<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, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ______ To ______
Commission File Number 0-850
[KEYCORP LOGO]
------------------------------------------------------
(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 with a par value of $1 each 440,071,075 Shares
------------------------------------------- --------------------------------
(Title of class) (Outstanding at April 30, 1998)
The number of pages of this report is 46.
<PAGE> 2
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Item 1. Financial Statements Page Number
-------------------- -----------
<S> <C>
Consolidated Balance Sheets --
March 31, 1998, December 31, 1997 and March 31, 1997 3
Consolidated Statements of Income --
Three months ended March 31, 1998 and 1997 4
Consolidated Statements of Changes in Shareholders' Equity --
Three months ended March 31, 1998 and 1997 5
Consolidated Statements of Cash Flow --
Three months ended March 31, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 18
Item 2. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations 19
-------------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 45
-----------------
Item 6. Exhibits and Reports on Form 8-K 45
--------------------------------
Signature 45
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
KEYCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 1998 1997 1997
- -----------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and due from banks $ 3,287 $ 3,651 $ 3,242
Short-term investments 1,171 1,928 502
Securities available for sale 7,115 7,708 7,971
Investment securities (fair value: $1,213, $1,262 and $1,657) 1,182 1,230 1,628
Loans, net of unearned income of $1,235, $1,197 and $857 54,900 53,380 49,724
Less: Allowance for loan losses 900 900 870
- -----------------------------------------------------------------------------------------------------------------------------------
Net loans 54,000 52,480 48,854
Premises and equipment 924 985 1,057
Goodwill 1,052 1,071 811
Other intangible assets 99 105 130
Corporate owned life insurance 1,921 1,895 1,535
Other assets 2,447 2,646 2,163
- -----------------------------------------------------------------------------------------------------------------------------------
Total assets $73,198 $73,699 $67,893
======= ======= =======
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 9,083 $ 9,368 $ 8,986
Interest-bearing 32,253 32,005 34,318
Deposits in foreign offices - interest-bearing 325 3,700 935
- -----------------------------------------------------------------------------------------------------------------------------------
Total deposits 41,661 45,073 44,239
Federal funds purchased and securities sold under repurchase agreements 6,468 6,979 7,509
Bank notes and other short-term borrowings 7,442 5,967 4,261
Other liabilities 2,498 2,303 1,936
Long-term debt 9,041 7,446 4,774
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 67,110 67,768 62,719
Corporation-obligated mandatorily redeemable preferred capital
securities of subsidiary trusts holding solely debentures of
the Corporation (See Note 8) 750 750 500
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- --
Common Shares, $1 par value; authorized 900,000,000 shares;
issued 491,888,780, 491,888,780 and 245,944,390 shares 492 492 246
Capital surplus 1,284 1,283 1,479
Retained earnings 4,743 4,611 4,180
Loans to ESOP trustee (42) (42) (49)
Treasury stock, at cost (52,573,384, 53,824,950 and 26,362,727 shares) (1,147) (1,174) (1,065)
Accumulated other comprehensive income 8 11 (117)
- -----------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 5,338 5,181 4,674
- -----------------------------------------------------------------------------------------------------------------------------------
Total liabilities, capital securities and shareholders' equity $73,198 $73,699 $67,893
======= ======= =======
- -----------------------------------------------------------------------------------------------------------------------------------
</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 1998 1997
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INTEREST INCOME
Loans $1,165 $1,095
Taxable investment securities 3 3
Tax-exempt investment securities 13 18
Securities available for sale 129 134
Short-term investments 17 5
- ---------------------------------------------------------------------------------------------------------------
Total interest income 1,327 1,255
INTEREST EXPENSE
Deposits 347 353
Federal funds purchased and securities sold under repurchase agreements 93 88
Bank notes and other short-term borrowings 98 57
Long-term debt 125 68
- ---------------------------------------------------------------------------------------------------------------
Total interest expense 663 566
- ---------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 664 689
Provision for loan losses 77 67
- ---------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 587 622
NONINTEREST INCOME
Service charges on deposit accounts 78 71
Trust and asset management income 77 64
Investment banking and capital markets income 47 18
Credit card fees 15 23
Insurance and brokerage income 22 21
Corporate owned life insurance income 23 19
Loan securitization income 10 1
Net securities gains 2 --
Gains from sales of branches/subsidiaries 29 --
Other income 53 42
- ---------------------------------------------------------------------------------------------------------------
Total noninterest income 356 259
NONINTEREST EXPENSE
Personnel 294 290
Net occupancy 56 56
Equipment 43 43
Amortization of intangibles 23 21
Marketing 28 21
Professional fees 17 11
Other expense 139 133
- ---------------------------------------------------------------------------------------------------------------
Total noninterest expense 600 575
INCOME BEFORE INCOME TAXES 343 306
Income taxes 108 94
- ---------------------------------------------------------------------------------------------------------------
NET INCOME $ 235 $ 212
======== =======
Per Common Share:
Net income $.53 $.48
Net Income - assuming dilution .53 .47
Weighted average Common Shares outstanding (000) 438,589 443,340
Weighted average Common Shares and potential Common
Shares outstanding (000) 444,836 448,558
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
4
<PAGE> 5
KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
<TABLE>
<CAPTION>
LOANS TO TREASURY
COMMON CAPITAL RETAINED ESOP STOCK
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 $246 $1,484 $4,060 $(49) $ (854)
Net income 212
Other comprehensive income:
Adjustment related to change in accounting for
transfers of financial assets, net of deferred
tax benefit of $(25)
Net unrealized losses on securities available
for sale, net of income taxes of $(38) (1)
Total comprehensive income
Cash dividends on Common Shares ($.21 per share) (92)
Issuance of Common Shares under employee benefit
and dividend reinvestment plans-1,007,626 net
shares (5) 47
Repurchase of Common Shares-4,880,000 shares (258)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1997 $246 $1,479 $4,180 $(49) $(1,065)
===== ======= ======= ===== ========
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 $492 $1,283 $4,611 $(42) $(1,174)
Net income 235
Other comprehensive income:
Net unrealized losses on securities available
for sale, net of income taxes of $(2) (1)
Total comprehensive income
Cash dividends on Common Shares ($.235 per share) (103)
Issuance of Common Shares under employee benefit
and dividend reinvestment plans-1,251,566 net
shares 1 27
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1998 $492 $1,284 $4,743 $(42) $(1,147)
===== ======= ======= ===== ========
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE COMPREHENSIVE
dollars in millions, except per share amounts INCOME INCOME
- -------------------------------------------------------------------------------- ------------------
<S> <C> <C>
BALANCE AT DECEMBER 31, 1996 $ (6)
Net income $212
Other comprehensive income:
Adjustment related to change in accounting for
transfers of financial assets, net of deferred
tax benefit of $(25) (43) (43)
Net unrealized losses on securities available
for sale, net of income taxes of $(38) (1) (68) (68)
------------------
Total comprehensive income $101
====
Cash dividends on Common Shares ($.21 per share)
Issuance of Common Shares under employee benefit
and dividend reinvestment plans-1,007,626 net
shares
Repurchase of Common Shares-4,880,000 shares
- --------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1997 $(117)
======
- --------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 $ 11
Net income $235
Other comprehensive income:
Net unrealized losses on securities available
for sale, net of income taxes of $(2) (1) (3) (3)
------------------
Total comprehensive income $232
====
Cash dividends on Common Shares ($.235 per share)
Issuance of Common Shares under employee benefit
and dividend reinvestment plans-1,251,566 net
shares
- --------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1998 $ 8
=====
- --------------------------------------------------------------------------------
</TABLE>
(1) Net of reclassification adjustments.
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 1998 1997
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 235 $ 212
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 77 67
Depreciation expense 35 39
Amortization of intangibles 23 21
Net gains from sales of branches/subsidiaries (29) --
Net securities gains (2) --
Deferred income taxes 60 2
Net (increase) decrease in mortgage loans held for sale (263) 17
Net (increase) decrease in trading account assets 150 (83)
Decrease in accrued restructuring charge (11) (36)
Other operating activities, net 309 68
- --------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 584 307
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (1,423) (1,101)
Loans sold 71 528
Purchases of investment securities (26) (122)
Proceeds from sales of investment securities 11 7
Proceeds from prepayments and maturities of investment securities 78 91
Purchases of securities available for sale (21) (867)
Proceeds from sales of securities available for sale 18 (37)
Proceeds from prepayments and maturities of securities available for sale 597 690
Net decrease in other short-term investments 607 277
Purchases of premises and equipment (16) (60)
Proceeds from sales of premises and equipment 42 30
Proceeds from sales of other real estate owned 2 4
Net cash paid for sales of branches/subsidiaries (89) --
- --------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (149) (560)
FINANCING ACTIVITIES
Net decrease in deposits (3,271) (1,078)
Net increase in short-term borrowings 965 876
Net proceeds from issuance of long-term debt 1,693 650
Payments on long-term debt (102) (89)
Purchases of treasury shares -- (258)
Proceeds from issuance of common stock pursuant to employee
benefit and dividend reinvestment plans 19 42
Cash dividends (103) (92)
- --------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (799) 51
- --------------------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND DUE FROM BANKS (364) (202)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,651 3,444
- --------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 3,287 $ 3,242
======= =======
- --------------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $637 $539
Income taxes received 22 21
Net amount received on portfolio swaps 3 18
Noncash items:
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
1. BASIS OF PRESENTATION
The unaudited consolidated interim financial statements include the accounts of
KeyCorp and its subsidiaries ("Key"). All significant intercompany accounts and
transactions have been eliminated in consolidation. In the opinion of
management, the unaudited consolidated interim financial statements reflect all
adjustments of a normal recurring nature and disclosures which are necessary for
a fair presentation of the results for the interim periods presented, and should
be read in conjunction with the audited consolidated financial statements and
related notes included in Key's 1997 Annual Report to Shareholders. In addition,
certain reclassifications have been made to prior year amounts to conform with
the current year presentation. The results of operations for the interim periods
are not necessarily indicative of the results of operations to be expected for
the full year.
As of January 1, 1998, Key adopted Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes
reporting and display standards for comprehensive income and its components in a
full set of general-purpose financial statements. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances arising from nonowner sources.
The new statement requires Key's unrealized gains or losses on securities
available for sale, which prior to adoption were reported as a separate
component of shareholders' equity, to be included in other comprehensive income.
Since SFAS No. 130 requires only the disclosure and presentation in a prescribed
format of information customarily presented elsewhere in the financial
statements, it had no impact on Key's financial position or results of
operations. Prior year financial statements have been reclassified to conform
with the new requirements. Comprehensive income is presented in the Statement of
Changes in Shareholders' Equity on page 5.
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
131,"Disclosures about Segments of an Enterprise and Related Information." SFAS
No. 131 requires that financial and descriptive information be disclosed for
each reportable operating segment based on the management approach. The
management approach focuses on financial information that an enterprise's
decision-makers use to assess performance and make decisions about resource
allocation. Key expects that its reportable operating segments will be its major
lines of business. The statement also prescribes the enterprise-wide disclosures
to be made about products, services, geographic areas and major customers. SFAS
No. 131 is effective for annual financial statements issued for periods
beginning after December 15, 1997, and for interim financial statements in the
second year of application. Comparative information presented for earlier
periods must be restated. Key will include the disclosures required by SFAS No.
131 in its December 31, 1998, financial statements.
2. EARNINGS PER COMMON SHARE
The computation of Key's basic and diluted earnings per Common Share is as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------------
dollars in millions, except per share amounts 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
NET INCOME $235 $212
==== ====
- ----------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average Common Shares outstanding (000) 438,589 443,340
Potential Common Shares outstanding (000) (1) 6,247 5,218
- ----------------------------------------------------------------------------------------------------------------------
Weighted average Common Shares and potential
Common Shares outstanding (000) 444,836 448,558
======= =======
- ----------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per Common Share $ .53 $ .48
Net income per Common Share - assuming dilution .53 .47
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Dilutive common stock options.
7
<PAGE> 8
3. MERGERS, ACQUISITIONS AND DIVESTITURES
COMPLETED MERGERS AND ACQUISITIONS
Business combinations completed by Key during 1997 (both of which were accounted
for as purchases) are summarized below. There were no such transactions during
the three-month period ended March 31, 1998.
<TABLE>
<CAPTION>
dollars in millions COMMON
LOCATION DATE ASSETS SHARES ISSUED
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Champion Mortgage Co., Inc. New Jersey August 1997 $ 317 3,336,118(1)
Leasetec Corporation Colorado July 1997 1,080 See note(2)
- --------------------------------------------------------------------------------------------------------------
</TABLE>
1 Pre-split Common Shares.
2 In accordance with a confidentiality clause in the purchase agreement, the
terms, which are not material, have not been publicly disclosed.
CHAMPION MORTGAGE CO., INC.
On August 29, 1997, Key acquired Champion Mortgage Co., Inc. ("Champion"), a
home equity finance company headquartered in Parsippany, New Jersey. Under the
terms of the agreement, 3,336,118 pre-split Common Shares, with a value of
approximately $200 million, were exchanged for all of the outstanding shares of
Champion common stock in a transaction structured as a tax-free exchange and
accounted for as a purchase. The agreement also provides an opportunity for
Champion's shareholders to receive additional consideration in the form of Key
Common Shares valued at up to $100 million in the event that certain performance
targets related to significant increases in profitability and origination
volumes established at the date of closing are achieved over the three-year
period following the closing. In connection with the transaction, Key recorded
goodwill of approximately $195 million, which is being amortized using the
straight-line method over a period of 25 years. At closing, Champion became a
wholly owned subsidiary of Key Bank USA, National Association ("KeyBank USA"), a
wholly owned subsidiary of the parent company.
LEASETEC CORPORATION
On July 1, 1997, Key acquired an 80% interest (with an option to purchase the
remaining 20%) in Leasetec Corporation ("Leasetec"), an equipment leasing
company headquartered in Boulder, Colorado, with operations in the United States
and overseas. In connection with the transaction, which was accounted for as a
purchase, Key recorded goodwill of approximately $126 million, which is being
amortized using the straight-line method over a period of 25 years.
COMPLETED DIVESTITURES
KEY MERCHANT SERVICES, LLC
On January 21, 1998, Key sold a 51% interest in Key Merchant Services, LLC ("Key
Merchant"), a wholly owned subsidiary formed to provide merchant services to
businesses, to NOVA Information Systems, Inc. ("NOVA"). A $23 million gain ($14
million after tax) was recognized at the time of closing. Under the terms of the
agreement with NOVA, Key can receive additional consideration at the end of each
of the next three years (through 2000), provided certain revenue-related
performance targets are met. In accordance with a confidentiality clause in the
agreement, the terms, which are not material, have not been disclosed.
KEYBANK NATIONAL ASSOCIATION (WYOMING)
On July 14, 1997, Key sold KeyBank National Association (Wyoming) ("KeyBank
Wyoming"), its 28-branch Wyoming bank subsidiary. KeyBank Wyoming had assets and
deposits of approximately $1.1 billion and $931 million, respectively, at the
time of the transaction. A $53 million ($35 million after tax) gain was realized
on the KeyBank Wyoming sale and included in gains from sales of
branches/subsidiaries on the income statement.
BRANCH DIVESTITURES
On November 26, 1996, Key announced its intention to divest approximately 140
branch offices (including the 28 branches associated with the sale of KeyBank
Wyoming). During the first three months of 1998, 13 such branches with deposits
of approximately $140 million were sold, resulting in aggregate gains of $6
million ($4 million after tax) which were recorded in gains from sales of
branches/subsidiaries on the income statement. During the last three quarters of
1997, excluding the KeyBank Wyoming transaction, 76 such branches with deposits
of
8
<PAGE> 9
approximately $1.3 billion were sold, resulting in aggregate gains of $98
million ($62 million after tax) which were recorded in gains from sales of
branches/subsidiaries on the income statement. As of April 30, 1998, contracts
have been entered into to sell a total of 33 other branch offices with deposits
of approximately $571 million. The sales of these remaining branches are
expected to close during the second quarter of 1998.
4. SECURITIES
Debt securities that Key has the positive intent and ability to hold to maturity
are classified as securities held to maturity and carried at cost, adjusted for
amortization of premiums and accretion of discounts using the level yield
method. Securities held to maturity and equity securities that do not have
readily determinable fair values are presented as investment securities on the
balance sheet. Debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
account assets, reported at fair value ($385 million, $535 million and $120
million at March 31, 1998, December 31, 1997 and March 31, 1997, respectively)
and included in short-term investments on the balance sheet. Realized and
unrealized gains and losses on such assets are reported in other income on the
income statement. Debt and equity securities that Key has not classified as
investment securities or trading account assets are classified as securities
available for sale and, as such, are reported at fair value, with unrealized
gains and losses, net of income taxes, reported as a component of shareholders'
equity. Gains and losses from sales of securities available for sale are
computed using the specific identification method and included in net securities
gains (losses) on the income statement.
