-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SEmUJzUF4v6c2J2AxQJHP5lbF4Kl+0+pmLCBT3C9bcNgg4ev7XvkCSDnaHhP7PtD /zQbddvgSqshFbftJY0pnQ== 0000950152-02-002483.txt : 20020415 0000950152-02-002483.hdr.sgml : 20020415 ACCESSION NUMBER: 0000950152-02-002483 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KEYCORP /NEW/ CENTRAL INDEX KEY: 0000091576 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 346542451 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-11302 FILM NUMBER: 02590462 BUSINESS ADDRESS: STREET 1: 127 PUBLIC SQ CITY: CLEVELAND STATE: OH ZIP: 44114-1306 BUSINESS PHONE: 2166896300 MAIL ADDRESS: STREET 1: 127 PUBLIC SQ CITY: CLEVELAND STATE: OH ZIP: 44114-1306 FORMER COMPANY: FORMER CONFORMED NAME: SOCIETY CORP DATE OF NAME CHANGE: 19920703 10-K 1 l92910ae10-k.txt KEYCORP 10-K/YEAR ENDING 12-31-2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 0-850 [KEYCORP LOGO] (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) OHIO --------------------------- (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) 127 PUBLIC SQUARE, CLEVELAND, OHIO --------------------------------------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) 34-6542451 --------------------------------------- (I.R.S. EMPLOYER IDENTIFICATION NO.) 44114-1306 ---------------- (ZIP CODE) (216) 689-6300 ---------------------------------------------- (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Securities registered pursuant Securities registered pursuant to Section 12(b) of the Act: to Section 12(g) of the Act: Common Shares, $1 par value Rights to Purchase Common Shares None - ------------------------------------------------ ------------------------------------------------ (TITLE OF EACH CLASS) (TITLE OF CLASS) New York Stock Exchange - ------------------------------------------------ (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by nonaffiliates of the Registrant was approximately $10,658,486,487 at February 28, 2002. (The aggregate market value has been computed using the closing market price of the stock as reported by the New York Stock Exchange on February 28, 2002.) 424,979,525 Shares - -------------------------------------------------------------------------------- (NUMBER OF KEYCORP COMMON SHARES OUTSTANDING AS OF FEBRUARY 28, 2002) Certain specifically designated portions of KeyCorp's 2001 Annual Report to Shareholders are incorporated by reference into Parts I, II and IV of this Form 10-K. Certain specifically designated portions of KeyCorp's definitive Proxy Statement for its 2002 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K. KEYCORP 2001 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
ITEM PAGE NUMBER NUMBER - ------ ------ PART I 1 Business.................................................... 1 2 Properties.................................................. 8 3 Legal Proceedings........................................... 8 4 Submission of Matters to a Vote of Security Holders......... 8 PART II 5 Market for Registrant's Common Equity and Related Stockholder Matters....................................... 8 6 Selected Financial Data..................................... 9 7 Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 9 7A Quantitative and Qualitative Disclosures about Market Risk...................................................... 9 8 Financial Statements and Supplementary Data................. 9 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 9 PART III 10 Directors and Executive Officers of the Registrant.......... 9 11 Executive Compensation...................................... 9 12 Security Ownership of Certain Beneficial Owners and Management................................................ 9 13 Certain Relationships and Related Transactions.............. 10 PART IV 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................................................... 10 Signatures.................................................. 14 Exhibits.................................................... 15
PART I ITEM 1. BUSINESS OVERVIEW KeyCorp is a legal entity separate and distinct from its banking and other subsidiaries. Accordingly, the right of KeyCorp, its security holders and its creditors to participate in any distribution of the assets or earnings of KeyCorp's banking and other subsidiaries is subject to the prior claims of the respective creditors of such banking and other subsidiaries, except to the extent that KeyCorp's claims in its capacity as creditor of such banking and other subsidiaries may be recognized. KeyCorp, organized in 1958 under the laws of the state of Ohio, is headquartered in Cleveland, Ohio. It has elected to be a bank holding company and a financial holding company under the Bank Holding Company Act of 1956, as amended ("BHCA"). At December 31, 2001, KeyCorp was one of the nation's largest bank-based financial services companies with consolidated total assets of $80.9 billion. Its subsidiaries provide a wide range of retail and commercial banking, commercial leasing, investment management, consumer finance and investment banking products and services to individual, corporate and institutional clients through three major lines of business: Key Consumer Banking, Key Corporate Finance and Key Capital Partners. As of December 31, 2001, these services were provided across much of the country through subsidiaries operating 911 full-service retail banking branches ("KeyCenters") in 12 states, a telephone banking call center services group and 2,333 ATMs. Additional information pertaining to the three business lines referred to above is included in the "Line of Business Results" section beginning on page 26 and in Note 4 ("Line of Business Results"), beginning on page 64 of the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders and is incorporated herein by reference. KeyCorp and its subsidiaries had 21,230 full-time equivalent employees as of December 31, 2001. In addition to the customary banking services of accepting deposits and making loans, KeyCorp's bank and trust company subsidiaries provide specialized services, including personal and corporate trust services, personal financial services, customer access to mutual funds, cash management services, investment banking and capital markets products, and international banking services. Through its subsidiary banks, trust company and registered investment adviser subsidiaries, KeyCorp provides investment management services to individual and institutional clients, including large corporate and public retirement plans, foundations and endowments, high-net-worth individuals and Taft-Hartley plans (i.e., multiemployer trust funds established for providing pension, vacation or other benefits to employees). KeyCorp provides other financial services both inside and outside of its primary banking markets through its nonbank subsidiaries. These services include accident and health insurance on loans made by subsidiary banks, venture capital, community development financing, securities underwriting and brokerage and other financial services. KeyCorp is an equity participant in a joint venture with Key Merchant Services, LLC, which provides merchant services to businesses. The executive offices of KeyCorp are located at 127 Public Square, Cleveland, Ohio 44114-1306, and its telephone number is (216) 689-6300. 1 The following financial data is included in the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders and is incorporated herein by reference:
DESCRIPTION OF FINANCIAL DATA PAGE - ----------------------------- ---- Selected Financial Data..................................... 25 Average Balance Sheets, Net Interest Income and Yields/Rates.............................................. 30 Components of Net Interest Income Changes................... 32 Composition of Loans........................................ 39 Maturities and Sensitivity of Certain Loans to Changes in Interest Rates............................................ 42 Securities Available for Sale............................... 42 Investment Securities....................................... 43 Allocation of the Allowance for Loan Losses................. 44 Summary of Loan Loss Experience............................. 46 Summary of Nonperforming Assets and Past Due Loans.......... 47 Maturity Distribution of Time Deposits of $100,000 or More...................................................... 48 Impaired Loans and Other Nonperforming Assets............... 69 Short-Term Borrowings....................................... 69
ACQUISITIONS AND DIVESTITURES The information presented in Note 3 ("Acquisitions and Divestitures"), beginning on page 63 of the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders is incorporated herein by reference. COMPETITION The market for banking and related financial services is highly competitive. KeyCorp and its subsidiaries ("Key") compete with other providers of financial services, such as other bank holding companies, commercial banks, savings associations, credit unions, mortgage banking companies, finance companies, mutual funds, insurance companies, investment management firms, investment banking firms, broker-dealers and a growing list of other local, regional and national institutions which offer financial services. Key competes by offering quality products and innovative services at competitive prices. In recent years, mergers between financial institutions have led to greater concentration in the banking industry and placed added competitive pressure on Key's core banking services. In addition, competition has intensified as a consequence of the financial modernization laws that were enacted in November 1999 and permit qualifying financial institutions to expand into other activities. For example, commercial banks are now permitted to have affiliates that underwrite and deal in securities, underwrite insurance and make merchant banking investments under certain conditions. See "Interstate Banking and Branching" and "Financial Modernization Legislation" on page 7. SUPERVISION AND REGULATION The following discussion addresses certain of the material elements of the regulatory framework applicable to bank holding companies and their subsidiaries, and provides certain specific information regarding Key. The regulatory framework is intended primarily for the protection of customers and depositors, the deposit insurance funds of the Federal Deposit Insurance Corporation ("FDIC") and the banking system as a whole, and generally is not intended for the protection of security holders. The following is a brief discussion of selected laws, regulations, and regulatory agency policies applicable to Key. Such discussion is not intended to be comprehensive, and is qualified in its entirety by reference to the full text of such statutes, regulations, and regulatory agency policies. Changes in applicable laws, regulations, and regulatory agency policies cannot necessarily be predicted, but may have a material effect on Key's business, financial condition and results of operation. 2 General As a bank holding company, KeyCorp is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") under the BHCA. Under the BHCA, bank holding companies may not, in general, directly or indirectly acquire the ownership or control of more than 5% of the voting shares, or substantially all of the assets, of any bank, without the prior approval of the Federal Reserve Board. In addition, bank holding companies are generally prohibited under the BHCA from engaging in commercial or industrial activities. KeyCorp's banking subsidiaries are also subject to extensive regulation, supervision and examination by applicable Federal banking agencies. KeyCorp operates two full-service, FDIC-insured national bank subsidiaries, KeyBank National Association ("KeyBank") and Key Bank USA, National Association ("KeyBank USA"), and one national bank subsidiary whose activities are limited to those of a fiduciary. All of KeyCorp's national bank subsidiaries and their subsidiaries are subject to regulation, supervision and examination by the Office of the Comptroller of the Currency (the "OCC"). Because the deposits in KeyBank and KeyBank USA are insured (up to applicable limits) by the FDIC, the FDIC also has certain regulatory and supervisory authority over both banking subsidiaries. KeyCorp also has other financial services subsidiaries that are subject to regulation, supervision and examination by the Federal Reserve Board, as well as other applicable state and Federal regulatory agencies and self-regulatory organizations. For example, KeyCorp's brokerage and asset management subsidiaries are subject to supervision and regulation by the Securities and Exchange Commission (the "SEC"), the National Association of Securities Dealers, Inc. or the New York Stock Exchange and state securities regulators; KeyCorp's insurance subsidiaries are subject to regulation by the insurance regulatory authorities of the various states. Other nonbank subsidiaries of KeyCorp are subject to other laws and regulations of both the Federal government and the various states in which they are authorized to do business. Dividend Restrictions The principal source of cash flow to KeyCorp, including cash flow to pay dividends on its common shares and debt service on its indebtedness, is dividends from its subsidiaries. Various statutory and regulatory provisions limit the amount of dividends that may be paid by KeyCorp's banking subsidiaries without regulatory approval. The approval of the OCC is required for the payment of any dividend by a national bank if the total of all dividends declared by the board of directors of such bank in any calendar year would exceed the total of: (i) the bank's net income for the current year plus (ii) the retained net income (as defined and interpreted by regulation) for the preceding two years, less any required transfer to surplus or a fund for the retirement of any preferred stock. In addition, a national bank can pay dividends only to the extent of its undivided profits. All of KeyCorp's national bank subsidiaries are subject to these restrictions. Since June 30, 2001, KeyBank USA has had a deficit in its undivided profits account. Accordingly, its payment of dividends to KeyCorp requires prior OCC consent. In addition, if, in the opinion of a Federal banking agency, a depository institution under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the institution, could include the payment of dividends), the agency may require, after notice and hearing, that such institution cease and desist from such practice. The OCC and the FDIC have indicated that paying dividends that would deplete a depository institution's capital base to an inadequate level would be an unsafe and unsound practice. Moreover, under the Federal Deposit Insurance Act (the "FDIA"), an insured depository institution may not pay any dividend if payment would cause it to become less than "adequately capitalized." See "Regulatory Capital Standards and Related Matters -- Prompt Corrective Action." The FDIA also prohibits the payment of any dividend while the institution is in default in the payment of any assessment due to the FDIC. Also, the Federal Reserve Board, the OCC and the FDIC have issued policy statements which provide that FDIC-insured depository institutions and their holding companies should generally pay dividends only out of their current operating earnings. Holding Company Structure Transactions Involving Banking Subsidiaries. KeyCorp's national bank subsidiaries (and their operating subsidiaries) are subject to Federal Reserve Act provisions which impose qualitative standards and quantitative limitations upon certain transactions with or involving KeyCorp (and its nonbank subsidiaries which are not 3 operating subsidiaries of KeyCorp's national banks). Transactions covered by these provisions, which include loans and other extensions of credit as well as purchases and sales of assets, must be on arm's length terms, cannot exceed certain amounts which are determined with reference to the bank's regulatory capital, and if a loan or other extension of credit, must be secured by collateral in an amount and quality expressly prescribed by statute. For example, the aggregate of all such outstanding covered transactions by KeyBank and KeyBank USA, including their operating subsidiaries, with or involving KeyCorp and its nonbank subsidiaries which are not operating subsidiaries of KeyBank and KeyBank USA was limited at December 31, 2001, to approximately $1.8 billion. As a result, these provisions materially restrict the ability of KeyCorp's national bank subsidiaries and their operating subsidiaries to fund KeyCorp and its nonbank subsidiaries, which are not operating subsidiaries of KeyCorp's national banks. Source of Strength Doctrine. Under Federal Reserve Board policy, a bank holding company is expected to serve as a source of financial and managerial strength to each of its subsidiary banks and, under appropriate circumstances, to commit resources to support each such subsidiary bank. This support may be required by the Federal Reserve Board at times when KeyCorp may not have the resources to provide it, or, for other reasons, would not otherwise be inclined to provide it. Certain loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits in, and certain other indebtedness of, the subsidiary bank. In addition, the Crime Control Act of 1990 provides that in the event of a bank holding company's bankruptcy, any commitment by a bank holding company to a Federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. Depositor Preference. The FDIA provides that, in the event of the "liquidation or other resolution" of an insured depository institution, the claims of depositors of such institution (including claims by the FDIC as subrogee of insured depositors) and certain claims for administrative expenses of the FDIC as a receiver would be afforded a priority over other general unsecured claims against such an institution, including Federal funds and letters of credit. If an insured depository institution fails, insured and uninsured depositors along with the FDIC will be placed ahead of unsecured, nondeposit creditors, including a parent holding company, in order of priority of payment. Liability of Commonly Controlled Institutions. Under the FDIA, an insured depository institution which is under common control with another insured depository institution is generally liable for any loss incurred, or reasonably anticipated to be incurred, by the FDIC in connection with the default of such commonly controlled institution, or any assistance provided by the FDIC to such commonly controlled institution which is in danger of default. The term "default" is defined generally to mean the appointment of a conservator or receiver and the term "in danger of default" is defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance. Subprime Lending. In 2001, the Federal banking agencies published expanded guidance to examiners in connection with their examination of subprime lending programs. For these purposes, a subprime lending program is one that targets borrowers with weakened credit histories or having questionable repayment capacity. The guidance addresses supervisory expectations with respect to risk management, the allowance for loan and lease losses, regulatory capital, portfolio and transaction level examination review, analysis, and classification, cure program documentation, and predatory or abusive lending practices. While this guidance principally applies to institutions with subprime lending programs having an aggregate credit exposure of at least 25% of Tier 1 capital, Federal banking examiners may apply it to other subprime portfolios, such as those that are experiencing rapid growth or adverse performance trends, those that are administered by inexperienced management, and those which possess inadequate or weak controls. The Federal banking agencies have indicated, however, that the guidance is neither intended nor considered by the agencies to be a capital regulation and does not represent a change in policy by the agencies. Moreover, the agencies have also indicated that examiners would not unilaterally require additional reserves or capital based upon the guidance, and that any determination made by an examiner that an institution's reserves or capital is deficient would be discussed with the institution's management and each agency's appropriate supervisory office before a final decision is made. Neither the Federal Reserve Board nor the OCC has advised KeyCorp or any of its national bank subsidiaries of any such deficiency. 4 Regulatory Capital Standards and Related Matters Regulatory Capital. Applicable law and regulation define and prescribe minimum levels of regulatory capital for bank holding companies and their banking subsidiaries. Adequacy of regulatory capital is assessed periodically by the Federal banking agencies in the examination and supervision process, and in the evaluation of applications in connection with specific transactions and activities, including acquisitions, expansion of existing activities, and commencement of new activities. Bank holding companies are subject to risk-based capital guidelines adopted by the Federal Reserve Board. These guidelines establish minimum ratios of qualifying capital to risk-weighted assets. Qualifying capital includes Tier 1 capital and Tier 2 capital. Risk-weighted assets are calculated by assigning varying risk-weights to broad categories of assets and off-balance-sheet exposures, based primarily on counterparty credit risk. The required minimum Tier 1 risk-based capital ratio, calculated by dividing Tier 1 capital by risk-weighted assets, is currently 4.00%. The required minimum total risk-based capital ratio is currently 8.00%. It is calculated by dividing the sum of Tier 1 capital and Tier 2 capital not in excess of Tier 1 capital, after deductions for investments in certain subsidiaries and associated companies and for reciprocal holdings of capital instruments, by risk-weighted assets. Tier 1 capital includes common equity, qualifying perpetual preferred equity, and minority interests in the equity accounts of consolidated subsidiaries less certain intangible assets (including goodwill) and certain other assets. Tier 2 capital includes qualifying hybrid capital instruments, perpetual debt, mandatory convertible debt securities, perpetual preferred equity not includable in Tier 1 capital, and limited amounts of: term subordinated debt, medium-term preferred equity, certain unrealized holding gains on certain equity securities, and the allowance for loan and lease losses. Bank holding companies, such as KeyCorp, whose trading activities exceed specified levels are required to maintain capital for market risk. Market risk includes changes in the market value of trading account, foreign exchange, and commodity positions, whether resulting from broad market movements (such as changes in the general level of interest rates, equity prices, foreign exchange rates, or commodity prices) or from position specific factors (such as idiosyncratic variation, event risk, and default risk). At December 31, 2001, Key's Tier 1 and total capital to risk-weighted assets ratios were 7.43% and 11.41%, respectively, which include required adjustments for market risk. In addition to the risk-based standard, bank holding companies are subject to the Federal Reserve Board's leverage ratio guidelines. These guidelines establish minimum ratios of Tier 1 capital to total assets. The minimum leverage ratio, calculated by dividing Tier 1 capital by average total consolidated assets, is 3.00% for bank holding companies that either have the highest supervisory rating or have implemented the Federal Reserve Board's risk-based capital measure for market risk. All other bank holding companies must maintain a minimum leverage ratio of at least 4.00%. Neither KeyCorp nor any of its banking subsidiaries has been advised by its primary Federal banking regulator of any specific leverage ratio applicable to it. At December 31, 2001, Key's Tier 1 capital leverage ratio was 7.65%. KeyCorp's national bank subsidiaries are also subject to risk-based and leverage capital requirements adopted by the OCC which are substantially similar to those imposed by the Federal Reserve Board on bank holding companies. At December 31, 2001, each of these banking subsidiaries had regulatory capital in excess of all minimum risk-based and leverage capital requirements. Besides establishing regulatory minimum ratios of capital to assets for all bank holding companies and their banking subsidiaries, the risk-based and leverage capital guidelines also identify various organization-specific factors and risks which are not taken into account in the computation of the capital ratios yet affect the overall supervisory evaluation of a banking organization's regulatory capital adequacy and can result in the imposition of higher minimum regulatory capital ratio requirements upon the particular organization. Neither the Federal Reserve Board nor the OCC has advised KeyCorp or any of its national bank subsidiaries of any specific minimum risk-based or leverage capital ratio applicable to KeyCorp or such national bank subsidiary. In late November 2001, the Federal banking agencies published their final rule on the revised regulatory capital treatment of on-balance sheet assets and off-balance sheet exposures consisting of recourse obligations, direct credit substitutes, and residual interests that expose banking organizations primarily to credit risk. The final rule 5 treats recourse obligations and direct credit substitutes more consistently and adds new standards for the treatment of residual interests, including a concentration limit for credit-enhancing interest-only strip receivables. In addition, the agencies use credit rating and certain alternative approaches to match regulatory capital requirements more closely to a banking organization's relative risk of loss for certain positions in asset securitizations. The final rule became effective on January 1, 2002, for any transactions that settle on or after such date. Transactions which settle before January 1, 2002, and result in increased regulatory capital requirements are not required to conform to the final rule until December 31, 2002. Management is in the process of completing its evaluation of the effect on Key of the final rule. In late January 2002, the Federal banking agencies published their final rule on the regulatory capital treatment of certain equity investments made by banking organizations in companies engaged