $67,893 $67,621 $65,052
======= ======= =======
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
3
<PAGE> 4
KEYCORP AND SUBSIDIARIES
Consolidated Statements of Income (Unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
dollars in millions, except per share amounts 1997 1996
- ------------------------------------------------------------------------------------------------------------------
INTEREST INCOME
<S> <C> <C>
Loans $1,095 $1,077
Taxable investment securities 3 4
Tax-exempt investment securities 18 19
Securities available for sale 134 129
Short-term investments 5 7
- ------------------------------------------------------------------------------------------------------------------
Total interest income 1,255 1,236
INTEREST EXPENSE
Deposits 353 384
Federal funds purchased and securities sold under repurchase agreements 88 72
Other short-term borrowings 57 45
Long-term debt 68 66
- ------------------------------------------------------------------------------------------------------------------
Total interest expense 566 567
- ------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 689 669
Provision for loan losses 67 44
- ------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 622 625
NONINTEREST INCOME
Service charges on deposit accounts 71 72
Trust and asset management income 64 58
Credit card fees 23 20
Insurance and brokerage income 21 18
Corporate owned life insurance income 19 12
Loan securitization income 1 13
Other income 60 56
- ------------------------------------------------------------------------------------------------------------------
Total noninterest income 259 249
NONINTEREST EXPENSE
Personnel 290 291
Net occupancy 56 54
Equipment 43 38
Amortization of intangibles 21 22
Professional fees 11 16
Marketing 21 21
Other expense 133 128
- ------------------------------------------------------------------------------------------------------------------
Total noninterest expense 575 570
INCOME BEFORE INCOME TAXES 306 304
Income taxes 94 96
- ------------------------------------------------------------------------------------------------------------------
NET INCOME $ 212 $ 208
======= =======
Net income applicable to Common Shares $212 $204
Net income per Common Share .96 .88
Weighted average Common Shares outstanding (000) 221,670 233,100
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
4
<PAGE> 5
KEYCORP AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
<TABLE>
<CAPTION>
Net
Unrealized
Loans to Gains Treasury
Preferred Common Capital Retained ESOP (Losses) Stock
dollars in millions, except per share amounts Stock Shares Surplus Earnings Trustee on Securities at Cost
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995 $160 $246 $1,500 $3,633 $(51) $ 48 $(383)
Net income 208
Cash dividends:
Common Shares ($.38 per share) (88)
Cumulative Preferred Stock ($3.125 per share) (4)
Issuance of Common Shares under dividend
reinvestment, stock option, and purchase
plans - 1,383,732 net shares (4) 44
Repurchase of Common Shares - 3,416,642 shares (124)
Net unrealized losses on securities, net of deferred
tax benefit of $(26) (63)
Loan payment from ESOP Trustee 2
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1996 $160 $246 $1,496 $3,749 $(49) $ (15) $(463)
==== ==== ====== ====== ==== ===== =====
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 -- $246 $1,484 $4,060 $(49) $ (6) $ (854)
Adjustment related to change in accounting for
transfers of financial assets, net of deferred
tax benefit of $(25) (43)
Net income 212
Cash dividends on Common Shares ($.42 per share) (92)
Issuance of Common Shares under dividend
reinvestment, stock option, and purchase
plans - 1,007,626 net shares (5) 47
Repurchase of Common Shares - 4,880,000 shares (258)
Net unrealized losses on securities, net of deferred
tax benefit of $(38) (68)
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1997 -- $246 $1,479 $4,180 $(49) $ (117) $(1,065)
==== ==== ====== ====== ==== ===== =====
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
5
<PAGE> 6
KEYCORP AND SUBSIDIARIES
Consolidated Statements of Cash Flow (Unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
in millions 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 212 $ 208
Adjustments to reconcile net income to net cash provided by operating activities:
Provisions for loan losses 67 44
Depreciation expense 39 34
Amortization of intangibles 21 22
Deferred income taxes 2 17
Net decrease in mortgage loans held for sale 17 528
Net increase in trading account assets (83) (9)
Decrease in accrued restructuring charge (36) --
Other operating activities, net 68 57
- ------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 307 901
INVESTING ACTIVITIES
Net increase in loans (1,101) (616)
Loans sold 528 103
Purchases of investment securities (122) (114)
Proceeds from sales of investment securities 7 3
Proceeds from prepayments and maturities of investment securities 91 126
Purchases of securities available for sale (867) (457)
Proceeds from sales of securities available for sale 37 8
Proceeds from prepayments and maturities of securities available for sale 690 944
Net decrease in other short-term investments 277 184
Purchases of premises and equipment (60) (43)
Proceeds from sales of premises and equipment 30 6
Proceeds from sales of other real estate owned 4 9
Purchases of corporate owned life insurance -- (65)
- ------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (560) 88
FINANCING ACTIVITIES
Net decrease in deposits (1,078) (1,881)
Net increase in short-term borrowings 876 348
Net proceeds from issuance of long-term debt 650 332
Payments on long-term debt (89) (83)
Loan payment received from ESOP trustee -- 2
Purchases of treasury shares (258) (124)
Proceeds from issuance of common stock pursuant to employee
stock purchase, stock option and dividend reinvestment plans 42 40
Cash dividends (92) (92)
- ------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 51 (1,458)
- ------------------------------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND DUE FROM BANKS (202) (469)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,444 3,444
- ------------------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 3,242 $ 2,975
======= =======
- ------------------------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $539 $619
Income taxes received 21 5
Net amount received on portfolio swaps 18 22
Noncash items:
Transfer of loans to other real estate owned $ 9 $ 12
Transfer of other assets to securities available for sale 280 --
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
6
<PAGE> 7
KEYCORP AND SUBSIDIARIES
Notes To Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The unaudited consolidated interim financial statements include the accounts of
KeyCorp and its subsidiaries ("Key"). All significant intercompany accounts and
transactions have been eliminated in consolidation. In the opinion of
management, the unaudited consolidated interim financial statements reflect all
adjustments of a normal recurring nature and disclosures which are necessary for
a fair presentation of the results for the interim periods presented, and should
be read in conjunction with the audited consolidated financial statements and
related notes included in Key's 1996 Annual Report to Shareholders. In addition,
certain reclassifications have been made to prior year amounts to conform with
the current year presentation. The results of operations for the interim periods
are not necessarily indicative of the results of operations to be expected for
the full year.
On January 1, 1997, Key adopted Statement of Financial Accounting Standards
("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities." SFAS No. 125 requires that certain assets
which are subject to prepayment and recorded in connection with a securitization
be accounted for like investments in interest-only strips. Accordingly, Key
reclassified approximately $280 million of these assets, which represent
uncertificated residual interests in securitizations, to securities available
for sale. At the time of the transfer, the difference between the fair value and
the carrying amount of these assets approximated $68 million and was recorded as
an adjustment to the carrying amount of the transferred assets. The related
after-tax adjustment of $43 million was made to net unrealized losses on
securities in shareholders' equity. SFAS No. 125 is more fully discussed in Note
1, Summary of Significant Accounting Policies, of Key's 1996 Annual Report.
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 128, "Earnings Per Share," which specifies the computation, presentation and
disclosure requirements for earnings per share for entities with publicly held
common stock or common stock equivalents. SFAS No. 128 replaces the presentation
of primary earnings per share with the presentation of basic earnings per share.
It also requires dual presentation of basic and diluted earnings per share on
the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator of the
basic earnings per share computation to the corresponding amounts of the diluted
earnings per share computation. SFAS No. 128 is effective for both interim and
annual financial statements issued for periods ending after December 15, 1997,
with earlier adoption prohibited. All prior period earnings per share data must
be restated. Key expects to adopt SFAS No. 128 as of January 1, 1998, with no
effect on prior period data.
2. Mergers, Acquisitions and Divestitures
COMPLETED MERGERS AND ACQUISITIONS
Mergers and acquisitions completed by Key during 1996 (each of which was
accounted for as a purchase business combination) are summarized below. There
were no such transactions during the three-month period ended March 31, 1997.
<TABLE>
<CAPTION>
Common
in millions Location Date Assets Shares Issued
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Carleton, McCreary, Holmes & Co. Ohio August 1996 $1 See note(1)
Knight Insurance Agency, Inc. (2) Massachusetts June 1996 8 --
- ------------------------------------------------------------------------------------------------------------------------
<FN>
(1) Carleton, McCreary, Holmes & Co. ("Carleton") is an investment-banking firm
specializing in mergers and acquisitions and other financial advisory
services for mid-sized and large corporations. In accordance with a
confidentiality clause in the purchase agreement, the terms, which are not
material, have not been publicly disclosed.
(2) Knight Insurance Agency, Inc. ("Knight") is an education financing company
doing business under the name "Knight College Resource Group."
</TABLE>
7
<PAGE> 8
COMPLETED DIVESTITURE
SOCIETY FIRST FEDERAL SAVINGS BANK
On June 1, 1996, the parent company sold Society First Federal Savings Bank
("SFF"), its Florida savings association subsidiary. SFF had assets of
approximately $1.2 billion at the time of the transaction. Key continues to
provide private banking services in Florida through a banking affiliate located
in Naples, Florida. An $8 million gain was realized on the SFF sale and included
in other income on the income statement.
TRANSACTIONS PENDING AS OF MARCH 31, 1997
LEASETEC CORPORATION
On April 7, 1997, the parent company entered into a definitive agreement to
acquire an 80% interest (with an option to purchase the remaining 20%) in
Leasetec Corporation ("Leasetec"), a privately held equipment leasing company
headquartered in Boulder, Colorado. Leasetec operates in the U.S. and eighteen
foreign countries and at December 31, 1996, had total assets of approximately
$1.1 billion. The transaction will be accounted for as a purchase and is
expected to close in the third quarter of 1997, pending necessary regulatory
approval.
KEYBANK NATIONAL ASSOCIATION (WYOMING)
On February 18, 1997, the parent company entered into a definitive agreement for
the sale of KeyBank National Association (Wyoming) ("KeyBank Wyoming"), its 28
branch Wyoming bank subsidiary. At December 31, 1996, KeyBank Wyoming had total
assets of approximately $1.2 billion. The transaction is expected to close in
the third quarter of 1997, pending necessary regulatory approval and various
other conditions, and result in a gain which has not yet been determined.
BRANCH DIVESTITURES
In addition to the strategic actions announced on November 26, 1996, as part of
Key's transformation to a nationwide, bank-based financial services company, Key
announced its intention to divest approximately 140 branch offices. As of April
18, 1997, contracts had been entered into to sell 77 branch offices (including
the 28 branches associated with the pending sale of KeyBank Wyoming) with
deposits of approximately $1.8 billion at December 31, 1996. The sales of
these branches under contract are expected to close primarily in the third
and fourth quarters of 1997.
3. Securities Available for Sale
Debt securities that Key has the positive intent and ability to hold to maturity
are classified as securities held to maturity and are carried at cost, adjusted
for amortization of premiums and accretion of discounts using the level yield
method. Securities held to maturity and equity securities that do not have
readily determinable fair values are presented as investment securities on the
balance sheet. Debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
account assets, reported at fair value ($120 million and $42 million as of March
31, 1997 and 1996, respectively) and included in short-term investments on the
balance sheet. Realized and unrealized gains and losses on such assets are
reported in other income on the income statement. Debt and equity securities
that Key has not classified as investment securities or trading account assets
are classified as securities available for sale and, as such, are reported at
fair value, with unrealized gains and losses, net of deferred taxes, reported as
a component of shareholders' equity.
At March 31, 1997, shareholders' equity was reduced by $117 million,
representing the net unrealized loss on available-for-sale securities, net of
deferred tax benefit.
8
<PAGE> 9
The amortized cost, unrealized gains and losses, and approximate fair values of
securities available for sale were as follows:
<TABLE>
<CAPTION>
MARCH 31, 1997
---------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury, agencies and corporations $ 529 $ 2 $ 8 $ 523
States and political subdivisions 41 -- -- 41
Collateralized mortgage obligations 3,720 1 60 3,661
Other mortgage-backed securities 3,467 25 77 3,415
Other securities 396 1 66 331
- ---------------------------------------------------------------------------------------------------------------------------
Total $8,153 $29 $211 $7,971
====== === ==== ======
- ---------------------------------------------------------------------------------------------------------------------------
December 31, 1996
---------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
in millions Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------------
U.S. Treasury, agencies and corporations $ 857 $ 3 $ 1 $ 859
States and political subdivisions 36 -- -- 36
Collateralized mortgage obligations 3,169 3 23 3,149
Other mortgage-backed securities 3,570 44 35 3,579
Other securities 104 1 -- 105
- ---------------------------------------------------------------------------------------------------------------------------
Total $7,736 $51 $59 $7,728
====== === === ======
- ---------------------------------------------------------------------------------------------------------------------------
March 31, 1996
---------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
in millions Cost Gains Losses Value
- ---------------------------------------------------------------------------------------------------------------------------
U.S. Treasury, agencies and corporations $ 995 $ 6 $ 4 $ 997
States and political subdivisions 27 1 -- 28
Collateralized mortgage obligations 2,604 2 33 2,573
Other mortgage-backed securities 3,721 48 49 3,720
Other securities 157 7 -- 164
- ---------------------------------------------------------------------------------------------------------------------------
Total $7,504 $64 $86 $7,482
====== === === ======
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
4. Investment Securities
The amortized cost, unrealized gains and losses and approximate fair values of
investment securities were as follows:
<TABLE>
<CAPTION>
MARCH 31, 1997
----------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
States and political subdivisions $1,401 $31 $ 2 $1,430
Other securities 227 -- -- 227
- ---------------------------------------------------------------------------------------------------------------------------
Total $1,628 $31 $ 2 $1,657
====== === === ======
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE> 10
<TABLE>
<CAPTION>
December 31, 1996
------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
in millions Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
States and political subdivisions $1,401 $37 $1 $1,437
Other securities 200 -- -- 200
- --------------------------------------------------------------------------------------------------------------------------
Total $1,601 $37 $1 $1,637
====== === == ======
- --------------------------------------------------------------------------------------------------------------------------
March 31, 1996
------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
in millions Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------------
U.S. Treasury, agencies and corporations $ 2 -- -- $ 2
States and political subdivisions 1,399 $44 $1 1,442
Other securities 278 -- 8 270
- --------------------------------------------------------------------------------------------------------------------------
Total $1,679 $44 $9 $1,714
====== === == ======
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
5. Loans
Loans are summarized as follows:
<TABLE>
<CAPTION>
MARCH 31, December 31, March 31,
in millions 1997 1996 1996
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial, financial and agricultural $12,826 $12,309 $11,949
Real estate-- commercial mortgage 7,107 7,151 7,190
Real estate-- construction 1,747 1,666 1,516
Commercial lease financing 2,595 2,671 2,273
- ---------------------------------------------------------------------------------------------------------------
Total commercial loans 24,275 23,797 22,928
Real estate-- residential mortgage 6,164 6,229 7,918
Home equity 4,868 4,793 3,955
Credit card 1,748 1,799 1,616
Consumer -- direct 2,227 2,245 1,929
Consumer -- indirect 7,930 8,062 7,498
- ---------------------------------------------------------------------------------------------------------------
Total consumer loans 22,937 23,128 22,916
Loans held for sale 2,512 2,310 2,429
- ---------------------------------------------------------------------------------------------------------------
Total $49,724 $49,235 $48,273
======= ======= =======
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
Changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
in millions 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of year $870 $876
Charge-offs (89) (70)
Recoveries 22 27
- ---------------------------------------------------------------------------------------------------------------------------
Net charge-offs (67) (43)
Provision for loan losses 67 44
Allowance sold -- (2)
- ---------------------------------------------------------------------------------------------------------------------------
Balance at end of period $870 $875
==== ====
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 11
6. Impaired Loans and Other Nonperforming Assets
At March 31, 1997, the recorded investment in impaired loans was $193 million.
