<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 September 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
[KEYCORP LOGO]
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(Exact name of registrant as specified in its charter)
Ohio 34-6542451
-------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
127 Public Square, Cleveland, Ohio 44114-1306
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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 425,826,510 Shares
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(Title of class) (Outstanding at October 31, 2000)
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KEYCORP
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS PAGE NUMBER
<S> <C>
Consolidated Balance Sheets --
September 30, 2000, December 31, 1999 and September 30, 1999 3
Consolidated Statements of Income --
Three months and nine months ended September 30, 2000 and 1999 4
Consolidated Statements of Changes in Shareholders' Equity --
Nine months ended September 30, 2000 and 1999 5
Consolidated Statements of Cash Flow --
Nine months ended September 30, 2000 and 1999 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 26
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 27
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK 59
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 60
Item 5. OTHER INFORMATION 61
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 62
Signature 62
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
Consolidated Balance Sheets
September 30, December 31, September 30,
dollars in millions 2000 1999 1999
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(Unaudited) (Unaudited)
<S> <C> <C> <C>
ASSETS
Cash and due from banks $ 2,691 $ 2,816 $ 3,018
Short-term investments 1,570 1,860 2,094
Securities available for sale 6,664 6,665 6,567
Investment securities (fair value:
$1,262, $998 and $1,005) 1,253 986 989
Loans, net of unearned income
of $1,756, $1,621 and $1,566 66,299 64,222 63,181
Less: Allowance for loan losses 1,001 930 930
-------------------------------------------------------------------------------------------------------
Net loans 65,298 63,292 62,251
Premises and equipment 711 797 818
Goodwill 1,339 1,389 1,422
Other intangible assets 48 60 64
Corporate owned life insurance 2,185 2,110 2,080
Other assets 3,741 3,420 3,274
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Total assets $85,500 $83,395 $82,577
======= ======= =======
LIABILITIES
Deposits in domestic offices:
Noninterest-bearing $ 8,386 $8,607 $9,050
Interest-bearing 35,016 33,390 34,029
Deposits in foreign office --
interest-bearing 4,407 1,236 387
-------------------------------------------------------------------------------------------------------
Total deposits 47,809 43,233 43,466
Federal funds purchased and securities
sold under repurchase agreements 5,324 4,177 3,510
Bank notes and other short-term
borrowings 6,407 8,439 8,551
Other liabilities 4,397 4,033 3,595
Long-term debt 13,800 15,881 15,815
Corporation-obligated mandatorily
redeemable preferred capital securities
of subsidiary trusts holding solely
subordinated debentures of the
Corporation (See Note 9) 1,243 1,243 1,243
-------------------------------------------------------------------------------------------------------
Total liabilities 78,980 77,006 76,180
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 1,402 1,412 1,412
Retained earnings 6,205 5,833 5,686
Loans to ESOP trustee (13) (24) (24)
Treasury stock, at cost
(64,628,931, 48,462,243 and 43,064,912
shares) (1,502) (1,197) (1,058)
Accumulated other comprehensive loss (64) (127) (111)
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Total shareholders' equity 6,520 6,389 6,397
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Total liabilities and shareholders'
equity $85,500 $83,395 $82,577
======= ======= =======
-------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
</TABLE>
3
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<TABLE>
<CAPTION>
Consolidated Statements of Income (Unaudited)
Three months ended September 30, Nine months ended September 30,
-------------------------------- -------------------------------
dollars in millions, except per share amounts 2000 1999 2000 1999
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<S> <C> <C> <C> <C>
INTEREST INCOME
Loans $1,460 $1,299 $4,204 $3,800
Taxable investment securities 8 4 18 11
Tax-exempt investment securities 5 7 18 24
Securities available for sale 106 106 325 310
Short-term investments 17 17 60 61
---------------------------------------------------------------------------------------------------------------------------------
Total interest income 1,596 1,433 4,625 4,206
INTEREST EXPENSE
Deposits 462 331 1,275 955
Federal funds purchased and securities
sold under repurchase agreements 88 51 194 168
Bank notes and other short-term borrowings 99 103 328 310
Long-term debt, including capital securities 263 248 800 691
---------------------------------------------------------------------------------------------------------------------------------
Total interest expense 912 733 2,597 2,124
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NET INTEREST INCOME 684 700 2,028 2,082
Provision for loan losses 131 78 382 265
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Net interest income after provision for loan losses 553 622 1,646 1,817
NONINTEREST INCOME
Trust and investment services income 148 145 458 445
Investment banking and capital markets income 91 77 278 243
Service charges on deposit accounts 85 83 256 246
Corporate owned life insurance income 28 25 78 76
Credit card fees 1 16 9 47
Net loan securitization gains (losses) (2) 32 7 82
Net securities gains (losses) (50) 2 (47) 26
Gains from divestitures -- 13 332 161
Other income 104 103 315 317
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Total noninterest income 405 496 1,686 1,643
NONINTEREST EXPENSE
Personnel 342 349 1,085 1,104
Net occupancy 55 58 168 175
Computer processing 59 60 178 173
Equipment 41 48 131 153
Marketing 29 35 82 84
Amortization of intangibles 26 25 76 79
Professional fees 30 18 70 50
Restructuring charges 102 7 109 7
Other expense 103 108 313 360
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Total noninterest expense 787 708 2,212 2,185
INCOME BEFORE INCOME TAXES 171 410 1,120 1,275
Income taxes 50 140 384 432
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NET INCOME $ 121 $ 270 $ 736 $ 843
====== ====== ====== =====
Per common share:
Net income $.28 $.60 $1.69 $1.88
Net Income - assuming dilution .28 .60 1.68 1.86
Weighted average common shares outstanding (000) 429,584 448,742 435,156 448,764
Weighted average common shares and potential
common shares outstanding (000) 431,972 452,886 437,231 453,267
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See Notes to Consolidated Financial Statements (Unaudited).
4
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<TABLE>
<CAPTION>
Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
Accumulated
Loans to Treasury Other
Common Capital Retained ESOP Stock, Comprehensive Comprehensive
dollars in millions, except per share amounts Shares Surplus Earnings Trustee at Cost (Loss) 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 843 $843
Other comprehensive losses:
Net unrealized losses on securities available
for sale, net of income taxes of $(85)(a) (136) (136)
Foreign currency translation adjustments (3) (3)
-----
Total comprehensive income $704
=====
Cash dividends on common shares ($.78 per share) (350)
Issuance of common shares:
Acquisition - 632,183 shares 6 15
Employee benefit and dividend reinvestment
plans - 2,146,512 net shares (6) 52
Repurchase of common shares - 6,406,424 shares (202)
ESOP transactions 1 10
-----------------------------------------------------------------------------------------------------------------
BALANCE AT SEPTEMBER 30, 1999 $492 $1,412 $5,686 $(24) $(1,058) $(111)
==== ====== ====== ==== ======= =====
-----------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1999 $492 $1,412 $5,833 $(24) $(1,197) $(127)
Net income 736 $736
Other comprehensive losses:
Net unrealized gains on securities available
for sale, net of income taxes of $41 (a) 73 73
Foreign currency translation adjustments (10) (10)
-----
Total comprehensive income $799
=====
Cash dividends on common shares ($.84 per share) (364)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans -1,486,112 net shares (10) 35
Repurchase of common shares-17,652,800 shares (340)
ESOP transactions 11
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BALANCE AT SEPTEMBER 30, 2000 $492 $1,402 $6,205 $(13) $(1,502) $ (64)
==== ====== ====== ==== ======= =====
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</TABLE>
(a) Net of reclassification adjustments.
(b) For the three months ended September 30, 2000 and 1999, comprehensive
income was $205 million and $266 million, respectively.
See Notes to Consolidated Financial Statements (Unaudited).
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<TABLE>
<CAPTION>
Consolidated Statements of Cash Flow (Unaudited)
Nine months ended September 30,
-------------------------------
in millions 2000 1999
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<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 736 $ 843
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 382 265
Depreciation expense and software amortization 211 219
Amortization of intangibles 76 79
Net gains from divestitures (332) (161)
Net securities (gains) losses 47 (26)
Net gains from venture capital investments (55) (26)
Net gains from loan securitizations and sales (26) (107)
Deferred income taxes 203 304
Net increase in mortgage loans held for sale (448) (13)
Net (increase) decrease in trading account assets 39 (326)
Net increase (decrease) in accrued restructuring charges 48 (2)
Other operating activities, net (456) (298)
------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 425 751
INVESTING ACTIVITIES
Net increase in loans, excluding acquisitions,
sales and divestitures (5,615) (6,019)
Purchases of loans -- (7)
Proceeds from loan securitizations and sales 4,377 4,374
Purchases of investment securities (276) (169)
Proceeds from sales of investment securities 32 9
Proceeds from prepayments and maturities of investment securities 127 192
Purchases of securities available for sale (4,908) (4,241)
Proceeds from sales of securities available for sale 4,162 382
Proceeds from prepayments and maturities of securities available for sale 723 2,961
Net decrease in other short-term investments 251 206
Purchases of premises and equipment (60) (61)
Proceeds from sales of premises and equipment 19 23
Proceeds from sales of other real estate owned 19 10
Cash used in acquisitions, net of cash acquired (375) --
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NET CASH USED IN INVESTING ACTIVITIES (1,524) (2,340)
FINANCING ACTIVITIES
Net increase in deposits 4,576 883
Net decrease in short-term borrowings (885) (2,115)
Net proceeds from issuance of long-term debt, including capital securities 3,153 5,147
Payments on long-term debt, including capital securities (5,217) (2,094)
Loan payment received from ESOP trustee 11 10
Purchases of treasury shares (317) (202)
Net proceeds from issuance of common stock 17 32
Cash dividends (364) (350)
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NET CASH PROVIDED BY FINANCING ACTIVITIES 974 1,311
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NET DECREASE IN CASH AND DUE FROM BANKS (125) (278)
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 $ 2,691 $ 3,018
======= =======
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Additional disclosures relative to cash flow:
Interest paid $ 2,560 $ 2,013
Income taxes paid 83 170
Net amount received on portfolio swaps 21 8
Noncash items:
Transfer of credit card receivables to loans held for sale -- $ 1,299
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 26 --
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</TABLE>
6
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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
TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES.
In September 2000, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities" (SFAS 140), which
replaces SFAS 125. SFAS 140 retains most of the SFAS 125 control provisions, but
includes new rules:
- for determining whether a special purpose entity ("SPE") is a
qualifying SPE, and that limit the amount and type of
derivative instruments that a qualifying SPE can hold and the
activities that it may engage in;
- that provide more restrictive guidance with respect to the
circumstances under which a transfer of assets to a qualifying
SPE relinquishes control of such assets and may be accounted
for as a sale; and
- that require extensive disclosures about collateral, assets
securitized and accounted for as a sale, and retained
interests in securitized assets.
SFAS 140 is effective for transactions entered into after March 31, 2001.
However, the statement is effective for recognition and reclassification of
collateral and for disclosures relating to securitization transactions and
collateral for fiscal years ending after December 15, 2000. Management is
currently reviewing SFAS 140 and has not yet determined the extent to which it
will impact Key's financial condition and results of operations.
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.
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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
in the final stages of testing the systems that will be relied upon to comply
with SFAS 133 and to determine the related impact on Key's financial condition
and results of operations. The financial impact of the transition to the
provisions of SFAS 133 can not be precisely measured prior to the effective date
because of several fluid factors, primary among which are the level of interest
rates and the shape of the yield curve. However, if we were to have adopted the
statement at September 30, 2000, the financial impact on Key would not have been
material at that time.
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 September 30, Nine months ended September 30,
-------------------------------- -------------------------------
dollars in millions, except per share amounts 2000 1999 2000 1999
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<S> <C> <C> <C> <C>
NET INCOME $121 $270 $736 $843
==== ==== ==== ====
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WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 429,584 448,742 435,156 448,764
Effect of dilutive common stock options (000) 2,388 4,144 2,075 4,503
----------------------------------------------------------------------------------------------------------------------------------
Weighted average common shares and potential 431,972 452,886 437,231 453,267
common shares outstanding (000) ======= ======= ======= =======
----------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per common share $.28 $.60 $1.69 $1.88
Net income per common share - assuming dilution .28 .60 1.68 1.86
----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
3. Acquisitions and Divestitures
Business acquisitions and divestitures that Key completed during 1999 and the
first nine months of 2000 are summarized below.
ACQUISITIONS
------------
NEWPORT MORTGAGE COMPANY L.P.
On September 30, 2000, Key purchased certain net assets of Newport Mortgage
Company, L.P., a commercial mortgage company headquartered in Dallas, Texas, for
$22 million in cash. Goodwill of approximately $4 million was recorded and is
being amortized using the straight-line method over a period of 10 years.
NATIONAL REALTY FUNDING L.C.
On January 31, 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
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<PAGE> 9
$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.
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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 932 KeyCenters, a 24-hour telephone banking call center
services group, 2,490 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, corporate electronic commerce ("e-commerce") 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, brokerage, investment banking,
capital markets and insurance expertise. It also offers specialized services to
high-net-worth clients through the wealth management and private banking
businesses. This line of business generates a substantial amount of Key's fee
income.
The table that spans pages 12 and 13 shows selected financial data for each
major line of business for the three- and nine-month periods ended September 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
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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.