in nonfinancial activities. The final rule becomes effective on April 1, 2002. The final rule imposes marginal capital charges (applied by making deductions from banking organization's Tier 1 capital) which increase as the banking organization's aggregate carrying amount of its covered equity investments increase in relation to its Tier 1 capital. Such capital charges range from 8% - 25% as such aggregate carrying amount increases from 15% to 25% of the banking organization's Tier 1 capital. Management is in the process of completing its evaluation of the effect on Key of the final rule. As noted on page 4 in "Subprime Lending," the subprime lending examination guidance addresses, among other matters, Federal banking agency supervisory expectations with respect to regulatory capital of institutions with subprime lending portfolios. For an institution having subprime lending portfolio exposure aggregating 25% or more of the institution's Tier 1 capital, the guidance indicates examiners will likely expect, as a minimum, that the institution would hold capital against such portfolio in an amount that is 1.5 to 3.0 times greater than what is appropriate for nonsubprime assets of a similar type. Federal banking agencies may also apply this additional capital requirement to other subprime portfolios such as those that are experiencing rapid growth or adverse performance trends, that are administered by inexperienced management, or which possess inadequate or weak controls. Prompt Corrective Action. The "prompt corrective action" provisions of the FDIA added by the FDIC Improvement Act ("FDICIA") create a statutory framework that applies a system of both discretionary and mandatory supervisory actions indexed to the capital level of FDIC-insured depository institutions. These provisions impose progressively more restrictive constraints on operations, management, and capital distributions of the institution as its regulatory capital decreases, or in some cases, based on supervisory information other than the institution's capital level. This framework and the authority it confers on the Federal banking agencies supplements other existing authority vested in such agencies to initiate supervisory actions to address capital deficiencies. Moreover, other provisions of law and regulation employ regulatory capital level designations the same as or similar to those established by the prompt corrective action provisions both in imposing certain restrictions and limitations and in conferring certain economic and other benefits upon institutions. These include restrictions on brokered deposits, FDIC deposit insurance limits on pass-through deposits, limits on exposure to interbank liabilities, risk-based FDIC deposit insurance premium assessments, and expedited action upon regulatory applications. FDIC-insured depository institutions are grouped into one of five prompt corrective action capital categories -- well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized -- using the Tier 1 risk-based, total risk-based, and Tier 1 leverage capital ratios as the relevant capital measures. An institution is considered well capitalized if it has a total risk-based capital ratio of at least 10.00%, a Tier 1 risk-based capital ratio of at least 6.00% and a Tier 1 leverage capital ratio of at least 5.00% and is not subject to any written agreement, order or capital directive to meet and maintain a specific capital level for any capital measure. An adequately capitalized institution must have a total risk-based capital ratio of at least 8.00%, a Tier 1 risk-based capital ratio of at least 4.00% and a Tier 1 leverage capital ratio of at least 4.00% (3.00% if the institution has achieved the highest composite rating in its most recent examination) and is not well capitalized. At December 31, 2001, each KeyCorp insured depository institution subsidiary met the requirements for the "well capitalized" capital category. An institution's prompt corrective action capital category, however, may not 6 constitute an accurate representation of the overall financial condition or prospects of KeyCorp or its banking subsidiaries, and should be considered in conjunction with other available information regarding Key's financial condition and results of operations. FDIC DEPOSIT INSURANCE AND FINANCING CORPORATION BOND ASSESSMENTS Because substantially all of the deposits of KeyCorp's depository institution subsidiaries are insured up to applicable limits by the FDIC, these subsidiaries are subject to deposit insurance premium assessments by the FDIC to maintain the Bank Insurance Fund (the "BIF") and the Savings Association Insurance Fund (the "SAIF") of the FDIC. The FDIC has adopted a risk-related deposit insurance assessment system under which premiums, ranging in 2001 from zero to $.27 for each $100 of domestic deposits, are imposed based upon the depository institution's capitalization and Federal supervisory evaluation. Each of KeyCorp's depository institution subsidiaries in 2001 qualified for a deposit insurance assessment rate of zero. The FDIC is authorized to increase deposit insurance premium assessments in certain circumstances. Any such increase would have an adverse effect on Key's earnings. Beginning in 1997, all BIF-member institutions were required to join with SAIF-member institutions in servicing the approximately $793 million of annual interest on 30-year non-callable bonds issued by the Financing Corporation ("FICO") in the late 1980s to fund losses incurred by the former Federal Savings and Loan Insurance Corporation. FICO bond assessments are separate from and in addition to deposit insurance premium assessments and, unlike deposit insurance premium assessments, do not vary with the depository institution's capitalization and Federal supervisory evaluation. Federal law required the FICO assessment rate on BIF assessable deposits to be one-fifth of that imposed on SAIF assessable deposits through 1999. Starting in 2000, BIF and SAIF FICO assessment rates equalized. Throughout 2001, Key paid FICO bond assessments at an annualized rate of less than $.02 per $100 of its FICO-assessable deposits. INTERSTATE BANKING AND BRANCHING The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Interstate Act") generally authorizes bank holding companies to acquire banks located in any state, and also generally permits FDIC-insured banks located in different states to merge, allowing the resulting institution to operate interstate branches. In addition, the Interstate Act allows an FDIC-insured bank to establish (or acquire) and operate a branch in a state in which such bank does not maintain a branch if that state expressly permits such transactions. Using the authority conferred by the Interstate Act, the number of FDIC-insured depository institutions operated by KeyCorp has been reduced to two -- KeyBank and KeyBank USA. FINANCIAL MODERNIZATION LEGISLATION The Gramm-Leach-Bliley Act (the "GLBA"), enacted in November 1999, authorizes new activities for qualifying financial institutions. The GLBA repeals significant provisions of the Glass-Steagall Act to permit commercial banks, among other things, to have affiliates that underwrite and deal in securities and make merchant banking investments provided certain conditions are met. The GLBA modifies the BHCA to permit bank holding companies that meet certain specified standards (known as "financial holding companies") to engage in a broader range of financial activities than previously permitted under the BHCA, and allows subsidiaries of commercial banks that meet certain specified standards (known as "financial subsidiaries") to engage in a wide range of financial activities that are prohibited to such banks themselves under certain circumstances. In 2000, KeyCorp elected to become a financial holding company. Under the authority conferred by the GLBA, Key has been able to expand the nature and scope of its equity investments in nonfinancial companies, operate its McDonald Investments Inc. subsidiary with fewer operating restrictions, and acquire financial subsidiaries to engage in real estate leasing activities and insurance agency activities without geographic restriction. GLBA also established new requirements for financial institutions to provide new privacy protections to consumers. The Federal banking agencies jointly adopted a final regulation providing for the implementation of these protections. It requires a financial institution to provide notice to customers about its privacy policies and 7 practices, describes under what conditions a financial institution may disclose nonpublic personal information about consumers to nonaffiliated third parties, and provides an "opt-out" method for consumers to prevent the financial institution from disclosing that information to nonaffiliated third parties. Financial institutions were required to be in compliance with the final regulation by July 1, 2001. Effective in May 2001, GLBA repealed the blanket exception of banks (and savings associations) from the definitions of "broker" and "dealer" under the Securities Exchange Act of 1934, and replaced this full exception with functional exceptions. Under the statute, banks that engage in securities activities either must conduct those activities through a broker-dealer or conform their securities activities to those which qualify for functional exceptions. The SEC issued interim final rules in May 2001 which included a temporary exemption for banks from the definitions of "broker" and "dealer" until October 2001. In July 2001, the SEC further extended this temporary exemption until May 2002. The SEC has also given notice that it expects to amend its interim final rules and further extend the temporary exemption so that banks will have a sufficient transition period to bring their operations into compliance with the amended rules. ITEM 2. PROPERTIES The headquarters of KeyCorp, KeyBank and KeyBank USA are located in Key Tower at 127 Public Square, Cleveland, Ohio 44114-1306. At December 31, 2001, Key leased approximately 695,000 square feet of the complex, encompassing the first twenty-three floors, the 28th floor and the 54th through 56th floors of the 57- story Key Tower. As of the same date, the banking subsidiaries of KeyCorp owned 502 of their branch banking offices and leased 409 offices. The lease terms for applicable branch banking offices are not individually material, with terms ranging from month-to-month to 99-years from inception. Additional information pertaining to Key's properties is presented in Note 1 ("Summary of Significant Accounting Policies"), beginning on page 58 of the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders and is incorporated herein by reference. ITEM 3. LEGAL PROCEEDINGS The information presented in the Legal Proceedings section of Note 17 ("Commitments, Contingent Liabilities and Other Disclosures"), beginning on page 76 of the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders is incorporated herein by reference. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of the fiscal year covered by this report, no matter was submitted to a vote of security holders of KeyCorp. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The dividend restrictions discussion on page 3 of this report and the following disclosures included in the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders are incorporated herein by reference:
PAGE ---- Discussion of common shares and shareholder information presented in the capital and dividends section............ 50 Presentation of quarterly market price and cash dividends per common share.......................................... 52 Discussion of dividend restrictions presented in Note 17 ("Commitments, Contingent Liabilities and Other Disclosures")............................................. 77
8 ITEM 6. SELECTED FINANCIAL DATA The Selected Financial Data presented on page 25 of the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information included under "Management's Discussion and Analysis of Financial Condition and Results of Operations" presented on pages 22 through 52 of the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information included under the caption "Market risk management" presented on pages 29, 32 and 33 of the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Selected Quarterly Financial Data and the financial statements and the notes thereto, presented on page 52 and on pages 54 through 83, respectively, of the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is set forth in the sections captioned "Issue One -- ELECTION OF DIRECTORS" and "EXECUTIVE OFFICERS" contained in KeyCorp's definitive Proxy Statement for the 2002 Annual Meeting of Shareholders to be held May 23, 2002, and is incorporated herein by reference. KeyCorp expects to file its final proxy statement on or before April 12, 2002. The information set forth in the sections captioned, "AUDIT AND RISK REVIEW COMMITTEE INDEPENDENCE" and "AUDIT AND RISK REVIEW COMMITTEE REPORT" contained in KeyCorp's definitive Proxy Statement for the 2002 Annual Meeting of Shareholders to be held May 23, 2002, are not incorporated by reference in this Report on Form 10-K. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is set forth in the sections captioned "THE BOARD OF DIRECTORS AND ITS COMMITTEES," "COMPENSATION OF EXECUTIVE OFFICERS" and "EMPLOYMENT AND CHANGE OF CONTROL AGREEMENTS" contained in KeyCorp's definitive Proxy Statement for the 2002 Annual Meeting of Shareholders to be held May 23, 2002, and is incorporated herein by reference. The information set forth in the sections captioned "COMPENSATION AND ORGANIZATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION" and "KEYCORP STOCK PRICE PERFORMANCE" contained in KeyCorp's definitive Proxy Statement for the 2002 Annual Meeting of Shareholders to be held May 23, 2002, is not incorporated by reference in this Report on Form 10-K. KeyCorp expects to file its final proxy statement on or before April 12, 2002. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is set forth in the section captioned "SHARE OWNERSHIP AND PHANTOM STOCK UNITS" contained in KeyCorp's definitive Proxy Statement for the 2002 Annual Meeting 9 of Shareholders to be held May 23, 2002, and is incorporated herein by reference. KeyCorp expects to file its final proxy statement on or before April 12, 2002. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is set forth in the section captioned "Issue One -- ELECTION OF DIRECTORS" contained in KeyCorp's definitive Proxy Statement for the 2002 Annual Meeting of Shareholders to be held May 23, 2002, and is incorporated herein by reference. KeyCorp expects to file its final proxy statement on or before April 12, 2002. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) FINANCIAL STATEMENTS The following financial statements of KeyCorp and its subsidiaries, and the auditor's report thereon, are incorporated herein by reference to the pages indicated in the Financial Review section of KeyCorp's 2001 Annual Report to Shareholders:
PAGE ---- Report of Ernst & Young LLP, Independent Auditors........... 53 Consolidated Financial Statements: Consolidated Balance Sheets at December 31, 2001 and 2000... 54 Consolidated Statements of Income for the Years Ended December 31, 2001, 2000 and 1999.......................... 55 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2001, 2000 and 1999...... 56 Consolidated Statements of Cash Flow for the Years Ended December 31, 2001, 2000 and 1999.......................... 57 Notes to Consolidated Financial Statements.................. 58
(a)(2) FINANCIAL STATEMENT SCHEDULES All financial statement schedules for KeyCorp and its subsidiaries have been included in the consolidated financial statements or the related footnotes, or they are either inapplicable or not required. (a)(3) EXHIBITS* 3.1 Amended and Restated Articles of Incorporation of KeyCorp filed, as Exhibit 3 to Form 10-Q for the quarter ended September 30, 1998, and incorporated herein by reference. 3.2 Amended and Restated Regulations of KeyCorp, effective May 15, 1997, filed on June 19, 1997, as Exhibit 2 to Form 8-A/A, and incorporated herein by reference. 4.1 Restated Rights Agreement, dated as of May 15, 1997, between KeyCorp and KeyBank National Association, as Rights Agent, filed on June 19, 1997, as Exhibit 1 to Form 8-A, and incorporated herein by reference. 10.1 Form of Change of Control Agreement between KeyCorp and Certain Executive Officers of KeyCorp, effective November 20, 1997, filed as Exhibit 10.5 to Form 10-K for the year ended December 31, 1997, and incorporated herein by reference. 10.2 First Amendment to Form of Change of Control Agreement between KeyCorp and Certain Executive Officers of KeyCorp, filed as Exhibit 10.1 to Form 10-Q for the quarter ended September 30, 1999, and incorporated herein by reference. 10.3 Form of Premium Priced Option Grant between KeyCorp and Robert W. Gillespie dated January 13, 1999, filed as Exhibit 10.2 to Form 10-Q for the quarter ended March 31, 1999, and incorporated herein by reference.
10 10.4 Form of Premium Priced Option Grant between KeyCorp and Henry L. Meyer III dated January 13, 1999, filed as Exhibit 10.3 to Form 10-Q for the quarter ended March 31, 1999, and incorporated herin by reference. 10.5 Form of Option Grant between KeyCorp and Robert W. Gillespie, dated November 15, 2000, filed as Exhibit 10.5 to Form 10-K for the year ended December 31, 2000, and incorporated herein by reference. 10.6 Form of Option Grant between KeyCorp and Henry L. Meyer III, dated November 15, 2000, filed as Exhibit 10.6 to Form10-K for the year ended December 31, 2000, and incorporated herein by reference. 10.7 Amended and Restated Employment Agreement between KeyCorp and Robert W. Gillespie, effective November 21, 1996, filed as Exhibit 10.33 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.8 First Amendment to Amended and Restated Employment Agreement between KeyCorp and Robert W. Gillespie, dated December 7, 1998, filed as Exhibit 10.10 to Form 10-K for the year ended December 31, 1998, and incorporated herein by reference. 10.9 Second Amendment to Amended and Restated Employment Agreement between KeyCorp and Robert W. Gillespie, dated November 23, 1999, filed as Exhibit 10.9 to Form 10-K for the year ended December 31, 1999, and incorporated herein by reference. 10.10 Amended Employment Agreement between KeyCorp and Henry L. Meyer III, dated February 1, 2001, filed as Exhibit 10.10 to Form 10-K for the year ended December 31, 2000, and incorporated herein by reference. 10.11 Employment Agreement among KeyCorp, Robert T. Clutterbuck and McDonald Investments Inc., dated October 4, 2000, filed as Exhibit 10.13 to Form 10-K for the year ended December 31, 2000, and incorporated herein by reference. 10.12 KeyCorp Long Term Incentive Plan (January 1, 1998) filed as Exhibit 10.3 to Form 10-K for the year ended December 31, 1997, and incorporated herein by reference. 10.13 KeyCorp Annual Incentive Plan as amended and restated on January 17, 2001, filed as Exhibit 10.3 to Form 10-Q for the quarter ended March 31, 2001, and incorporated herein by reference. 10.14 KeyCorp Amended and Restated 1991 Equity Compensation Plan (Amended as of November 14, 2001). 10.15 Society Corporation 1988 Stock Option Plan, amended as of September 19, 1996, filed as Exhibit 10.11 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.16 KeyCorp 1988 Stock Option Plan as Amended and Restated as of September 19, 1996, filed as Exhibit 10.20 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.17 McDonald & Company Investments, Inc. Stock Option Plan, filed as Exhibit 10.39 to Form 10-K for the year ended December 31, 1998, and incorporated herein by reference. 10.18 McDonald & Company Investments, Inc. 1995 Key Employees Stock Option Plan, filed as Exhibit 10.40 to Form 10-K for the year ended December 31, 1998, and incorporated herein by reference. 10.19 KeyCorp Directors' Stock Option Plan (November 17, 1994 Restatement) filed as Exhibit 10.37 to Form 10-K for the year ended December 31, 1994, and incorporated herein by reference. 10.20 KeyCorp 1997 Stock Option Plan for Directors as amended and restated on March 14, 2001, filed as Exhibit 10.1 to Form 10-Q for the quarter ended March 31, 2001, and incorporated herein by reference.
11 10.21 KeyCorp Umbrella Trust for Directors, between KeyCorp and National Bank of Detroit, dated July 1, 1990, filed as Exhibit 10.28 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.22 Amended and Restated Director Deferred Compensation Plan (May 18, 2000 Amendment and Restatement) filed as Exhibit 10 to Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by reference. 10.23 KeyCorp Directors' Survivor Benefit Plan, effective September 1, 1990, filed as Exhibit 10.25 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.24 KeyCorp Excess 401(k) Savings Plan (Amended and Restated as of January 1, 1998), filed as Exhibit 10.31 to Form 10-K for the year ended December 31, 1998, and incorporated herein by reference. 10.25 KeyCorp Excess Cash Balance Pension Plan (Amended and Restated as of January 1, 1998), filed as Exhibit 10.34 to Form 10-K for the year ended December 31, 1998, and incorporated herein by reference. 10.26 First Amendment to KeyCorp Excess Cash Balance Pension Plan, effective July 1, 1999, filed as Exhibit 10.4 to Form 10-Q for the quarter ended September 30, 1999, and incorporated herein by reference. 10.27 KeyCorp Deferred Compensation Plan (Amended and Restated as of January 1, 1998), filed as Exhibit 10.38 to Form 10-K for the year ended December 31, 1998, and incorporated herein by reference. 10.28 First Amendment to KeyCorp Deferred Compensation Plan. 10.29 Second Amendment to KeyCorp Deferred Compensation Plan. 10.30 KeyCorp Automatic Deferral Plan, filed as Exhibit 10.3 to Form 10-Q for the quarter ended September 30, 1999, and incorporated herein by reference. 10.31 First Amendment to KeyCorp Automatic Deferral Plan, filed as Exhibit 10.31 to Form 10-K for the year ended December 31, 2000, and incorporated herein by reference. 10.32 Trust Agreement for certain amounts that may become payable to certain executives and directors of KeyCorp, dated April 1, 1997, filed as Exhibit 10.2 to Form 10-Q for the quarter ended June 30, 1997, and incorporated herein by reference. 10.33 Trust Agreement (Executive Benefits Rabbi Trust), dated November 3, 1988, filed as Exhibit 10.20 to Form 10-K for the year ended December 31, 1995, and incorporated herein by reference. 10.34 KeyCorp Umbrella Trust for Executives, between KeyCorp and National Bank of Detroit, dated July 1, 1990, filed as Exhibit 10.27 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.35 KeyCorp Supplemental Retirement Plan, amended, restated and effective August 1, 1996, filed as Exhibit 10.32 to Form 10-K for the year ended December 31, 1997, and incorporated herein by reference. 10.36 First Amendment to KeyCorp Supplemental Retirement Plan, effective July 1, 1999, filed as Exhibit 10.5 to Form 10-Q for the quarter ended September 30, 1999, and incorporated herein by reference. 10.37 Second Amendment to KeyCorp Supplemental Retirement Plan, filed as Exhibit 10.37 to form 10-K for the year ended December 31, 2000, and incorporated herein by reference. 10.38 KeyCorp Supplemental Retirement Benefit Plan, effective January 1, 1981, restated August 16, 1990, amended January 1, 1995, and August 1, 1996, filed as Exhibit 10.26 to Form 10-K for the year ended December 31, 1998, and incorporated herein by reference.
12 10.39 Third Amendment to KeyCorp Supplemental Retirement Benefit Plan, effective July 1, 1999, filed as Exhibit 10.6 to Form 10-Q for the quarter ended September 30, 1999, and incorporated herein by reference. 10.40 KeyCorp Executive Supplemental Pension Plan, amended, restated and effective August 1, 1996, filed as Exhibit 10.29 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.41 First Amendment to KeyCorp Executive Supplemental Pension Plan, effective January 1, 1997, filed as Exhibit 10.27 to Form 10-K for the year ended December 31, 1997, and incorporated herein by reference. 10.42 Third Amendment to KeyCorp Executive Supplemental Pension Plan, filed as Exhibit 10.42 to Form 10-K for the year ended December 31, 2000, and incorporated herein by reference. 10.43 KeyCorp Supplemental Retirement Benefit Plan for Key Executives, effective July 1, 1990, restated August 16, 1990, amended as of January 1, 1995, and August 1, 1996, filed as Exhibit 10.26 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.44 Third Amendment to KeyCorp Supplemental Retirement Benefit Plan for Key Executives, effective July 1, 1999, filed as Exhibit 10.7 to Form 10-Q for the quarter ended September 30, 1999, and incorporated herein by reference. 10.45 KeyCorp Survivor Benefit Plan, effective September 1, 1990, filed as Exhibit 10.24 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 10.46 Old KeyCorp Supplemental Disability Plan (Specimen Document) filed as Exhibit 10.17 to Form 10-K for the year ended December 31, 1996, and incorporated herein by reference. 12 Statement re: Computation of Ratios. 13 KeyCorp 2001 Annual Report to Shareholders. 21 Subsidiaries of the Registrant. 23 Consent of Independent Auditors. 24 Powers of Attorney.
KeyCorp hereby agrees to furnish the Securities and Exchange Commission upon request, copies of instruments outstanding, including indentures, which define the rights of long-term debt security holders. All documents listed as Exhibits 10.1 through 10.46 constitute management contracts or compensatory plans or arrangements. * Copies of these Exhibits have been filed with the Securities and Exchange Commission. Shareholders may obtain a copy of any exhibit, upon payment of reproduction costs, by writing KeyCorp Investor Relations, at 127 Public Square (Mail Code OH-01-27-1113), Cleveland, OH 44114-1306. (b) REPORTS ON FORM 8-K December 20, 2001 -- The Registrant's December 20, 2001, press release announcing: (a) actions taken to increase the loan loss reserve and strengthen the balance sheet and (b) that the Registrant's Board of Directors increased the cash dividend on the Registrant's common stock. No other reports on Form 8-K were filed during the fourth quarter of 2001. 13 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTIONS 13 OR 15(d) 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, ON THE DATE INDICATED. KEYCORP /s/ THOMAS C. STEVENS ------------------------------------ THOMAS C. STEVENS Vice Chairman, Chief Administrative Officer and Secretary March 14, 2002 PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED.
