<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2000
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
[KEY CORP LOGO]
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(Exact name of registrant as specified in its charter)
OHIO 34-6542451
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306
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(Address of principal executive offices) (Zip Code)
(216) 689-6300
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X[ No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Shares with a par value of $1 each 430,516,421 Shares
-------------------------------------------- -------------------------------
(Title of class) (Outstanding at July 31, 2000)
<PAGE> 2
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
<TABLE>
<S> <C>
Item 1. Financial Statements Page Number
-------------------- -----------
Consolidated Balance Sheets --
June 30, 2000, December 31, 1999 and June 30, 1999 3
Consolidated Statements of Income --
Three months and six months ended June 30, 2000 and 1999 4
Consolidated Statements of Changes in Shareholders' Equity --
Six months ended June 30, 2000 and 1999 5
Consolidated Statements of Cash Flow --
Six months ended June 30, 2000 and 1999 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 24
Item 2. Management's Discussion and Analysis of Financial Condition
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and Results of Operations 25
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Item 3. Quantitative and Qualitative Disclosure of Market Risk 58
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings 58
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Item 4. Submission of Matters to a Vote of Security Holders 59
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Item 5. Other Information 59
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Item 6. Exhibits and Reports on Form 8-K 60
--------------------------------
Signature 60
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
dollars in millions
<S> <C> <C> <C>
JUNE 30, DECEMBER 31, JUNE 30,
2000 1999 1999
===================================================================================================================
(Unaudited) (Unaudited)
ASSETS
Cash and due from banks $ 3,178 $ 2,816 $ 3,060
Short-term investments 1,759 1,860 1,755
Securities available for sale 6,249 6,665 6,404
Investment securities (fair value; $1,136, $998 and $985) 1,128 986 967
Loans, net of unearned income of $1,660, $1,621 and $1,507 65,612 64,222 61,971
Less: Allowance for loan losses 979 930 930
--------------------------------------------------------------------------------------------------------------------
Net loans 64,633 63,292 61,041
Premises and equipment 726 797 846
Goodwill 1,357 1,389 1,446
Other intangible assets 52 60 68
Corporate owned life insurance 2,159 2,110 2,056
Other assets 3,478 3,420 3,246
--------------------------------------------------------------------------------------------------------------------
Total assets $ 84,719 $ 83,395 $ 80,889
======== ======== ========
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 9,057 $ 8,607 $ 9,058
Interest-bearing 34,733 33,390 31,948
Deposits in foreign office -- interest-bearing 5,286 1,236 2,010
--------------------------------------------------------------------------------------------------------------------
Total deposits 49,076 43,233 43,016
Federal funds purchased and securities sold under repurchase agreements 3,511 4,177 4,727
Bank notes and other short-term borrowings 5,998 8,439 7,344
Other liabilities 4,287 4,033 3,405
Long-term debt 14,097 15,881 15,168
Corporation-obligated mandatorily redeemable
preferred capital securities of subsidiary
trusts holding solely subordinated debentures
of the Corporation (See Note 9) 1,243 1,243 994
--------------------------------------------------------------------------------------------------------------------
Total liabilities 78,212 77,006 74,654
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 1,405 1,412 1,413
Retained earnings 6,203 5,833 5,533
Loans to ESOP trustee (24) (24) (34)
Treasury stock, at cost (60,723,102, 48,462,243 and 43,248,120 shares) (1,421) (1,197) (1,062)
Accumulated other comprehensive loss (148) (127) (107)
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Total shareholders' equity 6,507 6,389 6,235
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Total liabilities and shareholders' equity $ 84,719 $ 83,395 $ 80,889
======== ======== ========
====================================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
3
<PAGE> 4
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
dollars in millions, except per share amounts 2000 1999 2000 1999
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTEREST INCOME
Loans $1,397 $1,251 $2,744 $2,501
Taxable investment securities 6 3 10 7
Tax-exempt investment securities 7 8 13 17
Securities available for sale 107 107 219 204
Short-term investments 23 23 43 44
--------------------------------------------------------------------------------------------------------------------------
Total interest income 1,540 1,392 3,029 2,773
INTEREST EXPENSE
Deposits 436 315 813 624
Federal funds purchased and securities sold
under repurchase agreements 58 63 106 117
Bank notes and other short-term borrowings 103 88 229 207
Long-term debt, including capital securities 270 229 537 443
--------------------------------------------------------------------------------------------------------------------------
Total interest expense 867 695 1,685 1,391
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NET INTEREST INCOME 673 697 1,344 1,382
Provision for loan losses 68 76 251 187
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Net interest income after provision for loan losses 605 621 1,093 1,195
NONINTEREST INCOME
Trust and asset management income 116 110 231 216
Investment banking and capital markets income 98 100 187 166
Service charges on deposit accounts 85 82 171 163
Brokerage commission income 34 42 79 84
Corporate owned life insurance income 25 27 50 51
Credit card fees 2 21 8 31
Net loan securitization gains 7 18 9 50
Net securities gains 2 20 3 24
Gains from divestitures -- -- 332 148
Other income 106 112 211 214
--------------------------------------------------------------------------------------------------------------------------
Total noninterest income 475 532 1,281 1,147
NONINTEREST EXPENSE
Personnel 361 383 743 755
Net occupancy 56 58 113 117
Computer processing 60 59 119 113
Equipment 42 49 90 105
Marketing 31 24 53 49
Amortization of intangibles 25 26 50 54
Professional fees 21 17 40 32
Restructuring charges -- -- 7 --
Other expense 102 107 210 252
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Total noninterest expense 698 723 1,425 1,477
INCOME BEFORE INCOME TAXES 382 430 949 865
Income taxes 134 150 334 292
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NET INCOME $ 248 $ 280 $ 615 $ 573
====== ====== ====== ======
Per common share:
Net income $ .57 $ .63 $ 1.40 $ 1.28
Net Income - assuming dilution .57 .62 1.40 1.27
Weighted average common shares outstanding (000) 434,112 448,037 437,973 448,774
Weighted average common shares and potential common
shares outstanding (000) 436,022 452,733 439,889 453,461
==========================================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
4
<PAGE> 5
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
LOANS TO TREASURY COMPREHENSIVE
COMMON CAPITAL RETAINED ESOP STOCK, (LOSS) COMPREHENSIVE
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST INCOME INCOME(b)
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,1998 $492 $1,412 $5,192 $(34) $ (923) $ 28
Net income 573 $573
Other Comprehensive losses:
Net unrealized losses on securities available
for sale, net of income taxes of $(80)(a) (130) (130)
Foreign currency translation adjustments (5) (5)
-------
Total comprehensive income $ 438
=======
Cash dividends on common shares ($.52 per share) (233)
Issuance of common shares:
Acquisition-632,183 shares 6 15
Employee benefit and dividend reinvestment
plans - 1,963,304 net shares (5) 48
Repurchase of common shares - 6,406,424 shares (202)
ESOP transactions 1
----------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30,1999 $492 $1,413 $5,533 $(34) $(1,062) $(107)
==== ====== ====== ==== ======= =====
======================================================================================================================
BALANCE AT DECEMBER 31, 1999 $492 $1,412 $5,833 $(24) $(1,197) $(127)
Net income 615 $615
Other comprehensive losses:
Net unrealized losses on securities available
for sale, net of income taxes of $(19)(a) (17) (17)
Foreign currency translation adjustments (4) (4)
-------
Total comprehensive income $594
====
Cash dividends on common shares ($.56 per share) (245)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans- 804,141 net shares (7) 20
Repurchase of common shares-13,065,000 shares (244)
------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2000 $492 $1,405 $6,203 $(24) $(1,421) $(148)
==== ====== ====== ==== ======= =====
==================================================================================================================
</TABLE>
(a) Net of reclassification adjustments.
(b) For the three months ended June 30, 2000 and 1999, comprehensive
income was $257 million and $229 million, respectively.
See Notes to Consolidated Financial Statements (Unaudited).
<PAGE> 6
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
SIX MONTHS ENDED JUNE 30,
---------------------------
in millions 2000 1999
=======================================================================================================================
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 615 $ 573
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 251 187
Depreciation expense and software amortization 141 144
Amortization of intangibles 50 54
Net gains from divestitures (332) (148)
Net securities gains (3) (24)
Net gains from loan securitizations and sales (21) (72)
Deferred income taxes 138 163
Net increase in mortgage loans held for sale (270) (32)
Net increase in trading account assets (34) (233)
Net decrease in accrued restructuring charges (41) (1)
Other operating activities, net 93 (42)
-----------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 587 569
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions, sales and divestitures (4,214) (3,525)
Proceeds from loan securitizations and sales 3,586 3,037
Purchases of investment securities (203) (117)
Proceeds from sales of investment securities 11 8
Proceeds from prepayments and maturities of investment securities 94 152
Purchases of securities available for sale (2,176) (3,780)
Proceeds from sales of securities available for sale 2,030 325
Proceeds from prepayments and maturities of securities available for sale 385 2,611
Net decrease in other short-term investments 135 452
Purchases of premises and equipment (39) (50)
Proceeds from sales of premises and equipment 18 23
Proceeds from sales of other real estate owned 12 13
Cash used in acquisitions, net of cash acquired (357) --
-----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (718) (851)
FINANCING ACTIVITIES
Net increase in deposits 5,843 433
Net decrease in short-term borrowings (3,107) (2,145)
Net proceeds from issuance of long-term debt, including capital securities 1,789 3,756
Payments on long-term debt, including capital securities (3,555) (1,592)
Purchases of treasury shares (240) (202)
Net proceeds from issuance of common stock 8 29
Cash dividends (245) (233)
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NET CASH PROVIDED BY FINANCING ACTIVITIES 493 46
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NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 362 (236)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 2,816 3,296
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CASH AND DUE FROM BANKS AT END OF PERIOD $3,178 $3,060
====== ======
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Additional disclosures relative to cash flow:
Interest paid $1,667 $l,366
Income taxes paid 43 85
Net amount received on portfolio swaps 37 12
Noncash items:
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
Net transfer of premises and equipment to other assets $17 --
Net transfer of loans to other real estate owned 13 13
===================================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
6
<PAGE> 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited condensed consolidated interim financial statements include the
accounts of KeyCorp and its subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation. Management believes that
the unaudited condensed consolidated interim financial statements reflect all
adjustments of a normal recurring nature and disclosures which are necessary for
a fair presentation of the results for the interim periods presented. Some
previously reported results have been reclassified to conform to current
reporting practices. The results of operations for the interim periods are not
necessarily indicative of the results of operations to be expected for the full
year. When you read these financial statements, you should also look at the
audited consolidated financial statements and related notes included in Key's
1999 Annual Report to Shareholders.
As used in these Notes, KeyCorp refers solely to the parent company and Key
refers to the consolidated entity consisting of KeyCorp and its subsidiaries.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
DERIVATIVES AND HEDGING ACTIVITIES. In June 2000, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 138,
"Accounting for Certain Derivative Instruments and Certain Hedging Activities,
an amendment of SFAS 133." This new statement addresses a limited number of
issues causing implementation difficulties for entities that apply SFAS 133.
In July 1999, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 137, "Deferral of the Effective Date of SFAS
133." This new statement delays the effective date of SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities," until fiscal years beginning
after June 15, 2000.
SFAS 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively called "derivatives") and for hedging activities. SFAS
133 requires that all derivatives be recognized on the balance sheet at fair
value. Depending on the nature of the hedge, and the extent to which it is
effective, the changes in fair value of the derivative will either be offset
against the change in fair value of the hedged item (which also is recognized in
earnings) or 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.
Key will adopt the provisions of SFAS 133 as of January 1, 2001. Management is
currently reviewing SFAS 133 to determine the extent to which the statement will
alter Key's use of certain derivatives in the future and the impact on Key's
financial condition and results of operations.
2. EARNINGS PER COMMON SHARE
The computation of Key's basic and diluted earnings per common share is as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- --------------------------
dollars in millions, except per share amounts 2000 1999 2000 1999
===================================================================================================================
<S> <C> <C> <C> <C>
NET INCOME $ 248 $ 280 $ 615 $ 573
========= ========= ========= =========
-------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 434,112 448,037 437,973 448,774
Effect of dilutive common stock options (000) 1,910 4,696 1,916 4,687
-------------------------------------------------------------------------------------------------------------------
Weighted average common shares and potential
common shares outstanding (000) 436,022 452,733 439,889 453,461
========= ========= ========= =========
-------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per common share $ .57 $ .63 $ 1.40 $ 1.28
Net income per common share - assuming dilution .57 .62 1.40 1.27
-------------------------------------------------------------------------------------------------------------------
</TABLE>
7
<PAGE> 8
3. ACQUISITIONS AND DIVESTITURES
Business acquisitions and divestitures that Key completed during 1999 and the
first six months of 2000 are summarized below.
ACQUISITION
-----------
NATIONAL REALTY FUNDING L.C.
On January 10, 2000, Key purchased certain net assets of National Realty Funding
L.C., a commercial finance company headquartered in Kansas City, Missouri, for
$359 million in cash. Goodwill of approximately $10 million was recorded and is
being amortized using the straight-line method over a period of 15 years.
DIVESTITURES
------------
CREDIT CARD PORTFOLIO
On January 31, 2000, Key sold its credit card portfolio of $1.3 billion in
receivables and nearly 600,000 active VISA and MasterCard accounts to Associates
National Bank (Delaware). Key recognized a gain of $332 million ($207 million
after tax), which is included in "gains from divestitures" on the income
statement.
BRANCH DIVESTITURES
On October 18, 1999, Key sold its Long Island franchise, which included 28
KeyCenters with $1.3 billion in deposits and $505 million in loans. This
transaction resulted in a gain of $194 million ($122 million after tax).
COMPAQ CAPITAL EUROPE LLC AND COMPAQ CAPITAL ASIA PACIFIC LLC
On July 28, 1999, Key sold its 50% interests in Compaq Capital Europe LLC and
Compaq Capital Asia Pacific LLC to Compaq Capital Corporation. Key and Compaq
formed these limited liability companies in 1998 to provide customized equipment
leasing and financing programs to Compaq's clients in the United Kingdom, Europe
and Asia. Key recognized a gain of $13 million ($8 million after tax).
ELECTRONIC PAYMENT SERVICES, INC.
On February 28, 1999, Electronic Payment Services, Inc., an electronic funds
transfer processor in which Key held a 20% interest, merged with a wholly owned
subsidiary of Concord EFS, Inc. Key received 5,931,825 shares of Concord EFS in
exchange for its Electronic Payment Services stock, and recognized a gain of
$134 million ($85 million after tax), which is included in "gains from
divestitures" on the income statement. On June 17, 1999, Key sold its Concord
EFS shares and recognized a gain of $15 million ($9 million after tax).
KEY MERCHANT SERVICES, LLC
On January 21, 1998, Key sold a 51% interest in Key Merchant Services, LLC, a
wholly owned subsidiary formed to provide merchant credit card processing
services, to NOVA Information Systems, Inc. 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 payments if Key Merchant Services achieved certain revenue-related
performance targets. These additional payments created a gain of $27 million
($17 million after tax) in the fourth quarter of 1998 and a final gain of $14
million ($9 million after tax) during the first quarter of 1999. These gains are
included in "gains from divestitures" on the income statement. Due to a
confidentiality clause in the agreement, the terms, which are not material, have
not been disclosed.
8
<PAGE> 9
4. LINE OF BUSINESS RESULTS
Key's four major lines of business are Key Retail Banking, Key Specialty
Finance, Key Corporate Capital and Key Capital Partners.
KEY RETAIL BANKING
Key Retail Banking delivers a complete line of branch-based financial products
and services to small businesses and consumers. These products and services are
delivered through 938 KeyCenters, a 24-hour telephone banking call center
services group, 2,491 ATMs that access 13 different networks (resulting in one
of the largest ATM networks in the United States) and a core team of
relationship management professionals.
KEY SPECIALTY FINANCE
Key Specialty Finance provides indirect, non-branch-based consumer loan
products, including automobile loans and leases, home equity loans, education
loans, and marine and recreational vehicle loans. As of December 31, 1999, based
on the volume of loans generated, Key Specialty Finance was one of the nation's
leading providers of financing for education loans, automobile loans and leases,
and purchases of marine and recreational vehicles.
KEY CORPORATE CAPITAL
Key Corporate Capital offers a complete range of financing, transaction
processing and financial advisory services to corporations nationwide, and
operates one of the largest bank-affiliated equipment leasing companies in the
world, with operations in the United States, Europe and Asia. Based on total
transaction volume, Key Corporate Capital is also one of the leading cash
management providers in the United States.
Key Corporate Capital's business units are organized around six specialized
industry client segments: commercial banking, commercial real estate, lease
financing, structured finance, healthcare and media/telecommunications. These
targeted client segments can receive a number of specialized services, including
international banking, cash management and corporate finance advisory services.
Key Corporate Capital also offers investment banking, capital markets, 401(k)
and trust custody products in cooperation with Key Capital Partners.
KEY CAPITAL PARTNERS
Key Capital Partners provides asset management, wealth management, private
banking, brokerage, investment banking, capital markets and insurance expertise.
This line of business, which generates a substantial amount of Key's fee income,
comprises three major business groups. One group, operating under the name
McDonald Investments Inc., 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 group, referred to as Key Asset Management, includes asset
management, mutual funds, institutional asset services, wealth management and
insurance. The third group, known as Key Principal Partners, includes equity
capital, mezzanine finance and alliance funds. The future growth and success of
Key Capital Partners depend heavily on its ability to capitalize on the
corporate and retail banking distribution channels and client relationships that
other Key lines of business have already developed.
9
<PAGE> 10
The table that spans pages 11 and 12 shows selected financial data for each
major line of business for the three- and six-month periods ended June 30, 2000
and 1999. The financial information was derived from the internal profitability
reporting system that management uses to monitor and manage Key's financial
performance. The selected financial data are based on internal accounting
policies designed to ensure that results are compiled on a consistent basis and
reflect the underlying economics of Key's four major businesses. In accordance
with these policies:
- 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 funds transfer pricing
is included in the "Treasury and Other" columns of the table.
- Indirect expenses, such as computer servicing costs and corporate overhead,
were allocated based on the extent to which each line of business actually
used the service.
- The provision for loan losses was allocated among the lines of business
based primarily upon their actual net charge-offs, adjusted for loan growth
and changes in risk profile. The level of the consolidated provision is
based upon the methodology that Key uses to estimate its consolidated
allowance for loan losses. This methodology is described in Note 1
("Summary of significant accounting policies") under the heading "Allowance
for loan losses" on page 58 of Key's 1999 Annual Report to Shareholders.
- Income taxes were allocated based on the statutory Federal income tax rate
of 35% (adjusted for tax-exempt income from corporate owned life insurance,
nondeductible goodwill amortization and tax credits associated with
investments in low-income housing projects) and a blended state income tax
rate (net of the Federal income tax benefit) of 2% 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).
Developing and applying the methodologies that management follows to allocate
items among Key's lines of business is a dynamic process. Accordingly, financial
results may be revised periodically to reflect accounting enhancements, changes
in the risk profile of a particular segment of Key's business or changes in
Key's structure. Starting in the first quarter of 2000 the financial data for
both 2000 and 1999 presented in the table reflects a change in the manner of
reporting the results of divested businesses. The impact of these businesses is
now being included under the "Reconciling Items" columns, as opposed to being
allocated to the major business lines. In addition, the financial data presented
for both years reflects the second quarter 2000 reclassification of the Deposit
Marketing unit from Treasury and Other to Key Retail Banking.
There is no authoritative guidance for "management accounting"--the way that
management uses its judgment and experience to guide line of business reporting
decisions--similar to generally accepted accounting principles for financial
accounting. Consequently, the line of business results that Key reports are not
necessarily comparable with those presented by other companies.
10
<PAGE> 11
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, KEY RETAIL BANKING KEY SPECIALTY FINANCE KEY CORPORATE CAPITAL
-------------------- ----------------------- ---------------------
dollars in millions 2000 1999 2000 1999 2000 1999
================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ 298 $ 296 $ 125 $ 128 $ 262 $ 250
Noninterest income 88 85 19 38 53 54
Revenue sharing(a) 19 18 1 1 43 35
--------------------------------------------------------------------------------------------------------------------------------
Total revenue(b) 405 399 145 167 358 339
Provision for loan losses 16 15 23 22 37 30
Depreciation and amortization expense 35 38 13 15 16 14
Other noninterest expense 183 194 67 64 122 118
Expense sharing(a) 16 16 ___ ___ 25 20
--------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) 155 136 42 66 158 157
Allocated income taxes and taxable equivalent adjustments 56 49 18 26 61 59
--------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 99 $ 87 $ 24 $ 40 $ 97 $ 98
======= ======= ======= ======= ======= =======
Percent of consolidated net income 40% 31% 10% 14% 39% 35%
Percent of total segments' net income 40 34 10 16 39 38
--------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $10,813 $ 9,685 $14,909 $14,136 $31,307 $28,561
Total assets(b) 12,303 11,260 16,071 15,249 33,024 29,921
Deposits 34,803 33,029 122 113 2,981 2,733
--------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Efficiency ratio(g) 57.78% 62.16% 55.17% 47.31% 45.53% 44.84%
--------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
SIX MONTHS ENDED JUNE 30, KEY RETAIL BANKING KEY SPECIALTY FINANCE KEY CORPORATE CAPITAL
-------------------- ----------------------- ---------------------
dollars in millions 2000 1999 2000 1999 2000 1999
================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS
Net interest income (taxable equivalent) $ 588 $ 585 $ 253 $ 268 $ 520 $ 487
Noninterest income 171 159 36 82 106 103
Revenue sharing(a) 36 36 1 1 76 66
--------------------------------------------------------------------------------------------------------------------------------
Total revenue(b) 795 780 290 351 702 656
Provision for loan losses 34 32 48 54 64 50
Depreciation and amortization expense 71 76 26 31 31 29
Other noninterest expense 360 382 135 131 245 235
Expense sharing(a) 29 30 ___ ___ 45 39
--------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (taxable equivalent) 301 260 81 135 317 303
Allocated income taxes and taxable equivalent adjustments 109 90 34 53 122 115
--------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 192 $ 170 $ 47 $ 82 $ 195 $ 188
======= ======= ======= ======= ======= =======
Percent of consolidated net income 31% 30% 8% 14% 32% 33%
Percent of total segments' net income 39 36 10 17 40 39
--------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $10,642 $ 9,605 $14,784 $14,479 $31,065 $28,219
Total assets(b) 12,147 11,171 15,997 15,584 32,659 29,497
Deposits 34,242 33,034 126 117 2,907 2,739
--------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Efficiency ratio(g) 57.86% 62.56% 56.36% 46.15% 45.73% 46.19%
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Represents the assignment of Key Capital Partners' revenue and expense to
the lines of business principally responsible for maintaining the
relationships with the clients that used Key Capital Partners' products and
services.