The amortized cost, unrealized gains and losses and approximate fair value of
securities were as follows:
<TABLE>
<CAPTION>
MARCH 31, 1998
-----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 141 $ 2 -- $ 143
States and political subdivisions 63 1 -- 64
Collateralized mortgage obligations 3,660 11 $ 5 3,666
Other mortgage-backed securities 2,762 43 14 2,791
Residual interests in securitizations 414 -- 32 382
Other securities 61 8 -- 69
- -------------------------------------------------------------------------------------------------------------------
Total securities available for sale $ 7,101 $ 65 $ 51 $ 7,115
======= ===== ===== ======
INVESTMENT SECURITIES
States and political subdivisions $ 918 $ 31 -- $ 949
Other securities 264 -- -- 264
- -------------------------------------------------------------------------------------------------------------------
Total investment securities $ 1,182 $ 31 -- $ 1,213
======= ===== ==== ======
- -------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1997
-----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- -------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 202 $ 2 -- $ 204
States and political subdivisions 52 -- -- 52
Collateralized mortgage obligations 4,045 9 $ 3 4,051
Other mortgage-backed securities 2,908 53 10 2,951
Residual interests in securitizations 418 -- 44 374
Other securities 75 1 -- 76
- -------------------------------------------------------------------------------------------------------------------
Total securities available for sale $ 7,700 $ 65 $ 57 $ 7,708
======= ==== ==== ======
INVESTMENT SECURITIES
States and political subdivisions $ 973 $ 32 -- $ 1,005
Other securities 257 -- -- 257
- -------------------------------------------------------------------------------------------------------------------
Total investment securities $ 1,230 $ 32 -- $ 1,262
======= ==== ==== ======
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE> 10
<TABLE>
<CAPTION>
MARCH 31, 1997
-----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- -------------------------------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
<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
Residual interests in securitizations 300 -- 66 234
Other securities 96 1 -- 97
- -------------------------------------------------------------------------------------------------------------------
Total securities available for sale $8,153 $29 $211 $7,971
======= ==== ===== ======
INVESTMENT SECURITIES
States and political subdivisions $1,401 $31 $2 $1,430
Other securities 227 -- -- 227
- -------------------------------------------------------------------------------------------------------------------
Total investment securities $1,628 $31 $2 $1,657
======= ==== === ======
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
5. LOANS
Loans, net of unearned income, are summarized as follows:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
in millions 1998 1997 1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial, financial and agricultural $14,526 $14,023 $12,826
Real estate-- commercial mortgage 6,953 6,952 7,107
Real estate-- construction 2,511 2,231 1,747
Commercial lease financing 4,092 3,990 2,595
- ------------------------------------------------------------------------------------------------------------
Total commercial loans 28,082 27,196 24,275
Real estate-- residential mortgage 6,107 6,204 6,164
Home equity 5,482 5,421 4,868
Credit card 1,449 1,521 1,748
Consumer--direct 2,201 2,188 2,227
Consumer--indirect 8,268 7,989 7,930
- ------------------------------------------------------------------------------------------------------------
Total consumer loans 23,507 23,323 22,937
Loans held for sale 3,311 2,861 2,512
- ------------------------------------------------------------------------------------------------------------
Total loans $54,900 $53,380 $49,724
======== ======== =======
- ------------------------------------------------------------------------------------------------------------
</TABLE>
Portfolio interest rate swaps are used to manage interest rate risk by modifying
the repricing and maturity characteristics of certain loans. Additional
information pertaining to the notional amount, fair value and weighted average
rate of such swaps as of March 31, 1998, is presented in Note 10, Financial
Instruments with Off-Balance Sheet Risk, beginning on page 14.
10
<PAGE> 11
Changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
in millions 1998 1997
- ----------------------------------------------------------------------------------------
<S> <C> <C>
Balance at beginning of period $ 900 $870
Charge-offs (100) (89)
Recoveries 23 22
- ----------------------------------------------------------------------------------------
Net charge-offs (77) (67)
Provision for loan losses 77 67
- ----------------------------------------------------------------------------------------
Balance at end of period $ 900 $870
===== ====
- ----------------------------------------------------------------------------------------
</TABLE>
6. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
At March 31, 1998, impaired loans totaled $189 million. Included in this amount
are $84 million of impaired loans for which the specifically allocated allowance
for loan losses is $26 million, and $105 million of impaired loans which are
carried at their estimated fair value without a specifically allocated allowance
for loan losses. At the end of the prior year, impaired loans totaled $196
million, of which $91 million had a specifically allocated allowance of $26
million and $105 million were carried at their estimated fair value. The average
investment in impaired loans for the first quarter of 1998 and 1997 was $193
million and $192 million, respectively.
Nonperforming assets were as follows:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
in millions 1998 1997 1997
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Impaired loans $189 $196 $193
Other nonaccrual loans 184 185 178
- ---------------------------------------------------------------------------------------------------------------
Total nonperforming loans 373 381 371
Other real estate owned ("OREO") 67 66 62
Allowance for OREO losses (24) (21) (10)
- ---------------------------------------------------------------------------------------------------------------
OREO, net of allowance 43 45 52
Other nonperforming assets 5 5 2
- ---------------------------------------------------------------------------------------------------------------
Total nonperforming assets $421 $431 $425
===== ===== ====
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
Impaired loans are evaluated individually. The fair value of collateral, if any,
or estimates of the present value of the estimated future cash flows on the loan
are used to determine the extent of impairment. When such amounts do not support
the carrying amount of the loan, the amount which management deems uncollectible
is charged to the allowance for loan losses. In instances where collateral or
other sources of repayment are sufficient, yet uncertainty exists regarding the
ultimate repayment, an allowance is specifically allocated for in the allowance
for loan losses.
Key excludes smaller-balance, homogeneous nonaccrual loans (shown in the above
table as "Other nonaccrual loans") from impairment evaluation. Generally, this
portfolio includes loans to finance residential mortgages, automobiles,
recreational vehicles, boats and mobile homes. Key applies historical loss
experience rates to these loans, adjusted based on management's assessment of
emerging credit trends and other factors. The resulting loss estimates are
specifically allocated for by loan type in the allowance for loan losses.
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 1998 1997 1997
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Senior medium-term notes due through 2005(1) $ 469 $ 493 $ 507
Subordinated medium-term notes due through 2005(1) 182 183 183
7.50% Subordinated notes due 2006(2) 250 250 250
6.75% Subordinated notes due 2006(2) 200 200 200
8.125% Subordinated notes due 2002(2) 199 199 199
8.00% Subordinated notes due 2004 125 125 125
8.40% Subordinated capital notes due 1999(3) 75 75 75
8.404% Notes due through 2001 42 42 49
All other long-term debt(9) 14 14 15
- ------------------------------------------------------------------------------------------------------------------
Total parent company(10) 1,556 1,581 1,603
Senior medium-term bank notes due through 2002(4) 4,369 3,103 1,804
Senior euro medium-term bank notes due through 2007(5) 864 840 --
6.95% Subordinated notes due 2028(6) 300 -- --
7.25% Subordinated notes due 2005(6) 200 200 200
7.85% Subordinated notes due 2002(6) 200 200 200
6.75% Subordinated notes due 2003(6) 200 200 200
7.50% Subordinated notes due 2008(6) 165 165 165
7.125% Subordinated notes due 2006(6) 250 250 250
7.55% Subordinated notes due 2006(6) 75 75 75
7.375% Subordinated notes due 2008(6) 70 70 70
Lease financing debt due through 2003(7) 496 549 --
Federal Home Loan Bank advances due through 2014(8) 264 163 193
All other long-term debt(9) 32 50 14
- ------------------------------------------------------------------------------------------------------------------
Total subsidiaries(11) 7,485 5,865 3,171
- ------------------------------------------------------------------------------------------------------------------
Total long-term debt $9,041 $7,446 $4,774
====== ====== ======
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
Portfolio interest rate swaps, caps and floors are used to manage interest rate
risk by modifying the repricing and maturity characteristics of certain
long-term debt. Additional information pertaining to the notional amount, fair
value and weighted average rate of such financial instruments as of March 31,
1998, is presented in Note 10, Financial Instruments with Off-Balance Sheet
Risk, beginning on page 14.
1 At March 31, 1998, December 31, 1997 and March 31, 1997, the senior
medium-term notes had weighted average interest rates of 6.82%, 6.64% and
6.56%, respectively, and the subordinated medium-term notes had weighted
average interest rates of 6.95%, 6.90% and 7.07%, respectively. These notes
had a combination of both fixed and floating interest rates.
2 The 7.50%, 6.75% and 8.125% subordinated notes may not be redeemed or prepaid
prior to maturity.
3 The 8.40% subordinated capital notes may, at maturity, be exchanged for common
stock, preferred stock or other eligible securities having a market value
equal to the principal amount of the notes.
4 At March 31, 1998, December 31, 1997 and March 31, 1998, senior medium-term
bank notes of subsidiaries had weighted average interest rates of 5.33%, 5.51%
and 6.54% respectively. These notes had a combination of both fixed and
floating interest rates.
5 At March 31, 1998 and December 31, 1997, the senior euro medium-term bank
notes had weighted average interest rates of 5.93% and 5.91%, respectively.
These notes are obligations of KeyBank National Association ("KeyBank N. A.")
and had fixed and floating interest rates based on the three-month London
Interbank Offered Rate ("LIBOR"). As of March 31, 1998, the $5.0 billion
Euronote Program had an unused capacity of $4.1 billion.
6 The subordinated notes are all obligations of KeyBank N. A., with the
exception of the 7.55% note which is an obligation of KeyBank USA. These notes
may not be redeemed prior to their respective maturity dates.
7 At March 31, 1998 and December 31, 1997, lease financing debt had a weighted
average interest rate of 7.12% and represented primarily nonrecourse debt
collateralized by lease equipment under operating, direct financing and sales
type leases.
12
<PAGE> 13
8 At March 31, 1998, long-term advances from the Federal Home Loan Bank ("FHLB")
had adjustable and fixed interest rates ranging from 5.23% to 12.125%. Real
estate loans and securities of $368 million, $218 million and $257 million at
March 31, 1998, December 31, 1997 and March 31, 1997, respectively,
collateralize FHLB advances.
9 Other long-term debt at March 31, 1998, December 31, 1997 and March 31, 1997,
consisted of industrial revenue bonds, capital lease obligations and various
secured and unsecured obligations of corporate subsidiaries and had weighted
average interest rates of 8.03%, 8.06% and 7.48%, respectively.
10 At March 31, 1998, unused capacity under the parent company's shelf
registration totaled $1.3 billion, including $750 million reserved for future
issuance as medium-term notes.
11 As of March 31, 1998, the Bank Note Program had an unused capacity of $8.2
billion.
8. CAPITAL SECURITIES
The corporation-obligated mandatorily redeemable preferred capital securities of
subsidiary trusts holding solely debentures of the Corporation ("capital
securities") were issued by three business trusts, KeyCorp Institutional Capital
A ("Capital A"), KeyCorp Institutional Capital B ("Capital B") and KeyCorp
Institutional Capital C ("Capital C"), all of whose common securities are owned
by the parent company. Capital A and Capital B were formed in the fourth quarter
of 1996, and Capital C was formed in the second quarter of 1997. The proceeds
from the issuances of the capital securities and common securities were used to
purchase debentures of the parent company. Capital A and Capital B hold solely
junior subordinated deferrable interest debentures of the parent company.
Capital C holds solely coupon adjusted pass-through security debentures of the
parent company. Both the debentures and related income statement effects are
eliminated in Key's financial statements.
The parent company has entered into contractual arrangements which, taken
collectively, fully and unconditionally guarantee payment of: (i) accrued and
unpaid distributions required to be paid on the capital securities; (ii) the
redemption price with respect to any capital securities called for redemption by
Capital A, Capital B or Capital C; and (iii) payments due upon a voluntary or
involuntary liquidation, winding-up or termination of Capital A, Capital B or
Capital C.
The capital securities, common securities and related debentures are summarized
as follows:
<TABLE>
<CAPTION>
INTEREST RATE MATURITY
PRINCIPAL OF CAPITAL OF CAPITAL
CAPITAL COMMON AMOUNT OF SECURITIES AND SECURITIES AND
dollars in millions SECURITIES(1) SECURITIES DEBENTURES (2) DEBENTURES DEBENTURES
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
March 31, 1998
Capital A $350 $11 $361 7.826% 2026
Capital B 150 4 154 8.250 2026
Capital C 250 8 258 6.625 2029
- ----------------------------------------------------------------------------------------------------------------------------
Total $750 $23 $773 7.510%(3) --
==== === ====
- ----------------------------------------------------------------------------------------------------------------------------
December 31, 1997 $750 $23 $773 7.510%(3) --
==== === ====
- ----------------------------------------------------------------------------------------------------------------------------
March 31, 1997 $500 $15 $515 7.953%(3) --
==== === ====
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
1 The capital securities are mandatorily redeemable upon the respective maturity
dates of the debentures or upon earlier redemption as provided in the
indenture. Each issue of capital securities carries an interest rate identical
to that of the respective debenture. The interest rate related to the capital
securities issued by Capital C may be adjusted upon the remarketing of the
capital securities on the coupon adjustment date (June 1, 1999). The capital
securities issued by Capital A and Capital B constitute minority interests in
the equity accounts of consolidated subsidiaries and, therefore, qualify as
Tier 1 capital under Federal Reserve Board Guidelines.
2 The parent company has the right to redeem the debentures purchased by Capital
A, Capital B and Capital C: (i) in whole or in part, on or after December 1,
2006, December 15, 2006, and June 1, 2009, respectively, (ii) in whole at any
time within 90 days following the occurrence and during the continuation of a
tax event or a capital treatment event (as defined in the applicable offering
circular); and (iii) for Capital C, in whole or in part on the coupon
adjustment date. If the debentures are redeemed prior to maturity, the
redemption price will be expressed as a certain percentage of, or factor added
to, the principal amount, plus any accrued but unpaid interest.
3 Weighted average rate.
13
<PAGE> 14
9. SHAREHOLDERS' EQUITY
On January 15, 1998, Key announced a two-for-one stock split effected by means
of a 100% stock dividend payable March 6, 1998, to shareholders of record as of
February 18, 1998. Except where express reference is made to Common Shares on a
pre-split basis, all relevant Common Share amounts and per Common Share data in
this report have been adjusted to reflect the split.
10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Key, mainly through its lead bank (KeyBank N. A.), is party to various financial
instruments with off-balance sheet risk. It uses these financial instruments in
the normal course of business to meet the financing needs of its customers and
to manage its exposure to market risk. Market risk includes the possibility that
Key's net interest income will be adversely affected as a result of changes in
interest rates or other economic factors. The primary financial instruments used
include commitments to extend credit, standby and commercial letters of credit,
interest rate swaps, caps and floors, futures and foreign exchange forward
contracts. All of the interest rate swaps, caps and floors, and foreign exchange
forward contracts held are over-the-counter instruments. These financial
instruments may be used for lending-related, asset and liability management and
trading purposes, as discussed in the remainder of this note. In addition to the
market risk inherent in the use of these financial instruments, each contains an
element of credit risk. Credit risk is the possibility that Key will incur a
loss due to a counterparty's failure to meet its contractual obligations.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR LENDING-RELATED PURPOSES
These instruments involve, to varying degrees, credit risk in addition to
amounts recognized in Key's balance sheet. Key mitigates its exposure to credit
risk through internal controls over the extension of credit. These controls
include the process of credit approval and review, the establishment of credit
limits and, when deemed necessary, securing collateral.
Key's commitments to extend credit are agreements with customers to provide
financing at predetermined terms as long as the customer continues to meet
specified criteria. Loan commitments serve to meet the financing needs of
customers and generally carry variable rates of interest, have fixed expiration
dates or other termination clauses, and may require the payment of fees. Since
the commitments may expire without being drawn upon, the total amount of the
commitments does not necessarily represent the future cash outlay to be made by
Key. The credit-worthiness of each customer is evaluated on a case-by-case
basis. The estimated fair values of these commitments and standby letters of
credit discussed below are not material. Key does not have any significant
concentrations of credit risk.
Standby letters of credit enhance the credit-worthiness of Key's customers by
assuring the customers' financial performance to third parties in connection
with specified transactions. Amounts drawn under standby letters of credit
generally carry variable rates of interest, and the credit risk involved is
essentially the same as that involved in the extension of loan facilities.
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.
