<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ______ To ______
Commission File Number 0-850
[LOGO]
KEYCORP
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(Exact name of registrant as specified in its charter)
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<S> <C>
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)
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(216) 689-6300
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
<TABLE>
<S> <C>
Common Shares with a par value of $1 each 447,853,743 Shares
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(Title of class) (Outstanding at April 30, 1999)
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<PAGE> 2
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Item 1. Financial Statements Page Number
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<S> <C>
Consolidated Balance Sheets --
March 31, 1999, December 31, 1998 and March 31, 1998 3
Consolidated Statements of Income --
Three months ended March 31, 1999 and 1998 4
Consolidated Statements of Changes in Shareholders' Equity --
Three months ended March 31, 1999 and 1998 5
Consolidated Statements of Cash Flow --
Three months ended March 31, 1999 and 1998 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 22
Item 2. Management's Discussion and Analysis of Financial Condition
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and Results of Operations 23
-------------------------
Item 3. Quantitative and Qualitative Disclosure of Market Risk 46
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings 47
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Item 5. Other Information 47
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Item 6. Exhibits and Reports on Form 8-K 47
--------------------------------
Signature 48
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2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KEYCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 1999 1998 1998
================================================================================================================================
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and due from banks $ 2,981 $ 3,296 $ 3,287
Short-term investments 1,630 1,974 1,171
Securities available for sale 6,778 5,278 7,115
Investment securities (fair value: $1,031, $1,004 and $1,213) 1,005 976 1,182
Loans, net of unearned income of $1,479, $1,533 and $1,235 61,045 62,012 54,900
Less: Allowance for loan losses 930 900 900
- --------------------------------------------------------------------------------------------------------------------------------
Net loans 60,115 61,112 54,000
Premises and equipment 863 902 924
Goodwill 1,435 1,430 1,052
Other intangible assets 72 79 99
Corporate owned life insurance 2,032 2,008 1,921
Other assets 3,081 2,965 2,447
- --------------------------------------------------------------------------------------------------------------------------------
Total assets $ 79,992 $ 80,020 $ 73,198
============ ============ ============
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 8,601 $ 9,540 $ 9,083
Interest-bearing 32,555 32,091 32,253
Deposits in foreign office--interest-bearing 167 952 325
- --------------------------------------------------------------------------------------------------------------------------------
Total deposits 41,323 42,583 41,661
Federal funds purchased and securities sold under repurchase agreements 4,336 4,468 6,468
Bank notes and other short-term borrowings 8,242 9,728 7,442
Other liabilities 3,285 3,110 2,498
Long-term debt 15,457 12,967 9,041
Corporation-obligated mandatorily redeemable preferred capital securities
of subsidiary trusts holding solely debentures of the Corporation (See Note 9) 1,244 997 750
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities 73,887 73,853 67,860
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- --
Common Shares, $1 par value; authorized 1,400,000,000 shares;
issued 491,888,780 shares 492 492 492
Capital surplus 1,409 1,412 1,284
Retained earnings 5,369 5,192 4,743
Loans to ESOP trustee (34) (34) (42)
Treasury stock, at cost (44,066,638, 39,437,183 and 52,573,384 shares) (1,075) (923) (1,147)
Accumulated other comprehensive (loss) income (56) 28 8
- --------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,105 6,167 5,338
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 79,992 $ 80,020 $ 73,198
============ ============ ============
================================================================================================================================
</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 1999 1998
=======================================================================================================
<S> <C> <C>
INTEREST INCOME
Loans $ 1,250 $ 1,165
Taxable investment securities 4 3
Tax-exempt investment securities 9 13
Securities available for sale 97 129
Short-term investments 21 17
- -------------------------------------------------------------------------------------------------------
Total interest income 1,381 1,327
INTEREST EXPENSE
Deposits 309 347
Federal funds purchased and securities sold under repurchase agreements 54 93
Bank notes and other short-term borrowings 119 98
Long-term debt, including capital securities 214 139
- -------------------------------------------------------------------------------------------------------
Total interest expense 696 677
- -------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 685 650
Provision for loan losses 111 77
- -------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 574 573
NONINTEREST INCOME
Trust and asset management income 106 77
Service charges on deposit accounts 81 78
Investment banking and capital markets income 66 47
Insurance and brokerage income 57 22
Corporate owned life insurance income 24 23
Credit card fees 10 15
Net loan securitization income 39 10
Net securities gains 4 2
Gains from divestitures 148 29
Other income 74 53
- -------------------------------------------------------------------------------------------------------
Total noninterest income 609 356
NONINTEREST EXPENSE
Personnel 372 294
Net occupancy 59 56
Equipment 56 43
Computer processing 54 40
Marketing 25 28
Amortization of intangibles 28 23
Professional fees 15 17
Other expense 139 85
- -------------------------------------------------------------------------------------------------------
Total noninterest expense 748 586
INCOME BEFORE INCOME TAXES 435 343
Income taxes 142 108
- -------------------------------------------------------------------------------------------------------
NET INCOME $ 293 $ 235
============ ============
Per Common Share:
Net income $ .65 $ .53
Net Income - assuming dilution .65 .53
Weighted average Common Shares outstanding (000) 449,520 438,589
Weighted average Common Shares and potential Common
Shares outstanding (000) 454,197 444,836
=======================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
4
<PAGE> 5
KEYCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
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<CAPTION>
ACCUMULATED
LOANS TO TREASURY OTHER
COMMON CAPITAL RETAINED ESOP STOCK, COMPREHENSIVE COMPREHENSIVE
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST (LOSS) INCOME INCOME
=================================================================================================================== =============
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997 $492 $1,283 $4,611 $(42) $(1,174) $ 11
Net income 235 $235
Other comprehensive losses:
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) (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) $ 8
==== ====== ====== ==== ======= ====
===================================================================================================================
BALANCE AT DECEMBER 31, 1998 $492 $1,412 $5,192 $(34) $ (923) $ 28
Net income 293 $293
Other comprehensive losses:
Net unrealized losses on securities available
for sale, net of income taxes of $(45)(1) (84) (84)
-------------
Total comprehensive income $209
====
Cash dividends on Common Shares ($.26 per share) (116)
Issuance of Common Shares under employee benefit
and dividend reinvestment plans-925,769 net
shares (3) 22
Repurchase of Common Shares-5,555,224 shares (174)
- -------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1999 $492 $1,409 $5,369 $(34) $(1,075) $(56)
==== ====== ====== ==== ======= ====
===================================================================================================================
</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 1999 1998
=========================================================================================================================
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 293 $ 235
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 111 77
Depreciation expense and software amortization 71 54
Amortization of intangibles 28 23
Net gains from divestitures (148) (29)
Net securities gains (4) (2)
Deferred income taxes 100 60
Net (increase) decrease in mortgage loans held for sale 95 (263)
Net (increase) decrease in trading account assets (304) 150
Decrease in accrued restructuring charge (1) (11)
Other operating activities, net (26) 290
- -------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 215 584
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (1,678) (1,423)
Loans sold 2,093 71
Purchases of investment securities (66) (26)
Proceeds from sales of investment securities -- 11
Proceeds from prepayments and maturities of investment securities 55 78
Purchases of securities available for sale (3,287) (21)
Proceeds from sales of securities available for sale 51 18
Proceeds from prepayments and maturities of securities available for sale 2,116 597
Net decrease in other short-term investments 648 607
Purchases of premises and equipment (23) (16)
Proceeds from sales of premises and equipment 21 42
Proceeds from sales of other real estate owned 7 2
Net cash paid for divestitures -- (89)
- -------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (63) (149)
FINANCING ACTIVITIES
Net decrease in deposits (1,260) (3,271)
Net increase (decrease)in short-term borrowings (1,638) 965
Net proceeds from issuance of long-term debt, including capital securities 3,336 1,693
Payments on long-term debt (628) (102)
Purchases of treasury shares (174) --
Proceeds from issuance of common stock pursuant to employee
benefit and dividend reinvestment plans 13 19
Cash dividends (116) (103)
- -------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN FINANCING ACTIVITIES (467) (799)
- -------------------------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND DUE FROM BANKS (315) (364)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,296 3,651
- -------------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 2,981 $ 3,287
============ ============
- -------------------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $ 701 $ 637
Income taxes received 18 22
Net amount received on portfolio swaps 1 3
Noncash items:
Assets sold -- 24
Liabilities sold -- 142
Reclassification of financial instruments from loans to securities available for sale 374 --
Fair value of Concord EFS, Inc. shares received 170 --
Carrying amount of Electronic Payment Services, Inc. shares divested 36 --
=========================================================================================================================
</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 (the "parent company") and its subsidiaries (collectively referred to as
"Key"). All significant intercompany accounts and transactions have been
eliminated in consolidation. In the opinion of management, the unaudited
consolidated interim financial statements reflect all adjustments of a normal
recurring nature and disclosures which are necessary for a fair presentation of
the results for the interim periods presented, and should be read in conjunction
with the audited consolidated financial statements and related notes included in
Key's 1998 Annual Report to Shareholders. In addition, certain reclassifications
have been made to prior year amounts to conform 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.
ACCOUNTING PRONOUNCEMENTS ADOPTED IN 1999
As of January 1, 1999, Key adopted Statement of Financial Accounting Standard
("SFAS") No. 134, "Accounting for Mortgage-Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise." SFAS No. 134 amends SFAS No. 65, "Accounting for Certain Mortgage
Banking Activities" and SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." SFAS No. 134 requires an entity engaged in mortgage
banking activities to classify mortgage-backed securities or other retained
interests resulting from a mortgage loan securitization based on its ability and
intent to sell or hold those assets. The statement conforms the accounting for
securities and uncertificated interests retained after the securitization of
mortgage loans with the accounting for securities and uncertificated interests
retained after the securitization of other types of assets by a non-mortgage
banking enterprise. To date, Key has retained only uncertificated interests
resulting from mortgage loan securitizations. These retained interests are
classified as either available-for-sale or trading securities. Since Key was in
compliance with the standard at the date of adoption, SFAS No. 134 had minimal
impact on Key's financial condition and results of operations.
As of January 1, 1999, Key adopted Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." This SOP provides guidance on accounting for such costs,
including the characteristics to be considered in defining internal-use software
and the circumstances under which related costs should be expensed or
capitalized. The provisions of SOP 98-1 are substantially consistent with Key's
prior accounting policy for internally developed software. As a result, the
effect of prospective adoption did not have a material impact on Key's financial
condition or results of operations.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments including certain derivative
instruments embedded in other contracts (collectively "derivatives") and for
hedging activities. It requires that all derivatives be recognized on the
balance sheet at fair value. Changes in the fair value of all derivatives
qualifying as hedges will be recognized currently in earnings or comprehensive
income. Depending on the nature of the hedge, and the extent to which it is
effective, the changes in fair value either will be offset against the change in
fair value of the hedged item (which also is recognized in earnings) or will be
recorded in comprehensive income and subsequently recognized in earnings in the
period the hedged item affects earnings. The portion of a hedge that is deemed
ineffective and all changes in the fair value of derivatives not designated as
hedges will be recognized immediately in earnings. SFAS No. 133 is effective for
all fiscal quarters of all fiscal years beginning after June 15, 1999, with
earlier application permitted. Key will adopt the provisions of SFAS No. 133 as
of January 1, 2000. Key is currently reviewing SFAS No. 133 to determine the
extent to which the statement will alter its use of certain derivatives in the
future and the impact on its financial condition and results of operations.
7
<PAGE> 8
2. EARNINGS PER COMMON SHARE
The computation of Key's basic and diluted earnings per Common Share is as
follows:
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<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions, except per share amounts 1999 1998
====================================================================================
<S> <C> <C>
NET INCOME $293 $235
==== ====
- ------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average Common Shares outstanding (000) 449,520 438,589
Potential Common Shares outstanding (000) (1) 4,677 6,247
- ------------------------------------------------------------------------------------
Weighted average Common Shares and potential
Common Shares outstanding (000) 454,197 444,836
======= =======
- ------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per Common Share $ .65 $ .53
Net income per Common Share - assuming dilution .65 .53
====================================================================================
</TABLE>
(1)Dilutive common stock options.
3. MERGERS, ACQUISITIONS AND DIVESTITURES
Mergers, acquisitions and divestitures completed by Key during 1998 and the
first three months of 1999 are summarized below.
COMPLETED MERGERS AND ACQUISITIONS
MCDONALD & COMPANY INVESTMENTS, INC.
On October 23, 1998, Key acquired McDonald & Company Investments, Inc.
("McDonald"), a full-service investment banking and securities brokerage company
headquartered in Cleveland, Ohio, with assets of approximately $776 million at
the time of the transaction. Under the terms of the agreement, 19,337,159 Common
Shares, with a value of approximately $581 million, were issued in a transaction
structured as a tax-free merger and accounted for as a purchase. Key recorded
goodwill of $437 million, which is being amortized using the straight-line
method over a period of 25 years. In addition, Key established a retention
program for certain McDonald employees under which stock options for
approximately 3.3 million Key Common Shares were granted and will vest over a
three-year period, and approximately $30 million in cash may be paid over the
three-year period.
LEASETEC CORPORATION
On July 1, 1997, Key acquired an 80% interest (with an option to purchase the
remaining 20%) in Leasetec Corporation ("Leasetec"), an equipment leasing
company headquartered in Boulder, Colorado, with assets of approximately $1.1
billion at the time of the transaction and operations in the United States and
overseas. In connection with the transaction, which was accounted for as a
purchase, Key recorded goodwill of approximately $126 million, which is being
amortized using the straight-line method over a period of 25 years. On June 26,
1998, Key acquired the remaining 20% interest in Leasetec. This resulted in
additional goodwill of approximately $26 million, which is being amortized over
the remainder of the 25- year period which began July 1, 1997. In accordance
with a confidentiality clause in the purchase agreement, the terms, which are
not material, have not been publicly disclosed.
COMPLETED DIVESTITURES
ELECTRONIC PAYMENT SERVICES, INC.
On February 28, 1999, Electronic Payment Services, Inc. ("EPS"), an electronic
funds transfer processor in which Key held a 20% ownership interest, merged with
a wholly owned subsidiary of Concord EFS, Inc., a Delaware corporation. Key
received approximately 5.9 million shares of Concord EFS and recognized a gain
of $134 million ($85 million after tax). The gain was recorded in gains from
divestitures on the income statement.
8
<PAGE> 9
KEY MERCHANT SERVICES, LLC
On January 21, 1998, Key sold to NOVA Information Systems, Inc. ("NOVA") a 51%
interest in Key Merchant Services, LLC, a wholly owned subsidiary formed to
provide merchant credit card processing services to businesses. Key recognized a
$23 million gain ($14 million after tax) at the time of closing. Under the terms
of the agreement with NOVA, Key was entitled to receive additional consideration
if certain revenue-related performance targets were met. Accordingly, Key
recognized a gain of $27 million in the fourth quarter of 1998 and recorded a
final gain of $14 million during the first quarter of 1999. These gains were
recorded in gains from divestitures on the income statement. In accordance with
a confidentiality clause in the agreement, the terms, which are not material,
have not been disclosed.
BRANCH DIVESTITURES
During 1998, Key sold 46 branch offices with deposits of approximately $658
million, resulting in aggregate gains of $39 million ($22 million after tax).
The gains were recorded in gains from divestitures on the income statement.
4. LINE OF BUSINESS RESULTS
Key's four major lines of business as described below are Key Corporate Capital,
Key Consumer Finance, Key Community Bank and Key Capital Partners.
KEY CORPORATE CAPITAL
Key offers a complete range of financing, transaction processing and financial
advisory services to corporations throughout the country through its Key
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. Key Corporate Capital's business units are organized
around specialized industry client segments, inclusive of commercial real
estate, lease financing, structured finance, healthcare and
media/telecommunications. In serving these targeted segments, Key Corporate
Capital provides a number of specialized services including international
banking, corporate finance advisory services and, based on transaction volume,
is a leading provider of cash management services. Key Corporate Capital also
provides investment banking, capital markets, 401(k) and trust custody products
through Key Capital Partners.
KEY CONSUMER FINANCE
Key Consumer Finance is responsible for Key's indirect, non-branch-based
consumer loan products. This line of business specializes in automobile loans
and leases, home equity loans, education loans, marine and recreational vehicle
loans and credit cards. As of December 31, 1998, based on the volume of loans
generated, Key Consumer Finance was one of the five largest education lenders in
the nation, ranked in the top ten in retail automobile financing and was one of
the leading providers of financing for consumer purchases of marine and
recreational vehicles.
KEY COMMUNITY BANK
Key Community Bank is responsible for delivering a complete line of branch-based
financial products and services to small businesses, consumers, and commercial
banking businesses. The delivery of these products and services is accomplished
through 969 full-service banking offices ("Key Centers"), a 24-hour telephone
banking call center services group, nearly 2,600 automated teller machines
("ATMs") that access 14 different networks and comprise one of the largest ATM
networks in the United States, and a core team of relationship management
professionals.
KEY CAPITAL PARTNERS
Key Capital Partners provides clients with asset management, investment banking,
capital markets, insurance and brokerage expertise, and plays a major role in
generating fee income through its broad range of investment choices and
customized products. This line of business is comprised of two major business
groups. One group, operating under the name McDonald Investments, includes
retail and institutional brokerage, equity and fixed income trading and
underwriting, investment banking, capital markets products, loan syndication and
trading, public finance and clearing operations. The second major business group
includes asset management, mutual funds, institutional asset services, venture
capital, mezzanine finance, alliance funds, wealth management and insurance.
Leveraging Key's corporate and community banking distribution channels and
client relationships is and will continue to be an essential factor in ensuring
Key Capital Partners' future growth and success.
9
<PAGE> 10
Selected financial data for each major line of business for the three-month
periods ended March 31, 1999 and 1998, is presented in the following table. The
financial information was derived from the internal profitability reporting
system used by management to monitor and manage the financial performance of
Key. The selected financial data are based on internal management accounting
policies which have been developed to ensure that results are compiled on a
consistent basis and to reflect the underlying economics of the businesses.
These policies address the methodologies applied in connection with funds
transfer pricing as well as the allocation of certain costs and capital. Funds
transfer pricing was used in the determination of net interest income by
assigning a standard cost for funds used (or a standard credit for funds
provided) to assets and liabilities based on their maturity, prepayment and/or
repricing characteristics. The net effect of transfer pricing was allocated to
the lines of business based upon their respective contributions to net interest
income. Indirect expenses were allocated based on actual volume measurements and
other criteria, as appropriate. The provision for loan losses was allocated in
an amount based primarily upon the actual net charge-offs of each respective
line of business, adjusted for loan growth and changes in risk profile. The
level of the consolidated provision for loan losses was based upon the
application of a methodology designed by management to assess the adequacy of
the consolidated allowance by focusing on a number of specific factors. This
methodology and the factors which influence it are more fully discussed in the
Allowance for Loan Losses section of Note 1, Summary of Significant Accounting
Policies, beginning on page 65 of Key's 1998 Annual Report to Shareholders.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, KEY CORPORATE CAPITAL KEY CONSUMER FINANCE KEY COMMUNITY BANK
======================== ======================== ========================
dollars in millions 1999 1998 1999 1998 1999 1998
===========================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Net interest income (TE) $115 $110 $159 $129 $409 $416
Noninterest income 26 17 62 34 131 129
Revenue sharing--KCP(1) 6 4 1 -- 41 37
- ---------------------------------------------------------------------------------------------------------------------------
Total revenue(2) 147 131 222 163 581 582
Provision for loan losses 6 7 55 51 31 27
Depreciation and amortization expense 6 4 15 11 55 47
Other noninterest expense 32 31 79 68 267 274
Expense sharing--KCP(1) 3 1 -- -- 28 26
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes (TE) 100 88 73 33 200 208
Allocated income taxes and TE adjustment 37 32 28 13 66 71
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 63 $ 56 $ 45 $ 20 $134 $137
==== ==== ==== ==== ==== ====
Percent of consolidated net income 22% 24% 15% 9% 46% 58%
Efficiency ratio(6) 27.89 27.48 42.34 48.47 60.66 59.83
- ---------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $14,473 $11,679 $16,072 $12,975 $26,703 $26,022
Total assets(2) 15,302 12,294 17,459 14,210 36,028 37,410
Deposits 450 443 120 137 35,872 37,364
===========================================================================================================================
</TABLE>
1 Represents the assignment of KCP revenue and expense to the lines of business
principally responsible for maintaining the corresponding client
relationships.
2 Substantially all revenue generated by Key's primary lines of business is
derived from external clients domiciled in the United States and substantially
all long-lived assets held by such lines of business are located in the United
States. Long-lived assets include premises and equipment, capitalized software
and goodwill.
3 Noninterest income includes gains of $134 million ($85 million after tax) in
1999 and $6 million ($4 million after tax) in 1998 from certain divestitures.