(b) Substantially all revenue generated by Key's major lines of business is
derived from clients resident in the United States. Substantially all
long-lived assets, including premises and equipment, capitalized software
and goodwill, held by Key's major lines of business are located in the
United States.
(c) "Reconciling items" reflect certain nonrecurring items, the results of
divested businesses and charges related to unallocated nonearning assets of
corporate support functions, which are included in net interest income and
allocated to the business segments through noninterest expense.
In the second quarter of 1999, noninterest income includes a $15 million
($9 million after tax) gain from the sale of Concord EFS, Inc. common
shares. During the same period, divested businesses added $19 million ($12
million after tax) to noninterest income and $45 million ($28 million after
tax) to net interest income.
For the first six months of 2000, noninterest income includes a $332
million ($207 million after tax) gain from the January sale of Key's credit
card business and $6 million ($3 million after tax) earned by divested
businesses. For the first six months of 1999, noninterest income includes
gains totaling $163 million ($103 million after tax) from certain
divestitures and $37 million ($23 million after tax) earned by divested
businesses. These businesses also added $13 million ($8 million after tax)
to net interest income in the first half of 2000 and $89 million ($56
million after tax) to net interest income in the same period last year.
(d) In the first quarter of 2000, the provision for loan losses includes an
additional provision of $121 million ($77 million after tax) that resulted
from the implementation of an enhanced methodology for assessing credit
risk, particularly in the commercial loan
11
<PAGE> 12
<TABLE>
<CAPTION>
KEY CAPITAL PARTNERS TREASURY AND OTHER TOTAL SEGMENTS RECONCILING ITEMS KEYCORP CONSOLIDATED
------------------------- ------------------------ ------------------------- ------------------ -------------------------
2000 1999 2000 1999 2000 1999 2000 1999 2000 1999
=================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 54 $ 52 $ (29) $ (30) $ 710 $ 696 $ (30) $ 8 $ 680 $ 704
268 277 44 44 472 498 3 34 475 532
(63) (54) -- -- -- -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
259 275 15 14 1,182 1,194 (27)(c) 42(c) 1,155 1,236
1 2 1 1 78 70 (10)(d) 6(d) 68 76
24 23 7 7 95 97 1 1 96 98
222 225 25 35 619 636 (17)(e) (11)(e) 602 625
(41) (36) -- -- -- -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
53 61 (18) (29) 390 391 (1) 46 389 437
23 24 (17) (21) 141 137 -- 20 141 157
---------------------------------------------------------------------------------------------------------------------------------
$ 30 $ 37 $ (1) $ (8) $ 249 $ 254 $ (1) $ 26 $ 248 $ 280
==== ==== ===== ===== ===== ===== ===== ==== ===== ====
12% 13% (1)% (3)% 100% 90% -- % 10% 100% 100%
12 15 (1) (3) 100 100 N/A N/A N/A N/A
---------------------------------------------------------------------------------------------------------------------------------
$ 5,275 $ 4,327 $ 2,340 $ 2,919 $ 64,644 $ 59,628 $ 173 $ 1,976 $ 64,817 $ 61,604
9,546 8,062 10,976 11,715 81,920 76,207 1,485(f) 3,818(f) 83,405 80,025
3,388 3,225 4,535 1,454 45,829 40,554 4 1,227 45,833 41,781
---------------------------------------------------------------------------------------------------------------------------------
79.15% 77.09% N/M N/M 60.41% 61.39% N/M N/M 60.26% 59.21%
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
KEY CAPITAL PARTNERS TREASURY AND OTHER TOTAL SEGMENTS RECONCILING ITEMS KEYCORP CONSOLIDATED
------------------------- ------------------------ ------------------------- ------------------ -------------------------
2000 1999 2000 1999 2000 1999 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 102 $ 102 $ (59) $ (60) $ 1,404 $ 1,382 $ (46) $ 15 $ 1,358 $ 1,397
538 505 87 77 938 926 343 221 1,281 1,147
(113) (103) -- -- -- -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
527 504 28 17 2,342 2,308 297(c) 236(c) 2,639 2,544
2 2 2 2 150 140 101(d) 47(d) 251 187
48 47 14 12 190 195 1 3 191 198
449 433 50 57 1,239 1,238 (5)(e) 41(e) 1,234 1,279
(74) (69) -- -- -- -- -- -- -- --
---------------------------------------------------------------------------------------------------------------------------------
102 91 (38) (54) 763 735 200 145 963 880
43 38 (34) (39) 274 257 74 50 348 307
---------------------------------------------------------------------------------------------------------------------------------
$ 59 $ 53 $ (4) $ (15) $ 489 $ 478 $ 126 $ 95 $ 615 $ 573
===== ===== ==== ===== ===== ===== ===== ==== ===== ====
10% 9% (1)% (3)% 80% 83% 20% 17% 100% 100%
12 11 (1) (3) 100 100 N/A N/A N/A N/A
---------------------------------------------------------------------------------------------------------------------------------
$ 5,147 $ 4,314 $ 2,394 $ 3,045 $ 64,032 $ 59,662 $ 388 $ 1,986 $ 64,420 $ 61,648
9,618 8,115 11,087 11,759 81,508 76,126 1,788(f) 3,816(f) 83,296 79,942
3,389 3,126 3,783 1,163 44,447 40,179 7 1,270 44,454 41,449
---------------------------------------------------------------------------------------------------------------------------------
80.27% 81.55% N/M N/M 61.12% 62.09% N/M N/M 61.27% 60.16%
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
portfolio. In the first quarter of 1999, the provision includes an
additional provision of $30 million ($19 million after tax) related to an
enhancement of the allowance methodology pertaining to the credit card
portfolio.
(e) Noninterest expense in the second quarter of 2000 includes $2 million ($1
million after tax) of nonrecurring charges recorded in connection with
strategic actions being taken to improve Key's operating efficiency and
profitability. Noninterest expense for the second quarter of 1999 includes
special contributions of $3 million ($2 million after tax) made to the
charitable foundation that Key sponsors and $22 million ($14 million after
tax) incurred by divested businesses. For the first six months of 2000,
noninterest expense includes $16 million ($10 million after tax) of
nonrecurring charges recorded in connection with strategic actions being
taken to improve Key's operating efficiency and profitability and $7
million ($5 million after tax) incurred by divested businesses. For the
first six months of 1999, noninterest expense includes special
contributions of $23 million ($15 million after tax) made to the charitable
foundation that Key sponsors, $27 million ($17 million after tax) of other
nonrecurring charges and $44 million ($28 million after tax) incurred by
divested businesses.
(f) Total assets represent primarily the unallocated portion of nonearning
assets of corporate support functions.
(g) This ratio, which measures the extent to which recurring revenues are
absorbed by operating expenses, is calculated as follows: noninterest
expense (excluding certain nonrecurring charges) divided by the sum of
taxable-equivalent net interest income and noninterest income (excluding
gains from certain divestitures and certain nonrecurring charges).
N/M = Not Meaningful
N/A = Not Applicable
12
<PAGE> 13
5. SECURITIES
Key classifies its securities into three categories: held to maturity, trading
and available for sale.
SECURITIES HELD TO MATURITY. Key has the intent and ability to hold these debt
securities until maturity. These securities are carried at cost, adjusted for
amortization of premiums and accretion of discounts using the level-yield
method. Securities held to maturity and equity securities that do not have
readily determinable fair values are presented as "investment securities" on the
balance sheet.
TRADING ACCOUNT SECURITIES. These are debt and equity securities that are
purchased and held by Key with the intent of selling them in the near term.
These securities are reported at fair value ($802 million, $768 million and $1.1
billion at June 30, 2000, December 31, 1999 and June 30, 1999, respectively) and
included in "short-term investments" on the balance sheet. Realized and
unrealized gains and losses on trading account securities are reported in "other
income" on the income statement.
SECURITIES AVAILABLE FOR SALE. These are debt and equity securities that Key has
not classified as investment or trading account securities. Securities available
for sale are reported at fair value with unrealized gains and losses (net of
income taxes) recorded in shareholders' equity as a component of "accumulated
other comprehensive (loss) income." Actual gains and losses on the sales of
these securities are computed using the specific identification method and
included in "net securities gains" on the income statement.
When Key retains an interest in securitized loans, Key bears the risk that the
loans will be prepaid (which results in less interest income) or not paid at
all. Key's retained interests (which include both certificated and
uncertificated interests) are accounted for like debt securities that are
classified as available for sale or as trading account securities.
The amortized cost, unrealized gains and losses and approximate fair value of
Key's securities available for sale and investment securities were as follows:
<TABLE>
<CAPTION>
JUNE 30, 2000
----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
====================================================================================================================
SECURITIES AVAILABLE FOR SALE
<S> <C> <C> <C> <C>
U.S. Treasury, agencies and corporations $ 121 -- -- $ 121
States and political subdivisions 56 -- -- 56
Collateralized mortgage obligations 4,185 -- $ 195 3,990
Other mortgage-backed securities 1,551 $ 3 36 1,518
Retained interests in securitizations 335 -- 20 315
Other securities 259 1 11 249
--------------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,507 $ 4 $ 262 $6,249
====== ====== ====== ======
INVESTMENT SECURITIES
States and political subdivisions $ 380 $ 8 -- $ 388
Other securities 748 -- -- 748
--------------------------------------------------------------------------------------------------------------------
Total investment securities $1,128 $ 8 -- $1,136
====== ====== ======
--------------------------------------------------------------------------------------------------------------------
</TABLE>
13
<PAGE> 14
<TABLE>
<CAPTION>
DECEMBER 31, 1999
------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
====================================================================================================================
SECURITIES AVAILABLE FOR SALE
<S> <C> <C> <C> <C>
U.S. Treasury, agencies and corporations $ 128 -- $ 1 $ 127
States and political subdivisions 53 -- -- 53
Collateralized mortgage obligations 4,426 -- 189 4,237
Other mortgage-backed securities 1,705 $ 6 33 1,678
Retained interests in securitizations 340 3 -- 343
Other securities 223 4 -- 227
--------------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,875 $ 13 $ 223 $6,665
====== ====== ====== ======
INVESTMENT SECURITIES
States and political subdivisions $ 447 $ 12 -- $ 459
Other securities 539 -- -- 539
--------------------------------------------------------------------------------------------------------------------
Total investment securities $ 986 $ 12 -- $ 998
====== ====== ======
--------------------------------------------------------------------------------------------------------------------
<CAPTION>
JUNE 30, 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 $ 152 $ 1 $ 1 $ 152
States and political subdivisions 67 1 1 67
Collateralized mortgage obligations 4,029 2 143 3,888
Other mortgage-backed securities 1,878 12 29 1,861
Retained interests in securitizations 348 -- 13 335
Other securities 96 6 1 101
--------------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,570 $ 22 $ 188 $6,404
======= ====== ====== ======
INVESTMENT SECURITIES
States and political subdivisions $ 515 $ 18 -- $ 533
Other securities 452 -- -- 452
--------------------------------------------------------------------------------------------------------------------
Total investment securities $ 967 $ 18 -- $ 985
======= ====== ====== ======
--------------------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 15
6. LOANS
Key's loans by category are summarized as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2000 1999 1999
=================================================================================================
<S> <C> <C> <C>
Commercial, financial and agricultural $19,759 $18,497 $17,916
Real estate -- commercial mortgage 6,962 6,836 6,806
Real estate -- construction 4,713 4,528 4,153
Commercial lease financing 6,902 6,665 6,043
-------------------------------------------------------------------------------------------------
Total commercial loans 38,336 36,526 34,918
Real estate -- residential mortgage 4,251 4,333 4,330
Home equity 8,863 7,602 7,532
Credit card -- -- 1,313
Consumer -- direct 2,609 2,565 2,423
Consumer -- indirect lease financing 3,081 3,195 2,897
Consumer -- indirect other 6,019 6,398 6,402
-------------------------------------------------------------------------------------------------
Total consumer loans 24,823 24,093 24,897
Real estate -- commercial mortgage 340 146 134
Real estate -- residential mortgage 124 48 95
Home equity -- 371 --
Credit card -- 1,362 --
Education 1,989 1,676 1,927
-------------------------------------------------------------------------------------------------
Total loans held for sale 2,453 3,603 2,156
-------------------------------------------------------------------------------------------------
Total loans $65,612 $64,222 $61,971
======== ======== =======
-------------------------------------------------------------------------------------------------
</TABLE>
Key uses portfolio interest rate swaps to manage interest rate risk; these swaps
modify the repricing and maturity characteristics of certain loans. For more
information about the notional amount, fair value, and weighted average rate of
such swaps at June 30, 2000, see Note 11 ("Financial Instruments with
Off-Balance Sheet Risk"), which begins on page 19.
Changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
in millions 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 979 $ 930 $ 930 $ 900
Charge-offs (94) (105) (258) (212)
Recoveries 26 29 56 55
-----------------------------------------------------------------------------------------------------
Net charge-offs (68) (76) (202) (157)
Provision for loan losses 68 76 251 187
-----------------------------------------------------------------------------------------------------
Balance at end of period $ 979 $ 930 $ 979 $ 930
===== ===== ===== ====
-----------------------------------------------------------------------------------------------------
</TABLE>
15
<PAGE> 16
7. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
At June 30, 2000, impaired loans totaled $277 million. This amount includes $189
million of impaired loans with a specifically allocated allowance for loan
losses of $92 million and $88 million of impaired loans that are carried at
their estimated fair value without a specifically allocated allowance. At the
end of 1999, impaired loans totaled $246 million; $153 million of those loans
had a specifically allocated allowance of $63 million and $93 million were
carried at their estimated fair value. The average investment in impaired loans
for the second quarter of 2000 and 1999 was $279 million and $200 million,
respectively.
Nonperforming assets were as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2000 1999 1999
====================================================================================
<S> <C> <C> <C>
Impaired loans $ 277 $ 246 $ 188
Other nonaccrual loans 268 201 214
------------------------------------------------------------------------------------
Total nonperforming loans 545 447 402
OREO 30 27 46
Allowance for OREO losses (1) (3) (11)
------------------------------------------------------------------------------------
OREO, net of allowance 29 24 35
Other nonperforming assets 3 2 1
------------------------------------------------------------------------------------
Total nonperforming assets $ 577 $ 473 $ 438
===== ===== ====
------------------------------------------------------------------------------------
</TABLE>
When appropriate, an impaired loan is assigned a specific allowance. Management
calculates the extent of the impairment, which is the carrying amount of the
loan less the fair value of any existing collateral (for a secured loan) or the
estimated present value of future cash flows (for an unsecured loan). When
collateral value or expected cash flow does not justify the carrying amount of a
loan, the amount that management deems uncollectible (the impaired amount) is
charged against the allowance for loan losses. When collateral value or other
sources of repayment appear sufficient, but management remains uncertain about
whether the loan will be repaid in full, an amount is specifically allocated in
the allowance for loan losses.
Key does not perform a specific impairment valuation for smaller-balance,
homogeneous, nonaccrual loans (shown in the preceding table as "Other nonaccrual
loans"). Generally, this portfolio includes loans to finance residential
mortgages, automobiles, recreational vehicles, boats and mobile homes.
Management applies historical loss experience rates to these loans, adjusted
based on assessments of emerging credit trends and other factors, and then
allocates a portion of the allowance for loan losses to each loan type.
The amounts presented in the above table have been restated from those
previously reported. This restatement reflects a reclassification of certain
loans from those reported as 90 days past due and still accruing to those
reported as nonaccrual. The reclassified loans are predominantly home equity
loans held by Key Home Equity Services, a division of Key Bank USA, National
Association that acts as a third-party purchaser of home equity loans. Although
these loans had not been properly categorized as nonaccrual in Key's internal
reporting system, the accrual of interest on the balances had, in fact, ceased.
Therefore, the restatement had no impact on Key's earnings.
16
<PAGE> 17
8. LONG-TERM DEBT
The components of Key's long-term debt, presented net of unamortized discount
where applicable, were as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2000 1999 1999
================================================================================
<S> <C> <C> <C>
Senior medium-term notes due through 2005(a) $ 391 $ 396 $ 401
Subordinated medium-term notes due through
2005(a) 103 133 133
7.50% Subordinated notes due 2006(b) 250 250 250
6.75% Subordinated notes due 2006(b) 200 200 200
8.125% Subordinated notes due 2002(b) 199 199 199
8.00% Subordinated notes due 2004(b) 125 125 125
8.404% Notes due through 2001 24 24 34
All other long-term debt(h) 1 4 5
--------------------------------------------------------------------------------
Total parent company(i) 1,293 1,331 1,347
Senior medium-term bank notes due through
2039(c) 6,848 9,396 9,254
Senior euro medium-term bank notes due through
2007(d) 3,248 2,413 1,883
6.50% Subordinated remarketable securities due
2027(e) 312 312 313
6.95% Subordinated notes due 2028(e) 300 300 300
7.125% Subordinated notes due 2006(e) 250 250 250
7.25% Subordinated notes due 2005(e) 200 200 200
6.75% Subordinated notes due 2003(e) 200 200 200
7.50% Subordinated notes due 2008(e) 165 165 165
7.30% Subordinated notes due 2011(e) 107 107 107
7.85% Subordinated notes due 2002(e) 93 93 93
7.55% Subordinated notes due 2006(e) 75 75 75
7.375% Subordinated notes due 2008(e) 70 70 70
Lease financing debt due through 2006(f) 590 613 571
Federal Home Loan Bank advances due through
2030(g) 249 242 239
All other long-term debt(h) 97 114 101
--------------------------------------------------------------------------------
Total subsidiaries 12,804 14,550 13,821
--------------------------------------------------------------------------------
Total long-term debt $14,097 $15,881 $15,168
======= ======= =======
================================================================================
</TABLE>
Key uses portfolio interest rate swaps and caps to manage interest rate risk;
these instruments modify the repricing and maturity characteristics of certain
long-term debt. For more information about the notional amount, fair value and
weighted average rate of such financial instruments at June 30, 2000, see Note
11 ("Financial Instruments with Off-Balance Sheet Risk"), which begins on page
19.
(a) At June 30, 2000, December 31, 1999 and June 30,1999, the senior
medium-term notes had weighted average interest rates of 6.85%, 6.83% and
6.41%, respectively, and the subordinated medium-term notes had a weighted
average interest rate of 7.32%, 7.09% and 7.09% at each respective date.
These notes had a combination of fixed and floating interest rates.
(b) The 7.50%, 6.75%, 8.125%, and 8.00% subordinated notes may not be redeemed
or prepaid prior to maturity.
(c) At June 30, 2000, December 31, 1999 and June 30, 1999, senior medium-term
bank notes of subsidiaries had weighted average interest rates of 6.56%,
5.98% and 5.18%, respectively. These notes had a combination of fixed and
floating interest rates.
(d) At June 30, 2000, December 31, 1999 and June 30, 1999, senior euro
medium-term notes had weighted average interest rates of 6.47%, 6.26%, and
5.21%, respectively. These notes, which are obligations of KeyBank National
Association, had fixed and floating interest rates based on the three-month
London Interbank Offered Rate (known as "LIBOR").
17
<PAGE> 18
(e) The subordinated notes and securities are all obligations of KeyBank
National Association, with the exception of the 7.55% notes, which are
obligations of Key Bank USA, National Association. These notes may not be
redeemed prior to their maturity dates.
(f) At June 30, 2000, December 31, 1999 and June 30, 1999, lease financing debt
had weighted average interest rates of 7.74%, 7.64% and 6.66%,
respectively. This category of debt primarily comprises nonrecourse debt
collateralized by leased equipment under operating, direct financing and
sales type leases.
(g) At June 30, 2000, December 31, 1999 and June 30, 1999, long-term advances
from the Federal Home Loan Bank had weighted average interest rates of
6.59%, 6.27% and 5.14% respectively. These advances, which had a
combination of fixed and floating interest rates, were secured by $373
million, $363 million, and $357 million of real estate loans and securities
at June 30, 2000, December 31, 1999 and June 30, 1999, respectively.
(h) Other long-term debt, comprising industrial revenue bonds, capital lease
obligations, and various secured and unsecured obligations of corporate
subsidiaries, had weighted average interest rates of 8.14%, 6.76%, and
6.96% at June 30, 2000, December 31, 1999 and June 30, 1999, respectively.
(i) At June 30, 2000, unused capacity under KeyCorp's shelf registration
totaled $562 million, including $50 million reserved for future issuance as
medium-term notes.
9. CAPITAL SECURITIES
KeyCorp guarantees the corporation-obligated mandatorily redeemable preferred
capital securities of subsidiary trusts holding solely subordinated debentures
of the Corporation ("capital securities"). These securities were issued by five
business trusts: KeyCorp Institutional Capital A, KeyCorp Institutional Capital
B, KeyCorp Capital I, KeyCorp Capital II and KeyCorp Capital III. As guarantor,
KeyCorp unconditionally guarantees payment of:
- accrued and unpaid distributions required to be paid on the capital
securities;
- the redemption price when a capital security is called for redemption; and
- amounts due if a trust is liquidated or terminated.
KeyCorp owns all of the outstanding common stock of each of the five trusts. The
trusts used the proceeds from the issuance of their capital securities and
common stock to buy debentures issued by KeyCorp. These debentures are the
trusts' only assets and the interest payments from the debentures finance the
distributions paid on the capital securities. Key's financial statements do not
reflect the debentures or the related income statement effects because they are
eliminated in consolidation.