14
<PAGE> 15
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
in millions 1998 1997 1997
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Loan commitments:
Credit card lines $ 7,053 $ 8,205 $ 8,407
Home equity 4,334 3,977 3,352
Commercial real estate and construction 1,367 1,073 1,659
Commercial and other 19,179 15,867 10,944
- -------------------------------------------------------------------------------------------------------------------
Total loan commitments 31,933 29,122 24,362
Other commitments:
Standby letters of credit 2,133 1,431 1,351
Commercial letters of credit 137 109 171
Loans sold with recourse 25 27 263
- -------------------------------------------------------------------------------------------------------------------
Total loan and other commitments $34,228 $30,689 $26,147
======= ======= =======
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES
Key manages its exposure to interest rate risk, in part, by using off-balance
sheet financial instruments, commonly referred to as derivatives. Instruments
used for this purpose modify the repricing or maturity characteristics of
specified on-balance sheet assets and liabilities. The instruments must be both
effective at reducing the risk associated with the exposure being managed, and
designated as a risk management transaction at the inception of the derivative
contract. In addition, to be considered effective, a high degree of interest
rate correlation must exist between the derivative and the specified assets or
liabilities being managed at inception and over the life of the derivative
contract. Primary among the financial instruments used by Key to manage exposure
to interest rate risk are interest rate swaps, caps and floors, otherwise
referred to as portfolio swaps, caps and floors.
The following table summarizes the notional amount, fair value, maturity,
weighted average rate received and paid, and weighted average strike price for
the various types of portfolio swaps, caps and floors used by Key.
<TABLE>
<CAPTION>
MARCH 31, 1998
----------------------------------------------------------------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR MATURITY -----------------------------------
dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY STRIKE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Interest rate swaps:
Receive fixed/pay variable-indexed amortizing(1) $ 2,325 $ 12 1.0 6.89% 5.67% N/A
Receive fixed/pay variable-conventional 3,901 108 5.9 6.66 5.84 N/A
Pay fixed/receive variable-conventional 3,281 (19) 2.2 5.71 6.18 N/A
Basis swaps 1,304 (9) 1.7 5.35 5.66 N/A
- ------------------------------------------------------------------------------------------------------------------------------------
Total 10,811 92 -- 6.26% 5.89% --
Interest rate caps, collars and corridors:
Caps purchased - one to three month LIBOR based(2) 2,995 6 1.6 N/A N/A 5.81 %
Collars - one to three month LIBOR based 350 1 4.4 N/A N/A 4.75 AND 6.50
Collar - thirty year US Treasury based 250 (12) 1.2 N/A N/A 6.06 AND 8.25
1% payout corridor(3) 200 -- 1.6 N/A N/A 6.00 TO 7.00
- ------------------------------------------------------------------------------------------------------------------------------------
Total 3,795 (5) -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total $14,606 $ 87 -- -- -- --
======= ======
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
DECEMBER 31, 1997
----------------------------------------
NOTIONAL FAIR
dollars in millions AMOUNT VALUE
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest rate swaps:
Receive fixed/pay variable-indexed amortizing(1) $ 3,449 $ 12
Receive fixed/pay variable-conventional 3,626 100
Pay fixed/receive variable-conventional 2,990 (7)
Basis swaps 1,110 (3)
- ------------------------------------------------------------------------------------------------
Total 11,175 102
Interest rate caps, collars and corridors:
Caps purchased - one to three month LIBOR based(2) 2,845 11
Collars - one to three month LIBOR based 100 --
Collar - thirty year US Treasury based 250 (15)
1% payout corridor(3) 200 1
- ------------------------------------------------------------------------------------------------
Total 3,395 (3)
- ------------------------------------------------------------------------------------------------
Total $14,570 $ 99
======= ====
- ------------------------------------------------------------------------------------------------
</TABLE>
1 Maturity is based upon expected average lives rather than contractual terms.
2 Includes $350 million and $1.0 billion of forward starting caps as of March
31, 1998 and December 31, 1997, respectively.
3 Payout is indexed to three-month LIBOR.
N/A = Not Applicable
Interest rate swap contracts involve the exchange of interest payments
calculated based on an agreed-upon amount (notional amount) and are generally
used to mitigate Key's exposure to interest rate risk on certain loans,
deposits, short-term borrowings and long-term debt. Interest rate caps and
floors involve the payment of a premium by the buyer to the seller for the right
to receive an interest differential equal to the difference between the current
interest rate and an agreed-upon interest rate ("strike rate") applied to a
notional amount. With respect to interest rate caps and floors, Key generally
purchases caps, enters into collars (a combination of simultaneously purchasing
a cap and
15
<PAGE> 16
selling a floor), and enters into corridors (a combination of simultaneously
purchasing a cap at a specified strike price and selling a cap at a higher
strike price); these instruments are used to manage the risk of adverse
movements in interest rates on specified long-term debt and short-term
borrowings. The notional amount associated with the execution of swaps, caps and
floors is significantly greater than the amount at risk.
Credit risk on swaps, caps and floors results from the possibility that the
counterparty will not meet the terms of the contract and is measured as the cost
of replacing, at current market rates, contracts in an unrealized gain position.
Key deals exclusively with counterparties with high credit ratings. With regard
to its swap contracts, Key enters into bilateral collateral arrangements and
generally arranges master netting agreements. These agreements include legal
rights of setoff that provide for the net settlement of the subject contracts
with the same counterparty in the event of default. In addition, the credit risk
exposure to the counterparty on each interest rate swap is monitored by a credit
committee. Based upon credit reviews of the counterparties, limits on 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, 1998, all counterparties were expected
to meet their obligations. At March 31, 1998, Key had 41 different
counterparties to portfolio swaps and swaps entered into to offset the risk of
customer swaps. Key had aggregate credit exposure of $101 million to 19 of these
counterparties, with the largest credit exposure to an individual counterparty
amounting to $21 million. As of the same date, Key's aggregate credit exposure
on its interest rate caps and floors totaled $8 million. Portfolio swaps
(including the impact of both the spread on the swap portfolio and the
amortization of deferred gains and losses resulting from terminated swaps) and
portfolio caps and floors increased net interest income by $10 million in the
first quarter of 1998 and $21 million in the first quarter of 1997.
Conventional interest rate swap contracts involve the receipt of amounts based
on a fixed or variable rate in exchange for payments based on variable or fixed
rates, without an exchange of the underlying notional amount. Under an indexed
amortizing swap contract, the notional amount remains constant for a specified
period of time after which, based upon the level of an index at each review
date, the swap contract will mature, the notional amount will begin to amortize,
or the swap will continue in effect until its contractual maturity. Otherwise,
the characteristics of these swaps are similar to those of conventional swap
contracts. At March 31, 1998, Key was party to $790 million and $1.5 billion of
indexed amortizing swaps that used a LIBOR index and a Constant Maturity
Treasuries ("CMT") index, respectively, for the review date measurement. Under
basis swap contracts, interest payments based on different floating indices are
exchanged. In addition, Key had $516 million of conventional pay fixed forward
starting swaps which are not included in the preceding table. These swaps had a
fair value of $.3 million, a weighted average maturity of 3.6 years, and based
upon interest rates at March 31, 1998, would receive a weighted average variable
rate of 5.89% and pay a weighted average fixed rate of 5.99%.
Based on the weighted average rates in effect at March 31, 1998, the spread on
portfolio swaps, excluding the amortization of net deferred gains on terminated
swaps, provided a positive impact on net interest income (since the weighted
average rate received exceeded the weighted average rate paid by 37 basis
points). The aggregate fair value of $92 million at the same date was derived
through the use of discounted cash flow models, which contemplate interest rates
using the applicable forward yield curve, and represents an estimate of the
unrealized gain that would be recognized if the portfolio were to be liquidated
at that date.
Interest from portfolio swaps is recognized on an accrual basis over the lives
of the respective contracts as an adjustment of the interest income or expense
of the asset or liability whose risk is being managed. Gains and losses realized
upon the termination of interest rate swaps prior to maturity are deferred as an
adjustment to the carrying amount of the asset or liability. The deferred gain
or loss is amortized using the straight-line method over the shorter of the
projected remaining life of the related contract at its termination or the
underlying asset or liability. During the first quarter of 1998, swaps with a
notional amount of $268 million were terminated, resulting in a net deferred
loss of $1 million. During the same period last year, swaps with a notional
amount of $200 million were terminated, resulting in no deferred gain or loss.
At March 31, 1998, Key had a net deferred swap gain of $13 million with a
weighted average life of 5.1 years related to the management of debt and a net
deferred loss of $1 million with a weighted average life of 3.7 years related
to the management of loans.
In addition to interest rate swaps, caps and floors, Key uses treasury-based
interest rate locks as a component of its interest rate risk management
strategy. These rate locks are being used to reduce the price risk related to
the anticipated purchase and securitization of certain indirect consumer loans.
At March 31, 1998, the rate locks had a notional amount of $1.2 billion, a
weighted average maturity of less than one month and a fair value of less than
$1 million.
16
<PAGE> 17
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES
Key also uses interest rate swaps, caps and floors, and futures contracts for
dealer activities (which are generally limited to the banks' commercial loan
customers) and enters into other positions with third parties that are intended
to mitigate the interest rate risk of the customer positions. Interest rate swap
contracts entered into with customers are typically limited to conventional
swaps, as previously described. The customer swaps, caps and floors, and
futures, as well as the third-party positions, are recorded at their estimated
fair values, and adjustments to fair value are included in investment banking
and capital markets income on the income statement.
Foreign exchange forward contracts are used by Key to accommodate the business
needs of its customers and for proprietary trading purposes. These contracts
provide for the delayed delivery or purchase of foreign currency. The foreign
exchange risk associated with such contracts is mitigated by entering into other
foreign exchange contracts with third parties. Adjustments to the fair value of
all such foreign exchange forward contracts are included in investment banking
and capital markets income on the income statement.
Key also enters into treasury options and treasury futures options for
proprietary trading purposes. Adjustments to the fair value of all such options
are included in investment banking and capital markets income on the income
statement.
At March 31, 1998, credit exposure from financial instruments held or issued for
trading purposes was limited to the aggregate fair value of each contract with a
positive fair value, or $202 million. The risk of counterparties defaulting on
their obligations is monitored on an ongoing basis. Key contracts with
counterparties with high credit ratings and enters into master netting
agreements when possible in an effort to manage credit risk.
Trading income recognized on interest rate and foreign exchange forward
contracts totaled $12 million and $5 million, respectively, for the first three
months of 1998 and $7 million and $4 million, respectively, for the first three
months of 1997.
A summary of the notional amount and the respective fair value of derivative
financial instruments held or issued for trading purposes at March 31, 1998, 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 $12.3 billion notional amount of customer
swaps presented in the table includes $5.4 billion of interest rate swaps that
receive a fixed rate and pay a variable rate, $3.9 billion of interest rate
swaps that pay a fixed rate and receive a variable rate and $3.0 billion of
basis swaps. As of March 31, 1998, these swaps had an expected average life of
6.2 years, carried a weighted average rate received of 6.39% and had a weighted
average rate paid of 6.21%.
<TABLE>
<CAPTION>
MARCH 31, 1998 THREE MONTHS ENDED MARCH 31, 1998
------------------------ -------------------------------------------
NOTIONAL FAIR AVERAGE AVERAGE
in millions AMOUNT VALUE NOTIONAL AMOUNT FAIR VALUE
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest rate contracts:
Swap assets $8,597 $145 $8,168 $155
Swap liabilities 3,727 (74) 3,740 (90)
Caps and floors purchased 794 1 810 1
Caps and floors sold 968 (1) 990 (1)
Futures purchased 295 -- 474 1
Futures sold 6,362 (2) 6,233 (4)
Foreign exchange forward contracts:
Assets 880 25 899 25
Liabilities 875 (24) 891 (24)
Treasury based option contracts:
Options purchased 4,005 31 3,276 26
Options sold 4,073 (33) 3,162 (27)
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
17
<PAGE> 18
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, 1998 and 1997, 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, 1997, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flow for the year then ended (not presented herein) and in our report
dated January 13, 1998, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying consolidated balance sheet as of December 31, 1997, is fairly
stated, in all material respects, in relation to the consolidated balance sheet
from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
April 14, 1998
18
<PAGE> 19
KEYCORP AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
This section of the report, including the highlights summarized below, provides
a discussion and analysis of the financial condition and results of operations
of Key for the periods presented. It should be read in conjunction with the
unaudited consolidated interim financial statements and notes thereto, presented
on pages 3 through 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 manage expenses; consummation of
significant business combinations or divestitures; unforseen business risks
related to Year 2000 computer systems issues; and significant changes in
accounting, tax, or regulatory practices or requirements.
Key's earnings results for the first quarter of 1998 reflected the continuation
of trends evident throughout 1997 - strong commercial loan growth, revenue
growth through diverse fee income sources, successful noninterest expense
management, stable credit quality and continued reduction in the net interest
margin. The level of Key's noninterest expense is largely the result of
strategic actions taken in 1997 to complete its transformation to a nationwide
bank-based financial services company, as well as efforts made over the same
period to streamline operations. Included in these efforts is the planned
divestiture of 140 KeyCenters first announced in November 1996. As of March 31,
1998, Key had sold or reached agreements to sell all of the 140 KeyCenters
initially targeted for sale, as well as 10 additional KeyCenters. The sales of
13 KeyCenters closed during the first quarter.
During the first quarter of 1998, Key continued to evolve as a bank-based
financial services company by broadening the scope of products and services it
offers and by continuing to reallocate its resources (including those made
available or generated by its above-mentioned divestitures of KeyCenters) to
businesses with higher earnings potential. Specifically, during the first
quarter, Key entered into a joint venture with NOVA, an Atlanta-based merchant
transaction processor which provides transaction processing and electronic
payment services to merchant clients nationwide. This joint venture, in which
Key retained a 49% interest in its proprietary merchant processing business,
enables Key to participate in the same business, but with growth prospects
expected to be enhanced by NOVA's greater scale and focus on the business as a
specialty. Key also capitalized on its 1997 acquisition of Leasetec by entering
into an agreement to form a joint venture with Compaq Capital Corporation to
provide customized equipment leasing and financing programs to Compaq's
customers in the United Kingdom, Europe and Asia. In addition, in April Key
acquired more than $800 million of marine/recreational vehicle installment loans
originated through another bank's dealer distribution network. Key's
marine/recreational portfolio, which aggregated $2.6 billion at March 31, 1998,
is the largest such portfolio held by any bank holding company in the United
States.
The preceding items are described in greater detail in the remainder of this
discussion and in the notes to the consolidated interim financial statements
referred to previously.
PERFORMANCE OVERVIEW
The selected financial data set forth in Figure 1 presents certain information
highlighting the financial performance of Key for each of the last five
quarters. 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.
Unless otherwise stated, all earnings per share data included in this section
and throughout the remainder of this discussion are presented on a diluted
basis.
19
<PAGE> 20
Net income for the first quarter of 1998 was $235 million, up 11% from $212
million in the first quarter of 1997. On a diluted per Common Share basis, Key's
first quarter 1998 earnings were $.53, representing a 13% increase from $.47
recorded in the year-ago quarter. On an annualized basis, the return on average
equity for the first quarter of 1998 was 18.25%, up from 18.07% for the same
period last year. The annualized returns on average total assets were 1.32% and
1.30% for the first quarters of 1998 and 1997, respectively.
The increase in earnings relative to the first three months of 1997 resulted
from a $97 million improvement in noninterest income. The growth in noninterest
income was partially offset by a $27 million decrease in taxable-equivalent net
interest income, due to a 52 basis point decline in the net interest margin
which more than offset a $4.9 billion increase in average earning assets. Other
factors partially offsetting the growth in noninterest income were a $25 million
rise in noninterest expense and a $10 million increase in the provision for loan
losses (equivalent to the increase in net loan charge-offs). Included in
noninterest expense in the first quarter of 1998 were $6 million ($2 million in
the first quarter of 1997) of Year 2000 computer information system compliance
expenses and distributions on capital securities (which more closely resemble
interest payments than overhead) of $14 million and $10 million in the first
quarter of 1998 and 1997, respectively. Excluding these charges, noninterest
expense increased by only $17 million from the first quarter of 1997, despite
the mid-1997 acquisitions of Champion and Leasetec. These added approximately
$18 million of noninterest expense and $23 million of revenue in the first
quarter of 1998. The efficiency ratio, which measures the extent to which
recurring revenues are absorbed by operating expenses, rose slightly to 57.39%
for the first quarter of 1998 from 56.81% for the fourth quarter of 1997, and
improved from 58.92% for the first quarter of 1997. The increase in the
efficiency ratio from the prior quarter was due to declines in Key's net
interest income and noninterest income, while the improvement from the first
quarter of last year reflected Key's consolidation efforts, revenue growth and
successful expense management initiatives.