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<TABLE>
<CAPTION>
Three months ended September 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) $ 313 $ 292 $ 131 $ 128 $ 268 $ 248
Noninterest income 91 81 5 45 54 69
Revenue sharing (a) 19 16 -- -- 33 26
-----------------------------------------------------------------------------------------------------------------------------------
Total revenue (b) 423 389 136 173 355 343
Provision for loan losses 28 15 32 25 53 29
Depreciation and amortization expense 35 38 13 15 16 16
Other noninterest expense 179 186 64 69 128 119
Expense sharing (a) 13 14 -- -- 21 17
-----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes
(taxable equivalent) 168 136 27 64 137 162
Allocated income taxes and taxable equivalent
adjustments 65 53 12 26 52 61
-----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 103 $ 83 $ 15 $ 38 $ 85 $ 101
======= ======= ======= ======= ======= =======
Percent of consolidated net income 85% 31% 12% 14% 70% 37%
Percent of total segments' net income 49 34 7 16 40 42
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AVERAGE BALANCES
Loans $11,026 $10,026 $15,081 $14,352 $31,648 $29,293
Total assets (b) 12,531 11,557 16,222 15,476 33,103 30,758
Deposits 35,528 33,096 164 145 3,071 2,853
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OTHER FINANCIAL DATA
Efficiency ratio (g) 53.92% 61.17% 56.48% 48.44% 46.23% 45.89%
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</TABLE>
<TABLE>
<CAPTION>
Nine months ended September 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) $ 910 $ 885 $ 384 $ 396 $ 787 $ 731
Noninterest income 262 240 40 127 174 193
Revenue sharing (a) 55 52 1 1 97 83
-----------------------------------------------------------------------------------------------------------------------------------
Total revenue (b) 1,227 1,177 425 524 1,058 1,007
Provision for loan losses 62 46 80 79 117 80
Depreciation and amortization expense 107 114 39 45 48 45
Other noninterest expense 536 569 199 202 380 366
Expense sharing (a) 42 44 -- -- 61 53
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Income (loss) before income taxes
(taxable equivalent) 480 404 107 198 452 463
Allocated income taxes and taxable
equivalent adjustments 186 156 46 79 174 175
-----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 294 $ 248 $ 61 $ 119 $ 278 $ 288
======= ====== ======= ======= ======= =======
Percent of consolidated net income 40% 29% 8% 14% 38% 34%
Percent of total segments' net income 42 34 9 17 40 40
-----------------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $10,771 $ 9,747 $14,884 $14,436 $31,281 $28,581
Total assets (b) 12,286 11,287 16,073 15,547 32,857 29,965
Deposits 34,671 33,050 139 126 2,965 2,780
-----------------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Efficiency ratio (g) 55.87% 61.87% 56.28% 47.20% 46.14% 46.65%
-----------------------------------------------------------------------------------------------------------------------------------
</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.
During the third quarter of 1999, divested businesses added $20 million
($12 million after tax) to noninterest income and $50 million ($31 million
after tax) to net interest income.
For the first nine 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 nine months of 1999, noninterest income includes
gains totaling $163 million ($103 million after tax) from certain
divestitures and $57 million ($36 million after tax) earned by divested
businesses. These businesses also added $13 million ($8 million after tax)
to net interest income in the first nine months of 2000 and $138 million
($87 million after tax) to net interest income in the same period
last year.
(d) The provision for loan losses includes additional provisions of $27 million
($17 million after tax) and $121 million ($76 million after tax) recorded
in the third and first quarters of 2000, respectively. The latter provision
resulted from the implementation of an enhanced methodology for assessing
credit risk, particularly in the commercial loan portfolio. In the first
quarter of 1999,
12
<PAGE> 13
<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>
$ 55 $ 47 $ (34) $ (25) $ 733 $ 690 $ (42) $ 19 $ 691 $ 709
259 234 (1) 44 408 473 (3) 23 405 496
(52) (42) -- -- -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------------
262 239 (35) 19 1,141 1,163 (45)(c) 42(c) 1,096 1,205
3 1 1 1 117 71 14 7 131 78
23 24 7 7 94 100 2 -- 96 100
201 207 26 31 598 612 93(e) (4)(e) 691 608
(34) (31) -- -- -- -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------------
69 38 (69) (20) 332 380 (154) 39 178 419
28 15 (37) (17) 120 138 (63) 11 57 149
--------------------------------------------------------------------------------------------------------------------------
$ 41 $ 23 $ (32) $ (3) $ 212 $ 242 $ (91) $ 28 $ 121 $ 270
====== ====== ======= ======= ======= ======= ======= ====== ======= =======
34% 9% (26)% (1)% 175% 90% (75)% 10% 100% 100%
19 9 (15) (1) 100 100 N/A N/A N/A N/A
--------------------------------------------------------------------------------------------------------------------------
$5,563 $4,429 $ 2,232 $ 2,710 $65,550 $60,810 $ 227 $1,989 $65,777 $62,799
9,574 8,282 10,889 11,475 82,319 77,548 1,786(f) 3,747(f) 84,105 81,295
3,380 3,175 3,680 1,911 45,823 41,180 16 1,283 45,839 42,463
--------------------------------------------------------------------------------------------------------------------------
72.79% 84.46% N/M N/M 60.65% 61.22% N/M N/M 58.38% 58.91%
--------------------------------------------------------------------------------------------------------------------------
</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>
$ 155 $ 146 $ (85) $ (66) $ 2,151 $ 2,092 $ (102) $ 14 $ 2,049 $ 2,106
782 717 86 121 1,344 1,398 342 245 1,686 1,643
(153) (136) -- -- -- -- -- -- -- --
----------------------------------------------------------------------------------------------------------------------------
784 727 1 55 3,495 3,490 240(c) 259(c) 3,735 3,749
4 3 2 3 265 211 117(d) 54(d) 382 265
70 71 21 19 285 294 2 4 287 298
642 628 76 88 1,833 1,853 92(e) 34(e) 1,925 1,887
(103) (97) -- -- -- -- -- -- -- --
----------------------------------------------------------------------------------------------------------------------------
171 122 (98) (55) 1,112 1,132 29 167 1,141 1,299
70 51 (67) (49) 409 412 (4) 44 405 456
----------------------------------------------------------------------------------------------------------------------------
$ 101 $ 71 $ (31) $ (6) $ 703 $ 720 $ 33 $ 123 $ 736 $ 843
====== ====== ======= ======== ======= ======= ======== ======= ======= =======
14% 9% (4)% (1)% 96% 85% 4% 15% 100% 100%
14 10 (5) (1) 100 100 N/A N/A N/A N/A
----------------------------------------------------------------------------------------------------------------------------
$5,266 $4,352 $ 2,339 $ 2,933 $64,541 $60,049 $ 335 $ 1,987 $64,876 $62,036
9,543 8,111 11,022 11,665 81,781 76,575 1,787(f) 3,823(f) 83,568 80,398
3,383 3,140 3,751 1,420 44,909 40,516 11 1,274 44,920 41,790
----------------------------------------------------------------------------------------------------------------------------
77.59% 83.07% N/M N/M 60.60% 61.52% N/M N/M 60.31% 59.74%
----------------------------------------------------------------------------------------------------------------------------
</TABLE>
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 third quarter of 2000 includes $114 million ($72
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 third quarter of 1999 includes
$7 million ($4 million after tax) of restructuring charges and $19 million
($12 million after tax) incurred by divested businesses. For the first nine
months of 2000, noninterest expense includes $130 million ($82 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 nine months of 1999, noninterest expense includes special
contributions of $23 million ($15 million after tax) made to the charitable
foundation that Key sponsors, $7 million ($4 million after tax) of
restructuring charges, $27 million ($17 million after tax) of other
nonrecurring charges and $57 million ($36 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 significant nonrecurring items) divided by the sum of
taxable-equivalent net interest income and noninterest income (excluding
significant nonrecurring items).
N/M = Not Meaningful
N/A = Not Applicable
13
<PAGE> 14
5. Securities
Key classifies its securities into three categories: trading, investment and
available for sale.
TRADING ACCOUNT SECURITIES. These are debt and equity securities that are
purchased and held by Key with the intent of selling them in the near term.
These securities are reported at fair value ($729 million, $768 million and $1.1
billion at September 30, 2000, December 31, 1999 and September 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.
INVESTMENT SECURITIES. These include securities held to maturity and equity
securities that do not have readily determinable fair values. Securities held to
maturity are debt securities that Key has the intent and ability to hold until
maturity. These securities are carried at cost, adjusted for amortization of
premiums and accretion of discounts using the level-yield method.
SECURITIES AVAILABLE FOR SALE. These are debt and equity securities that Key has
not classified as trading account securities or investment securities.
Securities available for sale are reported at fair value with unrealized gains
and losses (net of income taxes) recorded in shareholders' equity as a component
of "accumulated other comprehensive income." Actual gains and losses on the
sales of these securities are computed using the specific identification method
and included in "net securities gains (losses)" 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, losses and approximate fair value of Key's
investment securities and securities available for sale were as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000
-----------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INVESTMENT SECURITIES
States and political subdivisions $ 364 $ 9 -- $ 373
Other securities 889 -- -- 889
-------------------------------------------------------------------------------------------------------------------
Total investment securities $1,253 $ 9 -- $1,262
====== === ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $2,105 -- -- $2,105
States and political subdivisions 48 -- -- 48
Collateralized mortgage obligations 2,561 $12 $ 99 2,474
Other mortgage-backed securities 1,425 6 23 1,408
Retained interests in securitizations 341 -- 15 326
Other securities 278 28 3 303
-------------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,758 $46 $140 $6,664
====== === ==== ======
-------------------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 15
<TABLE>
<CAPTION>
DECEMBER 31, 1999
--------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INVESTMENT SECURITIES
States and political subdivisions $ 447 $12 -- $ 459
Other securities 539 -- -- 539
------------------------------------------------------------------------------------------------------------------------
Total investment securities $ 986 $12 -- $ 998
====== === ======
SECURITIES AVAILABLE FOR SALE
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
====== === ==== ======
------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999
--------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INVESTMENT SECURITIES
States and political subdivisions $ 490 $16 -- $ 506
Other securities 499 -- -- 499
------------------------------------------------------------------------------------------------------------------------
Total investment securities $ 989 $16 -- $1,005
====== === ======
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 128 $ 1 $ 1 $ 128
States and political subdivisions 61 1 1 61
Collateralized mortgage obligations 4,240 1 157 4,084
Other mortgage-backed securities 1,772 9 29 1,752
Retained interests in securitizations 365 -- 14 351
Other securities 184 8 1 191
------------------------------------------------------------------------------------------------------------------------
Total securities available for sale $6,750 $20 $203 $6,567
====== === ==== ======
------------------------------------------------------------------------------------------------------------------------
</TABLE>
15
<PAGE> 16
6. Loans
Key's loans by category are summarized as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 2000 1999 1999
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial, financial and agricultural $19,884 $18,497 $18,275
Real estate -- commercial mortgage 6,900 6,836 6,831
Real estate -- construction 5,019 4,528 4,298
Commercial lease financing 7,011 6,665 6,399
-------------------------------------------------------------------------------------------------------------------------
Total commercial loans 38,814 36,526 35,803
Real estate -- residential mortgage 4,264 4,333 4,331
Home equity 9,344 7,602 7,502
Consumer -- direct 2,633 2,565 2,566
Consumer -- indirect lease financing 3,035 3,195 3,107
Consumer -- indirect other 5,891 6,398 6,488
-------------------------------------------------------------------------------------------------------------------------
Total consumer loans 25,167 24,093 23,994
Real estate -- commercial mortgage 588 146 152
Real estate -- residential mortgage 54 48 58
Home equity -- 371 153
Credit card -- 1,362 1,299
Education 1,676 1,676 1,722
-------------------------------------------------------------------------------------------------------------------------
Total loans held for sale 2,318 3,603 3,384
-------------------------------------------------------------------------------------------------------------------------
Total loans $66,299 $64,222 $63,181
======= ======= =======
-------------------------------------------------------------------------------------------------------------------------
</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 September 30, 2000, see Note 11 ("Financial Instruments with
Off-Balance Sheet Risk"), which begins on page 21.
Changes in the allowance for loan losses are summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
in millions 2000 1999 2000 1999
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of period $ 979 $ 930 $ 930 $ 900
Charge-offs (129) (102) (387) (314)
Recoveries 25 24 81 79
------------------------------------------------------------------------------------------------------------------
Net charge-offs (104) (78) (306) (235)
Allowance related to loans sold (5) -- (5) --
Provision for loan losses 131 78 382 265
------------------------------------------------------------------------------------------------------------------
Balance at end of period $1,001 $ 930 $1,001 $930
====== ===== ====== ====
------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 17
7. Impaired Loans and Other Nonperforming Assets
At September 30, 2000, impaired loans totaled $305 million. This amount includes
$206 million of impaired loans with a specifically allocated allowance for loan
losses of $83 million and $99 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 third quarter of 2000 and 1999 was $291 million and $204 million,
respectively.
Nonperforming assets were as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 2000 1999 1999
-------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Impaired loans $305 $246 $219
Other nonaccrual loans 287 201 193
-------------------------------------------------------------------------------------------------------------
Total nonperforming loans 592 447 412
OREO 26 27 32
Allowance for OREO losses (1) (3) (8)
-------------------------------------------------------------------------------------------------------------
OREO, net of allowance 25 24 24
Other nonperforming assets -- 2 4
-------------------------------------------------------------------------------------------------------------
Total nonperforming assets $617 $473 $440
==== ==== ====
-------------------------------------------------------------------------------------------------------------
</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 at September 30, 1999, 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.