The capital securities, 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(a) SECURITIES NET OF DISCOUNT(b) DEBENTURES(c) DEBENTURES
=======================================================================================================================
<S> <C> <C> <C> <C> <C>
June 30, 2000
KeyCorp Institutional Capital A $ 350 $11 $ 361 7.826% 2026
KeyCorp Institutional Capital B 150 4 154 8.250 2026
KeyCorp Capital I 247 8 255 7.030 2028
KeyCorp Capital II 247 8 255 6.875 2029
KeyCorp Capital III 249 8 257 7.750 2029
----------------------------------------------------------------------------------------------------------------------
Total $1,243 $39 $1,282 7.515% --
====== === ======
----------------------------------------------------------------------------------------------------------------------
December 31, 1999 $1,243 $39 $1,282 7.473% --
====== === ======
----------------------------------------------------------------------------------------------------------------------
June 30, 1999 $ 994 $31 $1,025 7.135% --
====== === ======
======================================================================================================================
</TABLE>
(a) The capital securities are mandatorily redeemable when the related
debentures mature, or earlier if provided in the governing indenture. Each
issue of capital securities carries an interest rate identical to that of
the related debenture. The capital securities constitute minority interests
in the equity accounts of KeyCorp's consolidated subsidiaries and,
therefore, qualify as Tier 1 capital under Federal Reserve Board
guidelines.
18
<PAGE> 19
(b) KeyCorp has the right to redeem its debentures: (i) in whole or in part, on
or after December 1, 2006 (for debentures owned by Capital A), December 15,
2006 (for debentures owned by Capital B), July 1, 2008 (for debentures
owned by Capital I), March 18, 1999 (for debentures owned by Capital II),
and July 16, 1999 (for debentures owned by Capital III); and (ii) in whole
at any time within 90 days after and during the continuation of a "tax
event" or a "capital treatment event" (as defined in the applicable
offering circular). If the debentures purchased by Capital A or Capital B
are redeemed before they mature, the redemption price will be the principal
amount, plus a premium, plus any accrued but unpaid interest. If the
debentures purchased by Capital I are redeemed before they mature, the
redemption price will be the principal amount, plus any accrued but unpaid
interest. If the debentures purchased by Capital II or Capital III are
redeemed before they mature, the redemption price will the greater of: (i)
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 (25 basis points for Capital III), plus any accrued but unpaid
interest. When debentures are redeemed in response to tax or capital
treatment events, the redemption price is generally slightly more favorable
to Key.
(c) The interest rates for Capital A, Capital B, Capital II, and Capital III
are fixed. Capital I has a floating interest rate (which reprices
quarterly) equal to three-month LIBOR plus 74 basis points. The rates shown
as the total at June 30, 2000, December 31, 1999, and June 30, 1999, are
weighted average rates.
10. RESTRUCTURING CHARGES
During 1999 and the first half of 2000, KeyCorp recorded net restructuring
charges of $98 million ($62 million after tax) and $9 million ($6 million after
tax), respectively, in connection with strategic actions being taken to improve
operating efficiency and profitability.
The primary strategic actions taken include the outsourcing of certain
technology and other corporate support functions, the consolidation of sites in
a number of Key's businesses and a reduction in the number of management layers.
These actions are expected to reduce Key's workforce by approximately 3,000
positions, or 11%, by the end of 2000. Approximately 25% of the reduction, which
will take place throughout the organization, is expected to occur at the
management level. As of June 30, 2000, almost 2,100 positions had been
eliminated.
Changes in the restructuring charge liability associated with the above actions
are as follows:
DECEMBER 31, RESTRUCTURING CASH JUNE 30,
in millions 1999 CHARGES PAYMENTS 2000
================================================================================
Severance $ 60 $ (6) $ 26 $ 28
Site consolidations 24 11 13 22
Equipment and other 7 4 6 5
--------------------------------------------------------------------------------
Total $ 91 $ 9 $ 45 $ 55
==== ==== ==== ====
--------------------------------------------------------------------------------
Key expects to record additional restructuring charges during 2000 in connection
with this productivity initiative. The net amount of such charges will depend on
a number of factors. These factors include the extent of reductions in space
requirements (which may result in excess real estate), the further consolidation
of sites, the elimination of positions in excess of the 3,000 originally
estimated and the identification of additional cost savings.
During the first quarter of 2000, KeyCorp also recorded a $2 million ($1 million
after tax) credit to restructuring charges in connection with separate actions
initiated during the fourth quarter of 1996 to complete Key's transformation to
a nationwide bank-based financial services company. The credit was taken to
reduce the remaining liability associated with branch consolidations, since
favorable market conditions resulted in lower costs to consolidate these
branches than originally expected. At June 30, 2000, the remaining liability
associated with this initiative was approximately $1 million.
11. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
Key, mainly through its lead bank (KeyBank National Association), is party to
various financial instruments with off-balance sheet risk. These financial
instruments may be used for lending-related purposes, asset and liability
management or trading purposes. Generally, these instruments help Key meet
19
<PAGE> 20
clients' financing needs and manage its exposure to "market risk"--the
possibility that net interest income will be adversely affected due to changes
in interest rates or other economic factors. However, like other financial
instruments, these contain an element of "credit risk"--the possibility that Key
will incur a loss because a counterparty fails to meet its contractual
obligations.
The primary financial instruments that Key uses are commitments to extend
credit; standby and commercial letters of credit; interest rate swaps, caps and
futures; and foreign exchange forward contracts. All of the foreign exchange
forward contracts and interest rate swaps and caps held are over-the-counter
instruments.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR LENDING-RELATED PURPOSES
These instruments--primarily loan commitments and standby letters of
credit--involve credit risk not reflected on Key's balance sheet. Key mitigates
its exposure to credit risk with internal controls that guide the way staff
reviews and approves applications for credit, establishes credit limits and,
when necessary, demands collateral. In particular, Key evaluates the
credit-worthiness of each prospective borrower on a case-by-case basis. Key does
not have any significant concentrations of credit risk.
COMMITMENTS TO EXTEND CREDIT are agreements to provide financing at
predetermined terms, as long as the client continues to meet specified criteria.
Loan commitments generally carry variable rates of interest and have fixed
expiration dates or other termination clauses. In many cases, a client must pay
a fee to induce Key to issue a loan commitment. Since a commitment may expire
without resulting in a loan, the total amount of outstanding commitments does
not necessarily represent the future cash outlay that Key will make.
STANDBY LETTERS OF CREDIT enhance the credit-worthiness of Key's clients by
assuring their financial performance to third parties in connection with
particular transactions. Amounts drawn under standby letters of credit are
essentially loans: they bear interest (generally at variable rates) and pose the
same credit risk to Key as a loan would.
The following table shows the contractual amount of each class of
lending-related, off-balance sheet financial instrument outstanding. The table
discloses Key's maximum possible accounting loss, which is equal to the
contractual amount of the various instruments. The estimated fair values of
these commitments and standby letters of credit are not material.
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2000 1999 1999
==========================================================================================
<S> <C> <C> <C>
Loan commitments:
Credit card lines -- $ 7,108 $ 6,316
Home equity $ 4,569 4,560 4,637
Commercial real estate and construction 1,859 1,842 1,939
Commercial and other 24,075 22,023 21,891
-----------------------------------------------------------------------------------------
Total loan commitments 30,503 35,533 34,783
Other commitments:
Standby letters of credit 1,840 1,987 1,812
Commercial letters of credit 148 120 180
Loans sold with recourse -- 16 19
-----------------------------------------------------------------------------------------
Total loan and other commitments $32,491 $37,656 $36,794
======== ======== =======
-----------------------------------------------------------------------------------------
</TABLE>
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES
Key manages 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 principal financial instruments
that
20
<PAGE> 21
Key uses to manage exposure to interest rate risk are interest rate swaps and
caps, also referred to as "portfolio" swaps and caps. In addition, Key uses
treasury-based interest rate locks to manage the risk associated with
anticipated loan securitizations.
To qualify for hedge accounting treatment, a derivative must be effective at
reducing the risk associated with the exposure being managed and must be
designated as a risk management transaction at the inception of the derivative
contract. To be considered effective, there must be a high degree of interest
rate correlation between the derivative and the asset or liability being
managed, both at inception and over the life of the derivative contract.
The following table summarizes the features of the various types of portfolio
swaps and caps that Key held at June 30, 2000.
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
----------------------------------------------------- --------------------
WEIGHTED AVERAGE RATE
NOTIONAL FAIR MATURITY ----------------------- NOTIONAL FAIR
dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY STRIKE AMOUNT VALUE
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Interest rate swaps:
Receive fixed/pay variable-indexed amortizing(a) $ 53 -- 1.3 7.98% 6.31% N/A $ 104 $ 1
Receive fixed/pay variable-conventional 4,967 $(142) 6.0 6.42 6.53 N/A 5,962 (135)
Receive fixed/pay variable-forward starting 135 -- 6.6 6.58 6.37 N/A -- --
Pay fixed/receive variable-conventional 7,300 107 3.8 6.53 6.46 N/A 5,545 105
Pay fixed/receive variable-forward starting 150 -- 7.4 6.74 7.23 N/A 278 --
Basis swaps 6,471 (48) 1.8 6.20 6.32 N/A 6,783 (20)
------------------------------------------------------------------------------------------------------------------------------------
Total 19,076 (83) -- 6.39% 6.43% -- 18,672 (49)
Interest rate caps and collars:
Caps purchased - one- to three-month LIBOR-based(b) 820 7 .7 N/A N/A 5.72% 2,000 7
Collar - one- to three-month LIBOR-based 250 -- .6 N/A N/A 4.75 AND 6.50 250 --
------------------------------------------------------------------------------------------------------------------------------------
Total 1,070 7 -- -- -- -- 2,250 7
------------------------------------------------------------------------------------------------------------------------------------
Total $20,146 $ (76) -- -- -- -- $20,922 $ (42)
======= ===== ======= =====
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Maturity is based upon expected average lives rather than contractual
terms.
(b) Includes $20 million of forward-starting caps at June 30, 2000.
N/A = Not Applicable
INTEREST RATE SWAP CONTRACTS involve the exchange of interest payments
calculated on an agreed-upon amount (known as the "notional amount"). Swaps are
generally used to mitigate Key's exposure to interest rate risk on certain
loans, securities, deposits, short-term borrowings and long-term debt. Key
generally uses three types of interest rate swap contracts.
- CONVENTIONAL INTEREST RATE SWAP CONTRACTS involve the receipt of interest
payments 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.
- INDEXED AMORTIZING SWAP CONTRACTS differ from conventional swaps because
the notional amount of an indexed amortizing swap contract remains constant
for a specified period of time. Then, based upon the level of an index at
agreed-upon dates, one of three events will occur: the swap contract will
mature, the notional amount will begin to amortize or the swap will
continue in effect until it matures. At June 30, 2000, Key was party to $53
million of indexed amortizing swaps that used a LIBOR index.
- BASIS SWAP CONTRACTS involve the exchange of interest payments based on
different floating indices.
INTEREST RATE CAPS require the buyer to pay a premium to the seller for the
right to receive an amount equal to the difference between the current interest
rate and an agreed-upon interest rate (known as the "strike rate") applied to a
notional amount. Key generally purchases caps, enters into collars (which
involves simultaneously purchasing a cap and selling a floor) and enters into
corridors (which involves 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.
21
<PAGE> 22
The notional amount of swaps and caps is significantly greater than the amount
at risk.
CREDIT RISK. Swaps and caps present credit risk because the counterparty may not
meet the terms of the contract. This risk is measured as the cost of replacing
contracts--at current market rates-- that have generated unrealized gains. To
mitigate credit risk, Key deals exclusively with counterparties that have high
credit ratings.
Key uses two additional precautions to manage exposure to credit risk on swap
contracts. First, Key generally enters into bilateral collateral and master
netting arrangements. These agreements include legal rights of setoff that
provide for the net settlement of the subject contracts with the same
counterparty in the event of default. Second, a credit committee monitors credit
risk exposure to the counterparty on each interest rate swap to determine
appropriate limits on Key's total credit exposure and the amount of collateral
required, if any.
At June 30, 2000, Key had 37 different counterparties to portfolio swaps and
swaps entered into to offset the risk of client swaps. Key had aggregate credit
exposure of $244 million to 24 of these counterparties, with the largest credit
exposure to an individual counterparty amounting to $39 million. As of the same
date, Key's aggregate credit exposure on its interest rate caps totaled $78
million. Based on management's assessment as of June 30, 2000, all
counterparties were expected to meet their obligations.
ACCOUNTING TREATMENT AND VALUATION. Management estimated the aggregate fair
value of interest rate swaps at a negative $83 million at June 30, 2000. Fair
value in this case represents an estimate of the unrealized loss that would be
recognized if the swap portfolio, but not the assets or liabilities being
managed, were to be liquidated at that date. However, because these swaps
qualify for hedge accounting treatment, their estimated negative fair values
should be substantially offset by the unrecognized positive fair values of the
assets and liabilities whose risk characteristics they are being used to modify.
Management arrived at this estimate by using discounted cash flow models, which
predict interest rates using the applicable forward yield curve.
Interest from a portfolio swap is recognized on an accrual basis over the life
of the contract 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 related asset or liability. The
deferred gain or loss is amortized using the straight-line method over the
projected remaining life of the swap at its termination or the projected
remaining life of the underlying asset or liability, whichever is shorter.
During the first six months of 2000, swaps with a notional amount of $1.3
billion were terminated, resulting in a net deferred loss of $4 million. During
the same period last year, swaps with a notional amount of $871 million were
terminated, resulting in a net deferred gain of $7 million. At June 30, 2000,
Key had a cumulative net deferred swap gain of $14 million with a weighted
average life of 4.6 years related to the management of debt, and a cumulative
net deferred gain of $3 million with a weighted average life of 7.8 years
related to the management of loans.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES
FUTURES CONTRACTS AND INTEREST RATE SWAPS, CAPS AND FLOORS. Key uses these
instruments for dealer activities (which are generally limited to the banks'
commercial loan clients), and enters into other positions with third parties to
mitigate the interest rate risk of the client positions. The swaps entered into
with clients are generally limited to conventional swaps. All of the above
instruments are recorded at their estimated fair values. Adjustments to fair
value are included in "investment banking and capital markets income" on the
income statement.
FOREIGN EXCHANGE FORWARD CONTRACTS. Key uses these instruments to accommodate
the business needs of clients and for proprietary trading purposes. Foreign
exchange forward contracts provide for the delayed delivery or purchase of
foreign currency. Key mitigates the associated foreign exchange risk by entering
into other foreign exchange contracts with third parties. Adjustments to the
fair value of all foreign
22
<PAGE> 23
exchange forward contracts are included in "investment banking and capital
markets income" on the income statement.
TREASURY OPTIONS AND FUTURES. Key uses these instruments 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.
CREDIT RISK. At June 30, 2000, 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 $561 million. Key manages credit risk by
contracting only with counterparties with high credit ratings, continuously
monitoring counterparties' performance, and entering into master netting
agreements when possible.
The following table shows trading income recognized on interest rate, foreign
exchange forward, and treasury-based option contracts.
SIX MONTHS ENDED JUNE 30,
-------------------------
in millions 2000 1999
=======================================================================
Interest rate contracts $29 $21
Foreign exchange forward contracts 17 13
Treasury-based option contracts -- 2
-----------------------------------------------------------------------
The following table summarizes the notional amount and fair value of derivative
financial instruments held or issued for trading purposes at June 30, 2000, and
on average for the six-month period then ended. The interest rate swaps and caps
related to securitization positions were executed in connection with the
residual interests retained when Key securitized certain home equity and
education loans. The positive fair values represent assets and the negative fair
values represent liabilities.
<TABLE>
<CAPTION>
JUNE 30, 2000 SIX MONTHS ENDED JUNE 30, 2000
----------------------- -------------------------------
NOTIONAL FAIR AVERAGE AVERAGE
in millions AMOUNT VALUE NOTIONAL AMOUNT FAIR VALUE
================================================================================================================
<S> <C> <C> <C> <C>
Interest rate contracts - client positions:
Swap assets $12,858 $ 387 $12,344 $ 424
Swap liabilities 12,400 (249) 12,896 (309)
Caps and floors purchased 743 5 670 6
Caps and floors sold 842 (5) 766 (6)
Futures purchased 463 -- 444 --
Futures sold 8,274 2 8,921 11
Interest rate contracts - securitization positions:
Swap assets $ 1,210 $ 36 $ 1,068 $ 27
Caps purchased 1,127 66 1,065 57
Caps sold 2,637 (66) 2,026 (57)
Foreign exchange forward contracts:
Assets $ 1,746 $ 53 $ 1,759 $ 64
Liabilities 1,531 (43) 1,662 (56)
Treasury-based option contracts:
Options purchased $ 1,220 $ 12 $ 1,459 $ 16
Options sold 2,104 (11) 2,283 (13)
----------------------------------------------------------------------------------------------------------------
</TABLE>
The $25.3 billion notional amount of client interest rate swaps presented in the
table includes $11.4 billion of client swaps that receive a fixed rate and pay a
variable rate, $9.1 billion of client swaps that pay a fixed rate and receive a
variable rate, and $4.8 billion of basis swaps. As of June 30, 2000, the client
swaps had an average expected life of 5.4 years, carried a weighted average rate
received of 6.51%, and had a weighted average rate paid of 6.61%.
23
<PAGE> 24
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
SHAREHOLDERS AND BOARD OF DIRECTORS
KEYCORP
We have reviewed the unaudited condensed consolidated balance sheets of KeyCorp
and subsidiaries ("Key") as of June 30, 2000 and 1999, and the related condensed
consolidated statements of income for the three- and six-month periods then
ended, and the condensed consolidated statements of changes in shareholders'
equity and cash flow for the six-month periods ended June 30, 2000 and 1999.
These financial statements are the responsibility of Key's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the condensed consolidated financial statements referred to above for
them to be in conformity with accounting principles generally accepted in the
United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Key as of
December 31, 1999, 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, 2000, 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, 1999, is fairly stated, in all material respects, in relation
to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
July 13, 2000
24
<PAGE> 25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
------------
This Management's Discussion and Analysis reviews the financial condition and
results of operations of KeyCorp and its subsidiaries for the quarterly and
year-to-date periods ended June 30, 2000 and 1999. Some tables may cover more
than these periods to comply with Securities and Exchange Commission disclosure
requirements or to illustrate trends over a period of time. When you read this
discussion, you should also look at the consolidated financial statements and
related notes that appear on pages 3 through 23.
TERMINOLOGY
This report contains some shortened names and industry-specific terms. We want
to explain some of these terms at the outset so you can better understand the
discussion that follows.
- KEYCORP refers solely to the parent company.
- KEY refers to the consolidated entity consisting of KeyCorp and its
subsidiaries.
- A KEYCENTER is one of Key's full-service retail banking facilities or
branches.
- KEY engages in CAPITAL MARKETS ACTIVITIES, primarily through the Key
Capital Partners line of business. These activities encompass a variety of
services. Among other things, we trade securities as a dealer, enter into
derivative contracts (both to accommodate clients' financing needs and for
proprietary trading purposes), invest in new or growing ventures and
conduct transactions in foreign currencies (both to accommodate clients'
needs and to benefit from fluctuations in exchange rates).
- When we want to draw your attention to a particular item in Key's Notes to
Consolidated Financial Statements, we refer to NOTE ___, giving the
particular number, name, and starting page number.
- All earnings per share data included in this discussion are presented on a
DILUTED basis, which takes into account all common shares outstanding and
potential common shares that could result from the exercise of outstanding
stock options. Some of the financial information tables also include BASIC
earnings per share, which takes into account only common shares
outstanding.
- For regulatory purposes, capital is divided into several classes. Federal
regulations prescribe that at least half of a bank or bank holding
company's TOTAL RISK-ADJUSTED CAPITAL must qualify as TIER 1. Both total
and Tier 1 capital serve as bases for several measures of capital adequacy,
which is an important indicator of financial stability and condition. You
will find a more detailed explanation of total and Tier 1 capital and how
they are calculated in the section entitled "Capital and dividends" which
begins on page 55.
OUR PROJECTIONS ARE NOT FOOLPROOF
This report contains "forward-looking statements" about issues like anticipated
improvement in earnings, expected expense reductions and revenue growth, and
related objectives (such as the anticipated reduction in Key's employment base).
Forward-looking statements by their nature are subject to assumptions, risks and
uncertainties. For a variety of reasons, including the following, actual results
could differ materially from those contained in or implied by the
forward-looking statements:
- Interest rates could change more quickly or more significantly than we
expect.
25
<PAGE> 26
- If the economy changes significantly in an unexpected way, the demand for
new loans and the ability of borrowers to repay outstanding loans may
change in ways that our models do not anticipate.
- The stock and bond markets could suffer a significant disruption, which may
have a negative effect on our financial condition and that of our
borrowers, and on our ability to raise money by issuing new securities.
- It could take us longer than we anticipate to implement strategic
initiatives designed to increase revenues or manage expenses, or we may be
unable to implement those initiatives at all.
- Acquisitions and dispositions of assets, business units or affiliates could
affect us in ways that management has not anticipated.
- We may become subject to new legal obligations or the resolution of
existing litigation may have a negative effect on our financial condition.
- We may become subject to new and unanticipated accounting, tax, or
regulatory practices or requirements.
HIGHLIGHTS OF KEY'S PERFORMANCE
-------------------------------
FINANCIAL PERFORMANCE
Some of the highlights of Key's financial performance for the second quarter and
first six months of 2000 are discussed below, first on a reported basis and then
on a core basis.
- Net income was $248 million, or $.57 per common share, compared with $280
million, or $.62 per common share, for the second quarter of 1999. For the
first six months of the year, Key's net income was $615 million, up 7% from
$573 million for the first half of 1999. This represents $1.40 per common
share, which amounts to a 10% increase from $1.27 reported for the same
period last year.
- Key's return on average equity was 15.40% and 18.16% for the second quarter
of 2000 and 1999, respectively. For the first half of the year, Key's
return on average equity was 19.04%, up from 18.81% for the first six
months of 1999.