Included in this amount is $110 million of impaired loans for which the
specifically allocated allowance for loan losses is $33 million, and $83 million
of impaired loans which are carried at their estimated fair value without a
specifically allocated allowance for loan losses. At the end of the prior year,
the recorded investment in impaired loans was $209 million, of which $81 million
had a specifically allocated allowance of $26 million and $128 million were
carried at their estimated fair value. The average recorded investment in
impaired loans for the first quarter of 1997 and 1996 was $192 million and $188
million, respectively.
Nonperforming assets were as follows:
<TABLE>
<CAPTION>
MARCH 31, December 31, March 31,
in millions 1997 1996 1996
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Impaired loans $193 $209 $186
Other nonaccrual loans 178 139 152
Restructured loans -- 1 3
- ------------------------------------------------------------------------------------------------------------
Total nonperforming loans 371 349 341
Other real estate owned 62 56 56
Allowance for OREO losses (10) (8) (11)
- ------------------------------------------------------------------------------------------------------------
Other real estate owned, net of allowance 52 48 45
Other nonperforming assets 2 3 3
- ------------------------------------------------------------------------------------------------------------
Total nonperforming assets $425 $400 $389
==== ==== ====
- ------------------------------------------------------------------------------------------------------------
</TABLE>
Key considers all nonaccrual loans to be impaired loans, except for
smaller-balance, homogeneous nonaccrual loans (shown in the preceding table as
"Other nonaccrual loans") excluded in accordance with the provisions of SFAS No.
114. A loan is not deemed impaired during a period of delay in payment of less
than 90 days if Key expects to collect all amounts due, including interest
accrued at the contractual interest rate, for the period of delay.
Impaired loans are evaluated individually. Where collateral exists, the extent
of impairment is determined based on the estimated fair value of the underlying
collateral. If collateral does not exist, or is insufficient to support the
carrying amount of the loan, management looks to other means of collection.
Where the estimated fair value of the collateral and the present value of the
estimated future cash flows from other means of collection do not support the
carrying amount of the loan, management charges off that portion of the loan
balance which it believes will not ultimately be collected. In instances where
collateral or other sources of repayment are sufficient, yet uncertainty exists
regarding the ultimate repayment, an allowance is specifically allocated in the
allowance for loan losses.
Key excludes smaller-balance, homogeneous nonaccrual loans from impairment
evaluation. Generally these include loans to finance residential mortgages,
automobiles, recreational vehicles, boats and mobile homes. Key applies
historical loss experience rates to these loans, adjusted based on management's
assessment of emerging credit trends and other factors. The resulting loss
estimates are specifically allocated by loan type in the allowance for loan
losses. In general, such loans are charged off when payment is 120-180 days past
due.
11
<PAGE> 12
7. Long-Term Debt
The components of long-term debt, presented net of unamortized discount where
applicable, were as follows:
<TABLE>
<CAPTION>
MARCH 31, December 31, March 31,
dollars in millions 1997 1996 1996
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Senior medium-term notes due through 2005(1) $507 $584 $941
Subordinated medium-term notes due through 2005(2) 183 183 183
7.50% Subordinated notes due 2006 250 250 --
6.75% Subordinated notes due 2006 200 200 200
8.125% Subordinated notes due 2002 199 199 199
8.00% Subordinated notes due 2004 125 125 125
8.40% Subordinated capital notes due 1999 75 75 75
8.404% Notes due 1997 through 2001 49 49 49
8.875% Notes due 1996 -- -- 75
8.255% Notes due 1996 -- -- 23
All other long-term debt 15 16 16
- ---------------------------------------------------------------------------------------------------------------------------
Total parent company 1,603 1,681 1,886
Senior medium-term bank notes due through 1998(3) 1,804 1,165 1,532
7.25% Subordinated notes due 2005 200 200 200
7.85% Subordinated notes due 2002 200 200 200
6.75% Subordinated notes due 2003 200 200 199
7.50% Subordinated notes due 2008 165 165 --
7.125% Subordinated notes due 2006 125 125 --
7.125% Subordinated notes due 2006 125 125 --
7.55% Subordinated notes due 2006 75 75 --
7.375% Subordinated notes due 2008 70 70 --
Federal Home Loan Bank Advances 193 193 234
Industrial revenue bonds 10 10 10
All other long-term debt 4 4 5
- ---------------------------------------------------------------------------------------------------------------------------
Total subsidiaries 3,171 2,532 2,380
- ---------------------------------------------------------------------------------------------------------------------------
Total $4,774 $4,213 $4,266
====== ====== ======
- ---------------------------------------------------------------------------------------------------------------------------
<FN>
(1) The weighted average rate on the senior medium-term notes due through 2005
was 6.56%, 6.57% and 6.54% at March 31, 1997, December 31, 1996 and March
31, 1996, respectively.
(2) The weighted average rate on the subordinated medium-term notes due through
2005 was 7.07%, 6.80% and 6.78% at March 31, 1997, December 31, 1996 and
March 31, 1996, respectively.
(3) The weighted average rate on the senior medium-term notes due through 1998
was 6.54%, 6.17% and 6.61% at March 31, 1997, December 31, 1996 and March
31, 1996, respectively.
</TABLE>
8. Capital Securities
In the fourth quarter of 1996, the parent company formed two wholly owned
Delaware business trusts, KeyCorp Institutional Capital A ("Capital A") and
KeyCorp Institutional Capital B ("Capital B"), which issued $350 million and
$150 million, respectively, of corporation-obligated mandatorily redeemable
capital securities of subsidiary trusts holding solely junior subordinated
deferrable interest debentures of the Corporation ("capital securities") that
qualify as Tier I capital under Federal Reserve Board Guidelines. All of the
common securities of Capital A and Capital B are owned by the parent company.
The proceeds from the issuances of the capital securities ($500 million) and
common securities ($15 million) were used by Capital A and Capital B to purchase
$361 million and $154 million, respectively, of junior subordinated deferrable
interest debentures ("debentures") of the parent company which carry interest
rates of 7.826% and 8.25%, respectively. These debentures represent the sole
asset of each of the subsidiary trusts. The proceeds from the sales of the
debentures may be used by the parent company for general corporate purposes. The
debentures and related income statement effects are eliminated in Key's
financial statements.
12
<PAGE> 13
The capital securities accrue and pay distributions semi-annually at a rate of
7.826% and 8.25%, respectively, per annum of the stated liquidation value of
$1,000 per capital security. The parent company has fully and unconditionally
guaranteed, on a subordinated basis, payment of: (i) accrued and unpaid
distributions required to be paid on the capital securities, (ii) the redemption
price with respect to any capital securities called for redemption by Capital A
or Capital B; and (iii) payments due upon a voluntary or involuntary termination
or liquidation of Capital A or Capital B.
The capital securities are mandatorily redeemable upon the respective maturity
dates of the debentures (December 1, 2026, for debentures purchased by Capital A
and December 15, 2026, for debentures purchased by Capital B) or upon earlier
redemption as provided in the indenture. The parent company has the right to
redeem the debentures purchased by Capital A and Capital B: (i) in whole or in
part, on or after December 1, 2006, and December 15, 2006, respectively, and
(ii) in whole (but not in part) at any time within 90 days following the
occurrence and during the continuation of a tax event or capital treatment event
(as defined in the applicable offering circular). As specified in the indenture,
if the debentures are redeemed prior to maturity, the redemption price will be
expressed as a certain percentage (depending on the timing of the redemption and
related circumstances) of the principal amount plus any accrued but unpaid
interest.
9. Restructuring Charge
During the fourth quarter of 1996, the parent company recorded a $100 million
($66 million after tax, $.29 per Common Share) restructuring charge in
connection with strategic actions to be taken over the next year to complete its
transformation to a nationwide, bank-based financial services company. The
primary actions to be taken include: (i) the formation of a nationwide bank from
Key's current network of banks in 13 states and four regions of the United
States (KeyBank USA will not take part in this consolidation), (ii) the
consolidation of nearly 140 of Key's branch offices, known as KeyCenters, into
other KeyCenters, and (iii) the reduction of approximately 2,700 positions, or
10% of Key's employment base, distributed throughout the organization at
substantially all levels of responsibility.
Included in the restructuring charge were accruals for expenses, primarily
consisting of severance payments ($54 million), consolidation costs related to
banking offices identified for closure ($18 million) and costs related to the
write-off of certain obsolete software previously developed for internal use
($28 million).
As of March 31, 1997, Key had completed the consolidation of more than 100 of
the 140 KeyCenters identified for merger into other KeyCenters and reduced its
employment base by over half of the 10% projected at the announcement date.
Remaining reserves at March 31, 1997, totaled $64 million. Changes in the
restructuring reserve are summarized as follows:
<TABLE>
<CAPTION>
Consolidation Obsolete
in millions Severance Costs Software Total
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at January 1, 1997 $54 $18 $28 $100
Cash payments (4) -- -- (4)
Noncash charges -- (4) (28) (32)
- ----------------------------------------------------------------------------------------------------------------------
Balance at March 31, 1997 $50 $14 -- $64
=== === == ===
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
10. Income Taxes
The effective income tax rate (provision for income taxes as a percentage of
income before income taxes) for the 1997 first quarter was 30.7% compared with
31.5% for the first quarter of 1996. The lower effective income tax rate was
primarily attributable to the favorable settlement of an IRS audit related to an
entity acquired in 1992 and higher income from corporate owned life insurance.
The effective income tax rate remains below the statutory Federal rate of 35%
due primarily to continued investment in tax-advantaged assets (such as
tax-exempt securities and corporate owned life insurance) and the recognition of
credits associated with investments in low-income housing projects.
13
<PAGE> 14
11. Financial Instruments with Off-Balance Sheet Risk
Key, mainly through its affiliate banks, is party to various financial
instruments with off-balance sheet risk. The banks use these financial
instruments in the normal course of business to meet the financing needs of
their customers and to manage their exposure to market risk. Market risk is the
possibility that Key's net interest income will be adversely affected as a
result of changes in interest rates or other economic factors. The primary
financial instruments used include commitments to extend credit, standby and
commercial letters of credit, interest rate swaps, caps and floors, futures and
foreign exchange forward contracts. All of the interest rate swaps, caps and
floors, and foreign exchange forward contracts held are over-the-counter
instruments. These financial instruments may be used for lending-related, asset
and liability management and trading purposes, as discussed in the remainder of
this note. In addition to the market risks inherent in the use of these
financial instruments, each contains an element of credit risk. Credit risk is
the possibility that Key will incur a loss due to a counterparty's failure to
perform its contractual obligations.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR LENDING-RELATED PURPOSES
These instruments involve, to varying degrees, credit risk in addition to
amounts recognized in Key's balance sheet. Key mitigates its exposure to credit
risk through internal controls over the extension of credit. These controls
include the process of credit approval and review, the establishment of credit
limits and, when deemed necessary, securing collateral.
The banks' commitments to extend credit are agreements with customers to provide
financing at predetermined terms as long as the customer continues to meet
specified criteria. Loan commitments serve to meet the financing needs of the
banks' customers and generally carry variable rates of interest, have fixed
expiration dates or other termination clauses, and may require the payment of
fees. Since the commitments may expire without being drawn upon, the total
amount of the commitments does not necessarily represent the future cash outlay
to be made by Key. The credit-worthiness of each customer is evaluated on a
case-by-case basis. The estimated fair values of these commitments and the
standby letters of credit discussed below are not material. Key does not have
any significant concentrations of credit risk.
Standby letters of credit enhance the credit-worthiness of the banks' customers
by assuring the customers' financial performance to third parties in connection
with specified transactions. Amounts drawn under standby letters of credit
generally carry variable rates of interest, and the credit risk involved is
essentially the same as that involved in the extension of loan facilities.
The following is a summary of the contractual amount of each class of
lending-related off-balance sheet financial instrument outstanding wherein Key's
maximum possible accounting loss equals the contractual amount of the
instruments:
<TABLE>
<CAPTION>
MARCH 31, December 31, March 31,
in millions 1997 1996 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Loan commitments:
Credit card lines $ 8,407 $ 8,078 $ 7,578
Home equity 3,352 3,239 4,108
Commercial real estate and construction 1,659 1,593 1,573
Commercial and other 10,944 10,327 9,989
- -----------------------------------------------------------------------------------------------------------------------
Total loan commitments 24,362 23,237 23,248
Other commitments:
Standby letters of credit 1,351 1,385 1,133
Commercial letters of credit 171 202 150
Loans sold with recourse 263 30 33
- -----------------------------------------------------------------------------------------------------------------------
Total loan and other commitments $26,147 $24,854 $24,564
======= ======= =======
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 15
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES
Key manages its exposure to market risk, in part, by using off-balance sheet
instruments to modify the existing interest rate risk characteristics of
specific assets and liabilities. Primary among the financial instruments used by
both the parent company and its subsidiary banks are interest rate swap
contracts. Interest rate swaps used for this purpose are designated as portfolio
swaps. The notional amount of the interest rate swap contracts represents only
an agreed-upon amount on which calculations of interest payments to be exchanged
are based, and is significantly greater than the amount at risk. Credit risk on
these instruments is the possibility that the counterparty will not meet the
terms of the swap contract and is measured as the cost of replacing, at current
market rates, contracts in an unrealized gain position. Key deals exclusively
with counterparties with high credit ratings, enters into bilateral collateral
arrangements and generally arranges master netting agreements. These agreements
include legal rights of setoff that provide for the net settlement of the
subject contracts with the same counterparty in the event of default. In
addition, the credit risk exposure to the counterparty on each interest rate
swap is monitored by a credit committee. Based upon credit reviews of the
counterparties, limits on the total credit exposure Key may have with each
counterparty and the amount of collateral required, if any, are determined.
Although Key is exposed to credit-related losses in the event of nonperformance
by the counterparties, based on management's assessment as of March 31, 1997,
all counterparties were expected to meet their obligations. At March 31, 1997,
Key had 17 different counterparties to portfolio swaps and swaps entered into to
offset the risk of customer swaps. Of these counterparties, Key had an aggregate
credit exposure of $8 million to 6, with the largest credit exposure to an
individual counterparty amounting to $4 million.