17
<PAGE> 18
8. LONG-TERM DEBT
The components of Key's long-term debt, presented net of unamortized discount
where applicable, were as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 2000 1999 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Senior medium-term notes due through 2005 (a) $ 303 $ 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 13 24 24
All other long-term debt (h) 1 4 4
---------------------------------------------------------------------------------------------------------------
Total parent company (i) 1,194 1,331 1,336
Senior medium-term bank notes due through 2039 (c) 6,389 9,396 9,394
Senior euro medium-term bank notes due through 2007 (d) 3,466 2,413 2,383
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) 588 613 580
Federal Home Loan Bank advances due through 2030 (g) 249 242 241
All other long-term debt (h) 142 114 108
---------------------------------------------------------------------------------------------------------------
Total subsidiaries 12,606 14,550 14,479
---------------------------------------------------------------------------------------------------------------
Total long-term debt $13,800 $15,881 $15,815
======= ======= =======
---------------------------------------------------------------------------------------------------------------
</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 September 30, 2000, see
Note 11 ("Financial Instruments with Off-Balance Sheet Risk"), which begins on
page 21.
(a) At September 30, 2000, December 31, 1999 and September 30,1999, the senior
medium-term notes had weighted average interest rates of 6.77%, 6.83% and
6.54%, 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 September 30, 2000, December 31,1999 and September 30, 1999, senior
medium-term bank notes of subsidiaries had weighted average interest rates
of 6.68%, 5.98% and 5.48%, respectively. These notes had a combination of
fixed and floating interest rates.
(d) At September 30, 2000, December 31, 1999 and September 30, 1999, senior
euro medium-term notes had weighted average interest rates of 6.88%, 6.26%,
and 5.56%, 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").
18
<PAGE> 19
(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 September 30, 2000, December 31, 1999 and September 30, 1999, lease
financing debt had weighted average interest rates of 7.78%, 7.64% and
6.70%, respectively. This category of debt primarily comprises nonrecourse
debt collateralized by leased equipment under operating, direct financing
and sales type leases.
(g) At September 30, 2000, December 31, 1999 and September 30, 1999, long-term
advances from the Federal Home Loan Bank had weighted average interest
rates of 6.56%, 6.27% and 5.43% respectively. These advances, which had a
combination of fixed and floating interest rates, were secured by $374
million, $363 million, and $361 million of real estate loans and securities
at September 30, 2000, December 31, 1999 and September 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 7.84%, 6.76%, and
7.01% at September 30, 2000, December 31, 1999 and September 30, 1999,
respectively.
(i) At September 30, 2000, unused capacity under KeyCorp's shelf registration
totaled $412 million, all of which is reserved for future issuance of
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>
September 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 7.519 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 7.612% --
====== === ======
-------------------------------------------------------------------------------------------------------------------------------
December 31, 1999 $1,243 $39 $1,282 7.473% --
====== === ======
-------------------------------------------------------------------------------------------------------------------------------
September 30, 1999 $1,243 $39 $1,282 7.328% --
====== === ======
-------------------------------------------------------------------------------------------------------------------------------
</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.
19
<PAGE> 20
(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 September 30, 2000, December 31, 1999, and September 30,
1999, are weighted average rates.
10. Restructuring Charges
During 1999 and the first nine months of 2000, KeyCorp recorded net
restructuring charges of $98 million ($62 million after tax) and $111 million
($70 million after tax), respectively, in connection with a three-year
"competitiveness initiative" undertaken last November to improve Key's operating
efficiency and profitability.
In the first phase of the initiative, 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.
During the third quarter of 2000, KeyCorp recorded restructuring charges of $102
million ($64 million after tax) in connection with the second and final phase of
this initiative. The final phase will focus on:
- simplifying Key's business structure by consolidating 22 business
lines into 12;
- streamlining and automating business operations and processes;
- standardizing product offerings and internal processes;
- consolidating operating facilities and service centers; and
- outsourcing certain noncore activities.
As a result of the competitiveness initiative, we expect to significantly reduce
Key's workforce with reductions occurring at all levels throughout the
organization. At September 30, 2000, over 2,100 positions had been eliminated.
In the second phase of the initiative, we expect to reduce our workforce by
approximately 2,300 additional positions over the next 15 months.
Changes in the restructuring charge liability associated with the above actions
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, RESTRUCTURING CASH SEPTEMBER 30,
in millions 1999 CHARGES PAYMENTS 2000
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Severance $60 $ 56 $37 $ 79
Site consolidations 24 51 14 61
Equipment and other 7 4 6 5
------------------------------------------------------------------------------------
Total $91 $111 $57 $145
=== ==== === ====
------------------------------------------------------------------------------------
</TABLE>
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
20
<PAGE> 21
conditions resulted in lower costs to consolidate these branches than originally
expected. At September 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
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.
21
<PAGE> 22
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 2000 1999 1999
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Loan commitments:
Credit card lines - $7,108 $6,776
Home equity $4,616 4,560 4,630
Commercial real estate and construction 2,019 1,842 1,778
Commercial and other 24,835 22,023 21,979
-------------------------------------------------------------------------------------------------------------------------
Total loan commitments 31,470 35,533 35,163
Other commitments:
Standby letters of credit 1,932 1,987 1,870
Commercial letters of credit 128 120 155
Loans sold with recourse - 16 17
-------------------------------------------------------------------------------------------------------------------------
Total loan and other commitments $33,530 $37,656 $37,205
======= ======= =======
-------------------------------------------------------------------------------------------------------------------------
</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 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 September 30, 2000.
<TABLE>
<CAPTION>
SEPTEMBER 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:
Received fixed/pay variable-indexed amortizing(a) $ 48 - 1.1 7.98 % 6.74 % N/A $ 104 $ 1
Receive fixed/pay variable-conventional 4,413 $ (67) 6.7 6.64 6.77 N/A 5,962 (135)
Pay fixed/receive variable-conventional 6,155 34 3.8 6.71 6.40 N/A 5,545 105
Pay fixed/receive variable-forward starting 13 - 10.0 6.62 6.85 N/A 278 -
Basis swaps 5,571 (126) 1.9 6.60 6.73 N/A 6,783 (20)
------------------------------------------------------------------------------------------------------------------------------------
Total 16,200 (159) - 6.64 % 6.60 % - 18,672 (49)
Interest rate caps and collars:
Caps purchased - one- to three-month LIBOR-based 350 3 .9 N/A N/A 5.67% 2,000 7
Collar - one- to three-month LIBOR-based 250 - .3 N/A N/A 4.75 and 6.50 250 -
------------------------------------------------------------------------------------------------------------------------------------
Total 600 3 - - - - 2,250 7
------------------------------------------------------------------------------------------------------------------------------------
Total $16,800 $(156) - - - - $20,922 $(42)
======= ====== ======= =====
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Maturity is based upon expected average lives rather than contractual terms.
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.
22
<PAGE> 23
- 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 September 30, 2000, Key was party
to $48 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.
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 September 30, 2000, Key had 35 different counterparties to portfolio swaps
and swaps entered into to offset the risk of client swaps. Key had aggregate
credit exposure of $160 million to 19 of these counterparties, with the largest
credit exposure to an individual counterparty amounting to $28 million. As of
the same date, Key's aggregate credit exposure on its interest rate caps totaled
$65 million. Based on management's assessment as of September 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 $159 million at September 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 nine months of 2000, swaps with a notional amount of $2.8
billion were terminated, resulting in a net deferred loss of $3 million. During
the same period last year, swaps with a notional amount of $3.2 billion were
terminated, resulting in a net deferred gain of $12 million. At September 30,
23
<PAGE> 24
2000, Key had a cumulative net deferred swap gain of $14 million with a weighted
average life of 4.1 years related to the management of debt, and a cumulative
net deferred gain of $3 million with a weighted average life of 7.5 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 exchange forward contracts are included in "investment
banking and capital markets income" on the income statement.
OPTIONS AND FUTURES. Key uses these instruments for proprietary trading
purposes. Adjustments to the fair value of all such options are included in
"investment banking and capital markets income" on the income statement.
CREDIT RISK. At September 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 $518 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 option and futures contracts.
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
in millions 2000 1999
-----------------------------------------------------------------------------
Interest rate contracts $21 $28
Foreign exchange forward contracts 27 21
Option and futures contracts 2 5
-----------------------------------------------------------------------------
The table on page 25 summarizes the notional amount and fair value of derivative
financial instruments held or issued for trading purposes at September 30, 2000,
and on average for the nine-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.
The $27.5 billion notional amount of client interest rate swaps presented in the
table includes $12.6 billion of client swaps that receive a fixed rate and pay a
variable rate, $10 billion of client swaps that pay a fixed rate and receive a
variable rate, and $4.9 billion of basis swaps. As of September 30, 2000, the
client swaps had an average expected life of 5.3 years, carried a weighted
average rate received of 6.62%, and had a weighted average rate paid of 6.65%.
24
<PAGE> 25
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 NINE MONTHS ENDED SEPTEMBER 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 $14,193 $339 $12,543 $401
Swap liabilities 13,323 (169) 12,981 (271)
Caps and floors purchased 773 5 701 5
Caps and floors sold 813 (5) 784 (6)
Futures purchased 754 - 465 -
Futures sold 11,145 (8) 9,218 6
Interest rate contracts - securitization positions:
Swap assets $1,130 $29 $1,083 $27
Caps purchased 1,079 57 1,068 57
Caps sold 2,574 (57) 2,163 (57)
Foreign exchange forward contracts:
Assets $1,383 $70 $1,695 $66
Liabilities 1,464 (64) 1,624 (58)
Option contracts:
Options purchased $2,758 $18 $1,678 $16
Options sold 3,092 (14) 2,455 (13)
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
25
<PAGE> 26
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
SHAREHOLDERS AND BOARD OF DIRECTORS
KEYCORP
We have reviewed the unaudited condensed consolidated balance sheets of KeyCorp
and subsidiaries ("Key") as of September 30, 2000 and 1999, and the related
condensed consolidated statements of income for the three- and nine-month
periods then ended, and the condensed consolidated statements of changes in
shareholders' equity and cash flow for the nine-month periods ended September
30, 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
October 12, 2000
26
<PAGE> 27
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 September 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 25.
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).
- CORE FINANCIAL RESULTS exclude the effects of significant nonrecurring
items such as gains from divestitures and restructuring charges.
- 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 57.
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.
27
<PAGE> 28
- If the economy or segments of the economy slow, the demand for new loans
and the ability of borrowers to repay outstanding loans may decline.
- The stock and bond markets could suffer a 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 core financial performance for the third quarter
and first nine months of 2000 are discussed below.
- Core income was $245 million, or $.57 per common share, compared with $266
million, or $.59 per common share, for the third quarter of 1999. For the
first nine months of the year, Key's core net income was $737 million, or
$1.69 per common share, compared with $787 million, or $1.74 reported for
the same period last year.
- Key's core return on average equity was 14.97% and 16.81% for the third
quarter of 2000 and 1999, respectively. For the first nine months of the
year, Key's core return on average equity was 15.15%, down from 17.00% for
the first nine months of 1999.
- Key's third quarter core return on average total assets was 1.16% compared
with 1.30% for the third quarter of 1999. For the first nine months of the
year, Key's core return on average total assets was 1.18%, down from 1.31%
for the comparable period in 1999.
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 1.
Each of these items is discussed in greater detail elsewhere in this report.
28
<PAGE> 29
FIGURE 1. SIGNIFICANT NONRECURRING ITEMS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
dollars in millions, except per share amounts 2000 1999 2000 1999
--------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net income as reported $121 $270 $ 736 $843
Nonrecurring items (net of tax):
Gain from sale of credit card portfolio - - (207) -
Additional provisions for loan losses 17 - 93 19
Restructuring and other special charges 71 4 80 4
Net losses from investment portfolio reconfiguration 32 - 32 -
Gain from sale of Electronic Payment Services, Inc. - - - (85)
Gain from sale of Compaq Capital Europe LLC and
Compaq Capital Asia Pacific LLC - (8) - (8)
Gains from sale of Key Merchant Services, LLC - - - (9)
Gain from sale of Concord EFS, Inc. common stock - - - (9)
Other nonrecurring items 4 - 3 32
--------------------------------------------------------------------------------------------------------------------------------
Net income - core $245 $266 $ 737 $787
==== ==== ===== ====
Net income per diluted common share $.28 $.60 $1.68 $1.86
Net income per diluted common share - core .57 .59 1.69 1.74
Return on average total assets .57 % 1.32 % 1.18 % 1.40 %
Return on average total assets - core 1.16 1.30 1.18 1.31
Return on average equity 7.39 17.06 15.12 18.21
Return on average equity - core 14.97 16.81 15.15 17.00
--------------------------------------------------------------------------------------------------------------------------------
</TABLE>
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 support the generation of consistent longer-term growth. These actions
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 decision 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 divested businesses
and net gains from the securitization and sale of home equity loans, Key's third
quarter core net income of $245 million, or $.57 per common share, was up 10% on
a per share basis from adjusted core earnings of $234 million, or $.52, in the
third quarter of 1999. Adjusting for the same items, earnings for the first nine
months of 2000 were $728 million, or $1.67 per common share, compared with $696
million, or $1.54, for the comparable period last year. The primary factors
contributing to the change in Key's revenue and expense components relative to
the third quarter and first nine months of 1999 are reviewed in detail in the
remainder of this discussion.
Figure 2 summarizes Key's financial performance on a reported basis for each of
the past five quarters and the first nine months of 2000 and 1999.