20
<PAGE> 21
FIGURE 1 SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1998 1997
----------- -----------------------------------------------------
dollars in millions, except per share amounts FIRST FOURTH THIRD SECOND FIRST
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FOR THE PERIOD
Interest income $1,327 $1,365 $1,347 $1,295 $1,255
Interest expense 663 660 643 599 566
Net interest income 664 705 704 696 689
Provision for loan losses 77 76 102 75 67
Noninterest income 356 366 393 288 259
Noninterest expense 600 630 648 582 575
Income before income taxes 343 365 347 327 306
Net income 235 248 236 223 212
- -----------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .53 $ .56 $ .54 $ .51 $ .48
Net income-assuming dilution .53 .56 .53 .51 .47
Cash dividends .235 .21 .21 .21 .21
Book value at period end 12.15 11.83 11.55 11.02 10.64
Market price:
High 39.25 36.59 32.72 29.22 28.19
Low 31.56 28.50 27.63 23.94 24.32
Close 37.81 35.41 31.82 27.94 24.38
Weighted average Common Shares (000) 438,589 438,746 436,214 437,946 443,340
Weighted average Common Shares and
potential Common Shares (000) 444,836 445,152 442,050 442,480 448,558
- -----------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $54,900 $53,380 $53,676 $51,644 $49,724
Earning assets 64,368 64,246 63,800 61,508 59,825
Total assets 73,198 73,699 72,077 69,672 67,893
Deposits 41,661 45,073 43,870 44,626 44,239
Long-term debt 9,041 7,446 7,567 5,182 4,774
Shareholders' equity 5,338 5,181 5,076 4,814 4,674
Full-time equivalent employees 24,650 24,595 25,622 25,882 26,603
Full-service banking offices 1,006 1,015 1,088 1,130 1,161
- -----------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.32% 1.38% 1.34% 1.32% 1.30%
Return on average equity 18.25 19.16 19.41 18.85 18.07
Efficiency(1) 57.39 56.81 56.75 57.66 58.92
Overhead(2) 35.36 36.17 37.76 41.02 43.71
Net interest margin (TE) 4.23 4.50 4.58 4.69 4.75
- -----------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets(3) 7.98% 7.71% 7.74% 7.63% 7.62%
Tangible equity to tangible assets(3) 6.51 6.21 6.16 6.39 6.32
Tier 1 risk-adjusted capital 6.81 6.65 6.73 7.14 7.47
Total risk-adjusted capital 11.38 10.83 11.10 11.66 12.31
Leverage 6.61 6.40 6.33 6.65 6.68
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
The comparability of the information presented above is affected by certain
acquisitions and divestitures completed by Key in the time periods presented.
For further information concerning these transactions, refer to Note 3, Mergers,
Acquisitions and Divestitures, beginning on page 8.
1 Calculated as noninterest expense (excluding certain nonrecurring charges and
distributions on capital securities) divided by taxable-equivalent net
interest income plus noninterest income (excluding net securities transactions
and gains from branch divestitures).
2 Calculated as noninterest expense (excluding certain nonrecurring charges and
distributions on capital securities) less noninterest income (excluding net
securities transactions and gains from branch divestitures) divided by
taxable-equivalent net interest income.
3 Excluding certain capital securities receiving Tier 1 treatment, these ratios
at March 31, 1998, are 7.29% and 5.81%, respectively; at December 31, 1997,
are 7.03% and 5.52%, respectively; at September 30, 1997, are 7.04% and 5.46%,
respectively; at June 30, 1997, are 6.91% and 5.67%, respectively; and at
March 31, 1997, are 6.88% and 5.58%, respectively.
TE = Taxable Equivalent
21
<PAGE> 22
CASH BASIS FINANCIAL DATA
The selected financial data presented in Figure 2 presents certain information
highlighting the performance of Key for each of the last five quarters, adjusted
to exclude the amortization of goodwill and other intangibles considered
nonqualifying in regulatory capital computations, and related balances resulting
from business combinations recorded by Key under the purchase method of
accounting. Had these business combinations qualified for accounting under the
pooling of interests method, no intangible assets would have been recorded.
Since the amortization of goodwill and other intangibles does not result in a
cash expense, the economic value to shareholders under either accounting method
is essentially the same. Moreover, such amortization does not impact Key's
liquidity and funds management activities. Cash basis financial data provide an
additional basis for measuring a company's ability to support future growth, pay
dividends and repurchase shares. Cash basis financial data, as defined above and
presented in Figure 2, have not been adjusted to exclude the impact of other
noncash items such as depreciation, provision for loan losses, deferred income
taxes, etc. This is the only section of this report in which Key's financial
results are discussed on a cash basis.
FIGURE 2 CASH BASIS SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1998 1997
------------ -------------------------------------------------------
dollars in millions, except per share amounts FIRST FOURTH THIRD SECOND FIRST
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FOR THE PERIOD
Noninterest expense $578 $611 $628 $563 $556
Income before income taxes 365 384 367 346 325
Net income 254 269 253 239 228
- -----------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $.58 $.61 $.58 $.55 $.51
Net income - assuming dilution .57 .60 .57 .54 .51
Weighted average Common Shares (000) 438,589 438,746 436,214 437,946 443,340
Weighted average Common Shares and potential
Common Shares (000) 444,836 445,152 442,050 442,480 448,558
- -----------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.45% 1.52% 1.45% 1.43% 1.41%
Return on average equity 25.37 27.07 26.82 25.03 24.16
Efficiency(1) 55.24 55.01 54.81 55.74 56.93
- -----------------------------------------------------------------------------------------------------------------------------
GOODWILL AND NONQUALIFYING INTANGIBLES
Goodwill average balance $1,063 $1,083 $977 $803 $816
Nonqualifying intangibles average balance 99 108 106 111 116
Goodwill amortization (after tax) 16 18 14 13 13
Nonqualifying intangibles amortization (after tax) 3 3 3 3 3
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
The comparability of the information presented above is affected by certain
acquisitions and divestitures completed by Key in the time periods presented.
For further information concerning these transactions, refer to Note 3, Mergers,
Acquisitions and Divestitures, beginning on page 8.
1 Calculated as noninterest expense (excluding certain nonrecurring charges, the
amortization of goodwill and nonqualifying intangibles, and distributions on
capital securities) divided by taxable-equivalent net interest income plus
noninterest income (excluding net securities transactions and gains from
branch divestitures).
22
<PAGE> 23
LINE OF BUSINESS RESULTS
Key's four major lines of business are Key Corporate Capital, Key Consumer
Finance, Key Community Bank and Key Capital Partners ("KCP"). A summary of
financial results and significant performance measures for each major line of
business for the three-month periods ended March 31, 1998 and 1997, is presented
in Figure 3.
FIGURE 3 LINE OF BUSINESS RESULTS
<TABLE>
<CAPTION>
Three months ended March 31, 1998 KEY KEY KEY KEY KEY
CORPORATE CONSUMER COMMUNITY CAPITAL SUPPORT KEYCORP
dollars in millions CAPITAL FINANCE BANK PARTNERS & ADMIN. CONSOLIDATED
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Net interest income (TE) $113 $132 $433 $ (5) -- $673
Provision for loan losses 8 51 27 -- $(9) 77
Noninterest income 16 31 156 144 9 356
Revenue sharing--KCP1 24 -- 58 (82) -- --
Noninterest expense 35 78 384 98 5 600
Expense sharing--KCP1 22 -- 27 (49) -- --
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 88 34 209 8 13 352
Allocated income taxes and TE adjustment 31 13 64 3 6 117
- --------------------------------------------------------------------------------------------------------------------------
Net income $ 57 $ 21 $145 $ 5 $ 7 $235
======= ======= ======= ======= ======= =======
Percent of consolidated net income 24% 9% 62% 2% 3% 100%
- --------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $11,709 $12,951 $29,286 -- -- $53,946
Earning assets 11,834 13,338 37,369 $ 1,408 -- 63,949
Deposits 498 1,071 40,060 5 -- 41,634
Allocated equity 895 1,252 2,959 116 -- 5,222
- --------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average allocated equity 25.78% 6.80% 19.87% 17.48% N/M 18.25%
Efficiency 37.25 47.85 61.55 85.96 N/M 57.39
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Three months ended March 31, 1997 KEY KEY KEY KEY KEY
CORPORATE CONSUMER COMMUNITY CAPITAL SUPPORT KEYCORP
dollars in millions CAPITAL FINANCE BANK PARTNERS & ADMIN. CONSOLIDATED
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Net interest income (TE) $85 $130 $487 $ (2) -- $700
Provision for loan losses 2 49 16 -- -- 67
Noninterest income 11 23 127 99 $(1) 259
Revenue sharing--KCP(1) 21 -- 42 (63) -- --
Noninterest expense 29 62 401 73 10 575
Expense sharing--KCP(1) 19 -- 25 (44) -- --
- --------------------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 67 42 214 5 (11) 317
Allocated income taxes and TE adjustment 23 16 67 2 (3) 105
- --------------------------------------------------------------------------------------------------------------------------
Net income $44 $ 26 $147 $ 3 $(8) $212
======= ======= ======= ======= ======= =======
Percent of consolidated net income 21% 12% 69% 1% (3)% 100%
- --------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $9,392 $12,675 $27,148 -- -- $49,215
Earning assets 9,393 12,878 36,224 $ 548 -- 59,043
Deposits 420 884 42,498 1 -- 43,803
Allocated equity 646 998 3,007 107 -- 4,758
- --------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average allocated equity 27.62% 10.57% 19.83% 11.37% N/M 18.07%
Efficiency 41.03 40.52 63.41 85.29 N/M 58.92
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
1 Represents the assignment of KCP revenue and expense to the lines of business
principally responsible for maintaining the relevant customer relationships
(See description of KCP on page 26).
TE = Taxable Equivalent
N/M = Not Meaningful
The financial information discussed in the remainder of this section was derived
from the internal profitability reporting system used by management to monitor
and manage the financial performance of Key. The financial results and
performance measures reported are based on internal management
23
<PAGE> 24
accounting policies which have been developed so as to enable the results to be
compiled on a consistent basis and to reflect the underlying economics of the
businesses. These policies address the methodologies applied in connection with
funds transfer pricing as well as the allocation of certain costs and capital.
Funds transfer pricing was used in the determination of net interest income by
assigning a standard cost for funds used (or a standard credit for funds
provided) to assets and liabilities based on their maturity, prepayment and/or
repricing characteristics. The net effect of transfer pricing is included in the
Key Community Bank line of business where the securities portfolios are also
maintained. Indirect expenses were allocated based on actual volume measurements
and other criteria, as appropriate. The provision for loan losses was allocated
in an amount based primarily upon the actual net charge-offs of each respective
line of business, adjusted for loan growth and changes in risk profile. The
level of the consolidated provision for loan losses was based upon the
application of methodologies designed by management to assess the adequacy of
the consolidated allowance by focusing on a number of specific factors. These
factors are more fully discussed in the Asset Quality section of Key's Annual
Report to Shareholders.
Income taxes were allocated based on the statutory Federal income tax rate of
35% (adjusted for tax-exempt income from corporate owned life insurance,
nondeductible goodwill amortization, and tax credits associated with investments
in low-income housing projects) for the periods presented. Capital was assigned
to each line of business based on management's assessment of economic risk
factors (primarily credit, operating and market risk).
The development and application of these methodologies is a dynamic process.
Accordingly, financial results may be revised periodically to reflect management
accounting enhancements, changes in risk profile or changes in the
organization's structure. Further, unlike financial accounting, there is no
authoritative guidance for management accounting similar to generally accepted
accounting principles. Consequently, reported results are not necessarily
comparable with those presented by other companies. During the first quarter of
1998, Key enhanced its capital allocation process, including the adoption of a
refined methodology for estimating credit risk that applies more detailed risk
factors to loans, considering both their grades and terms. This methodology is
also reflected in the first quarter 1997 results of operations presented in
Figure 3.
A description of each of Key's major lines of business is presented below.
KEY CORPORATE CAPITAL
Key offers a complete range of financing, transaction processing and financial
advisory services to corporations throughout the country through its Corporate
Capital unit. It also operates one of the largest bank-affiliated equipment
leasing companies with operations conducted both domestically and throughout
Europe and Asia. Corporate Capital's business units are organized around
specialized industry client segments, inclusive of healthcare,
media/telecommunications, structured finance and commercial real estate. In
serving these targeted segments, Key Corporate Capital provides a number of
specialized services including international banking, corporate finance advisory
services, investment banking and capital markets products, and 401(k) and trust
custody products. Key is also one of the leading cash management providers in
the country.
During the first quarter of 1998, Key Corporate Capital contributed
approximately 24% of Key's consolidated earnings with net income of $57 million,
resulting in a return on average allocated equity of 25.78%. In the same period
last year, net income was $44 million, or approximately 21% of Key's
consolidated earnings, and the return on average allocated equity was 27.62%.
The increase in earnings relative to the prior year reflected higher net
interest income resulting from a 25% increase in total average loans due in
large part to both commercial lending and lease financing, as well as the impact
of the July 1997 acquisition of Leasetec. Also contributing to the improved
earnings performance was growth in noninterest income, led by investment banking
and capital markets income, and trust and asset management income. Most of the
$6 million increase in noninterest expense compared with that of the first three
months of 1997 was attributable to Leasetec, which added approximately $5
million to Key Corporate Capital's operating costs and $15 million in revenues.
The $6 million increase in the provision for loan losses from the first quarter
of 1997 reflected an anticipated increase in the level of net charge-offs.
During the first quarter of 1998, Key Corporate Capital established a strategic
alliance with Compaq Capital Corporation, forming a joint venture to provide
customized equipment leasing and financing
24
<PAGE> 25
programs to Compaq customers throughout the United Kingdom, Europe, and Asia.
This new relationship reflects the benefits derived from the infrastructure and
experience attained through the acquisition of Leasetec.
KEY CONSUMER FINANCE
Key Consumer Finance is responsible for Key's indirect, non-branch-based
consumer loan and deposit products. This line of business specializes in credit
cards, automobile loans and leases, marine and recreational vehicle loans,
education loans, home equity loans and branchless deposit-generating activities.
As of December 31, 1997, based on the volume of loans generated, Key Consumer
Finance was the third largest education lender in the nation, ranked in the top
ten in retail automobile financing and was one of the leading providers of
financing for consumer purchases of marine and recreational vehicles.
For the first quarter of 1998, Key Consumer Finance generated net income of $21
million, or approximately 9% of Key's consolidated earnings, and a return on
average allocated equity of 6.80%. In the comparable prior year period, net
income was $26 million, or approximately 12% of Key's consolidated earnings, and
the return on average allocated equity was 10.57%. Primary factors affecting
financial performance relative to the prior year were a higher level of
noninterest expense, offset in part by growth in revenue, particularly
noninterest income. The August 1997 acquisition of Champion accounted for $13
million of the $16 million increase in noninterest expense, while adding $9
million of revenue in the first quarter of 1998. Noninterest income rose by $8
million, an increase which was entirely attributable to loan securitization
income, primarily servicing fees since no securitizations were completed during
the first quarter of 1998. This reflected substantial growth in securitized
loans which are serviced by Key to $4.7 billion at March 31, 1998, from $2.8
billion a year ago. The increase in noninterest income was moderated by a
decline in credit card fees which resulted from the sale of $365 million of
out-of-franchise credit card receivables during the first and third quarters of
1997. Net interest income was relatively unchanged from the first three months
of last year as the impact of moderate loan growth was substantially offset by a
lower net interest margin. Both loan growth and the net interest margin were
adversely affected by the fourth quarter 1997 securitization of $949 million of
prime credit automobile loans with low returns on equity and the sale of the
credit card receivables discussed above. The automobile loan securitization is
consistent with Key's goal of divesting assets which do not support its return
on equity objective.
In April, Key Consumer Finance acquired more than $800 million of
marine/recreational vehicle installment loans originated through another bank's
dealer distribution network. As a result of this transaction, Key now has one of
the largest marine/recreational vehicle portfolios in the United States.
Current legislation adopted by Congress in 1993 provides that, effective July 1,
1998, the interest rates that financial institutions may earn from certain
government-guaranteed education loans will be based on a blended long-term
interest rate plus 1%, rather than the 91-day Treasury bill rate plus 2.5%
during in-school periods and 3.1% during repayment periods (the current basis).
This represents a significant reduction in interest rates based on the current
interest rate environment. If this legislation is not amended prior to July 1,
1998, it could have a substantial impact on the profitability and extent of
Key's future education lending business. Various proposals to amend the
legislation are currently being discussed in Congress though it is not clear
whether a proposal will be enacted prior to July 1, 1998, and in what form.
Management is currently in the process of evaluating the effect of the
legislation on Key, including alternative lending strategies. Key's
government-guaranteed education loans generated approximately 2% of Key's total
interest on loans recorded during the first three months of 1998.