Conventional interest rate swap contracts involve the receipt of amounts based
on fixed or variable rates in exchange for payments based on variable or fixed
rates, without an exchange of the underlying notional amount. Under an indexed
amortizing swap contract, the notional amount remains constant for a specified
period of time after which, based upon the level of an index at each review
date, the swap contract will mature, the notional amount will begin to amortize,
or the swap will continue in effect until its contractual maturity. Otherwise,
the characteristics of these swaps are similar to those of conventional swap
contracts. At March 31, 1997, Key was party to $1.5 billion and $3.0 billion of
indexed amortizing swaps that used a London Interbank Offered Rate ("LIBOR")
index and a Constant Maturity Treasuries ("CMT") index, respectively, for the
review date measurement. Under basis swap contracts, interest payments based on
different floating indices are exchanged.
The following table summarizes the notional amount, fair value, maturity and
weighted average rate received and paid for the various types of portfolio
interest rate swaps used by Key:
<TABLE>
<CAPTION>
MARCH 31, 1997 December 31, 1996
---------------------------------------------------------- -------------------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR MATURITY --------------------- Notional Fair
dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY Amount Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Receive fixed/pay variable--
indexed amortizing(1) $4,776 $ (53) 2.6 6.79% 5.58% $5,078 $(8)
Receive fixed/pay variable--
conventional 3,452 (80) 7.0 6.76 5.57 3,505 21
Pay fixed/receive variable--
conventional 3,382 15 1.2 5.53 5.93 3,312 (5)
Basis swaps 600 -- .5 5.49 5.47 400 --
- ------------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps $12,210 $(118) 3.3 6.37% 5.67% $12,295 $ 8
======= ====== ======= ===
<FN>
(1) Maturity is based upon expected average lives rather than contractual
terms.
</TABLE>
Based on the weighted average rates in effect at March 31, 1997, the spread on
portfolio interest rate swaps, excluding the amortization of net deferred gains
on terminated swaps, provided a positive impact on net interest income (since
the weighted average rate received exceeded the weighted average rate paid by 70
basis points). The aggregate negative fair value of $(118) million at the same
date was derived through the use of discounted cash flow models, which
contemplate interest rates using the applicable forward yield curve, and
represents an estimate of the unrealized loss that would be recognized if the
portfolio were to be liquidated at that date.
Portfolio interest rate swaps are used to manage interest rate risk by modifying
the repricing or maturity characteristics of specified on-balance sheet assets
and liabilities. Interest from these swaps is recognized on an accrual basis
over the lives of the respective contracts as an adjustment of the interest
income or expense of the asset or liability whose risk is being managed. Gains
and losses realized upon the termination of interest rate swaps prior to
maturity are deferred and
15
<PAGE> 16
amortized, generally using the straight-line method over the projected remaining
life of the related swap contract at its termination and recorded as an
adjustment of the yield on the respective on-balance sheet instrument that was
being managed. Including the impact of both the spread on the swap portfolio and
the amortization of the deferred gains and losses resulting from terminated
swaps, portfolio interest rate swaps increased net interest income for the first
quarter of 1997 and 1996 by $21 million and $9 million, respectively. During the
first quarter of 1997, swaps with a notional amount of $200 million were
terminated, resulting in no deferred gain or loss. During the same period last
year, swaps with a notional amount of $500 million were terminated, resulting in
a deferred gain of $.3 million.
A summary of Key's deferred swap gains and (losses) is as follows:
<TABLE>
<CAPTION>
March 31, 1997
dollars in millions
- ------------------------------------------------------------------------------
Weighted Average
Deferred Remaining
Asset/Liability Managed Gains/(Losses) Amortization (Years)
- ------------------------------------------------------------------------------
<S> <C> <C>
Loans $ (1) 1.6
Debt 16 6.1
- ------------------------------------------------------------------------------
Total $15
===
- ------------------------------------------------------------------------------
</TABLE>
Key also uses interest rate caps and floors, and futures contracts to manage the
risk associated with the potential impact of adverse movements in interest rates
on specified long-term debt and other short-term borrowings. Interest rate caps
and floors involve the payment of a premium by the buyer to the seller for the
right to receive an interest differential equal to the difference between the
current interest rate and an agreed-upon interest rate ("strike rate") applied
to a notional amount. Key generally purchases or enters into net purchases (a
combination of buying and selling) of caps and floors for asset and liability
management purposes. Futures contracts are commitments to either purchase or
sell designated financial instruments at future dates for specified prices. Key
had caps and floors with a notional amount and fair value of $2.4 billion (of
which $865 million are forward-starting) and $31 million, respectively, at March
31, 1997. There were no futures contracts outstanding at the same date.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES
Key's affiliate banks also use interest rate swap, cap and floor, and futures
contracts for dealer activities (which are generally limited to the banks'
commercial loan customers) and enter into other positions with third parties
that are intended to mitigate the interest rate risk of the customer positions.
Interest rate swap contracts entered into with customers are typically limited
to conventional swaps, as previously described. The customer swaps, caps and
floors, and futures, as well as the third party positions, are recorded at their
estimated fair values, and adjustments to fair value are included in other
income on the income statement. Key had futures contracts with a notional amount
and fair value of $4.4 billion and $3 million, respectively, at March 31, 1997.
Key also enters into foreign exchange forward contracts to accommodate the
business needs of its customers and for proprietary trading purposes. These
contracts provide for the delayed delivery or purchase of foreign currency. The
foreign exchange risk associated with such contracts is mitigated by entering
into other foreign exchange contracts with third parties. Adjustments to the
fair value of all such foreign exchange forward contracts are included in other
income on the income statement.
At March 31, 1997, credit exposure from financial instruments held or issued for
trading purposes was limited to the aggregate fair value of each contract with a
positive fair value, or $46 million. The risk of counterparties defaulting on
their obligations is monitored on an ongoing basis. The affiliate banks contract
with counterparties of good credit standing and enter into master netting
agreements when possible in an effort to manage credit risk.
Trading income recognized on interest rate and foreign exchange forward
contracts totaled $7 million and $4 million, respectively, for the first three
months of 1997 and $4 million and $3 million, respectively, for the first
three months of 1996.
16
<PAGE> 17
A summary of the notional amounts and the respective fair values of derivative
financial instruments held or issued for trading purposes at March 31, 1997, and
on average for the three-month period then ended, is presented below. The
positive fair values represent assets to Key and are recorded in other assets,
while the negative fair values represent liabilities and are recorded in other
liabilities on the balance sheet. The $6.2 billion notional amount of customer
swaps presented in the table includes $3.8 billion of interest rate swaps that
receive a fixed rate and pay a variable rate and $2.4 billion of interest rate
swaps that pay a fixed rate and receive a variable rate. As of March 31, 1997,
these swaps had an expected average life of 4.9 years and carried a weighted
average rate received of 6.30% and a weighted average rate paid of 6.20%.
<TABLE>
<CAPTION>
March 31, 1997 Three months ended March 31, 1997
---------------------- --------------------------------------
Notional Fair Average Average
in millions Amount Value Notional Amount Fair Value
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate contracts:
Customer swaps:
Assets $3,796 $ 42 $4,000 $ 39
Liabilities 2,365 (27) 1,985 (21)
Caps and floors purchased 2,647 3 2,275 2
Caps and floors written 2,730 (3) 2,344 (2)
Foreign exchange forward contracts:(1)
Assets 484 19 477 22
Liabilities 408 (17) 418 (21)
- --------------------------------------------------------------------------------------------------------------------
<FN>
(1) Excludes the effect of foreign spot contracts.
</TABLE>
Independent Accountants' Review Report
Shareholders and Board of Directors
KeyCorp
We have reviewed the unaudited consolidated balance sheets of KeyCorp and
subsidiaries ("Key") as of March 31, 1997 and 1996, and the related consolidated
statements of income, changes in shareholders' equity and cash flow for the
three-month periods then ended. These financial statements are the
responsibility of Key's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, which will be performed
for the full year with the objective of expressing an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the consolidated financial statements referred to above for them to
be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Key as of December 31, 1996, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flow for the year then ended (not presented herein) and in our report
dated January 15, 1997, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying consolidated balance sheet as of December 31, 1996, is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
April 16, 1997
17
<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
This section of the report, including the highlights summarized below, provides
a discussion and analysis of the financial condition and results of operations
of Key for the periods presented. It should be read in conjunction with the
unaudited consolidated interim financial statements and notes thereto, presented
on pages 3 through 17.
This report contains forward-looking statements which are subject to numerous
assumptions, risks and uncertainties. Statements pertaining to future periods
are subject to uncertainty because of the possibility of changes in underlying
factors and assumptions. Actual results could differ materially from those
contained in or implied by such forward-looking statements for a variety of
factors including: sharp and/or rapid changes in interest rates; significant
changes in the economic scenario from the current anticipated scenario which
could materially change anticipated credit quality trends and the ability to
generate loans; significant delay in or inability to execute strategic
initiatives designed to grow revenues and/or control expenses, including plans
to form a nationwide bank, to reduce expenses to achieve a 55% efficiency ratio
by the end of 1997, and to both consolidate and divest branches; and significant
changes in accounting, tax, or regulatory practices or requirements.
During the first quarter of 1997, Key's operating results reflected the progress
made in executing strategic actions being taken to complete its transformation
to a nationwide bank-based financial services company and to implement expense
control initiatives. These planned actions, which were announced last November,
include the consolidation of Key's bank subsidiaries (other than Key Bank USA
National Association) into one nationwide banking institution by around
mid-1997, the consolidation of nearly 140 branch offices (known as KeyCenters),
and a reduction of approximately 10% of Key's employment base. These actions
will be taken throughout 1997 with the objective of improving the efficiency
ratio to the targeted amount referred to above, with further improvement
thereafter. At the same time, as part of a strategy to exit businesses which
management perceives as having low-growth potential, Key announced its plans to
divest another 140 branch offices. As of March 31, 1997, more than 100 of the
140 KeyCenters had been merged and contracts were in place for the sale of more
than half of the 140 KeyCenters targeted for sale. Included in these contracts
is a definitive agreement reached in February 1997 for the sale of KeyBank
National Association (Wyoming), Key's 28 branch Wyoming bank subsidiary. This
transaction is expected to close during the third quarter of 1997, pending
necessary regulatory approvals and various other conditions. In addition,
operations have been streamlined through a workforce reduction of nearly half of
the 10% projected at the November announcement date. As a result of these and
other factors, Key's efficiency ratio for the first three months of 1997
improved to just under 59% from the nearly 61% reported last quarter.
During the first quarter, Key also continued its efforts to reallocate resources
(including those made available or generated by its above-mentioned divestitures
of KeyCenters in areas of low-growth potential) to businesses with higher
earnings potential and to focus on certain customer segments, while emphasizing
technology to enhance service capability. Specifically, Key launched a new
subsidiary, Key Corporate Capital Inc., to expand corporate and specialty
finance businesses on a nationwide basis. As part of Key's Corporate Banking
line of business, this new unit targets certain client segments and geographic
markets, including media and telecommunications, healthcare, structured finance
and lease financing. In addition, Key entered into an alliance with Standard
Chartered Bank, of the United Kingdom, to provide expanded international banking
services to Key's clients doing business in Asia. In April 1997, Key moved to
increase the size and scope of its leasing business by entering into a
definitive agreement to acquire Leasetec, a privately held equipment leasing
company headquartered in Boulder, Colorado, which specializes in the leasing of
information-technology and telecommunications equipment to large corporate
clients.
In addition to the above actions, during the first quarter management continued
to manage Key's balance sheet and capital efficiently to improve returns to
shareholders, improve liquidity and manage credit risk. These steps included the
securitization and sale of $456 million of auto loans and the sale of a $41
million non-strategic affinity credit card portfolio. The latter was the second
credit card portfolio sale in the last three quarters and management will
continue to explore opportunities for sales of non-strategic credit card
portfolios in 1997.
During the fourth quarter of 1996, Key augmented its flexibility to continue its
management of capital through the issuance of $500 million of tax-advantaged
capital securities which receive Tier I capital treatment. In the first quarter
of 1997, 4,880,000 Key Common Shares were repurchased as part of a 12,000,000
Common Shares repurchase program authorized by Key's Board of Directors in
November 1996. This brings the total number of shares repurchased under the
authorization to 7,500,000. The repurchase of these shares reflected, in large
part, the additional capital flexibility achieved through loan sales and
securitizations completed during 1996 and in the first three months of 1997.
18
<PAGE> 19
The above items are reviewed in greater detail in the remainder of this
management's discussion and in the notes to the consolidated interim financial
statements referred to above.
FIGURE 1 SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1997 1996
------------- --------------------------------------------------------
dollars in millions, except per share amounts FIRST Fourth Third Second First
-------- -------- -------- -------- --------
- ---------------------------------------------------------------------------------------------------------------------------------
FOR THE PERIOD
<S> <C> <C> <C> <C> <C>
Interest income $ 1,255 $ 1,243 $ 1,238 $ 1,234 $ 1,236
Interest expense 566 560 555 552 567
Net interest income 689 683 683 682 669
Provision for loan losses 67 57 49 47 44
Noninterest income 259 285 289 264 249
Noninterest expense 575 700 615 579 570
Income before income taxes 306 211 308 320 304
Net income 212 151 207 217 208
Net income applicable to Common Shares 212 151 207 213 204
- ---------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .96 $ .67 $ .90 $ .92 $ .88
Cash dividends .42 .38 .38 .38 .38
Book value at period end 21.29 21.84 21.91 21.63 21.43
Market price:
High 56.38 54.25 44.38 40.25 39.13
Low 48.63 43.69 36.25 36.75 33.38
Close 48.75 50.50 44.00 38.75 38.63
Weighted average Common Shares (000) 221,670 225,562 229,668 231,341 233,100
- ---------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 49,724 $ 49,235 $ 48,373 $ 47,928 $ 48,273
Earning assets 59,825 59,260 57,640 57,404 57,941
Total assets 67,893 67,621 65,356 64,764 65,052
Deposits 44,239 45,317 44,523 44,417 45,401
Long-term debt 4,774 4,213 4,664 4,174 4,266
Common shareholders' equity 4,674 4,881 4,976 4,996 4,964
Total shareholders' equity 4,674 4,881 4,976 4,996 5,124
Full-time equivalent employees 26,603 27,689 28,337 28,319 28,902
Full-service banking offices 1,161 1,205 1,218 1,239 1,270
- ---------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.30% .92% 1.28% 1.35% 1.28%
Return on average common equity 18.07 12.53 16.73 17.15 16.42
Return on average total equity 18.07 12.53 16.73 16.93 16.22
Efficiency(1) 58.92 60.92 60.71 60.50 61.22
Overhead(2) 43.71 44.89 44.40 45.53 47.07
Net interest margin (TE) 4.75 4.80 4.82 4.80 4.70
- ---------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets(3) 6.88% 7.22% 7.61% 7.71% 7.88%
Tangible equity to tangible assets(3) 5.58 5.88 6.20 6.27 6.38
Tier I risk-adjusted capital 7.47 7.98 7.49 7.60 7.71
Total risk-adjusted capital 12.31 13.01 12.50 11.72 11.45
Leverage 6.68 6.93 6.38 6.43 6.43
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The comparability of the information presented above is affected by certain
mergers, acquisitions and divestitures completed by Key in the time periods
presented. For further information concerning these transactions, refer to Note
2, Mergers, Acquisitions and Divestitures, beginning on page 7.
(1) Calculated as noninterest expense (excluding certain nonrecurring charges
and distributions on capital securities) divided by taxable-equivalent net
interest income plus noninterest income (excluding net securities
transactions).