29
<PAGE> 30
FIGURE 2. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
2000 1999 NINE MONTHS ENDED SEPTEMBER 30,
--------------------------- --------------------- -------------------------------
dollars in millions, except per share amounts THIRD SECOND FIRST FOURTH THIRD 2000 1999
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
FOR THE PERIOD
Interest income $1,596 $1,540 $1,489 $1,489 $1,433 $4,625 $4,206
Interest expense 912 867 818 784 733 2,597 2,124
Net interest income 684 673 671 705 700 2,028 2,082
Provision for loan losses 131 68 183 83 78 382 265
Noninterest income 405 475 806 672 496 1,686 1,643
Noninterest expense 787 698 727 885 708 2,212 2,185
Income before income taxes 171 382 567 409 410 1,120 1,275
Net income 121 248 367 264 270 736 843
-----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $ .28 $ .57 $ .83 $ .59 $ .60 $ 1.69 $ 1.88
Net income-assuming dilution .28 .57 .83 .59 .60 1.68 1.86
Cash dividends .28 .28 .28 .26 .26 .84 .78
Book value at period end 15.26 15.09 14.84 14.41 14.25 15.26 14.25
Market price:
High 27.06 23.00 22.25 29.75 33.50 27.06 38.13
Low 17.50 17.00 15.56 21.00 25.19 15.56 25.19
Close 25.31 17.63 19.00 22.13 25.81 25.31 25.81
Weighted average common shares (000) 429,584 434,112 441,834 446,402 448,742 435,156 448,764
Weighted average common shares and
potential common shares (000) 431,972 436,022 443,757 449,678 452,886 437,231 453,267
-----------------------------------------------------------------------------------------------------------------------------------
AT PERIOD END
Loans $66,299 $65,612 $64,064 $64,222 $63,181 66,299 $63,181
Earning assets 75,786 74,748 73,953 73,733 72,831 75,786 72,831
Total assets 85,500 84,719 83,504 83,395 82,577 85,500 82,577
Deposits 47,809 49,076 46,036 43,233 43,466 47,809 43,466
Long-term debt 13,800 14,097 14,784 15,881 15,815 13,800 15,815
Shareholders' equity 6,520 6,507 6,493 6,389 6,397 6,520 6,397
Full-time equivalent employees 22,457 23,005 23,474 24,568 25,523 22,457 25,523
Branches 932 938 937 936 963 932 963
-----------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets .57% 1.20% 1.77% 1.27% 1.32% 1.18% 1.40%
Return on average equity 7.39 15.40 22.68 16.18 17.06 15.12 18.21
Efficiency(a) 58.38 60.26 62.27 59.23 58.91 60.31 59.74
Overhead(b) 30.68 32.50 35.75 30.39 31.03 32.96 31.91
Net interest margin (taxable equivalent) 3.68 3.68 3.68 3.88 3.92 3.68 3.95
-----------------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS AT PERIOD END
Equity to assets 7.63% 7.68% 7.78% 7.66% 7.75% 7.63% 7.75%
Tangible equity to tangible assets 6.10 6.12 6.16 6.03 6.06 6.10 6.06
Tier 1 risk-adjusted capital 7.59 7.88 7.98 7.68 7.84 7.59 7.84
Total risk-adjusted capital 11.34 11.74 12.04 11.66 11.94 11.34 11.94
Leverage 7.76 7.90 7.89 7.77 7.85 7.76 7.85
-----------------------------------------------------------------------------------------------------------------------------------
</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") beginning 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 significant nonrecurring items) DIVIDED BY the sum of
taxable-equivalent net interest income and noninterest income (excluding
significant nonrecurring items).
(b) This ratio is the difference between noninterest expense (excluding
significant nonrecurring items) and noninterest income (excluding
significant nonrecurring items) DIVIDED BY taxable-equivalent net interest
income.
30
<PAGE> 31
CORPORATE STRATEGY
Key's corporate strategy encompasses an ongoing review of business lines to
identify opportunities to generate higher earnings growth by deploying capital
from low-growth to high-growth businesses. We continue to focus on acquiring or
growing businesses that we believe are capable of achieving double-digit
earnings growth rates and selling portfolios and business units that have low
anticipated growth rates or do not have a competitive advantage or significant
market share.
This long-standing strategy was supplemented in the fourth quarter of 1999 by a
new three-year competitiveness initiative to improve profitability by reducing
the costs of doing business, sharpening the focus on the most profitable growth
businesses and enhancing revenues.
Key's corporate strategy also reflects the growing importance of the Internet
and related information technologies to the daily activities of people,
companies, and other institutions. As such, the strategy calls for the continual
and thoughtful application of such technologies to enhance Key's product and
service offerings and to streamline its internal business practices.
PRINCIPAL STRATEGIC ACTIONS DURING THE FIRST NINE 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) which begins on page 8.
In addition, throughout the year Key has 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 corporate 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 expand our capabilities in
originating and servicing loans in the commercial real estate market. In
the second quarter this was demonstrated by Key's participation in the
securitization and non-recourse 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 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 the first
quarter of 2001;
- during the third quarter, we acquired certain net assets of Newport
Mortgage Company, L.P., a commercial mortgage company headquartered in
Dallas, Texas. Through this acquisition we expect to expand the breadth of
our lending capabilities. We also reached an agreement with InsLogic, a
leader in online insurance services, which will allow us to offer various
insurance products and services on the Key web site sometime during the
fourth quarter. Finally, we entered into an agreement with MasterCard
International to provide MasterCard-branded debit card processing services
to other financial institutions that have limited or no access to an ATM
network; and
- early in the fourth quarter, we announced that our corporate e-commerce
program, which allows our middle market clients to buy and sell products
online, has moved from its pilot phase to a fully-functioning operation.
31
<PAGE> 32
During the third quarter, we entered the second and final phase of our
three-year competitiveness initiative. Key now expects that annual savings of
approximately $360 million will be achieved from the overall initiative when
actions are fully implemented by the end of 2002. In the initial phase, which
began last November, Key reduced its operating expenses by approximately $100
million as a result of efforts to outsource certain nonstrategic support
functions, consolidate sites in a number of our businesses and reduce management
layers. The final phase will focus on:
- simplifying Key's business structure by consolidating 22 business lines
into 12;
- streamlining and automating business operations and processes;
- standardizing product offerings and internal processes;
- consolidating operating facilities and service centers; and
- outsourcing certain noncore activities.
In the final phase, we expect to reduce Key's workforce by approximately 2,300
positions over the next 15 months. This will bring workforce reductions to well
above 4,000 positions for both phases of the initiative. In connection with the
competitiveness initiative we recorded an additional net $130 million of
restructuring and other special charges during the first nine months of 2000
($114 million during the third quarter), bringing the cumulative charges
recorded for this initiative to a net $282 million. The section entitled
"Noninterest expense," which begins on page 47, and Note 10 ("Restructuring
Charges"), which begins on page 20, provide more information about Key's
restructuring charges.
32
<PAGE> 33
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 nine months of
2000 and 1999. We provide cash basis financial data because we believe it offers
a useful tool for measuring Key's ability to support future growth, evaluating
liquidity and determining Key's ability to 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 2 (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) and significant nonrecurring items.
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>
NINE MONTHS ENDED
2000 1999 SEPTEMBER 30,
------------------------------ ------------------- --------------------
dollars in millions, except per share amounts THIRD SECOND FIRST FOURTH THIRD 2000 1999
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
FOR THE PERIOD
Noninterest expense $763 $672 $702 $860 $684 $2,137 $2,108
Income before income taxes 195 408 592 434 434 1,195 1,352
Net income 143 271 390 287 291 804 912
------------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE
Net income $.33 $.62 $.88 $.64 $.65 $1.85 $2.03
Net income - assuming dilution .33 .62 .88 .64 .64 1.84 2.01
Weighted average common shares (000) 429,584 434,112 441,834 446,402 448,742 435,156 448,764
Weighted average common shares and potential
common shares (000) 431,972 436,022 443,757 449,678 452,886 437,231 453,267
------------------------------------------------------------------------------------------------------------------------------------
PERFORMANCE RATIOS
Return on average total assets .69 % 1.33 % 1.92 % 1.40 % 1.45 % 1.31 % 1.55 %
Return on average equity 11.12 21.56 30.97 22.64 24.13 21.15 26.01
Efficiency(a) 56.30 58.01 60.10 57.18 56.89 58.14 57.58
------------------------------------------------------------------------------------------------------------------------------------
GOODWILL AND NON-QUALIFYING INTANGIBLES
Goodwill average balance $1,346 $1,370 $1,386 $1,402 $1,429 $1,367 $1,431
Non-qualifying intangibles average balance 50 54 58 62 66 54 70
Goodwill amortization (after tax) 20 21 20 20 20 61 61
Non-qualifying intangibles amortization (after tax) 2 2 3 3 1 7 8
------------------------------------------------------------------------------------------------------------------------------------
</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") beginning 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 significant nonrecurring items and the amortization of goodwill
and non-qualifying intangibles) DIVIDED BY the sum of taxable-equivalent net
interest income and noninterest income (excluding significant nonrecurring
items).
33
<PAGE> 34
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, e-commerce,
financial advisory, equipment leasing and a number of other specialized
services.
KEY CAPITAL PARTNERS offers asset management, brokerage, investment banking,
capital markets, and insurance products and services. It also provides
specialized services to high-net-worth clients through the wealth management and
private banking businesses.
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 10 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
nine-month periods ended September 30, 2000 and 1999.
FIGURE 4. NET INCOME (LOSS) BY LINE OF BUSINESS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 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 $103 $83 $ 20 24.1 % $294 $248 $ 46 18.5 %
Key Specialty Finance 15 38 (23) (60.5) 61 119 (58) (48.7)
Key Corporate Capital 85 101 (16) (15.8) 278 288 (10) (3.5)
Key Capital Partners(a) 41 23 18 78.3 101 71 30 42.3
Treasury and Other (32) (3) (29) (966.7) (31) (6) (25) (416.7)
----------------------------------------------------------------------------------------------------------------------------------
Total segments 212 242 (30) (12.4) 703 720 (17) (2.4)
Reconciling items (91) 28 (119) N/M 33 123 (90) (73.2)
----------------------------------------------------------------------------------------------------------------------------------
Total net income $121 $270 $(149) (55.2)% $736 $843 $(107) (12.7)%
==== ==== ====== ==== ==== ======
----------------------------------------------------------------------------------------------------------------------------------
</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 $52 million and $32 million in the
third quarter of 2000 and 1999, respectively, and $131 million and $96
million in the first nine months of 2000 and 1999, respectively, before
the assignment of income and expense.
N/M=Not Meaningful
KEY RETAIL BANKING
Net income for Key Retail Banking was $294 million for the first nine months of
2000, or approximately 40% of Key's consolidated earnings. In comparison, net
income was $248 million for the first nine months of 1999, or approximately 29%
of consolidated earnings. The increase in net income is primarily attributable
to a $50 million increase in total revenue, reflecting equal contributions from
net interest income and noninterest income, and a $42 million decline in
noninterest expense. These positive factors were partially offset by a $16
million increase in the provision for loan losses that reflected a higher level
of net charge-offs.
Revenue growth from the first nine months of 1999 includes a $25 million
improvement in net interest income, primarily due to continued loan growth.
Average loans outstanding rose by 11%, reflecting
34
<PAGE> 35
growth in the commercial and consumer portfolios. Also contributing to the rise
in net interest income was a 5% increase in average deposit balances.
Noninterest income was up $25 million from the first nine 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.
The noninterest expense decrease of $42 million from the same period last year
is principally the result of lower costs associated with personnel, depreciation
and amortization expense, 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 $61 million in the first nine months of
2000, or approximately 8% of Key's consolidated earnings. In comparison, net
income was $119 million for the first nine 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 noninterest expense.
Net interest income decreased by $12 million from the first nine months of 1999.
A 3% increase in average loans outstanding was more than offset by the higher
cost of 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 higher cost of funds
included in 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, the costs to fund them is based on the higher
rates associated with longer holding periods.
Virtually all of the $87 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 50.
The provision for loan losses was essentially unchanged, while the level of
noninterest expense was down 4% from the prior year as a result of actions taken
to control expenses under Key's competitiveness initiative.
KEY CORPORATE CAPITAL
Net income for Key Corporate Capital was $278 million for the first nine months
of 2000, or approximately 38% of Key's consolidated earnings. In comparison, net
income was $288 million for the same period last year, or approximately 34% of
consolidated earnings. The decrease in net income resulted from a $37 million
increase in the provision for loan losses and a $25 million increase in
noninterest expense. The increase in noninterest expense included higher
personnel expense, depreciation and amortization expense and costs associated
with investment banking and capital markets activities. These latter costs are
primarily the result of the income and expense sharing relationship described in
the Key Capital Partners section on page 36.
The higher costs discussed above were substantially offset by a $51 million
increase in total revenue. Total average loans grew by 9%, generating a $56
million increase in net interest income. This reflects strong increases in
essentially all major business units, including structured finance, lease
financing, real estate construction, healthcare, and the middle market
portfolios. In 1999, noninterest income included a $13
35
<PAGE> 36
million gain from the third quarter sale of Key's interest in a joint venture
with Compaq Capital Corporation. Excluding this nonrecurring item, noninterest
income grew by $8 million, primarily due to higher income from service charges
on deposit accounts, loan fees and various investment banking and capital
markets activities.