- Key's second quarter return on average total assets was 1.20% compared with
1.40% for the second quarter of 1999. For the first six months of the year,
Key's return on average total assets grew to 1.48% from 1.45% for the first
half of 1999.
Figure 1 summarizes Key's financial performance for each of the past five
quarters and the first six months of 2000 and 1999.
26
<PAGE> 27
FIGURE 1. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
2000 1999
------------------------ -------------------------------------------
dollars in millions, except per share amounts SECOND FIRST FOURTH THIRD SECOND
==============================================================================================================================
<S> <C> <C> <C> <C> <C>
FOR THE PERIOD
Interest income $ 1,540 $ 1,489 $ 1,489 $ 1,433 $ 1,392
Interest expense 867 818 784 733 695
Net interest income 673 671 705 700 697
Provision for loan losses 68 183 83 78 76
Noninterest income 475 806 672 496 532
Noninterest expense 698 727 885 708 723
Income before income taxes 382 567 409 410 430
Net income 248 367 264 270 280
------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .57 $ .83 $ .59 $ .60 $ .63
Net income-assuming dilution .57 .83 .59 .60 .62
Cash dividends .28 .28 .26 .26 .26
Book value at period end 15.09 14.84 14.41 14.25 13.90
Market price:
High 23.00 22.25 29.75 33.50 38.13
Low 17.00 15.56 21.00 25.19 29.13
Close 17.63 19.00 22.13 25.81 32.13
Weighted average common shares (000) 434,112 441,834 446,402 448,742 448,037
Weighted average common shares and
potential common shares (000) 436,022 443,757 449,678 452,886 452,733
------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $ 65,612 $ 64,064 $ 64,222 $ 63,181 $ 61,971
Earning assets 74,748 73,953 73,733 72,831 71,097
Total assets 84,719 83,504 83,395 82,577 80,889
Deposits 49,076 46,036 43,233 43,466 43,016
Long-term debt 14,097 14,784 15,881 15,815 15,168
Shareholders' equity 6,507 6,493 6,389 6,397 6,235
Full-time equivalent employees 23,005 23,474 24,568 25,523 25,758
Branches 938 937 936 963 965
------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.20% 1.77% 1.27% 1.32% 1.40%
Return on average equity 15.40 22.68 16.18 17.06 18.16
Efficiency(a) 60.26 62.27 59.23 58.91 59.21
Overhead(b) 32.50 35.75 30.39 30.18 29.97
Net interest margin (taxable equivalent) 3.68 3.68 3.88 3.92 3.97
------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.68% 7.78% 7.66% 7.75% 7.71%
Tangible equity to tangible assets 6.12 6.16 6.03 6.06 5.95
Tier 1 risk-adjusted capital 7.88 7.98 7.68 7.84 7.48
Total risk-adjusted capital 11.74 12.04 11.66 11.94 11.74
Leverage 7.90 7.89 7.77 7.85 7.41
------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
SIX MONTHS ENDED JUNE 30,
--------------------------
dollars in millions, except per share amounts 2000 1999
==========================================================================
<S> <C> <C>
FOR THE PERIOD
Interest income $ 3,029 $ 2,773
Interest expense 1,685 1,391
Net interest income 1,344 1,382
Provision for loan losses 251 187
Noninterest income 1,281 1,147
Noninterest expense 1,425 1,477
Income before income taxes 949 865
Net income 615 573
-------------------------------------------------------------------------
PER COMMON SHARE
Net income $ 1.40 $ 1.28
Net income-assuming dilution 1.40 1.27
Cash dividends .56 .52
Book value at period end 15.09 13.90
Market price:
High 23.00 38.13
Low 15.56 29.13
Close 17.63 32.13
Weighted average common shares (000) 437,973 448,774
Weighted average common shares and
potential common shares (000) 439,889 453,461
-------------------------------------------------------------------------
AT PERIOD END
Loans $ 65,612 $ 61,971
Earning assets 74,748 71,097
Total assets 84,719 80,889
Deposits 49,076 43,016
Long-term debt 14,097 15,168
Shareholders' equity 6,507 6,235
Full-time equivalent employees 23,005 25,758
Branches 938 965
-------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.48% 1.45%
Return on average equity 19.04 18.81
Efficiency(a) 61.27 60.16
Overhead(b) 34.12 31.57
Net interest margin (taxable equivalent) 3.68 3.96
-------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.68% 7.71%
Tangible equity to tangible assets 6.12 5.95
Tier 1 risk-adjusted capital 7.88 7.48
Total risk-adjusted capital 11.74 11.74
Leverage 7.90 7.41
-------------------------------------------------------------------------
</TABLE>
Key has completed several acquisitions and divestitures during the periods shown
in this table. One or more of these transactions may have had a significant
effect on Key's results, making it difficult to compare results from one period
to the next. Note 3 ("Acquisitions and Divestitures") on page 8 has specific
information about the acquisitions and divestitures that Key completed in the
periods presented above to help you understand how those transactions impacted
Key's financial condition and results of operations.
(a) This ratio measures the extent to which recurring revenues are absorbed by
operating expenses and is calculated as follows: noninterest expense
(excluding certain nonrecurring charges) DIVIDED BY the sum of
taxable-equivalent net interest income and noninterest income (excluding
gains from certain divestitures and certain nonrecurring charges).
(b) This ratio is the difference between noninterest expense (excluding
certain nonrecurring charges) and noninterest income (excluding gains from
certain divestitures and certain nonrecurring charges) DIVIDED BY
taxable-equivalent net interest income.
27
<PAGE> 28
In both the current and prior year, Key's financial results have been affected
by various nonrecurring items. The most significant of these items and their
impact on both earnings and primary financial ratios are summarized in Figure 2.
Each of these items is discussed in greater detail elsewhere in this report.
FIGURE 2. SIGNIFICANT NONRECURRING ITEMS
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
dollars in millions, except per share amounts 2000 1999 2000 1999
===========================================================================================================================
<S> <C> <C> <C> <C>
Net income as reported $ 248 $ 280 $ 615 $ 573
Nonrecurring items (net of tax):
Gain from sale of credit card portfolio -- -- (207) --
Enhancement of loan loss provision methodology -- -- 76 19
Restructuring and other special charges -- -- 9 --
Gain from sale of Electronic Payment Services, Inc. -- -- -- (85)
Gains from sale of Key Merchant Services, LLC -- -- -- (9)
Gain from sale of Concord EFS, Inc. common stock -- (9) -- (9)
Other nonrecurring items 1 2 (1) 32
---------------------------------------------------------------------------------------------------------------------------
Net income - core $ 249 $ 273 $ 492 $ 521
======== ======== ======== =====
Net income per diluted common share $ .57 $ .62 $ 1.40 $1.27
Net income per diluted common share - core .57 .60 1.12 1.15
Return on average total assets 1.20% 1.40% 1.48% 1.45%
Return on average total assets - core 1.20 1.37 1.19 1.31
Return on average equity 15.40 18.16 19.04 18.81
Return on average equity - core 15.46 17.70 15.24 17.10
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
On a core basis, which excludes the significant nonrecurring items, Key's
earnings were $249 million, or $.57 per common share, for the second quarter of
2000, compared with $273 million, or $.60, for the year-ago quarter. For the
first six months of the year, Key's core earnings were $492 million, or $1.12
per common share, compared with $521 million, or $1.15 for the same period last
year.
The decline in Key's core net income from the respective 1999 periods is due in
part to the short-term effects of actions that have been taken over the past
year to promote Key's development as an integrated, multiline financial services
company. These actions are intended to support the generation of consistent
longer-term growth and include the October 1999 sale of Key's Long Island
district branches and the January 2000 sale of Key's credit card business. The
decline in core earnings also reflects the impact of our intention to
de-emphasize the securitization and sale of home equity loans originated by our
home equity finance affiliate. By retaining these loans on the balance sheet, we
intend to replace over time the earnings capacity lost with the divestiture of
the credit card business. Management estimates that after excluding earnings
from the Long Island and credit card businesses, as well as net gains resulting
from the securitization and sale of home equity loans, Key's adjusted core net
income was $249 million, or $.57 per common share, for the second quarter of
2000, compared with $244 million, or $.53 for the second quarter of 1999.
Adjusting for the same items, estimated earnings for the first six months of
2000 were $485 million, or $1.10 per common share, compared with $465 million,
or $1.02, for the first half of last year. The primary factors contributing to
the change in Key's revenue and expense components relative to the second
quarter and first six months of 1999 are reviewed in greater detail in the
remainder of this discussion.
Although Key's core results declined from the prior year, the strategic actions
discussed above are beginning to have their desired effect. In comparison with
the prior quarter, core net income for the second quarter of 2000 rose by $6
million, or $.02 per common share. This growth reflects a stable net interest
margin, the continued strength of Key's lending activity (particularly in the
commercial and home equity portfolios), 13% annualized growth in the deposits
held by our Key Retail Banking line of business and a $22 million, or annualized
12%, decrease in core noninterest expense.
28
<PAGE> 29
CORPORATE STRATEGY
Key's corporate strategy continues to include an active program of selling
portfolios and business units that have low anticipated growth rates or do not
have a competitive advantage or significant market share, and acquiring or
growing businesses that management believes are capable of achieving
double-digit earnings growth rates.
This long-standing strategy was supplemented in the fourth quarter of 1999 by a
new three-year initiative to improve profitability by reducing the costs of
doing business, sharpening the focus on the most profitable growth businesses
and enhancing revenues.
PRINCIPAL STRATEGIC ACTIONS DURING THE FIRST SIX MONTHS OF 2000
On January 31, Key sold its $1.3 billion credit card portfolio as part of an
overall effort to direct financial resources and free up capital to support
faster growing businesses, such as the home equity business. The small size of
the credit card portfolio in relation to those of competitors did not provide
the scale necessary to allow Key to compete effectively in credit card lending.
The sale of the credit card portfolio is described in Note 3 (Acquisitions and
Divestitures) on page 8.
In addition, Key continued to take actions, including investing in high growth
businesses, to increase the potential for additional growth in fee income.
During the first quarter, we launched a retirement services campaign and
introduced an e-commerce program for our middle market clients. We also
announced the acquisition of certain net assets of National Realty Funding L.C.,
a commercial finance company headquartered in Kansas City, Missouri. Through
this acquisition we expect to significantly expand our capabilities in
originating and servicing loans in the commercial real estate market. During the
second quarter, Key participated in the securitization and sale of $816 million
of commercial mortgage loans, including Key loans totaling $483 million. Key
remains the primary servicer for all of its loans sold in the transaction.
During the second quarter we also announced our intent to form a strategic
alliance that will enhance and expand the trade products and services that Key
offers to its international clients. Under this alliance, ABN AMRO, the world's
sixth-largest bank, will process international trade transactions for Key's
clients through a variety of channels, including the Internet. The completion of
the alliance is expected to occur by the end of this year.
Finally, we continued to make progress on our three-year productivity
improvement initiative. As a result of our efforts to outsource certain
nonstrategic support functions, consolidate sites in a number of our businesses
and reduce management layers, we have reduced Key's employment base by almost
2,100 of the 3,000 positions initially targeted for elimination by the end of
this year. In connection with these actions, we recorded an additional net $16
million of restructuring and other special charges during the first six months
of 2000 ($2 million during the second quarter), bringing the cumulative charges
recorded for this initiative to a net $168 million.
Key expects to record additional restructuring and other special charges during
2000 in connection with this productivity initiative. The net amount of such
charges may be higher than the $180 million originally estimated and will depend
on a number of factors. These factors include the extent of reductions in space
requirements (which may result in excess real estate), the further consolidation
of sites, the elimination of positions in excess of the 3,000 originally
estimated and the identification of additional cost savings and revenue
enhancement opportunities. The section entitled "Noninterest expense," which
begins on page 45, and Note 10 ("Restructuring Charges"), on page 19, provide
more information about Key's restructuring charges.
29
<PAGE> 30
CASH BASIS FINANCIAL DATA
-------------------------
The selected financial data presented in Figure 3 highlight Key's performance on
a cash basis for each of the past five quarters and the first six months of 2000
and 1999. We provide cash basis financial data because we believe it offers a
useful tool for evaluating liquidity and measuring Key's ability to support
future growth, pay dividends and repurchase shares.
"Cash basis" accounting can mean different things. When we apply "cash basis"
accounting, the only adjustments that we make to get from the information in
Figure 1 (which is presented on an accrual basis) to the comparable line items
in Figure 3 are to exclude goodwill and other intangibles that do not qualify as
Tier 1 capital, and to exclude the amortization of those assets. Figure 3 does
not exclude the impact of other noncash items such as depreciation and deferred
taxes.
Goodwill and other intangibles that do not qualify as Tier 1 capital are the
result of business combinations that Key recorded using the "purchase" method of
accounting. Under the purchase method, assets and liabilities of acquired
companies are recorded at their fair values and any amount paid in excess of the
fair value of the net assets acquired is recorded as goodwill. If the same
transactions had qualified for accounting using the "pooling of interests"
method, the acquired company's financial statements would simply have been
combined with Key's. After a combination using purchase accounting, Key must
amortize goodwill and other intangibles by taking periodic charges against
income, but those charges are only accounting entries, not actual cash expenses.
Thus, from an investor's perspective, the economic effect of a transaction is
the same whether we account for it as a purchase or a pooling. For the same
reason, the amortization of intangibles does not impact Key's liquidity and
funds management activities.
This is the only section of this Financial Review that discusses Key's financial
results on a cash basis.
FIGURE 3. CASH BASIS SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
2000 1999 SIX MONTHS ENDED JUNE 30,
-------------------- ---------------------------- -------------------------
dollars in millions, except per share amounts SECOND FIRST FOURTH THIRD SECOND 2000 1999
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
FOR THE PERIOD
Noninterest expense $ 672 $ 702 $ 860 $ 684 $ 699 $ 1,374 $ 1,424
Income before income taxes 408 592 434 434 454 1,000 918
Net income 271 390 287 291 302 661 621
-----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .62 $ .88 $ .64 $ .65 $ .67 $ 1.51 $ 1.38
Net income - assuming dilution .62 .88 .64 .64 .66 1.50 1.37
Weighted average Common Shares (000) 434,112 441,834 446,402 448,742 448,037 437,973 448,774
Weighted average Common Shares and potential
Common Shares (000) 436,022 443,757 449,678 452,886 452,733 439,889 453,461
-----------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets 1.33% 1.92% 1.40% 1.45% 1.54% 1.62% 1.60%
Return on average equity 21.56 30.97 22.64 24.13 25.89 26.27 26.99
Efficiency(a) 58.01 60.10 57.18 56.89 57.24 59.06 57.93
-----------------------------------------------------------------------------------------------------------------------------------
GOODWILL AND NON-QUALIFYING INTANGIBLES
Goodwill average balance $ 1,370 $ 1,386 $ 1,402 $ 1,429 $ 1,437 $ 1,378 $ 1,432
Non-qualifying intangibles average balance 54 58 62 66 69 56 72
Goodwill amortization (after tax) 21 20 20 20 20 41 41
Non-qualifying intangibles amortization (after tax) 2 3 3 1 2 5 7
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Key has completed several acquisitions and divestitures during the periods
presented in this table. One or more of these transactions may have had a
significant effect on Key's results, making it difficult to compare results from
one period to the next. Note 3 ("Acquisitions and Divestitures") on page 8 has
specific information about the acquisitions and divestitures that Key completed
in the periods presented above to help you understand how those transactions
impacted Key's financial condition and results of operations.
(a) This ratio measures the extent to which recurring revenues are absorbed by
operating expenses and is calculated as follows: noninterest expense
(excluding certain nonrecurring charges and the amortization of goodwill and
non-qualifying intangibles) DIVIDED BY the sum of taxable-equivalent net
interest income and noninterest income (excluding gains from certain
divestitures and certain nonrecurring charges).
30
<PAGE> 31
LINE OF BUSINESS RESULTS
------------------------
Key has four primary lines of business:
KEY RETAIL BANKING offers branch-based financial products and services to small
businesses and consumers.
KEY SPECIALTY FINANCE offers non-branch-based consumer loan products, such as
education loans, home equity loans, automobile loans and leases, and marine and
recreational vehicle loans.
KEY CORPORATE CAPITAL offers financing, transaction processing, financial
advisory services, equipment leasing and a number of other specialized services.
KEY CAPITAL PARTNERS offers asset management, wealth management, private
banking, brokerage, investment banking, capital markets, and insurance products
and services.
This section summarizes the financial performance of each line of business and
its most recent strategic developments. To better understand the discussion
below concerning each line of business, see Note 4 ("Line of Business Results"),
which begins on page 9 and describes the activities and financial results of
each line of business in greater detail.
Figure 4 shows Key's net income (loss) by line of business for the three- and
six-month periods ended June 30, 2000 and 1999.
FIGURE 4. NET INCOME (LOSS) BY LINE OF BUSINESS
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, CHANGE SIX MONTHS ENDED JUNE 30, CHANGE
-------------------------- ------------------------ ------------------------------- ----------------------
dollars in millions 2000 1999 AMOUNT PERCENT 2000 1999 AMOUNT PERCENT
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Key Retail Banking $ 99 $ 87 $ 12 13.8% $192 $170 $ 22 12.9%
Key Specialty Finance 24 40 (16) (40.0) 47 82 (35) (42.7)
Key Corporate Capital 97 98 (1) (1.0) 195 188 7 3.7
Key Capital Partners(a) 30 37 (7) (18.9) 59 53 6 11.3
Treasury and Other (1) (8) 7 87.5 (4) (15) 11 (73.3)
-------------------------------------------------------------------------------------------------------------------- ----------
Total segments 249 254 (5) (2.0) 489 478 11 2.3
Reconciling items (1) 26 (27) (103.8) 126 95 31 32.6
-------------------------------------------------------------------------------------------------------------------------------
Total net income $248 $280 $(32) (11.4)% $615 $573 $ 42 7.3%
==== ==== ==== ==== ==== ====
===================================================================================================================================
</TABLE>
(a) Noninterest income and expense attributable to Key Capital Partners is
assigned to either Key Corporate Capital or Key Retail Banking if one of
those lines is principally responsible for maintaining the relationship
with the client that used Key Capital Partners' products and services. Key
Capital Partners had net income of $42 million and $50 million in the
second quarter of 2000 and 1999, respectively, and $82 million and $75
million in the first six months of 2000 and 1999, respectively, before it
assigned some of its income and expense.
KEY RETAIL BANKING
Net income for Key Retail Banking was $192 million for the first six months of
2000, or approximately 31% of Key's consolidated earnings. In comparison, net
income was $170 million for the first half of 1999, or approximately 30% of
consolidated earnings. The increase in net income is primarily attributable to a
$15 million increase in total revenue (primarily noninterest income) and a $28
million decline in noninterest expense. These positive factors were partially
offset by a slightly higher provision for loan losses.
Revenue growth from the first six months of 1999 includes a $3 million
improvement in net interest income, primarily due to strong loan growth. Average
loans outstanding rose by 11%, reflecting growth in the commercial and consumer
portfolios. Also contributing to the rise in net interest income was a 4%
increase in average deposit balances. Noninterest income was up $12 million from
the first six months of last year. Increases in both service charges on deposit
accounts and electronic banking fees are the primary factors driving the
improvement. The increase in service charges reflects the repricing of services,
while the growth in electronic banking fees resulted from a higher volume of
activity.
31
<PAGE> 32
The noninterest expense decrease of $28 million from the same period last year
is principally the result of lower costs associated with personnel, depreciation
and amortization expenses, and various indirect charges. The decline in
personnel expense reflects a decrease in the number of employees.
KEY SPECIALTY FINANCE
Net income for Key Specialty Finance was $47 million in the first six months of
2000, or approximately 8% of Key's consolidated earnings. In comparison, net
income was $82 million for the first six months of 1999, or approximately 14% of
consolidated earnings. The decline in net income had been anticipated by
management as a consequence of strategic changes (discussed in the following two
paragraphs) which led to decreases in both net interest income and noninterest
income. The decline in these revenue components was partially offset by a
reduction in the provision for loan losses.
Net interest income decreased by $15 million from the first half of 1999. A
slight increase in average loans outstanding was more than offset by the effect
of higher interest rate spreads used in determining the charge for funds used to
support the home equity loans originated by Champion Mortgage Co., Inc., our
home equity finance affiliate. Starting in 2000, we have de-emphasized our
practice of securitizing and selling home equity loans originated by Champion,
although we may continue to securitize these loans without then selling them. By
retaining these assets on the balance sheet, we intend to replace over time the
earnings capacity previously provided by the credit card business, which was
sold in January 2000. The additional funding charge to net interest income
resulted from the fact that since these loans are no longer classified as "held
for sale" and are expected to be retained on the balance sheet until maturity,
their funding costs reflect the higher rates associated with longer holding
periods.
Virtually all of the $46 million decrease in noninterest income from a year ago
is attributable to the absence of home equity securitization gains in the
current year, due in part to the change in practice discussed above. We estimate
that the change in our home equity loan securitization practice will reduce
Key's 2000 diluted earnings per common share by approximately $.08 from what it
would have been had we continued to securitize and sell home equity loans. For
more information about Key's loan securitization activities, see the section
entitled "Loans" which begins on page 48.
The provision for loan losses was reduced by $6 million, while the level of
noninterest expense is essentially unchanged from the prior year.
KEY CORPORATE CAPITAL
Net income for Key Corporate Capital was $195 million for the first six months
of 2000, or approximately 32% of Key's consolidated earnings. In comparison, net
income was $188 million for the same period last year, or approximately 33% of
consolidated earnings. The increase in net income derived primarily from two
sources. First, total average loans increased by 10%, generating higher net
interest income. This includes strong increases in all major business units,
including real estate construction, lease financing, structured finance,
healthcare, media and the middle market portfolios. Second, noninterest income
increased by $13 million, primarily due to higher income from service charges on
deposit accounts, loan fees and various investment banking and capital markets
activities.
The $46 million increase in total revenue was partially offset by a $14 million
increase in the provision for loan losses. Revenue was also offset by a $18
million increase in noninterest expense, primarily because of higher personnel
expense, fees for professional services, and depreciation and amortization
expense.