KEY COMMUNITY BANK
Key Community Bank is responsible for delivering a complete line of branch-based
retail financial products and services to small businesses and consumers,
addressing the more complex, diverse needs of the affluent client segment and
maximizing relationship management in the commercial banking and public sector
businesses. The delivery of these products and services is accomplished through
1,006 KeyCenters, a 24-hour telephone banking call center services group, more
than 2,200 automated teller machines ("ATMs") that access 14 different networks
and comprise one of the largest ATM networks in the United States, and a core
team of relationship management professionals.
In the first quarter of 1998, net income for Key Community Bank totaled $145
million, or approximately 62% of Key's consolidated earnings, compared with $147
million, or 69%, respectively, for the first quarter of 1997. Its return on
average allocated equity was 19.87% in the first three months of 1998 and 19.83%
25
<PAGE> 26
for the same period last year. The slight decrease in earnings relative to the
prior year reflected a decline in net interest income and a higher provision for
loan losses, which were substantially offset by growth in noninterest income and
a reduction in noninterest expense. The $54 million decline in net interest
income resulted from a lower net interest margin, which more than offset the
benefits derived from a $2.1 billion, or 8%, increase in average loans
outstanding. The lower net interest margin was due to a number of factors,
including greater reliance placed on higher-cost funding to support the
incremental increase in loan portfolios, the reduction in core deposits stemming
from branch divestitures, and changes in the mix and pricing of the remaining
core deposit base in response to customer preferences and competitive pressures.
The $11 million increase in the provision for loan losses reflected both growth
in loans as well as a higher level of net charge-offs. Noninterest income rose
$45 million, or 27%, due in part to the increased focus on and diversification
of fee income sources. The largest contributions to this growth came from trust
and asset management income, investment banking and capital markets income,
service charges on deposit accounts and ATM fees. Also included in first quarter
1998 noninterest income was a $23 million gain recognized in connection with the
joint venture with NOVA. The $17 million reduction in noninterest expense was
due primarily to lower personnel costs resulting from a decrease of
approximately 1,800 in the employment base as part of Key's consolidation and
expense control initiatives.
During the first quarter of 1998, strategic developments centered around
continued efforts to reconfigure Key's delivery systems. Specific activities
included the sale of 13 branches in Maine, expansion of the ATM delivery network
through the installation of 322 ATMs (representing the completion of the initial
phase of installations to occur in ARCO convenience stores in California,
Nevada, Arizona, Washington, and Oregon), the completion of the merchant
processing joint venture with NOVA and the opening of in-store branches in
Colorado.
KEY CAPITAL PARTNERS
KCP was formed at the end of 1997 to provide clients with asset management,
investment banking and capital markets, insurance and brokerage expertise, and
is expected to play a major role in developing fee income through its broad
range of investment choices and customized products. Leveraging Key's corporate
and community banking distribution channels and client relationships will be an
essential factor in ensuring KCP's future growth and success.
As indicated in Figure 3, a significant amount of noninterest income and expense
generated by KCP is reported under either Key Corporate Capital or Key Community
Bank. This reflects Key's management accounting practice of assigning such
income and expense to whichever of those two lines of business is principally
responsible for maintaining the relationships with the customers who also avail
themselves of the products and services offered by KCP. On an all-inclusive
basis (i.e., prior to the aforementioned assignments), KCP's net income totaled
$26 million (representing 11% of Key's consolidated earnings) in the first
quarter of 1998 and $15 million (representing 7% of Key's consolidated earnings)
in the year-ago quarter. Noninterest income rose $45 million ($26 million after
revenue sharing) from the prior year. The largest contribution to this
improvement came from investment banking and capital markets income which
increased $29 million, and accounted for approximately 33% of KCP's total
noninterest income in the first quarter of 1998. In addition, revenues related
to trust and asset management activities, which comprised the majority of KCP's
noninterest income, grew by $13 million, representing an increase of 20%. The
increase in noninterest income was partially offset by a $25 million increase in
noninterest expense, primarily personnel expense which tends to rise as
noninterest income rises due to incentive compensation arrangements.
KEY SUPPORT AND ADMINISTRATION
Key Support and Administration includes activities that are not directly
attributable to one of the four major lines of business. Included in this
category are certain nonbanking affiliates, eliminations of certain intercompany
transactions and certain nonrecurring transactions. Also included are portions
of certain assets, capital and support functions not specifically identifiable
with the four major lines of business. Included in first quarter 1998 results
was $6 million of gains from the divestiture of banking offices. These gains are
more fully described elsewhere in this management's discussion.
26
<PAGE> 27
RESULTS OF OPERATIONS
NET INTEREST INCOME
Net interest income, which is comprised of interest and loan-related fee income
less interest expense, is the principal source of earnings for Key. Net interest
income is affected by a number of factors including the level, pricing, mix and
maturity of earning assets and interest-bearing liabilities (including
off-balance sheet instruments described in Note 10, Financial Instruments with
Off-Balance Sheet Risk, beginning on page 14), interest rate fluctuations and
asset quality. To facilitate comparisons in the following discussion, net
interest income is presented on a taxable-equivalent basis, which restates
tax-exempt income to an amount that would yield the same after-tax income had
the income been subject to taxation at the statutory Federal income tax rate.
Various components of the balance sheet and their respective yields and rates
which affect interest income and expense are illustrated in Figure 4. The
information presented in Figure 5 provides a summary of the effect on net
interest income of changes in yields/rates and average balances from the first
quarter of 1997 to the first quarter of 1998. A more in-depth discussion of
changes in earning assets and funding sources is presented in the Financial
Condition section beginning on page 37.
For the first quarter of 1998, net interest income was $673 million, down $27
million, or 4%, from the same period last year. This decrease reflected a 52
basis point reduction in the net interest margin to 4.23%, which more than
offset an 8% increase in average earning assets (primarily loans) to $63.9
billion. Compared with the fourth quarter of 1997, net interest income declined
by $43 million as the net interest margin fell 27 basis points, while average
earning assets rose by $469 million during the first quarter of 1998. The net
interest margin is computed by dividing annualized taxable-equivalent net
interest income by average earning assets.
The decrease in the margin since the year-ago quarter resulted from a number of
factors. Primary among these are greater reliance placed on higher-cost funding
to support the incremental increase in loan portfolios, the reduction in core
deposits stemming from branch divestitures, the repricing of preexisting loan
portfolios in a period of competitive interest rate spread compression, and
changes in the mix and pricing of the remaining core deposit base in response to
customer preferences and competitive pressures. Another factor contributing to
the contraction of the margin was an increase in the cost of funds associated
with the growth in noninterest-earning assets (such as corporate owned life
insurance). The effects of these factors were especially pronounced during an
unusually (by historical standards) prolonged period of flatness in the yield
curve which has prevailed since the third quarter of 1997.
Average earning assets for the first quarter totaled $63.9 billion, which was
$4.9 billion, or 8%, higher than the first quarter 1997 level and $469 million,
or an annualized 3%, above the fourth quarter of 1997. The growth from the
year-ago quarter reflected a $4.7 billion, or 10%, increase in loans, with
substantially all of the increase coming from the commercial portfolio. The
growth in total loans relative to the prior quarter was moderated by Key's
decision to sell nearly $1 billion of prime credit automobile loans in
mid-December 1997. These were sold consistent with the goal of divesting assets
which do not support Key's return on equity objective. Key's strategy with
respect to its loan portfolio is discussed in greater detail in the Loan section
on page 37.
Key uses portfolio interest rate swaps, caps and floors (as defined in Note 10,
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 $10.8 billion at March 31, 1998, from $11.2 billion at
year-end 1997. Over the same period, the notional amount of interest rate caps
and floors rose $400 million to $3.8 billion. For the first quarter of 1998,
interest rate swaps (including the impact of both the spread on the swap
portfolio and the amortization of deferred gains and losses resulting from
terminated swaps) and interest rate caps and floors contributed $10 million and
6 basis points to net interest income and the net interest margin, respectively.
For the same period last year, these instruments increased net interest income
by $21 million and the net interest margin by 14 basis points. The manner in
which interest rate swaps, caps and floors are used in Key's overall program of
asset and liability management is described in the following Asset and Liability
Management section.
27
<PAGE> 28
FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
<TABLE>
<CAPTION>
FIRST QUARTER 1998 FOURTH QUARTER 1997
------------------------------------ --------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Loans (1,2)
Commercial, financial and agricultural $14,066 $ 288 8.30% $13,435 $ 290 8.56%
Real estate-- commercial mortgage 6,944 156 9.11 7,132 170 9.46
Real estate-- construction 2,347 52 8.99 2,214 54 9.68
Commercial lease financing 4,471 83 7.53 4,144 77 7.37
- -------------------------------------------------------------------------------------------------------------------------
Total commercial loans 27,828 579 8.44 26,925 591 8.71
Real estate-- residential 6,164 123 8.09 6,257 140 8.88
Credit card 1,482 54 14.78 1,487 55 14.67
Other consumer 15,380 349 9.20 15,990 373 9.25
- -------------------------------------------------------------------------------------------------------------------------
Total consumer loans 23,026 526 9.26 23,734 568 9.49
Loans held for sale 3,092 63 8.26 2,645 46 6.90
- -------------------------------------------------------------------------------------------------------------------------
Total loans 53,946 1,168 8.78 53,304 1,205 8.97
Taxable investment securities 256 3 4.53 243 3 4.90
Tax-exempt investment securities(1) 940 19 8.20 1,027 21 8.11
- -------------------------------------------------------------------------------------------------------------------------
Total investment securities 1,196 22 7.46 1,270 24 7.50
Securities available for sale(1,3) 7,457 129 7.02 7,502 130 6.87
Interest-bearing deposits with banks 29 1 12.54 34 1 12.31
Federal funds sold and securities
purchased under resale agreements 912 11 4.89 811 9 4.40
Trading account assets 409 5 4.96 559 7 4.97
- -------------------------------------------------------------------------------------------------------------------------
Total short-term investments 1,350 17 5.11 1,404 17 4.80
- -------------------------------------------------------------------------------------------------------------------------
Total earning assets 63,949 1,336 8.47 63,480 1,376 8.60
Allowance for loan losses (889) (893)
Other assets 9,062 8,903
- -------------------------------------------------------------------------------------------------------------------------
$72,122 $71,490
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $11,159 90 3.27 $10,883 87 3.17
Savings deposits 3,499 18 2.09 3,789 20 2.09
NOW accounts 1,244 5 1.63 1,370 6 1.74
Certificates of deposit ($100,000 or more) 3,362 46 5.55 3,307 47 5.64
Other time deposits 12,716 171 5.45 13,084 180 5.46
Deposits in foreign offices 1,245 17 5.54 1,663 21 5.01
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 33,225 347 4.24 34,096 361 4.20
Federal funds purchased and securities
sold under repurchase agreements 7,117 93 5.30 7,335 96 5.19
Bank notes and other short-term borrowings 6,683 98 5.95 5,678 89 6.22
Long-term debt (4) 8,326 125 6.09 7,443 114 6.08
- -------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 55,351 663 4.86 54,552 660 4.80
Noninterest-bearing deposits 8,409 8,750
Other liabilities 2,390 2,304
Capital securities 750 750
Common shareholders' equity 5,222 5,134
- -------------------------------------------------------------------------------------------------------------------------
$72,122 $71,490
======== =======
Interest rate spread (TE) 3.61 3.80
- -------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 673 4.23% $ 716 4.50%
======= ===== ======== =====
Taxable-equivalent adjustment (1) $9 $11
- -------------------------------------------------------------------------------------------------------------------------
</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
28
<PAGE> 29
<TABLE>
<CAPTION>
THIRD QUARTER 1997 SECOND QUARTER 1997 FIRST QUARTER 1997
- ----------------------------------- -----------------------------------------------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
$13,101 $286 8.66% $12,844 $282 8.81% $12,248 $268 8.87%
7,088 165 9.24 7,121 165 9.29 7,130 163 9.27
2,015 49 9.65 1,853 45 9.74 1,693 40 9.58
3,820 70 7.27 2,632 42 6.40 2,623 39 6.03
- ----------------------------------- -----------------------------------------------------------------------
26,024 570 8.69 24,450 534 8.76 23,694 510 8.73
6,161 131 8.44 6,153 127 8.28 6,196 126 8.25
1,788 68 15.09 1,781 66 14.86 1,786 67 15.21
15,926 372 9.27 15,389 356 9.28 15,070 346 9.31
- ----------------------------------- -----------------------------------------------------------------------
23,875 571 9.49 23,323 549 9.44 23,052 539 9.48
2,809 54 7.63 2,600 50 7.71 2,469 48 7.88
- ----------------------------------- -----------------------------------------------------------------------
52,708 1,195 8.99 50,373 1,133 9.02 49,215 1,097 9.04
270 3 5.88 252 3 5.79 222 3 5.48
1,143 22 7.64 1,349 27 8.03 1,395 27 7.85
- ----------------------------------- -----------------------------------------------------------------------
1,413 25 7.02 1,601 30 7.52 1,617 30 7.52
7,399 127 6.86 7,822 136 7.05 7,800 134 6.99
8 -- 3.94 17 -- 3.66 17 -- 4.11
535 6 4.45 337 5 5.95 299 4 5.43
264 5 7.51 143 2 5.61 95 1 5.63
- ----------------------------------- -----------------------------------------------------------------------
807 11 5.41 497 7 5.65 411 5 5.04
- ----------------------------------- -----------------------------------------------------------------------
62,327 1,358 8.64 60,293 1,306 8.69 59,043 1,266 8.70
(873) (866) (868)
8,658 8,351 8,179
- ----------------------------------- -----------------------------------------------------------------------
$70,112 $67,778 $66,354
======= ======= =======
$10,714 82 3.04 $10,984 83 3.03 $11,008 81 2.98
4,161 22 2.10 4,519 25 2.22 4,819 27 2.27
1,547 8 2.05 1,644 9 2.20 1,682 9 2.17
3,166 46 5.76 3,341 47 5.64 3,699 50 5.48
13,389 183 5.42 13,584 181 5.34 13,037 171 5.32
2,065 29 5.57 2,361 33 5.61 1,150 15 5.31
- ----------------------------------- -----------------------------------------------------------------------
35,042 370 4.19 36,433 378 4.16 35,395 353 4.04
6,939 91 5.20 6,461 84 5.21 7,028 88 5.08
5,001 73 5.79 4,350 64 5.90 3,912 57 5.91
6,879 109 6.33 4,772 73 6.20 4,486 68 6.22
- ----------------------------------- -----------------------------------------------------------------------
53,861 643 4.74 52,016 599 4.62 50,821 566 4.52
8,551 8,432 8,408
2,125 1,998 1,867
750 588 500
4,825 4,744 4,758
- ----------------------------------- -----------------------------------------------------------------------
$70,112 $67,778 $66,354
======= ======= =======
3.90 4.07 4.18
- -----------------------------------------------------------------------------------------------------------
$715 4.58% $707 4.69% $700 4.75%
======= ===== ======= ===== ======= =====
$11 $11 $11
- -----------------------------------------------------------------------------------------------------------
</TABLE>
29
<PAGE> 30
FIGURE 5 COMPONENTS OF NET INTEREST INCOME CHANGE
<TABLE>
<CAPTION>
FROM THREE MONTHS ENDED MARCH 31, 1997,
TO THREE MONTHS ENDED MARCH 31, 1998
----------------------------------------------------
AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
INTEREST INCOME
Loans $103 $(32) $ 71
Tax-exempt investment securities (9) 1 (8)
Securities available for sale (6) 1 (5)
Short-term investments 12 -- 12
- ---------------------------------------------------------------------------------------------------------
Total interest income (TE) 100 (30) 70
INTEREST EXPENSE
Money market deposit accounts 1 8 9
Savings deposits (7) (2) (9)
NOW accounts (2) (2) (4)
Certificates of deposit ($100,000 or more) (5) 1 (4)
Other time deposits (4) 4 --
Deposits in foreign offices 1 1 2
- ---------------------------------------------------------------------------------------------------------
Total interest-bearing deposits (16) 10 (6)
Federal funds purchased and securities sold
under repurchase agreements 1 4 5
Bank notes and other short-term borrowings 41 -- 41
Long-term debt 58 (1) 57
- ---------------------------------------------------------------------------------------------------------
Total interest expense 84 13 97
- ---------------------------------------------------------------------------------------------------------
Net interest income (TE) $ 16 $(43) $(27)
====== ===== =====
- ---------------------------------------------------------------------------------------------------------
</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
ASSET AND LIABILITY MANAGEMENT
Market risk is the exposure to economic loss that arises from changes in the
values of certain market risk sensitive instruments. Types of market risk
include interest rate, foreign exchange and equity price risk; foreign exchange
and equity price risk are not material to Key. Key manages its interest rate
risk through an active program of asset and liability management pursuant to
guidelines established by its Asset/Liability Management Policy Committee
("ALCO"). The ALCO has responsibility for approving the asset/liability
management policies of Key, overseeing the formulation and implementation of
strategies to improve balance sheet positioning and/or earnings, and reviewing
the interest rate sensitivity positions of Key and each of its affiliate banks.