(2) Calculated as noninterest expense (excluding certain nonrecurring charges
and distributions on capital securities) less noninterest income (excluding
net securities transactions) divided by taxable-equivalent net interest
income.
(3) Including capital securities (as defined in Note 8, Capital Securities,
beginning on page 12), these ratios at March 31, 1997, are 7.62% and 6.32%,
respectively, and at December 31, 1996, are 7.96% and 6.63%, respectively.
TE = Taxable Equivalent
19
<PAGE> 20
PERFORMANCE OVERVIEW
The selected financial data set forth in Figure 1 presents certain information
highlighting the financial performance of Key for the last five quarters. Each
of the items referred to in this performance overview and in Figure 1 is more
fully described in the following discussion or in the notes to the consolidated
interim financial statements presented on pages 7 through 17.
Net income for the first quarter of 1997 reached a record first quarter high of
$212 million, or $.96 per Common Share. This compared with net income of $208
million, or $.88 per Common Share, for the first quarter of 1996. On an
annualized basis, the return on average common equity for the first quarter of
1997 was 18.07%, up from 16.42% for the same period last year. The annualized
returns on average total assets were 1.30% and 1.28% for the first quarters of
1997 and 1996, respectively.
Contributing to the increase in earnings were an $18 million increase in
taxable-equivalent net interest income, a $10 million increase in noninterest
income and a $4 million reduction in the provision for income taxes (including
the taxable-equivalent adjustment). These positive factors were partially offset
by a $23 million rise in the provision for loan losses and a $5 million increase
in noninterest expense. Excluding the $10 million of distributions on capital
securities (which more closely resemble dividend or interest payments than
overhead expense) recorded in the first quarter of 1997, noninterest expense was
down $5 million from the comparable period a year-ago. The efficiency ratio,
which measures the extent to which recurring revenues are absorbed by operating
expenses, improved to 58.92% for the first quarter of 1997 compared with 60.92%
and 61.22% for the fourth quarter of 1996 and the first quarter of 1996,
respectively. As discussed in the preceding Introduction, this reflected
progress made by Key in its restructuring efforts and implementation of expense
control initiatives.
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income, which is comprised of interest and loan-related fee income
less interest expense, is the principal source of earnings for Key. Net interest
income is affected by a number of factors including the level, pricing, mix and
maturity of earning assets and interest-bearing liabilities (both on and
off-balance sheet), interest rate fluctuations and asset quality. To facilitate
comparisons in the following discussion, net interest income is presented on a
taxable-equivalent basis, which restates tax-exempt income to an amount that
would yield the same after-tax income had the income been subject to taxation at
the statutory Federal income tax rate.
The information presented in Figure 2 provides a summary of the effect on net
interest income of changes in yields/rates and average balances from the first
quarter of 1996 to the first quarter of 1997. Various components of the balance
sheet and their respective yields and rates which affect interest income and
expense are illustrated in Figure 3. A more in-depth discussion of changes in
earning assets and funding sources is presented in the Financial Condition
section beginning on page 29.
For the first quarter of 1997, net interest income was $700 million, up $18
million, or 3%, from the same period last year. This increase resulted from a
net interest margin which rose by 5 basis points to 4.75%, and a 1% increase in
average earning assets to $59.0 billion. The net interest margin is computed by
dividing annualized taxable-equivalent net interest income by average earning
assets.
The slight improvement in the net interest margin as compared with the year-ago
quarter was due primarily to two factors. During the first quarter of 1996, Key
completed the amortization of deferred swap losses resulting from interest rate
swap terminations taken late in 1994 and early in 1995 to reduce its exposure to
changes in interest rates. The net interest margin also benefited from favorable
funding associated with the issuance of $500 million of capital securities late
in the fourth quarter of 1996. The distributions related to these tax-advantaged
preferred securities are classified as noninterest expense, consistent with the
position of the Securities and Exchange Commission. The positive impact of the
above factors was largely offset by the effects of loan growth at spreads lower
than the first quarter 1996 margin, and increased borrowings associated with the
Common Share repurchase program.
Average earning assets for the first quarter totaled $59.0 billion, which was
$835 million, or 1%, higher than the first quarter 1996 level and $1.2 billion,
or an annualized 8% above the fourth quarter of 1996. The modest growth from the
year-ago quarter included a $1.1 billion, or 2%, increase in loans, reflecting
the sale of a subsidiary bank and the impact of Key's securitization and sales
programs. This loan growth was offset in part by small declines in securities
(including
20
<PAGE> 21
both investment securities and securities available for sale) and short-term
investments. The higher rate of earning asset growth relative to the prior
quarter reflected strong growth in targeted loans (such as commercial, home
equity, credit card and consumer installment loans), accompanied by a slower
pace of reduction in the residential mortgage portfolio, a trend which began
during the fourth quarter of 1996. Key's strategy with respect to its loan
portfolio is discussed in greater detail in the Loan section on page 29.
Key uses portfolio interest rate swaps (as defined in Note 11, Financial
Instruments with Off-Balance Sheet Risk, beginning on page 14) in the management
of its interest rate sensitivity position. The notional amount of such swaps
decreased to $12.2 billion at March 31, 1997, from $12.3 billion at year-end
1996. For the first quarter of 1997, interest rate swaps contributed $21 million
and 14 basis points to net interest income and the net interest margin,
respectively, including the impact of both the spread on the swap portfolio and
the amortization of deferred gains and losses resulting from terminated swaps.
During the same period in 1996, interest rate swaps increased net interest
income by $9 million and the net interest margin by 6 basis points. The manner
in which interest rate swaps are used in Key's overall program of asset and
liability management is described in Note 11.
Figure 2 Components of Net Interest Income Changes
<TABLE>
<CAPTION>
From Three Months Ended March 31, 1996
To Three Months Ended March 31, 1997
---------------------------------------
Average Yield/ Net
in millions Volume Rate Change
- -------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME
Loans $ 24 $ (7) $ 17
Taxable investment securities (1) -- (1)
Tax-exempt investment securities -- (2) (2)
Securities available for sale (1) 6 5
Short-term investments (1) (1) (2)
- -------------------------------------------------------------------
Total interest income (TE) 21 (4) 17
INTEREST EXPENSE
Money market deposit accounts 16 (22) (6)
Savings deposits (9) 13 4
NOW accounts (12) 3 (9)
Certificates of deposit
($100,000 or more) 1 (5) (4)
Other time deposits (16) (3) (19)
Deposits in foreign offices 4 (1) 3
- -------------------------------------------------------------------
Total interest-bearing deposits (16) (15) (31)
Federal funds purchased and
securities sold under
repurchase agreements 17 (1) 16
Other short-term borrowings 14 (2) 12
Long-term debt 6 (4) 2
- -------------------------------------------------------------------
Total interest expense 21 (22) (1)
- -------------------------------------------------------------------
Net interest income (TE) -- $ 18 $ 18
==== ==== ====
- -------------------------------------------------------------------
</TABLE>
The change in interest not due solely to volume or rate has been allocated in
proportion to the absolute dollar amounts of the change in each.
TE = Taxable Equivalent
21
<PAGE> 22
FIGURE 3. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
<TABLE>
<CAPTION>
First Quarter 1997 Fourth Quarter 1996
--------------------------------- ---------------------------------
Average Yield/ Average Yield/
dollars in millions Balance Interest Rate Balance Interest Rate
- ------------------------------------------------------------------------------------------------------------------
ASSETS
Loans: (1), (2)
<S> <C> <C> <C> <C> <C> <C>
Commercial, financial and ag $12,248 $ 268 8.87 % $12,027 $ 270 8.93 %
Real estate-commercial mortg 7,130 163 9.27 6,978 159 9.06
Real estate-construction 1,693 40 9.58 1,778 44 9.84
Commercial lease financing 2,623 39 6.03 2,514 40 6.33
- ------------------------------------------------------------------------------------------------------------------
Total commercial loans 23,694 510 8.73 23,297 513 8.76
Real estate-residential 6,196 126 8.25 6,312 131 8.26
Credit card 1,786 67 15.21 1,712 63 14.64
Other consumer 15,070 346 9.31 14,884 346 9.25
- ------------------------------------------------------------------------------------------------------------------
Total consumer loans 23,052 539 9.48 22,908 540 9.38
Loans held for sale 2,469 48 7.88 2,114 41 7.72
- ------------------------------------------------------------------------------------------------------------------
Total loans 49,215 1,097 9.04 48,319 1,094 9.01
Taxable investment securities 222 3 5.48 206 3 5.79
Tax-exempt investment securities(1) 1,395 27 7.85 1,409 28 7.91
- ------------------------------------------------------------------------------------------------------------------
Total investment securities 1,617 30 7.52 1,615 31 7.64
Securities available for sale(1),(3) 7,800 134 6.99 7,271 121 6.62
Interest-bearing deposits wit 17 -- 4.11 18 1 4.49
Federal funds sold and securities
purchased under resale agree 299 4 5.43 600 8 5.30
Trading account assets 95 1 5.63 60 -- 6.63
- ------------------------------------------------------------------------------------------------------------------
Total short-term investment 411 5 5.04 678 9 5.28
- ------------------------------------------------------------------------------------------------------------------
Total earning assets 59,043 1,266 8.70 57,883 1,255 8.63
Allowance for loan losses (868) (866)
Other assets 8,179 8,046
- ------------------------------------------------------------------------------------------------------------------
$66,354 $65,063
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $11,008 65 2.39 $10,979 66 2.39
Savings deposits 4,819 43 3.62 5,110 45 3.50
NOW accounts 1,682 9 2.17 1,702 9 2.10
Certificates of deposit ($100 3,699 50 5.48 3,448 51 5.88
Other time deposits 13,037 171 5.32 13,497 177 5.22
Deposits in foreign offices 1,150 15 5.31 793 10 5.02
- ------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 35,395 353 4.04 35,529 358 4.01
Federal funds purchased and securities
sold under repurchase agreements 7,028 88 5.08 6,087 77 5.03
Other short-term borrowings 3,912 57 5.91 3,568 53 5.91
Long-term debt (4) 4,486 68 6.22 4,567 72 6.27
- ------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 50,821 566 4.52 49,751 560 4.48
Noninterest-bearing deposits 8,408 8,615
Other liabilities 1,867 1,793
Capital securities 500 111
Preferred stock -- --
Common shareholders' equity 4,758 4,793
- ------------------------------------------------------------------------------------------------------------------
$66,354 $65,063
======= =======
Interest rate spread 4.18 4.15
- ------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 700 4.75 % $ 695 4.80 %
======= ==== ======= ====
Taxable-equivalent adjustment (1) $ 11 $12
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
22
<PAGE> 23
<TABLE>
<CAPTION>
Third Quarter 1996 Second Quarter 1996 First Quarter 1996
- ------------------------------- ---------------------------- ---------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$11,934 $ 270 9.00 % $12,233 $ 273 8.98 % $11,686 $ 258 8.88 %
7,056 162 9.13 6,993 162 9.32 7,130 165 9.31
1,671 43 10.24 1,554 40 10.35 1,520 39 10.32
2,413 37 6.10 2,302 36 6.29 2,246 35 6.27
- -----------------------------------------------------------------------------------------------
23,074 512 8.83 23,082 511 8.90 22,582 497 8.85
6,481 136 8.35 7,328 158 8.67 8,023 131 6.57
1,707 62 14.45 1,659 60 14.55 1,581 58 14.75
14,293 331 9.21 13,781 306 8.93 13,357 342 10.30
- -----------------------------------------------------------------------------------------------
22,481 529 9.36 22,768 524 9.26 22,961 531 9.30
2,548 51 7.96 2,442 50 8.24 2,609 52 8.02
- -----------------------------------------------------------------------------------------------
48,103 1,092 9.03 48,292 1,085 9.04 48,152 1,080 9.02
251 4 6.34 259 3 5.64 267 4 6.03
1,458 29 7.91 1,414 28 7.96 1,418 29 8.23
- -----------------------------------------------------------------------------------------------
1,709 33 7.68 1,673 31 7.45 1,685 33 7.88
7,152 120 6.75 7,410 124 6.73 7,864 129 6.60
18 -- 3.57 28 -- 2.70 32 -- 2.89
385 5 5.17 418 5 5.08 448 7 5.39
60 1 5.21 45 1 5.25 27 -- 5.30
- -----------------------------------------------------------------------------------------------
463 6 5.16 491 6 4.96 507 7 5.35
- -----------------------------------------------------------------------------------------------
57,427 1,251 8.67 57,866 1,246 8.66 58,208 1,249 8.63
(870) (877) (875)
7,923 7,634 7,778
- -----------------------------------------------------------------------------------------------
$64,480 $64,623 $65,111
======= ======= =======
$10,851 82 3.01 $10,273 76 2.98 $8,725 71 3.27
5,463 33 2.40 5,832 37 2.55 6,018 39 2.61
1,733 9 2.07 2,348 12 2.06 3,984 18 1.82
3,133 45 5.71 3,267 49 6.03 3,661 54 5.93
13,338 175 5.22 13,849 178 5.17 14,215 190 5.38
1,189 16 5.35 1,154 15 5.23 848 12 5.69
- -----------------------------------------------------------------------------------------------
35,707 360 4.01 36,723 367 4.02 37,451 384 4.12
5,694 72 5.03 5,899 74 5.05 5,691 72 5.09
3,669 55 5.96 2,922 44 6.06 2,950 45 6.14
4,359 68 6.28 4,152 67 6.60 4,102 66 6.59
- -----------------------------------------------------------------------------------------------
49,429 555 4.47 49,696 552 4.47 50,194 567 4.54
8,467 8,202 8,208
1,661 1,571 1,551
-- -- --
-- 158 160
4,923 4,996 4,998
- -----------------------------------------------------------------------------------------------
$64,480 $64,623 $65,111
======= ======= =======
4.20 4.19 4.09
- ------------------------------------------------------------------------------------------------
$ 696 4.82 % $ 694 4.80 % $ 682 4.70 %
======= ==== ======= ==== ======= ====
$ 13 $ 12 $ 13
- -----------------------------------------------------------------------------------------------
</TABLE>
(1) Interest income on tax-exempt securities and loans has been adjusted to a
taxable-equivalent basis using the statutory Federal income tax rate of
35%.
(2) For purposes of these computations, nonaccrual loans are included in the
average loan balances.
(3) Yield is calculated on the basis of amortized cost.
(4) Rate calculation excludes ESOP debt.
TE = Taxable Equivalent
23
<PAGE> 24
ASSET AND LIABILITY MANAGEMENT
ASSET/LIABILITY MANAGEMENT COMMITTEES
Key manages its exposure to economic loss from fluctuations in interest rates
through an active program of asset and liability management pursuant to
guidelines established by its Asset/Liability Management Policy Committee, and
strategies formulated and implemented by the Asset/Liability Strategy Committee
(collectively, "ALCO"). The ALCO has the responsibility for approving the
asset/liability management policies of Key, formulating and implementing
strategies to improve balance sheet positioning and/or earnings, and reviewing
the interest rate sensitivity positions of Key and each of its affiliate banks.
Both asset/liability management committees meet at least monthly.