Net interest income is primarily comprised of the funding cost related to
unallocated nonearning assets of corporate support functions.
10
<PAGE> 11
Income taxes were allocated based on the statutory Federal income tax rate of
35% (adjusted for tax-exempt income from corporate owned life insurance,
nondeductible goodwill amortization, and tax credits associated with investments
in low-income housing projects) and a blended state income tax rate (net of the
Federal income tax benefit) of 1.8% for the periods presented. Capital was
assigned to each line of business based on management's assessment of economic
risk factors (primarily credit, operating and market risk).
The development and application of these methodologies is a dynamic process.
Accordingly, financial results may be revised periodically to reflect management
accounting enhancements, changes in risk profile or changes in the
organization's structure. The financial data presented in the accompanying table
for both the current and prior year reflects a number of revisions in Key's
organization structure and funds transfer pricing methodology that occurred
during the first quarter of 1999. Primary among these was the reclassification
of the public sector, retail brokerage, wealth management, private banking and
franchise trust businesses from Key Community Bank to Key Capital Partners and
the reclassification of institutional asset services from Key Corporate Capital
to Key Capital Partners. In addition, funds transfer pricing was enhanced by
refining the methodology applied to the residential mortgage loan portfolio,
certain deposit products with indeterminate maturities and medium-term notes.
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.
<TABLE>
<CAPTION>
KEY CAPITAL PARTNERS ("KCP") TOTAL SEGMENTS RECONCILING ITEMS KEYCORP CONSOLIDATED
============================= ========================= ========================== =========================
1999 1998 1999 1998 1999 1998 1999 1998
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
$ 41 $ 29 $ 724 $ 684 $(31) $(25) $ 693 $ 659
238 156 457 336 152 20 609 356
(48) (41) -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
231 144 1,181 1,020 121(3) (5)(3) 1,302 1,015
-- -- 92 85 19 (8) 111 77
23 13 99 75 -- 2 99 77
210 112 588 485 61(4) 24 649 509
(31) (27) -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
29 46 402 375 41 (23) 443 352
10 15 141 131 9 (14) 150 117
- ------------------------------------------------------------------------------------------------------------------------------------
$ 19 $ 31 $ 261 $ 244 $ 32 $ (9) $ 293 $ 235
==== ==== ===== ===== ==== ==== ===== =====
6% 13% 89% 104% 11% (4)% 100% 100%
87.45 68.06 58.37 55.01 N/M N/M 60.22 58.19
- ------------------------------------------------------------------------------------------------------------------------------------
$4,244 $3,145 $61,492 $53,821 $ 201 $ 125 $61,693 $53,946
8,847 5,938 77,636 69,852 2,222(5) 2,270(5) 79,858 72,122
3,101 2,663 39,543 40,607 1,570 1,027 41,113 41,634
====================================================================================================================================
</TABLE>
4 Noninterest expense in 1999 includes a $20 million ($13 million after tax)
contribution made to the Key sponsored charitable foundation and $27 million
($17 million after tax) of other nonrecurring charges.
5 Total assets represent primarily the unallocated portion of nonearning
assets of corporate support functions.
6 Calculated as noninterest expense (excluding certain nonrecurring charges)
divided by taxable-equivalent net interest income plus noninterest income
(excluding net securities transactions and gains from certain divestitures).
TE=Taxable Equivalent
N/M= Not Meaningful
11
<PAGE> 12
5. SECURITIES
Debt securities that Key has the positive intent and ability to hold to maturity
are classified as securities held to maturity and carried at cost, adjusted for
amortization of premiums and accretion of discounts using the level yield
method. Securities held to maturity and equity securities that do not have
readily determinable fair values are presented as investment securities on the
balance sheet. Debt and equity securities that are bought and held principally
for the purpose of selling them in the near term are classified as trading
account assets, reported at fair value and included in short-term investments on
the balance sheet. Realized and unrealized gains and losses on trading account
assets are reported in other income on the income statement. Debt and equity
securities that Key has not classified as investment securities or trading
account assets are classified as securities available for sale and are reported
at fair value, with unrealized gains and losses, net of income taxes, reported
in shareholders' equity as a component of accumulated other comprehensive (loss)
income. Gains and losses from sales of securities available for sale are
computed using the specific identification method and included in net securities
gains on the income statement.
During the first quarter of 1999, Key reclassified approximately $374 million of
collateralized mortgage obligations from the commercial mortgage loan portfolio
to the securities available for sale portfolio.
The amortized cost, unrealized gains and losses and approximate fair value of
securities available for sale and investment securities were as follows:
<TABLE>
<CAPTION>
MARCH 31, 1999
---------------------------------------------
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 $ 206 $ 1 -- $ 207
States and political subdivisions 62 2 -- 64
Collateralized mortgage obligations 3,946 17 $ 79 3,884
Other mortgage-backed securities 2,006 29 11 2,024
Retained interests in securitizations 380 -- 22 358
Other securities 259 9 27 241
- --------------------------------------------------------------------------------------------
Total securities available for sale $6,859 $ 58 $ 139 $6,778
====== ====== ====== ======
INVESTMENT SECURITIES
States and political subdivisions $ 601 $ 26 -- $ 627
Other securities 404 -- -- 404
- --------------------------------------------------------------------------------------------
Total investment securities $1,005 $ 26 -- $1,031
====== ====== ======
============================================================================================
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 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 $ 420 $ 2 -- $ 422
States and political subdivisions 65 2 -- 67
Collateralized mortgage obligations 2,191 21 $ 1 2,211
Other mortgage-backed securities 2,123 34 6 2,151
Retained interests in securitizations 345 -- 17 328
Other securities 84 16 1 99
- --------------------------------------------------------------------------------------------
Total securities available for sale $5,228 $ 75 $ 25 $5,278
====== ====== ====== ======
INVESTMENT SECURITIES
States and political subdivisions $ 631 $ 28 -- $ 659
Other securities 345 -- -- 345
- --------------------------------------------------------------------------------------------
Total investment securities $ 976 $ 28 -- $1,004
====== ====== ======
============================================================================================
</TABLE>
12
<PAGE> 13
<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
====== ====== ======
============================================================================================
</TABLE>
Trading account assets had a fair value of $1.2 billion, $877 million and $385
million at March 31, 1999, December 31, 1998 and March 31, 1998, respectively.
At March 31, 1999, these assets included $74 million of retained interests in
securizations.
6. LOANS
Loans are summarized as follows:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
in millions 1999 1998 1998
================================================================================
<S> <C> <C> <C>
Commercial, financial and agricultural $17,249 $17,038 $14,526
Real estate-- commercial mortgage 6,994 7,309 6,953
Real estate-- construction 3,865 3,450 2,511
Commercial lease financing 5,799 5,613 4,594
- --------------------------------------------------------------------------------
Total commercial loans 33,907 33,410 28,584
Real estate-- residential mortgage 4,738 5,083 5,603
Home equity 7,305 7,301 5,986
Credit card 1,331 1,425 1,449
Consumer--direct 2,388 2,342 2,201
Consumer--indirect lease financing 2,785 2,580 1,770
Consumer--indirect other 6,497 7,009 5,996
- --------------------------------------------------------------------------------
Total consumer loans 25,044 25,740 23,005
Loans held for sale 2,094 2,862 3,311
- --------------------------------------------------------------------------------
Total loans $61,045 $62,012 $54,900
======= ======= =======
================================================================================
</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, 1999, is presented in Note 10, Financial
Instruments with Off-Balance Sheet Risk, beginning on page 17.
13
<PAGE> 14
Changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 1999 1998
<S> <C> <C>
==========================================================
Balance at beginning of period $ 900 $ 900
Charge-offs (107) (100)
Recoveries 26 23
- ----------------------------------------------------------
Net charge-offs (81) (77)
Provision for loan losses 111 77
- ----------------------------------------------------------
Balance at end of period $ 930 $ 900
===== =====
==========================================================
</TABLE>
7. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
At March 31, 1999, impaired loans totaled $212 million. Included in this amount
are $118 million of impaired loans for which the specifically allocated
allowance for loan losses is $65 million, and $94 million of impaired loans
which are carried at their estimated fair value without a specifically allocated
allowance for loan losses. At the end of the prior year, impaired loans totaled
$193 million, of which $95 million had a specifically allocated allowance of $42
million and $98 million were carried at their estimated fair value. The average
investment in impaired loans for the first quarter of 1999 and 1998 was $202
million and $193 million, respectively.
Nonperforming assets were as follows:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
in millions 1999 1998 1998
===========================================================================
<S> <C> <C> <C>
Impaired loans $ 212 $ 193 $ 189
Other nonaccrual loans 183 172 184
- ---------------------------------------------------------------------------
Total nonperforming loans 395 365 373
Other real estate owned ("OREO") 49 56 67
Allowance for OREO losses (15) (18) (24)
- ---------------------------------------------------------------------------
OREO, net of allowance 34 38 43
Other nonperforming assets 1 1 5
- ---------------------------------------------------------------------------
Total nonperforming assets $ 430 $ 404 $ 421
===== ===== =====
===========================================================================
</TABLE>
Impaired loans are evaluated individually. The fair value of any existing
collateral or an estimate of the present value of the future cash flows on the
loan is used to determine the extent of the impairment. When such amounts do not
support the carrying amount of the loan, the amount which management deems
uncollectible is charged to the allowance for loan losses. In instances where
collateral or other sources of repayment are sufficient, yet uncertainty exists
regarding the ultimate repayment, an allowance is specifically allocated for in
the allowance for loan losses.
Key excludes smaller-balance, homogeneous nonaccrual loans (shown in the
preceding table as "Other nonaccrual loans") from impairment evaluation.
Generally, this portfolio includes loans to finance residential mortgages,
automobiles, recreational vehicles, boats and mobile homes. Key applies
historical loss experience rates to these loans, adjusted based on management's
assessment of emerging credit trends and other factors. The resulting loss
estimates are specifically allocated for by loan type in the allowance for loan
losses.
14
<PAGE> 15
8. 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 1999 1998 1998
===================================================================================================
<S> <C> <C> <C>
Senior medium-term notes due through 2005(1) $ 401 $ 419 $ 469
Subordinated medium-term notes due through 2005(1) 133 133 182
7.50% Subordinated notes due 2006(2) 250 250 250
6.75% Subordinated notes due 2006(2) 200 200 200
8.125% Subordinated notes due 2002(2) 199 199 199
8.00% Subordinated notes due 2004(2) 125 125 125
8.40% Subordinated capital notes due 1999 75 75 75
8.404% Notes due through 2001 34 34 42
All other long-term debt(8) 5 5 14
- ---------------------------------------------------------------------------------------------------
Total parent company(9) 1,422 1,440 1,556
Senior medium-term bank notes due through 2004(3) 9,499 7,426 4,369
Senior euro medium-term bank notes due through 2007(4) 1,856 1,441 864
6.50% Subordinated remarketable securities due 2027(5) 313 313 --
6.95% Subordinated notes due 2028(5) 300 300 300
7.125% Subordinated notes due 2006(5) 250 250 250
7.25% Subordinated notes due 2005(5) 200 200 200
6.75% Subordinated notes due 2003(5) 200 200 200
7.50% Subordinated notes due 2008(5) 165 165 165
7.30% Subordinated notes due 2011(5) 107 -- --
7.85% Subordinated notes due 2002(5) 93 200 200
7.55% Subordinated notes due 2006(5) 75 75 75
7.375% Subordinated notes due 2008(5) 70 70 70
Lease financing debt due through 2004(6) 600 574 496
Federal Home Loan Bank advances due through 2028(7) 237 289 264
All other long-term debt(8) 70 24 32
- ---------------------------------------------------------------------------------------------------
Total subsidiaries(10) 14,035 11,527 7,485
- ---------------------------------------------------------------------------------------------------
Total long-term debt $15,457 $12,967 $ 9,041
======= ======= =======
===================================================================================================
</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,
1999, is presented in Note 10, Financial Instruments with Off-Balance Sheet
Risk, beginning on page 17.
(1) At March 31, 1999, December 31, 1998 and March 31, 1998, the senior
medium-term notes had weighted average interest rates of 6.38%, 6.55% and
6.82%, respectively, and the subordinated medium-term notes had weighted
average interest rates of 7.09%, 7.09% and 6.95%, respectively. These notes
had a combination of both fixed and floating interest rates.
(2) The 7.50%, 6.75%, 8.125% and 8.00% subordinated notes may not be redeemed or
prepaid prior to maturity.
(3) At March 31, 1999, December 31, 1998 and March 31, 1998, senior medium-term
bank notes of subsidiaries had weighted average interest rates of 5.11%,
5.30% and 5.33%, respectively. These notes had a combination of both fixed
and floating interest rates.
(4) At March 31, 1999, December 31, 1998 and March 31, 1998, the senior euro
medium-term bank notes had weighted average interest rates of 5.33%, 5.52%
and 5.93%, respectively. These notes are obligations of KeyBank National
Association ("KeyBank N.A.") issued under its $5.0 billion Euronote Program
and had fixed and floating interest rates based on the three-month London
Interbank Offered Rate ("LIBOR"). As of March 31, 1999, the Euronote Program
had an unused capacity of $3.1 billion.
15
<PAGE> 16
(5) The subordinated notes and securities are all obligations of KeyBank N.A.,
with the exception of the 7.55% notes which are obligations of KeyBank USA,
National Association ("KeyBank USA"). These notes may not be redeemed prior
to their respective maturity dates. The 7.30% notes were issued in exchange
for a portion of the 7.85% notes during the first quarter of 1999.
(6) At March 31, 1999, December 31, 1998 and March 31, 1998, lease financing
debt had weighted average interest rates of 5.99%, 6.56% and 7.12%,
respectively, and represented primarily nonrecourse debt collateralized by
lease equipment under operating, direct financing and sales type leases.
(7) At March 31, 1999, December 31, 1998 and March 31, 1998, long-term advances
from the Federal Home Loan Bank ("FHLB") had weighted average interest rates
of 4.97%, 5.39% and 6.01%, respectively. These advances had a combination of
both fixed and floating interest rates. Real estate loans and securities of
$355 million, $409 million and $368 million, at March 31, 1999, December 31,
1998 and March 31, 1998, respectively, collateralize FHLB advances.
(8) Other long-term debt at March 31, 1999, December 31, 1998 and March 31,
1998, consisted of industrial revenue bonds, capital lease obligations and
various secured and unsecured obligations of corporate subsidiaries and had
weighted average interest rates of 7.02%, 7.17% and 8.03%, respectively.
(9) At March 31, 1999, unused capacity under the parent company's shelf
registration totaled $1.3 billion, including $750 million reserved for
future issuance as medium-term notes.
(10)As of March 31, 1999, the Bank Note Program had an unused capacity of $15.7
billion.
9. CAPITAL SECURITIES
The corporation-obligated mandatorily redeemable preferred capital securities of
subsidiary trusts holding solely debentures of the Corporation ("capital
securities") were issued by five separate business trusts, all of whose common
securities are owned by the parent company. The proceeds from the issuances of
the capital securities and common securities were used to purchase debentures of
the parent company. All of the trusts except for Capital C 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
the trusts; and (iii) payments due upon a voluntary or involuntary liquidation,
winding-up or termination of the trusts.
The capital securities (net of discount), common securities and related
debentures are summarized as follows:
<TABLE>
<CAPTION>
PRINCIPAL INTEREST RATE MATURITY
CAPITAL AMOUNT OF OF CAPITAL OF CAPITAL
SECURITIES, COMMON DEBENTURES, SECURITIES AND SECURITIES AND
dollars in millions NET OF DISCOUNT (1) SECURITIES NET OF DISCOUNT(2) DEBENTURES(3) DEBENTURES
==================================================================================================================================
<S> <C> <C> <C> <C> <C>
March 31, 1999
KeyCorp Institutional Capital A $ 350 $11 $ 361 7.826% 2026
KeyCorp Institutional Capital B 150 4 154 8.250 2026
KeyCorp Institutional Capital C 250 8 258 6.625 2029
KeyCorp Capital I 247 8 255 5.816 2028
KeyCorp Capital II 247 8 255 6.875 2029
- ---------------------------------------------------------------------------------------------------------------------------------
Total $1,244 $39 $1,283 7.048% --
====== === ======
- ---------------------------------------------------------------------------------------------------------------------------------
December 31, 1998 $997 $31 $1,028 7.149% --
==== === ======
- ---------------------------------------------------------------------------------------------------------------------------------
March 31, 1998 $750 $23 $773 7.510% --
==== === ====
==================================================================================================================================
</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 the other trusts constitute minority
interests in the equity accounts of consolidated subsidiaries and,
therefore, qualify as Tier 1 capital under Federal Reserve Board Guidelines.
16
<PAGE> 17
2 The parent company has the right to redeem the debentures purchased by
Capital A, Capital B, Capital C, Capital I and Capital II: (i) in whole or
in part, on or after December 1, 2006, December 15, 2006, June 1, 2009, July
1, 2008 and March 18, 1999, 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 purchased by Capital A, Capital B, or
Capital C are redeemed prior to maturity, the redemption price will be
expressed as a certain percentage of, or factor added to, the principal
amount, plus any accrued but unpaid interest. If the debentures purchased by
Capital I are redeemed prior to maturity, the redemption price will be equal
to 100% of the principal amount of such debentures, plus any accrued but
unpaid interest. If the debentures purchased by Capital II are redeemed
prior to maturity, the redemption price will be equal to the greater of (i)
100% of the principal amount plus any accrued but unpaid interest or (ii)
the sum of the present values of principal and interest payments discounted
at the Treasury Rate (as defined in the applicable offering circular) plus
20 basis points, plus any accrued but unpaid interest. The price of
redemptions which occur in response to tax or capital treatment events is
generally slightly more favorable than that available under other
circumstances described above.
3 The interest rates for Capital A, Capital B, Capital C and Capital II are
fixed interest rates. The interest rate for Capital I is a floating interest
rate equal to three-month LIBOR plus 74 basis points and is repriced
quarterly. The rates shown as the total at March 31, 1999, December 31, 1998
and March 31, 1998, are weighted average rates.
10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Key, mainly through its lead bank (KeyBank N.A.), is party to various financial
instruments with off- balance sheet risk. It uses these financial instruments in
the normal course of business to meet the financing needs of its clients and to
manage its exposure to market risk. Market risk includes the possibility that
Key's net interest income will be adversely affected as a result of changes in
interest rates or other economic factors. The primary financial instruments used
include commitments to extend credit, standby and commercial letters of credit,
interest rate swaps, caps and floors, futures and foreign exchange forward
contracts. All of the interest rate swaps, caps and floors, and foreign exchange
forward contracts held are over-the-counter instruments. These financial
instruments may be used for lending-related, asset and liability management and
trading purposes, as discussed in the remainder of this note. In addition to the
market risk inherent in the use of these financial instruments, each contains an
element of credit risk. Credit risk is the possibility that Key will incur a
loss due to a counterparty's failure to meet its contractual obligations.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR LENDING-RELATED PURPOSES
These instruments involve, to varying degrees, credit risk in addition to
amounts recognized in Key's balance sheet. Key mitigates its exposure to credit
risk through internal controls over the extension of credit. These controls
include the process of credit approval and review, the establishment of credit
limits and, when deemed necessary, securing collateral.
Key's commitments to extend credit are agreements with clients to provide
financing at predetermined terms as long as the client continues to meet
specified criteria. Loan commitments serve to meet the financing needs of
clients and generally carry variable rates of interest, have fixed expiration
dates or other termination clauses, and may require the payment of fees. Since
the commitments may expire without being drawn upon, the total amount of the
commitments does not necessarily represent the future cash outlay to be made by
Key. The credit-worthiness of each client is evaluated on a case-by-case basis.
The estimated fair values of these commitments and standby letters of credit
discussed below are not material. Key does not have any significant
concentrations of credit risk.
Standby letters of credit enhance the credit-worthiness of Key's clients by
assuring the clients' financial performance to third parties in connection with
specified transactions. Amounts drawn under standby letters of credit generally
carry variable rates of interest, and the credit risk involved is essentially
the same as that involved in the extension of loan facilities.
17
<PAGE> 18
The following is a summary of the contractual amount of each class of
lending-related, off-balance sheet financial instrument outstanding wherein
Key's maximum possible accounting loss equals the contractual amount of the
instruments.
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
in millions 1999 1998 1998
<S> <C> <C> <C>
====================================================================================================
Loan commitments:
Credit card lines $ 6,349 $ 6,320 $ 7,053
Home equity 4,495 4,347 4,334
Commercial real estate and construction 2,009 2,046 1,367
Commercial and other 21,837 20,995 19,179
- ----------------------------------------------------------------------------------------------------
Total loan commitments 34,690 33,708 31,933
Other commitments:
Standby letters of credit 1,809 1,834 2,133
Commercial letters of credit 136 138 137
Loans sold with recourse 20 21 25
- ----------------------------------------------------------------------------------------------------
Total loan and other commitments $36,655 $35,701 $34,228
======= ======= =======
====================================================================================================
</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. In addition, Key uses
treasury-based interest rate locks to manage the risk associated with
anticipated loan securitizations.