SIGNATURE TITLE --------- ----- * Henry L. Meyer III Chairman, Chief Executive Officer, and President (Principal Executive Officer), and Director * K. Brent Somers Senior Executive Vice President and Chief Financial Officer (Principal Financial Officer) * Lee G. Irving Executive Vice President and Chief Accounting Officer (Principal Accounting Officer) * Cecil D. Andrus Director * William G. Bares Director * Albert C. Bersticker Director
SIGNATURE TITLE --------- ----- * Edward P. Campbell Director * Dr. Carol A. Cartwright Director * Kenneth M. Curtis Director * Alexander M. Cutler Director * Henry S. Hemingway Director * Charles R. Hogan Director * Douglas J. McGregor Director * Steven A. Minter Director * Bill R. Sanford Director * Ronald B. Stafford Director * Thomas C. Stevens Director * Dennis W. Sullivan Director * Peter G. Ten Eyck, II Director
/s/ Thomas C. Stevens ------------------------------------ * By Thomas C. Stevens, attorney-in-fact March 14, 2002 14 EX-10.14 3 l92910aex10-14.txt EXHIBIT 10.14 EXHIBIT 10.14 AMENDED AND RESTATED 1991 EQUITY COMPENSATION PLAN (AMENDED AS OF NOVEMBER 14, 2001) 1. PURPOSE. The KeyCorp Amended and Restated 1991 Equity Compensation Plan is intended to promote the interests of the Corporation and its shareholders by providing equity-based incentives for effective service and high levels of performance to Employees selected by the Committee. To achieve these purposes, the Corporation may grant Awards of Options, Stock Appreciation Rights, Limited Stock Appreciation Rights, Restricted Stock, and Performance Shares to selected Employees, all in accordance with the terms and conditions hereinafter set forth. 2. DEFINITIONS. 2.1 1934 ACT. The term "1934 Act" shall mean the Securities Exchange Act of 1934, as amended. 2.2 ACQUISITION PRICE. The term "Acquisition Price" with respect to Restricted Stock shall mean such amount, if any, required by applicable law and as may be specified by the Committee in the Award Instrument with respect to that Restricted Stock as the consideration to be paid by the Employee for that Restricted Stock. 2.3 AWARD. The term "Award" shall mean an award granted under the Plan of an Option, of Stock Appreciation Rights, of Limited Stock Appreciation Rights, of Restricted Stock, or of Performance Shares. 2.4 AWARD INSTRUMENT. The term "Award Instrument" shall mean a written instrument evidencing an Award in such form and with such provisions as the Committee may prescribe, including, without limitation, an agreement to be executed by the Employee and the Corporation, a certificate issued by the Corporation, or a letter executed by the Committee or its designee. Acceptance of the Award Instrument by an Employee constitutes agreement to the terms of the Award evidenced thereby. 2.5 CHANGE OF CONTROL. A "Change of Control" shall be deemed to have occurred if, at any time after the date of the grant of the relevant Award, there is a Change of Control under any of clauses (a), (b), (c), or (d) below. For these purposes, the Corporation will be deemed to have become a subsidiary of another corporation if any other corporation (which term shall include, in addition to a corporation, a limited liability company, partnership, trust, or other organization) owns, directly or indirectly, 50 percent or more of the total combined outstanding voting power of all classes of stock of the Corporation or any successor to the Corporation. (a) A Change of Control will have occurred under this clause (a) if the Corporation is a party to a transaction pursuant to which the Corporation is merged with or into, or is consolidated with, or becomes the subsidiary of another corporation and either (i) immediately after giving effect to that transaction, less than 65% of the then outstanding voting securities of the surviving or resulting corporation or (if the Corporation becomes a subsidiary in the transaction) of the ultimate parent of the Corporation represent or were issued in exchange for voting securities of the Corporation outstanding immediately prior to the transaction, or (ii) immediately after giving effect to that transaction, individuals who were directors of the Corporation on the day before the first public announcement of (A) the pendency of the transaction or (B) the intention of any person or entity to cause the transaction to occur, cease for any reason to constitute at least 51% of the directors of the surviving or resulting corporation or (if the Corporation becomes a subsidiary in the transaction) of the ultimate parent of the Corporation. (b) A Change of Control will have occurred under this clause (b) if a tender or exchange offer shall be made and consummated for 35% or more of the outstanding voting stock of the Corporation or any person (as the term "person" is used in Section 13(d) and Section 14(d)(2) of the 1934 Act) is or becomes the beneficial owner of 35% or more of the outstanding voting stock of the Corporation or there is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form or report), each as adopted under the 1934 Act, disclosing the acquisition of 35% or more of the outstanding voting stock of the Corporation in a transaction or series of transactions by any person (as defined earlier in this clause (b)). (c) A Change of Control will have occurred under this clause (c) if either (i) without the prior approval, solicitation, invitation, or recommendation of the Corporation's Board of Directors any person or entity makes a public announcement of a bona fide intention (A) to engage in a transaction with the Corporation that, if consummated, would result in a Change Event (as defined below in this clause (c)), or (B) to "solicit" (as defined in Rule 14a-1 under the 1934 Act) proxies in connection with a proposal that is not approved 2 or recommended by the Corporation's Board of Directors, or (ii) any person or entity publicly announces a bona fide intention to engage in an election contest relating to the election of directors of the Corporation (pursuant to Regulation 14A, including Rule 14a-11, under the 1934 Act), and, at any time within the 24 month period immediately following the date of the announcement of that intention, individuals who, on the day before that announcement, constituted the directors of the Corporation (the "Incumbent Directors") cease for any reason to constitute at least a majority thereof unless both (A) the election, or the nomination for election by the Corporation's shareholders, of each new director was approved by a vote of at least two-thirds of the Incumbent Directors in office at the time of the election or nomination for election of such new director, and (B) prior to the time that the Incumbent Directors no longer constitute a majority of the Board of Directors, the Incumbent Directors then in office, by a vote of at least 75% of their number, reasonably determine in good faith that the change in Board membership that has occurred before the date of that determination and that is anticipated to thereafter occur within the balance of the 24 month period to cause the Incumbent Directors to no longer be a majority of the Board of Directors was not caused by or attributable to, in whole or in any significant part, directly or indirectly, proximately or remotely, any event under subclause (i) or (ii) of this clause (c). For purposes of this clause (c), the term "Change Event" shall mean any of the events described in the following subclauses (x), (y), or (z) of this clause (c): (x) A tender or exchange offer shall be made for 25% or more of the outstanding voting stock of the Corporation or any person (as the term "person" is used in Section 13(d) and Section 14(d)(2) of the 1934 Act) is or becomes the beneficial owner of 25% or more of the outstanding voting stock of the Corporation or there is a report filed on Schedule 13D or Schedule 14D-1 (or any successor schedule, form, or report), each as adopted under the 1934 Act, disclosing the acquisition of 25% or more of the outstanding voting stock of the Corporation in a transaction or series of transactions by any person (as defined earlier in this subclause (x)). (y) The Corporation is a party to a transaction pursuant to which the Corporation is merged with or into, or is 3 consolidated with, or becomes the subsidiary of another corporation and, after giving effect to such transaction, less than 50% of the then outstanding voting securities of the surviving or resulting corporation or (if the Corporation becomes a subsidiary in the transaction) of the ultimate parent of the Corporation represent or were issued in exchange for voting securities of the Corporation outstanding immediately prior to such transaction or less than 51% of the directors of the surviving or resulting corporation or (if the Corporation becomes a subsidiary in the transaction) of the ultimate parent of the Corporation were directors of the Corporation immediately prior to such transaction. (z) There is a sale, lease, exchange, or other transfer (in one transaction or a series of related transactions) of all or substantially all the assets of the Corporation. (d) A Change of Control will have occurred under this clause (d) if there is a sale, lease, exchange, or other transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of the Corporation. 2.6 COMMITTEE. The term "Committee" shall mean a committee appointed by the Board of Directors of the Corporation to administer the Plan. The Committee shall be composed of not less than three directors of the Corporation. The Board of Directors may also appoint one or more directors as alternate members of the Committee. No officer or Employee of the Corporation or of any Subsidiary shall be a member or alternate member of the Committee. The Committee shall at all times be so comprised (a) as to satisfy the disinterested administration standard contained in Rule 16b-3, if required to qualify for the Rule 16b-3 Exemption and (b) as to satisfy the outside director standard under Section 162(m) of the Internal Revenue Code of 1986, as amended, if required to qualify compensation paid under one or more of the provisions of the Plan as performance-based compensation within the meaning of that section. 2.7 COMMON SHARES. The term "Common Shares" shall mean common shares of the Corporation, with a par value of $1 each. 2.8 CORPORATION. The term "Corporation" shall mean KeyCorp and its successors, including the surviving or resulting corporation of any merger of KeyCorp with or into, or any consolidation of KeyCorp with, any other corporation or corporations. 2.9 DISABILITY. The term "Disability" with respect to an Employee shall mean physical or mental impairment which entitles the Employee to receive disability payments under any long-term disability plan maintained by the Corporation. 4 2.10 EMPLOYEE. The term "Employee" shall mean any individual employed by the Corporation or by any Subsidiary and shall include officers as well as all other employees of the Corporation or of any Subsidiary (including employees who are members of the Board of Directors of the Corporation or any Subsidiary). 2.11 EMPLOYMENT TERMINATION DATE. The term "Employment Termination Date" with respect to an Employee shall mean the first date on which the Employee is no longer employed by the Corporation or any Subsidiary. 2.12 EXERCISE PRICE. The term "Exercise Price" with respect to an Option shall mean the price specified in the Option at which the Common Shares subject to the Option may be purchased by the holder of the Option. 2.13 FAIR MARKET VALUE. Except as otherwise determined by the Committee at the time of the grant of an Award, the term "Fair Market Value" with respect to Common Shares shall mean: (a) if the Common Shares are traded on a national exchange, the mean between the high and low sales price per Common Share on that national exchange on the date for which the determination of fair market value is made or, if there are no sales of Common Shares on that date, then on the next preceding date on which there were any sales of Common Shares, or (b) if the Common Shares are not traded on a national exchange, the mean between the high and low sales price per Common Share in the over-the-counter market, National Market System, as reported by the National Quotations Bureau, Inc. and NASDAQ on the date for which the determination of fair market value is made or, if there are no sales of Common Shares on that date, then on the next preceding date on which there were any sales of Common Shares. 2.14 INCENTIVE STOCK OPTION. The term "Incentive Stock Option" shall mean an Option intended by the Committee to qualify as an "incentive stock option" within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended. 2.15 LIMITED STOCK APPRECIATION RIGHT. The term "Limited Stock Appreciation Right" or "Limited SAR" shall mean an Award granted to an Employee with respect to all or any part of any Option, that entitles the holder thereof to receive from the Corporation, upon exercise of the Limited SAR and surrender of the related Option, or any portion of the Limited SAR and the related Option, an amount equal to (unless the Committee specifies a lesser amount at the time of the grant of the Award): (a) in the case of a Limited SAR granted with respect to an Incentive Stock Option, 100% of the excess, if any, measured at the time of the exercise of the Limited SAR, of (i) the Fair Market Value of the Common Shares subject to the Incentive Stock Option with respect to which the Limited SAR is exercised over (ii) the Exercise Price of those Common Shares under the Incentive Stock Option, or 5 (b) in the case of a Limited SAR granted with respect to a Nonqualified Option, 100% of the highest of: (i) the excess, measured at the time of the exercise of the Limited SAR, of (A) the Fair Market Value of the Common Shares subject to the Nonqualified Option with respect to which the Limited SAR is exercised over (B) the Exercise Price of those Common Shares under the Nonqualified Option, (ii) the excess of (A) the highest gross price (before brokerage commissions and soliciting dealers' fees) paid or to be paid for a Common Share (whether in cash or in property and whether by way of exchange, conversion, distribution upon liquidation, or otherwise) in connection with any Change of Control multiplied by the number of Common Shares subject to the Nonqualified Option with respect to which the Limited SAR is exercised over (B) the Exercise Price of those Common Shares under the Nonqualified Option, or (iii) the excess of (A) the highest Fair Market Value of the Common Shares subject to the Nonqualified Option with respect to which the Limited SAR is exercised on any one day during the period beginning on the sixtieth day prior to the date on which the Limited SAR is exercised multiplied by the number of Common Shares subject to the Nonqualified Option with respect to which the Limited SAR is exercised over (B) the Exercise Price of those Common Shares under the Nonqualified Option. 2.16 NONQUALIFIED OPTION. The term "Nonqualified Option" shall mean an Option intended by the Committee not to qualify as an "incentive stock option" under Section 422 of the Internal Revenue Code of 1986, as amended. 2.17 OPTION. The term "Option," (a) when used otherwise than in connection with the term Stock Appreciation Right or Limited Stock Appreciation Right, shall mean an Award entitling the holder thereof to purchase a specified number of Common Shares at a specified price during a specified period of time, and (b) when used in connection with the term Stock Appreciation Right or Limited Stock Appreciation Right, shall mean (i) any such Award or (ii) any award under any other plan maintained or assumed by the Corporation entitling the holder thereof to purchase a specified number of Common Shares at a specified price during a specified period of time. 6 2.18 OPTION EXPIRATION DATE. The term "Option Expiration Date" with respect to any Option shall mean the date selected by the Committee after which, except as provided in Section 10.4 in the case of the death of the Employee to whom the option was granted, the Option may not be exercised. 2.19 PERFORMANCE GOAL. The term "Performance Goal" shall mean a performance goal specified by the Committee in connection with the potential grant of Performance Shares and may include, without limitation, goals based upon cumulative earnings per Common Share, return on investment, return on shareholders' equity, or achievement of any other goals, whether or not readily expressed in financial terms, that are related to the performance by the Corporation, by any Subsidiary, or by any Employee or group of Employees in connection with services performed by that Employee or those Employees for the Corporation, a Subsidiary, or any one or more subunits of the Corporation or of any Subsidiary. 2.20 PERFORMANCE PERIOD. The term "Performance Period" shall mean such one or more periods of time, which may be of varying and overlapping durations, as the Committee may select, over which the attainment of one or more Performance Goals will be relevant in connection with one or more Awards of Performance Shares. 2.21 PERFORMANCE SHARES. The term "Performance Shares" shall mean an Award denominated in Common Shares and contingent upon attainment of one or more Performance Goals by the Corporation or a Subsidiary or any subunit of the Corporation or of any Subsidiary over a Performance Period. 2.22 PLAN. The term "Plan" shall mean this KeyCorp Amended and Restated 1991 Equity Compensation Plan as from time to time hereafter amended in accordance with Section 20. 2.23 RESTRICTED STOCK. The term "Restricted Stock" shall mean Common Shares of the Corporation delivered to an Employee pursuant to an Award subject to such restrictions, conditions and contingencies as the Committee may provide in the relevant Award Instrument, including (a) the restriction that the Employee not sell, transfer, otherwise dispose of, or pledge or otherwise hypothecate the Restricted Stock during the applicable Restriction Period, (b) the requirement that, subject to the provisions of Section 10, if the Employee's employment terminates so that the Employee is no longer employed by the Corporation or any Subsidiary before the end of the applicable Restriction Period, the Employee will offer to sell to the Corporation at the Acquisition Price each Common Share of Restricted Stock held by the Employee at the Employment Termination Date with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed, and (c) such other restrictions, conditions, and contingencies, if any, as the Committee may provide in the Award Instrument with respect to that Restricted Stock. 7 2.24 RESTRICTION PERIOD. The term "Restriction Period" with respect to an Award of Restricted Stock shall mean the period selected by the Committee and specified in the Award Instrument with respect to that Restricted Stock during which the Employee may not sell, transfer, otherwise dispose of, or pledge or otherwise hypothecate that Restricted Stock. 2.25 RULE 16b-3. Term "Rule 16b-3" shall mean Rule 16b-3 or any rule promulgated in replacement thereof or in substitution therefor under the 1934 Act. 2.26 RULE 16b-3 EXEMPTION. The term "Rule 16b-3 Exemption" shall mean the exemption from Section 16(b) of the 1934 Act that is available under Rule 16b-3. 2.27 SECTION 16(b) EMPLOYEE. The term "Section 16(b) Employee" shall mean an individual who is, or at any time within the preceding six months was, a director, officer, or 10% shareholder of the Corporation within the meaning of Section 16(b) of the 1934 Act. 2.28 STOCK APPRECIATION RIGHT. The term "Stock Appreciation Right "or "SAR" shall mean an Award granted to an Employee with respect to all or any part of any Option that entitles the holder thereof to receive from the Corporation, upon exercise of the SAR and surrender of the related Option, or any portion of the SAR and the related Option, an amount equal to 100%, or such lesser percentage as the Committee may determine at the time of the grant of the Award, of the excess, if any, measured at the time of the exercise of the SAR, of (a) the Fair Market Value of the Common Shares subject to the Option with respect to which the SAR is exercised over (b) the Exercise Price of those Common Shares under the Option. 2.29 SUBSIDIARY. The term "Subsidiary" shall mean any corporation, partnership, joint venture, or other business entity in which the Corporation owns, directly or indirectly, 50 percent or more of the total combined voting power of all classes of stock (in the case of a corporation) or other ownership interest (in the case of any entity other than a corporation). 2.30 TANDEM AWARD. The term "Tandem Award" shall mean any two or more Awards that are linked by the terms of any such Awards so that the exercise of one such Award, in whole or in part, requires or will automatically result in the surrender or cancellation, in whole or in proportionate part, of the other such Awards. 2.31 TRANSFEREE. The term "Transferee" shall mean, with respect to Nonqualified Options only, any person or entity to which an Employee is permitted by the Committee to transfer or assign all or part of his or her Options. 3. ADMINISTRATION. The Plan shall be administered by the Committee. No Award may be made under the Plan to any member or alternate member of the Committee. The Committee shall have authority, subject to the terms of the Plan, (a) to determine the Employees who are eligible to participate in the Plan, the type, size, and terms of Awards to be granted to any Employee, the time or times at which Awards shall be exercisable or at which restrictions, conditions, and contingencies shall lapse, and the terms and provisions of the instruments by 8 which Awards shall be evidenced, (b) to establish any other restrictions, conditions, and contingencies on Awards in addition to those prescribed by the Plan, (c) to interpret the Plan, and (d) to make all determinations necessary for the administration of the Plan. The construction and interpretation by the Committee of any provision of the Plan or any Award Instrument delivered pursuant to the Plan and any determination by the Committee pursuant to any provision of the Plan or any Award Instrument shall be final and conclusive. No member or alternate member of the Committee shall be liable for any such action or determination made in good faith. The Committee may act only by a majority of its members. Any determination of the Committee may be made, without a meeting, by a writing or writings signed by all of the members of the Committee. In addition, the Committee may authorize any one or more of their number or any officer of the Corporation to execute and deliver documents on behalf of the Committee and the Committee may delegate to one or more employees, agents, or officers of the Corporation, or to one or more third party consultants, accountants, lawyers, or other advisors, such ministerial duties related to the operation of the Plan as it may deem appropriate. 4. ELIGIBILITY. Awards may be granted to Employees of the Corporation or any Subsidiary selected by the Committee in its sole discretion. The granting of any Award to an Employee shall not entitle that Employee to, nor disqualify the Employee from, participation in any other grant of an Award. The maximum number of Common Shares with respect to which any Employee may receive Awards during any calendar year shall be the lesser of 400,000 Common Shares or .2% of the outstanding Common Shares of the Corporation on the date such award was made, which maximum number shall be subject to adjustment as provided in Section 13 of the Plan. 5. STOCK SUBJECT TO THE PLAN. The stock that may be issued and distributed to Employees in connection with Awards granted under the Plan shall be Common Shares and may be authorized and unissued Common Shares, treasury Common Shares, or Common Shares acquired on the open market specifically for distribution under the Plan, as the Board of Directors may from time to time determine. Subject to adjustment as provided in Section 13, the number of Common Shares available for grant of Awards under the Plan shall be determined from time to time as follows: (a) on the date of the 1994 Annual Meeting of Shareholders of the Corporation (at which meeting an amendment and restatement of the Plan was submitted for approval of the shareholders of the Corporation), the number of Common Shares available for grant of Awards under the Plan shall equal two percent of the total number of Common Shares outstanding on March 31, 1994, and (b) on January 2, 1995 and on each January 2 occurring thereafter during the life of the Plan, the number of Common Shares available for grant of Awards under the Plan shall be increased by adding to the number of Common Shares then available for grant of Awards under the Plan, the number of Common Shares of the Corporation that, when added to the number of Common Shares that otherwise remain available for grant of additional Awards under the Plan on that 9 January 2, equals two percent of the total number of Common Shares of the Corporation outstanding on December 31st of the next proceeding year. The number of Common Shares remaining available for grants of additional Awards under the Plan at any particular time during a calendar year shall be reduced, upon the granting thereafter of any Award under the Plan, by the full number of Common Shares subject to that Award except that, in the case of any particular Tandem Award, the number of Common Shares counted as being subject to such Tandem Award shall be the maximum number of Common Shares with respect to which the Employee may receive value under such Tandem Award. If any Award for any reason expires or is terminated, in whole or in part, without the receipt by an Employee of Common Shares (or the equivalent thereof in cash or other property), the Common Shares subject to that part of the Award that has so expired or terminated shall again be available for the future grant of Awards under the Plan. Notwithstanding any other provision of the Plan, but subject to adjustment under Section 13, (a) the maximum number of Common Shares that may be issued under the Plan pursuant to Incentive Stock Options shall be 9,600,000 Common Shares, and (b) the maximum number of Common Shares that may be issued under the Plan as Restricted Stock during any calendar year shall be that number of Common Shares that is equal to five percent of the total number of Common Shares available for grant of Awards under the Plan as of January 2 of that calendar year. 6. STOCK OPTIONS. 6.1 TYPE AND DATE OF GRANT OF OPTIONS. (a) The Award Instrument pursuant to which any Incentive Stock Option is granted shall specify that the Option granted thereby shall be treated as an Incentive Stock Option. The Award Instrument pursuant to which any Nonqualified Option is granted shall specify that the Option granted thereby shall not be treated as an Incentive Stock Option. (b) The day on which the Committee authorizes the grant of an Incentive Stock Option shall be the date on which that Option is granted. No Incentive Stock Option may be granted on any date after the tenth anniversary of the date of adoption, on March 17, 1994, by the Board of Directors of the Corporation, of the Plan as amended and restated. (c) The day on which the Committee authorizes the grant of a Nonqualified Option shall be considered the date on which that Option is granted, unless the Committee specifies a later date. 10 6.2 EXERCISE PRICE. The Exercise Price under any Option shall be not less than the Fair Market Value of the Common Shares subject to the Option on the date the Option is granted. 6.3 OPTION EXPIRATION DATE. The Option Expiration Date under any Incentive Stock Option shall be not later than ten years from the date on which the Option is granted. The Option Expiration Date under any Nonqualified Option shall not be later than ten years and one month from the date on which the Option is granted. 6.4 EXERCISE OF OPTIONS. (a) Except as otherwise provided in Section 10, an Option may be exercised only while the Employee to whom the Option was granted is in the employ of the Corporation or of a Subsidiary. Subject to this requirement, each Option shall become exercisable in one or more installments at the time or times provided in the Award Instrument evidencing the Option. Once any portion of an Option becomes exercisable, that portion shall remain exercisable until expiration or termination of the Option. An Employee to whom an Option is granted or, with respect to Nonqualified Options, the Employee's Transferee may exercise the Option from time to time, in whole or in part, up to the total number of Common Shares with respect to which the Option is then exercisable, except that no fraction of a Common Share may be purchased upon the exercise of any Option. (b) An Employee or, with respect to Nonqualified Options, any Transferee electing to exercise an Option shall deliver to the Corporation (i) the Exercise Price payable in accordance with Section 6.5 and (ii) written notice of the election that states the number of whole Common Shares with respect to which the Employee is exercising the Option. 6.5 PAYMENT FOR COMMON SHARES. Upon exercise of an Option by an Employee or, with respect to Nonqualified Options, any Transferee, the Exercise Price shall be payable by the Employee or Transferee in cash or in such other form of consideration as the Committee determines may be accepted, including without limitation, securities or other property, or any combination of cash, securities or other property, or by delivery by the Employee or Transferee (with the written notice of election to exercise) of irrevocable instructions to a broker registered under the 1934 Act promptly to deliver to the Corporation the amount of sale or loan proceeds to pay the Exercise Price. The Committee, in its sole discretion, may grant to an Employee or, with respect to Nonqualified Options, any Transferee the right to transfer Common Shares acquired upon the exercise of a part of an Option in payment of the Exercise Price payable upon immediate exercise of a further part of the Option. 6.6 CONVERSION OF INCENTIVE STOCK OPTIONS. The Committee may at any time in its sole discretion take such actions as may be necessary to convert any outstanding Incentive Stock Option (or any installments or portions of installments thereof) into a Nonqualified Option with 11 or without the consent of the Employee to whom that Incentive Stock Option was granted and whether or not that Employee is an Employee at the time of the conversion. 7. STOCK APPRECIATION RIGHTS AND LIMITED STOCK APPRECIATION RIGHTS. 7.1 GRANT OF SARS AND LIMITED SARS. An SAR may be granted only in connection with an Option. An SAR granted in connection with an Incentive Stock Option may be granted only when the Incentive Stock Option is granted. An SAR granted in connection with a Nonqualified Option may be granted either when the related Nonqualified Option is granted or at any time thereafter including, in the case of any Nonqualified Option resulting from the conversion of an Incentive Stock Option, simultaneously with or after the conversion. Similarly, a Limited SAR may be granted only in connection with an Option. A Limited SAR granted in connection with an Incentive Stock Option may be granted only when the Incentive Stock Option is granted. A Limited SAR granted in connection with a Nonqualified Option may be granted either when the related Nonqualified Option is granted or at any time thereafter including, in the case of any Nonqualified Option resulting from the conversion of an Incentive Stock Option, simultaneously with or after the conversion. 7.2 EXERCISE OF SARS AND LIMITED SARS. (a) An Employee electing to exercise an SAR or a Limited SAR shall deliver written notice to the Corporation of the election identifying the SAR or Limited SAR and the related Option with respect to which the SAR or Limited SAR was granted to the Employee and specifying the number of whole Common Shares with respect to which the Employee is exercising the SAR or Limited SAR. Upon exercise of the SAR or Limited SAR, the related Option shall be deemed to be surrendered to the extent that the SAR or Limited SAR is exercised. (b) SARs and Limited SARs may be exercised only (i) after the expiration of six months from the date of grant of the SAR or Limited SAR, (ii) on a date when the SAR or Limited SAR is "in the money" (i.e., when there would be positive consideration received upon exercise of the SAR or Limited SAR), (iii) at a time and to the same extent as the related Option is exercisable, (iv) unless otherwise provided in the relevant Award Instrument, by surrender to the Corporation, unexercised, of the related Option or any applicable portion thereof, and (v) in compliance with all restrictions set forth in or specified by the Committee pursuant to Section 7.2(c) (in the case of SARs) or Section 7.2(d) (in the case of Limited SARs). (c) The Committee may specify in the Award Instrument pursuant to which any SAR is granted waiting periods and restrictions on permissible exercise periods in addition to the restrictions on exercise set forth in 12 Section 7.2(b), including, without limitation, any restriction necessary to make applicable the Rule 16b-3 Exemption. 7.3 PAYMENT FOR SARS AND LIMITED SARS. The amount payable upon exercise of an SAR or Limited SAR may be paid by the Corporation in cash, or, if the Committee shall determine in its sole discretion, in whole Common Shares (taken at their Fair Market Value at the time of exercise of the SAR or Limited SAR) or in a combination of cash and whole Common Shares; provided, however, that in no event shall the total number of Common Shares that may be paid to an Employee pursuant to the exercise of an SAR or Limited SAR exceed the total number of Common Shares subject to the related Option. 7.4 TERMINATION, AMENDMENT, OR SUSPENSION OF SARS AND LIMITED SARS. SARs and Limited SARs shall terminate and may no longer by exercised upon the first to occur of (a) exercise or termination of the related Option, (b) any termination date specified by the Committee at the time of grant of the SAR or Limited SAR, or (c) the transfer by the Employee of the related Option. In addition, the Committee may in its sole discretion at any time before the occurrence of a Change of Control amend, suspend, or terminate any SAR or Limited SAR theretofore granted under the Plan without the holder's consent; provided that, in the case of amendment, no provision of the SAR or Limited SAR, as amended, shall be in conflict with any provision of the Plan. 8. RESTRICTED STOCK. 