During the first and third quarters of 2000, Key announced the acquisitions of
certain net assets of National Realty Funding L.C. and Newport Mortgage Company,
L.P., respectively. You can find more discussion of these acquisitions and
related activities in the section entitled "Principal strategic actions during
the first nine months of 2000," beginning on page 31.
KEY CAPITAL PARTNERS
Net income for Key Capital Partners was $101 million for the first nine months
of 2000, or approximately 14% of Key's consolidated earnings. In comparison, net
income was $71 million for the first nine 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 other 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 to other lines of business, net income for this line
would have been $131 million in the first nine months of 2000 (representing
approximately 18% of Key's consolidated earnings) and $96 million in the same
period last year (representing approximately 11% of Key's consolidated
earnings).
Total revenue for Key Capital Partners rose by $57 million from the first nine
months 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 fees due to lower levels of activity and the timing of certain
transactions.
Noninterest expense was up $7 million from the first nine months of last year,
due primarily to higher personnel related costs.
TREASURY AND OTHER
Treasury and Other includes the Treasury and Electronic Services business units,
as well as the net effect of funds transfer pricing. In the first nine months of
2000, this segment generated a net loss of $31 million, compared with a net loss
of $6 million for the first nine months of 1999. The higher net loss in the
current year is primarily due to $50 million ($32 million after tax) of net
losses resulting from the third quarter 2000 reconfiguration of Key's investment
portfolio. These losses were partially offset by an increase in the level of net
income generated by the Electronic Commerce unit.
RECONCILING ITEMS
The "reconciling items" shown in Figure 4 reflect certain nonrecurring items and
charges related to unallocated nonearning assets of 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. For more specific
information regarding the above items, see notes c, d and e to the table
included in Note 4 ("Line of Business Results") which begins on page 10.
36
<PAGE> 37
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 third quarter of 2000 was $691 million,
representing an $18 million, or 3%, decrease from the same period last year. The
decline reflects a 24 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 home equity loans) to $74.7 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 $50 million to net interest income in the third quarter of 1999.
Although the third quarter margin declined from the year-ago quarter, it was
unchanged from the first two quarters of this year despite a challenging
interest rate environment and the January sale of the low-growth, but
higher-yielding credit card business. The constant margin was largely due to the
growth of Key' s retail deposits which allowed us to stabilize our dependence on
higher-cost funds.
For the first nine months of 2000, net interest income totaled $2.0 billion,
down $57 million, or 3%, from the same period last year. The year-to-date
reduction also reflected a lower net interest margin which decreased 27 basis
points to 3.68%, while the growth of commercial and home equity loans was the
primary contributor to a 4% increase in average earning assets to $74.1 billion.
The divestitures discussed above added only $13 million to net interest income
in the current year, but added $138 million to Key's net interest income in the
first nine months 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 18
basis points in Key's third quarter 2000 net interest margin from that of
the 1999 third 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.
37
<PAGE> 38
FIGURE 5. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
<TABLE>
<CAPTION>
THIRD QUARTER 2000 SECOND 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 $19,647 $ 434 8.87 % $19,046 $ 405 8.56 %
Real estate - commercial mortgage 6,932 160 9.29 6,967 156 9.03
Real estate - construction 4,866 121 9.98 4,625 110 9.51
Commercial lease financing 6,861 122 7.14 6,773 124 7.30
-----------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 38,306 837 8.78 37,411 795 8.53
Real estate - residential 4,273 80 7.51 4,276 83 7.80
Home equity 9,095 219 9.68 8,600 196 9.16
Credit card - - - - - -
Consumer - direct 2,595 68 10.50 2,620 66 10.09
Consumer - indirect lease financing 3,052 62 8.08 3,107 62 7.97
Consumer - indirect other 5,952 142 9.55 6,078 142 9.33
-----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 24,967 571 9.17 24,681 549 8.92
Loans held for sale 2,504 56 8.96 2,725 58 8.52
-----------------------------------------------------------------------------------------------------------------------------------
Total loans 65,777 1,464 8.93 64,817 1,402 8.68
Taxable investment securities 787 8 3.63 671 6 3.63
Tax-exempt investment securities(a) 369 7 8.12 415 9 8.77
-----------------------------------------------------------------------------------------------------------------------------------
Total investment securities 1,156 15 5.06 1,086 15 5.60
Securities available for sale(a,c) 6,275 107 6.67 6,198 107 6.73
Short-term investments 1,501 17 4.76 1,757 23 5.29
-----------------------------------------------------------------------------------------------------------------------------------
Total earning assets 74,709 1,603 8.61 73,858 1,547 8.40
Allowance for loan losses (969) (976)
Other assets 10,365 10,523
-----------------------------------------------------------------------------------------------------------------------------------
$84,105 $83,405
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $11,956 102 3.43 $12,403 105 3.41
Savings deposits 2,151 8 1.49 2,275 8 1.44
NOW accounts 592 2 1.59 628 3 1.61
Certificates of deposit ($100,000 or more) 5,269 84 6.40 5,430 82 6.06
Other time deposits 14,634 218 6.01 13,656 190 5.61
Deposits in foreign office 2,860 48 6.70 3,029 48 6.39
-----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 37,462 462 4.96 37,421 436 4.69
Federal funds purchased and securities
sold under repurchase agreements 5,746 88 6.17 4,096 58 5.64
Bank notes and other short-term borrowings 6,403 99 6.19 6,972 103 5.96
Long-term debt, including capital securities(d) 15,356 263 6.91 15,668 270 6.92
-----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 64,967 912 5.65 64,157 867 5.43
Noninterest-bearing deposits 8,377 8,412
Other liabilities 4,248 4,357
Common shareholders' equity 6,513 6,479
-----------------------------------------------------------------------------------------------------------------------------------
$84,105 $83,405
======= =======
Interest rate spread (TE) 2.96 2.97
-----------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $691 3.68 % $680 3.68 %
==== ====== ==== =======
Capital securities $1,243 $24 $1,243 $24
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
average loan balances.
(c) Yield is calculated on the basis of amortized cost.
(d) Rate calculation excludes ESOP debt.
TE=Taxable Equivalent
38
<PAGE> 39
FIGURE 5. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
(CONTINUED)
<TABLE>
<CAPTION>
FIRST QUARTER 2000 FOURTH 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 $18,677 $ 379 8.17 % $18,311 $ 364 7.90 %
Real estate - commercial mortgage 6,891 150 8.74 6,824 147 8.52
Real estate - construction 4,601 104 9.12 4,438 100 8.88
Commercial lease financing 6,684 122 7.28 6,484 120 7.43
-----------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 36,853 755 8.23 36,057 731 8.05
Real estate - residential 4,318 81 7.48 4,338 80 7.56
Home equity 8,129 179 8.85 7,497 168 8.71
Credit card - - - - - -
Consumer - direct 2,572 62 9.72 2,560 63 9.85
Consumer - indirect lease financing 3,174 63 7.93 3,159 62 8.01
Consumer - indirect other 6,286 145 9.22 6,452 151 9.34
-----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 24,479 530 8.67 24,006 524 8.70
Loans held for sale 2,692 65 9.80 3,423 95 11.09
-----------------------------------------------------------------------------------------------------------------------------------
Total loans 64,024 1,350 8.47 63,486 1,350 8.46
Taxable investment securities 580 4 2.94 506 4 3.26
Tax-exempt investment securities(a) 436 10 8.74 468 11 8.69
-----------------------------------------------------------------------------------------------------------------------------------
Total investment securities 1,016 14 5.43 974 15 5.87
Securities available for sale(a,c) 6,475 112 6.81 6,667 114 6.77
Short-term investments 2,164 20 3.66 1,954 18 3.48
-----------------------------------------------------------------------------------------------------------------------------------
Total earning assets 73,679 1,496 8.15 73,081 1,497 8.15
Allowance for loan losses (899) (916)
Other assets 10,407 10,409
-----------------------------------------------------------------------------------------------------------------------------------
$83,187 $82,574
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $12,617 104 3.32 $12,836 100 3.09
Savings deposits 2,357 9 1.61 2,458 9 1.62
NOW accounts 627 3 1.62 610 4 1.76
Certificates of deposit ($100,000 or more) 5,555 80 5.78 5,151 71 5.48
Other time deposits 12,552 164 5.25 12,150 154 5.04
Deposits in foreign office 1,206 17 5.76 906 12 5.45
-----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 34,914 377 4.34 34,111 350 4.08
Federal funds purchased and securities
sold under repurchase agreements 4,003 48 4.85 4,384 52 4.71
Bank notes and other short-term borrowings 8,680 126 5.83 8,243 116 5.57
Long-term debt, including capital securities(d) 16,577 267 6.49 17,095 266 6.17
-----------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 64,174 818 5.13 63,833 784 4.87
Noninterest-bearing deposits 8,160 8,430
Other liabilities 4,344 3,836
Common shareholders' equity 6,509 6,475
-----------------------------------------------------------------------------------------------------------------------------------
$83,187 $82,574
======= =======
Interest rate spread (TE) 3.02 3.28
-----------------------------------------------------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $678 3.68 % $713 3.88 %
==== ====== ==== ======
Capital securities $1,243 $23 $1,243 $23
Taxable-equivalent adjustment(a) 7 8
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
THIRD QUARTER 1999
----------------------------------
AVERAGE YIELD/
DOLLARS IN MILLIONS BALANCE INTEREST RATE
---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
ASSETS
Loans(a,b)
Commercial, financial and agricultural $17,978 $ 348 7.66 %
Real estate - commercial mortgage 6,784 141 8.25
Real estate - construction 4,190 89 8.46
Commercial lease financing 6,261 113 7.16
-----------------------------------------------------------------------------------------
Total commercial loans 35,213 691 7.78
Real estate - residential 4,175 80 7.64
Home equity 7,739 161 8.32
Credit card 1,302 54 16.45
Consumer - direct 2,467 60 9.65
Consumer - indirect lease financing 2,993 61 8.15
Consumer - indirect other 6,457 148 9.17
-----------------------------------------------------------------------------------------
Total consumer loans 25,133 564 8.92
Loans held for sale 2,453 50 8.00
-----------------------------------------------------------------------------------------
Total loans 62,799 1,305 8.24
Taxable investment securities 471 4 3.47
Tax-exempt investment securities(a) 499 10 8.55
-----------------------------------------------------------------------------------------
Total investment securities 970 14 6.09
Securities available for sale(a,c) 6,359 106 6.54
Short-term investments 1,836 17 3.74
-----------------------------------------------------------------------------------------
Total earning assets 71,964 1,442 7.96
Allowance for loan losses (920)
Other assets 10,251
-----------------------------------------------------------------------------------------
$81,295
=======
LIABILITIES AND SHAREHOLDERS' EQUITY
Money market deposit accounts $13,274 100 2.97
Savings deposits 2,699 11 1.63
NOW accounts 610 1 1.37
Certificates of deposit ($100,000 or more) 4,475 59 5.22
Other time deposits 12,095 150 4.91
Deposits in foreign office 776 10 4.99
-----------------------------------------------------------------------------------------
Total interest-bearing deposits 33,929 331 3.87
Federal funds purchased and securities
sold under repurchase agreements 4,495 51 4.49
Bank notes and other short-term borrowings 7,428 103 5.50
Long-term debt, including capital securities(d) 17,069 248 5.79
-----------------------------------------------------------------------------------------
Total interest-bearing liabilities 62,921 733 4.62
Noninterest-bearing deposits 8,534
Other liabilities 3,561
Common shareholders' equity 6,279
-----------------------------------------------------------------------------------------
$81,295
Interest rate spread (TE) 3.34
-----------------------------------------------------------------------------------------
Net interest income (TE) and net
interest margin (TE) $709 3.92 %
==== =========
Capital securities $1,205 $22
Taxable-equivalent adjustment(a) 9
-----------------------------------------------------------------------------------------
</TABLE>
39
<PAGE> 40
INTEREST EARNING ASSETS. Average earning assets for the third quarter totaled
$74.7 billion, which was $2.7 billion, or 4%, higher than the third quarter 1999
level. For the first nine months of the year, average earning assets rose 4% to
$74.1 billion from the first nine 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. Late in
the first quarter of 2000 we created a commercial loan conduit through which
$805 million of lower-spread loans have been sold through September 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 of 2000, Key sold
without recourse $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 as a result of Key's
recent acquisitions of Newport Mortgage Company L.P. and 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 nine months of 2000. By retaining the
assets generated by this 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. We will continue, however, to consider securitizations of other
portfolios as a source of alternative funding when conditions in the capital
markets are favorable. During the first nine months of 2000, Key securitized and
sold approximately $1.0 billion of education loans.
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 interest 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
from the prior year 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 50.
40
<PAGE> 41
FIGURE 6. COMPONENTS OF NET INTEREST INCOME CHANGES
<TABLE>
<CAPTION>
FROM THREE MONTHS ENDED SEPTEMBER 30, 1999, FROM NINE MONTHS ENDED SEPTEMBER 30, 1999,
TO THREE MONTHS ENDED SEPTEMBER 30, 2000 TO NINE MONTHS ENDED SEPTEMBER 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 $64 $ 95 $159 $179 $224 $ 403
Taxable investment securities 3 1 4 7 - 7
Tax-exempt investment securities (2) (1) (3) (10) 1 (9)
Securities available for sale (1) 2 1 - 16 16
Short-term investments (3) 3 - (1) - (1)
---------------------------------------------------------------------------------------------------------------------------------
Total interest income (taxable equivalent) 61 100 161 175 241 416
INTEREST EXPENSE
Money market deposit accounts (10) 12 2 (15) 36 21
Savings deposits (2) (1) (3) (6) (4) (10)
NOW accounts - 1 1 (3) 3 -
Certificates of deposit ($100,000 or more) 11 14 25 63 31 94
Other time deposits 35 33 68 68 63 131
Deposits in foreign office 34 4 38 73 11 84
---------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing deposits 68 63 131 180 140 320
Federal funds purchased and securities sold
under repurchase agreements 16 21 37 (14) 40 26
Bank notes and other short-term borrowings (15) 11 (4) (19) 37 18
Long-term debt, including capital securities (26) 41 15 (17) 126 109
---------------------------------------------------------------------------------------------------------------------------------
Total interest expense 43 136 179 130 343 473
---------------------------------------------------------------------------------------------------------------------------------
Net interest income (taxable equivalent) $18 $(36) $ (18) $45 $(102) $ (57)
=== ===== ====== === ====== ======
---------------------------------------------------------------------------------------------------------------------------------
</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.