The following table summarizes the notional amount, fair value, maturity,
weighted average rate received and paid, and weighted average strike rate for
the various types of portfolio swaps, caps and floors used by Key.
<TABLE>
<CAPTION>
MARCH 31, 1999
--------------------------------------------------------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR MATURITY ---------------------------------
dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY STRIKE
=============================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Interest rate swaps:
Receive fixed/pay variable-indexed amortizing(1) $ 210 $ 3 .6 7.28% 5.00% N/A
Receive fixed/pay variable-conventional 6,041 123 5.1 6.08 4.95 N/A
Pay fixed/receive variable-conventional 4,018 (11) 4.4 5.13 5.90 N/A
Pay fixed/receive variable-forward starting 172 1 5.8 5.07 5.55 N/A
Basis swaps 5,056 (7) 2.1 5.06 5.00 N/A
- -----------------------------------------------------------------------------------------------------------------------------
Total 15,497 109 -- 5.50% 5.22% --
Interest rate caps, collars and corridors:
Caps purchased - one- to three-month LIBOR-based(2) 2,775 2 1.0 N/A N/A 5.88%
Collar - one- to three-month LIBOR-based 250 -- 1.8 N/A N/A 4.75 and 6.50
Collar - thirty-year U.S. Treasury-based 250 (7) .2 N/A N/A 5.79 and 7.98
1% payout corridor(3) 200 -- .6 N/A N/A 6.00 to 7.00
- -----------------------------------------------------------------------------------------------------------------------------
Total 3,475 (5) -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------
Total $18,972 $104 -- -- -- --
======= ====
=============================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
---------------------
NOTIONAL FAIR
dollars in millions AMOUNT VALUE
<S> <C> <C>
==============================================================================
Interest rate swaps:
Receive fixed/pay variable-indexed amortizing(1) $ 311 $ 4
Receive fixed/pay variable-conventional 4,325 223
Pay fixed/receive variable-conventional 4,872 (68)
Pay fixed/receive variable-forward starting 10 --
Basis swaps 2,872 19
- ------------------------------------------------------------------------------
Total 12,390 178
Interest rate caps, collars and corridors:
Caps purchased - one- to three-month LIBOR-based(2) 3,175 3
Collar - one- to three-month LIBOR-based 250 (1)
Collar - thirty-year U.S. Treasury-based 250 (24)
1% payout corridor(3) 200 --
- ------------------------------------------------------------------------------
Total 3,875 (22)
- ------------------------------------------------------------------------------
Total $16,265 $156
======= ====
==============================================================================
</TABLE>
(1) Maturity is based upon expected average lives rather than contractual terms.
(2) Includes $200 million of forward-starting caps as of March 31, 1999, and
December 31, 1998.
(3) Payout is indexed to three-month LIBOR.
N/A = Not Applicable
18
<PAGE> 19
Interest rate swap contracts involve the exchange of interest payments
calculated based on an agreed-upon amount (notional amount) and are generally
used to mitigate Key's exposure to interest rate risk on certain loans,
securities, deposits, short-term borrowings and long-term debt. Interest rate
caps and floors involve the payment of a premium by the buyer to the seller for
the right to receive an interest differential equal to the difference between
the current interest rate and an agreed-upon interest rate ("strike rate")
applied to a notional amount. Key generally purchases caps, enters into collars
(a combination of simultaneously purchasing a cap and selling a floor), and
enters into corridors (a combination of simultaneously purchasing a cap at a
specified strike rate and selling a cap at a higher strike rate) to manage the
risk of adverse movements in interest rates on specified long-term debt and
short-term borrowings. The notional amount associated with the execution of
swaps, caps and floors is significantly greater than the amount at risk.
Credit risk on swaps, caps and floors results from the possibility that the
counterparty will not meet the terms of the contract and is measured as the cost
of replacing, at current market rates, contracts in an unrealized gain position.
To mitigate this risk, Key deals exclusively with counterparties with high
credit ratings. With regard to its swap contracts, Key generally enters into
bilateral collateral and master netting arrangements. These agreements include
legal rights of setoff that provide for the net settlement of the subject
contracts with the same counterparty in the event of default. In addition, the
credit risk exposure to the counterparty on each interest rate swap is monitored
by a credit committee. Based upon credit reviews of the counterparties, limits
on Key's total credit exposure with each counterparty and the amount of
collateral required, if any, are determined. At March 31, 1999, Key had 41
different counterparties to portfolio swaps and swaps entered into to offset the
risk of client swaps. Key had aggregate credit exposure of $118 million to 16 of
these counterparties, with the largest credit exposure to an individual
counterparty amounting to $29 million. As of the same date, Key's aggregate
credit exposure on its interest rate caps and floors totaled $4 million. Based
on management's assessment as of March 31, 1999, all counterparties were
expected to meet their obligations. Portfolio swaps (including the impact of
both the spread on the swap portfolio and the amortization of deferred gains and
losses resulting from terminated swaps) and portfolio caps and floors increased
net interest income by $1 million in the first quarter of 1999 and $10 million
in the first quarter of 1998.
Conventional interest rate swap contracts involve the receipt of amounts based
on a fixed or variable rate in exchange for payments based on variable or fixed
rates, without an exchange of the underlying notional amount. Under an indexed
amortizing swap contract, the notional amount remains constant for a specified
period of time after which, based upon the level of an index at each review
date, the swap contract will mature, the notional amount will begin to amortize,
or the swap will continue in effect until its contractual maturity. Otherwise,
the characteristics of these swaps are similar to those of conventional swap
contracts. At March 31, 1999, Key was party to $103 million and $107 million of
indexed amortizing swaps that used a LIBOR index and a Constant Maturity
Treasuries ("CMT") index, respectively, for the review date measurement. Under
basis swap contracts, interest payments based on different floating indices are
exchanged.
Based on the weighted average rates in effect at March 31, 1999, the spread on
portfolio swaps, excluding the amortization of net deferred gains on terminated
swaps, provided a positive impact on net interest income (since the weighted
average rate received exceeded the weighted average rate paid by 28 basis
points). The aggregate fair value of $109 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.
19
<PAGE> 20
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 1999, swaps with a
notional amount of $551 million were terminated, resulting in a deferred gain of
$6 million. During the same period last year, swaps with a notional amount of
$268 million were terminated, resulting in a net deferred loss of $1 million. At
March 31, 1999, Key had a net deferred swap gain of $17 million with a weighted
average life of 4.0 years related to the management of debt and a net deferred
loss of $1 million with a weighted average life of 7.6 years related to the
management of loans.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES
Key also uses interest rate swaps, caps and floors, and futures contracts for
dealer activities (which are generally limited to the banks' commercial loan
clients) and enters into other positions with third parties that are intended to
mitigate the interest rate risk of the client positions. Interest rate swap
contracts entered into with clients are typically limited to conventional swaps,
as previously described. The client swaps, caps and floors, and futures, as well
as the third-party positions, are recorded at their estimated fair values, and
adjustments to fair value are included in investment banking and capital markets
income on the income statement.
Foreign exchange forward contracts are used by Key to accommodate the business
needs of its clients and for proprietary trading purposes. These contracts
provide for the delayed delivery or purchase of foreign currency. The foreign
exchange risk associated with such contracts is mitigated by entering into other
foreign exchange contracts with third parties. Adjustments to the fair value of
all such foreign exchange forward contracts are included in investment banking
and capital markets income on the income statement.
Key also enters into treasury options and treasury futures options for
proprietary trading purposes. Adjustments to the fair value of all such options
are included in investment banking and capital markets income on the income
statement.
At March 31, 1999, credit exposure from financial instruments held or issued for
trading purposes was limited to the aggregate fair value of each contract with a
positive fair value, or $362 million. The risk of counterparties defaulting on
their obligations is monitored on an ongoing basis. Key contracts with
counterparties with high credit ratings and enters into master netting
agreements when possible in an effort to manage credit risk.
Trading income recognized on interest rate, foreign exchange forward and
treasury-based option contracts totaled $8 million, $7 million and $2 million,
respectively, for the first three months of 1999 and $12 million, $5 million and
zero, respectively, for the first three months of 1998.
20
<PAGE> 21
A summary of the notional amount and the respective fair value of derivative
financial instruments held or issued for trading purposes at March 31, 1999, 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 $22.3 billion notional amount of client
interest rate swaps presented in the table includes $10.8 billion of client
swaps that receive a fixed rate and pay a variable rate, $8.4 billion of client
swaps that pay a fixed rate and receive a variable rate and $3.1 billion of
basis swaps. As of March 31, 1999, the client swaps had an average expected life
of 6.1 years, carried a weighted average rate received of 5.94% and had a
weighted average rate paid of 5.78%. Also included in the table below are
interest rate swaps and caps which were executed in connection with the residual
interests retained in the securitization of certain home equity loans.
<TABLE>
<CAPTION>
MARCH 31, 1999 THREE MONTHS ENDED MARCH 31, 1999
------------------------ ---------------------------------
NOTIONAL FAIR AVERAGE AVERAGE
in millions AMOUNT VALUE NOTIONAL AMOUNT FAIR VALUE
===========================================================================================================================
<S> <C> <C> <C> <C>
Interest rate contracts - client positions:
Swap assets $12,733 $ 238 $12,174 $ 280
Swap liabilities 9,578 (163) 8,771 (200)
Caps and floors purchased 420 1 405 1
Caps and floors sold 538 (1) 540 (1)
Futures purchased 143 (1) 281 --
Futures sold 18,066 15 17,741 12
Interest rate contracts - securitization positions:
Swap assets $ 666 $ 1 $ 411 --
Caps purchased 664 11 406 $ 5
Caps sold 664 (11) 406 (5)
Foreign exchange forward contracts:
Assets $ 1,367 $ 40 $ 1,229 $ 42
Liabilities 1,133 (39) 1,073 (39)
Treasury-based option contracts:
Options purchased $ 4,367 $ 56 $ 3,958 $ 64
Options sold 6,166 (62) 5,222 (56)
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
21
<PAGE> 22
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
SHAREHOLDERS AND BOARD OF DIRECTORS
KEYCORP
We have reviewed the unaudited condensed consolidated balance sheets of KeyCorp
and subsidiaries ("Key") as of March 31, 1999 and 1998, and the related
condensed 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 condensed consolidated financial statements referred to above for
them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Key as of December 31, 1998, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flow for the year then ended (not presented herein) and in our report
dated January 14, 1999, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated balance sheet as of December 31, 1998,
is fairly stated, in all material respects, in relation to the consolidated
balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
April 13, 1999
22
<PAGE> 23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
This section of the report, including the highlights summarized below, provides
a discussion and analysis of the financial condition and results of operations
of Key for the periods presented. It should be read in conjunction with the
consolidated financial statements and notes thereto, presented on pages 3
through 21.
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 economy which could materially change anticipated credit quality
trends and the ability to generate loans; failure of the capital markets to
function consistent with customary levels; significant delay in or inability to
execute strategic initiatives designed to grow revenues and/or manage expenses;
consummation of significant business combinations or divestitures; unforeseen
business risks related to Year 2000 computer systems issues; and significant
changes in accounting, tax, or regulatory practices or requirements.
Key's earnings results for the first quarter of 1999 reflected revenue growth
from diverse fee income sources, strong consumer loan demand, continued growth
in commercial lending and a high level of asset quality. Excluding a 1999 gain
of $134 million from the sale of Key's 20% interest in EPS and first quarter
1998 branch divestiture gains of $6 million, noninterest income rose 36% from
the year-ago quarter and comprised 41% of Key's total revenue (net interest
income plus noninterest income), up from 39% last quarter and 35% a year ago.
Key is aggressively moving toward its long-term goal of generating 50% of its
revenue from investment advisory and other noninterest income generating
activities. The progress made to date has been bolstered by the October 1998
acquisition of McDonald. At the same time, Key continues to experience strong
loan growth with the largest increases coming from the home equity and
commercial portfolios. Excluding the impact of sales, average outstanding home
equity loans were up an annualized 22% from the fourth quarter of 1998, while
commercial loan growth exceeded 10% for the eighth consecutive quarter.
Key's corporate strategy for the past several years has encompassed continued
reviews of business lines to identify opportunities to generate higher earnings
growth. This aspect of corporate strategy has led to an active program of
selling portfolios and business units that management determines to be of
low-return and/or low-growth potential. The strategy has also led to
acquisitions of businesses that Key's management sees as capable of achieving
double-digit earnings growth rates. The combination of these two aspects of
corporate strategy has resulted in an acceleration of loan growth and a
deceleration of deposit growth. As a partial response to this, Key has used
securitizations to supplement traditional sources of funding. To better align
its current funding sources with its ability to generate loans, Key's management
will continue its focus on selling portfolios and business units determined to
be of low-return and/or low-growth potential.
During the first quarter of 1999, Key also repurchased 5,555,224 of its Common
Shares. This included the repurchase of 3,869,761 shares remaining under the
authorization by the Board of Directors to repurchase up to 60% of the
19,337,159 shares issued in the October 1998 acquisition of McDonald. The other
1,685,463 shares were repurchased under a separate authorization that provides
for the repurchase of up to 10,000,000 shares in open market or negotiated
transactions. As of March 31, 1999, repurchase authority for 8,314,537 shares
remained under this program which has no expiration date.
The preceding items are reviewed in greater detail in the remainder of this
discussion and in the notes to the consolidated financial statements.
23
<PAGE> 24
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. Some of the items referred to in this performance overview and in
Figure 1 are more fully described in the following discussion or in the notes to
the consolidated financial statements presented on pages 7 through 21. Unless
otherwise indicated, all earnings per share data included in this section and
throughout the remainder of this discussion are presented on a diluted basis.
Net income for the first quarter of 1999 was $293 million, or $.65 per Common
Share ($.57 per Common Share, after excluding an aggregate $57 million impact of
a gain from the sale of Key's 20% interest in EPS, certain nonrecurring charges,
and the provision for loan losses in excess of net charge-offs). These results
compared with $235 million, or $.53 per Common Share, in the first quarter of
1998 and represented an 8% increase in per share earnings from the year-ago
quarter. On an annualized basis, the return on average equity for the first
quarter of 1999 was 19.48%, compared with 18.25% for the same period last year.
The annualized returns on average total assets were 1.49% and 1.32% for the
first quarters of 1999 and 1998, respectively. Excluding the factors comprising
the $57 million impact referred to above, Key's first quarter 1999 return on
average equity was 17.09% and its return on average total assets was 1.31%.
The increase in earnings relative to the first quarter of 1998 resulted from
continued growth in fee income and a moderate increase in taxable-equivalent net
interest income. Noninterest income for the first quarter of 1999 was $609
million, significantly higher than the $356 million recorded a year ago.
Excluding the $134 million gain from the sale of EPS recorded in the first
quarter of 1999 and branch divestiture gains of $6 million recorded in the first
quarter of last year, noninterest income grew by $125 million, or 36%. Compared
with the same period, taxable-equivalent net interest income rose by $34 million
as a $6.7 billion, or 10%, increase in average earning assets (primarily
commercial loans) more than offset a 19 basis point reduction in the net
interest margin to 3.95%. These positive factors were partially offset by a $162
million, or 28%, increase in noninterest expense. Included in noninterest
expense in the first quarter of 1999 was a $20 million contribution to the Key
sponsored charitable foundation made in light of the gain realized from the sale
of EPS. Excluding this contribution and $27 million of other nonrecurring
charges, noninterest expense was up $115 million, or 20%, from the first quarter
of last year. Contributing to the higher levels of both noninterest income and
expense were the results of McDonald, acquired in October 1998. Another factor
partially offsetting the growth in revenue was a higher provision for loan
losses. In the first quarter of 1999, the provision exceeded the level of net
charge-offs by $30 million and was $34 million higher than that of the year-ago
quarter.
24
<PAGE> 25
FIGURE 1 SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1999 1998
-------- --------------------------------------------------------
dollars in millions, except per share amounts FIRST FOURTH THIRD SECOND FIRST
================================================================================================================================
<S> <C> <C> <C> <C> <C>
FOR THE PERIOD
Interest income $ 1,381 $ 1,411 $ 1,415 $ 1,372 $ 1,327
Interest expense 696 724 734 706 677
Net interest income 685 687 681 666 650
Provision for loan losses 111 77 71 72 77
Noninterest income 609 447 392 380 356
Noninterest expense 748 667 628 602 586
Income before income taxes 435 390 374 372 343
Net income 293 260 252 249 235
- --------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .65 $ .58 $ .57 $ .57 $ .53
Net income-assuming dilution .65 .57 .57 .56 .53
Cash dividends .26 .235 .235 .235 .235
Book value at period end 13.63 13.63 12.73 12.55 12.15
Market price:
High 34.19 34.06 39.50 44.88 39.25
Low 29.69 23.38 24.75 34.44 31.56
Close 30.31 32.00 28.88 35.63 37.81
Weighted average Common Shares (000) 449,520 449,949 438,856 440,092 438,589
Weighted average Common Shares and
potential Common Shares (000) 454,197 454,527 443,750 446,568 444,836
- --------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 61,045 $ 62,012 $ 59,444 $ 57,769 $ 54,900
Earning assets 70,458 70,240 68,568 66,941 64,368
Total assets 79,992 80,020 77,691 75,778 73,198
Deposits 41,323 42,583 42,597 41,794 41,661
Long-term debt 15,457 12,967 11,353 10,196 9,041
Shareholders' equity 6,105 6,167 5,553 5,525 5,338
Full-time equivalent employees 25,650 25,862 24,586 24,711 24,650
Full-service banking offices 969 968 961 962 1,006
- --------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.49% 1.31% 1.32% 1.35% 1.32%
Return on average equity 19.48 17.12 18.14 18.47 18.25
Efficiency(1) 60.22 58.66 58.09 59.02 58.19
Overhead(2) 33.19 32.37 34.25 38.07 36.12
Net interest margin (TE) 3.95 3.99 4.08 4.10 4.14
- --------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.63% 7.71% 7.15% 7.29% 7.29%
Tangible equity to tangible assets 5.86 5.93 5.79 5.91 5.81
Tier 1 risk-adjusted capital 7.44 7.21 7.01 7.15 6.81
Total risk-adjusted capital 11.92 11.69 11.61 11.86 11.38
Leverage 7.21 6.95 6.88 7.04 6.61
================================================================================================================================
</TABLE>
The comparability of the information presented above is affected by certain
mergers, acquisitions and divestitures completed by Key in the time periods
presented. For further information concerning these transactions, refer to Note
3, Mergers, Acquisitions and Divestitures, beginning on page 8.
(1) Calculated as noninterest expense (excluding certain nonrecurring charges)
divided by taxable-equivalent net interest income plus noninterest income
(excluding net securities transactions and gains from certain divestitures).
(2) Calculated as noninterest expense (excluding certain nonrecurring charges)
less noninterest income (excluding net securities transactions and gains
from certain divestitures) divided by taxable-equivalent net interest
income.
TE = Taxable Equivalent
25
<PAGE> 26
CASH BASIS FINANCIAL DATA
The selected financial data presented in Figure 2 highlights the performance of
Key on a cash basis for each of the last five quarters. The data presented has
been adjusted to exclude the amortization of goodwill and other intangibles that
do not qualify for Tier 1 capital treatment, as well as the related assets.
These non-qualifying intangibles resulted from business combinations recorded by
Key under the purchase method of accounting. Had these business combinations
qualified for accounting under the pooling of interests method, no intangible
assets would have been recorded. Since the amortization of goodwill and other
non-qualifying intangibles does not result in a cash expense, the economic value
to shareholders under either accounting method is essentially the same.
Moreover, such amortization does not impact Key's liquidity and funds management
activities. Cash basis financial data provide an additional basis for measuring
a company's ability to support future growth, pay dividends and repurchase
shares. As defined above and presented in Figure 2, cash basis financial data
have not been adjusted to exclude the impact of other noncash items such as
depreciation, the provision for loan losses and restructuring charges. This is
the only section of this report in which Key's financial results are discussed
on a cash basis.