8.1 ADDITIONAL CONDITIONS ON RESTRICTED STOCK. In addition to the restrictions on disposition of Restricted Stock during the Restriction Period and the requirement to offer Restricted Stock to the Corporation if the Employee's employment terminates during the Restriction Period, the Committee may provide in the Award Instrument with respect to any Award of Restricted Stock other restrictions, conditions, and contingencies, which other restrictions, conditions, and contingencies, if any, may relate to, in addition to such other matters as the Committee may deem appropriate, the Employee's personal performance, corporate performance, or the performance of any subunit of the Corporation or any Subsidiary, in each case measured in such manner as may be specified by the Committee. The Committee may impose different restrictions, conditions, and contingencies on separate Awards of Restricted Stock granted to different Employees, whether at the same or different times, and on separate Awards of Restricted Stock granted to the same Employee, whether at the same or different times. The Committee may specify a single Restriction Period for all of the Restricted Stock subject to any particular Award Instrument or may specify multiple Restriction Periods so that the restrictions with respect to the Restricted Stock subject to the Award will expire in stages according to a schedule specified by the Committee and set forth in the Award Instrument; provided, however, that no Restriction Period with respect to any Restricted Stock shall end earlier than one year after the date on which that Restricted Stock is granted. 13 8.2 PAYMENT FOR RESTRICTED STOCK. Each Employee to whom an Award of Restricted Stock is made shall pay the Acquisition Price with respect to that Restricted Stock to the Corporation not later than 30 days after the delivery to the Employee of the Award Instrument with respect to that Restricted Stock. If any Employee fails to pay the Acquisition Price with respect to any Award of Restricted Stock within that 30 day period, the Employee's right under that Award shall be forfeited. 8.3 RIGHTS AS A SHAREHOLDER. Upon payment by an Employee in full of the Acquisition Price for Restricted Stock under an Award, the Employee shall have all of the rights of a shareholder with respect to the Restricted Stock, including voting and dividend rights, subject only to such restrictions and requirements referred to in Section 8.1 as may be incorporated in the Award Instrument with respect to that Restricted Stock. 9. PERFORMANCE SHARES. 9.1 DISCRETION OF COMMITTEE WITH RESPECT TO PERFORMANCE SHARES. The Committee shall have full discretion to select the Employees to whom Awards of Performance Shares are made, the number of Performance Shares to be granted to any Employee so selected, the kind and level of the Performance Goals and whether those Performance Goals are to apply to the Corporation, a Subsidiary, or any one or more subunits of the Corporation or of any Subsidiary, and the dates on which each Performance Period shall begin and end, and to determine the form and provisions of the Award Instrument to be used in connection with any Award of Performance Shares. 9.2 CONDITIONS TO PAYMENT FOR PERFORMANCE SHARES. (a) Unless otherwise provided in the relevant Award Instrument, an Employee must be employed by the Corporation or a Subsidiary on the last day of a Performance Period to be entitled to payment for any Performance Shares. (b) The Committee may establish, from time to time, one or more formulas to be applied against the Performance Goals to determine whether all, some portion but less than all, or none of the Performance Shares granted with respect to a Performance Period are treated as earned pursuant to any Award. An Employee will be entitled to receive payments with respect to any Performance Shares only to the extent that those Performance Shares are treated as earned under one or more such formulas. 9.3 PAYMENT FOR PERFORMANCE SHARES. The Corporation shall pay each Employee who is entitled to payment for Performance Shares earned with respect to any Performance Period an amount for those Performance Shares (a) in cash (based upon the per share Fair Market Value of Common Shares on the last day of the Performance Period), (b) in Common Shares (one Common Share for each Performance Share earned), (c) in Restricted Stock (one Common Share of Restricted Stock for each Performance Share earned), or (d) any combination of the 14 foregoing, in such proportions as the Committee may determine. Restricted Stock issued by the Corporation in payment of Performance Shares shall be subject to all the provisions of Section 8. 10. TERMINATION OF EMPLOYMENT. After an Employee's Employment Termination Date, the rules set forth in this Section 10 shall apply. All factual determinations with respect to the termination of an Employee's employment that may be relevant under this Section 10 shall be made by the Committee in its sole discretion. 10.1 TERMINATION OTHER THAN UPON DEATH, DISABILITY, OR CERTAIN RETIREMENTS. Upon any termination of an Employee's employment for any reason other than the Employee's retirement (under any retirement plan of the Corporation or of a Subsidiary) as provided in Section 10.2, disability as provided on Section 10.3, or death as provided in Section 10.4: (a) Unless otherwise provided in the relevant Award Instrument, the Employee or, with respect to Nonqualified Options, any Transferee shall have the right (i) during the period ending six months after the Employment Termination Date, but not later than the Option Expiration Date, to exercise any Nonqualified Options and related SARs that were outstanding on the Employment Termination Date, if and to the same extent as those Options and SARs were exercisable by the Employee or Transferee (as the case may be) on the Employment Termination Date, and (ii) during the period ending three months after the Employment Termination Date, but not later that the Option Expiration Date, to exercise any Incentive Stock Options and related SARs that were outstanding on the Employment Termination Date, if and to the same extent as those Options and SARs were exercisable by the Employee on the Employment Termination Date. Notwithstanding the preceding sentence, if within two years after a Change of Control an Employee's Employment Termination Date occurs other than as a result of a Voluntary Resignation, unless otherwise provided in the relevant Award Instrument, the Employee or, with respect to Nonqualified Options, any Transferee shall have the right, during the Extended Period, but not later than the Option Expiration Date, to exercise any Options and related SARs that were outstanding on the Employment Termination Date, if and to the same extent as those Options and SARs were exercisable by the Employee or Transferee (as the case may be) on the Employment Termination Date (even though, in the case of Incentive Stock Options, exercise of those Options more than three months after the Employment Termination Date may cause the Option to fail to qualify for Incentive Stock Option treatment under the Internal Revenue Code of 1986, as amended). As used in the immediately preceding sentence, the term "Extended Period" means the longer of the period that the Option or SAR would otherwise be exercisable in the absence of the immediately preceding sentence or the period ending with the second anniversary date of the Change of Control 15 last occurring before the Employment Termination Date and the term "Voluntary Resignation" means that the Employee shall have terminated his or her employment with the Corporation and its Subsidiaries by voluntarily resigning at his or her own instance without having been requested to so resign by the Corporation or its Subsidiaries except that any resignation by the Employee will not be deemed to be a Voluntary Resignation if, after the Change of Control, the Employee's base salary was reduced or the Employee was required to relocate his or her principal place of employment more than 35 miles, (b) Unless otherwise provided in the relevant Award Instrument, the Employee shall offer for resale at the Acquisition Price to the Corporation each Common Share of Restricted Stock held by the Employee at the Employment Termination Date with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed, and (c) Unless otherwise provided in the relevant Award Instrument, the Employee shall forfeit each Performance Share with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed. 10.2 TERMINATION DUE TO CERTAIN RETIREMENTS. Upon any termination of an Employee's employment with the Corporation or any Subsidiary under circumstances entitling the Employee to immediate payment of normal retirement or early retirement benefits under any retirement plan of the Corporation or of a Subsidiary (whether the Employee elects to commence or defer receipt of such payment): (a) Unless otherwise provided in the relevant Award Instrument, the Employee or, with respect to Nonqualified Options, any Transferee shall have the right (i) to exercise, from time to time during the period ending three years (two years if the Option was granted prior to January 1, 2002) after the Employment Termination Date, but not later than the Option Expiration Date, any Nonqualified Options and related SARs that were outstanding on the Employment Termination Date, if and to the same extent as those Options and SARs were exercisable by the Employee or Transferee (as the case may be) on the Employment Termination Date, and (ii) to exercise, from time to time during the period ending three years (two years if the Option was granted prior to January 1, 2002) after the Employment Termination Date, but no later than the Option Expiration Date, any Incentive Stock Options and related SARs that were outstanding on the Employment Termination Date, if and to the same extent as those Options and SARs were exercisable by the Employee on the Employment Termination Date (even though exercise of the Incentive Stock Option more than three months after the Employment Termination Date may 16 cause the Option to fail to qualify for Incentive Stock Option treatment under the Internal Revenue Code of 1986, as amended), (b) The relevant Award Instrument may provide that the Employee or, with respect to Nonqualified Options, any Transferee will have the right to exercise, from time to time until not later than the Option Expiration Date, Nonqualified Stock Options and SARs and Incentive Stock Options and SARs to the extent such Options and SARs become exercisable by their terms prior to the Option Expiration Date (or such earlier date as specified in the relevant Award Instrument), notwithstanding the fact that such Options and SARs were not exercisable in whole or in part (whether because a condition to exercise had not yet occurred or a specified time period had not yet elapsed or otherwise) on the Employment Termination Date, (c) Unless otherwise provided in the relevant Award Instrument, the Employee shall offer for resale at the Acquisition Price to the Corporation each Common Share of Restricted Stock held by the Employee at the Employment Termination Date with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed, and (d) Unless otherwise provided in the relevant Award Instrument, the Employee shall forfeit each Performance Share with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed. 10.3 TERMINATION DUE TO DISABILITY. Upon any termination of an Employee's employment due to disability: (a) Unless otherwise provided in the relevant Award Instrument, the Employee, the Employee's attorney in fact or legal guardian or, with respect to Nonqualified Options, any Transferee shall have the right (i) to exercise, from time to time during the period ending three years (two years if the Option was granted prior to January 1, 2002) after the Employment Termination Date, but not later than the Option Expiration Date, any Nonqualified Options and related SARs that were outstanding on the Employment Termination Date, if and to the same extent those Options and SARs were exercisable by the Employee or Transferee (as the case may be) on the Employment Termination Date, and (ii) to exercise, from time to time during the period ending three years (two years if the Option was granted prior to January 1, 2002) after the Employment Termination Date, but no later than the Option Expiration Date, any Incentive Stock Options and related SARs that were outstanding on the employment Termination Date, if and to the same extent as those Options and SARs were exercisable by the Employee on the Employment Termination Date 17 (even though exercise of the Incentive Stock Option more than one year after the Employment Termination Date may cause the Option to fail to qualify for Incentive Stock Option treatment under the Internal Revenue Code of 1986, as amended), (b) Unless otherwise provided in the relevant Award Instrument, the Employee shall offer for resale at the Acquisition Price to the Corporation each Common Share of Restricted Stock held by the Employee at the Employment Termination Date with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed, and (c) Unless otherwise provided in the relevant Award Instrument, the Employee shall forfeit each Performance Share with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed. 10.4. DEATH OF AN EMPLOYEE. Upon the death of an Employee while employed by the Corporation or any Subsidiary or within any of the periods referred to in any Section 10.1, 10.2, or 10.3 during which any particular Option or SAR remains potentially exercisable: (a) Unless otherwise provided in the relevant Award Instrument, if the Option Expiration Date of any Nonqualified Option that had not expired before the Employee's death would otherwise expire before the first anniversary of the Employee's death, that Option Expiration Date shall automatically be extended to the first anniversary of the Employee's death or such other date as provided in the relevant Award Instrument, (b) Unless otherwise provided in the relevant Award Instrument, the Employee's executor or administrator, the person or persons to whom the Employee's rights under any Option or SAR are transferred by will or the laws of descent and distribution or, with respect to Nonqualified Options, any Transferee shall have the right to exercise, from time to time during the period ending three years (two years if the Option was granted prior to January 1, 2002) after the date of the Employee's death, but not later than the Option Expiration Date, any Options and related SARs that were outstanding on the date of the Employee's death, if and to the same extent as those Options and SARs were exercisable by the Employee or Transferee (as the case may be) on the date of the Employee's death, (c) Unless otherwise provided in the relevant Award Instrument, the Employee shall offer for resale at the Acquisition Price to the Corporation each Common Share of Restricted Stock held by the Employee at the Employment Termination Date with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed, and 18 (d) Unless otherwise provided in the relevant Award Instrument, the Employee shall forfeit each Performance Share with respect to which, as of that date, any restrictions, conditions, or contingencies have not lapsed. 11. ACCELERATION UPON CHANGE OF CONTROL. Unless otherwise specified in the relevant Award Instrument, upon the occurrence of a Change of Control of the Corporation, each Award theretofore granted to any Employee that then remains outstanding shall be automatically treated as follows: (a) any outstanding Option shall become immediately exercisable in full, (b) SARs and Limited SARs related to any such Options shall also become immediately exercisable in full, (c) the Restriction Period with respect to all outstanding Awards of Restricted Stock shall immediately terminate, and (d) the restrictions, conditions, or contingencies on any Performance Shares shall be modified in such manner as the Committee may specify to give the Employee the benefit of those Performance Shares through the date of Change of Control. 12. ASSIGNABILITY. Nonqualified Options may not be assigned or transferred (other than by will or by the laws of descent and distribution) unless the Committee, in its sole discretion, determines to allow such assignment or transfer and, if the Committee determines to allow any such assignment or transfer, the Transferee shall have the power to exercise such Nonqualified Option in accordance with the terms of the Award and the provisions of this Plan. No Incentive Stock Option, SAR, Limited SAR, Restricted Stock during the Restriction Period, or Performance Share may be transferred other than by will or by the laws of descent and distribution. During an Employee's lifetime, only the Employee (or in the case of incapacity of an Employee, the Employee's attorney in fact or legal guardian) may exercise any Incentive Stock Option, SAR, Limited SAR, Restricted Stock during the Restriction Period, or Performance Share requiring or permitting exercise. 13. ADJUSTMENT UPON CHANGES IN COMMON SHARES. Automatically and without Committee action, in the event of any stock dividend, stock split, or share combination of the Common Shares, or by appropriate Committee action in the event of any reclassification, recapitalization, merger, consolidation, other form of business combination, liquidation, or dissolution involving the Corporation or any spin-off or other distribution to shareholders of the Corporation (other than normal cash dividends), appropriate adjustments to (a) the maximum number of Common Shares that may be issued under the Plan pursuant to Section 5, the maximum number of Common Shares that may be issued under the Plan pursuant to Incentive Stock Options as provided in Section 5, and the maximum number of Common Shares with respect to which any Employee may receive Awards during any calendar year as provided in Section 4, and (b) the number and kind of shares subject to, the price per share under, and the terms and conditions of each then outstanding Award shall be made to the extent necessary and in such manner that the benefits of Employees under all then outstanding Awards shall be maintained substantially as before the occurrence of such event. Any such adjustment shall be conclusive and binding for all purposes of the Plan and shall be effective, in the event of any stock dividend, stock split, or share combination, as of the date of such stock dividend, stock split, or share combination, and in all other cases, as of such date as the Committee may determine. 19 14. PURCHASE FOR INVESTMENT. Each person acquiring Common Shares pursuant to any Award may be required by the Corporation to furnish a representation that he or she is acquiring the Common Shares so acquired as an investment and not with a view to distribution thereof if the Corporation, in its sole discretion, determines that such representation is required to insure that a resale or other disposition of the Common Shares would not involve a violation of the Securities Act of 1933, as amended, or of applicable blue sky laws. Any investment representation so furnished shall no longer be applicable at any time such representation is no longer necessary for such purposes. 15. WITHHOLDING OF TAXES. The Corporation will withhold from any payments of cash made pursuant to the Plan such amount as is necessary to satisfy all applicable federal, state, and local withholding tax obligations. The Committee may, in its discretion and subject to such rules as the Committee may adopt from time to time, permit or require an Employee (or other person exercising an Option with respect to withholding taxes upon exercise of such Option) to satisfy, in whole or in part, any withholding tax obligation that may arise in connection with the grant of an Award, the lapse of any restrictions with respect to an Award, the acquisition of Common Shares pursuant to any Award, or the disposition of any Common Shares received pursuant to any Award by having the Corporation hold back some portion of the Common Shares that would otherwise be delivered pursuant to the Award or by delivering to the Corporation an amount equal to the withholding tax obligation arising with respect to such grant, lapse, acquisition, or disposition in (a) cash, (b) Common Shares, or (c) such combination of cash and Common Shares as the Committee may determine. The Fair Market Value of the Common Shares to be so held back by the Company or delivered by the Employee shall be determined as of the date on which the obligation to withhold first arose. 16. HARMFUL ACTIVITY. If an Employee shall engage in any "harmful activity" prior to or within six months after termination of employment with Key, then any Profits realized upon the exercise of any Covered Option on or after one year prior to the termination of employment with Key shall inure to the Corporation. The aforementioned restriction shall not apply in the event that employment with Key terminates within two years after a Change of Control of the Corporation if any of the following have occurred: a relocation of an Employee's principal place of employment more than 35 miles from an Employee's principal place of employment immediately prior to the Change of Control, a reduction in an Employee's base salary after a Change of Control, or termination of employment under circumstances in which an Employee is entitled to severance benefits or salary continuation or similar benefits under a change of control agreement, employment agreement, or severance or separation pay plan. If any Profits realized upon the exercise of any Covered Option inure to the benefit of the Corporation in accordance with the first sentence of this paragraph, an Employee shall pay all such Profits to the Corporation within 30 days after first engaging in any harmful activity and all unexercised Covered Options shall immediately be forfeited and canceled. Consistent with the provisions of Section 3 of the Plan, the determination by the Committee as to whether an Employee engaged in "harmful activity" prior to or within six months after termination of employment with Key shall be final and conclusive. 20 A "harmful activity" shall have occurred if an Employee shall do any one or more of the following: a. Use, publish, sell, trade or otherwise disclose Non-Public Information of Key unless such prohibited activity was inadvertent, done in good faith and did not cause significant harm to Key. b. After notice from the Corporation, fail to return to Key any document, data, or thing in an Employee's possession or to which an Employee has access that may involve Non-Public Information of Key. c. After notice from the Corporation, fail to assign to Key all right, title, and interest in and to any confidential or non-confidential Intellectual Property which an Employee created, in whole or in part, during employment with Key, including, without limitation, copyrights, trademarks, service marks, and patents in or to (or associated with) such Intellectual Property. d. After notice from the Corporation, fail to agree to do any acts and sign any document reasonably requested by Key to assign and convey all right, title, and interest in and to any confidential or non-confidential Intellectual Property which an Employee created, in whole or in part, during employment with Key, including, without limitation, the signing of patent applications and assignments thereof. e. Upon an Employee's own behalf or upon behalf of any other person or entity that competes or plans to compete with Key, solicit or entice for employment or hire any Employee of Key. f. Upon an Employee's own behalf or upon behalf of any other person or entity that competes or plans to compete with Key, call upon, solicit, or do business with (other than business which does not compete with any business conducted by Key) any customer of Key an Employee called upon, solicited, interacted with, or became acquainted with, or learned of through access to information (whether or not such information is or was non-public) while employed at Key unless such prohibited activity was inadvertent, done in good faith, and did not involve a customer whom an Employee should have reasonably known was a customer of Key. g. Upon an Employee's own behalf or upon behalf of any other person or entity that competes or plans to compete with Key, engage in any business activity in competition with Key in the same or a closely related activity that an Employee was engaged in for Key during the one year period prior to the termination of employment. 21 For purposes of this Section 16: "Covered Option" means any Option granted on or after January 1, 2001 unless the granting resolution expressly excludes the Option from the provisions of this Section 16. "Intellectual Property" shall mean any invention, idea, product, method of doing business, market or business plan, process, program, software, formula, method, work of authorship, or other information, or thing. "Key" shall mean the Corporation and its Subsidiaries collectively. "Non-Public Information" shall mean, but is not limited to, trade secrets, confidential processes, programs, software, formulas, methods, business information or plans, financial information, and listings of names (e.g., employees, customers, and suppliers) that are developed, owned, utilized, or maintained by an employer such as Key, and that of its customers or suppliers, and that are not generally known by the public. "Profit" shall mean, with respect to any Covered Option, the spread between the Fair Market Value of a Common Share on the date of exercise and the exercise price multiplied by the number of shares exercised under the Covered Option. 17. AWARDS IN SUBSTITUTION FOR AWARDS GRANTED BY OTHER COMPANIES. Awards, whether Incentive Stock Options, Nonqualified Options, SARs, Limited SARs Restricted Stock, or Performance Shares, may be granted under the Plan in substitution for awards held by employees of a company who become Employees of the Corporation or a Subsidiary as a result of the merger or consolidation of the employer company with the Corporation or a Subsidiary, or the acquisition by the Corporation or a Subsidiary of the assets of the employer company, or the acquisition by the Corporation or a Subsidiary of stock of the employer company as a result of which it becomes a Subsidiary. The terms, provisions, and benefits of the substitute Awards so granted may vary from the terms, provisions and benefits set forth in or authorized by the Plan to such extent as the Committee at the time of the grant may deem appropriate to conform, in whole or in part, to the terms, provisions, and benefits of the awards in substitution for which they are granted. 18. LEGAL REQUIREMENTS. No Awards shall be granted and the Corporation shall have no obligation to make any payment under the Plan, whether in Common Shares, cash, or any combination thereof, unless such payment is, without further action by the Committee, in compliance with all applicable Federal and state laws and regulations, including, without limitation, the United States Internal Revenue Code and Federal and state securities laws. 22 19. DURATION AND TERMINATION OF THE PLAN. The Plan shall become effective and shall be deemed to have been adopted on the date on which it is approved by the shareholders of the Corporation and shall remain in effect thereafter until terminated by action of the Board of Directors. No termination of the Plan shall adversely affect the rights of any Employee with respect to any Award granted before the effective date of the termination. 20. AMENDMENTS. The Board of Directors, or a duly authorized committee thereof, may alter or amend the Plan from time to time prior to its termination in any manner the Board of Directors, or such duly authorized committee, may deem to be in the best interests of the Corporation and its shareholders, except that no amendment may be made without shareholder approval if shareholder approval is required under Rule 16b-3 to qualify for the Rule 16b-3 Exemption, is required by any applicable securities law or tax law, or is required by the rules of any exchange on which the Common Shares of the Corporation are traded or, if the Common Shares are not listed on an exchange, by the rules of the registered national securities association through whose inter-dealer quotation system the Common Shares are quoted. The Committee shall have the authority to amend these terms and conditions applicable to outstanding Awards (a) in any case where expressly permitted by the terms of the Plan or of the relevant Award Instrument or (b) in any other case with the consent of the Employee to whom the Award was granted. Except as expressly provided in the Plan or in the Award Instrument evidencing the Award, the Committee may not, without the consent of the holder of an Award granted under the Plan, amend the terms and conditions applicable to that Award in a manner adverse to the interests of the Employee. 21. PLAN NONCONTRACTUAL. Nothing herein contained shall be construed as a commitment to or agreement with any person employed by the Corporation or a Subsidiary to continue such person's employment with the Corporation or the Subsidiary, and nothing herein contained shall be construed as a commitment or agreement on the part of the Corporation or any Subsidiary to continue the employment or the annual rate of compensation of any such person for any period. All Employees shall remain subject to discharge to the same extent as if the Plan had never been put into effect. 22. INTEREST OF EMPLOYEES. Any obligation of the Corporation under the Plan to make any payment at any future date merely constitutes the unsecured promise of the Corporation to make such payment from its general assets in accordance with the Plan, and no Employee shall have any interest in, or lien or prior claim upon, any property of the Corporation or any Subsidiary by reason of that obligation. 23. CLAIMS OF OTHER PERSONS. The provisions of the Plan shall in no event be construed as giving any person, firm, or corporation any legal or equitable right against the Corporation or any Subsidiary, their officers, employees, agents, or directors, except any such rights as are specifically provided for in the Plan or are hereafter created in accordance with the terms and provisions of the Plan. 23 24. ABSENCE OF LIABILITY. No member of the Board of Directors of the Corporation or a Subsidiary, of the Committee, of any other committee of the Board of Directors, or any officer or Employee of the Corporation or a Subsidiary shall be liable for any act or action under the Plan, whether of commission or omission, taken by any other member, or by any officer, agent, or Employee, or except in circumstances involving his bad faith or willful misconduct, for anything done or omitted to be done by himself. 25. SEVERABILITY. The invalidity or unenforceability of any particular provision of the Plan shall not affect any other provision hereof, and the Plan shall be construed in all respects as if such invalid or unenforceable provision were omitted herefrom. 26. GOVERNING LAW. The provisions of the Plan shall be governed and construed in accordance with the laws of the State of Ohio. 27. PLAN EFFECTIVE DATE. The Plan, originally named the Society Corporation 1991 Equity Compensation Plan, was approved by the Corporation's shareholders at the Annual Meeting of Shareholders held on April 16, 1991 and became effective on that date. On March 17, 1994, the Corporation's Board of Directors adopted, subject to shareholder approval, certain amendments to the Plan, then renamed the KeyCorp Amended and Restated 1991 Equity Compensation Plan. The shareholders approved these amendments at the Corporation's Annual Meeting of Shareholders held on May 19, 1994. The Plan was further amended by action of the Committee on July 17, 1996 to amend the definition of Change of Control as set forth in Section 2.5 of the Plan, which amendment was effective as of January 1, 1996. If the Corporation hereafter enters into a transaction intended to be accounted for as a pooling of interests and the Committee determines, based on the written advice of the Corporation's independent accountants, that the July 17, 1996 amendment or the operation thereof would conflict with or jeopardize the pooling of interests accounting treatment for such transaction, then the July 17, 1996 amendment shall be inoperative and shall be treated as if it had never been effected so that the definition of Change of Control would be as in effect prior to such amendment. The Plan was further amended and restated as of September 19, 1996, to provide for the transferability of Options granted hereunder. The Plan was further amended by action of the Equity Based Compensation Subcommittee of the Compensation and Organization Committee on May 6, 1998 to amend Section 10.1(a) of the Plan to extend the option exercise period for terminated employees upon a change of control in certain circumstances. The amendment to Section 10.1(a) only applies to Awards and Award Instruments granted or entered into on or after January 1, 1999. If the Corporation enters into a transaction intended to qualify as a pooling of interests for accounting purposes prior to January 1, 1999, the amendment to Section 10.1(a) shall become null and void. The Subcommittee also amended the Plan to delete Section 17 of the Plan and all cross-references thereto. References in the Plan to specific numbers of Common Shares have been adjusted pursuant to Section 13 to reflect the two-for-one split in the Common Shares effective March 6, 1998. With respect to clause (a) of the last paragraph of Section 5, as of May 6, 1998, Incentive Stock Options covering 451,823 Common Shares had been theretofore granted and not expired or terminated unexercised, leaving 9,148,177 Common Shares then available for future grant of Incentive Stock Options (subject to 24 increase in the event that outstanding Incentive Stock Options expire or terminate unexercised). The Plan was further amended by action of the Compensation and Organization Committee on March 15, 2000 to amend Section 1 of the Plan to clarify that Awards under the Plan may be made to any Employee of the Corporation. The Plan was amended on January 17, 2001 to amend Section 6.4(a) to remove the requirement that an Option will not become exercisable unless an Optionee has been continuously employed by the Corporation for at least six months from the date of grant. The Plan was also amended to add a new Section 16 entitled "Harmful Activity" which states that, if an Optionee engages in a "harmful activity" prior to or within six months of termination of employment, profits from the exercise of a Covered Option will inure to the benefit of the Corporation in certain circumstances. Section 16 does not apply to Options granted prior to January 1, 2001. The Plan was amended on March 14, 2001 to amend Sections 10.2, 10.3, and 10.4 to extend the period during which Options are exercisable pursuant to these sections to three years after retirement, disability, or death. The amendment only applies to Options granted on or after January 1, 2002. The Plan was amended on November 14, 2001 to amend Section 2.2 to change the consideration required for Restricted Stock. 