41
<PAGE> 42
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 September 30, 2000, based on the results of our simulation model, Key would
expect net interest income to increase by approximately 1.34% 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 .86%.
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 15%. 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.
42
<PAGE> 43
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 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 $156 million during the first nine
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, the value
of the euro declined and Key's "receive" fixed interest rate swap portfolio has
a slightly longer average remaining maturity than the "pay" fixed portfolio.
Because these instruments qualify for hedge accounting treatment, their
estimated net negative fair value should be substantially offset by the
unrecognized positive fair values of the assets and liabilities whose risk
characteristics they are being used to modify.
Key terminated swaps with a notional amount of $2.8 billion during the first
nine months of 2000, resulting in a net deferred loss of $3 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 nine months 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 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 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.
FIGURE 7. PORTFOLIO SWAPS AND CAPS BY INTEREST RATE MANAGEMENT STRATEGY
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999 SEPTEMBER 30, 1999
-------------------- ----------------- ----------------------
NOTIONAL FAIR NOTIONAL FAIR NOTIONAL FAIR
in millions AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Convert variable rate loans to fixed $ 1,208 $ (11) $ 1,254 $ (24) $ 1,282 $ (6)
Convert fixed rate loans to variable 1,065 (4) 587 14 642 9
Convert fixed rate securities to variable 357 10 316 18 322 11
Convert variable rate deposits and short-term borrowings to fixed 900 8 1,100 14 1,150 5
Convert fixed rate deposits and short-term borrowings to variable 471 -- 226 (6) 226 (3)
Convert variable rate long-term debt to fixed 3,846 20 3,820 59 1,880 29
Convert fixed rate long-term debt to variable 2,782 (56) 4,586 (104) 4,586 (48)
Basis swaps - foreign currency denominated debt 1,089 (124) 321 (23) 321 (9)
Basis swaps - interest rate indices 4,482 (2) 6,462 3 8,087 6
------------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps 16,200 (159) 18,672 (49) 18,496 (6)
Modify characteristics of variable rate short-term borrowings 500 2 2,050 6 2,050 4
Modify characteristics of variable rate long-term debt 100 1 200 1 515 1
------------------------------------------------------------------------------------------------------------------------------------
Total portfolio caps and collars 600 3 2,250 7 2,565 5
------------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and collars $16,800 $ (156) $ 20,922 $ (42) $ 21,061 $ (1)
======= ======= ======== ====== ========= ======
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
43
<PAGE> 44
Figure 8 summarizes the expected average maturities of Key's portfolio swaps and
caps at September 30, 2000.
FIGURE 8. EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS AND CAPS
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 RECEIVE FIXED PAY FIXED
--------------------------- ------------------------ TOTAL
INDEXED FORWARD- PORTFOLIO
in millions AMORTIZING CONVENTIONAL CONVENTIONAL STARTING BASIS SWAPS SWAPS
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Mature in one year or less -- $ 290 $ 1,478 -- $ 2,015 $ 3,783
Mature after one through five years $ 48 2,556 3,509 -- 3,556 9,669
Mature after five through ten years -- 947 805 -- -- 1,752
Mature after ten years -- 620 363 $ 13 -- 996
-----------------------------------------------------------------------------------------------------------------------------------
Total portfolio swaps, caps and collars $ 48 $ 4,413 $ 6,155 $ 13 $ 5,571 $ 16,200
=== ======= ======= ==== ======= ========
-----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
in millions CAPS TOTAL
--------------------------------------------------------------------------
<S> <C> <C>
Mature in one year or less $ 600 $ 4,383
Mature after one through five years -- 9,669
Mature after five through ten years -- 1,752
Mature after ten years -- 996
--------------------------------------------------------------------------
Total portfolio swaps, caps and collars $ 600 $ 16,800
===== ========
--------------------------------------------------------------------------
</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 21.
Management uses a value at risk ("VAR") model to estimate the potential 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 September 30, 2000, Key's
aggregate daily VAR was $1.1 million compared with $1 million at September 30,
1999. Aggregate daily VAR averaged less than $1 million for the first nine
months of 2000, compared with an average of $1.6 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.
NONINTEREST INCOME
Noninterest income for the third quarter of 2000 totaled $405 million, down $91
million, or 18%, from the same period last year. For the first nine months of
the year, noninterest income was $1.7 billion, representing an increase of $43
million, or 3%, from the first nine months 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 9 and include gains from
divestitures, net losses resulting from the reconfiguration of Key's investment
portfolio and various other nonrecurring net 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 $460 million for the
third quarter of 2000 and currently represents 40% 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 $481 million and included $20 million from the divested
Long Island branches and credit card business, as well as $17 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 on page 45. Excluding earnings from divested businesses and
gains from home equity loan securitizations, core noninterest income in the
current year was up $16 million, or 4%, from comparable third quarter 1999
results. The largest contribution to this growth came from a $14 million
increase in income from investment banking and capital markets activities.
44
<PAGE> 45
For the first nine months of 2000, core noninterest income was $1.4 billion
compared with $1.5 billion for the comparable period in 1999. The sales of the
Long Island branches and credit card business accounted for $51 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
$64 million. Adjusting for these items, core noninterest income was up $71
million, or 5%, from the first nine months of 1999. The strongest contributions
to this growth came from investment banking and capital markets activities (up
$35 million), service charges on deposit accounts (up $16 million) and trust and
investment services (up $13 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 an $8 million increase in electronic banking fees. The
growth in Key's core noninterest income was moderated by an $11 million
reduction in net gains from the securitization of loans, other than those of the
home equity portfolio.
Figure 9 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 primary factors that caused it
to change from the prior year. For detailed information about investment banking
and capital markets income, and trust and investment services, see Figures 10
and 11, respectively.
TRUST AND INVESTMENT SERVICES. Trust and investment services provide Key's
largest source of noninterest income. At September 30, 2000, Key's bank, trust,
and registered investment advisory subsidiaries had assets under discretionary
management (excluding corporate trust assets) of $68 billion, compared with $67
billion at September 30, 1999. This component of noninterest income was renamed
in the third quarter and now includes brokerage commission income, which was
previously presented as a separate component.
CREDIT CARD FEES. Credit card fees for the third quarter and first nine months
of 2000 declined by $15 million and $38 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 28, and Note 3 ("Acquisitions and
Divestitures") which begins on page 8.
LOAN SECURITIZATIONS. Key periodically 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. We decide which loans to securitize based upon a number of
specific factors as discussed in the section entitled "Loans," which begins on
page 50.
During the third quarter of 2000, we securitized and sold $502 million of
education loans at a gain of $6 million, and recorded impairment write-downs
relating to prior period securitizations. These transactions resulted in an
aggregate net loss of $2 million. For the first nine months of this year, we
have securitized and sold loans totaling $1.0 billion, all of which were in the
education portfolio. 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 nine months of last year, we securitized and sold $3.2 billion
of consumer loans (including $1.1 billion of home equity loans), resulting in
net gains of $82 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 50.
45
<PAGE> 46
SIGNIFICANT NONRECURRING ITEMS. Noninterest income for the first nine months of
2000 includes a $332 million first quarter gain from the sale of Key's credit
card business and $50 million of net losses that resulted from the
reconfiguration of Key's investment portfolio in the third quarter. Results for
the first nine months 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. Key also 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. and a third quarter 1999 gain of $13
million from the sale of its interest in a joint venture with Compaq Capital
Corporation.
FIGURE 9. NONINTEREST INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
----------------- ------------------- ------------------- ---------------
dollars in millions 2000 1999 AMOUNT PERCENT 2000 1999 Amount Percent
------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Trust and investment services income $ 148 $ 145 $ 3 2.1% $ 458 $ 445 $ 13 2.9%
Investment banking and capital markets income 91 77 14 18.2 278 243 35 14.4
Service charges on deposit accounts 85 83 2 2.4 256 246 10 4.1
Corporate owned life insurance income 28 25 3 12.0 78 76 2 2.6
Credit card fees 1 16 (15) (93.8) 9 47 (38) (80.9)
Net loan securitization gains (losses) (2) 32 (34) N/M 9 82 (73) (89.0)
Net securities gains -- -- -- -- 3 -- 3 N/M
Other income:
Letter of credit and loan fees 26 25 1 4.0 73 69 4 5.8
Electronic banking fees 18 16 2 12.5 50 42 8 19.0
Insurance income 16 13 3 23.1 47 45 2 4.4
Loan securitization servicing fees 6 6 -- -- 19 21 (2) (9.5)
Gains from sales of loans 12 3 9 300.0 24 25 (1) (4.0)
Miscellaneous income 31 40 (9) (22.5) 107 115 (8) (7.0)
------------------------------------------------------------------------------------------------------------------------------------
Total other income 109 103 6 5.8 320 317 3 .9
------------------------------------------------------------------------------------------------------------------------------------
Total core noninterest income 460 481 (21) (4.4) 1,411 1,456 (45) (3.1)
Gain from sale of credit card portfolio -- -- -- -- 332 -- 332 N/M
Net losses from investment portfolio reconfiguration (50) -- (50) N/M (50) -- (50) N/M
Gain from sale of Electronic Payment Services, Inc. -- -- -- -- -- 134 (134) (100.0)
Gain from sale of Compaq Capital Europe LLC and
Compaq Capital Asia Pacific LLC -- 13 (13) (100.0) -- 13 (13) (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)
Net securities gains -- 2 (2) (100.0) -- 11 (11) (100.0)
Other nonrecurring items (5) -- (5) N/M (7) -- (7) N/M
------------------------------------------------------------------------------------------------------------------------------------
Total significant nonrecurring items (55) 15 (70) N/M 275 187 88 47.1
------------------------------------------------------------------------------------------------------------------------------------
Total noninterest income $405 $ 496 $(91) (18.3)% $ 1,686 $ 1,643 $ 43 2.6%
==== ===== ===== ======= ======= ====
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
N/M=Not Meaningful
FIGURE 10. INVESTMENT BANKING AND CAPITAL MARKETS INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 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 $ 34 $ 28 $ 6 21.4% $ 118 $ 99 $ 19 19.2%
Investment banking income 25 28 (3) (10.7) 78 92 (14) (15.2)
Equity capital income 22 13 9 69.2 55 31 24 77.4
Foreign exchange income 10 8 2 25.0 27 21 6 28.6
------------------------------------------------------------------------------------------------------------------------------------
Total investment banking and capital markets income $ 91 $ 77 $ 14 18.2% $278 $ 243 $ 35 14.4%
==== ==== ==== ==== ===== ====
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
FIGURE 11. TRUST AND INVESTMENT SERVICES
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, CHANGE SEPTEMBER 30, CHANGE
------------------ --------------- --------------- ----------------
dollars in millions 2000 1999 AMOUNT PERCENT 2000 1999 AMOUNT PERCENT
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Personal asset management and custody fees $ 50 $ 48 $ 2 4.2% $ 143 $ 141 $ 2 1.4%
Institutional asset management and custody fees 22 22 -- -- 70 70 -- --
Bond services 7 7 -- -- 31 19 12 63.2
Brokerage commission income 34 33 1 3.0 113 117 (4) (3.4)
All other fees 35 35 -- -- 101 98 3 3.1
---------------------------------------------------------------------------------------------------------------------------------
Total trust and investment services income $ 148 $ 145 $ 3 2.1% $ 458 $ 445 $ 13 2.9%
===== ===== === ===== ===== ====
---------------------------------------------------------------------------------------------------------------------------------
dollars in billions
-------------------------------------------------------------------------------------
SEPTEMBER 30,
Discretionary assets $ 68 $ 67 $ 1 1.5%
Non-discretionary assets 55 48 7 14.6
-------------------------------------------------------------------------------------
Total trust assets $ 123 $ 115 $ 8 7.0%
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
46
<PAGE> 47
NONINTEREST EXPENSE
Noninterest expense for the third quarter of 2000 totaled $787 million, up $79
million, or 11%, from the third quarter of 1999. For the first nine months of
the year, noninterest expense was $2.2 billion, representing a modest increase
of $27 million from the same period last year. Significant nonrecurring items
that affect the comparability of results for 2000 and 1999 are shown in Figure
12. 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" on page 48. Primary among the
significant nonrecurring items recorded during the first nine 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. These
contributions were recorded prior to the third quarter.
Excluding nonrecurring charges, core noninterest expense was $672 million for
the third quarter of 2000, down $29 million, or 4%, from the year-ago quarter.
This represents Key's lowest quarterly level of core expense since the fourth
quarter of 1998 and the third consecutive quarter in which such expense has
declined. The improvement came largely from lower costs related to personnel and
equipment (each down $7 million) and marketing (down $6 million), and reflects
the actions taken by Key since last November to improve its competitiveness, as
well as the strategic divestitures discussed earlier.