FIGURE 2 CASH BASIS SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1999 1998
-------- ------------------------------------------------------------
dollars in millions, except per share amounts FIRST FOURTH THIRD SECOND FIRST
==================================================================================================================================
FOR THE PERIOD
<S> <C> <C> <C> <C> <C>
Noninterest expense $722 $644 $608 $581 $ 564
Income before income taxes 461 413 394 393 365
Net income 316 281 270 267 254
- ----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $.70 $.63 $.61 $.61 $ .58
Net income - assuming dilution .70 .62 .61 .60 .57
Weighted average Common Shares (000) 449,520 449,949 438,856 440,092 438,589
Weighted average Common Shares and potential
Common Shares (000) 454,197 454,527 443,750 446,568 444,836
- ----------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.64% 1.44% 1.43% 1.47% 1.45%
Return on average equity 27.87 24.02 24.43 25.08 25.37
Efficiency(1) 57.99 56.64 56.24 56.96 56.01
- ----------------------------------------------------------------------------------------------------------------------------------
GOODWILL AND NON-QUALIFYING INTANGIBLES
Goodwill average balance $1,428 $1,303 $1,042 $1,042 $ 1,063
Non-qualifying intangibles average balance 74 81 85 96 99
Goodwill amortization (after tax) 21 18 15 15 16
Non-qualifying intangibles amortization (after tax) 2 3 3 3 3
==================================================================================================================================
</TABLE>
The comparability of the information presented above is affected by certain
mergers, acquisitions and divestitures completed by Key in the time periods
presented. For further information concerning these transactions, refer to Note
3, Mergers, Acquisitions and Divestitures, beginning on page 8.
(1) Calculated as noninterest expense (excluding certain nonrecurring charges
and the amortization of goodwill and non-qualifying intangibles) divided by
taxable-equivalent net interest income plus noninterest income (excluding
net securities transactions and gains from certain divestitures).
26
<PAGE> 27
LINE OF BUSINESS RESULTS
Presented below is a summary of the comparative financial performance of each of
Key's major lines of business for the three-month periods ended March 31, 1999
and 1998, as well as a summary of significant strategic developments that
occurred within those lines during the first quarter of 1999. It should be read
in conjunction with Note 4, Line of Business Results, beginning on page 9. This
note provides additional information pertaining to the basis of the financial
results discussed and the nature of the business conducted by each line of
business.
Key's net income by line of business for the three-month periods ended March 31,
1999 and 1998, is shown in Figure 3.
Figure 3 Net Income by Line of Business
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, CHANGE
-------------------
dollars in millions 1999 1998 AMOUNT PERCENT
================================================================================
<S> <C> <C> <C> <C>
Key Corporate Capital $ 63 $ 56 $ 7 12.5%
Key Consumer Finance 45 20 25 125.0
Key Community Bank 134 137 (3) (2.2)
Key Capital Partners(1) 19 31 (12) (38.7)
- --------------------------------------------------------------------------------
Total segments 261 244 17 7.0
Reconciling items 32 (9) 41 N/M
- --------------------------------------------------------------------------------
Total net income $ 293 $ 235 $ 58 24.7%
===== ===== ===== ====
================================================================================
</TABLE>
(1) Prior to the assignment of income and expense to the other lines of
business, as described under the following Key Capital Partners heading, net
income was $30 million and $40 million for the first three months of 1999
and 1998, respectively.
N/M = Not Meaningful
KEY CORPORATE CAPITAL
During the first quarter of 1999, Key Corporate Capital contributed
approximately 22% of Key's consolidated earnings with net income of $63 million.
In the same period last year, net income was $56 million, or approximately 24%
of Key's consolidated earnings. The increase in earnings relative to the prior
year reflected higher net interest income resulting from a 24% increase in total
average loans as growth occurred in all of Key Corporate Capital's major
business units. Also contributing to the improved earnings was an $11 million
rise in noninterest income, led by growth in letter of credit and loan fees, and
higher income from various investment banking and capital markets activities.
Noninterest expense increased by $5 million compared with that of the first
quarter of 1998. This was primarily attributable to an increase in depreciation
and amortization expense, and higher costs associated with investment banking
and capital markets activities.
KEY CONSUMER FINANCE
During the first quarter of 1999, Key Consumer Finance generated net income of
$45 million, or approximately 15% of Key's consolidated earnings, up from $20
million, or approximately 9%, for the same period last year. Primary factors
contributing to improved financial performance were higher levels of both net
interest income and noninterest income. These positive factors were partially
offset by an increase in noninterest expense and a slightly higher provision for
loan losses. Net interest income increased $30 million as average loans
outstanding rose 24% from the year-ago quarter. The increase in loans reflected
strong growth in the home equity portfolio, as well as the April 1998
acquisition of an $805 million marine/recreational vehicle installment loan
portfolio. Growth in average loans occurred despite the securitization and sale
of an aggregate $2.1 billion of automobile, home equity and education loans
since December 31, 1997. Gains resulting from securitizations accounted for
virtually all of the $29 million increase in noninterest income from the first
three months of 1998. Noninterest expense rose $15 million from the year-ago
quarter due in large part to an increase in depreciation and amortization
expense associated with loan servicing and higher costs incurred to expand the
home equity business.
27
<PAGE> 28
KEY COMMUNITY BANK
Efforts are currently underway to strengthen sales generation capabilities and
improve efficiencies in branch-based delivery costs to support a goal of
achieving at least 8% earnings growth in the retail component of Key Community
Bank. In the first quarter of 1999, these efforts centered on streamlining
deposit product offerings and enhancing the deposit fee structure. Excluding the
allocation of indirect expenses to Key Community Bank from other KeyCorp units,
core net income for Key Community Bank was up almost 8% from the first three
months of 1998. On a fully allocated basis, however, in the first quarter of
1999, net income for Key Community Bank totaled $134 million, or approximately
46% of Key's consolidated earnings, compared with $137 million, or 58%,
respectively, for the first three months of 1998. The slight decrease in
earnings relative to the prior year reflected a decline in net interest income,
coupled with increases in both the provision for loan losses and noninterest
expense. These factors were partially offset by growth in noninterest income.
Net interest income declined by $7 million as a moderate increase in average
loans outstanding was more than offset by the impact of increased reliance on
higher-cost funding. The higher cost of funds reflected the reduction in core
deposits stemming from the 1998 divestiture of 46 branch offices with deposits
of approximately $658 million. The provision for loan losses increased by $4
million in response to a higher level of net charge-offs, while noninterest
expense rose by $3 million due primarily to an increase in depreciation and
amortization expense and higher costs associated with investment banking and
capital markets activities. Noninterest income was up $6 million from the
year-ago quarter with the largest contributions coming from service charges on
deposit accounts, investment banking and capital markets income, and a gain from
the sale of certain residential mortgage loans.
KEY CAPITAL PARTNERS
During the first quarter of 1999, Key Capital Partners recorded net income of
$19 million, or approximately 6% of Key's consolidated earnings, compared with
$31 million, or approximately 13%, a year-ago. A significant portion of
noninterest income and expense generated by Key Capital Partners is reported
under either Key Corporate Capital or Key Community Bank. This reflects Key's
management accounting practice of assigning such income and expense to whichever
line of business is principally responsible for maintaining the relationships
with clients who also avail themselves of the products and services offered by
Key Capital Partners. Prior to the aforementioned assignments, Key Capital
Partner's net income totaled $30 million (representing 10% of Key's consolidated
earnings) in the first three months of 1999 and $40 million (representing 17% of
Key's consolidated earnings) in the same period last year.
Total revenue for Key Capital Partners rose $87 million from the first three
months of 1998. This was primarily due to the October 1998 acquisition of
McDonald, but also reflected higher revenue from trust and asset management
activities as a result of new business, the strength of the stock and bond
markets and the repricing of certain services. A lower volume of investment
banking, derivative and equity capital activities moderated the overall increase
in revenue relative to the prior year. Noninterest expense was up $104 million
from the first quarter of last year, also due largely to the impact of the
McDonald acquisition and the associated increases in expenses related to
personnel, depreciation and amortization.
RECONCILING ITEMS
The impact on net income from reconciling items shown in Figure 3 is primarily
the result of certain nonrecurring items and charges related to unallocated
nonearning assets of corporate support functions. Noninterest income included a
$134 million ($85 million after tax) gain from the first quarter 1999 sale of
Key's 20% interest in EPS and $6 million ($4 million after tax) of branch
divestiture gains during the first quarter of 1998. Included in noninterest
expense for the first quarter of 1999 was a $20 million ($13 million after tax)
contribution made to the Key sponsored charitable foundation and $27 million
($17 million after tax) of other nonrecurring charges. Further information
pertaining to the nonrecurring items is included in Note 4, referred to in the
first paragraph of this section, and elsewhere in this management's discussion.
28
<PAGE> 29
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 17), 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 1998 to the first quarter of 1999. A more in-depth discussion of
changes in earning assets and funding sources is presented in the Financial
Condition section beginning on page 39.
In the first quarter of 1999, Key reclassified the distributions on its capital
securities (tax-advantaged preferred securities) from noninterest expense to
interest expense and restated prior quarters to conform to the current
presentation. The capital securities are more fully described in Note 9, Capital
Securities, beginning on page 16. As a result, the net interest margin for each
quarter presented in Figure 4 was reduced by approximately 10 basis points from
that previously reported and a corresponding reduction occurred in noninterest
expense. As measured using the new classification, net interest income for the
first quarter of 1999 was $693 million, up $34 million, or 5%, from the same
period last year. This improvement reflected a 10% increase in average earning
assets (primarily commercial loans) to $70.7 billion, that more than offset a 19
basis point reduction in the net interest margin to 3.95%. Compared with the
fourth quarter of 1998, net interest income was relatively unchanged as an
annualized 7% increase in average earning assets was offset by a 4 basis point
decline in the net interest margin. The net interest margin is computed by
dividing annualized taxable-equivalent net interest income by average earning
assets.
The decrease in the margin since the year-ago quarter 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 and the repricing of core
deposits in a low interest rate environment. Another factor contributing to the
contraction of the margin was an increase in trading account assets with low
interest rate spreads associated with various capital markets activities.
Average earning assets for the first quarter totaled $70.7 billion, which was
$6.7 billion, or 10%, higher than the first quarter 1998 level and $1.2 billion,
or an annualized 7%, above the fourth quarter of 1998. The growth from the year-
ago quarter reflected a $7.7 billion, or 14%, increase in loans with more than
70% of the increase coming from the commercial portfolio. The first quarter of
1999 marked the eighth consecutive quarter in which this portfolio has achieved
annualized growth exceeding 10%. Also contributing to the growth from the 1998
first quarter were increases in the home equity, lease financing and installment
segments of the consumer loan portfolio. Most of the growth in the installment
segment resulted from the acquisition of an $805 million marine/recreational
vehicle portfolio in April 1998. The growth in total loans relative to the prior
quarter was also due primarily to strong commercial loan growth. In addition,
each of the consumer segments referred to above contributed to this growth
despite the securitization and sale of $1.8 billion of consumer loans during the
first quarter of 1999. Key's strategy with respect to its loan portfolio is
discussed in greater detail in the Loans section beginning on page 39.
Key uses portfolio interest rate swaps, caps and floors (as defined in Note 10,
Financial Instruments with Off-Balance Sheet Risk, beginning on page 17) in the
management of its interest rate sensitivity position. The notional amount of
such swaps increased to $15.5 billion at March 31, 1999, from $12.4 billion at
year-end 1998. Over the same period, the notional amount of interest rate caps
and floors decreased $400 million to $3.5 billion. For the first quarter of
1999, interest rate swaps (including the impact of both the spread on the swap
portfolio and the amortization of deferred gains and losses resulting from
terminated swaps) and interest rate caps and floors contributed $1 million to
net interest income and had virtually no impact on the net interest margin. For
the same period last year, these instruments increased net interest income by
$10 million and the net interest margin by 6 basis points. The manner in which
interest rate swaps, caps and floors are used in Key's overall program of asset
and liability management is described in the following Market Risk Management
section.
29
<PAGE> 30
FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
<TABLE>
<CAPTION>
FIRST QUARTER 1999 FOURTH QUARTER 1998
----------------------------------- ---------------------------------
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 $16,994 $ 314 7.49% $16,711 $ 326 7.74%
Real estate-- commercial mortgage 7,176 148 8.36 7,394 158 8.48
Real estate-- construction 3,651 73 8.11 3,355 71 8.40
Commercial lease financing 5,723 103 7.30 5,241 100 7.57
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 33,544 638 7.71 32,701 655 7.95
Real estate-- residential 4,868 91 7.58 5,174 99 7.59
Credit card 1,377 49 14.43 1,388 52 14.86
Other consumer 19,485 432 8.99 18,682 421 8.94
- ------------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 25,730 572 9.02 25,244 572 8.99
Loans held for sale 2,419 44 7.38 2,711 54 7.90
- ------------------------------------------------------------------------------------------------------------------------------------
Total loans 61,693 1,254 8.24 60,656 1,281 8.38
Taxable investment securities 375 4 4.33 334 2 3.53
Tax-exempt investment securities(1) 615 13 8.57 668 15 8.91
- ------------------------------------------------------------------------------------------------------------------------------------
Total investment securities 990 17 6.96 1,002 17 6.73
Securities available for sale(1,3) 6,004 97 6.58 6,066 99 6.47
Interest-bearing deposits with banks 22 1 14.13 25 -- 13.66
Federal funds sold and securities
purchased under resale agreements 749 5 2.71 1,102 11 3.96
Trading account assets 1,204 15 5.05 620 11 7.04
- ------------------------------------------------------------------------------------------------------------------------------------
Total short-term investments 1,975 21 4.31 1,747 22 5.00
- ------------------------------------------------------------------------------------------------------------------------------------
Total earning assets 70,662 1,389 7.97 69,471 1,419 8.10
Allowance for loan losses (888) (888)
Other assets 10,084 10,385
- ------------------------------------------------------------------------------------------------------------------------------------
$79,858 $78,968
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $12,540 94 3.04 $12,152 98 3.20
Savings deposits 2,899 12 1.68 2,983 11 1.46
NOW accounts 1,210 4 1.34 1,205 5 1.65
Certificates of deposit ($100,000 or more) 3,646 46 5.12 3,816 52 5.41
Other time deposits 11,814 147 5.05 11,916 156 5.19
Deposits in foreign office 509 6 4.78 366 5 5.01
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 32,618 309 3.84 32,438 327 4.00
Federal funds purchased and securities
sold under repurchase agreements 5,077 54 4.31 5,205 61 4.65
Bank notes and other short-term borrowings 9,208 119 5.24 10,171 140 5.46
Long-term debt, including capital securities(4) 15,172 214 5.73 13,262 196 5.86
- ------------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 62,075 696 4.55 61,076 724 4.70
Noninterest-bearing deposits 8,495 8,810
Other liabilities 3,188 3,057
Common shareholders' equity 6,100 6,025
- ------------------------------------------------------------------------------------------------------------------------------------
$79,858 $78,968
======== =======
Interest rate spread (TE) 3.42 3.40
- ------------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 693 3.95% $ 695 3.99%
====== ====== ====== ======
Capital securities $1,039 $19 $997 $18
Taxable-equivalent adjustment (1) 8 8
====================================================================================================================================
</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 average
loan balances.
(3) Yield is calculated on the basis of amortized cost.
(4) Rate calculation excludes ESOP debt.
TE = Taxable Equivalent
30
<PAGE> 31
FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
(CONTINUED)
<TABLE>
<CAPTION>
THIRD QUARTER 1998 SECOND QUARTER 1998
------------------------------- -----------------------------
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 $15,815 $ 328 8.23% $15,026 $ 309 8.25%
Real estate-- commercial mortgage 7,034 160 9.02 6,944 153 8.84
Real estate-- construction 3,052 69 8.97 2,694 62 9.23
Commercial lease financing 4,933 90 7.24 4,634 86 7.44
- ---------------------------------------------------------------------------------------------------------------------
Total commercial loans 30,834 647 8.32 29,298 610 8.35
Real estate-- residential 5,274 102 7.67 5,549 108 7.81
Credit card 1,432 53 14.68 1,449 53 14.67
Other consumer 17,423 399 9.09 16,742 380 9.10
- ---------------------------------------------------------------------------------------------------------------------
Total consumer loans 24,129 554 9.11 23,740 541 9.14
Loans held for sale 3,596 75 8.27 3,403 70 8.25
- ---------------------------------------------------------------------------------------------------------------------
Total loans 58,559 1,276 8.64 56,441 1,221 8.68
Taxable investment securities 269 3 4.05 270 4 5.51
Tax-exempt investment securities(1) 726 15 8.20 871 18 8.29
- ---------------------------------------------------------------------------------------------------------------------
Total investment securities 995 18 7.18 1,141 22 7.63
Securities available for sale(1,3) 6,175 105 6.75 6,765 117 6.94
Interest-bearing deposits with banks 35 1 14.32 22 1 10.33
Federal funds sold and securities
purchased under resale agreements 951 12 5.01 790 10 4.92
Trading account assets 742 11 5.88 610 10 6.42
- ---------------------------------------------------------------------------------------------------------------------
Total short-term investments 1,728 24 5.51 1,422 21 5.92
- ---------------------------------------------------------------------------------------------------------------------
Total earning assets 67,457 1,423 8.37 65,769 1,381 8.42
Allowance for loan losses (888) (888)
Other assets 9,317 9,185
- ---------------------------------------------------------------------------------------------------------------------
$75,886 $74,066
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $11,783 99 3.33 $11,494 95 3.32
Savings deposits 3,118 14 1.78 3,307 16 1.94
NOW accounts 1,160 5 1.71 1,250 5 1.60
Certificates of deposit ($100,000 or more) 3,399 47 5.49 3,502 49 5.61
Other time deposits 11,965 161 5.34 12,375 166 5.38
Deposits in foreign office 954 13 5.41 1,095 15 5.49
- ---------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 32,379 339 4.15 33,023 346 4.20
Federal funds purchased and securities
sold under repurchase agreements 7,456 99 5.27 6,773 89 5.27
Bank notes and other short-term borrowings 7,305 108 5.87 7,710 113 5.88
Long-term debt, including capital securities(4) 12,026 188 6.20 10,277 158 6.17
- ---------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 59,166 734 4.92 57,783 706 4.90
Noninterest-bearing deposits 8,485 8,328
Other liabilities 2,724 2,547
Common shareholders' equity 5,511 5,408
- ---------------------------------------------------------------------------------------------------------------------
$75,886 $74,066
======= =======
Interest rate spread (TE) 3.45 3.52
- ---------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 689 4.08% $ 675 4.10%
======= ==== ======= ====
Capital securities $ 997 $19 $ 766 $14
Taxable-equivalent adjustment (1) 8 9
=====================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
FIRST QUARTER 1998
----------------------------
AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE
===============================================================================
<S> <C> <C> <C>
ASSETS
Loans (1,2)
Commercial, financial and agricultural $14,066 $ 288 8.30%
Real estate-- commercial mortgage 6,944 156 9.11
Real estate-- construction 2,347 52 8.99
Commercial lease financing 4,471 83 7.53
- -------------------------------------------------------------------------------
Total commercial loans 27,828 579 8.44
Real estate-- residential 5,773 113 7.94
Credit card 1,482 54 14.78
Other consumer 15,771 359 9.23
- -------------------------------------------------------------------------------
Total consumer loans 23,026 526 9.26
Loans held for sale 3,092 63 8.26
- -------------------------------------------------------------------------------
Total loans 53,946 1,168 8.78
Taxable investment securities 256 3 4.53
Tax-exempt investment securities(1) 940 19 8.20
- -------------------------------------------------------------------------------
Total investment securities 1,196 22 7.46
Securities available for sale(1,3) 7,457 129 7.02
Interest-bearing deposits with banks 29 1 12.54
Federal funds sold and securities
purchased under resale agreements 912 11 4.89
Trading account assets 409 5 4.96
- -------------------------------------------------------------------------------
Total short-term investments 1,350 17 5.11
- -------------------------------------------------------------------------------
Total earning assets 63,949 1,336 8.47
Allowance for loan losses (889)
Other assets 9,062
- -------------------------------------------------------------------------------
$72,122
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $11,159 90 3.27
Savings deposits 3,499 18 2.09
NOW accounts 1,244 5 1.63
Certificates of deposit ($100,000 or more) 3,362 46 5.55
Other time deposits 12,716 171 5.45
Deposits in foreign office 1,245 17 5.54
- -------------------------------------------------------------------------------
Total interest-bearing deposits 33,225 347 4.24
Federal funds purchased and securities
sold under repurchase agreements 7,117 93 5.30
Bank notes and other short-term borrowings 6,683 98 5.95
Long-term debt, including capital securities(4) 9,076 139 6.21
- -------------------------------------------------------------------------------
Total interest-bearing liabilities 56,101 677 4.89
Noninterest-bearing deposits 8,409
Other liabilities 2,390
Common shareholders' equity 5,222
- -------------------------------------------------------------------------------
$72,122
=======
Interest rate spread (TE) 3.58
- -------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $ 659 4.14%
======= ====
Capital securities $ 750 $14
Taxable-equivalent adjustment (1) 9
===============================================================================
</TABLE>
31
<PAGE> 32
FIGURE 5 COMPONENTS OF NET INTEREST INCOME CHANGES
<TABLE>
<CAPTION>
FROM THREE MONTHS ENDED MARCH 31, 1998,
TO THREE MONTHS ENDED MARCH 31, 1999
------------------------------------------
AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE
=========================================================================================
<S> <C> <C> <C>
INTEREST INCOME
Loans $ 161 $ (75) $ 86
Taxable investment securities 1 -- 1
Tax-exempt investment securities (7) 1 (6)
Securities available for sale (24) (8) (32)
Short-term investments 7 (3) 4
- -----------------------------------------------------------------------------------------
Total interest income (TE) 138 (85) 53
INTEREST EXPENSE
Money market deposit accounts 11 (7) 4
Savings deposits (3) (3) (6)
NOW accounts -- (1) (1)
Certificates of deposit ($100,000 or more) 4 (4) --
Other time deposits (12) (12) (24)
Deposits in foreign office (9) (2) (11)
- -----------------------------------------------------------------------------------------
Total interest-bearing deposits (9) (29) (38)
Federal funds purchased and securities sold
under repurchase agreements (24) (15) (39)
Bank notes and other short-term borrowings 34 (13) 21
Long-term debt, including capital securities 87 (12) 75
- -----------------------------------------------------------------------------------------
Total interest expense 88 (69) 19
- -----------------------------------------------------------------------------------------
Net interest income (TE) $ 50 $ (16) $ 34
===== ===== =====
======================================================================================
</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
MARKET RISK MANAGEMENT
Market risk is the exposure to economic loss that arises from changes in the
values of certain market risk sensitive instruments. Types of market risk
include interest rate, foreign exchange and equity price risk (the risk of
economic loss related to equity securities held as assets). Foreign exchange and
equity price risk are not material to Key.