25 EX-10.28 4 l92910aex10-28.txt EXHIBIT 10.28 EXHIBIT 10.28 FIRST AMENDMENT TO THE KEYCORP DEFERRED COMPENSATION PLAN WHEREAS, KeyCorp has established the KeyCorp Deferred Compensation Plan (the "Plan"), and WHEREAS, the Board of Directors of KeyCorp has authorized its Compensation and Organization Committee to permit amendments to the Plan, and WHEREAS, the Compensation and Organization Committee of the Board of Directors of KeyCorp has authorized by and through the adoption of the KeyCorp Automatic Deferral Plan the execution of this Amendment, NOW, THEREFORE, pursuant to such action of the Compensation and Organization Committee, the Plan is hereby amended as follows: 1. The Plan is amended to add a new Section 3.7 to the Plan to read in its entirety as follows: "3.7 ROLLOVERS. Subject to the Corporation's consent, the Plan may accept on behalf of a Participant, a rollover of the Participant's bookkeeping account balance from such other deferred compensation plan of the Employer in which the Participant also participates. The bookkeeping account balance so rolled shall be known as plan transfer contributions ("Plan Transfer Contributions"). The Participant's Plan Transfer Contributions shall be credited to the Participant's Plan Account on a bookkeeping basis in such a manner as the Corporation shall be able to separately identify such Plan Transfer Contributions and determine the net gains or losses attributable thereto. Such Plan Transfer Contributions shall, at all times, be invested in the Plan's Common Stock Account, and shall not be subject to the Participant's investment direction or diversification. Plan Transfer Contributions shall be fully vested under the Plan, and shall be subject to the distribution requirements contained in Article VI hereof." 2. Section 9.1 is amended to delete it in its entirety and to substitute therefor the following: "9.1 RESERVATION OF RIGHTS. The Corporation reserves the right to terminate the Plan at any time by action of the Board of Directors of the Corporation, or any duly authorized committee thereof, and to modify or amend the Plan, in whole or in part, at any time and for any reason, subject to the following: (a) PRESERVATION OF ACCOUNT BALANCE. No termination, amendment, or modification of the Plan shall reduce (i) the amount of Prior Plan Awards, Plan Transfer Contributions, Participant Deferrals and Corporate Contributions, and (ii) all earnings and gains on such Prior Plan Awards, Plan Transfer Contributions, Participant Deferrals, and Corporate Contributions that have accrued up to the effective date of the termination, amendment, or modification. 1 (b) CHANGES IN EARNINGS RATE. No amendment or modification of the Plan shall reduce the rate of earnings to be credited on all Prior Plan Awards, Plan Transfer Contributions, Participant Deferrals, and Corporate Contributions and all earnings accrued thereon until the close of the applicable Deferral Period in which such amendment or modification is made." 3. Section 10.1 is amended to delete it in its entirety and to substitute therefor the following: "10.1 CHANGE OF CONTROL. Notwithstanding any other provision of the Plan to the contrary, in the event of a Change of Control as defined in accordance with Section 2.2 of the Plan, no amendment or modification of the Plan may be made at any time on or after such Change of Control (1) to reduce or modify a Participant's Pre-Change of Control Account Balance, (2) to reduce or modify the Interest Bearing Account's rate of earnings on or method of crediting such earnings to a Participant's Pre-Change of Control Account Balances, (3) to reduce or modify the Common Stock Accounts' method of calculating all earnings, gains, and/or losses on a Participant's Pre-Change of Control Account Balance, (4) to reduce or modify any Investment Funds' method of calculating all earnings, gains, and/or losses on a Participant's Pre-Change of Control Account Balance, or (5) to reduce or modify the Participant's Participant Deferrals and/or Corporate Contributions to be credited to a Participant's Plan Account for the applicable Deferral Period. For purposes of this Section 10.1, the term "Pre-Change of Control Account Balance" shall mean, with regard to any Plan Participant, the aggregate amount of such Participant's Prior Plan Awards, Plan Transfer Contributions, Participant Deferrals, and Corporate Contributions with all earnings, gains, and losses thereon which are credited to the Participant's Plan Account through the close of the calendar year in which such Change of Control occurs." 4. Except as otherwise amended herein, the Plan shall remain in full force and effect. IN WITNESS WHEREOF, KeyCorp has caused this First Amendment to the Plan to be executed by its duly authorized officer to be effective as of the ___ day of December, 1999. KEYCORP By: ------------------------------------------- Title: ----------------------------------------- 2 EX-10.29 5 l92910aex10-29.txt EXHIBIT 10.29 SECOND AMENDMENT TO THE EXHIBIT 10.29 KEYCORP DEFERRED COMPENSATION PLAN WHEREAS, KeyCorp has established the KeyCorp Deferred Compensation Plan ("Plan") for certain employees of KeyCorp, and WHEREAS, the Board of Directors of KeyCorp has authorized its Compensation and Organization Committee to permit amendments to the Plan, and WHEREAS, the Compensation and Organization Committee of the Board of Directors of KeyCorp has determined it desirable to amend the Plan and has accordingly authorized the execution of this Second Amendment, NOW THEREFORE, pursuant to such action of the Compensation and Organization Committee, the Plan is hereby amended as follows: 1. Section 2.1(l) shall be amended to delete it in its entirety and to substitute therefore the following: (l) "EARLY RETIREMENT" shall mean the Participant's retirement from employment with an Employer on or after the Participant's attainment of age 55 and completion of a minimum of five years of Vesting Service, but prior to the Participant's Normal Retirement Date. 2. Section 2.1(q) shall be amended to delete it in its entirety and to substitute therefore the following: "(q) "INCENTIVE COMPENSATION" shall mean the incentive compensation awarded to a Participant under an Incentive Compensation Plan." 3. A new Section 2.1(s) "Incentive Compensation Plan" shall be added to the Plan, and all remaining definitions contained in Section 2.1 shall be sequentially re-alphabetized. The new Section 2.1(s) shall provide the following: "(s) "INCENTIVE COMPENSATION PLAN" shall mean a line of business or management incentive compensation plan that is sponsored by KeyCorp or an affiliate of KeyCorp which the Corporation in its sole discretion has determined constitutes an Incentive Compensation Plan for purposes of the Plan." 1 4. Section 3.1(a) shall be amended to delete it in its entirety and to substitute therefore the following: "(a) ELIGIBILITY. An Employee shall be eligible to participate in the Plan if (1) the Employee is a Participant in an Incentive Compensation Plan, (2) the Employee is employed in a job grade (or job grade equivalent) 86 and above, and (3) the Corporation selects such Employee to participate in the Plan. Notwithstanding the foregoing provisions of this Section 3.1(a), all Participants in the Plan as of December 31, 2000 shall continue to remain Plan Participants regardless of the Participant's job grade (or job grade equivalent)." 5. Except as specifically amended herein, the Plan shall remain in full force and effect. IN WITNESS WHEREOF, KeyCorp has caused this Second Amendment to the Plan to be executed by its duly authorized officer to be effective as of the first day of January, 2001. KEYCORP BY: --------------------------------- TITLE: ------------------------------ -2- EX-12 6 l92910aex12.txt EXHIBIT 12 EXHIBIT 12 KEYCORP COMPUTATION OF CONSOLIDATED RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS (DOLLARS IN MILLIONS) (UNAUDITED)
YEAR ENDED DECEMBER 31, ------------------------------------------ 2001 2000 1999 1998 1997 ------ ------ ------ ------ ------ COMPUTATION OF EARNINGS Net income.................................................. $ 132 $1,002 $1,107 $ 996 $ 919 Add: Provision for income taxes............................. 102 515 577 483 426 Less: Cumulative effect of accounting changes, net of tax... (25) -- -- -- -- ------ ------ ------ ------ ------ Income before income taxes and cumulative effect of accounting changes................................... 259 1,517 1,684 1,479 1,345 Fixed charges, excluding interest on deposits............... 1,367 1,820 1,649 1,517 1,085 ------ ------ ------ ------ ------ Total earnings for computation, excluding interest on deposits............................................. 1,626 3,337 3,333 2,996 2,430 Interest on deposits........................................ 1,478 1,768 1,305 1,359 1,462 ------ ------ ------ ------ ------ Total earnings for computation, including interest on deposits............................................. $3,104 $5,105 $4,638 $4,355 $3,892 ====== ====== ====== ====== ====== COMPUTATION OF FIXED CHARGES Net rental expense.......................................... $ 145 $ 146 $ 173 $ 139 $ 123 ====== ====== ====== ====== ====== Portion of net rental expense deemed representative of interest.................................................. $ 43 $ 41 $ 46 $ 35 $ 30 Interest on short-term borrowed funds....................... 500 715 646 801 642 Interest on long-term debt, including capital securities.... 824 1,064 957 681 413 ------ ------ ------ ------ ------ Total fixed charges, excluding interest on deposits..... 1,367 1,820 1,649 1,517 1,085 Interest on deposits........................................ 1,478 1,768 1,305 1,359 1,462 ------ ------ ------ ------ ------ Total fixed charges, including interest on deposits..... $2,845 $3,588 $2,954 $2,876 $2,547 ====== ====== ====== ====== ====== COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS Preferred stock dividend requirement on a pre-tax basis..... -- -- -- -- -- Total fixed charges, excluding interest on deposits......... $1,367 $1,820 $1,649 $1,517 $1,085 ------ ------ ------ ------ ------ Combined fixed charges and preferred stock dividends, excluding interest on deposits....................... 1,367 1,820 1,649 1,517 1,085 Interest on deposits........................................ 1,478 1,768 1,305 1,359 1,462 ------ ------ ------ ------ ------ Combined fixed charges and preferred stock dividends, including interest on deposits....................... $2,845 $3,588 $2,954 $2,876 $2,547 ====== ====== ====== ====== ====== RATIO OF EARNINGS TO FIXED CHARGES Excluding deposit interest.................................. 1.19X 1.83x 2.02x 1.97x 2.24x Including deposit interest.................................. 1.09X 1.42x 1.57x 1.51x 1.53x RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS Excluding deposit interest.................................. 1.19X 1.83x 2.02x 1.97x 2.24x Including deposit interest.................................. 1.09X 1.42x 1.57x 1.51x 1.53x
15 EX-13 7 l92910aex13.txt EXHIBIT 13 Exhibit 13 FINANCIAL REVIEW MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS Introduction 22 Highlights of Key's 2001 Performance 23 Cash Basis Financial Data 26 Line of Business Results 26 Results of Operations Net Interest Income 28 Market Risk Management 29 Noninterest Income 33 Noninterest Expense 36 Income Taxes 38 Financial Condition Loans 38 Securities 42 Asset Quality 43 Deposits and Other Sources of Funds 48 Liquidity 48 Capital and Dividends 50 Fourth Quarter Results 51 REPORT OF MANAGEMENT 53 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS 53 CONSOLIDATED FINANCIAL STATEMENTS 54 21 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES INTRODUCTION This Management's Discussion and Analysis generally reviews the financial condition and results of operations of KeyCorp and its subsidiaries for each of the past three years, although some tables may cover more than three years to comply with Securities and Exchange Commission disclosure requirements or to illustrate trends over a longer period of time. When you read this discussion, you should also look at the consolidated financial statements and related notes that appear on pages 54 through 83. ACCOUNTING POLICIES Key's business is dynamic and complex. Consequently, management must exercise judgment in choosing and applying the most appropriate accounting policies and methodologies in many areas. These choices are important; not only are they necessary to ensure compliance with generally accepted accounting principles, they also reflect the exercise of management's judgment in determining the most appropriate manner in which to record and report Key's financial performance. In management's opinion, some of these areas have a more significant impact than others on the financial performance of Key. This is because they apply to areas of relatively greater business importance, and/or require a more subjective decision-making process on the part of management. For Key, these areas include accounting for the allowance for loan losses, loan securitizations, and contingent obligations arising from litigation. Our accounting policies related to the first two of these three areas are disclosed in Note 1 ("Summary of Significant Accounting Policies"), which begins on page 58. A detailed description of contingent obligations arising from litigation is contained in Note 17 ("Commitments, Contingent Liabilities and Other Disclosures"), which begins on page 76. All accounting policies are important, and all policies contained in Note 1 should be reviewed for a greater understanding of how Key's financial performance is recorded and reported. 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), 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 accounting changes, write-downs of certain assets in connection with the implementation of strategic actions, gains from divestitures and restructuring charges. All of these items can distort results, particularly in period-to-period comparisons. Reported results include these items as required under accounting principles generally accepted in the United States. - - All earnings per share data included in this discussion are presented on a DILUTED basis, which takes into account all common shares outstanding as well as 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 two classes. Federal regulations prescribe that at least one-half of a bank or bank holding company's TOTAL RISK-BASED 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 50. - - 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. OUR PROJECTIONS ARE NOT FOOLPROOF This report contains "forward-looking statements" about issues like anticipated cost savings and revenue growth, and 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, which may have an adverse effect on our financial results. - - If the economy or segments of the economy fail to rebound or decline further, the demand for new loans and the ability of borrowers to repay outstanding loans may decline. - - The stock and bond markets could suffer additional disruption, which may have an adverse 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; we may be unable to implement certain initiatives; or the initiatives may be unsuccessful. - - Acquisitions and dispositions of assets, business units or affiliates could adversely affect us in ways that management has not anticipated. - - We may become subject to new legal obligations, or the resolution of pending litigation may have an adverse effect on our financial condition. - - Terrorist activities or military actions could further disrupt the economy and the general business climate, which may have an adverse effect on our financial results or condition and that of our borrowers. - - We may become subject to new accounting, tax, or regulatory practices or requirements. 22 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES HIGHLIGHTS OF KEY'S 2001 PERFORMANCE FINANCIAL PERFORMANCE In May and December, we announced actions designed to improve Key's business performance and to better position the company to take advantage of an eventual economic recovery. However, these actions had the effect of reducing Key's financial results for 2001. MAY 2001 ANNOUNCEMENT - --------------------- On May 17, concurrent with the election of Chief Executive Officer Henry L. Meyer III as Chairman of the Board of Directors, we announced a series of strategic initiatives designed to sharpen our business focus and strengthen our financial performance by returning to our core relationship businesses. Specific actions include exiting the automobile leasing business, de-emphasizing indirect prime automobile lending, and discontinuing nonrelationship lending in the leveraged financing and nationally syndicated lending businesses. These actions are part of a broader business plan discussed under the heading "Corporate strategy," on page 24. As a result of the above actions, we recorded several significant charges that had an adverse effect on Key's 2001 financial performance. These charges include a noncore $150 million write-down of goodwill, as well as two large charges included in Key's core financial results. The core charges include an additional provision for loan losses of $300 million ($189 million after tax) and $40 million ($25 million after tax) for losses incurred on the residual values of leased vehicles. DECEMBER 2001 ANNOUNCEMENT - -------------------------- On December 20, we announced several significant core charges recorded in connection with our commitment to restore Key's conservative risk management culture and strengthen the balance sheet. Specifically, we recorded an additional provision for loan losses of $590 million ($372 million after tax), a $45 million ($28 million after tax) write-down of our principal investing portfolio and a $15 million ($10 million after tax) charge to increase our reserve for customer derivative losses. We believe that these actions are critically important in the wake of the events of September 11 and the continued uncertainty surrounding the timing of an economic recovery; they position us to take full advantage of the economic recovery when it occurs. These charges, as well as those recorded in May, are reviewed in greater detail in the remainder of this discussion. Key's net income for 2001 was $132 million, or $.31 per common share, compared with $1.002 billion or $2.30 per share, in 2000. The primary measures of Key's core financial performance for 2001 are summarized below and reflect the effects of the core charges recorded in both May and December. - - Core net income was $320 million, or $.74 per common share, compared with $1.009 billion, or $2.32 per share in 2000, and $1.051 billion, or $2.33 per share, in 1999. - - Key's core return on average equity was 4.87%, compared with 15.49% in 2000 and 16.79% in 1999. - - Key's core return on average total assets was .38%, compared with 1.20% in 2000 and 1.30% in 1999. In each of the past three years, Key's financial results have been affected by significant items, including those related to the implementation of strategic actions. Those items that are considered to be nonrecurring (or noncore) and their impact on both earnings and primary financial ratios are summarized in Figure 1.
FIGURE 1 SIGNIFICANT NONRECURRING ITEMS YEAR ENDED DECEMBER 31, dollars in millions, except per share amounts 2001 2000 1999 - ------------------------------------------------------------------------------------------------- Net income as reported $132 $1,002 $1,107 Nonrecurring items (net of tax): Goodwill write-down (automobile finance business) 150 -- -- Cumulative effect of accounting change -- EITF 99-20 24 -- -- Additional litigation reserves 13 -- -- Restructuring and other special charges 1 78 96 Gain from sale of credit card portfolio -- (207) -- Additional provisions for loan losses -- 101 19 Net losses from reconfiguration of securities portfolio -- 32 -- Gains from branch divestitures -- -- (122) Gain from sale of Electronic Payment Services, Inc. -- -- (85) Gains from sale of Key Merchant Services, LLC -- -- (9) Other nonrecurring items -- 3 45 - ------------------------------------------------------------------------------------------------- Net income -- core $320 $1,009 $1,051 ==== ====== ====== Net income per diluted common share $.31 $2.30 $2.45 Net income per diluted common share -- core .74 2.32 2.33 Return on average total assets .16% 1.19% 1.37% Return on average total assets -- core .38 1.20 1.30 Return on average equity 2.01 15.39 17.68 Return on average equity -- core 4.87 15.49 16.79 - -------------------------------------------------------------------------------------------------
23 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES Key's core net income declined from 2000 to 2001 due primarily to the adverse effects of a sluggish economy, which weakened further after the events of September 11. We witnessed erosion in credit quality among our borrowers over the past year, particularly during the fourth quarter. The core charges (primarily provisions for loan losses) recorded in connection with the actions announced in May and December contributed significantly to the decline in core net income. The effects of poor economic conditions were also particularly noticeable in our more capital markets-sensitive businesses, such as principal investing (investing in privately held companies) and brokerage. The decrease in Key's core net income from 1999 to 2000 was due in part to 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 a decision made early in 2000 to discontinue securitizing and selling 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 formerly generated by the credit card business. The primary reasons that Key's specific revenue and expense components changed over the past two years 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 six years. CORPORATE STRATEGY Our objective is to achieve revenue and earnings per share growth that is consistently above the median for stocks that make up the Standard & Poors 500 Banks Index. In order to achieve this, our strategy is comprised of the following four primary elements: - - STAY FOCUSED ON OUR CORE BUSINESSES. To further this objective, we intend to focus on businesses where we can build relationships with our clients. We will primarily focus on a business mix that comprises our "footprint" businesses that serve individuals, particularly the affluent, small businesses and middle market companies. Additionally, we will focus on national businesses such as commercial real estate lending, asset management, home equity lending and equipment leasing. Over time, we also intend to diversify our revenue mix by emphasizing the growth of fee income and to invest in higher-growth and higher-return businesses. - - PUT OUR CLIENTS FIRST. To accomplish this, we are focusing on how we can deepen our relationship with each of our clients. We want to build relationships with those clients who have the potential to purchase multiple products and services or repeat business. One way in which we are pursuing this is to emphasize deposit growth across all of our lines of business. We also want to ensure that our clients are receiving a distinctive level of service. We are putting considerable effort into enhancing our service quality. - - ENHANCE OUR BUSINESS. To accomplish this objective, we will build on the success of our competitiveness initiative via a continuous improvement process, which will continue to focus on increasing revenues, controlling expenses and better serving our clients. Additionally, we will continue to leverage technology both to reduce costs and enhance the service quality provided to our clients. - - CULTIVATE A WORKFORCE THAT DEMONSTRATES KEY'S VALUES AND WORKS TOGETHER FOR A COMMON PURPOSE. Key intends to achieve this by: - paying for performance, but only if achieved in ways that are consistent with Key's values and keep the company's overall performance in mind; - attracting, developing and retaining a quality, high-performing and inclusive workforce; - developing leadership at all levels in the company; and - creating a positive, stimulating and entrepreneurial work environment. STATUS OF COMPETITIVENESS INITIATIVE Key launched a major initiative in November 1999, the first phase of which was completed in 2000. This initiative is designed to improve Key's profitability by reducing the costs of doing business, focusing on the most profitable growth businesses and enhancing revenues. During the initial phase, we reduced our operating expenses by approximately $100 million by outsourcing certain nonstrategic support functions, consolidating sites in a number of our businesses and reducing management layers. In the second and final phase of the initiative, referred to as PEG (Perform, Excel, Grow), we are working to: - - simplify Key's business structure by consolidating 22 business lines into 10; - - streamline and automate business operations and processes; - - standardize product offerings and internal processes; - - consolidate operating facilities and service centers; and - - outsource additional noncore activities. By year end, more than 90% of the PEG projects had been completed and we had reduced costs by more than two-thirds of the expected net annual savings rate of $200 million. Management expects that Key will achieve an annual savings rate of approximately $360 million from the overall initiative when all planned actions are fully implemented before the end of 2002. Approximately $60 million of these savings will be reinvested to fund activities that are designed to enhance Key's strategic competitive position, fuel higher growth and improve customer service. Management anticipates that the actions taken in the competitiveness initiative will reduce Key's workforce by approximately 4,000 positions (comprising both staffed and vacant positions) by the end of the first quarter of 2002. At December 31, 2001, nearly 3,900 of these positions had been eliminated. Since the inception of the competitiveness initiative, we have recorded related net charges of $279 million. The section entitled "Noninterest expense," which begins on page 36, and Note 14 ("Restructuring Charges"), which begins on page 73, provide more information about Key's restructuring charges. 24
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 2 SELECTED FINANCIAL DATA COMPOUND ANNUAL RATE OF CHANGE dollars in millions, except per share amounts 2001 2000 1999 1998 1997 1996 (1996-2001) - ------------------------------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, Interest income $ 5,627 $ 6,277 $ 5,695 $ 5,525 $ 5,262 $ 4,951 2.6% Interest expense 2,802 3,547 2,908 2,841 2,517 2,237 4.6 Net interest income 2,825 2,730 2,787 2,684 2,745 2,714 .8 Provision for loan losses 1,350 490 348 297 320 197 47.0 Noninterest income 1,725 2,194 2,315 1,600 1,315 1,090 9.6 Noninterest expense 2,941 2,917 3,070 2,508 2,395 2,464 3.6 Income before income taxes and cumulative effect of accounting changes 259 1,517 1,684 1,479 1,345 1,143 (25.7) Income before cumulative effect of accounting changes 157 1,002 1,107 996 919 783 (27.5) Net income 132 1,002 1,107 996 919 783 (30.0) - ------------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE Income before cumulative effect of accounting changes $ .37 $ 2.32 $ 2.47 $ 2.25 $ 2.09 $ 1.69 (26.2)% Income before cumulative effect of accounting changes -- assuming dilution .37 2.30 2.45 2.23 2.07 1.67 (26.0) Net income .31 2.32 2.47 2.25 2.09 1.69 (28.8) Net income -- assuming dilution .31 2.30 2.45 2.23 2.07 1.67 (28.6) Cash dividends paid 1.18 1.12 1.04 .94 .84 .76 9.2 Book value at year end 14.52 15.65 14.41 13.63 11.83 10.92 5.9 Market price at year end 24.34 28.00 22.13 32.00 35.41 25.25 (.7) Dividend payout ratio 380.65% 48.28% 42.11% 41.78% 40.19% 45.10% 53.2 Weighted average common shares (000) 424,275 432,617 448,168 441,895 439,042 459,810 (1.6) Weighted average common shares and potential common shares (000) 429,573 435,573 452,363 447,437 444,544 464,282 (1.5) - ------------------------------------------------------------------------------------------------------------------------------- AT DECEMBER 31, Loans $ 63,309 $ 66,905 $ 64,222 $ 62,012 $ 53,380 $ 49,235 5.2% Earning assets 71,672 77,316 73,733 70,240 64,246 59,260 3.9 Total assets 80,938 87,270 83,395 80,020 73,699 67,621 3.7 Deposits 44,795 48,649 43,233 42,583 45,073 45,317 (.2) Long-term debt 14,554 14,161 15,881 12,967 7,446 4,213 28.1 Common shareholders' equity 6,155 6,623 6,389 6,167 5,181 4,881 4.7 Total shareholders' equity 6,155 6,623 6,389 6,167 5,181 4,881 4.7 Full-time equivalent employees 21,230 22,142 24,568 25,862 24,595 27,689 (5.2) Branches 911 922 936 968 1,015 1,205 (5.4) - ------------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average total assets .16% 1.19% 1.37% 1.32% 1.33% 1.21% N/A Return on average common equity 2.01 15.39 17.68 17.97 18.89 15.73 N/A Return on average total equity 2.01 15.39 17.68 17.97 18.89 15.64 N/A Net interest margin (taxable equivalent) 3.81 3.69 3.93 4.08 4.54 4.78 N/A - ------------------------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS AT DECEMBER 31, Equity to assets 7.60% 7.59% 7.66% 7.71% 7.03% 7.22% N/A Tangible equity to tangible assets 6.29 6.12 6.03 5.93 5.52 5.88 N/A Tier 1 risk-based capital 7.43 7.72 7.68 7.21 6.65 7.98 N/A Total risk-based capital 11.41 11.48 11.66 11.69 10.83 13.01 N/A Leverage 7.65 7.71 7.77 6.95 6.40 6.93 N/A - -------------------------------------------------------------------------------------------------------------------------------
Key completed several acquisitions and divestitures during the six-year period 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 year to the next. Note 3 ("Acquisitions and Divestitures"), which begins on page 63, has specific information about the acquisitions and divestitures that Key completed in the past three years to help you understand how those transactions may have impacted Key's financial condition and results of operations. N/A = Not Applicable 25 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES CASH BASIS FINANCIAL DATA The selected financial data presented in Figure 3 summarize Key's performance on a "cash basis" for each of the past three years. We provide cash basis financial data because we believe it is a useful tool for measuring Key's ability to support future growth, evaluating liquidity and assessing Key's ability to pay dividends and repurchase shares. When we apply cash basis accounting, we make certain adjustments to get from the information in Figure 2 (which is presented on an accrual basis) to the comparable items in Figure 3. Specifically, we exclude goodwill and other intangibles that do not qualify as Tier 1 capital and exclude the amortization of those assets. The data provided in Figure 3 do not exclude the impact of any other noncash items (such as depreciation and deferred taxes) and significant nonrecurring items. Key's 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. After combinations using purchase accounting, Key amortized goodwill and other intangibles by taking periodic charges against income, but those charges were only accounting entries, not actual cash expenses. Thus, the amortization of intangibles did not adversely affect Key's cash position or its liquidity. As shown in Figure 3, Key's 2001 goodwill amortization was relatively high since it includes an impairment charge of $150 million that resulted from management's decision to downsize the automobile finance business. Effective January 1, 2002, a new accounting standard eliminates the amortization of goodwill and other intangible assets deemed to have indefinite lives. The absence of this noncash amortization will essentially eliminate the difference between Key's reported results and those presented on a cash basis. For more information pertaining to the new accounting standard, see the section entitled "Accounting Pronouncements Pending Adoption," included in Note 1 ("Summary of Significant Accounting Policies"), on page 62. 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 dollars in millions, except per share amounts 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, Noninterest expense $ 2,696 $ 2,817 $ 2,968 Income before income taxes and cumulative effect of accounting changes 504 1,617 1,786 Income before cumulative effect of accounting changes 393 1,617 1,786 Net income 368 1,093 1,199 - ------------------------------------------------------------------------------------------------------------ PER COMMON SHARE Income before cumulative effect of accounting changes $ .93 $ 2.53 $ 2.68 Income before cumulative effect of accounting changes-- assuming dilution .91 2.51 2.65 Net income .87 2.53 2.68 Net income-- assuming dilution .86 2.51 2.65 Weighted average common shares (000) 424,275 432,617 448,168 Weighted average common shares and potential common shares (000) 429,573 435,573 452,363 - ------------------------------------------------------------------------------------------------------------ PERFORMANCE RATIOS Return on average total assets .44% 1.32% 1.51% Return on average equity 6.89 21.43 25.14 - ------------------------------------------------------------------------------------------------------------ GOODWILL AND NONQUALIFYING INTANGIBLES Goodwill average balance $ 1,196 $ 1,359 $ 1,424 Nonqualifying intangibles average balance 37 52 68 Goodwill amortization (after tax) 228 82 81 Nonqualifying intangibles amortization (after tax) 8 9 11 - ------------------------------------------------------------------------------------------------------------ Key completed several acquisitions and divestitures during the three-year period 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 them from one year to the next. Note 3 ("Acquisitions and Divestitures"), which begins on page 63, has specific information about the acquisitions and divestitures that Key completed during the past three years to help you understand how those transactions impacted Key's financial condition and results of operations.