SHORT-TERM INTEREST RATE EXPOSURE
The primary tool utilized by management to measure and manage interest rate
exposure is a simulation model. Use of the model to perform simulations of
changes in interest rates over one- and two-year time horizons has enabled
management to develop strategies for managing exposure to interest rate risk. In
its simulations, management estimates the impact on net interest income of
various pro forma changes in the overall level of interest rates. These
estimates are based on a large number of assumptions related to loan and deposit
growth, prepayments, interest rates, and other factors. Management believes that
both individually and in the aggregate these assumptions are reasonable, but the
complexity of the simulation modeling process results in a sophisticated
estimate, not a precise calculation of exposure. For example, estimates of
future cash flows must be made for instruments without contractual repayment
schedules. The ALCO guidelines provide that a gradual 200 basis point increase
or decrease in short-term rates over the next twelve-month period should not
result in more than a 2% impact on net interest income from what net interest
income would have been if interest rates did not change. As shown in Figure 4,
Key has been operating well within these guidelines.
FIGURE 4 NET INTEREST INCOME AT RISK TO CHANGES IN INTEREST RATES
<TABLE>
<CAPTION>
ESTIMATED CHANGE IN NET INTEREST INCOME
June-95 Sep-95 Dec-95 Mar-96 Jun-96 Sep-96 Dec-96 Mar-97
<S> <C> <C> <C> <C> <C> <C> <C> <C>
GRADUAL 200 BASIS POINT
DECREASE OVER NEXT 12 MONTHS .27 .23 .30 .89 .92 .60 .71 .90
GRADUAL 200 BASIS POINT
INCREASE IN RATES OVER NEXT 12 MONTHS -1.10 -1.20 -1.24 -1.34 -1.13 -1.23 -1.28 -1.28
</TABLE>
LONG-TERM INTEREST RATE EXPOSURE
Short-term interest rate analysis is complemented by an economic value of equity
model. This model provides the added benefit of measuring the exposure to
interest rate changes outside the one- to two-year time frame not measured by
the simulation model. The economic value of Key's equity is determined by
modeling the net present value of future cash flows for asset, liability, and
off-balance sheet positions based on the implied forward yield curve. Economic
value analysis has several limitations including: the economic values of asset,
liability, and off-balance sheet positions do not represent the true fair values
of the positions, since they do not consider factors such as credit risk and
liquidity; indeterminate maturity assets and liabilities require that estimated
cash flows be developed; the future structure of the balance sheet derived from
ongoing loan and deposit activity by Key's core businesses is not factored into
present value calculations; and the analysis requires assumptions about events
that span an even longer time frame than that used in the simulation model. Key
is currently in the process of defining policy guidelines for managing long-term
interest rate risk.
RECENT MANAGEMENT ACTIONS
During 1996, a number of actions were taken in connection with the execution of
asset/liability management strategies designed to improve liquidity and reduce
longer-term interest rate exposure. These actions included the sale of
residential mortgage loans totaling $500 million and the securitization and sale
of non-prime auto loans totaling $212 million. Other actions taken during 1996
included the continued run-off of lower-yielding securities and residential
24
<PAGE> 25
mortgage loans. In the first quarter of 1997, Key securitized and sold an
additional $456 million of auto loans. With the enhanced capital management
flexibility derived from these actions and the issuance of $500 million of
tax-advantaged capital securities during the 1996 fourth quarter, 14,620,000 and
4,880,000 Common Shares were repurchased in 1996 and in the first quarter of
1997, respectively.
As was the case throughout 1996, Key continued to utilize both portfolio
interest rate swaps, which are more fully discussed below, and interest rate
caps and floors to manage its interest rate risk. In connection with the
previously announced branch divestitures, during the month of March and in early
April, strategies were executed to minimize the interest rate risk associated
with the anticipated sales of fixed-rate deposits. These strategies included the
execution of $650 million of forward-starting interest rate caps and $100
million of pay fixed swaps, and the issuance of $250 million of fixed-rate bank
notes. Management will continue to evaluate strategies to securitize and/or sell
loans, taking into account the strategies' impacts on liquidity, capital and
earnings.
PORTFOLIO INTEREST RATE SWAP CONTRACTS
In addition to Key's securities portfolios and debt issuances, management has
utilized interest rate swaps to manage interest rate risk by modifying the
repricing or maturity characteristics of specified on-balance sheet assets and
liabilities. Interest rate swaps used for this purpose are designated as
portfolio swaps. The decision to use portfolio interest rate swaps versus
on-balance sheet securities or debt to manage interest rate risk depends on
various factors, including the mix and cost of funding sources, liquidity, and
capital requirements. Further details pertaining to Key's swap portfolio are
included in Note 11, Financial Instruments with Off-Balance Sheet Risk,
beginning on page 14.
As shown in Note 11, the estimated fair value of Key's portfolio interest rate
swaps decreased $126 million during the first quarter of 1997 from a fair value
of $8 million at December 31, 1996. The decline in fair value over the past
three months reflected the financial markets' expectations, as measured by the
forward yield curve, for a future increase in interest rates and the fact that
Key's swap portfolio is primarily in a received fixed position. Swaps with a
notional amount of $200 million were terminated during the first quarter of
1997, resulting in no deferred gain or loss. A summary of Key's deferred swap
gains and losses at March 31, 1997, is also presented in Note 11. Each swap
termination was made in response to a unique set of circumstances and for
various reasons; however, the decision to terminate a swap contract is
integrated strategically with asset and liability management and other
appropriate processes. These terminations as well as other portfolio swap
activity for the three-month period ended March 31, 1997, are summarized in
Figure 5.
FIGURE 5 PORTFOLIO SWAP ACTIVITY FOR THE THREE MONTHS ENDED MARCH 31, 1997
<TABLE>
<CAPTION>
Receive Fixed
--------------------------------- Total
Indexed Pay Fixed- Basis Portfolio
in millions Amortizing Conventional Conventional Swaps Swaps
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year $5,078 $3,505 $3,312 $400 $12,295
Additions -- -- 950 200 1,150
Maturities -- 53 680 -- 733
Terminations -- -- 200 -- 200
Amortization 302 -- -- -- 302
- ------------------------------------------------------------------------------------------------------------------------
Balance at end of period $4,776 $3,452 $3,382 $600 $12,210
====== ====== ====== ==== =======
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
A summary of the notional and fair values of portfolio swaps by interest rate
management strategy is presented in Figure 6. The fair value at any given date
represents the estimated income (if positive) or cost (if negative) that would
be recognized if the portfolio were to be liquidated at that date. However,
because the portfolio interest rate swaps are used to alter the repricing or
maturity characteristics of specific assets and liabilities, the net unrealized
gains and losses related to the swaps are not recognized in earnings. Rather,
interest from these swaps is recognized on an accrual basis as an adjustment of
the interest income or expense from the asset or liability being managed.
25
<PAGE> 26
FIGURE 6 PORTFOLIO SWAPS BY INTEREST RATE STRATEGY
<TABLE>
<CAPTION>
March 31, 1997 December 31, 1996 March 31, 1996
----------------------------- ----------------------- -----------------------
Notional Fair Notional Fair Notional Fair
in millions Amount Value Amount Value Amount Value
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Convert variable rate loans to fixed $ 6,141 $(103) $ 6,443 $(20) $ 7,018 $(35)
Convert variable rate deposits and short-term
borrowings to fixed 3,082 14 3,082 (4) 1,775 (8)
Convert variable rate long-term debt to fixed 300 1 230 (1) 112 (2)
Convert fixed rate long-term debt to variable 2,087 (30) 2,140 33 1,282 12
Basis swaps 600 -- 400 -- -- --
- ---------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps $12,210 $(118) $12,295 $ 8 $10,187 $(33)
======= ===== ======= ====== ======= ====
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The expected average maturities of the portfolio swaps at March 31, 1997, are
summarized in Figure 7.
FIGURE 7 EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS AT MARCH 31, 1997
<TABLE>
<CAPTION>
Receive Fixed
------------------------------- Total
Indexed Pay Fixed- Basis Portfolio
in millions Amortizing Conventional Conventional Swaps Swaps
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Due in one year or less $ 89 $ 204 $1,100 $600 $ 1,993
Due after one through five years 4,503 115 2,282 -- 6,900
Due after five through ten years 184 2,323 -- -- 2,507
Due after ten years -- 810 -- -- 810
- ----------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps $4,776 $3,452 $3,382 $600 $12,210
====== ====== ====== ==== =======
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
In June 1996, the FASB issued an Exposure Draft of a proposed SFAS, "Accounting
for Derivatives and Similar Financial Instruments and for Hedging Activities."
If adopted in its present form, this SFAS would eliminate indexed amortizing
swaps as a permitted instrument for hedging activities and, therefore, would
likely alter Key's use of this instrument in the future. It is not clear whether
this SFAS will be adopted in its present form, and it is not currently
practicable to estimate the potential effects of any final standard.
Key also uses interest rate caps and floors, and futures contracts to manage the
risk associated with the potential impact of adverse movements in interest
rates. Futures contracts are commitments to either purchase or sell designated
financial instruments at future dates for specific prices. Key had caps and
floors with a notional amount and fair value of $2.4 billion and $31 million,
respectively, at March 31, 1997. There were no futures contracts outstanding at
the same date.
CUSTOMER INTEREST RATE SWAP CONTRACTS
While not directly related to asset and liability management, in addition to
portfolio swaps, Key has entered into interest rate swap contracts to
accommodate the needs of its customers, typically commercial loan customers, and
other positions with third parties that are intended to mitigate the interest
rate risk of the customer positions. Adjustments to the fair values of such
swaps are included in other income on the income statement. Further information
pertaining to these contracts as well as caps and floors, and futures contracts
used for trading purposes is included in Note 11, Financial Instruments with
Off-Balance Sheet Risk, beginning on page 14.
NONINTEREST INCOME
As shown in Figure 8, noninterest income for the 1997 first quarter totaled $259
million, up $10 million, or 4%, from the same period last year. This improvement
reflected growth in income from corporate owned life insurance (up $7 million),
trust and asset management income (up $6 million), credit card fees, and
insurance and brokerage income (both up $3 million) and other income (up $4
million). The growth of the trust and asset management component was moderated
slightly as a result of the progress made in transferring Key's shareholder
services business to an unrelated party. As the year progresses, it is
anticipated that the level of shareholder services income will decline, since
the transfer of accounts to the new servicer should be completed during the
second quarter. Shareholder services contributed approximately $11 million to
Key's revenues during all of 1996. Additional detail pertaining to the
composition of trust and asset management income is presented in Figure 9. The
increase in other income relative to the
26
<PAGE> 27
first three months of 1996 was due primarily to a $3 million increase in income
from trading account activities, a $3 million gain on the sale of a
non-strategic affinity credit card portfolio and a $4 million increase in
automated teller machine ("ATM") surcharge fees, offset in part by a $6 million
decline in mortgage banking income. The decrease in mortgage banking income
reflected the 1996 transition to a telephone based method of processing loan
originations.
The growth in income contributed by the above categories was partially offset by
a $12 million decrease in loan securitization income, due largely to the impact
of two factors. Effective January 1, 1997, Key adopted SFAS No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." This new accounting standard served to reduce loan securitization
income in the first quarter by approximately $8 million. Of this reduction, $6
million was reclassified to interest income and the remaining $2 million is
expected to be recognized as interest income over the life of the respective
securitizations. SFAS No. 125 is discussed in greater detail in Note 1, Summary
of Significant Accounting Policies, in Key's 1996 Annual Report. The second
factor was a positive $4 million adjustment to loan securitization income in the
year-ago quarter which resulted from a change in the method of servicing income
recognition. Additional information pertaining to the type and volume of
securitized loans which are either administered or serviced by Key and not
recorded on its balance sheet is included in the Loans section beginning on page
29. Excluding the loan securitization component, noninterest income in the first
quarter of 1997 was up $22 million, or 9%, from the first three months of 1996.
FIGURE 8 NONINTEREST INCOME
<TABLE>
<CAPTION>
Three Months ended March 31, Change
--------------------------- -----------------------
dollars in millions 1997 1996 Amount Percent
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Service charges on deposit accounts $ 71 $ 72 $ (1) (1.4)%
Trust and asset management income 64 58 6 10.3
Credit card fees 23 20 3 15.0
Insurance and brokerage income 21 18 3 16.7
Corporate owned life insurance 19 12 7 58.3
Loan securitization income 1 13 (12) (92.3)
Other income:
Trading account income 7 4 3 75.0
Foreign exchange income 4 3 1 33.3
Venture capital income 6 7 (1) (14.3)
Letter of credit fees 4 4 -- --
Mortgage banking income 2 8 (6) (75.0)
Miscellaneous income 37 30 7 23.3
- ------------------------------------------------------------------------------------------------------------
Total other income 60 56 4 7.1
- ------------------------------------------------------------------------------------------------------------
Total noninterest income $259 $249 $ 10 4.0%
==== ==== ====
- ------------------------------------------------------------------------------------------------------------
</TABLE>
FIGURE 9 TRUST AND ASSET MANAGEMENT INCOME
<TABLE>
<CAPTION>
Three Months ended March 31, Change
---------------------------------- ----------------------
dollars in millions 1997 1996 Amount Percent
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Personal asset management and custody fees $34 $35 $(1) (2.9)%
Institutional asset management and custody fees 17 14 3 21.4
Bond services 3 3 -- --
All other fees 10 6 4 66.7
- ------------------------------------------------------------------------------------------------------------------------
Total trust and asset management income $64 $58 $ 6 10.3 %
=== === ===
dollars in billions
- ------------------------------------------------------------------------------------------------------------------------
March 31,
Discretionary assets $47 $48 $(1) (2.1)%
Non-discretionary assets 47 39 8 20.5
- ------------------------------------------------------------------------------------------------------------------------
Total trust assets $94 $87 $ 7 8.0 %
=== === ===
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
27
<PAGE> 28
NONINTEREST EXPENSE
As shown in Figure 10, noninterest expense for the first quarter of 1997 totaled
$575 million, up $5 million, or less than 1%, from the first quarter of 1996.
Included in noninterest expense for the first quarter of 1997 was $10 million of
distributions accrued on the capital securities (tax-advantaged preferred
securities) issued by Key during the fourth quarter of last year. Excluding
these distributions, noninterest expense was slightly below the year-ago
quarter. This improvement was due in large part to the progress made with
respect to the restructuring efforts announced last November which center around
the formation of a single nationwide community bank by around mid-1997, as well
as the implementation of expense control initiatives. Further information
pertaining to specific actions taken in connection with the restructuring and
expense control initiatives is included in the Introduction beginning on page
18.
Personnel expense, the largest category of noninterest expense, came in slightly
below the first quarter 1996 level. Reduction in staff was a major reason for
the decrease in personnel expense. Full-time equivalent employees totaled 26,603
at March 31, 1997, down from 28,902 at March 31, 1996. This reflected the impact
of Key's restructuring and expense control initiatives (including branch
mergers), as well as the divestiture of SFF last June. The effect of these
actions on personnel expense compared with the year-ago quarter was
substantially offset by the combined impact of 1996 merit increases (effective
April 1 for the vast majority of Key's employees); the acquisitions in June and
August 1996, respectively, of Knight and Carleton; and the partial-quarter
impact of staff reductions which occurred in the first quarter of 1997. Also
contributing to the control of noninterest expense were reductions of $5 million
in both professional fees and other expense (excluding the capital securities
distributions), offset in part by a $5 million increase in equipment expense.