Short-term Interest Rate Exposure
- ---------------------------------
The primary tool utilized by management to measure and manage interest rate risk
is a net interest income simulation model. Use of the model to perform
simulations of changes in interest rates over one- and two-year time horizons
has enabled management to develop strategies for managing exposure to interest
rate risk. In its simulations, management estimates the impact on net interest
income of various pro forma changes in the overall level of interest rates.
These estimates are based on a large number of assumptions related to loan and
deposit growth, asset and liability prepayments, interest rates, on and
off-balance sheet management strategies and other factors. Management believes
that both individually and in the aggregate these assumptions are reasonable,
but the complexity of the simulation modeling process results in a sophisticated
estimate, not a precise calculation of exposure. The ALCO guidelines provide
that a gradual 200 basis point increase or decrease in short-term rates over the
next twelve-month period should not result in more than a 2% impact on net
interest income over the same period from what net interest income would have
been if such interest rates did not change. Based on the results of the
simulation model using the
30
<PAGE> 31
ALCO guidelines, as of March 31, 1998, Key would expect its net interest income
to increase by approximately $23 million if short-term interest rates gradually
decrease. Conversely, if short-term interest rates gradually increase, net
interest income would be expected to decrease by approximately $22 million. As
shown in Figure 6, Key has been operating well within the above guidelines.
FIGURE 6 NET INTEREST INCOME AT RISK TO CHANGES IN INTEREST RATES
<TABLE>
<CAPTION>
Rise Decline
<S> <C> <C>
Jun-96 -0.0113 0.0092
Sep-96 -0.0123 0.0060
Dec-96 -0.0128 0.0071
Mar-97 -0.0128 0.0090
Jun-97 -0.0113 0.0050
Sep-97 -0.0091 0.0024
Dec-97 -0.0107 0.0096
Mar-98 -0.0079 0.0082
</TABLE>
[GRAPHIC]
ESTIMATED CHANGE IN NET INTEREST INCOME
Long-term Interest Rate Exposure
- --------------------------------
Short-term interest rate risk analysis is complemented by an economic value of
equity model. This model provides the added benefit of measuring exposure to
interest rate changes outside the one- to two-year time frame measured by the
simulation model. The economic value of Key's equity is determined by modeling
the net present value of future cash flows for asset, liability and off-balance
sheet positions based on the implied forward yield curve. Economic value
analysis has several limitations including: the economic values of asset,
liability and off-balance sheet positions do not represent the true fair values
of the positions, since they do not consider factors such as credit risk and
liquidity; estimated cash flows are required for assets and liabilities with
indeterminate maturities; the future structure of the balance sheet derived from
ongoing loan and deposit activity by Key's core businesses is not factored into
present value calculations; and the analysis requires assumptions about events
that span an even longer time frame than that used in the simulation model. The
ALCO guidelines provide that an immediate 200 basis point increase or decrease
in interest rates should not result in more than a 1.75% change in the ratio of
base case economic value of equity to the sum of base case economic value of
assets and net receive fixed interest rate swaps, caps and floors. Key has been
operating well within these guidelines.
Management of Interest Rate Exposure
- ------------------------------------
Key utilizes the results of its short-term and long-term interest rate exposure
models to formulate strategies to improve balance sheet positioning and/or
earnings within interest rate risk, liquidity and capital guidelines established
by the ALCO. In addition to the interest rate exposure measured using ALCO
guidelines, the risk to earnings and economic value arising from various other
pro forma changes in the overall level of interest rates is periodically
measured. The variety of interest rate scenarios modeled, and their impact on
earnings and economic value, quantifies the level of interest rate exposure
arising from several sources, namely option risk, basis risk and gap risk.
Option risk exists in the form of options (including caps and floors) embedded
in certain products. These options permit the customer (either a loan customer
or a depositor) to take advantage of changes in interest rates without penalty.
Examples include floating-rate loans that contain an interest rate cap,
fixed-rate loans that do not contain prepayment penalties and deposits that are
withdrawable on demand. Basis risk refers to floating-rate assets and
floating-rate liabilities that reprice simultaneously, but are tied to different
indices. The risk arises when one index does not move consistently with another.
Gap risk is the risk that assets, liabilities or related interest rate swaps,
caps and floors will mature in different time frames. For example, floating-rate
loans that reprice monthly may be funded with fixed-rate certificates of deposit
that mature in one year.
To manage interest rate risk, management regularly utilizes Key's securities
portfolios, issues debt, and securitizes and sells certain consumer loans. In
addition, management has utilized interest rate swaps, caps and floors to manage
interest rate risk by modifying the repricing or maturity characteristics of
specified
31
<PAGE> 32
on-balance sheet assets and liabilities. Instruments used for this purpose are
designated as portfolio swaps, caps and floors. The decision to use these
instruments versus the on-balance sheet alternatives mentioned above depends on
various factors, including the mix and cost of funding sources, liquidity and
capital requirements. Further details pertaining to portfolio swaps, caps and
floors are included in Note 10, Financial Instruments with Off-Balance Sheet
Risk, beginning on page 14.
In addition to interest rate swaps, caps and floors, Key uses treasury-based
interest rate locks as a component of its interest rate risk management
strategy. These rate locks are being used to reduce the price risk related to
the anticipated purchase and securitization of certain indirect consumer loans.
At March 31, 1998, the rate locks had a notional amount of $1.2 billion, a
weighted average maturity of less than one month and a fair value of less than
$1 million.
Portfolio Swaps, Caps and Floors
- --------------------------------
As shown in Note 10, the estimated fair value of Key's portfolio swaps decreased
to $92 million at March 31, 1998, from a fair value of $102 million at December
31, 1997, while the notional amount of such swaps was relatively unchanged. 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 receive fixed interest rate position. Swaps with a notional amount of $268
million were terminated during the first quarter of 1998, resulting in a net
deferred loss of $1 million. Further information pertaining to the balance and
remaining amortization period of Key's deferred swap gains and losses at March
31, 1998, is also presented in Note 10. Each swap termination was made in
response to a unique set of circumstances and for various reasons; however, the
decision to terminate any swap contract is integrated strategically with asset
and liability management and other appropriate processes. During 1997 and
continuing through the first quarter of 1998, Key increased its use of portfolio
caps in response to its reduced sensitivity to potential declines in interest
rates and the heavier reliance placed on higher cost funding to support earning
asset growth. These instruments are used primarily to protect against the
adverse impact that a future rise in interest rates could have on variable rate
short-term borrowings, while having no impact in the event of a decline in
rates. Portfolio swaps, caps and floors activity for the three-month period
ended March 31, 1998, is summarized in Figure 7.
FIGURE 7 PORTFOLIO SWAPS, CAPS AND FLOORS ACTIVITY
<TABLE>
<CAPTION>
RECEIVE FIXED
------------------------ TOTAL CAPS
INDEXED PAY FIXED- BASIS PORTFOLIO AND
in millions AMORTIZING CONVENTIONAL CONVENTIONAL SWAPS SWAPS FLOORS TOTAL
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997 $3,449 $3,626 $2,990 $1,110 $11,175 $3,395 $14,570
Additions -- 301 411 394 1,106 500 1,606
Maturities -- 26 120 200 346 100 446
Terminations 268 -- -- -- 268 -- 268
Amortization 856 -- -- -- 856 -- 856
- -------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1998 $2,325 $3,901 $3,281 $1,304 $10,811 $3,795 $14,606
======= ======= ======= ======= ======= ======= =======
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
A summary of the notional amount and fair values of portfolio swaps, caps and
floors by interest rate management strategy is presented in Figure 8. The fair
value at any given date represents the estimated income (if positive) or cost
(if negative) that would be recognized if the portfolios were to be liquidated
at that date. However, because these instruments are used to alter the repricing
or maturity characteristics of specific assets and liabilities, the net
unrealized gains and losses are not recognized in earnings. Rather, interest
from these swaps, caps and floors is recognized on an accrual basis as an
adjustment of the interest income or expense from the asset or liability being
managed. In addition to the items presented in Figures 8 and 9, as of March 31,
1998, Key had $516 million of conventional pay fixed forward starting swaps
which will convert certain short term borrowings to fixed rate. These swaps had
a fair value of $.3 million and a weighted average maturity of 3.6 years.
32
<PAGE> 33
FIGURE 8 PORTFOLIO SWAPS, CAPS AND FLOORS BY INTEREST RATE MANAGEMENT STRATEGY
<TABLE>
<CAPTION>
MARCH 31, 1998 DECEMBER 31, 1997 MARCH 31, 1997
--------------------- --------------------- ----------------------
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 $ 3,806 $28 $4,630 $25 $ 6,141 $(103)
Convert fixed rate loans to variable 551 (13) 160 (1) -- --
Convert variable rate deposits and short-term borrowings
to fixed 1,980 (4) 2,080 (4) 3,082 14
Convert variable rate long-term debt to fixed 750 (2) 750 (2) 300 1
Convert fixed rate long-term debt to variable 2,420 92 2,445 87 2,087 (30)
Basis swaps - foreign currency 304 (9) 280 (3) -- --
Basis swaps - other 1,000 -- 830 -- 600 --
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps 10,811 92 11,175 102 12,210 (118)
Modify characteristics of variable rate short-term borrowings 2,980 6 2,580 2 1,964 21
Modify characteristics of variable rate long-term debt 565 1 565 10 665 9
Modify characteristics of capital securities remarketing 250 (12) 250 (15) -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio caps and floors 3,795 (5) 3,395 (3) 2,629 30
- -----------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $14,606 $87 $14,570 $99 $14,839 $(88)
======= ======= ======= ======= ======= =======
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The expected average maturities of the portfolio swaps, caps and floors at March
31, 1998, are summarized in Figure 9.
FIGURE 9 EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS, CAPS AND FLOORS
<TABLE>
<CAPTION>
March 31, 1998 RECEIVE FIXED
------------------------
TOTAL CAPS
INDEXED PAY FIXED- BASIS PORTFOLIO AND
in millions AMORTIZING CONVENTIONAL CONVENTIONAL SWAPS SWAPS FLOORS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Mature in one year or less -- $ 321 $2,032 $ 930 $ 3,283 $ 870 $ 4,153
Mature after one through five years $2,325 942 896 350 4,513 2,925 7,438
Mature after five through ten years -- 2,403 201 24 2,628 -- 2,628
Mature after ten years -- 235 152 -- 387 -- 387
- ------------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $2,325 $3,901 $3,281 $1,304 $10,811 $3,795 $14,606
======= ======= ======= ======= ======== ======= ========
- ------------------------------------------------------------------------------------------------------------------------------------
</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, an effect of this SFAS would be to disqualify
the use of hedge accounting for indexed amortizing swaps currently accounted for
by Key as hedging instruments and, therefore, would likely alter Key's use of
such instruments in the future. It is not currently practicable to estimate the
potential effects of any final standard, which may differ from its present form.
TRADING PORTFOLIO
Key's trading portfolio includes interest rate swap contracts entered into to
accommodate the needs of its customers, and other positions with third parties
that are intended to mitigate the interest rate risk of the customer positions,
foreign exchange contracts entered into to accommodate the needs of its
customers and financial assets and liabilities (trading positions) included in
short-term investments and other liabilities, respectively, on the balance
sheet. Further information pertaining to the off-balance sheet contracts is
included in Note 10, Financial Instruments with Off-Balance Sheet Risk,
beginning on page 14.
During the second half of 1997, Key began using a value at risk ("VAR") model to
estimate the adverse effect of changes in interest and foreign exchange rates on
the fair value of its trading portfolio. VAR uses statistical methods to
estimate the maximum potential one-day loss with a 95% confidence level. At
March 31, 1998, Key's aggregate daily VAR was $.6 million and averaged $.6
million for the first quarter of 1998. As of the 1997 year end, Key's aggregate
daily VAR was less than $.8 million and averaged less than $.5 million for the
second half of 1997. VAR augments other controls used by Key to mitigate the
market risk exposure of its trading portfolio. These controls are established by
Key's Financial Markets
33
<PAGE> 34
Committee and include, in addition to VAR, loss and position equivalent limits
which are based on the level of activity and volatility of trading products and
market liquidity.
NONINTEREST INCOME
As shown in Figure 10, noninterest income for the 1998 first quarter totaled
$356 million, up $97 million, or 37%, from the same period last year. This
improvement reflected growth in almost all major categories, including
investment banking and capital markets income (up $29 million), gains from sales
of branches/subsidiaries (up $29 million), trust and asset management income (up
$13 million) and loan securitization income (up $9 million). The only major
category experiencing a decrease was credit card fees, which declined by $8
million due primarily to the sales of $365 million of Key's credit card
receivables during 1997. The increase in investment banking and capital markets
income reflected higher revenues from dealer and trading activities, as well as
increased gains recognized in connection with equity capital investments. Growth
in trust and asset management income resulted from continued strong performance
of both the stock and bond markets and new business. Additional detail
pertaining to the composition of this noninterest income component is presented
in Figure 11. Key did not execute any loan securitizations during the 1998 first
quarter; the improvement in loan securitization income came primarily from
servicing fees. This reflected growth in loans securitized and sold, which are
either administered or serviced by Key, to $4.7 billion at March 31, 1998, from
$2.8 billion a year ago. Additional information pertaining to the type and
volume of these loans is included in the Loans section beginning on page 37. The
acquisitions of Leasetec and Champion, which were completed during the third
quarter of last year, contributed approximately $23 million (including $6
million of noninterest income) to the total increase in Key's revenue from the
first quarter of 1997.
Included in 1998 gains from the sales of branches/subsidiaries was $6 million in
branch divestiture gains and a $23 million gain recognized in connection with
the joint venture with NOVA. The agreement with NOVA also specifies that Key can
receive additional consideration at the end of each of the next three years
through the year 2000, provided that certain revenue-related performance targets
are met. The $23 million gain was accompanied by related reductions in both
merchant services revenue and noninterest expense (primarily personnel). The
NOVA transaction is more fully disclosed in Note 3, Mergers, Acquisitions and
Divestitures, beginning on page 8.
FIGURE 10 NONINTEREST INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- --------------------
dollars in millions 1998 1997 AMOUNT PERCENT
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Service charges on deposit accounts $ 78 $ 71 $ 7 9.9%
Trust and asset management income 77 64 13 20.3
Investment banking and capital markets income 47 18 29 161.1
Credit card fees 15 23 (8) (34.8)
Insurance and brokerage income 22 21 1 4.8
Corporate owned life insurance income 23 19 4 21.1
Loan securitization income 10 1 9 900.0
Net securities gains 2 -- 2 N/M
Gains from sales of branches/subsidiaries 29 -- 29 N/M
Other income:
Letter of credit and loan fees 17 11 6 54.5
Electronic banking fees 9 7 2 28.6
Mortgage banking income 2 2 -- --
Miscellaneous income 25 22 3 13.6
- -----------------------------------------------------------------------------------------------------------------------
Total other income 53 42 11 26.2
- -----------------------------------------------------------------------------------------------------------------------
Total noninterest income $356 $259 $97 37.5%
===== ===== =====
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
N/M = Not Meaningful
34
<PAGE> 35
FIGURE 11 TRUST AND ASSET MANAGEMENT
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- ----------------------
dollars in millions 1998 1997 AMOUNT PERCENT
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Personal asset management and custody fees $40 $34 $ 6 17.6%
Institutional asset management and custody fees 21 17 4 23.5
Bond services -- 3 (3) (100.0)
All other fees 16 10 6 60.0
- -------------------------------------------------------------------------------------------------------------------------
Total trust and asset management income $77 $64 $13 20.3%
==== ==== ====
dollars in billions
- -------------------------------------------------------------------------------------------------------------------------
MARCH 31,
Discretionary assets $ 64 $47 $17 36.2%
Non-discretionary assets 50 47 3 6.4
- -------------------------------------------------------------------------------------------------------------------------
Total trust assets $114 $94 $20 21.3%
==== ==== ====
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
NONINTEREST EXPENSE
As shown in Figure 12, noninterest expense for the first quarter of 1998 totaled
$600 million, up $25 million, or 4%, from the first quarter of 1997 with the
largest increases coming from marketing expense (up $7 million) and professional
fees (up $6 million). The 1997 acquisitions of Leasetec and Champion, accounted
for approximately $18 million of the total increase in noninterest expense from
the first three months of 1997.