Asset and Liability Management
- ------------------------------
Key manages its interest rate risk through an active program of asset and
liability management pursuant to guidelines established by its Asset/Liability
Management Policy Committee ("ALCO"). The ALCO has responsibility for approving
the asset/liability management policies of Key, overseeing the formulation and
implementation of strategies to improve balance sheet positioning and/or
earnings, and reviewing Key's interest rate sensitivity position.
Measurement of Short-term Interest Rate Exposure: The primary tool utilized by
management to measure and manage interest rate risk is a net interest income
simulation model. Use of the model to perform simulations of changes in interest
rates over one- and two-year time horizons has enabled management to develop
strategies for managing exposure to interest rate risk. In its simulations,
management estimates the impact on net interest income of various pro forma
changes in the overall level of interest rates. These estimates are based on a
large number of assumptions related to loan and deposit growth, asset and
liability prepayments, interest rates, on- and off-balance sheet management
strategies and other factors. Management believes that both individually and in
the aggregate these assumptions are reasonable, but the complexity of the
simulation modeling process results in a sophisticated estimate, not a precise
32
<PAGE> 33
calculation of exposure. The ALCO guidelines provide that a gradual 200 basis
point increase or decrease in short-term rates over the next twelve-month period
should not result in more than a 2% impact on net interest income over the same
period from what net interest income would have been if such interest rates did
not change. As of March 31, 1999, based on the results of the simulation model
using the ALCO guidelines, Key would expect its net interest income to increase
by approximately $32 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 $30 million.
Measurement of Long-term Interest Rate Exposure: Short-term interest rate risk
analysis is complemented by an economic value of equity model. This model
provides the added benefit of measuring exposure to interest rate changes
outside the one- to two-year time frame measured by the simulation model. The
economic value of Key's equity is determined by modeling the net present value
of future cash flows for asset, liability and off-balance sheet positions based
on the implied forward yield curve. Economic value analysis has several
limitations including: the economic values of asset, liability and off-balance
sheet positions do not represent the true fair values of the positions, since
they do not consider factors such as credit risk and liquidity; the use of
estimates of cash flows is necessary for assets and liabilities with
indeterminate maturities; the future structure of the balance sheet derived from
ongoing loan and deposit activity by Key's core businesses is not factored into
present value calculations; and the analysis requires assumptions about events
that span an even longer time frame than that used in the simulation model.
Despite its limitations, the economic value of equity model does provide
management with a relatively sophisticated tool for evaluating the longer term
effect of possible interest rate movements. The ALCO guidelines provide that an
immediate 200 basis point increase or decrease in interest rates should not
result in more than a 1.75% change in the ratio of base case economic value of
equity to the sum of base case economic value of assets and net fixed rate
interest rate swaps, caps and floors. Key has been operating well within these
guidelines.
Other Sources of Interest Rate Exposure: Key utilizes the results of its
short-term and long-term interest rate exposure models to formulate strategies
to improve balance sheet positioning and/or earnings within interest rate risk,
liquidity and capital guidelines established by the ALCO. In addition to the
interest rate exposure measured using ALCO guidelines, the risk to earnings and
economic value arising from various other pro forma changes in the overall level
of interest rates is periodically measured. The variety of interest rate
scenarios modeled, and their potential impact on earnings and economic value,
quantifies the level of interest rate exposure arising from several sources,
namely option risk, basis risk and gap risk. Option risk exists in the form of
options (including caps and floors) embedded in certain products. These options
permit the client (either a loan client or a depositor) to take advantage of
changes in interest rates without penalty. Examples include floating-rate loans
that contain an interest rate cap, fixed-rate loans that do not contain
prepayment penalties and deposits that can be withdrawn on demand. Basis risk
refers to floating-rate assets and floating-rate liabilities that reprice
simultaneously, but are tied to different indices. Basis risk arises when one
index does not move consistently with another. Gap risk is the risk that assets,
liabilities or related interest rate swaps, caps and floors will mature or
reprice in different time frames. For example, floating-rate loans that reprice
monthly may be funded with fixed-rate certificates of deposit that mature in one
year.
Management of Interest Rate Exposure: To manage interest rate risk, management
uses interest rate swaps, caps and floors to modify the repricing or maturity
characteristics of specified on-balance sheet assets and liabilities.
Instruments used for this purpose are designated as portfolio swaps, caps and
floors. The decision to use these instruments versus on- balance sheet
alternatives depends on various factors, including the mix and cost of funding
sources, liquidity and capital requirements. Further details pertaining to
portfolio swaps, caps and floors are included in Note 10, Financial Instruments
with Off-Balance Sheet Risk, beginning on page 17. In addition, management
strategically selects the interest sensitivity structure of additions to Key's
securities portfolio, new debt issuances and loan securitizations in light of
interest rate risk management objectives.
Portfolio Swaps, Caps and Floors: As shown in Note 10, the estimated fair value
of Key's portfolio swaps, caps and floors decreased to $104 million at March 31,
1999, from a fair value of $156 million at December 31, 1998. The decrease in
fair value over the past three months reflected the combined impact of a number
of factors, including the increase in interest rates, the steepening of the
implied forward yield curve, and the fact that Key's receive fixed interest rate
swap portfolio has a slightly longer average remaining maturity than the pay
fixed portfolio. Swaps with a notional amount of $551 million were terminated
during the first quarter of 1999, resulting in a deferred gain of $6 million.
Further information pertaining to the balance and remaining amortization period
of Key's deferred swap gains and losses at March 31, 1999, is also presented in
Note 10. Each swap termination was made in response to a unique set of
circumstances and for various reasons; however, the decision to terminate any
swap contract is integrated strategically with asset and liability management
and other appropriate processes. Key continues to use portfolio caps in response
to
33
<PAGE> 34
heavier reliance placed on variable rate funding to support earning asset
growth. These instruments are used primarily to protect against the adverse
impact that a future rise in interest rates could have on variable rate
short-term borrowings, while having no impact in the event of a decline in
rates. Portfolio swaps, caps and floors activity for the three-month period
ended March 31, 1999, is summarized in Figure 6.
FIGURE 6 PORTFOLIO SWAPS, CAPS AND FLOORS ACTIVITY
<TABLE>
<CAPTION>
RECEIVE FIXED
-------------------------- PAY FIXED- TOTAL
INDEXED PAY FIXED- FORWARD- BASIS PORTFOLIO
in millions AMORTIZING CONVENTIONAL CONVENTIONAL STARTING SWAPS SWAPS
=================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998 $311 $4,325 $4,872 $10 $2,872 $12,390
Additions -- 1,840 119 169 2,484 4,612
Maturities -- 24 529 -- 300 853
Terminations -- 100 451 -- -- 551
Forward-starting becoming effective -- -- 7 (7) -- --
Amortization 101 -- -- -- -- 101
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 1999 $210 $6,041 $4,018 $172 $5,056 $15,497
==== ====== ====== ==== ====== ======
=================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
CAPS
AND
in millions FLOORS TOTAL
=====================================================================
<S> <C> <C>
BALANCE AT DECEMBER 31, 1998 $ 3,875 $16,265
Additions -- 4,612
Maturities 400 1,253
Terminations -- 551
Forward-starting becoming effective -- --
Amortization -- 101
- ---------------------------------------------------------------------
BALANCE AT MARCH 31, 1999 $ 3,475 $18,972
======= =======
=====================================================================
</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 7. The fair
value at any given date represents the estimated income (if positive) or cost
(if negative) that would be recognized if the portfolios were to be liquidated
at that date. However, because these instruments are used to alter the repricing
or maturity characteristics of specific assets and liabilities, the net
unrealized gains and losses are not recognized in earnings. Interest from these
swaps, caps and floors is recognized on an accrual basis as an adjustment of the
interest income or expense from the asset or liability being managed.
FIGURE 7 PORTFOLIO SWAPS, CAPS AND FLOORS BY INTEREST RATE MANAGEMENT STRATEGY
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
---------------------- ---------------------
NOTIONAL FAIR NOTIONAL FAIR
in millions AMOUNT VALUE AMOUNT VALUE
======================================================================================================================
<S> <C> <C> <C> <C>
Convert variable rate loans to fixed $ 1,528 $ 31 $ 1,526 $ 58
Convert fixed rate loans to variable 822 (1) 909 (38)
Convert fixed rate securities to variable 323 (8) -- --
Convert variable rate deposits and short-term borrowings to fixed 1,650 (12) 2,378 (24)
Convert fixed rate short-term borrowings to variable 550 -- 200 --
Convert variable rate long-term debt to fixed 1,395 11 1,595 (6)
Convert fixed rate long-term debt to variable 4,173 95 2,910 169
Basis swaps - foreign currency denominated debt 304 (7) 304 19
Basis swaps - interest rate indices 4,752 -- 2,568 --
- ----------------------------------------------------------------------------------------------------------------------
Total portfolio swaps 15,497 109 12,390 178
Modify characteristics of variable rate short-term borrowings 2,825 2 3,060 2
Modify characteristics of variable rate long-term debt 400 -- 565 --
Modify characteristics of capital securities remarketing 250 (7) 250 (24)
- ----------------------------------------------------------------------------------------------------------------------
Total portfolio caps and floors 3,475 (5) 3,875 (22)
- ----------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $18,972 $104 $16,265 $156
======= ==== ======= ====
======================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1998
----------------------
NOTIONAL FAIR
in millions AMOUNT VALUE
=============================================================================================
<S> <C> <C>
Convert variable rate loans to fixed $ 3,806 $ 28
Convert fixed rate loans to variable 551 (13)
Convert fixed rate securities to variable -- --
Convert variable rate deposits and short-term borrowings to fixed 1,980 (4)
Convert fixed rate short-term borrowings to variable -- --
Convert variable rate long-term debt to fixed 750 (2)
Convert fixed rate long-term debt to variable 2,420 92
Basis swaps - foreign currency denominated debt 304 (9)
Basis swaps - interest rate indices 1,000 --
- --------------------------------------------------------------------------------------------
Total portfolio swaps 10,811 92
Modify characteristics of variable rate short-term borrowings 2,980 6
Modify characteristics of variable rate long-term debt 565 1
Modify characteristics of capital securities remarketing 250 (12)
- --------------------------------------------------------------------------------------------
Total portfolio caps and floors 3,795 (5)
- --------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $14,606 $ 87
======= ====
============================================================================================
</TABLE>
The expected average maturities of the portfolio swaps, caps and floors at March
31, 1999, are summarized in Figure 8.
FIGURE 8 EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS, CAPS AND FLOORS
<TABLE>
<CAPTION>
MARCH 31, 1999 RECEIVE FIXED
--------------------------- PAY FIXED-
INDEXED PAY FIXED- FORWARD- BASIS
in millions AMORTIZING CONVENTIONAL CONVENTIONAL STARTING SWAPS
==========================================================================================================================
<S> <C> <C> <C> <C> <C>
Mature in one year or less $210 $1,465 $1,111 -- $ 950
Mature after one through five years -- 2,258 2,108 $111 4,106
Mature after five through ten years -- 1,968 387 2 --
Mature after ten years -- 350 412 59 --
- --------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $210 $6,041 $4,018 $172 $5,056
==== ====== ====== ==== ======
==========================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1999
TOTAL CAPS
PORTFOLIO AND
in millions SWAPS FLOORS TOTAL
=======================================================================================
<S> <C> <C> <C>
Mature in one year or less $ 3,736 $2,525 $ 6,261
Mature after one through five years 8,583 950 9,533
Mature after five through ten years 2,357 -- 2,357
Mature after ten years 821 -- 821
- ---------------------------------------------------------------------------------------
Total portfolio swaps, caps and floors $15,497 $3,475 $18,972
======= ====== =======
=======================================================================================
</TABLE>
34
<PAGE> 35
Trading Portfolio Risk Management
- ---------------------------------
Key's trading portfolio includes interest rate swap contracts entered into to
accommodate the needs of its clients, and other positions with third parties
that are intended to mitigate the interest rate risk of the client positions,
foreign exchange contracts entered into to accommodate the needs of its clients
and financial assets and liabilities (trading positions) included in other
assets and other liabilities, respectively, on the balance sheet. Further
information pertaining to off-balance sheet contracts is included in Note 10,
Financial Instruments with Off-Balance Sheet Risk, beginning on page 17.
Key uses a value at risk ("VAR") model to estimate the adverse effect of changes
in interest and foreign exchange rates on the fair value of its trading
portfolio. VAR uses statistical methods to estimate the maximum potential
one-day loss with a 95% confidence level. At March 31, 1999, Key's aggregate
daily VAR was $1 million and averaged $2 million for the first three months of
1999. As of March 31, 1998, Key's aggregate daily VAR was $.6 million and
averaged $.6 million for the first quarter of 1998. VAR augments other controls
used by Key to mitigate the market risk exposure of its trading portfolio. These
controls are established by Key's Financial Markets Committee and include, in
addition to VAR, loss and position equivalent limits which are based on the
level of activity and volatility of trading products and market liquidity.
NONINTEREST INCOME
As shown in Figure 9, noninterest income for the 1999 first quarter totaled $609
million, up $253 million, or 71%, from the same period last year. Included in
first quarter 1999 results was a $134 million gain from the sale of Key's 20%
interest in EPS. Excluding this gain and branch divestiture gains of $6 million
recorded in the first quarter of 1998, noninterest income increased by $125
million, or 36%, and comprised 41% of total revenue for the quarter, compared
with 39% last quarter and 35% a year-ago. Strong contributions to noninterest
income came from insurance and brokerage (up $35 million), trust and asset
management (up $29 million) and investment banking and capital markets (up $19
million). The growth of these revenue components reflected the impact of the
October 1998 acquisition of McDonald, as well as the strength of the stock and
bond markets and the repricing of certain services. The $29 million increase in
net loan securitization income was largely due to gains recognized in connection
with the securitization and sale of $1.8 billion of consumer loans during the
first quarter of 1999. The high volume of securitizations reflected Key's desire
to diversify its funding sources and the fact that the volatility experienced in
the capital markets during the latter half of 1998 subsided, providing a more
attractive environment for securitizations. Key had delayed some securitizations
previously planned for the 1998 fourth quarter in anticipation of a more
attractive environment. Additional detail pertaining to investment banking and
capital markets income, and trust income and assets is presented in Figures 10
and 11, respectively.
FIGURE 9 NONINTEREST INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- ----------------------
dollars in millions 1999 1998 AMOUNT PERCENT
=====================================================================================================
<S> <C> <C> <C> <C>
Trust and asset management income $106 $ 77 $ 29 37.7%
Service charges on deposit accounts 81 78 3 3.8
Investment banking and capital markets income 66 47 19 40.4
Insurance and brokerage income 57 22 35 159.1
Corporate owned life insurance income 24 23 1 4.3
Credit card fees 10 15 (5) (33.3)
Net loan securitization income 39 10 29 290.0
Net securities gains 4 2 2 100.0
Gains from divestitures 148 29 119 410.3
Other income:
Letter of credit and loan fees 20 17 3 17.6
Electronic banking fees 12 9 3 33.3
Gains from sales of loans 10 7 3 42.9
Mortgage banking income 1 2 (1) (50.0)
Miscellaneous income 31 18 13 72.2
- -----------------------------------------------------------------------------------------------------
Total other income 74 53 21 39.6
- -----------------------------------------------------------------------------------------------------
Total noninterest income $609 $356 $253 71.1%
==== ==== ====
=====================================================================================================
</TABLE>
35
<PAGE> 36
FIGURE 10 INVESTMENT BANKING AND CAPITAL MARKETS INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- ---------------------
dollars in millions 1999 1998 AMOUNT PERCENT
=============================================================================================================
<S> <C> <C> <C> <C>
Dealer trading and derivatives income $37 $17 $ 20 117.6%
Investment banking income 19 10 9 90.0
Equity capital income 3 15 (12) (80.0)
Foreign exchange income 7 5 2 40.0
- -------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $66 $47 $ 19 40.4%
=== === ====
=============================================================================================================
</TABLE>
FIGURE 11 TRUST AND ASSET MANAGEMENT
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, CHANGE
--------------------------- ---------------------
dollars in millions 1999 1998 AMOUNT PERCENT
====================================================================================================
<S> <C> <C> <C> <C>
Personal asset management and custody fees $ 48 $ 40 $ 8 20.0%
Institutional asset management and custody fees 25 21 4 19.0
Bond services 5 -- 5 N/M
All other fees 28 16 12 75.0
- ----------------------------------------------------------------------------------------------------
Total trust and asset management income $106 $ 77 $ 29 37.7%
==== ==== ====
dollars in billions
- ----------------------------------------------------------------------------------------------------
MARCH 31,
Discretionary assets $ 67 $ 64 $ 3 4.7%
Non-discretionary assets 48 50 (2) (4.0)
- ----------------------------------------------------------------------------------------------------
Total trust assets $115 $114 $ 1 .9%
==== ==== ====
====================================================================================================
</TABLE>
N/M = Not Meaningful
NONINTEREST EXPENSE
As shown in Figure 12, noninterest expense for the first quarter of 1999 totaled
$748 million, compared with $586 million for the first quarter of 1998. During
the first quarter of 1999, Key reclassified the distributions on its tax-
advantaged preferred securities from noninterest expense to interest expense and
restated prior quarters to conform to the current presentation. As a result,
noninterest expense was reduced by $19 million and $14 million in the first
quarter of 1999 and 1998, respectively. Included in first quarter 1999 expense
was a $20 million contribution to the Key sponsored charitable foundation made
in light of the gain realized from the sale of EPS. Excluding this contribution
and $27 million of other nonrecurring charges, noninterest expense increased by
$115 million, or 20%. On the same basis, noninterest expense was $34 million, or
an annualized 5%, above the fourth quarter of 1998. The increase from the
year-ago quarter came largely from the impact of the McDonald acquisition
completed in October 1998, higher personnel costs associated with various
incentive programs and increases in computer processing expense (up $14 million)
and equipment expense (up $13 million). The increase in computer processing
expense was primarily the result of a higher level of computer software
amortization, while the growth in equipment expense reflected higher rental
costs for data processing equipment. Additional information pertaining to the
McDonald transaction is disclosed in Note 3, Mergers, Acquisitions and
Divestitures, beginning on page 8.
Included in noninterest expense for the first three months of 1999 was $5
million ($6 million in the first quarter of 1998) of expense incurred in
connection with efforts being undertaken by Key to modify computer information
systems to be Year 2000 compliant. As of March 31, 1999, Key had recognized
approximately $44 million of the estimated $45 to $50 million of expense that it
expects to incur (primarily for internal and external programmers) to complete
this project. Further information pertaining to the Year 2000 issue and the
status of Key's efforts to address it is included below.