LINE OF BUSINESS RESULTS Key has three major lines of business: KEY CONSUMER BANKING consists of two of Key's primary divisions: RETAIL BANKING and HOME EQUITY AND CONSUMER FINANCE. - - RETAIL BANKING offers branch-based deposit, investment and credit products and personal financial services to consumers. - - HOME EQUITY AND CONSUMER FINANCE offers non-branch-based consumer loan products, such as education loans, home equity loans, automobile loans and marine loans. KEY CORPORATE FINANCE offers financing, as well as financial advisory services and specialized services related to, among other things, transaction processing, corporate electronic commerce and equipment leasing. It also serves the needs of Key's small business clients. 26 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES KEY CAPITAL PARTNERS offers specialized services to high-net-worth clients through the wealth management and private banking businesses. It also provides asset management, investment banking and capital markets expertise, and various other services, including brokerage, employee benefits and insurance. This section summarizes the financial performance and related strategic developments of each line of business. To better understand this discussion, see Note 4 ("Line of Business Results"), which begins on page 64 and presents the activities and financial results of each line of business in greater detail. Figure 4 summarizes the contribution made by each major line of business to Key's net income for each of the past three years.
FIGURE 4 NET INCOME BY LINE OF BUSINESS(a) YEAR ENDED DECEMBER 31, CHANGE 2001 VS 2000 ------------------- dollars in millions 2001 2000 1999 AMOUNT PERCENT - ---------------------------------------------------------------------------------------- Key Consumer Banking: Retail Banking $ 315 $ 281 $ 214 $ 34 12.1% Home Equity and Consumer Finance(b) 68 69 112 (1) (1.4) Key Corporate Finance 515 477 429 38 8.0 Key Capital Partners(c) 65 82 68 (17) (20.7) Other Segments (28) 45 66 (73) N/M - ---------------------------------------------------------------------------------------- Total segments 935 954 889 (19) (2.0) Reconciling items(d) (803) 48 218 (851) N/M - ---------------------------------------------------------------------------------------- Total net income $ 132 $1,002 $1,107 $ (870) (86.8)% ====== ====== ====== ====== - ----------------------------------------------------------------------------------------
(a) Key's management accounting system utilizes a methodology for loan loss provisioning by line of business that reflects credit quality expectations within each line of business over a normal business cycle. The "normalized provision for loan losses" assigned to each line as a result of this methodology does not necessarily coincide with the level of net loan charge-offs at any given point in the cycle. (b) Results for 2001 exclude a second quarter cumulative charge of $39 million ($24 million after tax) resulting from a prescribed change, applicable to all companies, in the accounting for retained interests in securitized assets. (c) Noninterest income and expense attributable to Key Capital Partners is assigned to Retail Banking, Home Equity and Consumer Finance or Key Corporate Finance if one of those businesses 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 $112 million in 2001, $127 million in 2000 and $105 million in 1999 before its income and expense were reassigned. (d) Reconciling items include certain strategic and nonrecurring items summarized in notes (c), (d) and (e) to the table included in Note 4 ("Line of Business Results"), beginning on page 64. Also included are charges related to unallocated nonearning assets of corporate support functions and the effect of the accounting change described in note (b) above. N/M= Not Meaningful KEY CONSUMER BANKING RETAIL BANKING (A DIVISION OF KEY CONSUMER BANKING) - --------------------------------------------------- Retail Banking's net income was $315 million for 2001, up from $281 million for 2000 and $214 million for 1999. The 2001 increase in net income is attributable primarily to a decrease in noninterest expense, but also reflects an increase in total revenue. In 2000, net income increased principally because of growth in total revenue and a decline in noninterest expense. Noninterest expense decreased by $45 million, or 5%, from 2000, due largely to lower costs associated with personnel, capital markets activities and a number of other direct expense components, including occupancy and marketing. The decline in costs related to capital markets activities is primarily a result of the income and expense sharing relationship, described under the heading "Key Capital Partners," on page 28. The improvement in noninterest expense is also reflected in the efficiency ratio, which is calculated by dividing operating revenues by operating expenses. That ratio measures the extent to which revenues are used to pay expenses and improved to 59.28% for 2001 from 62.91% for 2000. Noninterest income rose by $18 million, or 4%, from 2000. This growth was largely the result of higher income from service charges on deposit accounts, which resulted from the implementation of strategies developed under Key's competitiveness initiative. At the same time, net interest income decreased by $11 million, or 1%, primarily because interest rate spreads on deposits were narrower and average deposits decreased slightly. HOME EQUITY AND CONSUMER FINANCE (A DIVISION OF KEY CONSUMER BANKING) - --------------------------------------------------------------------- The Home Equity and Consumer Finance division had net income of $68 million for 2001. This compares with net income of $69 million for 2000 and $112 million for 1999. Total revenue increased in 2001, as strong growth in net interest income more than offset a significant decrease in noninterest income. The improvement in total revenue was offset, however, by a rise in noninterest expense. In 2000, net income decreased primarily as a result of lower noninterest income stemming from management's decision to discontinue securitizing and selling Key's home equity loans. Net interest income increased by $68 million, or 13%, from 2000, largely because interest rate spreads on loans improved. The growth in net interest income also reflects a favorable change in the composition of earning assets resulting from Key's decision to retain (rather than securitize and sell) home equity loans starting in 2000. Management believes that these assets have an attractive risk/reward profile. They helped to generate a 4% increase in total average loans outstanding despite a very challenging economic environment. Noninterest income 27 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES declined by $50 million, or 96%, from 2000 due to unfavorable results related to capital markets activities and losses incurred from reduced residual values of leased vehicles. Noninterest expense rose by $24 million, or 8%, reflecting higher costs associated with collections, professional fees and computer processing. KEY CORPORATE FINANCE Key Corporate Finance's net income rose to $515 million for 2001, from $477 million for 2000 and $429 million for 1999. The improvement from 2000 was driven by revenue growth, offset in part by a moderate increase in noninterest expense. In 2000, the increase in net income was due primarily to higher net interest income. During 2001, net interest income increased by $75 million, or 6%. More favorable interest rate spreads and modest growth in both total average loans and deposits were the primary factors contributing to this improvement. The strongest growth in loans occurred in the commercial real estate, equipment leasing and business banking units. At the same time, noninterest income rose by $27 million, or 6%, due largely to increases in income from service charges on deposit accounts and from letter of credit and non-yield-related loan fees. The increase in service charges on deposit accounts resulted from strategies implemented under Key's competitiveness initiative. The $35 million, or 4%, increase in noninterest expense reflects higher costs associated with computer processing and extensions of credit, offset in part by lower personnel expense. KEY CAPITAL PARTNERS Key Capital Partners' net income was $65 million for 2001, compared with $82 million for 2000 and $68 million for 1999. Prior to assigning revenue and expense to other business lines whose clients use products and services offered by Key Capital Partners, net income was $112 million for 2001, $127 million for 2000 and $105 million for 1999. Total revenue for Key Capital Partners decreased by $7 million, or 1% (a decrease of $25 million, or 2%, prior to revenue sharing), from 2000. Higher revenues were generated by fixed income products, derivatives and foreign exchange, all of which benefited from unstable market interest rates and favorable conditions in the fixed income securities markets. In addition, Key Capital Partners' revenue for 2001 benefited from a net gain from the sale of residential mortgage loans associated with the private banking business. However, weak conditions in the capital markets adversely affected Key Capital Partners' overall financial performance in 2001. As a result, income derived from trust and investment services and from investment banking declined by approximately $64 million, or 9%, from the prior year. Noninterest expense increased by $20 million, or 2% (a decrease of $2 million, or less than 1%, prior to expense sharing). The rise in noninterest expense was moderated by lower personnel costs and other expense reductions related to a lower volume of business activity. In 2000, the increase in net income was mainly the result of an increase in total revenue stemming from increases in dealer trading and derivatives income and in trust and investment advisory fees. OTHER SEGMENTS Other Segments includes the Treasury unit, the Principal Investing unit and the net effect of funds transfer pricing among certain Key affiliates and business units. Financial results for years prior to 2001 have been restated to reflect the reclassification of two businesses. During 2001, the Principal Investing unit moved from Key Capital Partners to Other Segments and the Key Electronic Services unit moved from Other Segments to the Retail Banking division of Key Consumer Banking. In 2001, Other Segments generated a net loss of $28 million, compared with net income of $45 million in the prior year. The decrease in results was primarily due to net losses of $79 million ($50 million after tax) recorded by the Principal Investing unit in 2001, compared with net gains of $70 million ($44 million after tax) in 2000. In addition, net interest income declined by $50 million ($32 million after tax), or 50%, due primarily to the net effect of funds transfer pricing. The adverse effects of these factors were partially offset by net securities gains of $31 million ($19 million after tax) recorded by the Treasury unit in 2001, compared with net securities losses of $40 million ($25 million after tax) in 2000. In 2000, Other Segments generated net income of $45 million, down from $66 million in 1999. The Treasury unit recorded the net securities losses discussed above, compared with net gains of less than $1 million in 1999. The adverse effect of securities transactions was partially offset by a $26 million ($17 million after tax) increase in net gains generated by the Principal Investing unit. RESULTS OF OPERATIONS NET INTEREST INCOME Key's principal source of earnings is net interest income, which is 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 derivative instruments to manage interest rate risk; - - interest rate fluctuations; and - - asset quality. To make it easier to compare results among several periods and 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 yield $100. Figure 5 shows the various components of Key's balance sheet that affect interest income and expense, and their respective yields or rates over the past six years. Net interest income for 2001 was $2.9 billion, representing a $112 million, or 4%, increase from 2000. This growth reflected an improved net interest margin, which increased 12 basis points to 3.81%. The net interest margin is an indicator of the profitability of the earning asset portfolio and is calculated by dividing net interest income by average earning assets. Average earning assets increased by 1% to $75.4 billion, as growth in the commercial and home equity portfolios more than offset declines in other portfolios, some of which were due to strategic decisions to exit and/or reduce certain lending activities. These decisions are more fully discussed in the section entitled "Interest earning assets," on page 29. 28 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES In 2000, net interest income was $2.8 billion, down $61 million, or 2%, from the previous year. Average earning assets, primarily commercial and home equity loans, increased by 4% to $74.6 billion. That improvement was more than offset, however, by a decline in the net interest margin from 3.93% in 1999 to 3.69% in 2000. The sales of Key's Long Island branches in the fourth quarter of 1999 and its credit card business in the first quarter of 2000 slowed the growth in earning assets and contributed to the reduction in the net interest margin. NET INTEREST MARGIN. The net interest margin improved over the past year, primarily because: - - we benefited from declining short-term interest rates; - - the interest rate spread on our total loan portfolio improved as we continued to focus on those businesses, such as home equity lending, that typically generate higher interest rate spreads; - - we sold loans with interest rate spreads that did not meet Key's internal profitability standards; and - - a greater proportion of Key's earning assets was supported by noninterest-bearing liabilities (such as demand deposits) and shareholders' equity. INTEREST EARNING ASSETS. Average earning assets for 2001 totaled $75.4 billion, which was $866 million, or 1%, higher than the 2000 level. This increase came principally from the loan portfolio, with the largest growth occurring in the commercial and home equity sectors. However, our decision in May to scale back or exit certain types of lending, and slower demand for loans in a recessionary economy, led to declines in Key's commercial and consumer loans during the second half of the year. The September sale of $1.4 billion of residential mortgage loans also contributed to the decline in consumer loans. In 2000, average earning assets totaled $74.6 billion, representing a $2.9 billion, or 4%, increase from the prior year. This improvement was driven by the growth of Key's loan portfolio, despite the January 2000 sale of the credit card business. Most of the increase was attributable to the commercial loan portfolio, but the growth of the home equity portfolio was also strong. Over the past two years, the growth and composition of Key's loan portfolio has been affected by several actions: - - During the third quarter of 2001, we sold approximately $1.4 billion of residential mortgage loans generated by our private banking and community development businesses. These loans are originated as a customer and community accommodation and are sold periodically because they have relatively low interest rate spreads that do not meet Key's internal profitability standards. - - During the second quarter of 2001, management announced that Key would exit the automobile leasing business, de-emphasize indirect prime automobile lending and discontinue certain nonrelationship credit-only commercial lending. - - During 2001 and 2000, Key sold commercial mortgage loans aggregating $2.8 billion. Since a portion of these loans was sold with limited recourse, Key established a loss reserve of an amount estimated by management to be appropriate to reflect the recourse risk. More information about the related recourse agreement is provided in Note 19 ("Other Financial Instruments with Off-Balance Sheet Risk") under the section entitled "Recourse agreement with Federal National Mortgage Association," on page 79. Our business of originating and servicing commercial mortgage loans has grown, in part, as a result of acquiring Newport Mortgage Company, L.P. and National Realty Funding L.C. in 2000. - - During 2000, we became a referral agent to an asset-backed commercial paper conduit. This arrangement allows us to generate referral revenue without having to add certain low interest rate spread assets to the balance sheet. During 2001, Key sold $434 million of federally guaranteed education loans to a qualified special purpose entity, which issued beneficial interests that were acquired by the conduit. This followed the sale of $805 million of commercial loans to the conduit in 2000. In each year, the loans sold were performing in accordance with their contractual terms. Note 19 ("Other Financial Instruments with Off-Balance Sheet Risk") on page 79, provides more information about the asset-backed commercial paper conduit. - - Early in 2000, we began to retain, rather than securitize and sell, home equity loans generated by our home equity finance affiliate. Over time, we expect earnings from this growing business to replace the earnings formerly generated by the divested credit card business. We will continue, however, to consider securitizations of other portfolios as a source of funding when conditions in the capital markets are favorable. We securitized and sold education loans of $491 million in 2001 and $1.0 billion in 2000. Figure 6 shows how the changes in yields or rates and average balances from the prior year affected net interest income. The section entitled "Financial Condition," which begins on page 38, contains more discussion about changes in earning assets and funding sources. MARKET RISK MANAGEMENT The values of some financial instruments vary not only with changes in external interest rates, but also with changes in foreign exchange rates, the fair value of equity securities held as assets, and other market-driven rates or prices. For example, the value of a fixed-rate bond will decline if market interest rates increase; the bond will become a less attractive investment. Similarly, the value of the U.S. dollar regularly fluctuates in relation to other currencies. The exposure that instruments tied to such external factors presents is called "market risk." Most of Key's market risk is derived from interest rate fluctuations. INTEREST RATE RISK MANAGEMENT - ----------------------------- Key's Asset/Liability Management Policy Committee has developed 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 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. 29
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 5 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES YEAR ENDED DECEMBER 31, 2001 2000 ----------------------------- -------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE - ---------------------------------------------------------------------------------------------------------------- ASSETS Loans(a,b) Commercial, financial and agricultural $ 19,459 $ 1,362 7.00% $ 19,369 $ 1,669 8.63% Real estate-- commercial mortgage 6,821 511 7.50 6,911 628 9.10 Real estate-- construction 5,654 411 7.27 4,815 464 9.63 Commercial lease financing 7,049 490 6.95 6,821 493 7.22 - ---------------------------------------------------------------------------------------------------------------- Total commercial loans 38,983 2,774 7.12 37,916 3,254 8.59 Real estate-- residential 3,607 275 7.64 4,274 325 7.61 Home equity 10,595 906 8.55 8,857 822 9.29 Credit card -- -- -- -- -- -- Consumer-- direct 2,427 232 9.55 2,592 265 10.19 Consumer-- indirect lease financing 2,618 217 8.27 3,089 249 8.03 Consumer-- indirect other 5,529 530 9.58 6,032 570 9.44 - ---------------------------------------------------------------------------------------------------------------- Total consumer loans 24,776 2,160 8.72 24,844 2,231 8.97 Loans held for sale 2,217 169 7.64 2,534 230 9.05 - ---------------------------------------------------------------------------------------------------------------- Total loans 65,976 5,103 7.73 65,294 5,715 8.75 Taxable investment securities 908 27 2.99 734 26 3.52 Tax-exempt investment securities(a) 277 25 8.76 391 34 8.76 - ---------------------------------------------------------------------------------------------------------------- Total investment securities 1,185 52 4.34 1,125 60 5.34 Securities available for sale(a,c) 6,568 452 6.91 6,439 447 6.81 Short-term investments 1,712 65 3.81 1,717 83 4.84 - ---------------------------------------------------------------------------------------------------------------- Total earning assets 75,441 5,672 7.52 74,575 6,305 8.45 Allowance for loan losses (1,090) (959) Accrued income and other assets 10,552 10,419 - ---------------------------------------------------------------------------------------------------------------- $ 84,903 $ 84,035 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Money market deposit accounts $ 12,323 254 2.06 $ 12,211 414 3.39 Savings deposits 1,952 21 1.05 2,206 32 1.47 NOW accounts 619 9 1.43 612 10 1.59 Certificates of deposit ($100,000 or more)(d) 5,284 301 5.71 5,511 340 6.15 Other time deposits 14,208 786 5.53 13,974 805 5.76 Deposits in foreign office 2,715 107 3.94 2,593 167 6.45 - ---------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits 37,101 1,478 3.98 37,107 1,768 4.76 Federal funds purchased and securities sold under repurchase agreements 5,197 198 3.80 4,931 287 5.82 Bank notes and other short-term borrowings(d) 6,829 302 4.43 7,121 428 6.01 Long-term debt, including capital securities(d,e) 15,911 824 5.20 15,707 1,064 6.78 - ---------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 65,038 2,802 4.31 64,866 3,547 5.47 Noninterest-bearing deposits 8,354 8,328 Accrued expense and other liabilities 4,939 4,329 Preferred stock -- -- Common shareholders' equity 6,572 6,512 - ---------------------------------------------------------------------------------------------------------------- $ 84,903 $ 84,035 ======== ======== Interest rate spread (TE) 3.21 2.98 - ---------------------------------------------------------------------------------------------------------------- Net interest income (TE) and net interest margin (TE) $ 2,870 3.81% $ 2,758 3.69% ======== ==== ======== ==== Capital securities $ 1,309 $ 89 $ 1,243 $ 95 Taxable-equivalent adjustment(a) 45 28 - ----------------------------------------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 5 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES YEAR ENDED DECEMBER 31, 1999 ---------------------------- AVERAGE YIELD/ dollars in millions BALANCE INTEREST RATE - --------------------------------------------------------------------------------- ASSETS Loans(a,b) Commercial, financial and agricultural $ 17,695 $ 1,350 7.63% Real estate-- commercial mortgage 6,946 580 8.35 Real estate-- construction 4,076 343 8.42 Commercial lease financing 6,092 445 7.30 - --------------------------------------------------------------------------------- Total commercial loans 34,809 2,718 7.81 Real estate-- residential 4,479 338 7.55 Home equity 7,548 645 8.55 Credit card 997 152 15.25 Consumer-- direct 2,457 238 9.69 Consumer-- indirect lease financing 2,922 236 8.08 Consumer-- indirect other 6,584 608 9.23 - --------------------------------------------------------------------------------- Total consumer loans 24,987 2,217 8.87 Loans held for sale 2,605 228 8.75 - --------------------------------------------------------------------------------- Total loans 62,401 5,163 8.27 Taxable investment securities 444 15 3.38 Tax-exempt investment securities(a) 535 46 8.60 - --------------------------------------------------------------------------------- Total investment securities 979 61 6.23 Securities available for sale(a,c) 6,403 425 6.68 Short-term investments 1,873 78 4.16 - --------------------------------------------------------------------------------- Total earning assets 71,656 5,727 7.99 Allowance for loan losses (911) Accrued income and other assets 10,201 - --------------------------------------------------------------------------------- $ 80,946 ========= LIABILITIES AND SHAREHOLDERS' EQUITY Money market deposit accounts $ 12,950 390 3.01 Savings deposits 2,716 44 1.62 NOW accounts 791 12 1.52 Certificates of deposit ($100,000 or more)(d) 4,257 223 5.24 Other time deposits 11,969 595 4.97 Deposits in foreign office 823 41 4.98 - --------------------------------------------------------------------------------- Total interest-bearing deposits 33,506 1,305 3.89 Federal funds purchased and securities sold under repurchase agreements 4,856 220 4.53 Bank notes and other short-term borrowings(d) 7,912 426 5.38 Long-term debt, including capital securities(d,e) 16,473 957 6.09 - --------------------------------------------------------------------------------- Total interest-bearing liabilities 62,747 2,908 4.63 Noninterest-bearing deposits 8,474 Accrued expense and other liabilities 3,464 Preferred stock -- Common shareholders' equity 6,261 - --------------------------------------------------------------------------------- $ 80,946 ========= Interest rate spread (TE) 3.36 - --------------------------------------------------------------------------------- Net interest income (TE) and net interest margin (TE) $ 2,819 3.93% ======== ==== Capital securities $ 1,162 $ 85 Taxable-equivalent adjustment(a) 32 - ---------------------------------------------------------------------------------
(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 basis adjustments related to fair value hedges. See Note 20 ("Derivatives and Hedging Activities"), which begins on page 80, for an explanation of fair value hedges. (e) Rate calculation excludes ESOP debt. TE = Taxable Equivalent N/M = Not Meaningful 30
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES COMPOUND ANNUAL RATE OF CHANGE 1998 1997 1996 (1996-2001) - ---------------------------- ---------------------------------- ---------------------------------- ------------------------ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST - ----------------------------------------------------------------------------------------------------------------------------------- $15,413 $1,251 8.12% $12,911 $1,126 8.72% $11,970 $1,070 8.94% 10.2% 4.9% 7,080 627 8.86 7,101 663 9.34 7,039 648 9.21 (.6) (4.6) 2,866 254 8.86 1,945 188 9.67 1,631 166 10.18 28.2 19.9 4,822 359 7.45 3,310 228 6.89 2,372 148 6.24 24.3 27.1 - ----------------------------------------------------------------------------------------------------------------------------------- 30,181 2,491 8.25 25,267 2,205 8.73 23,012 2,032 8.83 11.1 6.4 5,440 422 7.76 6,192 524 8.46 7,224 593 8.21 (13.0) (14.2) 6,353 557 8.77 5,180 469 9.05 4,214 378 8.97 20.2 19.1 1,438 212 14.74 1,710 256 14.97 1,665 243 14.59 N/M N/M 2,139 228 10.66 2,238 246 10.99 2,183 246 11.27 2.1 (1.2) 2,024 171 8.45 1,156 99 8.56 671 56 8.35 31.3 31.1 6,647 603 9.07 7,023 633 9.01 6,819 604 8.86 (4.1) (2.6) - ----------------------------------------------------------------------------------------------------------------------------------- 24,041 2,193 9.12 23,499 2,227 9.48 22,776 2,120 9.31 1.7 .4 3,200 262 8.19 2,649 198 7.47 2,428 198 8.15 (1.8) (3.1) - ----------------------------------------------------------------------------------------------------------------------------------- 57,422 4,946 9.02 51,415 4,630 9.01 48,216 4,350 9.02 6.5 3.2 282 12 4.83 247 12 4.86 246 14 5.69 29.8 14.0 801 67 8.36 1,227 97 7.91 1,425 114 8.00 (27.9) (26.2) - ----------------------------------------------------------------------------------------------------------------------------------- 1,083 79 7.29 1,474 109 7.39 1,671 128 7.66 (6.6) (16.5) 6,610 450 6.84 7,629 527 6.69 7,423 495 6.69 (2.4) (1.8) 1,563 84 5.37 782 40 5.12 535 28 5.23 26.2 18.3 - ----------------------------------------------------------------------------------------------------------------------------------- 66,678 5,559 8.34 61,300 5,306 8.66 57,845 5,001 8.65 5.5 2.6 (888) (875) (872) 4.6 9,491 8,525 7,846 6.1 - ----------------------------------------------------------------------------------------------------------------------------------- $75,281 $68,950 $64,819 5.5 ====== ======= ======= $11,650 382 3.28 $10,897 333 3.06 $10,211 311 3.05 3.8 (4.0) 3,225 59 1.83 4,319 94 2.18 5,604 138 2.46 (19.0) (31.4) 1,215 20 1.65 1,560 32 2.05 2,438 48 1.97 (24.0) (28.5) 3,520 194 5.51 3,376 190 5.63 3,377 199 5.89 9.4 8.6 12,240 654 5.34 13,273 715 5.39 13,723 720 5.25 .7 1.8 913 50 5.48 1,812 98 5.41 996 53 5.32 22.2 15.1 - ----------------------------------------------------------------------------------------------------------------------------------- 32,763 1,359 4.15 35,237 1,462 4.15 36,349 1,469 4.04 .4 .1 6,635 342 5.15 6,942 359 5.17 5,843 295 5.05 (2.3) (7.7) 7,975 459 5.76 4,741 283 5.97 3,279 197 6.01 15.8 8.9 11,175 681 6.30 6,554 413 6.38 4,324 276 6.38 29.8 24.5 - ----------------------------------------------------------------------------------------------------------------------------------- 58,548 2,841 4.85 53,474 2,517 4.71 49,795 2,237 4.49 5.5 4.6 8,509 8,536 8,374 -- 2,681 2,074 1,644 24.6 -- -- 79 N/M 5,543 4,866 4,927 5.9 - ----------------------------------------------------------------------------------------------------------------------------------- $75,281 $68,950 $64,819 5.5 ======= ======= ======= 3.49 3.95 4.16 - ----------------------------------------------------------------------------------------------------------------------------------- $2,718 4.08% $2,789 4.54% $2,764 4.78% .8% ====== ==== ====== ==== ====== ==== $879 $65 $648 $49 $28 $3 N/M 34 44 50 (2.1)% - -----------------------------------------------------------------------------------------------------------------------------------