The reduction in other expense was spread among a number of categories of
operating expense.
The efficiency ratio, which provides a measure of the extent to which recurring
revenues are used to pay operating expenses, improved to 58.92% for the first
quarter, from 60.92% in the previous quarter and 61.22% for the first quarter of
1996. The 200 basis point improvement during the first quarter of 1997 reflects
the benefits of Key's expense control strategies and progress made on Key's
year-long effort to reduce its efficiency ratio to the previously announced
target of 55%.
FIGURE 10 NONINTEREST EXPENSE
<TABLE>
<CAPTION>
Three Months ended March 31, Change
---------------------------- -----------------------
dollars in millions 1997 1996 Amount Percent
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Personnel $ 290 $ 291 $(1) (.3)%
Net occupancy 56 54 2 3.7
Equipment 43 38 5 13.2
Amortization of intangibles 21 22 (1) (4.5)
Professional fees 11 16 (5) (31.3)
Marketing 21 21 -- --
Other expense:
Distributions on capital securities 10 -- 10 100.0
Equity and gross receipts based taxes 10 7 3 42.9
OREO expense, net(1) 1 1 -- --
FDIC insurance assessments 1 2 (1) (50.0)
Miscellaneous 111 118 (7) (5.9)
- --------------------------------------------------------------------------------------------------------------------------
Total other expense 133 128 5 3.9
- --------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 575 $ 570 $ 5 .9%
======= ======= ===
Full-time equivalent employees at period end 26,603 28,902
Efficiency ratio(2) 58.92% 61.22%
Overhead ratio(3) 43.71 47.07
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) OREO expense is net of income of $1 million for the first quarter of both
1997 and 1996.
(2) Calculated as noninterest expense (excluding certain nonrecurring charges
and distributions on capital securities) divided by taxable-equivalent net
interest income plus noninterest income (excluding net securities
transactions).
(3) Calculated as noninterest expense (excluding certain nonrecurring charges
and distributions on capital securities) less noninterest income (excluding
net securities transactions) divided by taxable-equivalent net interest
income.
28
<PAGE> 29
INCOME TAXES
The provision for income taxes was $94 million for the three-month period ended
March 31, 1997, as compared with $96 million for the same period in 1996. The
effective tax rate (provision for income taxes as a percentage of income before
income taxes) for the 1997 first quarter was 30.7% compared with 31.5% for the
first quarter of 1996. The lower effective income tax rate was primarily
attributable to the favorable settlement of an IRS audit related to an entity
acquired in 1992 and higher income from corporate owned life insurance. The
effective income tax rate remains below the statutory Federal rate of 35% due
primarily to continued investment in tax-advantaged assets (such as tax-exempt
securities and corporate owned life insurance) and the recognition of credits
associated with investments in low-income housing projects.
FINANCIAL CONDITION
LOANS
At March 31, 1997, total loans outstanding were $49.7 billion, up from $49.2
billion at December 31, 1996, and $48.3 billion at March 31, 1996. The
composition of the loan portfolio by loan type, as of each of these respective
dates, is presented in Note 5, Loans, beginning on page 10.
The moderate increase in loans outstanding from the March 31, 1996, level
reflected the impact of Key's continued strategy of securitizing and/or selling
student loans, auto loans and other loans which do not meet certain return on
equity, credit or other internal standards. A summary of loans securitized, sold
and divested during 1997 and 1996 is presented in Figure 11. Over the past year,
this activity included the sale of $1.0 billion of student loans (of which $711
million was associated with securitizations) and the securitization and sale of
auto loans totaling $630 million (of which $79 million was classified as held
for sale). Generally, Key sells or securitizes student loans in order to reduce
the credit risk that arises when a borrower enters repayment status. Other
factors restricting the increase in total loans over the past year were the sale
of $142 million of out-of-franchise or non-strategic affinity credit card
receivables and the sale of $763 million of loans (primarily residential real
estate) in conjunction with the June 1996 divestiture of SFF. This latter
transaction is described in greater detail in Note 2, Mergers, Acquisitions and
Divestitures, beginning on page 7. Management will continue to explore
opportunities for sales of non-strategic credit card portfolios in 1997.
Excluding the impact of the above sales, loan portfolios targeted for growth
(which exclude one-to-four family mortgages) increased $5.0 billion, or 13%,
with the largest advances coming from consumer loans (up $2.5 billion, including
increases of $913 million in home equity loans and $274 million in credit card
receivables), commercial loans (up $1.3 billion) and student loans held for sale
(up $1.2 billion).
FIGURE 11 LOANS SECURITIZED, SOLD AND DIVESTED
<TABLE>
<CAPTION>
Securitized/Sold Sold Divested
----------------------------------------- ------------------------------------ ---------------
Mortgage Real Estate--
Student Loans Loans Held Credit Card Residential
in millions Auto Loans Held for Sale for Sale Receivables Mortgage Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996
- ----------------
First quarter $ 38 $ 44 $500 -- -- $ 582
Second quarter 47 99 -- -- $762 908
Third quarter 56 464 -- $101 -- 621
Fourth quarter 71 403 -- -- -- 474
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 212 $1,010 $500 $101 $762 $2,585
====== ====== ==== ==== ==== ======
1997
- ----------------
First quarter $ 456 $ 31 -- $ 41 -- $ 528
====== ====== ==== ==== ==== ======
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The $489 million increase in loans from the December 31, 1996, level reflected
strong growth in targeted loan portfolios as the aggregate annualized growth
rate of average outstanding balances in these portfolios was 10%. Excluding the
impact of sales, targeted loans rose $1.1 billion due primarily to higher levels
of commercial loans (up $478 million), loans held for sale (up $330 million,
including $239 million of student loans) and consumer loans (up $292 million).
29
<PAGE> 30
This growth was substantially offset, however, by the securitization and sale of
$456 million of auto loans (of which $79 million was non-prime auto loans
classified as held for sale), the sale of $41 million of non-strategic affinity
credit card receivables and the sale of $31 million of student loans held for
sale. At March 31, 1997, targeted loans comprised 88% of total loans and 64% of
total assets compared with 87% of total loans and 64% of total assets at
December 31, 1996.
As shown in Figure 12, new loan volume during the first quarter of 1997 was
largely attributable to the Consumer Finance companies. These companies include
KeyBank USA, a nationally chartered bank formed from Key's existing Community
Banking franchise during the third quarter of 1995, which serves as the
national platform for prime auto lending, credit card receivables, student
loans, mortgage loan originations and all nonbranch consumer finance business.
The majority of new loan volume generated by the Consumer Finance companies is
either participated to Key's other banks or securitized and sold.
FIGURE 12 PERIOD END LOAN GROWTH BY REGION
<TABLE>
<CAPTION>
Net Intercompany
December 31, Originations/ Participations/ Acquired/ March 31, Percent
dollars in millions 1996 (Repayments) (Sales) (Sold) 1997 Change
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Northeast Region $14,111 $ (230) $ 308 $ (12) $14,177 .5%
Great Lakes Region 20,089 206 448 -- 20,743 3.3
Rocky Mountain Region 3,833 (102) 40 -- 3,771 (1.6)
Northwest Region 9,707 (174) 182 (3) 9,712 .1
Consumer Finance companies 2,768 1,358 (978) (513) 2,635 (4.8)
Eliminations/other (1,273) (41) -- (1,314) N/M
- ------------------------------------------------------------------------------------------------------------------------------
Total $49,235 $1,017 -- $(528) $49,724 1.0%
======= ======= ===== ======= =======
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
N/M = Not Meaningful
Shown in Figure 13 are loans which have been securitized and sold and are either
administered or serviced by Key, but not recorded on its balance sheet. Income
recognized in connection with such transactions is derived from two sources.
Noninterest income earned from servicing or administering the loans is recorded
as loan securitization income; while income earned on assets subject to
prepayment, recorded in connection with securitizations and accounted for like
investments in interest-only strips is recorded as interest income on
securities available for sale.
FIGURE 13 LOANS SECURITIZED/SOLD AND ADMINISTERED OR SERVICED
<TABLE>
<CAPTION>
March 31, December 31, March 31,
in millions 1997 1996 1996
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Student loans $2,014 $2,089 $1,543
Auto loans 754 386 391
- --------------------------------------------------------------------------------------
Total $2,768 $2,475 $1,934
====== ====== ======
- --------------------------------------------------------------------------------------
</TABLE>
SECURITIES
At March 31, 1997 the securities portfolio totaled $9.6 billion, consisting of
$8.0 billion of securities available for sale and $1.6 billion of investment
securities. This compares with a total portfolio of $9.3 billion, comprised of
$7.7 billion of securities available for sale and $1.6 billion of investment
securities, at December 31, 1996. The increase in collateralized mortgage
obligations since year end 1996 is in part the result of programs instituted in
the fourth quarter of 1996 to better manage securities used to meet the
collateral requirements of the affiliate banks. Previously, lower-yielding
securities with shorter maturities had been relied upon for this purpose.
Certain information pertaining to the composition, yields, and maturities of the
securities available for sale and investment securities portfolios is presented
in Figures 14 and 15, respectively.
30
<PAGE> 31
FIGURE 14 SECURITIES AVAILABLE FOR SALE AT MARCH 31, 1997
<TABLE>
<CAPTION>
Other
U.S. Treasury, States and Collateralized Mortgage- Weighted
Agencies and Political Mortgage Backed Other Average
dollars in millions Corporations Subdivisions Obligations(1) Securities(1) Securities Total Yield (2)
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Maturity:
One year or less $276 $ 4 $ 190 $ 16 $ 2 $ 488 5.99%
After one through five years 125 18 3,470 1,045 18 4,676 6.91
After five through ten years 14 16 1 1,743 7 1,781 7.14
After ten years 108 3 -- 611 304(3) 1,026 5.48
- -----------------------------------------------------------------------------------------------------------------------------
Fair value $523 $41 $3,661 $3,415 $331 $7,971 6.72
Amortized cost 529 41 3,720 3,467 396 8,153
Weighted average yield 6.29% 7.13% 6.65% 7.15% 2.31% 6.72%
Weighted average maturity 5.8 years 5.8 years 3.0 years 6.8 years 2.1 years 4.8 years
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Maturity is based upon expected average lives rather than contractual
terms.
(2) Weighted average yields are calculated on the basis of amortized cost. Such
yields have been adjusted to a taxable-equivalent basis using the
statutory Federal income tax rate of 35%.
(3) Includes securities with no stated maturity.
FIGURE 15 INVESTMENT SECURITIES AT MARCH 31, 1997
<TABLE>
<CAPTION>
States and Weighted
Political Other Average
dollars in millions Subdivisions Securities Total Yield(1)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Maturity:
One year or less $ 583 $ 1 $ 584 6.84%
After one through five years 553 85 638 8.94
After five through ten years 208 -- 208 9.99
After ten years 57 141 198 2.69
- ---------------------------------------------------------------------------------------------------------
Amortized cost $1,401 $227 $1,628 7.56%
Fair value 1,430 227 1,657
Weighted average yield 8.09% 4.25% 7.56%
Weighted average maturity 2.8 years 3.1 years 2.8 years
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(1) Weighted average yields are calculated on the basis of amortized cost. Such
yields have been adjusted to a taxable-equivalent basis using the
statutory Federal income tax rate of 35%.
ASSET QUALITY
Through its Credit Policy, Credit Administration and Loan Review Groups, Key
evaluates and monitors the level of risk in its credit-related assets;
formulates underwriting standards and guidelines for line management; develops
commercial and consumer credit policies and systems; establishes credit-related
concentration limits; reviews loans, leases and other corporate assets to
evaluate credit quality; and reviews the adequacy of the allowance for loan
losses ("Allowance"). Geographic diversity throughout Key is a significant
factor in managing credit risk.
Management has developed methodologies designed to assess the adequacy of the
Allowance. The Allowance allocation methodologies applied at Key focus on
changes in the size and character of the loan portfolio, changes in the levels
of impaired and other nonperforming and past due loans, the risk inherent in
specific loans, concentrations of loans to specific borrowers or industries,
existing and prospective economic conditions and historical losses on a
portfolio basis. In addition, indirect risk in the form of off-balance sheet
exposure for unfunded commitments is taken into consideration. Management
continues to target and maintain an Allowance equal to the allocated requirement
plus an unallocated portion, as appropriate. Management believes this is an
appropriate posture in light of current and expected economic conditions and
trends, the geographic and industry mix of the loan portfolio and similar
risk-related matters.
31
<PAGE> 32
As shown in Figure 16, net loan charge-offs for the first quarter of 1997 were
$67 million, or .55% of average loans, compared with $43 million, or .36% of
average loans, for the same period last year. The higher level of net
charge-offs was concentrated in the credit card and consumer-indirect
portfolios. The $8 million increase in consumer-indirect net charge-offs
(primarily indirect auto loans) also reflected the impact of a recent strategy
adopted by Key to expand its consumer base to include various credit risk
profiles. This strategy also includes risk-adjusted pricing to address the
relative credit risk of various strata of the consumer base. In addition, Key's
consumer portfolio was impacted by the continuing widespread nationwide
deterioration in consumer credit quality, as indicated by the high number of
bankruptcies. As a result of the higher level of net charge-offs, the provision
for loan losses was increased to $67 million for the first quarter of 1997 from
$57 million for the prior quarter and $44 million for the first quarter of last
year. This increase reflected management's intention to continue to maintain the
provision for loan losses at a level equal to or above net charge-offs.
FIGURE 16 SUMMARY OF LOAN LOSS EXPERIENCE
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
dollars in millions 1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Average loans outstanding during the period $ 49,163 $ 47,800
- -------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $ 870 $ 876
Loans charged off:
Commercial, financial and agricultural 12 18
Real estate-commercial mortgage 3 4
Real estate-construction 1 --
Commercial lease financing 3 1
- -------------------------------------------------------------------------------
Total commercial loans 19 23
Real estate-residential mortgage 3 2
Home equity 1 --
Credit card 29 16
Consumer-direct 8 7
Consumer-indirect 29 22
- -------------------------------------------------------------------------------
Total consumer loans 70 47
- -------------------------------------------------------------------------------
89 70
Recoveries:
Commercial, financial and agricultural 8 11
Real estate-commercial mortgage 3 2
Commercial lease financing -- 1
- -------------------------------------------------------------------------------
Total commercial loans 11 14
Real estate-residential mortgage 1 1
Credit card 2 3
Consumer-direct 2 2
Consumer-indirect 6 7
- -------------------------------------------------------------------------------
Total consumer loans 11 13
- -------------------------------------------------------------------------------
22 27
- -------------------------------------------------------------------------------
Net loans charged off (67) (43)
Provision for loan losses 67 44
Allowance acquired/sold, net -- (2)
- -------------------------------------------------------------------------------
Allowance for loan losses at end of period $ 870 $ 875
======== ========
- -------------------------------------------------------------------------------
Net loan charge-offs to average loans .55% .36%
Allowance for loan losses to period end loans 1.75 1.81
Allowance for loan losses to nonperforming loans 234.50 256.60
- -------------------------------------------------------------------------------
</TABLE>
32
<PAGE> 33
The Allowance at March 31, 1997, was $870 million, or 1.75% of loans, little
changed from $870 million, or 1.77% of loans at December 31, 1996, and $875
million, or 1.81% of loans at March 31, 1996. At March 31, 1997, the Allowance
was 234.50% of nonperforming loans, compared with 249.28% at December 31, 1996
and 256.60% at March 31, 1996. Although this percentage is not a primary factor
used by management in determining the adequacy of the Allowance, it has general
short to medium-term relevance. There have been no significant changes in the
allocation of the Allowance since year end.