The efficiency ratio, which provides a measure of the extent to which recurring
revenues are used to pay operating expenses, was 60.22% for the first quarter,
compared with 58.19% for the first quarter of 1998 and 58.66% for the prior
quarter. The increase in the ratio over the past year was primarily due to the
impact of the October 1998 acquisition of McDonald. Included in other expense
are equity- and gross receipts-based taxes that are assessed in lieu of an
income
36
<PAGE> 37
tax in certain states in which Key operates. These taxes, which are shown in
Figure 12, represented 69, 89 and 106 basis points of Key's efficiency ratio for
the first quarter of 1999, the first quarter of 1998 and the fourth quarter of
1998, respectively. The extent to which such taxes impact the level of
noninterest expense will vary among companies based on the geographic locations
in which they conduct their business.
FIGURE 12 NONINTEREST EXPENSE
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, CHANGE
---------------------------- -----------------------
dollars in millions 1999 1998 AMOUNT PERCENT
============================================================================================================
<S> <C> <C> <C> <C>
Personnel $372 $294 $78 26.5%
Net occupancy 59 56 3 5.4
Equipment 56 43 13 30.2
Computer processing 54 40 14 35.0
Marketing 25 28 (3) (10.7)
Amortization of intangibles 28 23 5 21.7
Professional fees 15 17 (2) (11.8)
Other expense:
Postage and delivery 19 18 1 5.6
Telecommunications 14 13 1 7.7
Equity- and gross receipts- based taxes 8 9 (1) (11.1)
Miscellaneous 98 45 53 117.8
- ------------------------------------------------------------------------------------------------------------
Total other expense 139 85 54 63.5
- ------------------------------------------------------------------------------------------------------------
Total noninterest expense $748 $586 $162 27.6%
==== ==== ====
Full-time equivalent employees at period end 25,650 24,650
Efficiency ratio(1) 60.22% 58.19%
Overhead ratio(2) 33.19 36.12
============================================================================================================
</TABLE>
(1) Calculated as noninterest expense (excluding certain nonrecurring charges)
divided by taxable-equivalent net interest income plus noninterest income
(excluding net securities transactions and gains from certain divestitures).
(2) Calculated as noninterest expense (excluding certain nonrecurring charges)
less noninterest income (excluding net securities transactions and gains
from certain divestitures) divided by taxable-equivalent net interest
income.
Year 2000
- ---------
During the first quarter of 1999, Key continued its efforts to prepare its
systems to be Year 2000 compliant. The Year 2000 issue refers to the fact that
many computer systems were originally programmed using two digits rather than
four digits to identify the applicable year. Therefore, when the year 2000
occurs, these systems could interpret the year as 1900 rather than 2000. Unless
hardware, system software and applications are corrected to be Year 2000
compliant, computers and the devices they control could generate miscalculations
and create operational problems. Various systems could be affected ranging from
complex computer systems to telephone systems, ATMs and elevators.
To address this issue, Key developed an extensive plan in 1995, including the
formation of a team consisting of internal resources and third-party experts.
The plan has been in implementation since that time and consists of five major
phases: awareness-ensuring a common understanding of the issue throughout Key;
assessment-identifying and prioritizing the systems and third parties with whom
Key has exposure to Year 2000 issues; renovation-enhancing, replacing or
retiring hardware, software and systems applications; validation-testing
modifications made; and implementation-certifying Year 2000 compliance and user
understanding and acceptance. The awareness and assessment phases have been
completed. The remaining phases are substantially complete and final testing and
refinement will be addressed in 1999. As of March 31, 1999, all of the above
phases have been completed for approximately 90% of the core systems identified
and compliance efforts for all remaining technology components are expected to
be completed by June 30, 1999.
As a financial institution, Key may experience increases in problem loans and
credit losses in the event that borrowers fail to properly respond to this
issue. In addition, financial institutions may incur higher funding costs if
consumers react to publicity about the issue by withdrawing deposits. They also
could be impacted if third parties they deal with in
37
<PAGE> 38
conducting their business, such as foreign banks, governmental agencies,
clearing houses, telephone companies and other service providers fail to
properly address this issue.
Accordingly, Key has formed a separate internal team charged with the task of
identifying critical business interfaces; assessing potential problems relating
to credit, liquidity and counterparty risk; and where appropriate, developing
contingency plans. This team has been surveying significant credit clients to
determine their Year 2000 readiness and to evaluate the level of potential
credit risk to Key. Based on the information obtained, specific follow-up
programs have been established and the adequacy of the allowance for loan losses
will be assessed on an ongoing basis. The results of the assessment will be
reflected in the assignment of an appropriate risk rating in Key's loan grading
system. On an ongoing basis, Key is also contacting significant third parties
with whom it conducts business to determine the status of their Year 2000
compliance efforts.
Despite the actions taken by Key, there can be no assurance that significant
clients or critical third parties will adequately address their Year 2000
issues. Consequently, Key is developing contingency plans to help mitigate the
risks associated with potential delays in completing the renovation, validation
and implementation phases of its Year 2000 plan, as well as the potential
failure of external parties to adequately address their Year 2000 issues. These
plans are underway and address primarily contingency solutions for Key's core
systems and the identification of alternative business partners. Because the
Year 2000 issue has never occurred, it is not possible to foresee or quantify
the possible overall financial and operational impact and/or to determine
whether it will be material to the financial condition or operations of Key.
The cost of the project (currently estimated to be $45 to $50 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. However, there
can be no guarantee that these estimates will be achieved, and actual results
could differ materially from those anticipated. As of March 31, 1999, Key had
recognized approximately $44 million of its total estimated project cost. It is
currently expected that the estimated remaining cost of $1 million to $6 million
will be recognized in 1999 and the first half of 2000. The total cost of the
project is being funded through operating cash flows.
INCOME TAXES
The provision for income taxes was $142 million for the three-month period ended
March 31, 1999, up from $108 million for the same period in 1998. The effective
tax rate (provision for income taxes as a percentage of income before income
taxes) for the 1999 first quarter was 32.6% compared with 31.6% for the first
quarter of 1998. Primary factors contributing to the increase in the effective
tax rate were a lower proportion of tax-exempt income and tax credits to pretax
earnings in the current year. 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.
38
<PAGE> 39
FINANCIAL CONDITION
LOANS
At March 31, 1999, total loans outstanding were $61.0 billion compared with
$62.0 billion at December 31, 1998, and $54.9 billion at March 31, 1998.
The $6.1 billion, or 11%, increase in loans outstanding from the March 31, 1998,
level was due primarily to internal growth, but also included the net impact of
acquisitions, sales and divestitures. During the second quarter of 1998, Key
acquired an $805 million marine/recreational vehicle installment loan portfolio.
The sales and divestitures which occurred during 1999 and 1998 are summarized in
Figure 13 and include the impact of branch divestitures, as well as the
securitization and/or sale of education loans, automobile loans, certain
non-prime home equity loans and other loans which do not meet Key's return on
equity, credit or other internal standards. In addition to branch divestitures,
activity since March 31, 1998, included the sales of $1.1 billion of education
loans (of which $799 million was associated with securitizations), $903 million
of home equity loans (of which $700 million was associated with
securitizations), $555 million of automobile loans (all of which were associated
with securitizations), $251 million of commercial real estate loans and $208
million of residential real estate loans. Securitizations are considered an
alternative funding source and the extent to which they are used is dependent
upon whether conditions in the capital markets make them more attractive as a
funding source than on-balance sheet alternatives. During the first quarter of
1999, Key benefited from a record high volume of loan securitizations ($1.8
billion) as the capital markets volatility experienced during the last half of
1998 subsided. Management will continue to explore opportunities for sales
and/or other arrangements with respect to certain loan portfolios, consistent
with prudent asset/liability management practices.
FIGURE 13 LOANS SOLD AND DIVESTED
<TABLE>
<CAPTION>
COMMERCIAL RESIDENTIAL BRANCH
in millions EDUCATION AUTOMOBILE HOME EQUITY REAL ESTATE REAL ESTATE DIVESTITURES TOTAL
=======================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
1999
- -------------
First quarter $818 $555 $428 $ 84 $208 -- $2,093
- -----------------------------------------------------------------------------------------------------------------------
$818 $555 $428 $ 84 $208 -- $2,093
==== ==== ==== ==== ====
1998
- -------------
Fourth quarter $ 29 -- $ 48 -- -- -- $ 77
Third quarter 201 -- 374 -- -- -- 575
Second quarter 45 -- 53 $167 -- $124 389
First quarter 71 -- -- -- -- 20 91
- -----------------------------------------------------------------------------------------------------------------------
Total $346 -- $475 $167 -- $144 $1,132
==== ==== ==== ==== ======
=======================================================================================================================
</TABLE>
Excluding the net impact of acquisitions, sales and divestitures, loans (other
than one-to-four family mortgage loans and loans held for sale) increased by
$8.7 billion, or 19%, since March 31, 1998, and were up $1.2 billion, or an
annualized 9%, from the 1998 year end. Key's policy regarding new originations
of one-to-four family mortgage loans is to originate such loans as a client and
community accommodation, but to retain few of such loans on the balance sheet
due to their marginal returns. Over the past year, the largest growth in Key's
loan portfolio came from commercial loans which rose by $5.4 billion, due
primarily to a $2.8 billion increase in commercial, financial and agricultural
loans and increases of $1.4 billion and $1.2 billion in the real
estate-construction and lease financing portfolios, respectively. Additionally,
consumer loans rose by $3.2 billion, and included increases of $1.9 billion and
$1.0 billion in the home equity and lease financing portfolios, respectively.
The strong growth in loans over the past twelve months reflected a number of
factors, including the continued strength of the economy, targeted efforts to
increase the commercial and home equity portfolios and Key's success in
leveraging its Leasetec operation.
39
<PAGE> 40
The $1.0 billion decline in loans from the December 31, 1998, level was due
primarily to the record volume of loans securitized and sold during the first
quarter of 1999. Excluding the impact of the 1999 loan sales shown in Figure 13,
loans (other than one-to-four family mortgage loans and loans held for sale)
grew by $1.2 billion, or an annualized 9%, during the first quarter of 1999.
Consumer loans accounted for $632 million of the increase with the largest
growth occurring in the home equity (up $432 million) and lease financing (up
$205 million) portfolios. Commercial loans contributed $581 million to the first
quarter increase due to increases of $415 million and $186 million in the real
estate-construction and lease financing portfolios, respectively. On the same
basis, the aggregate annualized growth rate of average outstanding balances in
the commercial loan portfolio was 10% for the first quarter of 1999 and has
exceeded that level for every quarter during the past two years.
Shown in Figure 14 are loans that have been securitized/sold and are either
administered or serviced by Key, but not recorded on its balance sheet. Income
recognized in connection with such transactions is derived from two sources.
Noninterest income earned from servicing or administering the loans is recorded
as loan securitization income, while income earned on assets retained in
connection with securitizations and accounted for like investments in
interest-only strip securities, is recorded as interest income on securities
available for sale. The increase in these balances since the 1998 year end
reflected the impact of securitizations, offset in part by loan repayments.
FIGURE 14 LOANS SECURITIZED/SOLD AND ADMINISTERED OR SERVICED
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
in millions 1999 1998 1998
=============================================================
<S> <C> <C> <C>
Education loans $2,987 $2,312 $2,540
Automobile loans 1,339 946 1,493
Home equity loans 1,079 744 625
- -------------------------------------------------------------
Total $5,405 $4,002 $4,658
====== ====== ======
=============================================================
</TABLE>
SECURITIES
At March 31, 1999, the securities portfolio totaled $7.8 billion, consisting of
$6.8 billion of securities available for sale and $1.0 billion of investment
securities. This compares with a total portfolio of $6.3 billion, comprised of
$5.3 billion of securities available for sale and $976 million of investment
securities, at December 31, 1998. Certain information pertaining to the
composition, yields, and remaining maturities of the securities available for
sale and investment securities portfolios is presented in Figures 15 and 16,
respectively. Additional information pertaining to gross unrealized gains and
losses by type of security is presented in Note 5, Securities, beginning on page
12. As shown in Note 5, the increase in securities available for sale from the
December 31, 1998, level occurred as funds previously held in short-term
investments, such as Federal funds sold and securities purchased under resale
agreements, were reinvested in higher-yielding collateralized mortgage
obligations.
FIGURE 15 SECURITIES AVAILABLE FOR SALE
<TABLE>
<CAPTION>
OTHER
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- RETAINED
AGENCIES AND POLITICAL MORTGAGE BACKED INTERESTS IN OTHER
dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(1) SECURITIES(1) SECURITIZATIONS(1) SECURITIES
===============================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
MARCH 31, 1999
Remaining maturity:
One year or less $ 33 $ 1 $ 828 $ 3 -- $18
After one through five years 141 16 2,695 1,728 $160 14
After five through ten years 11 45 157 271 198 2
After ten years 22 2 204 22 -- 207(3)
- -------------------------------------------------------------------------------------------------------------------------------
Fair value $207 $64 $3,884 $2,024 $358 $241
Amortized cost 206 62 3,946 2,006 380 259
Weighted average yield 5.57% 6.18% 6.50% 6.94% 8.60% 3.39%
Weighted average maturity 3.4 years 6.5 years 3.7 years 5.1 years 3.2 years 9.6 years
- -------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1998
Fair value $422 $67 $2,211 $2,151 $328 $99
Amortized cost 420 65 2,191 2,123 345 84
- -------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 1998
Fair value $143 $64 $3,666 $2,791 $382 $69
Amortized cost 141 63 3,660 2,762 414 61
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
dollars in millions TOTAL YIELD(2)
==============================================================
<S> <C> <C>
MARCH 31, 1999
Remaining maturity:
One year or less $ 883 6.74%
After one through five years 4,754 6.44
After five through ten years 684 7.57
After ten years 457 6.50
- --------------------------------------------------------------
Fair value $6,778 --
Amortized cost 6,859 6.60%
Weighted average yield 6.60% --
Weighted average maturity 4.3 years --
- --------------------------------------------------------------
DECEMBER 31, 1998
Fair value $5,278 --
Amortized cost 5,228 6.69%
- --------------------------------------------------------------
MARCH 31, 1998
Fair value $7,115 --
Amortized cost 7,101 7.03%
- --------------------------------------------------------------
</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.
40
<PAGE> 41
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, 1999
Remaining maturity:
One year or less $170 $ 1 $ 171 7.99%
After one through five years 295 102 397 8.20
After five through ten years 117 -- 117 9.65
After ten years 19 301(2) 320 3.58
- ---------------------------------------------------------------------------------------
Amortized cost $601 $404 $1,005 6.86%
Fair value 627 404 1,031 --
Weighted average yield 8.84% 3.90% 6.86% --
Weighted average maturity 3.1 years 7.8 years 5.0 years --
- ---------------------------------------------------------------------------------------
DECEMBER 31, 1998
Amortized cost $631 $345 $ 976 7.13%
Fair value 659 345 1,004 --
- ---------------------------------------------------------------------------------------
MARCH 31, 1998
Amortized cost $918 $264 $1,182 7.84%
Fair value 949 264 1,213 --
=======================================================================================
</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%.
(2) Includes equity securities with no stated maturity.
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.
Management relies upon an iterative methodology to estimate the level of the
Allowance on a quarterly and at times more frequent basis, as deemed necessary.
This methodology is described in detail in the Allowance for Loan Losses section
of Note 1, Summary of Significant Accounting Policies, beginning on page 65 of
Key's 1998 Annual Report to Shareholders.
As shown in Figure 17, net loan charge-offs for the first quarter of 1999 were
$81 million, or .53% of average loans, compared with $77 million, or .58% of
average loans, for the same period last year. The slight increase in the level
of net charge-offs occurred primarily in the indirect installment sector of the
consumer loan portfolio. One factor contributing to this increase was
management's decision to reduce the volume of consumer loan securitizations in
1998 due to capital markets volatility at the time. Small increases in net
charge-offs were also recorded in the commercial and home equity portfolios,
reflecting the significant growth that has occurred in these sectors over the
past year.
The provision for loan losses was $111 million for the first quarter of 1999 and
exceeded the level of net charge-offs by $30 million. The increase from the $77
million provision recorded in both the prior quarter and the first quarter of
1998 reflected a number of factors, including Key's continued commercial loan
growth and an enhancement in the Allowance allocation methodology pertaining to
the credit card portfolio that was implemented during the first quarter of 1999.
41
<PAGE> 42
Figure 17 Summary of Loan Loss Experience
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions 1999 1998
==============================================================================
<S> <C> <C>
Average loans outstanding during the period $61,693 $53,946
- ------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $900 $900
Loans charged off:
Commercial, financial and agricultural 22 16
Real estate--commercial mortgage -- 4
Commercial lease financing 2 1
- ------------------------------------------------------------------------------
Total commercial loans 24 21
Real estate--residential mortgage 2 4
Home equity 3 2
Credit card 26 27
Consumer--direct 12 11
Consumer--indirect 40 35
- ------------------------------------------------------------------------------
Total consumer loans 83 79
- ------------------------------------------------------------------------------
107 100
Recoveries:
Commercial, financial and agricultural 8 6
Real estate--commercial mortgage 2 2
- ------------------------------------------------------------------------------
Total commercial loans 10 8
Real estate--residential mortgage 1 1
Credit card 3 2
Consumer--direct 1 2
Consumer--indirect 11 10
- ------------------------------------------------------------------------------
Total consumer loans 16 15
- ------------------------------------------------------------------------------
26 23
Net loans charged off (81) (77)
Provision for loan losses 111 77
- ------------------------------------------------------------------------------
Allowance for loan losses at end of period $930 $900
==== ====
- ------------------------------------------------------------------------------
Net loan charge-offs to average loans .53% .58%
Allowance for loan losses to period end loans 1.52 1.64
Allowance for loan losses to nonperforming loans 235.44 241.29
==============================================================================
</TABLE>
The Allowance at March 31, 1999, was $930 million, or 1.52% of loans, compared
with $900 million, or 1.64% of loans, at March 31, 1998. Included in the 1999
and 1998 Allowance was $65 million and $42 million, respectively, which was
specifically allocated for impaired loans. For a further discussion of impaired
loans see Note 7, Impaired Loans and Other Nonperforming Assets, on page 14. At
March 31, 1999, the Allowance was 235.44% of nonperforming loans, compared with
241.29% at March 31, 1998. As a result of the enhancement to the Allowance
allocation methodology discussed on page 41, the portion of the Allowance
allocated to the credit card portfolio increased from the 1998 year end.
The composition of nonperforming assets is shown in Figure 18. These assets
totaled $430 million at March 31, 1999, and represented .70% of loans, OREO and
other nonperforming assets compared with $404 million, or .65%, at December 31,
1998. The $26 million rise in the level of nonperforming assets since the 1998
year end reflected a $30 million increase in nonperforming loans, of which $26
million pertained to commercial loans and lease financing receivables. This
increase was broad-based and represents the slow, anticipated return to a more
normalized level. Over the past two years, the level of nonperforming assets has
ranged from a quarterly high of $433 million at June 30, 1997, to a low of $402
million at September 30, 1998.
42
<PAGE> 43
Figure 18 Summary of Nonperforming Assets and Past Due Loans
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 1999 1998 1998
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial, financial and agricultural $160 $144 $152
Real estate--commercial mortgage 86 79 77
Real estate--construction 4 6 20
Commercial lease financing 39 29 14
Real estate--residential mortgage 59 60 62
Consumer 47 47 48
- --------------------------------------------------------------------------------------
Total nonperforming loans (1) 395 365 373
OREO 49 56 67
Allowance for OREO losses (15) (18) (24)
- --------------------------------------------------------------------------------------
OREO, net of allowance 34 38 43
Other nonperforming assets 1 1 5
- --------------------------------------------------------------------------------------
Total nonperforming assets $430 $404 $421
==== ==== ====
- --------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $191 $178 $159
- --------------------------------------------------------------------------------------
Nonperforming loans to period end loans .65% .59% .68%
Nonperforming assets to period end loans plus
OREO and other nonperforming assets .70 .65 .77
- --------------------------------------------------------------------------------------
</TABLE>
(1) Includes impaired loans of $212 million, $193 million and $189 million
at March 31, 1999, December 31, 1998 and March 31, 1998, respectively.
DEPOSITS AND OTHER SOURCES OF FUNDS
Core deposits, defined as domestic deposits other than certificates of deposit
of $100,000 or more, are Key's primary source of funding. During the first
quarter of 1999, these deposits averaged $37.0 billion and represented 52% of
Key's funds supporting earning assets, compared with $37.0 billion and 58%,
respectively, during the first three months of 1998. As shown in Figure 4
beginning on page 30, the mix of core deposits changed over the course of the
past year as decreases in the levels of savings and time deposits were largely
offset by substantial growth in money market deposit accounts. The consistent
level and change in the mix of core deposits reflected the 1998 divestiture of
46 branches with deposits of approximately $658 million, and investment
alternatives pursued by clients in response to the strength of the stock and
bond markets. The increase in money market deposit accounts from the year-ago
quarter reflects these client preferences as well as actions taken by management
in 1998 to reprice such deposits.