During the first quarter of 2000, Key announced the acquisition of certain net
assets of National Realty Funding L.C. You can find more discussion of this
acquisition and related activities in the section entitled "Principal strategic
actions during the first six months of 2000," on page 29.
32
<PAGE> 33
KEY CAPITAL PARTNERS
Net income for Key Capital Partners was $59 million for the first six months of
2000, or approximately 10% of Key's consolidated earnings. In comparison, net
income was $53 million for the first six months of 1999, or approximately 9% of
consolidated earnings.
If personnel in another line of business are responsible for maintaining a
relationship with a client that uses the products and services offered by Key
Capital Partners, that line of business is assigned the income and expense
arising from our work for the client. As a result, a significant amount of Key
Capital Partners' noninterest income and expense is reported under either Key
Corporate Capital or Key Retail Banking. If Key Capital Partners had not
assigned income and expense items to other lines of business, net income for
this line would have been $82 million in the first six months of 2000
(representing approximately 13% of Key's consolidated earnings) and $75 million
in the same period last year (representing approximately 11% of Key's
consolidated earnings).
Total revenue for Key Capital Partners rose by $23 million from the first half
of 1999. Primary factors contributing to this improvement were higher net gains
from equity capital investments, an increase in dealer trading and derivatives
income, and growth in trust and investment advisory fees, which reflected an
expanded base of clients and the repricing of certain services. The growth of
these revenue components was moderated by a decline in investment banking
management fees due to lower levels of activity and the timing of certain
transactions.
Noninterest expense was up $12 million from the first six months of last year,
due primarily to higher personnel related costs.
TREASURY AND OTHER
Treasury and Other includes the Treasury and Electronic Services units, as well
as the net effect of funds transfer pricing. In the first six months of 2000,
this segment generated a net loss of $4 million, compared with a net loss of $15
million for the first six months of 1999. The $11 million improvement from the
prior year is primarily due to growth in the Electronic Services business and
lower noninterest expense in the Treasury unit.
RECONCILING ITEMS
The "reconciling items" shown in Figure 4 reflect certain nonrecurring items and
charges related to unallocated corporate support functions. Also included in
both the current and prior year are the results of divested businesses. Prior to
restatement in 2000, these results had been included in the individual lines of
business to which they pertained.
The $61 million decrease in net interest income is attributable to the decline
in earnings contributed by Key's credit card business (divested in January 2000)
and Long Island district branches (divested in October 1999).
Noninterest income for the first six months of 2000 includes a $332 million
($207 million after tax) gain from the January sale of Key's credit card
business and $6 million ($3 million after tax) earned by divested businesses.
For the first six months of 1999, noninterest income includes a $134 million
($85 million after tax) gain from the first quarter sale of Key's 20% interest
in Electronic Payment Services, Inc., a $14 million ($9 million after tax) gain
from the sale of Key Merchant Services, LLC, a $15 million ($9 million after
tax) gain from the sale of Concord EFS, Inc. common shares and $37 million ($23
million after tax) earned by divested businesses.
The $54 million increase in the provision for loan losses resulted primarily
from an additional provision of $121 million ($77 million after tax) recorded in
the first quarter of 2000 in connection with the implementation of an enhanced
methodology for assessing credit risk, particularly in the commercial loan
33
<PAGE> 34
portfolio. The effect of this additional provision was offset in part by the
result of two actions. During the first quarter of 1999, Key recorded an
additional provision for loan losses of $30 million ($19 million after tax),
largely as a result of an enhancement in the allowance for loan losses
methodology pertaining to the credit card portfolio. In addition, the January
sale of the credit card business alleviated the need to record a credit card
loan loss provision in the current year.
Noninterest expense in the first six months of 2000 includes restructuring and
other special charges of $16 million ($10 million after tax) related to Key's
profitability improvement initiative and $7 million ($5 million after tax)
incurred by divested businesses. In the first six months of 1999, noninterest
expense includes special contributions of $23 million ($15 million after tax)
made to the charitable foundation that Key sponsors, $27 million ($17 million
after tax) of various other nonrecurring charges and $44 million ($28 million
after tax) incurred by divested businesses.
34
<PAGE> 35
RESULTS OF OPERATIONS
---------------------
NET INTEREST INCOME
Key's principal source of earnings is net interest income, which comprises
interest and loan-related fee income less interest expense. There are several
factors that affect net interest income, including:
- the volume, pricing, mix, and maturity of earning assets and
interest-bearing liabilities;
- the use of off-balance sheet instruments to manage interest rate risk;
- interest rate fluctuations; and
- asset quality.
To make it easier to compare results from one period to the next, as well as the
yields on various types of earning assets, we present all net interest income on
a "taxable-equivalent basis." In other words, if we earn $100 of tax-exempt
income, we present those earnings at a higher amount (specifically, $154)
that--if taxed at the statutory Federal income tax rate of 35%--would amount to
$100.
Figure 5 shows various components of the balance sheet that affect interest
income and expense, and their respective yields or rates over the past five
quarters. Net interest income for the second quarter of 2000 was $680 million,
representing a $24 million, or 3%, decrease from the same period last year. The
decline reflects a 29 basis point reduction in the net interest margin to 3.68%,
which more than offset the impact of a 4% increase in average earning assets
(primarily commercial and consumer loans) to $73.9 billion. Both earning assets
and the net interest margin were reduced by the sales of Key's Long Island
branches and credit card business. These operations contributed approximately
$45 million to net interest income in the second quarter of 1999. Although the
second quarter margin declined from the year-ago quarter, it was unchanged from
the first quarter of this year despite a challenging interest rate environment
and the January sale of the low-growth, but higher-yielding credit card
business. This stabilization was largely due to the growth of Key' s retail
deposits which allowed us to reduce our dependence on higher-cost funds.
For the first six months of 2000, net interest income totaled $1.4 billion, down
$39 million, or 3%, from the first half of 1999. The year-to-date reduction also
reflected a lower net interest margin which decreased 28 basis points to 3.68%,
while the growth of commercial and consumer loans was the primary contributor to
a 4% increase in average earning assets to $73.8 billion. The divestitures
discussed above added approximately $89 million to Key's net interest income in
the first half of 1999.
NET INTEREST MARGIN. There are several reasons that the net interest margin
declined over the past year:
- the October 1999 divestiture of Key's Long Island branches with
approximately $1.3 billion in deposits and the January 2000 sale of the
$1.3 billion credit card portfolio resulted in an estimated decrease of 23
basis points in Key's net interest margin from that of the 1999 second
quarter;
- increased competition has impacted the rates that we can charge for loans
and the rates that we must pay for deposits;
- core deposit growth has not kept pace with loan growth due in part to
branch divestitures and client preferences for other investment
alternatives; and
- we have intensified our efforts to grow deposits such as money market
deposit accounts and time deposits. These deposits are among the more
costly of our core deposit products, but they provide more stable funding
than wholesale sources.
35
<PAGE> 36
FIGURE 5. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
<TABLE>
<CAPTION>
SECOND QUARTER 2000 FIRST QUARTER 2000
---------------------------------- -----------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
===============================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Loans(a,b)
Commercial, financial and agricultural $19,046 $ 405 8.56% $18,677 $ 379 8.17%
Real estate-- commercial mortgage 6,967 156 9.03 6,891 150 8.74
Real estate-- construction 4,625 110 9.51 4,601 104 9.12
Commercial lease financing 6,773 124 7.30 6,684 122 7.28
-------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 37,411 795 8.53 36,853 755 8.23
Real estate-- residential 4,276 83 7.80 4,318 81 7.48
Home equity 8,600 196 9.16 8,129 179 8.85
Credit card -- -- -- -- -- --
Consumer - direct 2,620 66 10.09 2,572 62 9.72
Consumer - indirect lease financing 3,107 62 7.97 3,174 63 7.93
Consumer - indirect other 6,078 142 9.33 6,286 145 9.22
-------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 24,681 549 8.92 24,479 530 8.67
Loans held for sale 2,725 58 8.52 2,692 65 9.80
-------------------------------------------------------------------------------------------------------------------------------
Total loans 64,817 1,402 8.68 64,024 1,350 8.47
Taxable investment securities 671 6 3.63 580 4 2.94
Tax-exempt investment securities(a) 415 9 8.77 436 10 8.74
-------------------------------------------------------------------------------------------------------------------------------
Total investment securities 1,086 15 5.60 1,016 14 5.43
Securities available for sale(a,c) 6,198 107 6.73 6,475 112 6.81
Short-term investments 1,757 23 5.29 2,164 20 3.66
-------------------------------------------------------------------------------------------------------------------------------
Total earning assets 73,858 1,547 8.40 73,679 1,496 8.15
Allowance for loan losses (976) (899)
Other assets 10,523 10,407
-------------------------------------------------------------------------------------------------------------------------------
$83,405 $83,187
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $12,403 105 3.41 $12,617 104 3.32
Savings deposits 2,275 8 1.44 2,357 9 1.61
NOW accounts 628 3 1.61 627 3 1.62
Certificates of deposit ($100,000 or more) 5,430 82 6.06 5,555 80 5.78
Other time deposits 13,656 190 5.61 12,552 164 5.25
Deposits in foreign office 3,029 48 6.39 1,206 17 5.76
-------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 37,421 436 4.69 34,914 377 4.34
Federal funds purchased and securities
sold under repurchase agreements 4,096 58 5.64 4,003 48 4.85
Bank notes and other short-term borrowings 6,972 103 5.96 8,680 126 5.83
Long-term debt, including capital securities(d) 15,668 270 6.92 16,577 267 6.49
-------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 64,157 867 5.43 64,174 818 5.13
Noninterest-bearing deposits 8,412 8,160
Other liabilities 4,357 4,344
Common shareholders' equity 6,479 6,509
-------------------------------------------------------------------------------------------------------------------------------
$83,405 $83,187
======== =======
Interest rate spread (TE) 2.97 3.02
-------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $680 3.68% $678 3.68%
===== ===== ==== =====
Capital securities $1,243 $24 $1,243 $23
Taxable-equivalent adjustment(a) 7 7
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Interest income on tax-exempt securities and loans has been adjusted to a
taxable-equivalent basis using the statutory Federal income tax rate of 35%
(b) For purposes of these computations, nonaccrual loans are included in the
average loan balances.
(c) Yield is calculated on the basis of amortized cost.
(d) Rate calculation excludes ESOP debt.
(e) TE = Taxable Equivalent
36
<PAGE> 37
FIGURE 5. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND
YIELDS/RATES (CONTINUED)
<TABLE>
<CAPTION>
FOURTH QUARTER 1999 THIRD QUARTER 1999
--------------------------------- --------------------------------
AVERAGE YIELD/ AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Loans(a,b)
Commercial, financial and agricultural $18,311 $ 364 7.90% $17,978 $ 348 7.66%
Real estate-- commercial mortgage 6,824 147 8.52 6,784 141 8.25
Real estate-- construction 4,438 100 8.88 4,190 89 8.46
Commercial lease financing 6,484 120 7.43 6,261 113 7.16
---------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 36,057 731 8.05 35,213 691 7.78
Real estate-- residential 4,338 80 7.56 4,175 80 7.64
Home equity 7,497 168 8.71 7,739 161 8.32
Credit card -- -- -- 1,302 54 16.45
Consumer - direct 2,560 63 9.85 2,467 60 9.65
Consumer - indirect lease financing 3,159 62 8.01 2,993 61 8.15
Consumer - indirect other 6,452 151 9.34 6,457 148 9.17
---------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 24,006 524 8.70 25,133 564 8.92
Loans held for sale 3,423 95 11.09 2,453 50 8.00
---------------------------------------------------------------------------------------------------------------------------------
Total loans 63,486 1,350 8.46 62,799 1,305 8.24
Taxable investment securities 506 4 3.26 471 4 3.47
Tax-exempt investment securities(a) 468 11 8.69 499 10 8.55
---------------------------------------------------------------------------------------------------------------------------------
Total investment securities 974 15 5.87 970 14 6.09
Securities available for sale(a,c) 6,667 114 6.77 6,359 106 6.54
Short-term investments 1,954 18 3.48 1,836 17 3.74
---------------------------------------------------------------------------------------------------------------------------------
Total earning assets 73,081 1,497 8.15 71,964 1,442 7.96
Allowance for loan losses (916) (920)
Other assets 10,409 10,251
---------------------------------------------------------------------------------------------------------------------------------
$82,574 $81,295
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $12,836 100 3.09 $13,274 100 2.97
Savings deposits 2,458 9 1.62 2,699 11 1.63
NOW accounts 610 4 1.76 610 1 1.37
Certificates of deposit ($100,000 or more) 5,151 71 5.48 4,475 59 5.22
Other time deposits 12,150 154 5.04 12,095 150 4.91
Deposits in foreign office 906 12 5.45 776 10 4.99
---------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 34,111 350 4.08 33,929 331 3.87
Federal funds purchased and securities
sold under repurchase agreements 4,384 52 4.71 4,495 51 4.49
Bank notes and other short-term borrowings 8,243 116 5.57 7,428 103 5.50
Long-term debt, including capital securities(d) 17,095 266 6.17 17,069 248 5.79
---------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 63,833 784 4.87 62,921 733 4.62
Noninterest-bearing deposits 8,430 8,534
Other liabilities 3,836 3,561
Common shareholders' equity 6,475 6,279
---------------------------------------------------------------------------------------------------------------------------------
$82,574 $81,295
======== ========
Interest rate spread (TE) 3.28 3.34
---------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $713 3.88% $709 3.92%
===== ====== ====== =====
Capital securities $1,243 $23 $1,205 $22
Taxable-equivalent adjustment(a) 8 9
---------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
SECOND QUARTER 1999
----------------------------------
AVERAGE YIELD/
dollars in millions BALANCE INTEREST RATE
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ASSETS
Loans(a,b)
Commercial, financial and agricultural $17,479 $324 7.43%
Real estate-- commercial mortgage 7,007 144 8.27
Real estate-- construction 4,015 81 8.09
Commercial lease financing 5,889 109 7.39
-------------------------------------------------------------------------------------------------
Total commercial loans 34,390 658 7.67
Real estate-- residential 4,546 87 7.71
Home equity 7,556 160 8.47
Credit card 1,322 49 14.93
Consumer - direct 2,425 58 9.59
Consumer - indirect lease financing 2,826 57 8.07
Consumer - indirect other 6,425 146 9.09
-------------------------------------------------------------------------------------------------
Total consumer loans 25,100 557 8.90
Loans held for sale 2,114 39 7.35
-------------------------------------------------------------------------------------------------
Total loans 61,604 1,254 8.16
Taxable investment securities 424 3 3.25
Tax-exempt investment securities(a) 560 12 8.63
-------------------------------------------------------------------------------------------------
Total investment securities 984 15 6.31
Securities available for sale(a,c) 6,575 107 6.46
Short-term investments 1,725 23 5.32
-------------------------------------------------------------------------------------------------
Total earning assets 70,888 1,399 7.91
Allowance for loan losses (919)
Other assets 10,056
-------------------------------------------------------------------------------------------------
$80,025
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $13,145 96 2.93
Savings deposits 2,811 12 1.62
NOW accounts 743 3 1.45
Certificates of deposit ($100,000 or more) 3,737 47 5.07
Other time deposits 11,811 144 4.90
Deposits in foreign office 1,096 13 4.75
-------------------------------------------------------------------------------------------------
Total interest-bearing deposits 33,343 315 3.79
Federal funds purchased and securities
sold under repurchase agreements 5,479 63 4.59
Bank notes and other short-term borrowings 6,786 88 5.22
Long-term debt, including capital securities(d) 16,530 229 5.57
-------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 62,138 695 4.48
Noninterest-bearing deposits 8,438
Other liabilities 3,264
Common shareholders' equity 6,185
-------------------------------------------------------------------------------------------------
$80,025
=======
Interest rate spread (TE) 3.43
-------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $704 3.97%
===== ====
Capital securities $1,162 $21
Taxable-equivalent adjustment(a) 7
-------------------------------------------------------------------------------------------------
</TABLE>
37
<PAGE> 38
INTEREST EARNING ASSETS. Average earning assets for the second quarter totaled
$73.9 billion, which was $3.0 billion, or 4%, higher than the second quarter
1999 level. For the first six months of the year, average earning assets rose 4%
to $73.8 billion from the first six months of 1999. Both the quarterly and
year-to-date increases came principally from the loan portfolio, despite the
sale of Key's credit card business last January. The largest growth occurred in
the commercial loan portfolio, but the growth of the home equity portfolio was
also strong.
Key's loan growth has been affected by several strategic developments over the
past nine months. Late in the first quarter of 2000 we created a commercial loan
conduit through which more than $800 million of lower-spread loans have been
sold through June 30. This arrangement allows us to continue to meet our
customers' funding needs and to generate servicing revenue without having to
retain these lower-spread assets on the balance sheet. In addition, during the
second quarter, Key sold $483 million of its commercial mortgage loans in its
initial participation in the securitization and sale of such assets. Our
business of originating and servicing these loans is expected to grow
significantly as a result of Key's recent acquisition of National Realty Funding
L.C. Finally, during 1999, we securitized and sold loans aggregating $3.4
billion as part of our strategy to diversify Key's funding sources, but that
strategy moderated the growth of the consumer loan portfolio. Earlier this year,
we announced our intention to de-emphasize the securitization and sale of home
equity loans generated by our home equity finance affiliate. No such
transactions occurred during the first six months of 2000. By retaining the
assets generated by this rapidly growing business on Key's balance sheet, we
intend to replace over time the earnings capacity lost with the divestiture of
our credit card business.
INTEREST RATE SWAPS AND CAPS. As discussed in the following section entitled
"Market risk management," Key uses portfolio interest rate swaps and caps to
help manage its interest rate sensitivity position. Interest rate swaps and caps
are complicated instruments, but briefly:
- INTEREST RATE SWAPS are contracts under which two parties agree to exchange
interest payment streams that are calculated on agreed-upon amounts (known
as "notional amounts"). For example, party A will pay interest at a fixed
rate to, and receive interest at a variable rate from, party B. Key
generally uses interest rate swaps to mitigate its exposure to interest
rate risk on certain loans, securities, deposits, short-term borrowings and
long-term debt.
- INTEREST RATE CAPS are contracts that provide for the holder to be
compensated based on an agreed-upon notional amount when a benchmark
interest rate exceeds a specified level (known as the "strike rate"). Key
uses interest rate caps to manage the risk of adverse movements in interest
rates on certain of our long-term debt and short-term borrowings. A cap
limits Key's exposure to interest rate increases; caps do not have any
impact if market rates decline.
For more information about how Key uses interest rate swaps and caps to manage
its balance sheet, please see the next section, entitled "Market risk
management." Figure 6 shows how changes in yields or rates and average balances
in the first quarters of 2000 and 1999 affected net interest income. You can
find more discussion of the changes in earning assets and funding sources in the
section entitled "Financial Condition," which begins on page 48.
38
<PAGE> 39
FIGURE 6. COMPONENTS OF NET INTEREST INCOME CHANGES
<TABLE>
<CAPTION>
FROM THREE MONTHS ENDED JUNE 30, 1999 FROM SIX MONTHS ENDED JUNE 30, 1999,
TO THREE MONTHS ENDED JUNE 30, 2000 TO SIX MONTHS ENDED JUNE 30, 2000
------------------------------------ -----------------------------------
AVERAGE YIELD/ NET AVERAGE YIELD/ NET
in millions VOLUME RATE CHANGE VOLUME RATE CHANGE
==================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Loans $ 67 $ 81 $ 148 $ 115 $ 129 $ 244
Taxable investment securities 2 1 3 4 (1) 3
Tax-exempt investment securities (3) -- (3) (7) 1 (6)
Securities available for sale (6) 6 -- 1 14 15
Short-term investments -- -- -- 3 (4) (1)
----------------------------------------------------------------------------------------------------------------------------------
Total interest income (taxable equivalent) 60 88 148 116 139 255
INTEREST EXPENSE
Money market deposit accounts (6) 15 9 (5) 24 19
Savings deposits (2) (2) (4) (4) (3) (7)
NOW accounts (1) 1 -- (3) 2 (1)
Certificates of deposit ($100,000 or more) 24 11 35 51 18 69
Other time deposits 24 22 46 33 30 63
Deposits in foreign office 29 6 35 39 7 46
----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 68 53 121 111 78 189
Federal funds purchased and securities sold
under repurchase agreements (18) 13 (5) (30) 19 (11)
Bank notes and other short-term borrowings 2 13 15 (4) 26 22
Long-term debt, including capital securities (12) 53 41 8 86 94
----------------------------------------------------------------------------------------------------------------------------------
Total interest expense 40 132 172 85 209 294
----------------------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $ 20 $ (44) $ (24) $ 31 $ (70) $ (39)
==== ===== ====== ==== ===== ======
----------------------------------------------------------------------------------------------------------------------------------
</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.
MARKET RISK MANAGEMENT
"Market risk" is the exposure to economic loss that arises when the value of a
financial instrument adversely changes due to variations in interest rates,
foreign exchange rates, equity prices (the value of equity securities held as
assets), or other market-driven rates or prices. For example, the value of a
fixed-rate bond will decline if market interest rates increase because the bond
will become a less attractive investment. Similarly, the value of the U.S.
dollar regularly fluctuates in relation to other currencies. Key is not affected
in any material way by changes in foreign exchange rates.
Asset and liability management
------------------------------
Key's Asset/Liability Management Policy Committee has established guidelines for
a program to measure and manage interest rate risk. This committee is also
responsible for approving Key's asset/liability management policies, overseeing
the formulation and implementation of strategies to improve balance sheet
positioning and earnings, and reviewing Key's interest rate sensitivity
position.
MEASUREMENT OF SHORT-TERM INTEREST RATE EXPOSURE. The primary tool that
management uses to measure and manage interest rate risk is a net interest
income simulation model. These simulations estimate the impact that various
changes in the overall level of interest rates over one and two-year time
horizons would have on net interest income. The results help Key develop
strategies for managing exposure to interest rate risk.