The composition of nonperforming assets is shown in Figure 17. These assets
totaled $425 million at March 31, 1997, and represented .85% of loans, other
real estate owned ("OREO") and other nonperforming assets compared with $400
million, or .81%, at year end 1996 and $389 million, or .81%, at March 31, 1996.
The $22 million increase in nonperforming loans since year end 1996 was
geographically broad based and spread across a number of product types in the
commercial (up $27 million) and consumer (up $12 million) loan portfolios. These
increases were partially offset by a $16 million decline in the level of
nonperforming residential real estate loans. Additional information pertaining
to changes in impaired and other nonaccrual loans and the percentage of
nonperforming loans to period end loans by type within Key's geographically
dispersed banking regions is presented in Figures 18 and 19, respectively.
FIGURE 17. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
<TABLE>
<CAPTION>
March 31, December 31, March 31,
dollars in millions 1997 1996 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial, financial and agricultural $ 135 $ 120 $ 132
Real estate--commercial mortgage 88 84 90
Real estate--construction 19 19 8
Commercial lease financing 16 8 14
Real estate--residential mortgage 64 80 70
Consumer 49 37 24
- ------------------------------------------------------------------------------------------
Total nonaccrual loans 371 348 338
Restructured loans -- 1 3
- ------------------------------------------------------------------------------------------
Total nonperforming loans 371 349 341
Other real estate owned 62 56 56
Allowance for OREO losses (10) (8) (11)
- ------------------------------------------------------------------------------------------
Other real estate owned, net of allowance 52 48 45
Other nonperforming assets 2 3 3
- ------------------------------------------------------------------------------------------
Total nonperforming assets $ 425 $ 400 $ 389
===== ===== =====
- ------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 113 $ 103 $ 89
- ------------------------------------------------------------------------------------------
Nonperforming loans to period end loans .75% .71% .71%
Nonperforming assets to period end loans plus other
real estate owned and other nonperforming assets .85 .81 .81
- ------------------------------------------------------------------------------------------
</TABLE>
FIGURE 18. SUMMARY OF CHANGES IN IMPAIRED AND OTHER NONACCRUAL LOANS
<TABLE>
<CAPTION>
Three months ended March 31,
------------------------------
in millions 1997 1996
- ------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of period $348 $330
Loans placed on nonaccrual 65 81
Charge-offs(1) (12) (19)
Payments (24) (21)
Loans sold -- (20)
Transfers to OREO (3) (8)
Loans returned to accrual (3) (5)
- ------------------------------------------------------------------------------------
Balance at end of period $371 $338
==== ====
- ------------------------------------------------------------------------------------
</TABLE>
(1) Represents the gross charge-offs taken against nonaccrual loans; excluded
are charge-offs taken against accruing loans, credit card receivables,
and interest reversals.
33
<PAGE> 34
FIGURE 19 PERCENTAGE OF NONPERFORMING LOANS TO PERIOD END LOANS BY TYPE AT MARCH
31, 1997
<TABLE>
<CAPTION>
Commercial, Real Estate- Commercial Real Estate-
Financial and Commercial Real Estate- Lease Residential
Agricultural Mortgage Construction Financing Mortgage Consumer(1) Total
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Northeast Region 1.91% 2.29% .51% -- 1.33% .22% 1.17%
Great Lakes Region .48 .73 1.64 .19% .55 .24 .47
Rocky Mountain Region 2.45 1.07 .64 .20 .64 .65 1.23
Northwest Region .63 .62 .92 2.88 1.28 .37 .69
Financial Services -- -- -- .63 .13 .09 .31
- --------------------------------------------------------------------------------------------------------------------
Total 1.05% 1.24% 1.07% .60% 1.04% .32% .75%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Excludes credit card receivables, which are charged off prior to entering
nonperforming status.
DEPOSITS AND OTHER SOURCES OF FUNDS
Core deposits, defined as domestic deposits other than certificates of deposit
of $100,000 or more, are Key's primary source of funding. During the first
quarter of 1997, these deposits averaged $39.0 billion and represented 66% of
Key's funds supporting earning assets compared with $41.2 billion and 71%,
respectively, for the first quarter of 1996. As shown in Figure 3 beginning on
page 22, over the past year the mix of core deposits has changed significantly.
Primary among the factors contributing to this change is a program started
during the fourth quarter of 1995 under which deposit balances (above a defined
threshold) in certain NOW and noninterest-bearing checking accounts are
transferred to money market deposit accounts, thereby reducing the level of
deposit reserves required to be maintained with the Federal Reserve. Based on
certain limitations, funds are periodically transferred back to the checking
accounts to cover checks presented for payment or withdrawals. As a result of
this program, during the first quarter of 1997, demand deposits and NOW account
balances averaging $1.7 billion and $3.6 billion, respectively, were transferred
to the money market deposit account category, compared with balances averaging
$1.0 billion and $2.1 billion, respectively, for the same period last year. In
Figure 3, the demand deposits transferred continue to be reported as
noninterest-bearing deposits, while the NOW accounts transferred are included in
the money market deposit account category. During the second quarter of 1996,
the implementation of this program was completed in the last of Key's four
banking regions. Contributing to the overall decrease in core deposits relative
to the prior year was the impact of investment alternatives (including stocks,
bonds, and mutual funds, among others) pursued by customers and the impact of
the SFF divestiture early in June 1996.
Purchased funds, which are comprised of large certificates of deposit, deposits
in foreign offices and short-term borrowings, averaged $15.7 billion for the
first quarter of 1997, up $2.6 billion, or 20%, from the comparable prior year
period. As illustrated in Figure 3, the increase was attributable primarily to a
$2.3 billion increase in short-term borrowings. Purchased funds have increased
to offset declines in the volume of core deposits and to fund asset growth.
FIGURE 20 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE AT MARCH
31, 1997
<TABLE>
<CAPTION>
Domestic Foreign
in millions Offices Offices Total
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Time remaining to maturity:
Three months or less $1,760 $935 $2,695
Over three through six months 535 -- 535
Over six through twelve months 552 -- 552
Over twelve months 648 -- 648
- -----------------------------------------------------------------------------------
Total $3,495 $935 $4,430
====== ==== ======
- -----------------------------------------------------------------------------------
</TABLE>
LIQUIDITY
Liquidity represents the availability of funding to meet the needs of
depositors, borrowers and creditors at a reasonable cost on a timely basis and
without adverse consequences. Key's ALCO actively analyzes and manages Key's
liquidity in coordination with similar committees at each affiliate bank. The
affiliate banks individually maintain liquidity in the form of short-term money
market investments, securities available for sale, anticipated prepayments and
maturities of securities, the maturity structure of their loan portfolios and
the ability to securitize and package loans for sale.
34
<PAGE> 35
Liquidity is also enhanced by a sizable concentration of core deposits,
previously discussed, which are generated by more than 1,100 full-service
banking offices in 15 states. The affiliate banks individually monitor deposit
flows and evaluate alternate pricing structures with respect to their deposit
base. This process is supported by a Central Funding Unit within Key's Funds &
Investment Management Group. This group monitors the overall mix of funding
sources in conjunction with the affiliate banks' deposit pricing and in response
to the structure of the earning assets portfolio. In addition, the affiliate
banks have access to various sources of non-core market funding (such as Federal
funds purchased, securities sold under repurchase agreements and bank notes) and
borrowings from the Federal Reserve system for short-term liquidity requirements
should the need arise. One of the affiliate banks, KeyBank USA, has a line of
credit with the Federal Reserve which provides for overnight borrowings of up to
$1.2 billion and is secured by $1.7 billion of KeyBank USA's credit card
receivables at March 31, 1997. There were no borrowings outstanding under this
line of credit as of March 31, 1997.
During the first quarter of 1997, Key's affiliate banks raised $1.4 billion
under Key's Bank Note Program which allows for the issuance of up to $12.3
billion, covering eleven affiliate banks. Of the notes issued during this
period, $650 million have original maturities in excess of one year and are
included in long-term debt, while $750 million have original maturities of one
year or less and are included in other short-term borrowings. As of March 31,
1997, the program had unused capacity of $5.9 billion.
The parent company's Commercial Paper/Note Program provides for the availability
of up to $500 million of additional short-term funding. The proceeds from this
program may be used for general corporate purposes and have been used to fund
AFG's lending activities in conjunction with securitizations of its auto loans.
The parent company also has a revolving credit agreement with several banks
under which the banks have agreed to lend collectively up to $500 million to the
parent company. This credit agreement is used primarily as a backup source of
liquidity for the Commercial Paper/Note Program. There were no borrowings
outstanding under either of these facilities as of March 31, 1997.
During the third quarter of 1996, the parent company filed a new universal shelf
registration statement with the SEC to provide for the possible issuance of up
to $1.2 billion of debt and equity securities in addition to the unused capacity
under a previous shelf registration. Accordingly, at March 31, 1997, unused
capacity under the 1996 shelf registration totaled $1.3 billion, of which $750
million is reserved for future issuance as medium-term notes. The proceeds from
the issuances under the shelf registration and the Bank Note Program discussed
previously may be used for general corporate purposes, including acquisitions.
The liquidity requirements of the parent company, primarily for dividends to
shareholders, servicing of debt and other corporate purposes are principally met
through regular dividends from affiliate banks. Excess funds are maintained in
short-term investments. The parent company has ready access to the capital
markets as a result of its favorable debt ratings which, at March 31, 1997, were
as follows:
<TABLE>
<CAPTION>
Senior Subordinated
Commercial Long-Term Long-Term
Paper Debt Debt
---------- ---------- ------------
<S> <C> <C> <C>
Duff & Phelps D-1+ AA- A+
Standard & Poor's A-2 A- BBB+
Moody's P-1 A1 A2
</TABLE>
Further information pertaining to Key's sources and uses of cash for the
three-month periods ended March 31, 1997 and 1996, is presented in the
Consolidated Statements of Cash Flow on page 6.
CAPITAL AND DIVIDENDS
Total shareholders' equity at March 31, 1997, was $4.7 billion, down $207
million, or 4%, from the December 31, 1996, balance and $450 million, or 9%,
from the end of the first quarter of 1996. The decrease from the end of the
prior year and from the year-ago quarter was due primarily to the share
repurchases discussed below, net unrealized losses on securities and dividends
paid to shareholders from current period net income. As of March 31, 1997,
cumulative net unrealized securities losses totaled $117 million and were
recorded in connection with SFAS No. 115, "Accounting for Investments in Certain
Debt and Equity Securities." This amount compares with losses of $6 million and
$15 million at December 31, 1996, and March 31, 1996, respectively. The increase
which occurred during the first quarter of 1997
35
<PAGE> 36
reflected a rise in the level of interest rates, as well as the impact of
adopting SFAS No. 125. Other factors contributing to the change in shareholders'
equity during the first three months of 1997 are shown in the Statement of
Changes in Shareholders' Equity presented on page 5.
In November 1996, the Board of Directors approved a new share repurchase program
which authorized the repurchase of up to 12,000,000 Common Shares by the end of
1997. Under the new program, shares will be repurchased from time to time in the
open market or through negotiated transactions. During the first quarter of
1997, Key repurchased 4,880,000 shares at a total cost of $258 million (an
average of $52.89 per share) and reissued 1,007,626 Treasury Shares for employee
benefit plans. Coupled with the 2,620,000 shares repurchased in the fourth
quarter of 1996, this brings the total number of shares repurchased under the
new program to 7,500,000. The 26,362,727 Treasury Shares at March 31, 1997, are
expected to be reissued over time in connection with employee stock purchase,
401(k), stock option and dividend reinvestment plans and for other corporate
purposes.
Capital adequacy is an important indicator of financial stability and
performance. Overall, Key's capital position remains strong with a ratio of
total shareholders' equity to total assets of 6.88% at March 31, 1997, compared
with 7.22% at December 31, 1996, and 7.88% at March 31, 1996. The share
repurchases and SFAS No. 115 impact previously discussed, combined with modest
asset growth, led to the decreases. Including the capital securities issued in
the fourth quarter of 1996, the ratio of total shareholders' equity to total
assets at March 31, 1997, and December 31, 1996, is 7.62% and 7.96%,
respectively.
Banking industry regulators define minimum capital ratios for bank holding
companies and their banking subsidiaries. Based on the risk-adjusted capital
rules and definitions prescribed by the banking regulators, Key's Tier I and
total risk-adjusted capital ratios at March 31, 1997, were 7.47% and 12.31%,
respectively. These compare favorably with the minimum requirements of 4.0% for
Tier I and 8.0% for total capital. The regulatory leverage ratio standard
prescribes a minimum ratio of 3.0%, although most banking organizations are
expected to maintain ratios of at least 100 to 200 basis points above the
minimum. At March 31, 1997, Key's leverage ratio was 6.68%, substantially higher
than the minimum requirement. Figure 21 presents the details of Key's regulatory
capital position at March 31, 1997, December 31, 1996, and March 31, 1996.
Under the Federal Deposit Insurance Act, the Federal bank regulators group
FDIC-insured depository institutions into five broad categories based on certain
capital ratios. The five categories are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." All of Key's affiliate banks qualify as "well
capitalized" at March 31, 1997, since they exceeded the well-capitalized
thresholds of 10%, 6% and 5% for the total capital, Tier I capital and leverage
ratios, respectively. Although these provisions are not directly applicable to
Key under existing laws and regulations, based upon its ratios Key would qualify
as "well capitalized" at March 31, 1997. The FDIC-defined capital categories may
not constitute an accurate representation of the overall financial condition or
prospects of Key or its affiliate banks.