31
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 6 COMPONENTS OF NET INTEREST INCOME CHANGES 2001 VS 2000 2000 VS 1999 ------------------------- ------------------------- AVERAGE YIELD/ NET AVERAGE YIELD/ NET in millions VOLUME RATE CHANGE VOLUME RATE CHANGE - ---------------------------------------------------------------------------------------------------- INTEREST INCOME Loans $ 59 $(671) $(612) $ 246 $ 306 $ 552 Taxable investment securities 6 (5) 1 10 1 11 Tax-exempt investment securities (10) 1 (9) (13) 1 (12) Securities available for sale 9 (4) 5 2 20 22 Short-term investments -- (18) (18) (7) 12 5 - ---------------------------------------------------------------------------------------------------- Total interest income (taxable equivalent) 64 (697) (633) 238 340 578 INTEREST EXPENSE Money market deposit accounts 4 (164) (160) (23) 47 24 Savings deposits (3) (8) (11) (8) (4) (12) NOW accounts -- (1) (1) (3) 1 (2) Certificates of deposit ($100,000 or more) (14) (25) (39) 73 44 117 Other time deposits 13 (32) (19) 108 102 210 Deposits in foreign office 8 (68) (60) 111 15 126 - ---------------------------------------------------------------------------------------------------- Total interest-bearing deposits 8 (298) (290) 258 205 463 Federal funds purchased and securities sold under repurchase agreements 15 (104) (89) 3 64 67 Bank notes and other short-term borrowings (17) (109) (126) (45) 47 2 Long-term debt, including capital securities 14 (254) (240) (46) 153 107 - ---------------------------------------------------------------------------------------------------- Total interest expense 20 (765) (745) 170 469 639 - ---------------------------------------------------------------------------------------------------- Net interest income (taxable equivalent) $ 44 $ 68 $ 112 $ 68 $(129) $ (61) ===== ===== ===== ===== ===== ======= - ----------------------------------------------------------------------------------------------------
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. Like any forecasting technique, interest rate simulation modeling is based on a large number of assumptions and judgments. 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 Key makes are reasonable. Nevertheless, the simulation modeling process produces only a sophisticated estimate, not a precise calculation of exposure. Key's guidelines for risk management call for preventive measures to be taken if the simulation modeling demonstrates that a gradual 2% increase or decrease in short-term rates over the next twelve months would adversely affect net interest income over the same period by more than 2%. Key is operating within these guidelines. The low level of short-term interest rates at December 31, 2001, necessitated a modification of Key's standard rate scenario of a gradual decrease of 2% over twelve months to a gradual decrease of 1% over six months. As of December 31, 2001, based on the results of our simulation model, and assuming that management does not take action to alter the outcome, Key would expect net interest income to decrease by approximately .86% if short-term interest rates gradually increase by 2%. Conversely, if short-term interest rates gradually decrease by 1% over the next six months, net interest income would be expected to increase by approximately .21%. 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 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 derivative positions based on the current yield curve. However, economic value does not represent the true fair values of asset, liability and derivative positions, since it does not consider factors like credit risk and liquidity. Key's guidelines for risk management call for preventive measures to be taken if an immediate 2% increase or decrease in interest rates is estimated to reduce the economic value of equity by more than 15%. Key is operating 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 hypothetical changes in the overall level of interest rates. The many interest rate scenarios modeled, and their potential impact on earnings and economic value, quantify the level of Key's 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 high as the 32 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES return that would have been generated had payments been received for the duration 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 follows to manage interest rate risk is to use floating-rate liabilities (such as borrowings) to fund 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 fund an interest-earning asset. For example, Key may sell certificates of deposit and use the proceeds to make loans. That strategy presents "GAP RISK" if the related liabilities and assets do not mature or reprice at the same time. MANAGEMENT OF INTEREST RATE EXPOSURE. Key manages interest rate risk by using portfolio swaps and caps, which modify the repricing or maturity characteristics of some of our assets and liabilities. The decision to 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, and interest rate implications. A brief description of interest rate swaps and caps is as follows: - - INTEREST RATE SWAPS are contracts in 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"). Caps limit exposure to interest rate increases, but have no effect if interest rates decline. Key has used interest rate caps to manage the risk of adverse movements in interest rates on some of its debt. For more information about how Key uses interest rate swaps and caps to manage its balance sheet, see Note 20 ("Derivatives and Hedging Activities"), starting on page 80. 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 "accrued income and other assets" and "accrued expense and other liabilities," respectively, on the balance sheet. For more information about these contracts, see Note 20 ("Derivatives and Hedging Activities"), which begins on page 80. 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% probability. At December 31, 2001, Key's aggregate daily VAR was $1.4 million, compared with $1.1 million at December 31, 2000. Aggregate daily VAR averaged $1.3 million for 2001, compared with an average of $1.0 million during 2000. 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 was $1.7 billion for 2001, compared with $2.2 billion for 2000 and $2.3 billion for 1999. In both 2000 and 1999, noninterest income was affected by various nonrecurring items. The most significant of these items, including gains from divestitures and net losses resulting from the reconfiguration of Key's securities portfolio, are shown in Figure 7. For more information on the divestitures, see Note 3 ("Acquisitions and Divestitures"), which begins on page 63. Core noninterest income, which excludes significant nonrecurring items, was $1.7 billion (38% of total core revenue) in 2001, compared with $1.9 billion (41% of total core revenue) in 2000 and $2.0 billion (41% of total core revenue) in 1999. Key's core noninterest income for 2001 was reduced by several significant core charges. In the second quarter, Key recorded a $40 million charge (included in miscellaneous income) for losses incurred on the residual values of leased vehicles. This was followed by a $60 million fourth quarter charge (included in investment banking and capital markets income) for principal investing write-downs ($45 million) and to increase our reserve for customer derivative losses ($15 million). The 2001 decrease in core noninterest income was also attributable to the decline in Key's capital markets-sensitive revenues, particularly those generated by the asset management, principal investing and brokerage businesses, which were affected adversely by the recessionary economy. Income from investment banking and capital markets activities decreased by $123 million (excluding the $60 million charge discussed above), while income from trust and investment services declined by $58 million. These reductions were substantially offset by growth in service charges on deposit accounts (up $46 million), letter of credit and non-yield-related loan fees (up $17 million) and net securities gains (up $13 million). Excluding revenue from divested businesses and gains from home equity loan securitizations, core noninterest income in 2000 was up $92 million, or 5%, from the prior year and reflected nearly across-the-board growth in traditional sources of fee income. In 2000, the absence of revenue from the divested Long Island branches and the credit card business accounted for a $69 million decrease in core noninterest income, while the absence of gains from the securitization and sale of home equity loans (a substantial source of income in 1999) accounted for a $64 million decrease. Figure 7 shows the major components of Key's noninterest income. The discussion that follows provides additional information, such as the composition of certain components and the factors that caused them to change in 2001 and 2000. 33
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 7 NONINTEREST INCOME YEAR ENDED DECEMBER 31, CHANGE 2001 VS 2000 --------------------- dollars in millions 2001 2000 1999 AMOUNT PERCENT - -------------------------------------------------------------------------------------------------------------- Trust and investment services income $ 550 $ 608 $ 599 $ (58) (9.5)% Investment banking and capital markets income 189 372 354 (183) (49.2) Service charges on deposit accounts 387 341 330 46 13.5 Corporate-owned life insurance income 114 109 107 5 4.6 Letter of credit and loan fees 124 107 98 17 15.9 Net securities gains 35 22 -- 13 59.1 Other income: Electronic banking fees 74 68 58 6 8.8 Insurance income 56 62 52 (6) (9.7) Loan securitization servicing fees 16 24 28 (8) (33.3) Net gains from loan securitizations and sales 49 38 115 11 28.9 Credit card fees 7 11 63 (4) (36.4) Miscellaneous income 124 157 157 (33) (21.0) - -------------------------------------------------------------------------------------------------------------- Total other income 326 360 473 (34) (9.4) - -------------------------------------------------------------------------------------------------------------- Total core noninterest income 1,725 1,919 1,961 (194) (10.1) Gain from sale of credit card portfolio -- 332 -- (332) (100.0) Net losses from reconfiguration of securities portfolio -- (50) -- 50 (100.0) Gains from branch divestitures -- -- 194 -- -- Gain from sale of Electronic Payment Services, Inc. -- -- 134 -- -- Gain from sale of Concord EFS, Inc. common shares -- -- 15 -- -- Gains from sale of Key Merchant Services, LLC -- -- 14 -- -- Gain from sale of Compaq Capital Europe LLC and Compaq Capital Asia Pacific LLC -- -- 13 -- -- Other securities gains -- -- 14 -- -- Other nonrecurring items -- (7) (30) 7 (100.0) - -------------------------------------------------------------------------------------------------------------- Total significant nonrecurring items -- 275 354 (275) (100.0) - -------------------------------------------------------------------------------------------------------------- Total noninterest income $ 1,725 $ 2,194 $ 2,315 $ (469) (21.4)% ======= ======= ======= ======= - --------------------------------------------------------------------------------------------------------------
TRUST AND INVESTMENT SERVICES INCOME. Trust and investment services provide Key's largest source of noninterest income. As shown in Figure 8, the 2001 decrease in revenue derived from these services was due largely to the effects of a weakened economy, leading to declines in brokerage commission income and fee income that is based on the value of assets.
FIGURE 8 TRUST AND INVESTMENT SERVICES INCOME YEAR ENDED DECEMBER 31, CHANGE 2001 VS 2000 ------------------- dollars in millions 2001 2000 1999 AMOUNT PERCENT - ---------------------------------------------------------------------------------------- Personal asset management and custody fees $179 $189 $188 $(10) (5.3)% Institutional asset management and custody fees 86 93 93 (7) (7.5) Bond services 41 42 26 (1) (2.4) Brokerage commission income 101 145 156 (44) (30.3) All other fees 143 139 136 4 2.9 - ---------------------------------------------------------------------------------------- Total trust and investment services income $550 $608 $599 $(58) (9.5)% ==== ==== ==== ==== - ----------------------------------------------------------------------------------------
At December 31, 2001, Key's bank, trust and registered investment advisory subsidiaries had assets under management of $73 billion, compared with $74 billion at the end of 2000. These assets are managed on behalf of both institutions and individuals through a variety of equity, fixed income and money market accounts. The composition of Key's assets under management is shown in Figure 9. The value of total assets under management declined by a net 2% in 2001. This modest decline reflects the positive effect of net new asset inflows of approximately $2.7 billion, representing a 145% increase from net new asset inflows in 2000, and an approximate 5% decline in the market value of assets under management at December 31, 2000. This market performance compares favorably with that of the equity markets in general. The Standard & Poors 500 Banks Index decreased by 12%, while the NASDAQ index was down 21% for the year. Key's relatively favorable market results are due primarily to two factors: approximately one-half of 34 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES the assets Key manages are invested in more stable fixed income or money market funds and the performance of the majority of our equity and fixed income products exceeded the performance of their respective benchmarks. FIGURE 9 ASSETS UNDER MANAGEMENT DECEMBER 31, in millions 2001 2000 1999 - -------------------------------------------------------------- Assets under management by investment type: Equity $35,798 $37,748 $39,257 Fixed income 16,919 14,579 14,360 Money market 20,000 21,688 19,675 - -------------------------------------------------------------- Total $72,717 $74,015 $73,292 ======= ======= ======= Proprietary mutual funds included in assets under management: Equity $ 3,973 $ 4,405 $ 4,601 Fixed income 1,190 1,042 1,124 Money market 13,801 15,307 13,735 - -------------------------------------------------------------- Total $18,964 $20,754 $19,460 ======= ======= ======= - -------------------------------------------------------------- INVESTMENT BANKING AND CAPITAL MARKETS INCOME. The 2001 decrease in this revenue component reflects the $60 million charge taken for principal investing write-downs and to increase our reserve for customer derivative losses, as well as the overall effects of a recessionary economy. As shown in Figure 10, results for 2001 include net losses from principal investing, compared with net gains in 2000. The $150 million decrease in principal investing results is attributable to unrealized mark-to-market adjustments of $114 million recorded in 2001, including the $45 million charge taken in the fourth quarter. Principal investing income is by nature susceptible to volatility since it is derived from investments in small to medium-sized businesses, some of which are in their early stages of economic development and strategy implementation, and thus more susceptible to changes in general economic conditions. Principal investing assets are carried on the balance sheet at fair value. The cost basis, unrealized losses and fair value of direct and indirect investments contained in Key's principal investing portfolio at December 31, 2001, are summarized in Figure 11. Investments in technology-rich companies, which have been particularly hard hit by the effects of the weak economy, accounted for only $38 million, or 6%, of the fair value of Key's portfolio at year end.
FIGURE 10 INVESTMENT BANKING AND CAPITAL MARKETS INCOME YEAR ENDED DECEMBER 31, CHANGE 2001 VS 2000 ------------------- dollars in millions 2001 2000 1999 AMOUNT PERCENT - ---------------------------------------------------------------------------------------------------- Dealer trading and derivatives income $ 126 $ 159 $ 140 $ (33) (20.8)% Investment banking income 102 107 140 (5) (4.7) Net gains (losses) from principal investing (79) 71 44 (150) N/M Foreign exchange income 40 35 30 5 14.3 - ---------------------------------------------------------------------------------------------------- Total investment banking and capital markets income $ 189 $ 372 $ 354 $(183) (49.2)% ===== ===== ===== ===== - ----------------------------------------------------------------------------------------------------
N/M = Not Meaningful FIGURE 11 PRINCIPAL INVESTING PORTFOLIO DECEMBER 31, 2001 COST UNREALIZED FAIR in millions BASIS LOSSES VALUE - ---------------------------------------------------------------- Direct investments $451 $59 $392 Indirect investments 248 20 228 - ---------------------------------------------------------------- Total $699 $79 $620 ==== === ==== - ---------------------------------------------------------------- SERVICE CHARGES ON DEPOSIT ACCOUNTS. Service charges on deposit accounts reached a record high in 2001 and account for the largest increase in fee income. The growth of these fees over the past two years is attributable primarily to strategies implemented in connection with Key's competitiveness initiative. CORPORATE-OWNED LIFE INSURANCE INCOME. Income from corporate-owned life insurance, representing a tax-deferred increase in cash surrender values and tax-exempt death benefits, increased by 5% in 2001, following a 2% increase in the prior year. SECURITIES TRANSACTIONS. During 2001, Key realized $35 million of net securities gains from the sales of securities held in the available-for-sale portfolio, compared with core net gains of $22 million a year ago. Since the sales involved primarily equity securities issued by financial service companies, the sales will not have a significant adverse affect on Key's future net interest income. OTHER INCOME. The decrease in other income in 2001 was due largely to the $40 million charge for losses incurred on the residual values of leased vehicles. This charge was offset in part by an increase in net gains from loan securitizations and sales, and higher fees from electronic banking services. Also, traditional fee income was supplemented in the fourth quarter of 2001 by $10 million of additional revenue, representing the value of shares received as a result of a demutualization of an insurance company in which Key is a policyholder. Key contributed these shares to its charitable foundation, which also increased miscellaneous expense by $10 million. 35 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES In 2000, the decrease in other income was attributable to lower net gains from loan securitizations and sales, and a substantial reduction in credit card fees, partially offset by higher income from electronic banking services and insurance activities. The decrease in net gains from loan securitizations and sales was attributable primarily to the fact that in 2000 we ceased securitizing Champion Mortgage's home equity loans. For information about the type and volume of securitized loans that are either administered or serviced by Key, but not recorded on the balance sheet, see the section entitled "Loans," which begins on page 38. The decline in credit card fees reflects the sale of Key's credit card business in January 2000. For more information about this transaction, see Note 3 ("Acquisitions and Divestitures"), which begins on page 63. SIGNIFICANT NONRECURRING ITEMS. Noninterest income for 2000 includes a $332 million gain from the sale of Key's credit card business and $50 million of net losses that resulted from the reconfiguration of Key's securities portfolio. Results for 1999 include gains of $194 million from the sale of Key's Long Island franchise, which included 28 branches. These branches are located in a geographic area where Key held a very small share of the market for deposits and loans, and where management viewed Key's growth potential to be very limited. Also included in 1999 results are a $134 million gain from the sale of Key's interest in Electronic Payment Services, Inc.; a $14 million gain recorded in connection with the 1998 sale of a 51% interest in Key Merchant Services, LLC; a $15 million gain from the sale of Concord EFS, Inc. shares obtained in the sale of Electronic Payment Services, Inc.; and a $13 million gain from the sale of Key's interest in a joint venture with Compaq Capital Corporation. NONINTEREST EXPENSE Noninterest expense for 2001 was $2.9 billion, relatively unchanged from 2000 and slightly down from $3.1 billion for 1999. Significant nonrecurring items that hinder a direct comparison of results over the past three years are shown in Figure 12. In the current year, these items include a $150 million write-down of goodwill associated with Key's decision to downsize the automobile finance business and a second quarter increase of $20 million in litigation reserves. In 2000 and 1999, significant nonrecurring items include restructuring and other special charges recorded in connection with strategic actions implemented to improve operating efficiency and profitability. More information about these charges can be found under the heading "Restructuring and other special charges." Noninterest expense in 1999 also includes other nonrecurring charges of $68 million. These charges include $23 million of charitable contributions made in light of the gains realized from the sales of Key's interests in Electronic Payment Services, Inc. and Concord EFS, Inc. For more information on these divestitures, see Note 3 ("Acquisitions and Divestitures"), which begins on page 63. Core noninterest expense, which excludes significant nonrecurring items, decreased by $25 million, or 1%, from 2000. The decrease was due primarily to a $67 million improvement in personnel expense and a $21 million decline in equipment expense. These reductions were partially offset by increases in a number of other expense components. Included in miscellaneous expense for 2001 is the $10 million contribution to our charitable foundation discussed previously under the heading "Other income," on page 35. In 2000, core noninterest expense decreased by $56 million, or 2%. The decrease came largely from personnel expense (down $29 million), equipment expense (down $25 million) and net occupancy expense (down $8 million). These improvements were partially offset by higher costs associated with professional fees (up $7 million) and computer processing expense (up $4 million). In addition, miscellaneous expense for 2000 includes a $7 million charge 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 certain components and the factors that caused them to change in 2001 and 2000. PERSONNEL. Personnel expense, the largest category of Key's noninterest expense, decreased in both 2001 and 2000, largely because of our successful competitiveness initiative. Through this initiative we have improved efficiency and reduced the level of personnel required to conduct our business. At December 31, 2001, the number of full-time equivalent employees was 21,230, compared with 22,142 at the end of 2000 and 24,568 at the end of 1999. Moreover, in 2001, weaker economic conditions reduced revenues on which certain incentive compensation programs, including those related to investment banking and capital markets activities, are based. In 2000, the decline in personnel expense was also attributable to the effect of divestitures and the fact that 1999 costs for technical staff were unusually high due to Year 2000 compliance issues. Figure 13 shows the major components of Key's core personnel expense. COMPUTER PROCESSING. The increases in computer processing expense in 2001 and 2000 were due primarily to a higher level of computer software amortization, but also include increases related to software rental and maintenance. In each year, the increase in these costs was substantially offset by the reduced need for outside services. EQUIPMENT. The decrease in equipment expense in 2001 and 2000 was driven by reductions in depreciation and rental expense stemming from cost management efforts and our competitiveness initiative. The improvement in 2000 was also attributable to lower maintenance costs. Rental expense for 1999 includes a $5 million charge for the early termination of a lease. PROFESSIONAL FEES. Professional fees comprise expenses incurred for legal, audit, consulting and certain other business services. The level of professional fees rose by 14% in 2001 and 10% in 2000. In 2001, the increase was due primarily to higher legal expenses associated with litigation. The increase in fees for 2000 reflects additional costs incurred in connection with Key's competitiveness initiative. RESTRUCTURING AND OTHER SPECIAL CHARGES. Key recorded net nonrecurring charges of $127 million (including net restructuring charges of $104 million) in 2000 and $152 million (including net restructuring charges of $98 million) in 1999 in connection with strategic actions related to the competitiveness initiative. For more information related to the actions taken, anticipated cost savings and reductions to Key's workforce, see the section entitled "Status of competitiveness initiative," on page 24. Additional information related to the restructuring charges can be found in Note 14 ("Restructuring Charges"), which begins on page 73. Cash generated by Key's operations is expected to fund the restructuring charge liability; none of the charges had a material impact on Key's liquidity. 36 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 12 NONINTEREST EXPENSE
YEAR ENDED DECEMBER 31, CHANGE 2001 VS 2000 ---------------------------- dollars in millions 2001 2000 1999 AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------------------------------------ Personnel $1,378 $1,445 $1,474 $ (67) (4.6)% Net occupancy 232 223 231 9 4.0 Computer processing 252 240 236 12 5.0 Equipment 152 173 198 (21) (12.1) Marketing 112 110 106 2 1.8 Amortization of intangibles 95 101 104 (6) (5.9) Professional fees 88 77 70 11 14.3 Other expense: Postage and delivery 63 65 73 (2) (3.1) Telecommunications 44 51 56 (7) (13.7) Equity- and gross receipts-based taxes 29 33 35 (4) (12.1) OREO expense, net 6 7 13 (1) (14.3) Miscellaneous expense 318 269 254 49 18.2 - ------------------------------------------------------------------------------------------------------------------------------------ Total other expense 460 425 431 35 8.2 - ------------------------------------------------------------------------------------------------------------------------------------ Total core noninterest expense 2,769 2,794 2,850 (25) (.9) Goodwill write-down (automobile finance business) 150 -- -- 150 N/M Additional litigation reserves 20 -- -- 20 N/M Restructuring and other special charges 2 125 152 (123) (98.4) Other nonrecurring items -- (2) 68 2 (100.0) - ------------------------------------------------------------------------------------------------------------------------------------ Total significant nonrecurring items 172 123 220 49 39.8 - ------------------------------------------------------------------------------------------------------------------------------------ Total noninterest expense $2,941 $2,917 $3,070 $ 24 .8% ====== ====== ====== ===== Full-time equivalent employees at year end 21,230 22,142 24,568 (912) (4.1) - ------------------------------------------------------------------------------------------------------------------------------------ N/M = Not Meaningful FIGURE 13 CORE PERSONNEL EXPENSE YEAR ENDED DECEMBER 31, CHANGE 2001 VS 2000 ---------------------------- dollars in millions 2001 2000 1999 AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------------------------------------ Salaries $ 842 $ 875 $ 907 $(33) (3.8)% Employee benefits 188 192 187 (4) (2.1) Incentive compensation 348 378 380 (30) (7.9) - ------------------------------------------------------------------------------------------------------------------------------------ Total core personnel expense $1,378 $1,445 $1,474 $(67) (4.6)% ====== ====== ====== ==== - ------------------------------------------------------------------------------------------------------------------------------------