Like any forecasting technique, interest rate simulation modeling is based on a
large number of assumptions. In this case, the assumptions relate primarily to
loan and deposit growth, asset and liability prepayments, interest rates and on-
and off-balance sheet management strategies. Management believes that both
individually and in the aggregate the assumptions we make are reasonable.
Nevertheless, the simulation modeling process only produces a sophisticated
estimate, not a precise calculation of exposure.
39
<PAGE> 40
Key's guidelines for risk management require management to take preventive
measures if a gradual 200 basis point increase or decrease in short-term rates
over the next twelve months would affect net interest income over the same
period by more than 2%. Key has been operating well within these guidelines. As
of June 30, 2000, based on the results of our simulation model, Key would expect
net interest income to increase by approximately $14 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 $14 million.
MEASUREMENT OF LONG-TERM INTEREST RATE EXPOSURE. Key uses an economic value of
equity model to complement short-term interest rate risk analysis. The benefit
of this model is that it measures exposure to interest rate changes over time
frames that are longer than two years. The economic value of Key's equity is
determined by aggregating the present value of projected future cash flows for
asset, liability, and off-balance sheet positions based on the current yield
curve.
Economic value analysis has several limitations. For example, the economic
values of asset, liability, and off-balance sheet positions do not represent the
true fair values of the positions, since economic values do not consider factors
such as credit risk and liquidity. In addition, we must estimate cash flow for
assets and liabilities with indeterminate maturities. Moreover, 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. Finally,
the analysis requires assumptions about events that span several years. 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.
Key's guidelines for risk management require management to take preventive
measures if an immediate 200 basis point increase or decrease in interest rates
would decrease the economic value of equity by more than 20%. Key has been
operating well within these guidelines.
OTHER SOURCES OF INTEREST RATE EXPOSURE. Management uses the results of
short-term and long-term interest rate exposure models to formulate strategies
to improve balance sheet positioning, earnings, or both within the bounds of
Key's interest rate risk, liquidity, and capital guidelines. We also
periodically measure the risk to earnings and economic value arising from
various other pro forma changes in the overall level of interest rates. The
variety of interest rate scenarios modeled, and their potential impact on
earnings and economic value, quantify the level of interest rate exposure
arising from option risk, basis risk and gap risk.
- A financial instrument presents "OPTION RISK" when one party can take
advantage of changes in interest rates without penalty. For example, when
interest rates decline, borrowers may choose to prepay fixed rate loans by
refinancing at a lower rate. Such a prepayment gives Key a return on its
investment (the principal plus some interest), but unless there is a
prepayment penalty, that return will not be as much as the loan would have
generated had payments been received as originally scheduled. Floating rate
loans that are capped against potential interest rate increases and
deposits that can be withdrawn on demand also present option risk.
- One approach that Key uses to manage interest rate risk is to offset
floating rate liabilities (such as deposits) with floating rate assets
(such as loans). That way, as our interest expense increases, so will our
interest income. We face "BASIS RISK" when our floating-rate assets and
floating-rate liabilities reprice in response to different market factors
or indices. Under those circumstances, even if equal amounts of assets and
liabilities are repricing at the same time, interest expense and interest
income may not change by the same amount.
- We often use an interest-bearing liability to provide funding for an
interest-earning asset. For example, Key may sell certificates of deposit
and use the proceeds to make loans. That strategy presents "GAP RISK" if
the related liabilities and assets do not mature or reprice at the same
time.
MANAGEMENT OF INTEREST RATE EXPOSURE. Key manages interest rate risk by using
portfolio swaps and caps which modify the repricing or maturity characteristics
of some of our assets and liabilities. The decision to
40
<PAGE> 41
use these instruments rather than securities, debt, or other on-balance sheet
alternatives depends on many factors, including the mix and cost of funding
sources, liquidity and capital requirements. In addition, management considers
interest rate implications when adding to Key's securities portfolio, issuing
new debt and packaging loans for securitization.
PORTFOLIO SWAPS AND CAPS. The estimated fair value of Key's portfolio swaps and
caps decreased to a negative fair value of $76 million during the first six
months of 2000 from a negative fair value of $42 million at December 31, 1999.
Fair value decreased because of the combined impact of a number of factors:
interest rates increased, the implied forward yield curve steepened, and Key's
"receive" fixed interest rate swap portfolio has a slightly longer average
remaining maturity than the "pay" fixed portfolio.
Key terminated swaps with a notional amount of $1.3 billion during the first six
months of 2000, resulting in a net deferred loss of $4 million. Each swap
termination was made in response to a unique set of circumstances. Generally,
the decision to terminate any swap contract is integrated strategically with
asset and liability management and takes many factors into account.
During 1999 and the first half of 2000, management also used portfolio rate
locks and futures from time to time since Key relied more heavily on variable
rate funding to support earning asset growth.
Figure 7 summarizes Key's activity in portfolio swaps and caps for the six-month
period ended June 30, 2000. For more information about these instruments,
including the balance and remaining amortization period of Key's deferred swap
gains and losses, see Note 11 ("Financial Instruments with Off-Balance Sheet
Risk"), which begins on page 19.
FIGURE 7. PORTFOLIO SWAPS AND CAPS ACTIVITY
<TABLE>
<CAPTION>
RECEIVE FIXED PAY FIXED BASIS SWAPS
---------------------------------- ----------------------- --------------------------
INDEXED FORWARD- FORWARD- FORWARD-
in millions AMORTIZING CONVENTIONAL STARTING CONVENTIONAL STARTING CONVENTIONAL STARTING
================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1999 $104 $5,962 -- $5,545 $ 278 $6,783 --
Additions -- 660 $135 2,667 408 400 $ 1,268
Maturities -- 1,155 -- 736 -- 1,880 --
Terminations -- 500 -- 654 58 100 --
Forward-starting becoming effective -- -- -- 478 (478) 1,268 (1,268)
Amortization 51 -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------------------
BALANCE AT JUNE 30, 2000 $ 53 $4,967 $135 $7,300 $ 150 $6,471 --
==== ====== ==== ====== ===== ======
--------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
TOTAL
PORTFOLIO
in millions SWAPS CAPS TOTAL
===============================================================================
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1999 $18,672 $2,250 $20,922
Additions 5,538 50 5,588
Maturities 3,771 1,200 4,971
Terminations 1,312 30 1,342
Forward-starting becoming effective -- -- --
Amortization 51 -- 51
-----------------------------------------------------------------------------
BALANCE AT JUNE 30, 2000 $19,076 $1,070 $20,146
======== ====== =======
-------------------------------------------------------------------------------
</TABLE>
Figure 8 shows the notional amount and fair values of portfolio swaps and caps
by interest rate management strategy. The fair value of an instrument at any
given date represents the estimated income (if positive) or cost (if negative)
that would be recognized if the instrument was sold at that date. However,
because these instruments are used to alter the repricing or maturity
characteristics of other assets and liabilities, the net unrealized gains and
losses are not recognized separately in earnings. Rather, interest from swaps
and caps is recognized on an accrual basis as an adjustment of the interest
income or expense from the asset or liability being managed.
41
<PAGE> 42
FIGURE 8. PORTFOLIO SWAPS AND CAPS BY INTEREST RATE MANAGEMENT STRATEGY
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
---------------------- --------------------------
NOTIONAL FAIR NOTIONAL FAIR
in millions AMOUNT VALUE AMOUNT VALUE
===========================================================================================================================
<S> <C> <C> <C> <C>
Convert variable rate loans to fixed $ 1,203 $ (30) $ 1,254 $ (24)
Convert fixed rate loans to variable 1,042 8 587 14
Convert fixed rate securities to variable 390 20 316 18
Convert variable rate deposits and short-term borrowings to fixed 1,250 16 1,100 14
Convert fixed rate deposits and short-term borrowings to variable 396 (6) 226 (6)
Convert variable rate long-term debt to fixed 4,768 63 3,820 59
Convert fixed rate long-term debt to variable 3,556 (106) 4,586 (104)
Basis swaps - foreign currency denominated debt 1,089 (46) 321 (23)
Basis swaps - interest rate indices 5,382 (2) 6,462 3
-------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps 19,076 (83) 18,672 (49)
Modify characteristics of variable rate short-term borrowings 950 6 2,050 6
Modify characteristics of variable rate long-term debt 120 1 200 1
-------------------------------------------------------------------------------------------------------------------------------
Total portfolio caps and collars 1,070 7 2,250 7
-------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and collars $20,146 $ (76) $20,922 $ (42)
======== ==== ======== ====
--------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
JUNE 30, 1999
----------------------
NOTIONAL FAIR
in millions AMOUNT VALUE
==============================================================================================
<S> <C> <C>
Convert variable rate loans to fixed $ 1,297 $ 1
Convert fixed rate loans to variable 571 6
Convert fixed rate securities to variable 322 6
Convert variable rate deposits and short-term borrowings to fixed 1,250 2
Convert fixed rate deposits and short-term borrowings to variable 635 (2)
Convert variable rate long-term debt to fixed 1,645 26
Convert fixed rate long-term debt to variable 4,656 2
Basis swaps - foreign currency denominated debt 321 (18)
Basis swaps - interest rate indices 5,798 1
---------------------------------------------------------------------------------------------
Total portfolio swaps 16,495 24
Modify characteristics of variable rate short-term borrowings 2,825 5
Modify characteristics of variable rate long-term debt 400 --
---------------------------------------------------------------------------------------------
Total portfolio caps and collars 3,225 5
---------------------------------------------------------------------------------------------
Total portfolio swaps, caps and collars $19,720 $ 29
======== ===
---------------------------------------------------------------------------------------------
</TABLE>
Figure 9 summarizes the expected average maturities of Key's portfolio swaps and
caps at June 30, 2000.
FIGURE 9. EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS AND CAPS
<TABLE>
<CAPTION>
JUNE 30, 2000 RECEIVE FIXED PAY FIXED
------------------------------------ ------------------------
INDEXED FORWARD- FORWARD-
in millions AMORTIZING CONVENTIONAL STARTING CONVENTIONAL STARTING
===========================================================================================================
Mature in one year or less -- $ 985 -- $ 885 --
Mature after one through five years $53 2,490 $ 50 5,216 $ 56
Mature after five through ten years -- 892 35 814 --
Mature after ten years -- 600 50 385 94
-----------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and collars $53 $4,967 $135 $7,300 $150
=== ====== ==== ====== ====
-----------------------------------------------------------------------------------------------------------
<CAPTION>
JUNE 30, 2000
TOTAL
PORTFOLIO
in millions BASIS SWAPS SWAPS CAPS TOTAL
================================================================================================
<S> <C> <C> <C> <C>
Mature in one year or less $2,225 $ 4,095 $ 700 $ 4,795
Mature after one through five years 4,246 12,111 370 12,481
Mature after five through ten years -- 1,741 -- 1,741
Mature after ten years -- 1,129 -- 1,129
------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and collars $6,471 $19,076 $1,070 $20,146
====== ======= ====== =======
------------------------------------------------------------------------------------------------
</TABLE>
Trading portfolio risk management
---------------------------------
Key's trading portfolio includes interest rate swap contracts entered into to
accommodate the needs of clients, other positions with third parties that are
intended to mitigate the interest rate risk of client positions, foreign
exchange contracts entered into to accommodate the needs of clients and
financial assets and liabilities (trading positions) included in "other assets"
and "other liabilities," respectively, on the balance sheet. For more
information about off-balance sheet contracts, see Note 11 ("Financial
Instruments with Off-Balance Sheet Risk"), which begins on page 19.
Management 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 Key's
trading portfolio. Using statistical methods, this model estimates the maximum
potential one-day loss with 95% certainty. At June 30, 2000, Key's aggregate
daily VAR was $.9 million compared with $1 million at June 30, 1999. Aggregate
daily VAR averaged less than $1 million for the first six months of 2000,
compared with an average of $1.9 million during the same period last year. VAR
modeling augments other controls that Key uses to mitigate the market risk
exposure of the trading portfolio. These controls include loss and portfolio
size limits that are based on market liquidity and the level of activity and
volatility of trading products.
42
<PAGE> 43
NONINTEREST INCOME
Noninterest income for the second quarter of 2000 totaled $475 million, down $57
million, or 11%, from the same period last year. For the first six months of the
year, noninterest income was $1.3 billion, representing an increase of $134
million, or 12%, from the first half of 1999. In both the current and prior
year, noninterest income has been affected by various nonrecurring items. The
most significant of these items are shown in Figure 10 and include gains from
divestitures and nonrecurring charges. For more information on the divestitures,
see Note 3 ("Acquisitions and Divestitures"), which begins on page 8.
Excluding nonrecurring items, core noninterest income was $475 million for the
second quarter of 2000 and currently represents 41% of Key's total core revenue.
One of management's long-term objectives is to increase core noninterest income
as a percentage of total core revenue to 50%. Core noninterest income in the
year-ago quarter was $517 million and included $19 million from the divested
Long Island branches and credit card business, as well as $21 million of gains
resulting from the securitization and sale of home equity loans. No home equity
loan securitizations have been recorded in 2000 as a result of our revised
strategy discussed below. The remaining $477 million of core noninterest income
reported a year ago was nearly equaled by the $475 million of core noninterest
income in the second quarter of 2000. Increases in income from trust and asset
management (up $6 million) and service charges on deposit accounts (up $3
million) were substantially offset by an $8 million reduction in brokerage
commissions due to a lower volume of activity.
For the first six months of 2000, core noninterest income was $951 million
compared with $984 million for the comparable period in 1999. The sales of the
Long Island branches and credit card business accounted for $32 million of the
decrease in core earnings, while the absence of gains from the securitization
and sale of home equity loans in the current year accounted for a decrease of
$47 million. Adjusting for these items, core noninterest income was up $46
million, or 5% from the first six months of 1999. The strongest contributions to
this growth came from investment banking and capital markets activities (up $21
million), trust and asset management (up $15 million) and service charges on
deposit accounts (up $8 million). The growth of these revenue components
reflects the overall strength of the securities markets, new business and the
repricing of certain services. Also contributing to the improvement in
noninterest income was a $6 million increase in electronic banking fees. The
growth in Key's core noninterest income was moderated by a $5 million reduction
in brokerage commissions.
Figure 10 shows the major components of Key's noninterest income. For some of
these components, the discussion that follows provides additional information,
such as the composition of the component and the factors that may have caused it
to change from the prior year. For detailed information about investment banking
and capital markets income, and trust income and assets, see Figures 11 and 12,
respectively.
TRUST AND ASSET MANAGEMENT. Trust and asset management activities provide Key's
largest source of noninterest income. At June 30, 2000, Key's bank, trust, and
registered investment advisory subsidiaries had assets under discretionary
management (excluding corporate trust assets) of $70 billion, compared with $69
billion at June 30, 1999.
CREDIT CARD FEES. Credit card fees for the second quarter and first six months
of 2000 declined by $19 million and $23 million from the respective periods in
1999 due to the sale of Key's credit card business in January 2000. For more
information about this transaction, see the section entitled "Highlights of
Key's Performance," which begins on page 26, and Note 3 ("Acquisitions and
Divestitures") on page 8.
LOAN SECURITIZATIONS. Key often securitizes and sells loans to generate funds.
The extent to which we use securitizations is dependent upon whether conditions
in the capital markets make them more attractive than other funding
alternatives. Typically we securitize education, home equity, and automobile
loans. We decide which loans to securitize based upon a number of specific
factors as discussed in the section entitled "Loans," which begins on page 48.
43
<PAGE> 44
During the second quarter of 2000, we securitized and sold $503 million of
education loans at a gain of $10 million, and recorded impairment write-downs
relating to prior period securitizations. These transactions resulted in an
aggregate net gain of $7 million. In the current year, we have not securitized
any of our home equity loans due in part to our plans announced earlier this
year to de-emphasize the securitization and sale of home equity loans originated
by our home equity finance affiliate. By retaining these assets on the balance
sheet, we intend to replace over time the earnings capacity lost with the
divestiture of the credit card portfolio.
During the first half of last year, we securitized and sold $2.2 billion of
consumer loans, resulting in net gains of $50 million. The level of
securitizations was particularly high during the first quarter ($1.8 billion)
because a securitization originally planned for the fourth quarter of 1998 was
postponed due to instability in the capital markets and was added to the
expected volume of securitizations for the first quarter of 1999. For
information about the type and volume of securitized loans that are either
administered or serviced by Key and not recorded on the balance sheet, see the
section entitled "Loans," which begins on page 48.
SIGNIFICANT NONRECURRING ITEMS. Noninterest income for the first six months of
2000 includes a $332 million first quarter gain from the sale of Key's credit
card business. Results for the first half of 1999 include first quarter gains of
$134 million from the sale of Key's interest in Electronic Payment Services,
Inc. and $14 million, representing the final gain recorded in connection with
the 1998 sale of a 51% interest in Key Merchant Services, LLC. In addition, Key
recorded a second quarter 1999 gain of $15 million from the sale of common
shares obtained in the first quarter sale of Electronic Payment Services, Inc.
FIGURE 10. NONINTEREST INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, CHANGE SIX MONTHS ENDED JUNE 30, CHANGE
--------------------------- ---------------- ------------------------ ----------------
dollars in millions 2000 1999 AMOUNT PERCENT 2000 1999 AMOUNT PERCENT
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Trust and asset management income $ 116 $110 $ 6 5.5% $ 231 $ 216 $ 15 6.9%
Investment banking and capital markets income 98 100 (2) (2.0) 187 166 21 12.7
Service charges on deposit accounts 85 82 3 3.7 171 163 8 4.9
Brokerage commission income 34 42 (8) (19.0) 79 84 (5) (6.0)
Corporate owned life insurance income 25 27 (2) (7.4) 50 51 (1) (2.0)
Credit card fees 2 21 (19) (90.5) 8 31 (23) (74.2)
Net loan securitization gains 7 18 (11) (61.1) 11 50 (39) (78.0)
Net securities gains 2 5 (3) (60.0) 3 9 (6) (66.7)
Other income:
Letter of credit and loan fees 24 24 -- -- 47 44 3 6.8
Electronic banking fees 17 14 3 21.4 32 26 6 23.1
Insurance income 14 17 (3) (17.6) 31 32 (1) (3.1)
Loan securitization servicing fees 7 8 (1) (12.5) 13 15 (2) (13.3)
Gains from sales of loans 5 12 (7) (58.3) 12 22 (10) (45.5)
Miscellaneous income 39 37 2 5.4 76 75 1 1.3
------------------------------------------------------------------------------------------------------------------------------------
Total other income 106 112 (6) (5.4) 211 214 (3) (1.4)
------------------------------------------------------------------------------------------------------------------------------------
Total core noninterest income 475 517 (42) (8.1) 951 984 (33) (3.4)
Gain from sale of credit card portfolio -- -- -- -- 332 -- 332 N/M
Gain from sale of Electronic Payment Services, Inc. -- -- -- -- -- 134 (134) (100.0)
Gain from sale of Key Merchant Services, LLC -- -- -- -- -- 14 (14) (100.0)
Gain from sale of Concord EFS, Inc. common shares -- 15 (15) (100.0) -- 15 (15) (100.0)
Nonrecurring charges -- -- -- -- (2) -- (2) N/M
------------------------------------------------------------------------------------------------------------------------------------
Total significant nonrecurring items -- 15 (15) (100.0) 330 163 167 102.5
------------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $ 475 $532 $(57) (10.7)% $1,281 $1,147 $ 134 11.7%
===== ==== ==== ====== ====== =====
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
N/M = Not meaningful
FIGURE 11. INVESTMENT BANKING AND CAPITAL MARKETS INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, CHANGE SIX MONTHS ENDED JUNE 30, CHANGE
--------------------------- ---------------- ------------------------ ----------------
dollars in millions 2000 1999 AMOUNT PERCENT 2000 1999 AMOUNT PERCENT
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Dealer trading and derivatives income $40 $ 34 $ 6 17.6% $ 84 $ 71 $ 13 18.3%
Investment banking income 32 45 (13) (28.9) 53 64 (11) (17.2)
Equity capital income 18 15 3 20.0 33 18 15 83.3
Foreign exchange income 8 6 2 33.3 17 13 4 30.8
-----------------------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $98 $100 $ (2) (2.0)% $187 $166 $ 21 12.7%
=== ==== ==== ==== ==== ====
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
44
<PAGE> 45
FIGURE 12. TRUST AND ASSET MANAGEMENT
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, CHANGE SIX MONTHS ENDED JUNE 30, CHANGE
-------------------------- ---------------- ------------------------ ---------------
dollars in millions 2000 1999 AMOUNT PERCENT 2000 1999 AMOUNT PERCENT
==================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Personal asset management and custody fees $ 46 $ 45 $ 1 2.2% $ 93 $ 93 -- --
Institutional asset management and custody fees 24 23 1 4.3 48 48 -- --
Bond services 15 7 8 114.3 24 12 $ 12 100.0%
All other fees 31 35 (4) (11.4) 66 63 3 4.8
----------------------------------------------------------------------------------------------------------------------------------
Total trust and asset management income $116 $110 $ 6 5.5% $231 $216 $ 15 6.9%
==== ==== ==== ==== ==== ====
dollars in billions
------------------------------------------------------------------------------------------
JUNE 30,
Discretionary assets $ 70 $ 69 $ 1 1.4%
Non-discretionary assets 54 50 4 8.0
------------------------------------------------------------------------------------------
Total trust assets $124 $119 $ 5 4.2%
==== ==== ====
------------------------------------------------------------------------------------------
</TABLE>
NONINTEREST EXPENSE
Noninterest expense for the second quarter of 2000 totaled $698 million, down
$25 million, or 4%, from the second quarter of 1999. For the first six months of
the year, noninterest expense was $1.4 billion, representing a decrease of $52
million, or 4%, from the first half of 1999. Significant nonrecurring items that
affect the comparability of results for 2000 and 1999 are shown in Figure 13. In
the current year, these items primarily comprise restructuring and other special
charges which are discussed in greater detail under the heading "Restructuring
and other special charges" beginning on page 46. Primary among the significant
nonrecurring items recorded during the first six months of 1999 are $23 million
of charitable contributions made in light of the gain realized from the sale of
Key's interest in Electronic Payment Services, Inc. Of these contributions, $3
million was recorded during the second quarter.