Purchased funds, which are comprised of large certificates of deposit, deposits
in the foreign office and short-term borrowings, averaged $18.4 billion during
the first quarter of 1999, compared with $19.6 billion during the prior quarter
and $18.4 billion a year-ago. As shown in Figure 4, long-term debt and capital
securities have been more heavily relied upon to fund earning asset growth and
increased substantially during the first quarter of 1999. In addition, Key
continues to consider loan securitizations as a funding alternative, provided
capital market conditions are conducive to such activity. During the first three
months of 1999, Key securitized and sold $1.8 billion of consumer loans.
43
<PAGE> 44
LIQUIDITY
Key actively analyzes and manages its liquidity, which represents the
availability of funding to meet the needs of depositors, borrowers and creditors
at a reasonable cost on a timely basis and without adverse consequences. Key
maintains liquidity in the form of short-term money market investments,
securities available for sale, anticipated prepayments and maturities on
securities, the maturity structure of its loan portfolios and the ability to
securitize and package loans for sale. Liquidity is also enhanced by a sizable
concentration of core deposits, previously discussed, which are generated by 969
full-service KeyCenters in 13 states. Key monitors deposit flows and evaluates
alternate pricing structures with respect to its deposit base. This process is
managed by Key's Funding and Investment Management Group, which monitors the
overall mix of funding sources in conjunction with deposit pricing and in
response to the structure of the earning assets portfolio. In addition, Key has
access to various sources of money market funding (such as Federal funds
purchased, securities sold under repurchase agreements and bank notes) and
borrowings from the Federal Reserve Bank for short-term liquidity requirements
should the need arise. In addition, KeyBank USA has a line of credit with the
Federal Reserve Bank which provides for overnight borrowings of up to $919
million and which is secured by $1.3 billion of KeyBank USA's credit card
receivables at March 31, 1999. There were no borrowings outstanding under this
line of credit as of March 31, 1999.
During the first three months of 1999, Key's affiliate banks raised $2.7 billion
under Key's Bank Note Program, which provides for the issuance of both long-and
short-term debt of up to $20.0 billion ($19.0 billion by KeyBank N.A. and $1.0
billion by KeyBank USA) in the aggregate. All of the notes issued during the
first quarter have original maturities in excess of one year and are included in
long-term debt. At March 31, 1999, the program had an unused capacity of $15.7
billion.
Under Key's Euronote Program, the parent company, KeyBank N.A. and KeyBank USA
may issue both long- and short-term debt of up to $5.0 billion in the aggregate.
The notes are offered exclusively to non-U.S. investors and can be denominated
in dollars and/or most European currencies. There were $1.9 billion of
borrowings outstanding under this facility as of March 31, 1999, $415 million of
which were issued during 1999.
The parent company has a commercial paper program and a four-year revolving
credit agreement; each facility provides funding availability of up to $500
million. The proceeds from these facilities may be used for general corporate
purposes. As of March 31, 1999, $370 million of borrowings were outstanding
under the commercial paper program.
The parent company also has a universal shelf registration statement on file
with the Securities and Exchange Commission, which provides for the possible
issuance of up to $1.3 billion of debt and equity securities. At March 31, 1999,
unused capacity under the shelf registration totaled $1.3 billion, including
$750 million reserved for issuance as medium-term notes. The proceeds
from the issuances under the shelf registration, the Bank Note Program and the
Euronote Program described above may be used for general corporate purposes,
including acquisitions.
The liquidity requirements of the parent company, primarily for dividends to
shareholders, servicing of debt and other corporate purposes are principally met
through regular dividends from affiliate banks. Excess funds are maintained in
short-term investments. In addition, the parent company has access to the
capital markets as a result of its favorable debt ratings which, at March 31,
1999, 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, 1999 and 1998, is presented in the
Consolidated Statements of Cash Flow on page 6.
44
<PAGE> 45
CAPITAL AND DIVIDENDS
Total shareholders' equity at March 31, 1999, was $6.1 billion, essentially
unchanged from the balance at the end of 1998 and up $767 million, or 14%, from
the end of the first quarter of last year. During the first quarter of 1999 the
increase provided by retained net income was offset by a net increase in
treasury stock, resulting from the share repurchases discussed below. The
increase from the March 31, 1998, balance was due primarily to retained net
income and the net decrease in treasury stock resulting from the shares issued
in the McDonald acquisition, also discussed below. Other factors contributing to
the change in shareholders' equity during the first three months of 1999 are
shown in the Consolidated Statements of Changes in Shareholders' Equity
presented on page 5.
During the first quarter of 1999, Key repurchased 5,555,224 of its Common Shares
at an average price per share of $31.27. This included the repurchase of
3,869,761 shares remaining under the authorization by the Board of Directors to
repurchase up to 60% of the 19,337,159 shares issued in the October 1998
acquisition of McDonald. The other 1,685,463 shares were repurchased under a
separate repurchase program authorized in January 1998. That authority provides
for the repurchase of up to 10,000,000 shares in open market or negotiated
transactions and has no expiration date. At March 31, 1999, the number of
shares remaining in that authority was 8,314,537. The 44,066,638 shares held in
treasury at March 31, 1999, are expected to be reissued over time in connection
with employee stock purchase, 401(k), stock option and dividend reinvestment
plans and for other corporate purposes. During the first quarter of 1999, Key
reissued 925,769 Treasury Shares for employee benefit and dividend reinvestment
plans.
Capital adequacy is an important indicator of financial stability and
performance. Overall, Key's capital position remains strong with a ratio of
total shareholders' equity to total assets of 7.63% at March 31, 1999, compared
with 7.71% at December 31, 1998, and 7.29% at March 31, 1998.
Banking industry regulators define minimum capital ratios for bank holding
companies and their banking subsidiaries. Based on risk-adjusted capital rules
and definitions prescribed by the banking regulators, Key's Tier 1 and total
risk- adjusted capital ratios at March 31, 1999, were 7.44% and 11.92%,
respectively, compared with minimum regulatory requirements of 4.0% for Tier 1
and 8.0% for total capital. The regulatory leverage ratio standard prescribes a
minimum ratio of 3.0%, although most banking organizations are expected to
maintain ratios of at least 100 to 200 basis points above the minimum. At March
31, 1999, Key's leverage ratio was 7.21%, substantially higher than the minimum
requirement. Figure 19 presents the details of Key's regulatory capital position
at March 31, 1999, December 31, 1998, and March 31, 1998.
Under the Federal Deposit Insurance Act, Federal bank regulators group
FDIC-insured depository institutions into the following five categories based on
certain capital ratios: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized" and "critically
undercapitalized." Both of Key's affiliate banks qualify as "well capitalized"
at March 31, 1999, since they exceeded the well-capitalized thresholds of 10%,
6% and 5% for the total capital, Tier 1 capital and leverage ratios,
respectively. Although these provisions are not directly applicable to bank
holding companies, Key would also qualify as "well capitalized" at March 31,
1999, if the same provisions were applied to it. The FDIC-defined capital
categories may not constitute an accurate representation of the overall
financial condition or prospects of Key or its affiliates.
45
<PAGE> 46
Figure 19 Capital Components and Risk-Adjusted Assets
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 1999 1998 1998
============================================================================================
<S> <C> <C> <C>
TIER 1 CAPITAL
Common shareholders' equity(1) $6,156 $6,137 $5,330
Qualifying capital securities 994 747 500
Less: Goodwill (1,435) (1,430) (1,052)
Other intangible assets(2) (67) (71) (89)
- --------------------------------------------------------------------------------------------
Total Tier 1 capital 5,648 5,383 4,689
- --------------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(3) 930 900 861
Net unrealized holding gains(4) 1 3 --
Qualifying long-term debt 2,470 2,445 2,285
- --------------------------------------------------------------------------------------------
Total Tier 2 capital 3,401 3,348 3,146
- --------------------------------------------------------------------------------------------
Total capital $9,049 $8,731 $7,835
====== ====== ======
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $64,017 $63,721 $58,209
Risk-adjusted off-balance sheet exposure 12,816 12,198 11,844
Less: Goodwill (1,435) (1,430) (1,052)
Other intangible assets(2) (67) (71) (89)
Plus: Market risk-equivalent assets 611 242 --
Net unrealized holding gains(4) 1 3 --
- --------------------------------------------------------------------------------------------
Gross risk-adjusted assets 75,943 74,663 68,912
Less: Excess allowance for loan losses(3) -- -- (39)
- --------------------------------------------------------------------------------------------
Net risk-adjusted assets $75,943 $74,663 $68,873
======= ======= =======
AVERAGE QUARTERLY TOTAL ASSETS $79,858 $78,968 $72,122
======= ======= =======
CAPITAL RATIOS
Tier 1 risk-adjusted capital ratio 7.44% 7.21% 6.81%
Total risk-adjusted capital ratio 11.92 11.69 11.38
Leverage ratio(5) 7.21 6.95 6.61
============================================================================================
</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) recorded after February 19,
1992, and deductible portions of purchased mortgage servicing rights.
(3) The allowance for loan losses included in Tier 2 capital is limited to
1.25% of gross risk-adjusted assets.
(4) Net unrealized holding gains included in Tier 2 capital are limited to
45% of net unrealized holding gains on available for sale equity
securities with readily determinable fair values.
(5) Tier 1 capital as a percentage of average quarterly total assets, less
goodwill and other non-qualifying intangible assets as defined in 2
above.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information included in the Market Risk Management section beginning on page
32 of the Management's Discussion and Analysis of Financial Condition and
Results of Operations is incorporated herein by reference.
46
<PAGE> 47
PART II.OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
In the ordinary course of business, Key is subject to legal actions
which involve claims for substantial monetary relief. Based on
information presently known to management and Key's counsel,
management does not believe that there exists any legal action to
which KeyCorp or any of its subsidiaries is a party, or of which their
properties are the subject, that, individually or in the aggregate,
will have a material adverse effect on the financial condition of Key.
Item 5. Other Information
-----------------
On February 10, 1999, the Federal banking agencies published their
final Uniform Retail Credit Classification and Account Management
Policy (the "Retail Credit Policy"), which revises their 1980 Uniform
Policy for Classification of Consumer Installment Credit Based on
Delinquency Status. The Retail Credit Policy applies to all financial
institutions which file call reports or thrift financial reports with
a Federal banking agency.
In general, the Retail Credit Policy establishes a uniform charge-off
policy at 120 and 180 days delinquency for closed-end and open-end
credit, respectively, provides uniform guidance for loans affected by
bankruptcy, fraud, and death, establishes guidelines for re-aging,
extending, deferring, or rewriting past due accounts, classifies
certain delinquent residential mortgage and home equity loans, and
broadens recognition of partial payments that qualify as full
payments. Changes made by the Retail Credit Policy which involve
manual adjustments to an institution's policies and procedures must be
implemented by June 30, 1999, while changes involving programming
resources are required to be implemented by December 31, 2000.
Management is still in the process of completing its evaluation of the
effect on Key of the revisions made by the Retail Credit Policy. In
Key's case, the Retail Credit Policy will generally be effective
December 31, 2000.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
(10.1) KeyCorp Annual Incentive Plan (February 15, 1999, Restatement)
(10.2) Form of Premium Priced Option Grant between KeyCorp and
Robert W. Gillespie, dated January 13, 1999.
(10.3) Form of Premium Priced Option Grant between KeyCorp and
Henry L. Meyer III, dated January 13, 1999.
(15) Acknowledgment Letter of Independent Auditors
(27) Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
January 20, 1999 - Item 5. Other Events and Item 7. Financial
Statements and Exhibits. Reporting that on January 19, 1999, the
Registrant issued a press release announcing its earnings results for
the three-month and twelve-month periods ended December 31, 1998.
March 15, 1999 - Item 5. Other Events. Reporting that KeyCorp filed as
an exhibit the Underwriting Agreement, dated March 10, 1999, among
KeyCorp Capital II ("the Issuer Trust"), KeyCorp and Credit Suisse
First Boston Corporation, as representative of several underwriters
named in Schedule A to the Underwriting Agreement (the
"Underwriters"), relating to the issuance and sale of $250,000,000 of
6.875% Capital Securities of the Issuer Trust.
No other reports on Form 8-K were filed during the three-month period
ended March 31, 1999.
47
<PAGE> 48
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, 1999 /s/ Lee Irving
-----------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
48
<PAGE> 1
Exhibit 10.1
KEYCORP
ANNUAL INCENTIVE PLAN
(FEBRUARY 15, 1999 RESTATEMENT)
KeyCorp (the "Corporation") hereby establishes this Annual Incentive
Plan for the purpose of providing an incentive to selected key officers of the
Corporation and its subsidiaries.
ARTICLE I
DEFINITIONS
-----------
For the purposes hereof, the following words and phrases shall have the
meanings indicated:
1. A "Beneficiary" shall mean any person designated by a Participant in
accordance with the Plan to receive payment of all or a portion of any Incentive
Award for which the Participant is eligible at the time of the Participant's
death.
2. A "Change of Control" shall mean a Change of Control under any of
clauses (a), (b), (c), or (d) below. A "Non-Initiated Change of Control" shall
mean (i) a Change of Control under clause (c) below (regardless of whether it
also constitutes a Change of Control under any other clause below), and (ii) a
Change of Control under clause (a), (b), or (d) below if such Change of Control
results in whole or in any significant part, directly or indirectly, proximately
or remotely, from or in response or reaction to an offer or proposal (whether to
the Board of Directors or the shareholders of the Corporation) which was not
solicited or invited by the management of the Corporation to engage in a
transaction with the Corporation that, if consummated, would result in a Change
Event under clause (c) below. An "Initiated Change of Control" shall mean all
Changes of Control other than a Non-Initiated Change of Control. The
determination of the Committee whether a Change of Control constitutes an
Initiated or Non-Initiated Change of Control shall be final and conclusive. For
purposes of this definition, the Corporation will be deemed to have become a
subsidiary of another corporation if any other corporation (which term shall
include, in addition to a corporation, a limited liability company, partnership,
trust, or other organization) owns, directly or indirectly, 50 percent or more
of the total combined outstanding voting power of all classes of stock of the
Corporation or any successor to the Corporation.
1
<PAGE> 2
(a) A Change of Control will have occurred under this
clause (a) if the Corporation is a party to a transaction
pursuant to which the Corporation is merged with or into, or
is consolidated with, or becomes the subsidiary of another
corporation and either
(i) immediately after giving effect to that
transaction, less than 65% of the then outstanding
voting securities of the surviving or resulting
corporation or (if the Corporation becomes a
subsidiary in the transaction) of the ultimate parent
of the Corporation represent or were issued in
exchange for voting securities of the Corporation
outstanding immediately prior to the transaction, or
(ii) immediately after giving effect to that
transaction, individuals who were directors of the
Corporation on the day before the first public
announcement of (x) the pendency of the transaction
or (y) the intention of any person or entity to cause
the transaction to occur, cease for any reason to
constitute at least 51% of the directors of the
surviving or resulting corporation or (if the
Corporation becomes a subsidiary in the transaction)
of the ultimate parent of the Corporation.
(b) A Change of Control will have occurred under this
clause (b) if a tender or exchange offer shall be made and
consummated for 35% or more of the outstanding voting stock of
the Corporation or any person (as the term "person" is used in
Section 13(d) and Section 14(d)(2) of the 1934 Act) is or
becomes the beneficial owner of 35% or more of the outstanding
voting stock of the Corporation or there is a report filed on
Schedule 13D or Schedule 14D-1 (or any successor schedule,
form or report), each as adopted under the 1934 Act,
disclosing the acquisition of 35% or more of the outstanding
voting stock of the Corporation in a transaction or series of
transactions by any person (as defined earlier in this clause
(b)).
2
<PAGE> 3
(c) A Change of Control will have occurred under this
clause (c) if either (i) without the prior approval,
solicitation, invitation, or recommendation of the
Corporation Board of Directors any person or entity
makes a public announcement of a bona fide intention
(A) to engage in a transaction with the Corporation
that, if consummated, would result in a Change Event
(as defined below in this clause (c)), or (B) to
"solicit" (as defined in Rule 14a-1 under the 1934
Act) proxies in connection with a proposal that is
not approved or recommended by the Corporation Board
of Directors, or (ii) any person or entity publicly
announces a bona fide intention to engage in an
election contest relating to the election of
directors of the Corporation (pursuant to Regulation
14A, including Rule 14a-11, under the 1934 Act),
and, at any time within the 24 month period immediately
following the date of the announcement of that intention,
individuals who, on the day before that announcement,
constituted the directors of the Corporation (the "Incumbent
Directors") cease for any reason to constitute at least a
majority thereof unless both (A) the election, or the
nomination for election by the Corporation's shareholders, of
each new director was approved by a vote of at least
two-thirds of the Incumbent Directors in office at the time of
the election or nomination for election of such new director,
and (B) prior to the time that the Incumbent Directors no
longer constitute a majority of the Board of Directors, the
Incumbent Directors then in office, by a vote of at least 75%
of their number, reasonably determine in good faith that the
change in Board membership that has occurred before the date
of that determination and that is anticipated to thereafter
occur within the balance of the 24 month period to cause the
Incumbent Directors to no longer be a majority of the Board of
Directors was not caused by or attributable to, in whole or in
any significant part, directly or indirectly, proximately or
remotely, any event under subclause (i) or (ii) of this clause
(c).
3
<PAGE> 4
For purposes of this clause (c), the term "Change Event" shall
mean any of the events described in the following subclauses
(x), (y), or (z) of this clause (c):
(x) A tender or exchange offer shall be made for 25%
or more of the outstanding voting stock of the
Corporation or any person (as the term "person" is
used in Section 13(d) and Section 14(d)(2) of the
1934 Act) is or becomes the beneficial owner of 25%
or more of the outstanding voting stock of the
Corporation or there is a report filed on Schedule
13D or Schedule 14D-1 (or any successor schedule,
form, or report), each as adopted under the 1934 Act,
disclosing the acquisition of 25% or more of the
outstanding voting stock of the Corporation in a
transaction or series of transactions by any person
(as defined earlier in this subclause (x)). (y) the
Corporation is a party to a transaction pursuant to
which the Corporation is merged with or into, or is
consolidated with, or becomes the subsidiary of
another corporation and, after giving effect to such
transaction, less than 50% of the then outstanding
voting securities of the surviving or resulting
corporation or (if the Corporation becomes a
subsidiary in the transaction) of the ultimate parent
of the Corporation represent or were issued in
exchange for voting securities of the Corporation
outstanding immediately prior to such transaction or
less than 51% of the directors of the surviving or
resulting corporation or (if the Corporation becomes
a subsidiary in the transaction) of the ultimate
parent of the Corporation were directors of the
Corporation immediately prior to such transaction.
(z) There is a sale, lease, exchange, or other
transfer (in one transaction or a series of related
transactions) of all or substantially all the assets
of the Corporation.
(d) A Change of Control will have occurred under this
clause (d) if there is a sale, lease, exchange, or other
transfer (in one transaction or a series of related
transactions) of all or substantially all of the assets of the
Corporation.
4
<PAGE> 5
3. The "Committee" shall mean the Compensation and Organization
Committee of the Board of Directors of the Corporation or other Committee of the
Board of Directors hereafter succeeding to the responsibilities currently
performed by the Compensation and Organization Committee with respect to the
Plan.
4. An "Incentive Award" shall mean the incentive which may be paid to a
Participant pursuant to the Plan.
5. "Market Point" shall mean for any Participant for any calendar year
the market point (as determined under the Corporation's salary administration
program) of such Participant's job grade at the end of the calendar year;
provided, however, that if the Corporation changes such Participant's job grade
during any such calendar year or such Participant is promoted, transferred, or
otherwise moves into a different job grade during such calendar year, then such
Market Point shall be calculated on a pro rata basis for each of the periods in
which such job grades were in effect for such Participant.
6. A "Participant" shall mean a senior officer of the Corporation or
one of its subsidiaries who is selected by the Committee to participate in the
Plan.
7. The "Plan" shall mean this Annual Incentive Plan, together with all
amendments hereto.
8. "Plan Year" shall mean each calendar year for which the Plan remains
in existence.
9. "Subsidiary" shall mean a corporation organized and existing under
the laws of the United States or of any state or the District of Columbia of
which 50 percent or more of the issued and outstanding stock is owned by the
Corporation or by a Subsidiary of the Corporation.
10. The "Target Incentive Pool" shall mean the aggregate amount, as
determined in accordance with Article II of the Plan, of the aggregate
individual target Incentive Awards of Participants.
11. "Target Pool Percentage" shall mean the percentage determined
pursuant to Article II, Sections 3 and 4 below that will be used to establish
the aggregate amount available for Incentive Awards.
12. The "1934 Act" shall mean the Securities Exchange Act of 1934 as
from time to time amended.