Also contributing to the increase in noninterest expense from the year-ago
quarter was $4 million in distributions accrued on capital securities
(tax-advantaged preferred securities) issued by Key during the second quarter of
1997. These securities are more fully described in Note 8, Capital Securities,
on page 13. Noninterest expense for first quarter of 1998 also reflected a $4
million increase in costs incurred in connection with efforts being undertaken
by Key to modify computer information systems to be Year 2000 compliant. As of
March 31, 1998, Key had recognized approximately $24 million of the estimated
$40 million of expense that it expects to incur (primarily for internal and
external programmers) to substantially complete this project by the end of 1998.
Further information pertaining to the Year 2000 issue is included below.
The efficiency ratio, which provides a measure of the extent to which recurring
revenues are used to pay operating expenses, was 57.39% for the first quarter
compared with 58.92% in the first quarter of 1997 and 56.81% for the prior
quarter. The slight increase from the fourth quarter of 1997 was the result of
declines in Key's net interest income and noninterest income. Included in other
expense are equity-and gross receipts-based taxes which are assessed in lieu of
an income tax in certain states in which Key operates. These taxes, which are
shown in Figure 12, represented 88, 104 and 76 basis points of Key's efficiency
ratio for the first quarter of 1998, the first quarter of 1997 and the fourth
quarter of 1997, respectively. The extent to which such taxes impact the level
of noninterest expense will vary among companies based on the geographic
locations in which they conduct their business.
Year 2000
- ---------
The Year 2000 issue refers to computer systems that were originally programmed
using two digits rather than four digits to identify the applicable year. When
the year 2000 occurs, these systems could interpret the year as 1900 rather than
2000. Unless hardware, system software and applications are corrected to be Year
2000 compliant, computers and the devices they control could generate
miscalculations and create operational problems. In addition, financial
institutions may experience increases in problem loans and credit losses in the
event that borrowers fail to properly respond to this issue. Various systems
could be affected ranging from complex computer systems to telephone systems,
ATMs and elevators.
To address this issue, in 1995, Key developed a comprehensive plan, including
the formation of a team consisting of internal resources and third-party
experts. Key prioritized the various systems (including those maintained by its
business partners and suppliers) that could be affected by the Year 2000, and
35
<PAGE> 36
efforts to ensure compliance of core systems deemed critical to Key have been
accelerated. The cost of the project (currently estimated to be $40 million) and
timing of its implementation are based on management's best estimates, which
were derived using numerous assumptions about future events, including the
continued availability of certain resources and other factors. Key is monitoring
the efforts of its business partners, suppliers and customers involved in
addressing the potential problem and expects to complete substantially all of
the necessary work by the end of 1998, allowing 1999 as a year of final testing
and refinement. As of March 31, 1998, compliance efforts had been completed for
approximately 29% of the core systems identified. Key believes the efforts
described above will ensure its systems are adequately prepared for the Year
2000.
FIGURE 12 NONINTEREST EXPENSE
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, CHANGE
----------------------------- --------------------
dollars in millions 1998 1997 AMOUNT PERCENT
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Personnel $294 $290 $ 4 1.4%
Net occupancy 56 56 -- --
Equipment 43 43 -- --
Amortization of intangibles 23 21 2 9.5
Marketing 28 21 7 33.3
Professional fees 17 11 6 54.5
Other expense:
Distributions on capital securities 14 10 4 40.0
Equity-and gross receipts-based taxes 9 10 (1) (10.0)
OREO expense, net(1) 1 1 -- --
FDIC insurance assessments 2 1 1 100.0
Year 2000 expense 6 2 4 200.0
Miscellaneous 107 109 (2) (1.8)
- ---------------------------------------------------------------------------------------------------
Total other expense 139 133 6 4.5
- ---------------------------------------------------------------------------------------------------
Total noninterest expense $600 $575 $ 25 4.3%
======= ======= =======
Full-time equivalent employees at period end 24,650 26,603
Efficiency ratio(2) 57.39% 58.92%
Overhead ratio(3) 35.36 43.71
- ---------------------------------------------------------------------------------------------------
</TABLE>
1 OREO expense is net of income of $1 million for the first quarter of 1998 and
1997.
2 Calculated as noninterest expense (excluding certain nonrecurring charges and
distributions on capital securities) divided by taxable-equivalent net
interest income plus noninterest income (excluding net securities transactions
and gains from branch divestitures).
3 Calculated as noninterest expense (excluding certain nonrecurring charges and
distributions on capital securities) less noninterest income (excluding net
securities transactions and gains from branch divestitures) divided by
taxable-equivalent net interest income.
36
<PAGE> 37
INCOME TAXES
The provision for income taxes was $108 million for the three-month period ended
March 31, 1998, up from $94 million for the same period in 1997. The effective
tax rate (provision for income taxes as a percentage of income before income
taxes) for the 1998 first quarter was 31.6% compared with 30.6% for the first
quarter of 1997. Primary factors contributing to the increase in the effective
tax rate were a lower proportion of tax credits and tax-exempt income to pretax
earnings in the current year, and the favorable settlement of an IRS audit
related to an entity acquired in 1992 recorded during the first quarter of 1997.
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, 1998, total loans outstanding were $54.9 billion, up from $53.4
billion at December 31, 1997, and $49.7 billion at March 31, 1997. The
composition of the loan portfolio by loan type, as of each of these respective
dates, is presented in Note 5, Loans, beginning on page 10.
The $5.2 billion, or 10%, increase in loans outstanding from the March 31, 1997,
level was due primarily to internal growth, but also included the net impact of
acquisitions, sales and divestitures. During the third quarter of 1997, Key
acquired Leasetec and Champion, which added total loans outstanding of
approximately $1.0 billion and $225 million, respectively. The sales and
divestitures which occurred during 1998 and 1997 are summarized in Figure 13 and
included the impact of planned bank and branch divestitures, as well as the
securitization and/or sale of education loans, automobile loans and other loans
which do not meet certain return on equity, credit or other internal standards.
Key generally sells or securitizes education loans when a borrower enters
repayment status. In addition, home equity loans originated by Champion and all
non-prime automobile loans were targeted for securitization in 1997. In addition
to bank and branch divestitures, activity since March 31, 1997, included the
sale of $1.1 billion of education loans (of which $744 million was associated
with securitizations), the sale of automobile loans totaling $1.3 billion and
the sale of $249 million of home equity loans. All of the automobile loan sales
and $205 million of the home equity loan sales were associated with
securitizations. Included in the automobile loan sales was $949 million of prime
credit loans with low returns on equity. This particular portfolio was sold
during the fourth quarter of 1997 in keeping with Key's strategy of divesting
assets which do not support its return on equity objective. Also moderating the
increase in total loans over the past year was the sale of $324 million of
out-of-franchise credit card receivables which had an historically high level of
delinquency. Management will continue to explore opportunities for sales and/or
other arrangements with respect to its credit card and certain other portfolios
in efforts to improve financial returns and manage credit risk over the
remainder of 1998.
Excluding the net impact of acquisitions, sales and divestitures, loan
portfolios (other than one-to-four family mortgages and loans held for sale)
increased $5.3 billion, or 13%, since March 31, 1997, and were up $1.2 billion,
or an annualized 11% from the 1997 year end. Over the past year, the largest
increase came from commercial loans which rose by $3.2 billion, due primarily to
higher levels of commercial, financial and agricultural loans (up $1.9 billion),
real estate-construction loans (up $772 million) and lease financing receivables
(up $490 million). Additionally, consumer loans rose by $2.2 billion, and
included increases of $1.5 billion in installment loans and $668 million in home
equity loans.
37
<PAGE> 38
FIGURE 13 LOANS SOLD AND DIVESTED
<TABLE>
<CAPTION>
CREDIT CARD
in millions EDUCATION AUTOMOBILE HOME EQUITY RECEIVABLES ALL OTHER TOTAL
- -------------------------------------------------------------------------------------------------------------------------
1998
- ----------------------
<S> <C> <C> <C> <C> <C> <C>
FIRST QUARTER $71 -- -- -- $20(1) $91
- -------------------------------------------------------------------------------------------------------------------------
$71 -- -- -- $20 $91
==== ==== ===
1997
- ----------------------
Fourth quarter $ 879 $1,046 $ 44 -- $147(1) $2,116
Third quarter 100 112 205 $324 491(1) 1,232
Second quarter 52 103 -- -- -- 155
First quarter 31 456 -- 41 -- 528
- -------------------------------------------------------------------------------------------------------------------------
Total $1,062 $1,717 $249 $365 $638 $4,031
======= ======= ===== ===== ===== ======
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
1 Part of branch divestitures, including the sale of KeyBank Wyoming in the
third quarter of 1997.
The $1.5 billion increase in loans from the December 31, 1997, level also
reflected strong growth in loan portfolios other than one-to-four family
mortgages and loans held for sale. Excluding the small impact of loan sales and
branch divestitures shown in Figure 13, such loans increased $1.2 billion, or an
annualized 11%, during the first quarter of 1998. Commercial loans accounted for
$894 million of the increase with the largest growth coming from commercial,
financial and agricultural loans (up $509 million) and construction loans (up
$280 million). On the same basis, the aggregate annualized growth rate of
average outstanding balances in the commercial loan portfolio was 14% for the
first quarter of 1998 and exceeded 12% in each of the prior three quarters.
Consumer loans contributed $293 million to the first quarter increase in loans,
due principally to growth in the installment portfolio.
Shown in Figure 14 are loans which have been securitized/sold and are either
administered or serviced by Key, but not recorded on its balance sheet. Income
recognized in connection with such transactions is derived from two sources.
Noninterest income earned from servicing or administering the loans is recorded
as loan securitization income, while income earned on assets subject to
prepayment, recorded in connection with securitizations and accounted for like
investments in interest-only strip securities, is recorded as interest income on
securities available for sale.
FIGURE 14 LOANS SECURITIZED/SOLD AND ADMINISTERED OR SERVICED
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
in millions 1998 1997 1997
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Student loans $2,540 $2,611 $2,014
Automobile loans 1,493 1,601 754
Home equity loans 625 735 ___
- --------------------------------------------------------------------------------------
Total $4,658 $4,947 $2,768
======= ======= ======
- --------------------------------------------------------------------------------------
</TABLE>
SECURITIES
At March 31, 1998, the securities portfolio totaled $8.3 billion, consisting of
$7.1 billion of securities available for sale and $1.2 billion of investment
securities. This compares with a total portfolio of $8.9 billion, comprised of
$7.7 billion of securities available for sale and $1.2 billion of investment
securities, at December 31, 1997. The composition of the two securities
portfolios by type of security, as of each of these respective dates, is
presented in Note 4, Securities, starting on page 9. The decrease in
collateralized mortgage obligations and other mortgage backed securities since
the 1997 year end was due primarily to scheduled amortization, as well as
prepayments which occurred in connection with refinancings completed in the
continued low interest rate environment. Certain information pertaining to the
composition, yields, and maturities of the securities available for sale and
investment securities portfolios is presented in Figures 15 and 16,
respectively.
38
<PAGE> 39
FIGURE 15 SECURITIES AVAILABLE FOR SALE
<TABLE>
<CAPTION>
Other
U.S. Treasury, States and Collateralized Mortgage- Residual
Agencies and Political Mortgage Backed Interest in
dollars in millions Corporations Subdivisions Obligations(1) Securities(1) Securitizations
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
MARCH 31, 1998
Maturity:
One year or less $ 52 $ 2 $ 989 $ 19 --
After one through five years 53 7 2,595 1,581 $170
After five through ten years 16 44 82 1,089 212
After ten years 22 11 -- 102 --
- ------------------------------------------------------------------------------------------------------------------------------------
Fair value $143 $64 $3,666 $2,791 $382
Amortized cost 141 63 3,660 2,762 414
Weighted average yield 7.02% 6.53% 6.75% 7.27% 8.10%
Weighted average maturity 3.8 years 7.5 years 2.2 years 5.5 years 5.7 years
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1997
Fair value $204 $52 $4,051 $2,951 $374
Amortized cost 202 52 4,045 2,908 418
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 1997
Fair value $523 $41 $3,661 $3,415 $234
Amortized cost 529 41 3,720 3,467 300
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Weighted
Other Average
Securities Total Yield(2)
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Maturity:
One year or less $20 $1,082 6.56%
After one through five years 18 4,424 7.15
After five through ten years 2 1,445 7.01
After ten years 29(3) 164 6.93
- --------------------------------------------------------------------------------------------
Fair value $69 $7,115 --
Amortized cost 61 7,101 7.03%
Weighted average yield 5.70% 7.03% --
Weighted average maturity 6.8 years 3.8 years --
- --------------------------------------------------------------------------------------------
DECEMBER 31, 1997
Fair value $76 $7,708 --
Amortized cost 75 7,700 7.19%
- --------------------------------------------------------------------------------------------
MARCH 31, 1997
Fair value $97 $7,971 --
Amortized cost 96 8,153 6.67%
- --------------------------------------------------------------------------------------------
</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 equity securities with no stated maturity.
FIGURE 16 INVESTMENT SECURITIES
<TABLE>
<CAPTION>
States and Weighted
Political Other Average
dollars in millions Subdivisions Securities Total Yield(1)
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
MARCH 31, 1998
Maturity:
One year or less $305 -- $ 305 7.39%
After one through five years 420 $ 93 513 8.22
After five through ten years 155 -- 155 9.90
After ten years 38 171 209 6.10
- ------------------------------------------------------------------------------------------------------------
Amortized cost $918 $264 $1,182 7.84%
Fair value 949 264 1,213 --
Weighted average yield 8.45% 5.70% 7.84% --
Weighted average maturity 3.0 years 7.2 years 3.9 years --
- ------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1997
Amortized cost $973 $257 $1,230 7.59%
Fair value 1,005 257 1,262 --
- ------------------------------------------------------------------------------------------------------------
MARCH 31, 1997
Amortized cost $1,401 $227 $1,628 7.56%
Fair value 1,430 227 1,657 --
- ------------------------------------------------------------------------------------------------------------
</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
Key has established groups dedicated to evaluating and monitoring the level of
risk in its credit-related assets; formulating underwriting standards and
guidelines for line management; developing commercial and consumer credit
policies and systems; establishing credit-related concentration limits;
reviewing loans, leases and other corporate assets to evaluate credit quality;
and reviewing the adequacy of the allowance for loan losses ("Allowance").
Geographic diversity throughout Key is a significant factor in managing credit
risk.
39
<PAGE> 40
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.
FIGURE 17 SUMMARY OF LOAN LOSS EXPERIENCE
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions 1998 1997
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Average loans outstanding during the period $53,946 $49,215
- -----------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $900 $870
Loans charged off:
Commercial, financial and agricultural 16 12
Real estate--commercial mortgage 4 3
Real estate--construction -- 1
Commercial lease financing 1 3
- -----------------------------------------------------------------------------------------------------------
Total commercial loans 21 19
Real estate--residential mortgage 4 3
Home equity 2 1
Credit card 27 29
Consumer--direct 11 8
Consumer--indirect 35 29
- -----------------------------------------------------------------------------------------------------------
Total consumer loans 79 70
- -----------------------------------------------------------------------------------------------------------
100 89
Recoveries:
Commercial, financial and agricultural 6 8
Real estate--commercial mortgage 2 3
- -----------------------------------------------------------------------------------------------------------
Total commercial loans 8 11
Real estate--residential mortgage 1 1
Credit card 2 2
Consumer--direct 2 2
Consumer--indirect 10 6
- -----------------------------------------------------------------------------------------------------------
Total consumer loans 15 11
- -----------------------------------------------------------------------------------------------------------
23 22
- -----------------------------------------------------------------------------------------------------------
Net loans charged off (77) (67)
Provision for loan losses 77 67
- -----------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $900 $870
===== ====
- -----------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans .58% .55%
Allowance for loan losses to period end loans 1.64 1.75
Allowance for loan losses to nonperforming loans 241.29 234.50
- -----------------------------------------------------------------------------------------------------------
</TABLE>
As shown in Figure 17, net loan charge-offs in the first three months of 1998
were $77 million, or .58% of average loans, compared with $67 million, or .55%
of average loans, for the same period last year. The increase in net charge-offs
was evenly split between the commercial and consumer portfolios. The higher
level of commercial loan net charge-offs was concentrated in the commercial,
financial and agricultural portfolio and reflected significant growth in
outstanding loans over the past year. Contributing to the increase in consumer
loan net charge-offs, which occurred primarily in the direct and indirect
installment
40
<PAGE> 41
portfolios, was the continued weakness in consumer credit quality. Overall, the
level of net loan charge-offs has been fairly consistent over the past five
quarters and is expected to benefit from the fourth quarter 1997 sale of $949
million of prime credit automobile loans. As a result of the higher level of net
charge-offs, the provision for loan losses was increased to $77 million for the
first quarter of 1998 from $76 million for the prior quarter and $67 million for
the first quarter of last year. This increase reflected management's current
intention to maintain the provision for loan losses at a level equal to or above
net charge-offs.