Excluding nonrecurring charges, core noninterest expense of $696 million for the
second quarter of 2000 decreased by $24 million, or 3%, from the year-ago
quarter and represents Key's lowest quarterly level of core expense over the
last year and a half. This improvement came largely from lower costs related to
personnel (down $22 million) and equipment (down $7 million) that are primarily
the result of Key's productivity improvement initiative and the strategic
divestitures discussed earlier. These decreases were offset in part by a $7
million increase in marketing expense.
For the first six months of 2000, core noninterest expense was $1.4 billion,
relatively unchanged from the same period last year. The largest decreases in
expense came from equipment (down $15 million) and personnel (down $12 million).
These improvements were substantially offset, however, by higher costs
associated with professional fees (up $8 million), computer processing (up $6
million) and marketing (up $4 million). In addition, miscellaneous expense in
the first quarter of 2000 included a $7 million charge to reduce the carrying
amount of residual values related to leased vehicles.
Figure 13 shows the components of Key's noninterest expense. The discussion that
follows explains the composition of some of these components and the factors
that caused some components to change from the prior year.
PERSONNEL. Personnel expense, the largest category of Key's noninterest expense,
posted decreases from the prior year for both the quarterly and year-to-date
periods. These improvements are attributable to the heightened attention to cost
management brought about by our productivity improvement initiative, as well as
the effects of the strategic divestitures. At June 30, 2000, the number of
full-time equivalent employees was 23,005, compared with 24,568 at the end of
1999 and 25,758 a year ago.
COMPUTER PROCESSING. The increases in computer processing expense is due to
higher levels of computer software amortization, as well as increases related to
software rental and maintenance.
45
<PAGE> 46
EQUIPMENT. Decreases in equipment expense for both the quarterly and
year-to-date periods were driven by reductions in both depreciation and rental
expense.
PROFESSIONAL FEES. Professional fees comprise expenses incurred for legal,
audit, consulting and certain other business services. The $4 million and $8
million increases from the respective quarterly and year-to-date periods in 1999
were spread among all of the above categories.
FIGURE 13. NONINTEREST EXPENSE
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, CHANGE SIX MONTHS ENDED JUNE 30,
--------------------------------- ----------------------- -------------------------
dollars in millions 2000 1999 AMOUNT PERCENT 2000 1999
==================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Personnel $ 361 $ 383 $ (22) (5.7)% $ 743 $ 755
Net occupancy 56 58 (2) (3.4) 113 117
Computer processing 60 59 1 1.7 119 113
Equipment 42 49 (7) (14.3) 90 105
Marketing 31 24 7 29.2 53 49
Amortization of intangibles 25 26 (1) (3.8) 50 54
Professional fees 21 17 4 23.5 40 32
Other expense:
Postage and delivery 17 18 (1) (5.6) 34 37
Telecommunications 13 14 (1) (7.1) 27 28
Equity- and gross receipts- based taxes 8 9 (1) (11.1) 16 17
OREO expense, net 1 3 (2) (66.7) 3 8
Miscellaneous expense 61 60 1 1.7 126 112
----------------------------------------------------------------------------------------------------------------------------------
Total other expense 100 104 (4) (3.8) 206 202
----------------------------------------------------------------------------------------------------------------------------------
Total core noninterest expense 696 720 (24) (3.3) 1,414 1,427
Restructuring and other special charges 2 -- 2 N/M 14 --
Other nonrecurring items -- 3 (3) (100.0) (3) 50
----------------------------------------------------------------------------------------------------------------------------------
Total significant nonrecurring items 2 3 (1) (33.3) 11 50
----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 698 $ 723 $ (25) (3.5)% $ 1,425 $ 1,477
======= ======= ======= ======== ========
Full-time equivalent employees at period end 23,005 25,758 23,005 25,758
Efficiency ratio(a) 60.26% 59.21% 61.27% 60.16%
Overhead ratio(b) 32.50 29.97 34.12 31.57
----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
CHANGE
--------------------------
dollars in millions AMOUNT PERCENT
==========================================================================
<S> <C> <C>
Personnel $ (12) (1.6)%
Net occupancy (4) (3.4)
Computer processing 6 5.3
Equipment (15) (14.3)
Marketing 4 8.2
Amortization of intangibles (4) (7.4)
Professional fees 8 25.0
Other expense:
Postage and delivery (3) (8.1)
Telecommunications (1) (3.6)
Equity- and gross receipts- based taxes (1) (5.9)
OREO expense, net (5) (62.5)
Miscellaneous expense 14 12.5
--------------------------------------------------------------------------
Total other expense 4 2.0
--------------------------------------------------------------------------
Total core noninterest expense (13) (.9)
Restructuring and other special charges 14 N/M
Other nonrecurring items (53) N/M
--------------------------------------------------------------------------
Total significant nonrecurring items (39) (78.0)
--------------------------------------------------------------------------
Total noninterest expense $ (52) (3.5)%
========
</TABLE>
(a) This ratio measures the extent to which recurring revenues are absorbed by
operating expenses and is calculated as follows: noninterest expense
(excluding certain nonrecurring charges) divided by the sum of
taxable-equivalent net interest income and noninterest income (excluding
gains from certain divestitures and certain nonrecurring charges).
(b) This ratio is the difference between noninterest expense (excluding
certain nonrecurring charges) and noninterest income (excluding gains from
certain divestitures and certain nonrecurring charges) divided by
taxable-equivalent net interest income.
N/M=Not Meaningful
RESTRUCTURING AND OTHER SPECIAL CHARGES. During the first six months of 2000,
Key recorded net nonrecurring charges of $16 million (including net
restructuring charges of $9 million) in connection with strategic actions
initiated in the fourth quarter of 1999, as more fully discussed in Note 10
("Restructuring Charges") on page 19. Of these charges, $2 million, which was
not related to restructuring, was recorded during the second quarter. These
actions include the outsourcing of certain nonstrategic support functions (which
resulted in the write-off of selected assets, including certain software), site
consolidations in a number of Key's businesses and a reduction in the number of
management layers. Cash generated by Key's operations will fund the
restructuring charge liability. None of the charges will have a material impact
on Key's liquidity.
During the first quarter of 2000, Key also recorded a $2 million credit to
restructuring charges in connection with separate actions initiated during the
fourth quarter of 1996 to complete Key's transformation to a nationwide
bank-based financial services company. The credit was taken to reduce the
remaining liability associated with branch consolidations, since favorable
market conditions resulted in lower costs to consolidate these branches than
originally expected.
46
<PAGE> 47
EFFICIENCY RATIO. The efficiency ratio, which provides a measure of the extent
to which recurring revenues are used to pay operating expenses, was 60.26% for
the second quarter of 2000, compared with 62.27% for the first quarter of 2000
and 59.21% for the same period last year.
"Other expense" includes equity- and gross receipts-based taxes that are
assessed in lieu of an income tax in certain states in which Key operates. These
taxes represented 69 basis points of Key's efficiency ratio for both the second
and first quarters of 2000 and 74 basis points of Key's efficiency ratio for the
second quarter of 1999. The extent to which such taxes impact noninterest
expense will vary among companies based on the geographic locations in which
they conduct their business.
INCOME TAXES
The provision for income taxes was $134 million for the three-month period ended
June 30, 2000, down from $150 million for the same period in 1999. The effective
tax rate (which is the provision for income taxes as a percentage of income
before income taxes) for the second quarter of 2000 was 35.1%, compared with
34.9% for the second quarter of 1999. For the first six months of 2000, the
provision for income taxes was $334 million compared with $292 million for the
first six months of last year. The effective tax rates for these periods was
35.2% and 33.8%, respectively. Primary factors contributing to the slight
increase in the effective tax rate for the quarterly period were higher state
taxes and higher levels of amortization related to non-deductible intangibles.
The increase in the year-to-date rate also reflects higher state taxes, as well
as lower proportions of tax-exempt income and tax credits to pretax earnings in
the current year. For both the quarterly and year-to-date periods the increase
from 1999 was moderated by the impact of a second quarter 1999 catch-up
adjustment related to the amortization of certain investments in low-income
housing projects.
The effective income tax rate remains below Key's combined statutory Federal and
state rate of 37%, primarily because we continue to invest in tax-advantaged
assets (such as tax-exempt securities and corporate owned life insurance) and to
recognize credits associated with investments in low-income housing projects.
47
<PAGE> 48
FINANCIAL CONDITION
-------------------
LOANS
At June 30, 2000, total loans outstanding were $65.6 billion, compared with
$64.2 billion at the end of 1999 and $62.0 billion a year ago. A summary of the
composition of the loan portfolio at each of these respective dates is presented
in Note 6 ("Loans") on page 15. Key achieved a 6% increase in loans during the
past twelve months, primarily as a result of our targeted efforts to increase
the commercial and home equity portfolios. These efforts were supported by the
overall strength of the economy.
Key's success in generating new loan volume has resulted in loan growth that has
outpaced the growth of Key's deposits. As a result, we have used alternative
funding sources such as securitizations to continue to capitalize on our lending
opportunities. Our acquisition of National Realty Funding L.C. is expected to
facilitate these efforts, especially with regard to commercial real estate
lending. In addition, during the first quarter, we created a commercial loan
conduit to facilitate the sale of lower-spread commercial loans, which we
continue to service for a fee. Loans outstanding (excluding loans held for sale)
would have grown by $7.0 billion, or 12%, over the past twelve months, if we had
not securitized and/or sold $5.4 billion of loans during that time period. This
includes the fourth quarter 1999 divestiture of branches with loan portfolios
aggregating $505 million and the first quarter 2000 sale of our $1.3 billion
credit card portfolio.
Excluding the impact of loan sales, commercial loans rose by $5.2 billion, or
15%, since June 30, 1999, due primarily to strong growth in the structured
finance, healthcare, media and middle market portfolios, a $953 million increase
in commercial real-estate mortgage loans, an $859 million increase in the lease
financing portfolio and a $565 million increase in real estate-construction
loans. Consumer loans (excluding loan sales) rose by $1.8 billion, or 7%.
Increases of $1.9 billion in the home equity portfolio and $184 million in the
lease financing portfolio were partially offset by decreases in both the
installment and mortgage portfolios.
On the same basis, commercial loans grew by $3.0 billion, or an annualized 17%,
from the 1999 year end, reflecting growth in all major sectors of the portfolio.
At the same time, home equity loans were up $937 million, or an annualized 25%.
SALES, SECURITIZATIONS, AND DIVESTITURES. Among the factors that Key considers
in determining which loans to securitize are:
- the extent to which the characteristics of a specific loan portfolio make
it conducive to securitization;
- the relative cost of funds;
- the level of credit risk; and
- capital requirements.
In addition to balancing the above factors, we may securitize loans when
conditions in the capital markets make that strategy more attractive than
conventional funding sources like debt.
During the past twelve months, in addition to selling loans in connection with
branch divestitures and the sale of the credit card portfolio, Key sold $1.6
billion of education loans ($1.4 billion through securitizations), $805 million
of commercial loans, $697 million of commercial real estate loans and $438
million of home equity loans ($347 million through securitizations).
Management will continue to explore opportunities to sell certain loan
portfolios, consistent with prudent asset/liability management practices.
However, we intend to securitize and sell fewer of the home equity loans
originated by our home equity finance affiliate. By retaining these assets, we
intend to replace over
48
<PAGE> 49
time the revenue generated by our former credit card business. This is one of
the factors that led to the strong growth of the home equity portfolio discussed
above.
Figure 14 summarizes Key's loan sales (including securitizations) and branch
divestitures for the first six months of 2000 and all of 1999.
FIGURE 14. LOANS SOLD AND DIVESTED
<TABLE>
<CAPTION>
COMMERCIAL RESIDENTIAL HOME CREDIT CARD BRANCH
in millions COMMERCIAL REAL ESTATE REAL ESTATE EQUITY RECEIVABLES AUTOMOBILE EDUCATION DIVESTITURES TOTAL
===========================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
2000
-------------
Second quarter $ 451 $ 499 -- $ 23 -- -- $ 518 -- $1,491
First quarter 354 6 -- 24 $1,339 -- 29 -- 1,752
---------------------------------------------------------------------------------------------------------------------------
Total $ 805 $ 505 -- $ 47 $1,339 -- $ 547 -- $3,243
====== ====== ====== ====== ====== ======
1999
-------------
Fourth Quarter -- $ 92 -- $ 32 -- -- $ 299 $ 505 $ 928
Third quarter -- 100 -- 359 -- -- 786 -- 1,245
Second quarter -- 63 $ 292 442 -- -- 132 -- 929
First quarter -- 84 208 428 -- $ 555 818 -- 2,093
---------------------------------------------------------------------------------------------------------------------------
Total -- $ 339 $ 500 $1,261 -- $ 555 $2,035 $ 505 $5,195
====== ====== ====== ====== ====== ====== ======
---------------------------------------------------------------------------------------------------------------------------
</TABLE>
Figure 15 shows loans that are either administered or serviced by Key, but are
not recorded on the balance sheet. This includes loans that have been both
securitized and sold, or simply sold outright. The increase in commercial real
estate loans serviced resulted from the first quarter acquisition of National
Realty Funding L.C., while the increase in commercial loans reflects sales that
occurred through Key's new commercial loan conduit.
FIGURE 15. LOANS ADMINISTERED OR SERVICED
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31, JUNE 30,
in millions 2000 1999 1999
==========================================================================================================
<S> <C> <C> <C>
Education loans $3,783 $3,475 $2,785
Automobile loans 602 855 1,153
Home equity loans 1,361 1,542 1,392
Commercial real estate loans 3,700 -- --
Commercial loans 805 -- --
----------------------------------------------------------------------------------------------------------
Total $10,251 $5,872 $5,330
======= ======= ======
----------------------------------------------------------------------------------------------------------
</TABLE>
Key derives income from two sources as a result of such arrangements. We earn
noninterest income (recorded as "other income") from servicing or administering
the loans, and we earn interest income from assets retained in connection with
securitizations and accounted for like debt securities that are classified as
available for sale or trading account assets.
SECURITIES
At June 30, 2000, the securities portfolio totaled $7.4 billion and comprised
$6.3 billion of securities available for sale and $1.1 billion of investment
securities. In comparison, the total portfolio at December 31, 1999, was $7.7
billion, including $6.7 billion of securities available for sale and $986
million of investment securities.
49
<PAGE> 50
Figure 16 shows the composition, yields and remaining maturities of Key's
securities available for sale. Figure 17 provides the same information about
Key's investment securities. For more information about retained interests in
securitizations and gross unrealized gains and losses by type of security,
please see Note 5 ("Securities"), which begins on page 13.
FIGURE 16. SECURITIES AVAILABLE FOR SALE
<TABLE>
<CAPTION>
OTHER
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE-
AGENCIES AND POLITICAL MORTGAGE BACKED
dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(a) SECURITIES(a)
---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
JUNE 30, 2000
Remaining maturity:
One year or less $99 $1 $ 119 $ 2
After one through five years 5 21 3,087 490
After five through ten years 5 29 609 912
After ten years 12 5 175 114
---------------------------------------------------------------------------------------------------------------------------
Fair value $121 $56 $3,990 $1,518
Amortized cost 121 56 4,185 1,551
Weighted average yield 5.33 % 4.73% 6.53% 7.09%
Weighted average maturity 2.3 YEARS 5.8 YEARS 4.1 YEARS 6.0 YEARS
---------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999
Fair value $127 $53 $4,237 $1,678
Amortized cost 128 53 4,426 1,705
---------------------------------------------------------------------------------------------------------------------------
JUNE 30, 1999
Fair value $152 $67 $3,888 $1,861
Amortized cost 152 67 4,029 1,878
---------------------------------------------------------------------------------------------------------------------------
<CAPTION>
RETAINED WEIGHTED
INTERESTS IN OTHER AVERAGE
dollars in millions SECURITIZATIONS(a) SECURITIES TOTAL YIELD(b)
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
JUNE 30, 2000
Remaining maturity:
One year or less -- $ 9 $ 230 6.03%
After one through five years $100 19 3,722 6.47
After five through ten years 215 5 1,775 7.04
After ten years -- 216(c) 522 6.29
------------------------------------------------------------------------------------------------------------
Fair value $315 $249 $6,249 --
Amortized cost 335 259 6,507 6.88%
Weighted average yield 8.91% 3.58% 6.88% --
Weighted average maturity 4.1 YEARS 9.8 YEARS 4.8 YEARS --
------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999
Fair value $343 $227 $6,665 --
Amortized cost 340 223 6,875 6.77%
------------------------------------------------------------------------------------------------------------
JUNE 30, 1999
Fair value $335 $101 $6,404 --
Amortized cost 348 96 6,570 6.61%
--------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Maturity is based upon expected average lives rather than contractual
terms.
(b) Weighted average yields are calculated based on amortized cost. Such yields
have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
(c) Includes equity securities with no stated maturity.
FIGURE 17. INVESTMENT SECURITIES
<TABLE>
<CAPTION>
STATES AND WEIGHTED
POLITICAL OTHER AVERAGE
dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(a)
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
JUNE 30, 2000
Remaining maturity:
One year or less $128 $ 1 $ 129 5.02%
After one through five years 158 -- 158 6.18
After five through ten years 79 24 103 6.24
After ten years 15 723(b) 738 3.51
-----------------------------------------------------------------------------------------------------------
Amortized cost $380 $748 $1,128 4.30%
Fair value 388 748 1,136 --
Weighted average yield 5.73% 3.58% 4.30% --
Weighted average maturity 3.2 YEARS 10.0 YEARS 7.7 YEARS --
-----------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999
Amortized cost $447 $539 $986 6.15%
Fair value 459 539 998 --
-----------------------------------------------------------------------------------------------------------
JUNE 30, 1999
Amortized cost $515 $452 $967 6.57%
Fair value 533 452 985 --
-----------------------------------------------------------------------------------------------------------
</TABLE>
(a) Weighted average yields are calculated based on amortized cost. Such yields
have been adjusted to a taxable-equivalent basis using the statutory
Federal income tax rate of 35%.
(b) Includes equity securities with no stated maturity.
50
<PAGE> 51
ASSET QUALITY
Key manages asset quality by following procedures that address the issue from
many perspectives. Specifically, Key has groups of professionals that:
- evaluate and monitor the level of risk in credit-related assets;
- formulate underwriting standards and guidelines for line management;
- develop commercial and consumer credit policies and systems;
- establish credit-related concentration limits;
- review loans, leases, and other corporate assets to evaluate credit
quality; and
- review the adequacy of the allowance for loan losses.
ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses at June 30, 2000, was
$979 million, or 1.49% of loans. This compares with $930 million, or 1.50% of
loans, at June 30, 1999. The allowance includes $92 million (for 2000) and $51
million (for 1999) that is specifically allocated for impaired loans. For more
information about impaired loans, see Note 7 ("Impaired Loans and Other
Nonperforming Assets") on page 16. At June 30, 2000, the allowance for loan
losses was 179.63% of nonperforming loans, compared with 231.34% at June 30,
1999.
Management relies on an iterative methodology to estimate the appropriate level
of the allowance for loan losses on a quarterly (and at times more frequent)
basis. This methodology is described in Note 1 ("Summary of Significant
Accounting Policies") under the heading "Allowance for Loan Losses," on page 58
of Key's 1999 Annual Report to Shareholders. With the advent of enhanced credit
scoring capabilities, management continues to review and refine Key's
methodology for estimating the appropriate level of the allowance for loan
losses. During the first quarter of 2000, Key enhanced its methodology for
assessing credit risk, particularly within the commercial loan portfolio. As a
result, we recorded an additional provision for loan losses of $121 million in
March. In the prior year, first quarter results included an additional provision
of $30 million related to an enhancement in the allowance methodology pertaining
to the credit card portfolio.
NET LOAN CHARGE-OFFS. As shown in Figure 18, net loan charge-offs for the second
quarter of 2000 were $68 million, or .42% of average loans, compared with $76
million, or .49%, for the same period last year. For the first six months of
2000, net loan charge-offs totaled $202 million, or .63% of average loans,
compared with $157 million, or .51%, for the first half of 1999. Included in net
charge-offs in the current year are $15 million of credit card net charge-offs,
including holdbacks and putbacks related to the January 2000 sale of the credit
card portfolio. Excluding these net charge-offs and the $57 million of one-time
charge-offs discussed below, Key's core net charge-offs for the first six months
of 2000 totaled $130 million, or .41% of average loans.
In February 1999, the Federal banking agencies published revised guidelines
which, among other things, require that consumer loans be charged off when
payments are past due by a prescribed number of days. One of the factors that
drove this change is concern that existing guidance is being interpreted
differently within the banking industry, resulting in disparity in how financial
institutions carry out their charge-off practices. Key elected to implement
these new guidelines during the first quarter of 2000, although compliance is
not required until the end of this year. This resulted in the acceleration of
$57 million of consumer loan charge-offs that might otherwise have occurred at
later dates. Key's allowance at December 31, 1999, had already included an
allocation for these potential losses. For more information on the revised
guidelines, see Item 5. ("Other Information") which begins on page 59.
In comparison with the second quarter of 1999, net charge-offs in the commercial
loan portfolio rose by $9 million. This increase reflected the growth
experienced in the overall portfolio, as well as a modest rise in
51
<PAGE> 52
the proportion of troubled credits within the portfolio. The increase in
commercial loan net charge-offs was more than offset by a $17 million decline in
the level of net charge-offs in the consumer loan portfolio. Net charge-offs of
credit card receivables decreased by $19 million due to the sale of the
portfolio. At the same time, net charge-offs in the remainder of the consumer
portfolio increased by only $2 million. Management anticipates that the levels
of Key's net charge-offs and provision for loan losses will likely rise in the
third quarter for various reasons, including the write-down of three particular
commercial credits predicated on questionable borrower representations.