For the first nine months of 2000, core noninterest expense was $2.1 billion,
down $42 million from that reported for the same period last year. The largest
decreases in expense came from equipment (down $17 million), personnel (down $15
million) and net occupancy (down $7 million). These improvements were partially
offset, however, by higher costs associated with professional fees (up $8
million) and computer processing (up $5 million). In addition, miscellaneous
expense included a first quarter 2000 charge of $7 million to reduce the
carrying amount of residual values related to leased vehicles.
Figure 12 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 competitiveness initiative, as well as the
effects of the strategic divestitures. At September 30, 2000, the number of
full-time equivalent employees was 22,457, compared with 24,568 at the end of
1999 and 25,523 a year ago.
COMPUTER PROCESSING. The increase in computer processing expense for the
year-to-date period is due primarily to higher levels of computer software
amortization, as well as increases related to software rental and maintenance.
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. Each of these categories
contributed to the increase for the year-to-date period, while all but legal
expense contributed to the quarterly increase.
47
<PAGE> 48
\
FIGURE 12. NONINTEREST EXPENSE
<TABLE>
<CAPTION>
THREE MONTHS ENDED Nine months ended
SEPTEMBER 30, CHANGE September 30, Change
------------------ ----------------- ------------------ ----------------
dollars in millions 2000 1999 AMOUNT PERCENT 2000 1999 Amount Percent
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Personnel $ 342 $ 349 $ (7) (2.0)% $ 1,085 $ 1,100 $ (15) (1.4)%
Net occupancy 55 58 (3) (5.2) 168 175 (7) (4.0)
Computer processing 59 60 (1) (1.7) 178 173 5 2.9
Equipment 41 48 (7) (14.6) 131 148 (17) (11.5)
Marketing 29 35 (6) (17.1) 82 84 (2) (2.4)
Amortization of intangibles 26 25 1 4.0 76 79 (3) (3.8)
Professional fees 18 18 -- -- 58 50 8 16.0
Other expense:
Postage and delivery 15 17 (2) (11.8) 49 54 (5) (9.3)
Telecommunications 12 14 (2) (14.3) 39 42 (3) (7.1)
Equity- and gross receipts- based taxes 8 9 (1) (11.1) 24 26 (2) (7.7)
OREO expense, net 2 3 (1) (33.3) 5 11 (6) (54.5)
Miscellaneous expense 65 65 -- -- 191 186 5 2.7
-----------------------------------------------------------------------------------------------------------------------------------
Total other expense 102 108 (6) (5.6) 308 319 (11) (3.4)
-----------------------------------------------------------------------------------------------------------------------------------
Total core noninterest expense 672 701 (29) (4.1) 2,086 2,128 (42) (2.0)
Restructuring and other special charges 114 7 107 1,528.6 128 7 121 1,728.6
Other nonrecurring items 1 -- 1 N/M (2) 50 (52) N/M
-----------------------------------------------------------------------------------------------------------------------------------
Total significant nonrecurring items 115 7 108 1,542.9 126 57 69 121.1
-----------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense $ 787 $ 708 $ 79 11.2% $ 2,212 $ 2,185 $ 27 1.2%
======= ======= ===== ======= ======== ====
Full-time equivalent employees at period end 22,457 25,523 22,457 25,523
Efficiency ratio(a) 58.38% 58.91% 60.31% 59.74%
Overhead ratio(b) 30.68 31.03 32.96 31.91
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) This ratio measures the extent to which recurring revenues are absorbed by
operating expenses and is calculated as follows: noninterest expense
(excluding significant nonrecurring items) DIVIDED BY the sum of
taxable-equivalent net interest income and noninterest income (excluding
significant nonrecurring items).
(b) This ratio is the difference between noninterest expense (excluding
significant nonrecurring items) and noninterest income (excluding
significant nonrecurring items) DIVIDED BY taxable-equivalent net interest
income.
N/M=Not Meaningful
RESTRUCTURING AND OTHER SPECIAL CHARGES. During the first nine months of 2000,
we recorded net nonrecurring charges of $130 million (including net
restructuring charges of $111 million) in connection with strategic actions
related to Key's competitiveness initiative. Of these charges, $114 million were
recorded during the third quarter as Key entered the second and final phase of
this initiative which began last November. For more information related to the
actions taken or to be taken in each phase, anticipated cost savings and
expected reductions to Key's workforce, see the section entitled "Principal
strategic actions during the first nine months of 2000," which begins on page
31. Additional information related to the restructuring charges can be found in
Note 10 ("Restructuring Charges") which begins on page 20. Cash generated by
Key's operations will fund the restructuring charge liability and 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.
48
<PAGE> 49
EFFICIENCY RATIO. The efficiency ratio, which provides a measure of the extent
to which recurring revenues are used to pay operating expenses, improved to
58.38% for the third quarter of 2000, from 60.26% for the second quarter of 2000
and 58.91% 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 70, 69 and 75 basis points of Key's efficiency ratio for the
third quarter of 2000, the second quarter of 2000 and the third quarter of 1999,
respectively. The extent to which such taxes impact noninterest expense will
vary among companies, including Key's financial services peer group, based on
the geographic locations in which they conduct their business.
INCOME TAXES
The provision for income taxes was $50 million for the three-month period ended
September 30, 2000, down from $140 million for the comparable period in 1999.
The effective tax rate (which is the provision for income taxes as a percentage
of income before income taxes) for the third quarter of 2000 was 29.2%, compared
with 34.1% for the third quarter of 1999. The effective tax rate for the third
quarter of 2000 was distorted by the large dollar amount of significant
nonrecurring charges recorded during the quarter. These charges are summarized
in Figure 1 on page 29. Excluding these charges and the related tax benefits,
the effective tax rate for the third quarter of 2000 was 33.4%. The decline in
the adjusted tax rate from that reported for the year-ago quarter is
attributable primarily to higher tax-exempt income from corporate owned life
insurance and a favorable adjustment to the level of tax credits recorded in the
third quarter of 2000.
For the first nine months of 2000, the provision for income taxes was $384
million compared with $432 million for the first nine months of last year. The
effective tax rates for these periods were 34.3% and 33.9%, respectively.
Primary factors contributing to the slight increase in the effective
year-to-date tax rate were higher state income taxes and higher levels of
amortization related to non-deductible intangible assets. Also contributing to
the increase in the effective tax rate was a 1999 tax benefit associated with a
charitable contribution of appreciated stock.
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.
49
<PAGE> 50
FINANCIAL CONDITION
-------------------
LOANS
At September 30, 2000, total loans outstanding were $66.3 billion, compared with
$64.2 billion at the end of 1999 and $63.2 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 16. Key achieved a 5% 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 recent acquisitions of Newport Mortgage Company, L.P. and
National Realty Funding L.C. are 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. The conduit 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.
Loans outstanding (excluding loans held for sale) would have grown by $6.3
billion, or 10%, over the past twelve months, if we had not securitized and/or
sold $4.9 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 $4.8 billion, or
13%, since September 30, 1999, due primarily to strong growth in the structured
finance, healthcare and middle market portfolios, an $836 million increase in
commercial real-estate mortgage loans, a $612 million increase in the lease
financing portfolio and a $726 million increase in real estate-construction
loans. Consumer loans (excluding loan sales) rose by $1.5 billion, or 6%,
reflecting a $2.1 billion increase in the home equity portfolio. This growth was
partially offset by a $506 million decline in Key's installment loans.
On the same basis, commercial loans grew by $3.6 billion, or an annualized 13%,
from the 1999 year end, reflecting growth in all major sectors of the portfolio.
At the same time, home equity loans were up $1.5 billion, or an annualized 26%.
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.
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 $1.5
billion of education loans ($1.2 billion through securitizations), $832 million
of commercial loans, $667 million of commercial real estate loans and $151
million of home equity loans ($11 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 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.
50
<PAGE> 51
Figure 13 summarizes Key's loan sales (including securitizations) and branch
divestitures for the first nine months of 2000 and all of 1999.
FIGURE 13. LOANS SOLD AND DIVESTED
<TABLE>
<CAPTION>
COMMERCIAL RESIDENTIAL HOME CREDIT CARD
in millions COMMERCIAL REAL ESTATE REAL ESTATE EQUITY RECEIVABLES
------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
2000
--------------
Third quarter $ 27 $ 70 -- $ 72 --
Second quarter 451 499 -- 23 --
First quarter 354 6 -- 24 $ 1,339
------------------------------------------------------------------------------------------------------------------------------
Total $ 832 $ 575 -- $ 119 $ 1,339
====== ===== ===== ========
<CAPTION>
BRANCH
in millions AUTOMOBILE EDUCATION DIVESTITURES TOTAL
------------------------------------------------------------------------------------------------------------
2000
--------------
<S> <C> <C> <C> <C>
Third quarter -- $ 618 -- $ 787
Second quarter -- 518 -- 1,491
First quarter -- 29 -- 1,752
--------------------------------------------------------------------------------------------------------------
Total -- $ 1,165 -- $ 4,030
======== =======
<CAPTION>
<S> <C> <C> <C> <C> <C>
COMMERCIAL RESIDENTIAL HOME CREDIT CARD
in millions COMMERCIAL REAL ESTATE REAL ESTATE EQUITY RECEIVABLES
------------------------------------------------------------------------------------------------------------------------------
1999
--------------
<S> <C> <C> <C> <C> <C>
Fourth quarter -- $ 92 -- $ 32 --
Third quarter -- 100 -- 359 --
Second quarter -- 63 $ 292 442 --
First quarter -- 84 208 428 --
---------------------------------------------------------------------------------------------------------------------------
Total -- $ 339 $ 500 $ 1,261 --
===== ===== =======
============================================================================================================================
<CAPTION>
BRANCH
in millions AUTOMOBILE EDUCATION DIVESTITURES TOTAL
------------------------------------------------------------------------------------------------------------
1999
--------------
<S> <C> <C> <C> <C>
Fourth quarter -- $ 299 $ 505 $ 928
Third quarter -- 786 -- 1,245
Second quarter -- 132 -- 929
First quarter $ 555 818 -- 2,093
-------------------------------------------------------------------------------------------------------------
Total $ 555 $ 2,035 $ 505 $ 5,195
======= ======== ===== =======
=============================================================================================================
</TABLE>
Figure 14 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 14. LOANS ADMINISTERED OR SERVICED
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
in millions 2000 1999 1999
------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Education loans $ 3,946 $ 3,475 $ 3,377
Automobile loans 505 855 994
Home equity loans 1,266 1,542 1,627
Commercial real estate loans 4,071 -- --
Commercial loans 916 -- --
------------------------------------------------------------------------------------------------
Total $ 10,704 $ 5,872 $ 5,998
======== ======= =======
------------------------------------------------------------------------------------------------
</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 September 30, 2000, the securities portfolio totaled $7.9 billion and
comprised $6.7 billion of securities available for sale and $1.2 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.
51
<PAGE> 52
Figure 15 shows the composition, yields and remaining maturities of Key's
securities available for sale. Figure 16 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 14.
FIGURE 15. 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)
-----------------------------------------------------------------------------------------------------------------------------------
September 30, 2000
Remaining maturity:
<S> <C> <C> <C> <C>
One year or less $ 2,081 $ 2 $ 105 $ 2
After one through five years 6 18 1,861 657
After five through ten years 5 28 331 716
After ten years 13 -- 177 33
-----------------------------------------------------------------------------------------------------------------------------------
Fair value $ 2,105 $ 48 $ 2,474 $ 1,408
Amortized cost 2,105 48 2,561 1,425
Weighted average yield(b) 6.52% 4.70% 7.71% 7.15%
Weighted average maturity 0.2 YEARS 5.5 YEARS 7.3 YEARS 5.4 YEARS
-----------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999
Fair value $ 127 $ 53 $ 4,237 $ 1,678
Amortized cost 128 53 4,426 1,705
-----------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1999
Fair value $ 128 $ 61 $ 4,084 $ 1,752
Amortized cost 128 61 4,240 1,772
-----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
RETAINED WEIGHTED
INTERESTS IN OTHER AVERAGE
dollars in millions SECURITIZATIONS(a) SECURITIES TOTAL YIELD(b)
------------------------------------------------------------------------------------------------------------------------
September 30, 2000
Remaining maturity:
<S> <C> <C> <C> <C>
One year or less $ 56 $ 10 $ 2,256 6.60%
After one through five years 93 19 2,654 7.02
After five through ten years 177 6 1,263 7.46
After ten years -- 268(c) 491 8.72
------------------------------------------------------------------------------------------------------------------------
Fair value $ 326 $ 303 $ 6,664 --
Amortized cost 341 278 6,758 7.25%
Weighted average yield(b) 9.19% 6.31% 7.25% --
Weighted average maturity 4.0 YEARS 10.5 YEARS 4.6 YEARS --
------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999
Fair value $ 343 $ 227 $ 6,665 --
Amortized cost 340 223 6,875 6.77%
------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1999
Fair value $ 351 $ 191 $ 6,567 --
Amortized cost 365 184 6,750 6.78%
------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Maturity is based upon expected average lives rather than contractual terms.
(b) Weighted average yields are calculated based on amortized cost and exclude
equity securities that have no stated yield. Such yields have been adjusted
to a taxable-equivalent basis using the statutory Federal income tax rate of
35%.
(c) Includes equity securities with no stated maturity.