The Allowance at March 31, 1998, was $900 million, or 1.64% of loans, compared
with $870 million, or 1.75% of loans, at March 31, 1997. Included in both the
1998 and 1997 Allowance was $26 million and $33 million, respectively, which was
specifically allocated for impaired loans. For a further discussion of impaired
loans see Note 6, Impaired Loans and Other Nonperforming Assets, on page 11. At
March 31, 1998, the Allowance was 241.29% of nonperforming loans, compared with
236.22% at December 31, 1997, and 234.50% at March 31, 1997. There have been no
significant changes in the allocation of the Allowance since year end.
The composition of nonperforming assets is shown in Figure 18. These assets
totaled $421 million at March 31, 1998, and represented .77% of loans, OREO and
other nonperforming assets compared with $431 million, or .81%, at year end 1997
and $425 million, or .85%, at March 31, 1997. The level of nonperforming assets
has remained consistent over the past five quarters, ranging from a high of $433
million at June 30, 1997, to a low of $411 million at September 30, 1997.
FIGURE 18 SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 1998 1997 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial, financial and agricultural $152 $162 $135
Real estate--commercial mortgage 77 88 88
Real estate--construction 20 21 19
Commercial lease financing 14 5 16
Real estate--residential mortgage 62 58 64
Consumer 48 47 49
- -----------------------------------------------------------------------------------------------------------------------
Total nonperforming loans (1) 373 381 371
OREO 67 66 62
Allowance for OREO losses (24) (21) (10)
- -----------------------------------------------------------------------------------------------------------------------
OREO, net of allowance 43 45 52
Other nonperforming assets 5 5 2
- -----------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $421 $431 $425
===== ===== ====
- -----------------------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $159 $132 $113
- -----------------------------------------------------------------------------------------------------------------------
Nonperforming loans to period end loans .68% .71% .75%
Nonperforming assets to period end loans plus
OREO and other nonperforming assets .77 .81 .85
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
1 Includes impaired loans of $189 million, $196 million and $193 million at
March 31, 1998, December 31, 1997 and March 31, 1997, respectively.
DEPOSITS AND OTHER SOURCES OF FUNDS
Core deposits, defined as domestic deposits other than certificates of deposit
of $100,000 or more, are Key's primary source of funding. During the first
quarter of 1998, these deposits averaged $37.0 billion and represented 58% of
Key's funds supporting earning assets, compared with $39.0 billion and 66%,
respectively, during the first three months of 1997. Over the past year the
decrease in core deposits was due primarily to declines in the levels of both
savings deposits and NOW accounts. This resulted primarily from the sale of
KeyBank Wyoming in July 1997 and the divestiture of 89 other branch offices
since March 31, 1997. The divested branches (including KeyBank Wyoming) had
deposits of approximately $2.4 billion. Also contributing to both the decrease
and change in the mix of core deposits were investment alternatives pursued by
customers in response to the continued strength of the stock and bond
41
<PAGE> 42
markets. The increase in money market deposit accounts over the past two
quarters reflects these customer preferences as well as actions taken by
management to reprice such deposits.
Purchased funds, which are comprised of large certificates of deposit, deposits
in foreign offices and short-term borrowings, averaged $18.4 billion during the
first quarter of 1998, up $2.6 billion, or 17%, from the comparable prior year
period. As illustrated in Figure 4, the increase was attributable to higher
levels of short-term borrowings and deposits in foreign offices, which rose by
$2.9 billion and $95 million, respectively. Purchased funds have been more
heavily relied upon to offset declines in the volume of core deposits and to
fund earning asset growth. This trend is expected to continue well into 1998 due
in large part to the impact of the bank and branch divestitures which are
expected to be completed near the close of the second quarter.
FIGURE 19 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE
<TABLE>
<CAPTION>
March 31, 1998 DOMESTIC FOREIGN
in millions OFFICES OFFICES TOTAL
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Time remaining to maturity:
Three months or less $1,863 $325 $2,188
Over three through six months 634 -- 634
Over six through twelve months 549 -- 549
Over twelve months 424 -- 424
- ----------------------------------------------------------------------------------------
Total $3,470 $325 $3,795
======= ===== ======
- ----------------------------------------------------------------------------------------
</TABLE>
LIQUIDITY
Key actively analyzes and manages its liquidity, which represents the
availability of funding to meet the needs of depositors, borrowers and creditors
at a reasonable cost on a timely basis and without adverse consequences. The
affiliate banks maintain liquidity in the form of short-term money market
investments, securities available for sale, anticipated prepayments and
maturities on securities, the maturity structure of their loan portfolios and
the ability to securitize and package loans for sale. Liquidity is also enhanced
by a sizable concentration of core deposits, previously discussed, which are
generated by more than 1,000 full-service KeyCenters in 13 states. The affiliate
banks monitor deposit flows and evaluate alternate pricing structures with
respect to their deposit base. This process is supported by Key's Funds &
Investment Management Group, which 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 money market funding (such as Federal funds
purchased, securities sold under repurchase agreements and bank notes) and
borrowings from the Federal Reserve system for short-term liquidity requirements
should the need arise. One of the affiliate banks, KeyBank USA, has a line of
credit with the Federal Reserve, which provides for overnight borrowings of up
to $980 million and is secured by $1.4 billion of KeyBank USA's credit card
receivables at March 31, 1998. There were no borrowings outstanding under this
line of credit as of March 31, 1998.
During the first quarter of 1998, Key's affiliate banks raised $4.1 billion
under Key's Bank Note Program, which provides for the issuance of up to $13
billion ($12 billion by KeyBank N.A. and $1 billion by KeyBank USA). Of the
notes issued during the first quarter, $1.6 billion have original maturities in
excess of one year and are included in long-term debt, while $2.5 billion have
original maturities of one year or less and are included in short-term
borrowings. At March 31, 1998, the program had an unused capacity of $8.2
billion.
During the second quarter of 1997, Key diversified its funding sources by
establishing a Euronote Program under which the parent company, KeyBank N.A. and
KeyBank USA may issue both long- and short-term debt of up to $5 billion in the
aggregate. The notes will be offered exclusively to non-U.S. investors and can
be denominated in dollars and most European currencies. There was $864 million
of borrowings outstanding under this facility as of March 31, 1998, $24 million
of which was issued during the first quarter.
The parent company has a commercial paper program and a four-year revolving
credit agreement; both facilities provide funding availability of $500 million.
The proceeds from the commercial paper program
42
<PAGE> 43
may be used for general corporate purposes and have been used to fund certain
non-prime automobile lending activities in conjunction with securitizations.
There were no borrowings outstanding under either of these facilities as of
March 31, 1998.
The parent company also has a universal shelf registration statement on file
with the SEC, which provides for the possible issuance of up to $1.3 billion of
debt and equity securities. At March 31, 1998, unused capacity under the shelf
registration totaled $1.3 billion, including $750 million reserved for future
issuance as medium-term notes. The proceeds from the issuances under the shelf
registration, the Bank Note Program and the Euronote Program described above may
be used for general corporate purposes, including acquisitions.
The liquidity requirements of the parent company, primarily for dividends to
shareholders, servicing of debt and other corporate purposes are principally met
through regular dividends from affiliate banks. Excess funds are maintained in
short-term investments. The parent company has ready access to the capital
markets as a result of its favorable debt ratings which, at March 31, 1998, were
as follows:
<TABLE>
<CAPTION>
Senior Subordinated
Commercial Long-Term Long-Term
Paper Debt Debt
--------------- ----------------- -----------------
<S> <C> <C> <C>
Duff & Phelps D-1 A+ 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, 1998 and 1997, is presented in the
Consolidated Statements of Cash Flow on page 6.
CAPITAL AND DIVIDENDS
Total shareholders' equity at March 31, 1998, was $5.3 billion, up $157 million,
or 3%, from the December 31, 1997, balance and $664 million, or 14%, from the
end of the first quarter of 1997. The increase from the end of the prior year
and from the year-ago quarter was due primarily to retained net income, offset
in part by dividends paid to shareholders. The increase over the past 12 months
was also moderated by a net increase in treasury stock resulting from the share
repurchases which occurred during the last three quarters of 1997. Other factors
contributing to the change in shareholders' equity during the first three months
of 1998 are shown in the Statement of Changes in Shareholders' Equity presented
on page 5.
In January 1998, the Board of Directors approved a share repurchase program
which authorized the repurchase from that date of up to 5,000,000 Common Shares
(10,000,000 shares on a post-split basis), with no expiration date for the
authority. Under the program, shares may be repurchased from time to time in the
open market or through negotiated transactions. During the first quarter of
1998, Key did not repurchase any shares under this program and reissued
1,251,566 Treasury Shares for employee benefit and dividend reinvestment plans.
The 52,573,384 Treasury Shares at March 31, 1998, are expected to be reissued
over time in connection with employee stock purchase, 401(k), stock option and
dividend reinvestment plans and for other corporate purposes.
Capital adequacy is an important indicator of financial stability and
performance. Overall, Key's capital position remains strong with a ratio of
total shareholders' equity to total assets of 7.98% at March 31, 1998, compared
with 7.71% at December 31, 1997, and 7.62% at March 31, 1997. Excluding certain
capital securities receiving Tier 1 treatment, these ratios are 7.29%, 7.03% and
6.88%, respectively.
Banking industry regulators define minimum capital ratios for bank holding
companies and their banking subsidiaries. Based on risk-adjusted capital rules
and definitions prescribed by the banking regulators, Key's Tier 1 and total
risk-adjusted capital ratios at March 31, 1998, were 6.81% and 11.38%,
respectively. These compare favorably with the minimum requirements of 4.0% for
Tier 1 and 8.0% for total capital. The regulatory leverage ratio standard
prescribes a minimum ratio of 3.0%, although most banking organizations are
expected to maintain ratios of at least 100 to 200 basis points above the
minimum. At March 31, 1998, Key's leverage ratio was 6.61%, substantially higher
than the minimum requirement. Figure 20 presents the details of Key's regulatory
capital position at March 31, 1998, December 31, 1997, and March 31, 1997.
43
<PAGE> 44
FIGURE 20 CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 1998 1997 1997
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
TIER 1 CAPITAL
Common shareholders' equity(1) $5,330 $5,170 $4,791
Qualifying capital securities 500 500 500
Less: Goodwill (1,052) (1,071) (811)
Other intangible assets(2) (89) (95) (112)
- -------------------------------------------------------------------------------------------------
Total Tier 1 capital 4,689 4,504 4,368
- -------------------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(3) 861 847 733
Qualifying long-term debt 2,285 1,982 2,102
- -------------------------------------------------------------------------------------------------
Total Tier 2 capital 3,146 2,829 2,835
- -------------------------------------------------------------------------------------------------
Total capital $7,835 $7,333 $7,203
======== ======== ========
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $58,209 $58,412 $52,659
Risk-adjusted off-balance sheet exposure 11,844 10,501 6,893
Less: Goodwill (1,052) (1,071) (811)
Other intangible assets(2) (89) (95) (112)
- -------------------------------------------------------------------------------------------------
Gross risk-adjusted assets 68,912 67,747 58,629
Less: Excess allowance for loan losses(3) (39) (53) (137)
- -------------------------------------------------------------------------------------------------
Net risk-adjusted assets $68,873 $67,694 $58,492
======== ======== ========
AVERAGE QUARTERLY TOTAL ASSETS $72,122 $71,490 $66,354
======== ======== ========
CAPITAL RATIOS
Tier 1 risk-adjusted capital ratio 6.81% 6.65% 7.47%
Total risk-adjusted capital ratio 11.38 10.83 12.31
Leverage ratio(4) 6.61 6.40 6.68
- -------------------------------------------------------------------------------------------------
</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 2 capital is limited to 1.25%
of gross risk-adjusted assets.
4 Tier 1 capital as a percentage of average quarterly assets, less goodwill and
other non-qualifying intangible assets as defined in 2 above.
Under the Federal Deposit Insurance Act, the Federal bank regulators group
FDIC-insured depository institutions into five broad categories based on certain
capital ratios. The five categories are "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." All of Key's affiliate banks qualify as "well
capitalized" at March 31, 1998, since they exceeded the well-capitalized
thresholds of 10%, 6% and 5% for the total capital, Tier 1 capital and leverage
ratios, respectively. Although these provisions are not directly applicable to
Key under existing laws and regulations, based upon its ratios Key would also
qualify as "well capitalized" at March 31, 1998. The FDIC-defined capital
categories may not constitute an accurate representation of the overall
financial condition or prospects of Key or its affiliate banks.
On January 15, 1998, Key announced a two-for-one stock split effected by means
of a 100% stock dividend payable March 6, 1998, to shareholders of record as of
February 18, 1998. All relevant Common Share amounts and per share data in this
report have been adjusted to reflect the split.
At the Annual Meeting of Shareholders held May 7, 1998, shareholders increased
the authorized number of Key Common Shares from 900,000,000 to 1,400,000,000
Common Shares. Additionally, on January 15,
44
<PAGE> 45
1998, the Board voted to cancel and retire all 1,400,000 authorized shares of
Key's 10% Cumulative Preferred Stock, Class A, none of which were outstanding.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
In the ordinary course of business, Key is subject to legal actions
which involve claims for substantial monetary relief. Based on
information presently available to management and Key's counsel,
management does not believe that any legal actions, individually or in
the aggregate, will have a material adverse effect on the consolidated
financial condition of Key.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(15) Acknowledgment Letter of Independent Auditors
(27) Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
January 21, 1998 - Item 5. Other Events and Item 7. Financial
Statements and Exhibits. Reporting that the Registrant issued two press
releases on January 15, 1998. The first announced the earnings results
for the three-month and twelve-month period ended December 31, 1997.
The second announced: (i) a declaration of a quarterly cash dividend in
the amount of $.47 per common share ($.235 per common share on a
post-split basis), (ii) a two-for-one stock split by means of a 100%
stock dividend payable on common shares, and (iii) a repurchase
authorization of up to 5 million (10 million on a post-split basis)
common shares from time to time.
March 6, 1998 - Item 5. Other events. Reporting that the Board of
Directors declared a stock split on January 15, 1998, to be effected in
the form of a 100% stock dividend payable on March 6, 1998, to
shareholders of record on February 18, 1998. Also reporting that the
Registration Statement on Form S-3 (Reg. No. 333-37287) filed on
October 6, 1997, is deemed to cover the additional Common Shares
resulting from the payment of the stock dividend.
No other reports on Form 8-K were filed during the three-month period
ended March 31, 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
--------------------------------------
(Registrant)
Date: May 14, 1998 /s/ Lee Irving
--------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
45
<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 14, 1998, 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, 1998.
Form S-3 No. 33-10634
Form S-3 No. 33-56881
Form S-3 No. 33-58405
Form S-3 No. 333-10577
Form S-3 No. 333-37287
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-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. 333-49609
Form S-8 No. 333-49633
Form S-8 No. 33-31569 (Post-Effective Amendment No. 1 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 11, 1998
46
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 3,287
<INT-BEARING-DEPOSITS> 120
<FED-FUNDS-SOLD> 667
<TRADING-ASSETS> 385
<INVESTMENTS-HELD-FOR-SALE> 7,115
<INVESTMENTS-CARRYING> 1,182
<INVESTMENTS-MARKET> 1,213
<LOANS> 54,900
<ALLOWANCE> 900
<TOTAL-ASSETS> 73,198
<DEPOSITS> 41,661
<SHORT-TERM> 13,910
<LIABILITIES-OTHER> 2,498
<LONG-TERM> 9,041
0
0
<COMMON> 492
<OTHER-SE> 5,596
<TOTAL-LIABILITIES-AND-EQUITY> 73,198
<INTEREST-LOAN> 1,165
<INTEREST-INVEST> 162
<INTEREST-OTHER> 0
<INTEREST-TOTAL> 1,327
<INTEREST-DEPOSIT> 347
<INTEREST-EXPENSE> 316
<INTEREST-INCOME-NET> 664
<LOAN-LOSSES> 77
<SECURITIES-GAINS> 2
<EXPENSE-OTHER> 600
<INCOME-PRETAX> 343
<INCOME-PRE-EXTRAORDINARY> 343
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 235
<EPS-PRIMARY> 0.53
<EPS-DILUTED> 0.53
<YIELD-ACTUAL> 4.23
<LOANS-NON> 373
<LOANS-PAST> 159
<LOANS-TROUBLED> 0
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<ALLOWANCE-OPEN> 900
<CHARGE-OFFS> 100
<RECOVERIES> 23
<ALLOWANCE-CLOSE> 900
<ALLOWANCE-DOMESTIC> 900
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