5
<PAGE> 6
ARTICLE II
INCENTIVE AWARDS
----------------
1. PARTICIPATION. Annually, the Committee shall select the Participants
in the Plan for the Plan Year. In general, the selection will be made prior to
the beginning of each Plan Year or as soon thereafter as is reasonably
practicable; in addition, such selection may be made at any time during a Plan
Year in the case of a newly hired employee or an employee that receives a new
position. Not in limitation of the foregoing, the Committee shall have the
authority to designate at the beginning of a Plan Year, or as soon thereafter as
is reasonably practicable, employees in selected job grades as Participants,
including any employee that may later be hired or promoted into any such job
grade during the Plan Year, without further action on behalf of the Committee.
Participants shall be notified of their selection in writing. In the event that
employees are determined to be Participants by job grade, the Chief Executive
Officer, or his or her designee, may select, subject to the approval of the
Committee or in accordance with guidelines established by the Committee,
additional eligible employees for Plan participation notwithstanding their job
grade. Employees otherwise eligible for participation because of their job grade
may be excluded, by action of the Committee or the Chief Executive Officer (or
his or her designee), if they are participants in business unit or other
incentive compensation plans.
2. INCENTIVE POOL. The individual target incentives for persons
selected to be in the Plan are set forth in Exhibit A to the Plan, which Exhibit
A may be amended by action of the Committee from time to time. Target incentives
for Participants who are eligible for part of the Plan Year or whose incentive
group assignment changed during the Plan Year will be calculated on a pro rata
basis for both the period of each incentive group assignment and the period
during the Plan Year in which the Participant was an eligible employee. In the
event that an individual whose job does not have an assigned salary grade is
approved for participation in the Plan, the Chief Executive Officer, or his or
her designee, is authorized to select a target incentive percentage for such
individual and base the calculation of target incentive and other calculations
under this Plan on such individual's base salary.
6
<PAGE> 7
3. FORMULA FOR TARGET POOL PERCENTAGE; KNOCK-OUT FACTOR. Prior to each
Plan Year or as soon as practical thereafter, the Committee shall devise a
formula to determine the Target Pool Percentage which formula shall be based on
one or more financial criteria or other performance goals. The Committee shall
have the discretion to set minimal performance goals which must be met before
any Incentive Awards will be made under the Plan. In its sole discretion the
Committee may revise or waive one or more of such minimal performance goals as a
result of any change in conditions or the occurrence of any events or other
factors which make such goal or goals unsuitable or undesirable. Notwithstanding
that the Corporation has not met a minimal performance goal, if the Committee
determines that one or more lines of business of the Corporation have had a
level of performance deserving of Incentive Awards, the Committee may establish
a pool for Incentive Awards utilizing a Target Pool Percentage fixed at 25% (or
such higher or lower percentage as the Committee, in its sole discretion, shall
determine).
4. INCENTIVE AWARDS. As soon as practical after the end of the Plan
Year, the Committee shall determine the Target Pool Percentage (not to exceed
200%) to be applied to the Target Incentive Pool to establish the maximum
aggregate amount to be distributed as Incentive Awards. The percentage shall be
based on the formula established in Section 3 hereof but the Committee shall
have the discretion to decrease or increase the Target Pool Percentage by not
more than twenty per cent (20%). In determining whether, and the extent to
which, the formula established in Section 3 hereof has been achieved, the
Committee shall have the discretion to disregard changes in accounting rules or
practices, gains from the sale of subsidiaries or assets outside the ordinary
course of business, or restructuring or other nonrecurring charges or similar
adjustments. It is contemplated that Incentive Awards may, depending upon the
responsibilities of the Participant, be based wholly on corporate performance,
partially on corporate performance and partially on line of business or business
unit performance, or wholly on line of business or business unit performance.
Ordinarily, the Committee will delegate to management responsibility for
determining Target Pool Percentages for each line of business or business unit
provided that the aggregate weighted average Target Pool Percentages for all
lines of business and business units shall be substantially equivalent to the
Target Pool Percentage established by the Committee.
7
<PAGE> 8
The Committee shall determine or approve the amount of the
Incentive Award for each Participant above such job grade level as the Committee
shall from time to time select and, with respect to all other Participants, the
Committee shall approve the Incentive Awards based on the methodology utilized
by management consistent with the Committee's overall discretion.
It may be determined that a Participant shall receive no
Incentive Award for the Plan Year. In addition, the Plan does not restrict the
maximum amount of an Incentive Award that may be paid to an individual
Participant.
5. ACTIVE EMPLOYMENT REQUIREMENT. Ordinarily, Incentive Awards shall be
made only to Participants who are actively employed at the end of the Plan Year;
however, Participants who retire at age 65 or over or become disabled during a
Plan Year, or the Beneficiary(s) or estate of a Participant whose death occurs
during a Plan Year shall be entitled to, on a pro rata basis (for the period of
time the Participant was in the Plan for the Plan Year) the lesser of (i) the
Participant's target incentive or (ii) the Participant's target incentive times
the Target Pool Percentage if the Committee determines a Target Pool Percentage
of less than 100%. Except as provided in Section 6 hereof, no other Participant
who is not actively employed at the end of the Plan Year shall receive an
Incentive Award unless the Committee, in its sole discretion, so determines that
an Incentive Award shall be made.
6. EFFECT OF CHANGE OF CONTROL. Upon the occurrence of a Non-Initiated
Change of Control during the Plan Year, this Plan shall terminate and each
Participant immediately prior to the occurrence of such Non-Initiated Change of
Control shall promptly receive 200% of such Participant's target incentive
payable under the Plan for the full Plan Year. In the event of the occurrence of
an Initiated Change of Control during the Plan Year, the Committee, in its sole
discretion, shall determine whether the Plan should terminate and the manner of
calculating, and the time for payment, of Incentive Awards (if any) to be made
under the Plan for the Plan Year.
7. PAYMENT OF INCENTIVE AWARD. Except as provided in the first sentence
of Section 6 hereof, Incentive Awards shall be paid on or prior to March 15 of
the year following the Plan Year. Notwithstanding any other provision of the
Plan, the Committee, in its sole discretion, shall have the authority to
authorize payment of all or a portion of all Incentive Awards prior to the end
of the Plan Year,
8
<PAGE> 9
and if a portion, the Corporation shall pay the remaining portion of the Award
on or prior to March 15 of the year following the Plan Year.
Notwithstanding any other provision of the Plan, the Committee, in its
sole discretion, shall have the authority to require deferral of payment of all
or a portion of all Incentive Awards due to any Plan Participant if the
Committee determines that the Corporation would be denied a deduction for
federal income tax purposes for such Award or the portion thereof by reason of
Section 162(m) of the Internal Revenue Code of 1986, as amended, and the
regulations issued thereunder, if the Award or the portion thereof were not so
deferred. Such deferred Incentive Awards, or the portion thereof, shall be
deferred in accordance with the provisions of the KeyCorp Deferred Compensation
Plan.
ARTICLE III
ADMINISTRATION
--------------
The Corporation shall be responsible for the general administration of
the Plan and for carrying out the provisions hereof. The Committee shall have
all such powers as may be necessary to carry out its duties under the Plan,
including the power to determine all questions pertaining to claims for benefits
and procedures for claim review, and the power to resolve all other questions
arising under the Plan, including any questions of construction. The Corporation
and the Committee may take such further action as the Corporation and the
Committee shall deem advisable in the administration of the Plan. The actions
taken and the decisions made by the Corporation and the Committee hereunder
shall be final and binding upon all interested parties. In accordance with the
provisions of Section 503 of the Employee Retirement Income Security Act of
1974, as amended, the Committee shall provide a procedure for handling claims of
Participants or their Beneficiaries under this Plan. Such procedure shall be in
accordance with regulations issued by the Secretary of Labor and shall provide
adequate written notice within a reasonable period of time with respect to the
denial of any such claims as well as a reasonable opportunity for a full and
fair review by the Committee of any such denial. Notwithstanding anything to the
contrary contained herein, the Corporation shall be the "administrator" for the
purpose of the Employment Retirement Income Security Act of 1974, as amended.
Any action authorized under the Plan to be done by the Committee may be done by
the Board of Directors or any other Board committee authorized by the Board of
Directors.
9
<PAGE> 10
ARTICLE IV
AMENDMENT AND TERMINATION
-------------------------
The Corporation reserves the right to amend or terminate the Plan at
any time by action of the Board of Directors or the Committee, but, from and
after the occurrence of a Non-Initiated Change of Control, no such amendment or
termination shall adversely affect the rights of a Participant which have
accrued prior to such amendment or termination except with the written consent
of such Participant.
ARTICLE V
MISCELLANEOUS
-------------
1. NOT AN EMPLOYMENT AGREEMENT. Nothing herein contained shall be
construed as a commitment to or agreement with any person employed by the
Corporation or a Subsidiary to continue such person's employment with the
Corporation or Subsidiary, and nothing herein contained shall be construed as a
commitment or agreement on the part of the Corporation or any Subsidiary to
continue the employment or the annual rate of compensation of any such person
for any period. All Participants shall remain subject to discharge to the same
extent as if the Plan had never been put into effect.
2. UNFUNDED FOR TAX AND ERISA PURPOSES. It is the intention of the
Corporation and the Participants that the Plan be unfunded for tax purposes and
for the purposes of Title I of the Employee Retirement Income Security Act of
1974, as amended.
3. CLAIMS OF OTHER PERSONS. The provisions of the Plan shall in no
event be construed as giving any person, firm, or corporation any legal or
equitable right against the Corporation or any Subsidiary, their officers,
employees, agents, or directors, except any such rights as are specifically
provided for in the Plan or are hereafter created in accordance with the terms
and provisions of the Plan.
4. ABSENCE OF LIABILITY. No member of the Board of Directors of the
Corporation or a Subsidiary or any officer or employee of the Corporation or a
Subsidiary shall be liable for any act or action hereunder, whether of
commission or omission.
5. SEVERABILITY. The invalidity or unenforceability of any particular
provisions of the Plan shall not affect any other provision hereof, and the Plan
shall be construed in all respects as if such invalid or unenforceable provision
were omitted herefrom.
10
<PAGE> 11
6. GOVERNING LAW. The provisions of the Plan shall be governed and
construed in accordance with the laws of the State of Ohio.
KEYCORP
By: /s/ Thomas E. Helfrich
---------------------------------------------
Thomas E. Helfrich, Executive Vice President
11
<PAGE> 12
Exhibit A
---------
<TABLE>
<CAPTION>
Incentive Job Target Incentive As a
Group Grades Percent of Market Point
----- ------ -----------------------
<S> <C> <C>
I 95 100%
II 94 85%
III 92-93 70%
IV 90-91 55%
V 89 45%
VI 88 35%
VII 87 30%
VIII 86 25%
IX 85 20%
X 84 and below 15%
</TABLE>
12
<PAGE> 1
Exhibit 10.2
KEYCORP
NON-QUALIFIED GRANT AGREEMENT
PREMIUM PRICED OPTIONS
Robert W. Gillespie
By action of the Compensation and Organization Committee ("Committee")
of the Board of Directors of KeyCorp, taken pursuant to the KeyCorp Amended and
Restated 1991 Equity Compensation Plan ("Plan") on January 13, 1999 (the "Option
Grant Date"), you have been granted Non-Qualified Stock Options (the "Options")
to purchase 150,000 Common Shares at a price per share as set forth in paragraph
1 below (the "Exercise Price"), which may be exercised, subject to the
provisions of the Plan, from time to time, in part as to such Options as you
specify or, if you so direct, with respect to the full number of Common Shares
then remaining subject to the Options, during the period commencing July 13,
1999 and ending January 13, 2009 ("Option Expiration Date"). (Unless otherwise
indicated, the capitalized terms used herein shall have the same meaning as set
forth in the Plan).
1. As to one-third of such Options, the Exercise Price of such Options
shall be $40.00 per Common Share; (ii) as to one-third of such Options, the
Exercise Price of such Options shall be $45.00 per Common Share; and (iii) as to
one-third of such Options, the Exercise Price of such Options shall be $50.00
per Common Share. Within the foregoing limits, at the time or times you exercise
Options granted hereunder, you shall specify the number of Options being
exercised and the Exercise Price of the Options you desire to exercise. Upon
exercise of Options with a specified Exercise Price, the number of Options, if
any, remaining available for future exercise at that specified Exercise Price
shall be reduced accordingly.
2. Unless your employment is terminated for "Cause" (as defined in your
employment agreement hereinafter referred to), death, disability, or "Voluntary
Resignation" without "Good Reason" prior to the end of the "Scheduled Term", all
as defined in and under your Amended and Restated Employment Agreement, dated as
of November 21, 1996, as amended from time to time (the "Employment Agreement"),
you shall be treated, for all purposes (including vesting and period of
exercisability), as if your employment with KeyCorp continued through the Option
Expiration Date. In the event that your employment is terminated because of
death or disability, the Options may be exercised for one year from your death
or disability, as the case may be. In the event that your employment is
terminated for Cause or Voluntary Resignation without Good Reason prior to the
end of the Scheduled Term under the Employment Agreement, the Options shall
immediately be forfeited and cease to be exercisable.
3. If, after written notice from KeyCorp, you shall engage in any
competitive activity in violation of the Employment Agreement within one year
after the Employment Termination Date, then any Profits realized upon the
exercise of Options granted pursuant to this Agreement on or after one year
prior to the Employment Termination Date shall inure to KeyCorp. If any Profits
realized upon the exercise of any Option inure to the benefit of KeyCorp in
accordance with the first sentence of this paragraph, you shall pay all such
Profits to KeyCorp within 30 days after first
1
<PAGE> 2
engaging in any prohibited activity and all unexercised Options granted pursuant
to this Agreement shall immediately be forfeited and canceled.
For purposes of this Agreement:
"Profit" shall mean, with respect to any Option, the positive
spread between the Fair Market Value of a Common Share on the
date of exercise and the applicable Exercise Price.
4. Because the Options granted hereunder are performance options, they
are not subject to the provisions of Section 25 of the Employment Agreement.
The Options shall be governed by the terms, conditions, and provisions
of the Plan.
This Agreement may not be modified, amended or waived except by an
instrument in writing signed by both parties hereto.
January 13, 1999
---------------------------
Thomas E. Helfrich
Executive Vice President
ACCEPTANCE
- ----------
The undersigned hereby acknowledges receipt of the Plan, agrees to be
bound by the foregoing Agreement and agrees and consents to the terms,
conditions, and provisions of the Agreement, Plan and the Award evidenced by
this Agreement.
----------------------
Robert W. Gillespie
2
<PAGE> 1
Exhibit 10.3
KEYCORP
NON-QUALIFIED GRANT AGREEMENT
PREMIUM PRICED OPTIONS
Henry L. Meyer III
By action of the Compensation and Organization Committee ("Committee")
of the Board of Directors of KeyCorp, taken pursuant to the KeyCorp Amended and
Restated 1991 Equity Compensation Plan ("Plan") on January 13, 1999 (the "Option
Grant Date"), you have been granted Non-Qualified Stock Options (the "Options")
to purchase 75,000 Common Shares at a price per share as set forth in paragraph
1 below (the "Exercise Price"), which may be exercised, subject to the
provisions of the Plan, from time to time, in part as to such Options as you
specify or, if you so direct, with respect to the full number of Common Shares
then remaining subject to the Options, during the period commencing July 13,
1999 and ending January 13, 2009 ("Option Expiration Date"). (Unless otherwise
indicated, the capitalized terms used herein shall have the same meaning as set
forth in the Plan).
1. As to one-third of such Options, the Exercise Price of such Options
shall be $40.00 per Common Share; (ii) as to one-third of such Options, the
Exercise Price of such Options shall be $45.00 per Common Share; and (iii) as to
one-third of such Options, the Exercise Price of such Options shall be $50.00
per Common Share. Within the foregoing limits, at the time or times you exercise
Options granted hereunder, you shall specify the number of Options being
exercised and the Exercise Price of the Options you desire to exercise. Upon
exercise of Options with a specified Exercise Price, the number of Options, if
any, remaining available for future exercise at that specified Exercise Price
shall be reduced accordingly.
2. Unless your employment is terminated for "Cause" (as defined in your
employment agreement hereinafter referred to), death, disability, or voluntary
resignation by you at any time without either having "Good Reason" during a
"Window Period" or being "Constructively Terminated", all as defined in and
under your Employment Agreement, dated as of May 15, 1997, as amended from time
to time (the "Employment Agreement"), you shall be treated, for all purposes
(including vesting and period of exercisability), as if your employment with
KeyCorp continued through the Option Expiration Date. In the event that your
employment is terminated because of death or disability, the Options may be
exercised for one year from your death or disability, as the case may be. In the
event that your employment is terminated for Cause or voluntary resignation by
you at any time without either having Good Reason during a Window Period or
being Constructively Terminated under the Employment Agreement, the Options
shall immediately be forfeited and cease to be exercisable.
3. If, after written notice from KeyCorp, you shall engage in any
competitive activity in violation of the Employment Agreement within one year
after the Employment Termination Date, then any Profits realized upon the
exercise of Options granted pursuant to this Agreement on or after one year
prior to the Employment Termination Date shall inure to KeyCorp. If any Profits
realized upon the exercise of any Option inure to the benefit of KeyCorp in
accordance with the
1
<PAGE> 2
first sentence of this paragraph, you shall pay all such Profits to KeyCorp
within 30 days after first engaging in any prohibited activity and all
unexercised Options granted pursuant to this Agreement shall immediately be
forfeited and canceled.
For purposes of this Agreement:
"Profit" shall mean, with respect to any Option, the positive
spread between the Fair Market Value of a Common Share on the
date of exercise and the applicable Exercise Price.
The Options shall be governed by the terms, conditions, and provisions
of the Plan.
This Agreement may not be modified, amended or waived except by an
instrument in writing signed by both parties hereto.
January 13, 1999
---------------------------
Thomas E. Helfrich
Executive Vice President
ACCEPTANCE
The undersigned hereby acknowledges receipt of the Plan, agrees to be
bound by the foregoing Agreement and agrees and consents to the terms,
conditions, and provisions of the Agreement, Plan and the Award evidenced by
this Agreement.
-----------------------
Henry L. Meyer III
2
<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 13, 1999, relating to
the unaudited condensed consolidated interim financial statements of Key,
included in the Quarterly Report on Form 10-Q for the quarter ended March 31,
1999.
Form S-3 No. 33-58405
Form S-3 No. 333-10577
Form S-3 No. 333-55959
Form S-3 No. 333-59175
Form S-3 No. 333-64601
Form S-3 No. 333-76619
Form S-4 No. 33-31569
Form S-4 No. 33-44657
Form S-4 No. 33-51717
Form S-4 No. 33-55573
Form S-4 No. 33-57329
Form S-4 No. 33-61539
Form S-4 No. 333-19151
Form S-4 No. 333-61025
Form S-8 No. 2-97452
Form S-8 No. 33-21643
Form S-8 No. 333-49609
Form S-8 No. 333-49633
Form S-8 No. 333-65391
Form S-8 No. 333-70669
Form S-8 No. 333-70703
Form S-8 No. 333-70775
Form S-8 No. 333-72189
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)
Form S-8 No. 333-61025 (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 10, 1999
49
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> $2,981
<INT-BEARING-DEPOSITS> 26
<FED-FUNDS-SOLD> 423
<TRADING-ASSETS> 1,181
<INVESTMENTS-HELD-FOR-SALE> 6,778
<INVESTMENTS-CARRYING> 1,005
<INVESTMENTS-MARKET> 1,031
<LOANS> 61,045
<ALLOWANCE> 930
<TOTAL-ASSETS> $79,992
<DEPOSITS> 41,323
<SHORT-TERM> 12,578
<LIABILITIES-OTHER> 3,285
<LONG-TERM> 15,457
1,244
0
<COMMON> 492
<OTHER-SE> 5,613
<TOTAL-LIABILITIES-AND-EQUITY> $79,992
<INTEREST-LOAN> $1,250
<INTEREST-INVEST> 131
<INTEREST-OTHER> 0
<INTEREST-TOTAL> $1,381
<INTEREST-DEPOSIT> 309
<INTEREST-EXPENSE> 387
<INTEREST-INCOME-NET> 685
<LOAN-LOSSES> 111
<SECURITIES-GAINS> 4
<EXPENSE-OTHER> 748
<INCOME-PRETAX> 435
<INCOME-PRE-EXTRAORDINARY> 435
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 293
<EPS-PRIMARY> 0.65
<EPS-DILUTED> 0.65
<YIELD-ACTUAL> 3.95
<LOANS-NON> $395
<LOANS-PAST> 191
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> $900
<CHARGE-OFFS> 107
<RECOVERIES> 26
<ALLOWANCE-CLOSE> 930
<ALLOWANCE-DOMESTIC> 930
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