FIGURE 18. SUMMARY OF LOAN LOSS EXPERIENCE
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
dollars in millions 2000 1999 2000 1999
============================================================================================================
<S> <C> <C> <C> <C>
Average loans outstanding during the period $ 64,817 $ 61,604 $ 64,420 $ 61,648
-----------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $ 979 $ 930 $ 930 $ 900
Loans charged off:
Commercial, financial and agricultural 37 29 71 51
Real estate-commercial mortgage 2 -- 4 --
Commercial lease financing 3 7 7 9
-----------------------------------------------------------------------------------------------------------
Total commercial loans 42 36 82 60
Real estate-residential mortgage 3 3 4 5
Home equity 3 2 11 5
Credit card -- 22 16 48
Consumer-direct 9 10 29 22
Consumer-indirect lease financing 4 2 11 6
Consumer-indirect other 33 30 105 66
-----------------------------------------------------------------------------------------------------------
Total consumer loans 52 69 176 152
-----------------------------------------------------------------------------------------------------------
94 105 258 212
Recoveries:
Commercial, financial and agricultural 4 7 14 15
Real estate-commercial mortgage 1 -- 3 2
Commercial lease financing -- 1 2 1
-----------------------------------------------------------------------------------------------------------
Total commercial loans 5 8 19 18
Real estate-residential mortgage 2 2 2 3
Home equity 1 -- 1 --
Credit card 2 5 3 8
Consumer-direct 2 3 3 4
Consumer-indirect lease financing -- 1 2 2
Consumer-indirect other 14 10 26 20
-----------------------------------------------------------------------------------------------------------
Total consumer loans 21 21 37 37
-----------------------------------------------------------------------------------------------------------
26 29 56 55
-----------------------------------------------------------------------------------------------------------
Net loans charged off (68) (76) (202) (157)
Provision for loan losses 68 76 251 187
-------------------------------------------------------------------------------------------- -------
Allowance for loan losses at end of period $ 979 $ 930 $ 979 $ 930
======== ======== ======== ========
-----------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans .42% .49% .63% .51%
Allowance for loan losses to period-end loans 1.49 1.50 1.49 1.50
Allowance for loan losses to nonperforming loans 179.63 231.34 179.63 231.34
-----------------------------------------------------------------------------------------------------------
</TABLE>
NONPERFORMING ASSETS. Figure 19 shows the composition of Key's nonperforming
assets. These assets totaled $577 million at June 30, 2000, and represented .88%
of loans, other real estate owned (known as "OREO") and other nonperforming
assets, compared with $438 million, or .71%, at June 30, 1999. The $139 million
increase in the level of nonperforming assets over the past twelve months
resulted from a $143 million increase in nonperforming loans, offset in part by
a $6 million decrease in OREO. The increase in nonperforming reflects, in part,
significant loan growth, the maturation of certain segments of the portfolio and
the effect of changes in the Government's reimbursement policies for the health
care industry.
The amounts presented in Figure 19 have been restated from those previously
reported. This restatement reflects a reclassification of certain loans from
those reported as 90 days past due and still accruing to those reported as
nonaccrual. The reclassified loans are predominantly home equity loans held by
Key Home Equity Services, a division of Key Bank USA, National Association that
acts as a third-party purchaser of
52
<PAGE> 53
home equity loans. Although these loans had not been properly categorized as
nonaccrual in Key's internal reporting system, the accrual of interest on the
balances had, in fact, ceased. Therefore, the restatement had no impact on Key's
earnings.
FIGURE 19. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2000 1999 1999
========================================================================================
<S> <C> <C> <C>
Commercial, financial and agricultural $ 224 $ 175 $ 146
Real estate-- commercial mortgage 95 102 99
Real estate-- construction 20 7 2
Commercial lease financing 54 28 38
--------------------------------------------------------------------------------------
Total commercial loans 393 312 285
Real estate-- residential mortgage 40 44 53
Home equity 68 50 36
Consumer-- direct 8 6 5
Consumer-- indirect lease financing 5 3 2
Consumer-- indirect other 31 32 21
--------------------------------------------------------------------------------------
Total consumer loans 152 135 117
--------------------------------------------------------------------------------------
Total nonperforming loans 545 447 402
OREO 30 27 46
Allowance for OREO losses (1) (3) (11)
--------------------------------------------------------------------------------------
OREO, net of allowance 29 24 35
Other nonperforming assets 3 2 1
--------------------------------------------------------------------------------------
Total nonperforming assets $ 577 $ 473 $ 438
===== ===== ====
--------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 276 $ 219 $ 172
--------------------------------------------------------------------------------------
Nonperforming loans to period-end loans .83% .70% .65%
Nonperforming assets to period-end loans
plus OREO and other nonperforming assets .88 .74 .71
--------------------------------------------------------------------------------------
</TABLE>
DEPOSITS AND OTHER SOURCES OF FUNDS
"Core deposits" are Key's primary source of funding. These deposits consist of
domestic deposits other than certificates of deposit of $100,000 or more. During
the second quarter of 2000, core deposits averaged $37.4 billion, and
represented 51% of the funds Key used to support earning assets, compared with
$36.9 billion and 52%, respectively, during the same period last year. As shown
in Figure 5 (which spans pages 36 and 37), Key has experienced a change in the
mix of core deposits over the past twelve months. The levels of money market
deposits, savings deposits and NOW accounts declined, primarily because we sold
28 branches with deposits of $1.3 billion as part of the October 1999
divestiture of our Long Island franchise. In addition, client preferences for
higher returns and the strength of the securities markets during 1999 have also
caused a shift from traditional bank products to nonbank financial investments,
such as equity securities. At the same time, Key's time deposits have grown
steadily as a result of client preferences for investments that offer higher
returns, as well as our heightened focus on building Key's deposit base. During
the second quarter, the deposits in Key's Retail Banking line of business grew
by an annualized 13% from the prior quarter.
Purchased funds, comprising large certificates of deposit, deposits in the
foreign office, and short-term borrowings, averaged $19.5 billion during the
second quarter of 2000, compared with $17.1 billion a year ago. As shown in
Figure 5, Key has relied more on purchased deposits and long-term debt,
including
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<PAGE> 54
capital securities, to fund earning assets in the current year. In addition, Key
continues to consider loan securitizations as a funding alternative when market
conditions are favorable. During the first six months of 2000, Key securitized
and sold $503 million of education loans, all of which occurred in the second
quarter.
LIQUIDITY
"Liquidity" measures whether an entity has sufficient cash flow to meet its
financial obligations when due. Key has sufficient liquidity when it can meet
the needs of depositors, borrowers, and creditors at a reasonable cost, on a
timely basis, and without adverse consequences. KeyCorp has sufficient liquidity
when it can pay dividends to shareholders, service its debt, and support
customary corporate operations and activities, including acquisitions.
LIQUIDITY FOR KEY. Management actively analyzes and manages Key's liquidity. In
particular, Key's Funding and Investment Management Group monitors the overall
mix of funding sources with the objective of maintaining an appropriate mix in
light of the structure of the asset portfolios. We use several tools to maintain
sufficient liquidity.
- We maintain portfolios of short-term money market investments and
securities available for sale, substantially all of which could be
converted to cash quickly at a small expense.
- Key's portfolio of investment securities generates prepayments (often at a
premium) and payments at maturity.
- We try to structure the maturities of our loans so we receive a relatively
consistent stream of payments from borrowers. We also selectively
securitize and package loans for sale.
- Our 938 full-service KeyCenters in 13 states generate a sizable volume of
core deposits. Key's Funding and Investment Management Group monitors
deposit flows and considers alternate pricing structures to attract
deposits when necessary. For more information about core deposits, see the
previous section entitled "Deposits and other sources of funds."
- Key has access to various sources of money market funding (such as Federal
funds purchased, securities sold under repurchase agreements, and bank
notes) and also can borrow from the Federal Reserve Bank to meet short-term
liquidity requirements. Key did not have any borrowings from the Federal
Reserve outstanding as of June 30, 2000.
LIQUIDITY FOR THE PARENT COMPANY. KeyCorp meets its liquidity requirements
principally through regular dividends from affiliate banks. During the first
half of 2000, affiliates paid KeyCorp a total of $455 million in dividends. As
of June 30, 2000, the affiliate banks had an additional $584 million available
to pay dividends without prior regulatory approval. These excess funds are
generally maintained in short-term investments.
ADDITIONAL SOURCES OF LIQUIDITY. Management has implemented several programs
that enable Key and KeyCorp to raise money in the public and private markets
when necessary. The proceeds from all of these programs can be used for general
corporate purposes, including acquisitions.
BANK NOTE PROGRAM. During the first six months of 2000, Key's affiliate banks
raised $2.9 billion under Key's bank note program. Of the notes issued during
the first half of 2000, $700 million have original maturities in excess of one
year and are included in long-term debt; the remaining $2.2 billion have
original maturities of one year or less and are included in short-term
borrowings. On January 21, 2000, Key commenced a new bank note program which
provides for the aggregate issuance of both long- and short-term debt up to
$20.0 billion ($19.0 billion by KeyBank National Association and $1.0 billion by
Key Bank USA, National Association).
EURO NOTE PROGRAM. Under Key's euro note program, KeyCorp, KeyBank National
Association and Key Bank USA, National Association may issue both long- and
short-term debt of up to $7.0 billion in the
54
<PAGE> 55
aggregate. The notes are offered exclusively to non-U.S. investors and can be
denominated in dollars and most European currencies. There were $3.2 billion of
borrowings outstanding under this facility as of June 30, 2000, $848 million of
which were issued during the current year.
COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp has a commercial paper program
and a three-year revolving credit agreement. Each of these facilities provides
funding availability of up to $500 million. As of June 30, 2000, $24 million of
borrowings were outstanding under the commercial paper program; no amount was
outstanding under the revolving credit agreement.
OTHER PUBLICLY ISSUED SECURITIES. KeyCorp has a universal shelf registration
statement on file with the Securities and Exchange Commission that provides for
the possible issuance of up to $1.3 billion of debt and equity securities. At
June 30, 2000, unused capacity under the shelf registration totaled $562
million, including $50 million reserved for issuance as medium-term notes. If
KeyCorp maintains its favorable debt ratings, shown below as of June 30, 2000,
management believes that, under normal conditions in the capital markets, any
eventual offering of securities should be well-received by investors.
Senior Subordinated
Commercial Long-Term Long-Term
Paper Debt Debt
---------------- ------------------- ---------------
Fitch F1 A+ A
Standard & Poor's A-2 A- BBB+
Moody's P-1 A1 A2
For more information about Key's sources and uses of cash for the six-month
periods ended June 30, 2000 and 1999, see the Consolidated Statements of Cash
Flow on page 6.
CAPITAL AND DIVIDENDS
SHAREHOLDERS' EQUITY. Total shareholders' equity at June 30, 2000, was $6.5
billion, up $118 million from the balance at December 31, 1999. Retained
earnings increased by $370 million during the first six months of 2000, offset
to a large extent by a $224 million net increase in treasury stock due to share
repurchases, and a $17 million increase in net unrealized losses on securities
available for sale.
SHARE REPURCHASES. During the first half of 2000, Key repurchased 13,065,000 of
its common shares at an average price per share of $18.64. These shares were
repurchased under a January 2000 authorization by Key's Board of Directors to
repurchase up to 20,000,000 shares in the open market or through negotiated
transactions.
At June 30, 2000, Key had 60,723,102 treasury shares. Management expects to
reissue those shares over time to support the employee stock purchase, 401(k),
stock option, and dividend reinvestment plans, and for other corporate purposes.
During the first six months of 2000, Key reissued 804,141 treasury shares for
employee benefit and dividend reinvestment plans.
CAPITAL ADEQUACY. Capital adequacy is an important indicator of financial
stability and performance. Overall, Key's capital position remains strong: the
ratio of total shareholders' equity to total assets was 7.68% at June 30, 2000,
compared with 7.66% at December 31, 1999, and 7.71% at June 30, 1999.
Banking industry regulators prescribe minimum capital ratios for bank holding
companies and their banking subsidiaries. Risk-based capital guidelines require
a minimum level of capital as a percent of "risk-adjusted assets," which is
total assets plus certain off-balance sheet items that are adjusted for
predefined credit risk factors. Currently, banks and bank holding companies must
maintain, at a minimum, Tier 1 capital as a percent of risk-adjusted assets of
4.0%, and total capital as a percent of risk-adjusted assets of 8.0%. As of June
30, 2000, Key's Tier 1 capital ratio was 7.88%, and its total capital ratio was
11.74%.
55
<PAGE> 56
The leverage ratio is Tier 1 capital as a percentage of tangible assets.
Leverage ratio requirements vary with the condition of the financial
institution. Bank holding companies that either have the highest supervisory
rating or have implemented the Federal Reserve's risk-adjusted measure for
market risk--as KeyCorp has--must maintain a minimum leverage ratio of 3.0%. All
other bank holding companies must maintain a minimum ratio of 4.0%. As of June
30, 2000, KeyCorp had a leverage ratio of 7.90%, which is substantially higher
than the minimum requirement.
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 qualified as
"well capitalized" at June 30, 2000, since each exceeded the prescribed
thresholds of 10% for total capital, 6% for Tier 1 capital, and 5% for the
leverage ratio. If these provisions applied to bank holding companies, KeyCorp
would also qualify as "well capitalized" at June 30, 2000. The FDIC-defined
capital categories serve a limited regulatory function. Investors should not
treat them as a representation of the overall financial condition or prospects
of Key or its affiliates.
Figure 20 presents the details of Key's regulatory capital position at June 30,
2000, December 31, 1999, and June 30, 1999.
56
<PAGE> 57
FIGURE 20. CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31, JUNE 30,
dollars in millions 2000 1999 1999
===============================================================================================
<S> <C> <C> <C>
TIER 1 CAPITAL
Common shareholders' equity(a) $ 6,643 $ 6,508 $ 6,335
Qualifying capital securities 1,243 1,243 994
Less: Goodwill (1,357) (1,389) (1,446)
Other intangible assets(b) (49) (56) (64)
-----------------------------------------------------------------------------------------------
Total Tier 1 capital 6,480 6,306 5,819
-----------------------------------------------------------------------------------------------
TIER 2 CAPITAL
Allowance for loan losses(c) 979 930 930
Net unrealized holding gains(d) -- 3 --
Qualifying long-term debt 2,191 2,330 2,383
-----------------------------------------------------------------------------------------------
Total Tier 2 capital 3,170 3,263 3,313
-----------------------------------------------------------------------------------------------
Total capital $ 9,650 $ 9,569 $ 9,132
======= ======= ======
RISK-ADJUSTED ASSETS
Risk-adjusted assets on balance sheet $ 69,733 $ 68,619 $ 65,923
Risk-adjusted off-balance sheet exposure 13,754 14,513 13,004
Less: Goodwill (1,357) (1,389) (1,446)
Other intangible assets(b) (49) (56) (64)
Plus: Market risk-equivalent assets 150 391 392
Net unrealized holding gains(d) -- 3 --
-----------------------------------------------------------------------------------------------
Gross risk-adjusted assets 82,231 82,081 77,809
Less: Excess allowance for loan losses(c) -- -- --
-----------------------------------------------------------------------------------------------
Net risk-adjusted assets $ 82,231 $ 82,081 $ 77,809
======== ======== =======
AVERAGE QUARTERLY TOTAL ASSETS $ 83,405 $ 82,574 $ 80,025
======== ======== =======
CAPITAL RATIOS
Tier 1 risk-adjusted capital ratio 7.88% 7.68% 7.48%
Total risk-adjusted capital ratio 11.74 11.66 11.74
Leverage ratio(e) 7.90 7.77 7.41
-----------------------------------------------------------------------------------------------
</TABLE>
(a) Common shareholders' equity excludes the impact of net unrealized gains or
losses on securities, except for net unrealized losses on marketable equity
securities.
(b) Intangible assets (excluding goodwill) recorded after February 19, 1992,
and deductible portions of purchased mortgage servicing rights.
(c) The allowance for loan losses included in Tier 2 capital is limited to
1.25% of gross risk-adjusted assets.
(d) 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.
(e) Tier 1 capital as a percentage of average quarterly total assets, less
goodwill and other non-qualifying intangible assets as defined in footnote
(b).
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<PAGE> 58
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The information included in the Market Risk Management section beginning on page
39 of the Management's Discussion and Analysis of Financial Condition and
Results of Operations is incorporated herein by reference.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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.
In March 1998, McDonald Investments Inc. ("McDonald"), now a
subsidiary of KeyCorp, participated as an initial purchaser in an
offering to institutional investors of certain securities of
Nakornthai Strip Mill Public Company Ltd. ("NSM"), a Thailand public
company, and certain NSM affiliates, including approximately $452
million in debt securities and related warrants (the "Securities").
The offering was part of the financing of an NSM steel mini-mill
located in Chonburi, Thailand. McDonald served as a financial advisor
to NSM and was an initial purchaser of approximately $44 million of
the Securities. On December 24, 1998, holders of Securities gave a
Notice of Default alleging a number of defaults under the terms of
the Securities. NSM is currently working toward a restructuring of
its obligations, including obligations to holders of the Securities
and other creditors.
Certain purchasers of Securities have commenced litigation against
McDonald and other parties in California, Connecticut, Illinois,
Minnesota, New Jersey and New York, claiming that McDonald, the other
initial purchasers and certain other third party service providers to
NSM have violated certain state and federal securities and other
laws. The lawsuits are based on alleged misstatements and omissions
in the Offering Memorandum for the Securities, and on certain other
information and oral statements allegedly provided to potential
investors. In each lawsuit the plaintiffs allege misrepresentations
relating to (among other things) the physical facilities at the mill,
the management of the mill, the supply of inputs to the mill and the
use of the proceeds of the offering.
There are currently pending eight separate lawsuits brought by
purchasers of the Securities against McDonald, as well as other
defendants (two suits in Federal District Court in Minnesota; one
suit in Federal District Court in New York; two suits in California;
and one suit in each of Connecticut, Illinois and New Jersey). The
aggregate amount of Securities alleged to have been purchased by the
plaintiffs in these eight lawsuits is at least $257 million. While
the relief claimed in the lawsuits varies, generally, the plaintiffs
seek rescission of the sale of the Securities, compensatory damages,
legal fees, expenses, and in the case of the New Jersey action (which
currently covers approximately $107 million face value of
Securities), treble damages consistent with applicable law, exemplary
damages and civil penalties.
McDonald is vigorously defending these actions and has filed, or will
file, responses to each complaint denying liability.
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<PAGE> 59
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the 2000 Annual Meeting of Shareholders of KeyCorp held on May 18,
2000, six directors were elected for three-year terms expiring in 2003,
and shareholders adopted a resolution to ratify the appointment by the
Board of Directors of Ernst & Young LLP as independent auditors for
KeyCorp for the fiscal year ending December 31, 2000. Shareholders
approved a shareholder proposal requesting that the Board of Directors
take the necessary steps to cause annual election of all directors.
Director nominees for terms expiring in 2003 were: William G. Bares,
Dr. Carol A. Cartwright, Robert W. Gillespie, Henry S. Hemingway,
Steven A. Minter and Ronald B. Stafford. Directors whose term in office
as a director continued after the Annual Meeting of Shareholders were:
Cecil D. Andrus, Albert C. Bersticker, Edward P. Campbell, Thomas A.
Commes, Kenneth M. Curtis, Alexander M. Cutler, Charles R. Hogan,
Douglas J. McGregor, Henry L. Meyer III, Bill R. Sanford, Dennis W.
Sullivan and Peter G. Ten Eyck, II.
The vote on each issue was as follows:
<TABLE>
<CAPTION>
For Against Abstain
-------------------------------------------------------
<S> <C> <C> <C>
Election of Directors:
William G. Bares 354,008,572 * 22,546,675
Dr. Carol A. Cartwright 353,814,089 * 22,741,158
Robert W. Gillespie 349,879,748 * 26,675,499
Henry S. Hemingway 356,870,200 * 19,685,047
Steven A. Minter 353,747,627 * 22,807,620
Ronald B. Stafford 354,170,979 * 22,384,268
Ratification of Ernst & Young as
independent auditors of KeyCorp 363,023,730 10,601,763 2,929,753
Shareholder proposal requesting
necessary steps to cause
annual election of all Directors 172,128,693 143,970,075 8,027,678 **
</TABLE>
*Proxies provide that shareholders may either cast a vote for, or
abstain from voting for, directors.
**In addition, there were 52,428,801 broker non-votes on this matter.
ITEM 5. OTHER INFORMATION
REGULATORY CAPITAL. In March 2000, the Federal Reserve Board published
for public comment a proposal to amend its regulatory capital
guidelines to increase the amount of consolidated regulatory capital
required to be held by bank holding companies with respect to certain
equity and debt investments made by bank holding companies, or their
subsidiaries, in nonfinancial companies. The financial impact of the
proposal upon Key cannot be determined until a final rule is published.
However, based upon its estimate of the impact of applying the proposed
rule to Key's current investments covered by the proposed rule,
management anticipates that Key's regulatory capital ratios will remain
in excess of the ratios required to be maintained by FDIC-insured
depository institutions, in order to be considered "well-capitalized"
under the prompt corrective action provisions of the FDIA.
UNIFORM RETAIL CREDIT POLICY. In February 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
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<PAGE> 60
or thrift financial reports with a Federal banking agency. In general,
the Retail Credit Policy:
- establishes uniform delinquency charge-off policies for
closed-end and open-end credit;
- 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.
Key elected to implement these new guidelines during the first quarter
of 2000, although compliance is not required until December 31, 2000.
This resulted in the acceleration of $57 million of consumer loan
charge-offs that might otherwise have occurred at later dates. Key's
allowance at December 31, 1999, had already included an allocation for
these potential losses. In June, the Federal banking agencies further
revised the Retail Credit Policy to clarify certain provisions. The
impact of these revisions, however, is not anticipated by management to
have any material adverse effect on Key's financial condition and
results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10) KeyCorp Director Deferred Compensation Plan (May 18, 2000
Restatement)
(15) Acknowledgment Letter of Independent Auditors
(27) Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
April 21, 2000 - Item 5. Other Events and Item 7. Financial
Statements and Exhibits. Reporting that on April 20, 2000, the
Registrant issued a press release announcing its earnings results
for the three-month period ended March 31, 2000.
No other reports on Form 8-K were filed during the three-month
period ended June 30, 2000.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEYCORP
------------------------------------
(Registrant)
Date: August 10, 2000 /s/ Lee Irving
------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting Officer
60