36
<PAGE> 37
FIGURE 21 CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
<TABLE>
<CAPTION>
MARCH 31, December 31, March 31,
dollars in millions 1997 1996 1996
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
TIER I CAPITAL
Common shareholders' equity(1) $4,791 $4,887 $4,979
Qualifying preferred stock -- -- 160
Capital securities 500 500 --
Less: Goodwill (811) (824) (881)
Other intangible assets(2) (112) (121) (136)
- ---------------------------------------------------------------------------------------------------------------------------------
Total Tier I capital 4,368 4,442 4,122
- ---------------------------------------------------------------------------------------------------------------------------------
TIER II CAPITAL
Allowance for loan losses(3) 733 698 670
Qualifying long-term debt 2,102 2,103 1,326
- ---------------------------------------------------------------------------------------------------------------------------------
Total Tier II capital 2,835 2,801 1,996
- ---------------------------------------------------------------------------------------------------------------------------------
Total capital $ 7,203 $ 7,243 $ 6,118
======= ======= =======
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $52,659 $52,228 $49,615
Risk-adjusted off-balance sheet exposure 6,893 4,541 5,050
Less: Goodwill (811) (824) (881)
Other intangible assets(2) (112) (121) (136)
- ---------------------------------------------------------------------------------------------------------------------------------
Gross risk-adjusted assets 58,629 55,824 53,648
Less: Excess allowance for loan losses(3) (137) (172) (205)
- ---------------------------------------------------------------------------------------------------------------------------------
Net risk-adjusted assets $58,492 $55,652 $53,443
======= ======= =======
AVERAGE QUARTERLY TOTAL ASSETS $66,354 $65,063 $65,111
======= ======= =======
CAPITAL RATIOS
Tier I risk-adjusted capital ratio 7.47% 7.98% 7.71%
Total risk-adjusted capital ratio 12.31 13.01 11.45
Leverage ratio(4) 6.68 6.93 6.43
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Common shareholders' equity excludes the impact of net unrealized gains or
losses on securities, except for net unrealized losses on marketable
equity securities.
(2) Intangible assets (excluding goodwill and portions of purchased credit card
relationships) recorded after February 19, 1992, and deductible
portions of purchased mortgage servicing rights.
(3) The allowance for loan losses included in Tier II capital is limited to
1.25% of gross risk-adjusted assets.
(4) Tier I capital as a percentage of average quarterly assets, less goodwill
and other non-qualifying intangible assets as defined in 2 above.
37
<PAGE> 38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
In the ordinary course of business, Key is subject to legal actions
which involve claims for substantial monetary relief. Based on
information presently available to management and Key's counsel,
management does not believe that any legal actions, individually or in
the aggregate, will have a material adverse effect on the consolidated
financial condition of Key.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(10) Amendment to Form of Change of Control Agreements between KeyCorp
and certain executive officers of KeyCorp effective March 17,
1997.
(11) Computation of Net Income Per Common Share
(15) Acknowledgment Letter of Independent Auditors
(27) Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
January 17, 1997 - Item 5. Other Events and Item 7. Financial
Statements, Pro Forma Financial Statements and Exhibits. Reporting
that the Registrant issued a press release on January 16, 1997,
announcing its earnings results for the three-month period ended
December 31, 1996.
No other reports on Form 8-K were filed during the three-month period
ended March 31, 1997.
38
<PAGE> 39
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: May 13, 1997 /s/ Lee Irving
--------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
39
<PAGE> 1
EXHIBIT 10
AMENDMENT TO CHANGE OF CONTROL AGREEMENT
THIS AMENDMENT, effective as of March 17, 1997, amends the agreement
that was entered into as of October 15, 1996, between KEYCORP, an Ohio
corporation ("Key"), and [NAME OF EXECUTIVE] (the "Executive") to provide the
Executive with certain rights in the event of a Change of Control of Key, as
defined in that agreement (the "Agreement"). This Amendment (a) eliminates the
provision captioned "Excess Parachute Payment Reduction," which was originally
incorporated in the Agreement at Section 4.3, (b) substitutes for that
provision, at new section 2.4, a new provision captioned "Gross-Up of Payments
Deemed to be Excess Parachute Payments," and (c) makes various conforming
changes.
Key and the Executive agree, effective as of the date first set forth
above, as follows:
1. The first sentence of Section 1 of the Agreement is hereby amended
by deleting therefrom the text "4.3 (regarding excess parachute payments), and
4.4" and inserting in its place the text "and 4.3" so that, as amended, that
sentence reads, in its entirety, as follows:
"The benefits described in Sections 1.1, 1.2, and 1.3 below are subject
to the limitations set forth in Sections 4.1 (which requires an
election among applicable agreements providing severance benefits if
more than one such agreement would apply in the particular
circumstances of the termination of the Executive's employment and
stipulates that any payments received under this Agreement are in lieu
of other claims or rights), 4.2 (regarding withholding), and 4.3
(requiring the execution of a waiver and release by the Executive)."
2. Section 4.3 of the Agreement, captioned "Excess Parachute Payment
Reduction," is hereby deleted from the Agreement.
3. Section 4.4 of the Agreement, captioned "Waiver and Release," is
hereby renumbered as Section 4.3.
4. Section 3 of the Agreement is hereby amended by deleting the cross
reference to "Section 4.4" and substituting in its place a cross reference to
"Section 4.3".
5. Section 4.1 of the Agreement is hereby amended by deleting the text
"(y) if the Executive elects to receive payments under the Prior
Agreement, the provisions of Sections 2.1 and 2.2 of this Agreement
shall nevertheless continue to be applicable, but without duplication
of payments."
<PAGE> 2
and substituting in its place the text:
"(y) if the Executive elects to receive payments under the Prior
Agreement, the provisions of Sections 2.1, 2.2, and 2.4 of this
Agreement shall nevertheless continue to be applicable, but without
duplication of payments."
6. Section 4.2 of the Agreement is hereby amended by deleting therefrom
the text:
"Without limiting the right of Key or its Subsidiary to withhold taxes
pursuant to this Section 4.2,"
and substituting in its place the text:
"Without limiting either the right of Key or its Subsidiary to withhold
taxes pursuant to this Section 4.2 or the obligation of Key to make
gross-up payments pursuant to Section 2.4,"
7. A new Section 2.4 is hereby added to the Agreement immediately after
existing Section 2.3, reading in its entirety as follows:
"2.4 Gross-Up of Payments Deemed to be Excess Parachute Payments.
"(a) Key and the Executive acknowledge that, following a
Change of Control, one or more payments or distributions to be made by
Key to or for the benefit of the Executive (whether paid or payable or
distributed or distributable pursuant to the terms of this Agreement,
under some other plan, agreement, or arrangement, or otherwise) (a
"Payment") may be determined to be an "excess parachute payment" that
is not deductible by Key for federal income tax purposes and with
respect to which the Executive will be subject to an excise tax because
of Sections 280G and 4999, respectively, of the Internal Revenue Code
(hereinafter referred to respectively as "Section 280G" and "Section
4999"). If the Executive's employment is terminated after a Change of
Control occurs, the Accounting Firm, which, subject to any inconsistent
position asserted by the Internal Revenue Service, shall make all
determinations required to be made under this Section 2.4, shall
determine whether any Payment would be an excess parachute payment and
shall communicate its determination, together with detailed supporting
calculations, to Key and to the Executive within 30 days after the
Termination Date or such earlier time as is requested by Key. Key and
the Executive shall cooperate with each other and the Accounting Firm
and shall provide necessary information so that the Accounting Firm may
make all such determinations. Key shall pay all of the fees of the
Accounting Firm for services performed by the Accounting Firm as
contemplated in this Section 2.4.
2
<PAGE> 3
"(b) If the Accounting Firm determines that any Payment gives
rise, directly or indirectly, to liability on the part of the Executive
for excise tax under Section 4999 (and/or any penalties and/or interest
with respect to any such excise tax), Key shall make additional cash
payments to the Executive, from time to time and at the same time as
any Payment constituting an excess parachute payment is paid or
provided to the Executive, in such amounts as are necessary to put the
Executive in the same position, after payment of all federal, state,
and local taxes (whether income taxes, excise taxes under Section 4999
or otherwise, or other taxes) and any and all penalties and interest
with respect to any such excise tax, as the Executive would have been
in after payment of all federal, state, and local income taxes if the
Payments had not given rise to an excise tax under Section 4999 and no
such penalties or interest had been imposed.
"(c) If the Internal Revenue Service determines that any
Payment gives rise, directly or indirectly, to liability on the part of
the Executive for excise tax under Section 4999 (and/or any penalties
and/or interest with respect to any such excise tax) in excess of the
amount, if any, previously determined by the Accounting Firm, Key shall
make further additional cash payments to the Executive not later than
the due date of any payment indicated by the Internal Revenue Service
with respect to these matters, in such amounts as are necessary to put
the Executive in the same position, after payment of all federal,
state, and local taxes (whether income taxes, excise taxes under
Section 4999 or otherwise, or other taxes) and any and all penalties
and interest with respect to any such excise tax, as the Executive
would have been in after payment of all federal, state, and local
income taxes if the Payments had not given rise to an excise tax under
Section 4999 and no such penalties or interest had been imposed.
"(d) If Key desires to contest any determination by the
Internal Revenue Service with respect to the amount of excise tax under
Section 4999, the Executive shall, upon receipt from Key of an
unconditional written undertaking to indemnify and hold the Executive
harmless (on an after tax basis) from any and all adverse consequences
that might arise from the contesting of that determination, cooperate
with Key in that contest at Key's sole expense. Nothing in this
Paragraph (d) shall require the Executive to incur any expense other
than expenses with respect to which Key has paid to the Executive
sufficient sums so that after the payment of the expense by the
Executive and taking into account the payment by Key with respect to
that expense and any and all taxes that may be imposed upon the
Executive as a result of the Executive's receipt of that payment, the
net effect is no cost to the Executive. Nothing in this Paragraph (d)
shall require the Executive to extend the statute of limitations with
respect to any item or issue in the Executive's tax returns other than,
exclusively, the excise tax under Section 4999. If, as the result of
the contest of any assertion by the Internal Revenue Service with
respect to excise tax under Section 4999, the Executive
3
<PAGE> 4
receives a refund of a Section 4999 excise tax previously paid and/or
any interest with respect thereto, the Executive shall promptly pay to
Key such amount as will leave the Executive, net of the repayment and
all tax effects, in the same position, after all taxes and interest,
that he would have been in if the refunded excise tax had never been
paid."
8. Except as expressly amended by this Amendment, the Agreement remains
in full force and effect.
IN WITNESS WHEREOF, the parties have executed this Amendment effective
as of the date first written above.
KEYCORP
By
-------------------------------------
Robert W. Gillespie
Chairman of the Board, President, and
Chief Executive Officer
THE "EXECUTIVE"
------------------------------
[NAME OF EXECUTIVE]
4
<PAGE> 1
EXHIBIT 11
KEYCORP
COMPUTATION OF NET INCOME PER COMMON SHARE
(dollars in millions, except per share amounts)
<TABLE>
<CAPTION>
Three months ended March 31,
---------------------------
1997 1996
------------ -------------
<S> <C> <C>
NET INCOME APPLICABLE TO COMMON SHARES
Net income $ 212 $ 208
Less: Preferred dividend requirements -- 4
-------- --------
Net income applicable to Common Shares $ 212 $ 204
======== ========
NET INCOME PER COMMON SHARE
Weighted average Common Shares outstanding (000) 221,670 233,100
======== ========
Net income applicable to Common Shares $ 212 $ 204
======== ========
Net income per Common Share $ .96 $ .88
======== ========
NET INCOME PER COMMON SHARE -- PRIMARY
Weighted average Common Shares outstanding (000) 221,670 233,100
Dilutive common stock options (000)(1) 4,074 3,321
-------- --------
Weighted average Common Shares and Common Share
equivalents outstanding (000) 225,744 236,421
======== ========
Net income applicable to Common Shares $ 212 $ 204
======== ========
Net income per Common Share $ .94 $ .86
======== ========
NET INCOME PER COMMON SHARE -- FULLY DILUTED
Weighted average Common Shares outstanding (000) 221,670 233,100
Dilutive common stock options (000)(1) 4,082 3,842
-------- --------
Weighted average Common Shares and Common Share
equivalents outstanding (000) 225,752 236,942
======== ========
Net income applicable to Common Shares $ 212 $ 204
======== ========
Net income per Common Share $ .94 $ .86
======== ========
</TABLE>
- ----------
(1) Dilutive common stock options are based on the treasury stock method using
average market price in computing net income per Common Share--primary,
and the higher of period-end market price or average market price in
computing net income per Common Share--fully diluted.
40
<PAGE> 1
EXHIBIT 15
ACKNOWLEDGMENT LETTER OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
KeyCorp
We are aware of the incorporation by reference in the following KeyCorp ("Key")
Registration Statements of our review report, dated April 16, 1997, relating to
the unaudited consolidated interim financial statements of Key, included in the
Quarterly Report on Form 10-Q for the quarter ended March 31, 1997.
Form S-3 No. 33-5064
Form S-3 No. 33-10634
Form S-3 No. 33-39733
Form S-3 No. 33-51652
Form S-3 No. 33-53643
Form S-3 No. 33-56881
Form S-3 No. 33-58405
Form S-3 No. 333-10577
Form S-4 No. 33-31569
Form S-4 No. 33-44657
Form S-4 No. 33-51717
Form S-4 No. 33-55573
Form S-4 No. 33-57329
Form S-4 No. 33-61539
Form S-4 No. 333-19151
Form S-4 No. 333-19153
Form S-8 No. 2-97452
Form S-8 No. 33-21643
Form S-8 No. 33-42691
Form S-8 No. 33-45518
Form S-8 No. 33-46278
Form S-8 No. 33-52293
Form S-8 No. 33-54819
Form S-8 No. 33-56745
Form S-8 No. 33-56879
Form S-8 No. 33-31569 (Post-Effective Amendment No. 1 to Form S-4)
Form S-8 No. 33-31569 (Post-Effective Amendment No. 2 to Form S-4)
Form S-8 No. 33-31569 (Post-Effective Amendment No. 3 to Form S-4)
Form S-8 No. 33-44657 (Post-Effective Amendment No. 1 to Form S-4)
Form S-8 No. 33-51717 (Post-Effective Amendment No. 1 to Form S-4)
Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part
of the Registration Statements prepared or certified by accountants within the
meaning of Section 7 or 11 of the Securities Act of 1933.
/s/ Ernst & Young LLP
Cleveland, Ohio
May 9, 1997
41
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 3,242
<INT-BEARING-DEPOSITS> 15
<FED-FUNDS-SOLD> 368
<TRADING-ASSETS> 120
<INVESTMENTS-HELD-FOR-SALE> 7,971
<INVESTMENTS-CARRYING> 1,628
<INVESTMENTS-MARKET> 1,657
<LOANS> 49,724
<ALLOWANCE> 870
<TOTAL-ASSETS> 67,893
<DEPOSITS> 44,239
<SHORT-TERM> 11,770
<LIABILITIES-OTHER> 1,936
<LONG-TERM> 4,774
<COMMON> 500
0
246
<OTHER-SE> 4,428
<TOTAL-LIABILITIES-AND-EQUITY> 67,893
<INTEREST-LOAN> 1,095
<INTEREST-INVEST> 155
<INTEREST-OTHER> 5
<INTEREST-TOTAL> 1,255
<INTEREST-DEPOSIT> 353
<INTEREST-EXPENSE> 566
<INTEREST-INCOME-NET> 689
<LOAN-LOSSES> 67
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 575
<INCOME-PRETAX> 306
<INCOME-PRE-EXTRAORDINARY> 306
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 212
<EPS-PRIMARY> 0.96
<EPS-DILUTED> 0.94
<YIELD-ACTUAL> 4.75
<LOANS-NON> 371
<LOANS-PAST> 113
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 870
<CHARGE-OFFS> 89
<RECOVERIES> 22
<ALLOWANCE-CLOSE> 870
<ALLOWANCE-DOMESTIC> 870
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