FIGURE 16. INVESTMENT SECURITIES
<TABLE>
<CAPTION>
STATES AND WEIGHTED
POLITICAL OTHER AVERAGE
dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(a)
---------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2000
Remaining maturity:
<S> <C> <C> <C> <C>
One year or less $ 123 $ 1 $ 124 8.49%
After one through five years 150 -- 150 9.67
After five through ten years 79 24 103 8.86
After ten years 12 864(b) 876 6.23
---------------------------------------------------------------------------------------------------------------
Amortized cost $ 364 $ 889 $ 1,253 8.22%
Fair value 373 889 1,262 --
Weighted average yield(a) 9.20% 6.13% 8.22% --
Weighted average maturity 3.1 YEARS 10.0 YEARS 8.1 YEARS --
---------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1999
Amortized cost $ 447 $ 539 $ 986 6.15%
Fair value 459 539 998 --
---------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1999
Amortized cost $ 490 $ 499 $ 989 6.32%
Fair value 506 499 1,005 --
---------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Weighted average yields are calculated based on amortized cost and exclude
equity securities that have no stated yield. Such yields have been adjusted
to a taxable-equivalent basis using the statutory Federal income tax rate of
35%.
(b) Includes equity securities with no stated maturity.
52
<PAGE> 53
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 September 30, 2000,
was $1.0 billion, or 1.51% of loans. This compares with $930 million, or 1.47%
of loans, at September 30, 1999. The allowance includes $83 million (for 2000)
and $47 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 17. At September 30, 2000, the allowance for loan
losses was 169.09% of nonperforming loans, compared with 225.73% at September
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. This was followed by an additional $27 million provision in September
that was driven principally by the impact of changing conditions within the
economy and recorded in accordance with Key's risk management practices. 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 17, net loan charge-offs for the third
quarter of 2000 were $104 million, or .63% of average loans, compared with $78
million, or .49%, for the same period last year. For the first nine months of
2000, net loan charge-offs totaled $306 million, or .63% of average loans,
compared with $235 million, or .50%, for the first nine months 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 nine months of 2000 totaled $234 million, or .48% 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") on page 61.
53
<PAGE> 54
In comparison with the third quarter of 1999, net charge-offs in the commercial
loan portfolio rose by $34 million. This increase reflected a number of factors
including the growth experienced in the overall portfolio, an increase in losses
attributable to fraud and $21 million of charge-offs on shared national credits
recorded in the third quarter of 2000. The increase in commercial loan net
charge-offs was partially offset by an $8 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 a modest $11 million.
FIGURE 17. SUMMARY OF LOAN LOSS EXPERIENCE
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
dollars in millions 2000 1999 2000 1999
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Average loans outstanding during the period $ 65,777 $ 62,799 $ 64,876 $ 62,036
-------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at beginning of period $ 979 $ 930 $ 930 $ 900
Loans charged off:
Commercial, financial and agricultural 60 28 131 79
Real estate-commercial mortgage 2 2 6 2
Commercial lease financing 2 4 9 13
-------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 64 34 146 94
Real estate-residential mortgage 1 2 5 7
Home equity 3 2 14 7
Credit card -- 21 16 69
Consumer-direct 14 12 43 34
Consumer-indirect lease financing 2 -- 13 --
Consumer-indirect other 45 31 150 103
-------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 65 68 241 220
-------------------------------------------------------------------------------------------------------------------------------
129 102 387 314
Recoveries:
Commercial, financial and agricultural 4 6 18 21
Real estate-commercial mortgage -- 2 3 4
Commercial lease financing -- -- 2 1
-------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 4 8 23 26
Real estate-residential mortgage 1 1 3 4
Home equity -- -- 1 --
Credit card 1 3 4 11
Consumer-direct 2 2 5 6
Consumer-indirect lease financing -- -- 2 --
Consumer-indirect other 17 10 43 32
-------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 21 16 58 53
-------------------------------------------------------------------------------------------------------------------------------
25 24 81 79
-------------------------------------------------------------------------------------------------------------------------------
Net loans charged off (104) (78) (306) (235)
Allowance related to loans sold (5) -- (5) --
Provision for loan losses 131 78 382 265
-------------------------------------------------------------------------------------------------------------------------------
Allowance for loan losses at end of period $ 1,001 $ 930 $ 1,001 $ 930
========= ========= ========= ========
-------------------------------------------------------------------------------------------------------------------------------
Net loan charge-offs to average loans .63% .49% .63% .50%
Allowance for loan losses to period-end loans 1.51 1.47 1.51 1.47
Allowance for loan losses to nonperforming loans 169.09 225.73 169.09 225.73
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>
NONPERFORMING ASSETS. Figure 18 shows the composition of Key's nonperforming
assets. These assets totaled $617 million at September 30, 2000, and represented
.93% of loans, other real estate owned (known as "OREO") and other nonperforming
assets, compared with $440 million, or .70%, at September 30, 1999. The $177
million increase in the level of nonperforming assets over the past twelve
months resulted from a $180 million increase in nonperforming loans, offset in
part by a $3 million net decrease in OREO and other nonperforming assets. The
increase in nonperforming loans 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.
54
<PAGE> 55
The amounts presented in Figure 18 at September 30, 2000, 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.
FIGURE 18. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 2000 1999 1999
----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Commercial, financial and agricultural $ 251 $ 175 $ 146
Real estate-- commercial mortgage 92 102 102
Real estate-- construction 28 7 6
Commercial lease financing 45 28 31
----------------------------------------------------------------------------------------------------------------------------------
Total commercial loans 416 312 285
Real estate-- residential mortgage 50 44 50
Home equity 71 50 42
Consumer-- direct 8 6 5
Consumer-- indirect lease financing 6 3 3
Consumer-- indirect other 41 32 27
----------------------------------------------------------------------------------------------------------------------------------
Total consumer loans 176 135 127
----------------------------------------------------------------------------------------------------------------------------------
Total nonperforming loans 592 447 412
OREO 26 27 32
Allowance for OREO losses (1) (3) (8)
----------------------------------------------------------------------------------------------------------------------------------
OREO, net of allowance 25 24 24
Other nonperforming assets -- 2 4
----------------------------------------------------------------------------------------------------------------------------------
Total nonperforming assets $ 617 $ 473 $ 440
===== ===== =====
----------------------------------------------------------------------------------------------------------------------------------
Accruing loans past due 90 days or more $ 252 $ 219 $ 235
----------------------------------------------------------------------------------------------------------------------------------
Nonperforming loans to period-end loans .89% .70% .65%
Nonperforming assets to period-end loans
plus OREO and other nonperforming assets .93 .74 .70
----------------------------------------------------------------------------------------------------------------------------------
</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 third quarter of 2000, core deposits averaged $37.7 billion, and represented
50% of the funds Key used to support earning assets, compared with $37.2 billion
and 52%, respectively, during the same period last year. As shown in Figure 5
(which spans pages 38 and 39), 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 third
quarter, the deposits in Key's Retail Banking line of business grew by an
annualized 8% from the prior quarter.
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<PAGE> 56
Purchased funds, comprising large certificates of deposit, deposits in the
foreign office, and short-term borrowings, averaged $20.3 billion during the
third quarter of 2000, compared with $17.2 billion a year ago. As shown in
Figure 5, Key has relied more on purchased deposits and borrowings 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 nine months of 2000, Key securitized and sold $1.0 billion of
education loans, $502 million of which occurred in the third 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 932 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 September 30, 2000.
LIQUIDITY FOR THE PARENT COMPANY. KeyCorp meets its liquidity requirements
principally through regular dividends from affiliate banks. During the first
nine months of 2000, affiliates paid KeyCorp a total of $506 million in
dividends. As of September 30, 2000, the affiliate banks had an additional $703
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 nine months of 2000, Key's affiliate banks
raised $5.6 billion under Key's bank note program. Of the notes issued during
this period of time, $1.8 billion have original maturities in excess of one year
and are included in long-term debt; the remaining $3.8 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).
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<PAGE> 57
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 aggregate. The notes are offered
exclusively to non-U.S. investors and can be denominated in U.S. dollars and
many other foreign currencies. There were $3.5 billion of borrowings outstanding
under this facility as of September 30, 2000, $1.1 billion of which were issued
during the current year.
COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp has a commercial paper program
and a two-year revolving credit agreement that provide funding availability of
up to $500 million and $400 million, respectively. As of September 30, 2000,
$372 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
September 30, 2000, unused capacity under the shelf registration totaled $412
million, all of which is reserved for future issuance as medium-term notes. If
KeyCorp maintains its favorable debt ratings, shown below as of September 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
-------------------- ------------------- -------------------
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 nine-month
periods ended September 30, 2000 and 1999, see the Consolidated Statements of
Cash Flow on page 6.
CAPITAL AND DIVIDENDS
SHAREHOLDERS' EQUITY. Total shareholders' equity at September 30, 2000, was $6.5
billion, up $131 million from the balance at December 31, 1999. Retained
earnings grew by $372 million, while net unrealized losses on securities
available for sale decreased by $73 million during the first nine months of
2000. The increase resulting from these items was substantially offset by a $305
million net increase in treasury stock stemming from share repurchases.
SHARE REPURCHASES. In light of Key's earnings outlook and strong capital
position, in September 2000 the Board of Directors authorized the repurchase of
25,000,000 common shares, including the 3,647,200 shares remaining from the
prior authority. These shares may be repurchased in the open market or through
negotiated transactions. During the first nine months of 2000, Key repurchased a
total of 17,652,800 of its common shares (including 1,200,000 shares under the
September authorization) at an average price per share of $19.28.
At September 30, 2000, Key had 64,628,931 treasury shares. Management expects to
reissue those shares over time to support the employee stock purchase, 401(k),
stock option, and dividend reinvestment plans, and for other corporate purposes.
During the first nine months of 2000, Key reissued 1,486,112 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 7.63% at September 30,
2000, compared with 7.66% at December 31, 1999, and 7.75% at September 30, 1999.
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<PAGE> 58
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
September 30, 2000, Key's Tier 1 capital ratio was 7.59%, and its total capital
ratio was 11.34%.
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
September 30, 2000, KeyCorp had a leverage ratio of 7.76%, 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 September 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 September 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 19 presents the details of Key's regulatory capital position at September
30, 2000, December 31, 1999, and September 30, 1999.
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<PAGE> 59
Figure 19. Capital Components and Risk-Adjusted Assets
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
dollars in millions 2000 1999 1999
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Tier 1 capital
Common shareholders' equity(a) $6,565 $6,508 $6,503
Qualifying capital securities 1,243 1,243 1,243
Less: Goodwill (1,339) (1,389) (1,422)
Other intangible assets(b) (48) (56) (60)
-----------------------------------------------------------------------------------------------------------------------------------
Total Tier 1 capital 6,421 6,306 6,264
-----------------------------------------------------------------------------------------------------------------------------------
Tier 2 capital
Allowance for loan losses(c) 1,001 930 930
Net unrealized holding gains(d) 13 3 2
Qualifying long-term debt 2,158 2,330 2,350
-----------------------------------------------------------------------------------------------------------------------------------
Total Tier 2 capital 3,172 3,263 3,282
-----------------------------------------------------------------------------------------------------------------------------------
Total capital $9,593 $9,569 $9,546
====== ====== ======
Risk-adjusted assets
Risk-adjusted assets on balance sheet $71,152 $68,619 $67,342
Risk-adjusted off-balance sheet exposure 14,636 14,513 13,713
Less: Goodwill (1,339) (1,389) (1,422)
Other intangible assets(b) (48) (56) (60)
Plus: Market risk-equivalent assets 174 391 370
Net unrealized holding gains(d) 13 3 2
-----------------------------------------------------------------------------------------------------------------------------------
Gross risk-adjusted assets 84,588 82,081 79,945
Less: Excess allowance for loan losses(c) - - -
-----------------------------------------------------------------------------------------------------------------------------------
Net risk-adjusted assets $84,588 $82,081 $79,945
====== ====== ======
Average quarterly total assets $84,105 $82,574 $81,295
====== ====== ======
Capital ratios
Tier 1 risk-adjusted capital ratio 7.59 % 7.68 % 7.84 %
Total risk-adjusted capital ratio 11.34 11.66 11.94
Leverage ratio(e) 7.76 7.77 7.85
-----------------------------------------------------------------------------------------------------------------------------------
</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 note (b).
Item 3. Quantitative and Qualitative Disclosure of Market Risk
The information included in the Market Risk Management section beginning on page
41 of the Management's Discussion and Analysis of Financial Condition and
Results of Operations is incorporated herein by reference.
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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 (one suit in Federal District Court in Minnesota; two
suits 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,
punitive damages, pre- and post judgment interest, legal fees and
expenses, and in the case of the New Jersey action (in which
plaintiffs allege damages of approximately $54 million), treble
damages consistent with applicable law.
McDonald is vigorously defending these actions and has filed, or will
file, responses to each complaint denying liability.
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<PAGE> 61
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
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.
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<PAGE> 62
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(15) Acknowledgment Letter of Independent Auditors
(27) Financial Data Schedule (filed electronically only)
(b) Reports on Form 8-K
July 19, 2000 - Item 5. Other Events and Item 7. Financial Statements
and Exhibits. Reporting that on July 18, 2000, the Registrant issued a
press release announcing its earnings results for the three- and
six-month periods ended June 30, 2000.
No other reports on Form 8-K were filed during the three-month period
ended September 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: November 10, 2000 /s/ Lee Irving
------------------------------------
By: Lee Irving
Executive Vice President
and Chief Accounting
Officer
62