During the first quarter of 2000, Key also recorded a $2 million credit to restructuring charges in connection with 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 enabled Key to consolidate these branches at a lower cost than originally expected. Key continues to benefit from the expense management disciplines instituted as part of the competitiveness initiative implemented in November 1999. As illustrated in Figure 14, Key's core noninterest expense, adjusted for the divestiture of the Long Island branches (October 1999) and the sale of the credit card business (January 2000), has been stable over the past three years. One of management's goals is to keep noninterest expense relatively flat from 2001 to 2002, unless the growth can be attributed to incentive compensation related to even greater increases in revenue. This figure also shows that Key's noninterest expense for 2000 and 2001 was significantly lower than it would have been had it simply grown at the rate of inflation as measured by the annual change in the consumer price index. If we are successful in hitting our targeted expense level in 2002, management estimates that the difference between Key's actual expense and that adjusted for inflation (based on an assumed 2% increase in the consumer price index for 2002) will grow to approximately $240 million. The dollar amounts shown for all years in Figure 14 are presented on a consistent basis, including the accounting for goodwill amortization. Information on the change in accounting for goodwill and other intangible assets that became effective as of January 1, 2002, can be found in Note 1 ("Summary of Significant Accounting Policies") under the heading "Accounting Pronouncements Pending Adoption," on page 62. 37 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 14 COMPETITIVENESS INITIATIVE - COST SAVINGS
[LINE/BAR GRAPH] Noninterest Expense Noninterest Adjusted for In millions Expense(a) Inflation - -------------------------------------------------- 1999 $2,776 $2,776(b) 2000 2,789 2,869(c) 2001 2,769 2,949(d) 2002T 2,770 3,010(e) - --------------------------------------------------
(a) Noninterest expense less significant nonrecurring items, adjusted for divested operations (b) CPI base (c) CPI + 3.4% (Bureau of Labor Statistics Jan-Dec 2000) (d) CPI + 2.8% (Bureau of Labor Statistics Jan-Nov 2001) (e) CPI + 2.0% (Estimate of 2% for 2002) T = Targeted noninterest expense, assuming a 2% increase in the consumer price index for 2002 INCOME TAXES The provision for income taxes was $102 million for 2001, compared with $515 million for 2000 and $577 million for 1999. The effective tax rate (which is the provision for income taxes as a percentage of income before income taxes) was 39.4% for 2001, compared with 33.9% for 2000 and 34.3% for 1999. In 2001, the effective tax rate was significantly affected by the $150 million nondeductible write-down of goodwill recorded in connection with Key's decision to downsize the automobile finance business. Excluding this charge, the effective tax rate for 2001 was approximately 25%. This adjusted effective tax rate declined from 2000 because tax-exempt interest income, nontaxable income from corporate-owned life insurance and tax credits accounted for a significantly higher proportion of Key's lower pre-tax income in 2001. A nonrecurring tax benefit resulting from the charitable contribution of appreciated stock also contributed to the lower effective tax rate. In 2001, pre-tax income was substantially lower than previous years due to the effects of a weak economy and significant charges recorded in the second and fourth quarters. In 2000, the effective tax rate decreased primarily because Key had larger tax credits and more tax-exempt income from corporate-owned life insurance. The effect of these items was offset, in part, by higher state income taxes and a higher level of amortization related to nondeductible intangible assets. In addition, in 1999 Key recorded a nonrecurring tax benefit associated with a charitable contribution of appreciated stock. We have invested in tax-advantaged assets (such as tax-exempt securities and corporate-owned life insurance) and we continue to recognize credits associated with investments in low-income housing projects in order to reduce Key's effective income tax rate. FINANCIAL CONDITION LOANS At December 31, 2001, total loans outstanding were $63.3 billion, compared with $66.9 billion at the end of 2000 and $64.2 billion at the end of 1999. Among the factors that contributed to the 5% decrease in our loans over the past year are: - - weaker loan demand stemming from the sluggish economy; - - our decision to exit the automobile leasing business, de-emphasize indirect prime automobile lending and discontinue certain nonrelationship, credit-only commercial lending; and - - loan sales completed to improve the profitability of Key's overall portfolio, or to accommodate our funding needs. Over the past several years, we have used alternative funding sources like loan sales and securitizations to allow us to continue to capitalize on our lending opportunities. Management expects Newport Mortgage Company, L.P. and National Realty Funding L.C., both of which were acquired in 2000, to improve Key's ability to generate and securitize new loans, especially in the area of commercial real estate. In addition, over the past two years, we have sold loans and referred new business to an asset-backed commercial paper conduit. This arrangement allows us to generate referral revenue without having to add certain low interest rate spread assets to the balance sheet. For more information about the conduit, see Note 19 ("Other Financial Instruments with Off-Balance Sheet Risk"), on page 79. Figure 15 shows the composition of Key's loan portfolio at December 31 for each of the past five years. The level of Key's loans outstanding (excluding loans held for sale) would have been unchanged from a year ago if we had not securitized and/or sold $3.7 billion of loans during 2001. Assuming no loan sales, commercial loans grew by $488 million, or 1%, during the year. Growth in our commercial real estate and lease financing portfolios was substantially offset by declines in other commercial portfolios, reflecting continued weakness in the economy and our decision to eliminate nonrelationship lending in the leveraged financing and nationally syndicated lending businesses. At December 31, 2001, Key's commercial real estate portfolio included mortgage loans of $6.7 billion and construction loans of $5.9 billion. The average size of a mortgage loan was $.5 million and the largest mortgage loan had a balance of $32 million. The average size of a construction loan was $8 million for commercial projects and $1 million for residential projects. The largest construction loan was $84 million. Key conducts its commercial real estate lending business through two primary sources: a 12-state banking franchise, which includes 911 retail banking branches, and a national line of business that cultivates relationships both within and beyond the branch system. At December 31, our national line of business accounted for approximately 50% of Key's total commercial real estate loans outstanding. Our commercial real estate business as a whole focuses on larger real estate developers and, as shown in Figure 16, is diversified by both industry type and geography. 38 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 15 COMPOSITION OF LOANS
DECEMBER 31, 2001 2000 1999 ----------------------- ------------------------ ----------------------- dollars in millions AMOUNT % OF TOTAL AMOUNT % OF TOTAL AMOUNT % OF TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ COMMERCIAL Commercial, financial and agricultural $18,159 28.7% $20,100 30.0% $18,497 28.8% Commercial real estate(a): Commercial mortgage 6,669 10.5 6,876 10.3 6,836 10.6 Construction 5,878 9.3 5,154 7.7 4,528 7.1 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial real estate loans 12,547 19.8 12,030 18.0 11,364 17.7 Commercial lease financing 7,357 11.6 7,164 10.7 6,665 10.4 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 38,063 60.1 39,294 58.7 36,526 56.9 CONSUMER Real estate -- residential mortgage 2,315 3.6 4,212 6.3 3,962 6.1 Home equity 11,184 17.7 9,908 14.8 7,973 12.4 Credit card -- -- -- -- -- -- Consumer -- direct 2,342 3.7 2,539 3.8 2,565 4.0 Consumer -- indirect: Lease financing 2,036 3.2 3,005 4.5 3,195 5.0 Automobile 2,497 4.0 2,809 4.2 3,082 4.8 Marine 1,780 2.8 1,657 2.5 1,716 2.7 Other 1,036 1.6 1,252 1.9 1,600 2.5 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer -- indirect loans 7,349 11.6 8,723 13.1 9,593 15.0 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 23,190 36.6 25,382 38.0 24,093 37.5 LOANS HELD FOR SALE 2,056 3.3 2,229 3.3 3,603 5.6 - ------------------------------------------------------------------------------------------------------------------------------------ Total $63,309 100.0% $66,905 100.0% $64,222 100.0% ======= ===== ======= ===== ======= ===== - ------------------------------------------------------------------------------------------------------------------------------------ 1998 1997 -------------------- -------------------- AMOUNT % OF TOTAL AMOUNT % OF TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ COMMERCIAL Commercial, financial and agricultural $17,038 27.5% $14,023 26.3% Commercial real estate(a): Commercial mortgage 7,309 11.8 6,952 13.0 Construction 3,450 5.6 2,231 4.2 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial real estate loans 10,759 17.4 9,183 17.2 Commercial lease financing 5,613 9.0 4,439 8.3 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 33,410 53.9 27,645 51.8 CONSUMER Real estate -- residential mortgage 4,394 7.1 5,962 11.2 Home equity 7,990 12.9 5,663 10.6 Credit card 1,425 2.3 1,521 2.8 Consumer -- direct 2,342 3.8 2,188 4.1 Consumer -- indirect: Lease financing 2,580 4.2 1,576 2.9 Automobile See note(b) See note(b) See note(b) See note(b) Marine See note(b) See note(b) See note(b) See note(b) Other 7,009 11.2 5,964 11.2 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer -- indirect loans 9,589 15.4 7,540 14.1 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 25,740 41.5 22,874 42.8 LOANS HELD FOR SALE 2,862 4.6 2,861 5.4 - ------------------------------------------------------------------------------------------------------------------------------------ Total $62,012 100.0% $53,380 100.0% ======= ===== ======= ===== - ------------------------------------------------------------------------------------------------------------------------------------
(a) See Figure 16 for a more detailed breakdown of Key's commercial real estate loan portfolio at December 31, 2001. (b) For 1998 and 1997, indirect automobile and marine loans are included in other indirect loans. 39 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 16 COMMERCIAL REAL ESTATE LOANS
DECEMBER 31, 2001 GEOGRAPHIC REGION ---------------------------------------------------- TOTAL PERCENT OF dollars in millions EAST MIDWEST CENTRAL WEST AMOUNT TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Nonowner-occupied: Multi-family properties $ 359 $ 582 $ 637 $ 599 $ 2,177 17.4% Retail properties 248 915 133 285 1,581 12.6 Office buildings 129 323 149 270 871 6.9 Residential properties 59 100 97 338 594 4.7 Warehouses 37 104 18 27 186 1.5 Manufacturing facilities 28 32 2 10 72 .6 Hotels/Motels 24 4 2 14 44 .3 Other 388 684 224 383 1,679 13.4 - ------------------------------------------------------------------------------------------------------------------------------------ 1,272 2,744 1,262 1,926 7,204 57.4 Owner-occupied 668 2,477 605 1,593 5,343 42.6 - ------------------------------------------------------------------------------------------------------------------------------------ Total $1,940 $5,221 $1,867 $3,519 $12,547 100.0% ====== ====== ====== ====== ======= ===== - ------------------------------------------------------------------------------------------------------------------------------------
As illustrated in Figure 17, our commercial lease financing portfolio has grown in each of the past five years. In the third quarter of 1997, Key increased the size and scope of its leasing business by acquiring Leasetec Corporation, which specializes in the leasing of information technology and telecommunications equipment to large corporate clients. The Leasetec acquisition has been a major reason for the 22% compound annual growth rate in lease financing receivables since 1996. During the same period, Key has consistently achieved net residual gains in connection with the commercial lease financing business. Residual value pricing and management are important elements of lease financing profitability. FIGURE 17 COMMERCIAL LEASE FINANCING
DECEMBER 31, in millions 2001 2000 1999 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Lease financing receivables $7,357 $7,164 $6,665 $5,613 $4,439 $2,671 Net residual gains for the year 19 22 20 25 5 7 Net charge-offs for the year 57 12 17 11 8 6 Nonperforming leases 94 48 28 29 5 8 - ------------------------------------------------------------------------------------------------------------------------------------
Consumer loans decreased (assuming no loan sales) by $257 million, or 1%. The growth of the home equity portfolio in 2001 was offset by declines of $602 million in installment loans, $969 million in automobile lease financing receivables and $449 million in residential real estate mortgage loans. The declines in installment loans and lease financing receivables reflect our decision to de-emphasize indirect prime automobile lending and exit the automobile leasing business. Our home equity portfolio grew by $1.8 billion, largely as a result of lower interest rates and our decision to stop securitizing and selling these loans starting in 2000. By retaining these assets, we intend to replace over time the revenue generated by our former credit card business, which was sold in January 2000. Key's home equity portfolio is derived from both our Retail Banking line of business (58% of the home equity portfolio at December 31, 2001), and our National Home Equity line of business. The National Home Equity line of business has two components: Champion Mortgage Company, a home equity finance company that Key acquired in August 1997; and Key Home Equity Services, which acts as a third-party purchaser of home equity loans. The average loan-to-value ratio at origination for a loan generated by the National Home Equity line of business is 77%. First lien positions comprised 83% of the portfolio for this line of business at December 31, 2001. Key Home Equity Services purchases loans in two primary ways: on a loan-by-loan basis from an extensive network of correspondents and agents, and in bulk portfolio acquisitions from home equity loan companies. Key intends to discontinue the latter approach in 2002. Figure 18 summarizes Key's home equity loan portfolio at December 31 for each of the last six years, as well as certain asset quality statistics and the yields achieved on the portfolio as a whole. The portfolio grew by 13% in 2001, and had a 5-year compound annual growth rate of 18%. SALES, SECURITIZATIONS AND DIVESTITURES. During 2001, Key sold $1.7 billion of commercial real estate loans, $1.4 billion of residential mortgage loans, $1.2 billion of education loans ($491 million through securitizations) and $531 million of other types of loans. Among the factors that Key considers in determining which loans to securitize are: - - whether 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. 40 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 18 HOME EQUITY LOANS
DECEMBER 31, dollars in millions 2001 2000 1999 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------------ Retail banking branches and other $ 6,431 $6,136 $5,740 $6,036 $5,210 $4,793 Champion Mortgage Company 1,886 1,082 371 689 242 -- Key Home Equity Services division 2,867 2,690 1,862 1,265 211 -- - ------------------------------------------------------------------------------------------------------------------------------------ Total $11,184 $9,908 $7,973 $7,990 $5,663 $4,793 ======= ====== ====== ====== ====== ====== - ------------------------------------------------------------------------------------------------------------------------------------ Nonperforming loans $50 $80 $50 $26 $15 $10 Net charge-offs for the year 98 17 9 5 4 2 Yield for the year 8.55% 9.29% 8.54% 8.77% 9.05% 8.97% - ------------------------------------------------------------------------------------------------------------------------------------
Figure 19 summarizes Key's loan sales (including securitizations) for 2001 and 2000. FIGURE 19 LOANS SOLD AND DIVESTED
COMMERCIAL RESIDENTIAL HOME CREDIT CARD IN MILLIONS COMMERCIAL REAL ESTATE REAL ESTATE EQUITY RECEIVABLES EDUCATION TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ 2001 - ------------- Fourth quarter -- $ 678 -- $145 -- $ 23 $ 846 Third quarter -- 93 $1,427 269 -- 597 2,386 Second quarter $44 577 20 59 -- 144 844 First quarter -- 327 1 14 -- 449 791 - ------------------------------------------------------------------------------------------------------------------------------------ Total $44 $1,675 $1,448 $487 -- $1,213 $4,867 ==== ====== ====== ==== ====== ====== ====== 2000 - ------------- Fourth quarter -- $ 560 -- $ 22 -- $ 13 $ 595 Third quarter $ 27 70 -- 72 -- 618 787 Second quarter 451 499 -- 23 -- 518 1,491 First quarter 354 6 -- 24 $1,339 29 1,752 - ------------------------------------------------------------------------------------------------------------------------------------ Total $832 $1,135 -- $141 $1,339 $1,178 $4,625 ==== ====== ====== ==== ====== ====== ====== - ------------------------------------------------------------------------------------------------------------------------------------
Figure 20 shows loans that are either administered or serviced by Key, but not recorded on the balance sheet. This includes loans that have been both securitized and sold, or simply sold outright. In the event of default, Key is subject to recourse with respect to approximately $976 million of the $16.7 billion of loans administered or serviced at December 31, 2001. Key derives income from two sources when we sell or securitize loans but retain the right to administer or service them. We earn noninterest income (recorded as "other income") from servicing or administering the loans, and we earn interest income from the securitized assets retained. The commercial real estate loans shown in Figure 20 are serviced by National Realty Funding L.C., which was acquired by Key in January 2000. Most of these loans were originated by other financial institutions. The $970 million of loans held in the asset-backed commercial paper conduit, for which Key serves as a referral agent, are also included in Figure 20. For more information regarding the conduit, see Note 19 ("Other Financial Instruments with Off-Balance Sheet Risk"), on page 79. FIGURE 20 LOANS ADMINISTERED OR SERVICED DECEMBER 31, in millions 2001 2000 1999 - ------------------------------------------------------------------ Education loans $ 4,433 $ 4,113 $3,475 Automobile loans 131 422 855 Home equity loans 768 1,176 1,542 Commercial real estate loans 10,471 7,108 1,905 Commercial loans 913 973 -- - ------------------------------------------------------------------ Total $16,716 $13,792 $7,777 ======= ======= ====== - ------------------------------------------------------------------ Figure 21 shows the maturities of certain commercial and real estate loans, and the sensitivity of those loans to changes in interest rates. As indicated, at December 31, 2001, approximately 50% of these outstanding loans were scheduled to mature within one year. Loans with maturities greater than one year include $11.3 billion with floating or adjustable rates and $5.2 billion with predetermined rates. 41 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 21 MATURITIES AND SENSITIVITY OF CERTAIN LOANS TO CHANGES IN INTEREST RATES
DECEMBER 31, 2001 WITHIN 1-5 OVER in millions 1 YEAR YEARS 5 YEARS TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Commercial, financial and agricultural $10,625 $4,706 $2,828 $18,159 Real estate -- construction 3,734 1,993 151 5,878 Real estate -- residential and commercial mortgage 2,173 2,544 4,267 8,984 - ------------------------------------------------------------------------------------------------------------------------------------ $16,532 $9,243 $7,246 $33,021 ======= ====== ====== ======= Loans with floating or adjustable interest rates(a) $6,737 $4,557 Loans with predetermined interest rates(b) 2,506 2,689 - ------------------------------------------------------------------------------------------------------------------------------------ $9,243 $7,246 ====== ====== - ------------------------------------------------------------------------------------------------------------------------------------
(a) "Floating" and "adjustable" rates vary in relation to other interest rates (such as the base lending rate) or a variable index that may change during the term of the loan. (b) "Predetermined" interest rates either are fixed or will change during the term of the loan according to a specific formula or schedule. SECURITIES At December 31, 2001, the securities portfolio totaled $6.5 billion and included $5.4 billion of securities available for sale and $1.1 billion of investment securities. In comparison, the total portfolio at December 31, 2000, was $8.5 billion, including $7.3 billion of securities available for sale and $1.2 billion of investment securities. The size and composition of Key's securities portfolio are dependent largely on our needs for liquidity and the extent to which we are required or elect to hold these assets as collateral to secure public and trust deposits. Although debt securities are generally used for this purpose, other assets, such as securities purchased under resale agreements, may be used temporarily when they provide more favorable yields. The majority of Key's securities portfolio consists of collateralized mortgage obligations that provide a source of interest income and serve as collateral in connection with pledging requirements. A collateralized mortgage obligation (sometimes called a "CMO") is a debt security that is secured by a pool of mortgages, mortgage-backed securities, U.S. government securities, corporate debt obligations or other bonds. At December 31, 2001, Key had $4.8 billion invested in collateralized mortgage obligations and other mortgage-backed securities in the available-for-sale portfolio, compared with $5.7 billion at December 31, 2000. Substantially all of these securities were issued or backed by Federal agencies. Figure 22 shows the composition, yields and remaining maturities of Key's securities available for sale. Figure 23 provides the same information about Key's investment securities. For more information about retained interests in securitizations, gross unrealized gains and losses by type of security and securities pledged, see Note 5 ("Securities"), which begins on page 66. FIGURE 22 SECURITIES AVAILABLE FOR SALE
OTHER U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- RETAINED WEIGHTED AGENCIES AND POLITICAL MORTGAGE BACKED INTERESTS IN OTHER AVERAGE dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(a) SECURITIES(a) SECURITIZATIONS(a) SECURITIES TOTAL YIELD(b) - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2001 Remaining maturity: One year or less $ 3 -- $1,610 $ 1 $ 10 $ 6 $1,630 7.13% After one through five years 80 $10 1,833 965 224 7 3,119 7.14 After five through ten years 6 11 191 39 -- 4 251 8.23 After ten years 10 -- 171 27 -- 138(c) 346 8.49 - ------------------------------------------------------------------------------------------------------------------------------------ Fair value $99 $21 $3,805 $1,032 $234 $155 $5,346 -- Amortized cost 99 21 3,791 1,008 214 170 5,303 7.26% Weighted average yield(b) 3.85% 4.74% 6.94% 7.30% 14.77% 5.75% 7.26% -- Weighted average maturity 3.8 years 4.9 years 2.8 years 3.0 years 3.7 years 10.4 years 3.1 years -- - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2000 Fair value $984 $33 $4,298 $1,355 $316 $343 $7,329 -- Amortized cost 984 33 4,296 1,355 334 307 7,309 7.16% - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 1999 Fair value $127 $53 $4,237 $1,678 $343 $227 $6,665 -- Amortized cost 128 53 4,426 1,705 340 223 6,875 6.77% - ------------------------------------------------------------------------------------------------------------------------------------
(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 of $145 million 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 primarily marketable equity securities (including an internally managed portfolio of bank common stock investments) with no stated maturity. 42 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 23 INVESTMENT SECURITIES
STATES AND WEIGHTED POLITICAL OTHER AVERAGE dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(a) - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2001 Remaining maturity: One year or less $ 89 $ 5 $ 94 7.22% After one through five years 96 -- 96 9.74 After five through ten years 39 40 79 7.03 After ten years 1 849(b) 850 4.78 - ------------------------------------------------------------------------------------------------------------------------------------ Amortized cost $225 $894 $1,119 7.24% Fair value 234 894 1,128 -- Weighted average yield(a) 8.71% 4.79% 7.24% -- Weighted average maturity 2.6 years 9.9 years 8.4 years -- - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2000 Amortized cost $323 $875 $1,198 8.16% Fair value 333 875 1,208 -- - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 1999 Amortized cost $447 $539 $986 6.15% Fair value 459 539 998 -- - ------------------------------------------------------------------------------------------------------------------------------------
(a) Weighted average yields are calculated based on amortized cost and exclude equity securities of $759 million 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 (primarily principal investing assets) with no stated maturity. ASSET QUALITY Key has a multi-faceted program to manage asset quality. Our professionals: - - evaluate and monitor credit quality and risk in credit-related assets; - - develop commercial and consumer credit policies and systems; - - monitor compliance with internal underwriting standards; - - establish credit-related concentration limits; and - - review the adequacy of the allowance for loan losses. ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses at December 31, 2001, was $1.7 billion, or 2.65% of loans. This compares with $1.0 billion, or 1.50% of loans, at December 31, 2000. The allowance includes $180 million (for 2001) and $107 million (for 2000) that is specifically allocated for impaired loans. For more information about impaired loans, see Note 8 ("Impaired Loans and Other Nonperforming Assets") on page 69. At December 31, 2001, the allowance for loan losses was 184.29% of nonperforming loans, compared with 154.00% at December 31, 2000. Management estimates the appropriate level of the allowance for loan losses on a quarterly (and at times more frequent) basis. The methodology used is described in Note 1 ("Summary of Significant Accounting Policies") under the heading "Allowance for Loan Losses," on page 59. The allowance was increased in 2001 because of continued weakness in the economy and the related adverse effects on specific loan portfolios. As discussed in the following section entitled "Run-off Loan Portfolio," the higher allowance was also necessary to implement Key's decision to eliminate certain types of commercial lending. At the time loans are made, all of them appear collectible. Nonetheless, experience has shown that at any given time there is some risk of loss inherent in the loan portfolio. Management estimates the level of probable losses and adjusts the amount of the allowance for loan losses accordingly. Estimating the amount and timing of probable loan losses is an imperfect science. Management establishes an allowance for losses arising from nonimpaired loans by using statistical measurement tools and by exercising judgment to assess the impact of factors such as changes in economic conditions, credit policies or underwriting standards, and the level of credit risk associated with specific industries and markets. Management establishes an allowance for impaired loan losses based on loss characteristics specific to those impaired loans. As shown in Figure 24, these efforts, in combination with the use of continually enhanced modeling techniques, enabled management to allocate the entire allowance to various segments of Key's loan portfolio in each of the past two years rather than leave a portion "unallocated" as we did in previous years. The 2001 increase in allocations among the specific portfolios reflects a number of factors, including the effects of a weak economy, continued loan growth (primarily in the commercial and home equity portfolios) and loan aging. The aggregate balance of the allowance for loan losses at December 31, 2001, represents management's best estimate of the losses inherent in the loan portfolio at that date. The amount of allowance allocated to Key's credit card portfolio at December 31, 1999, is included in the held-for-sale category. This allocation was based on the level of net credit card charge-offs that Key expected to record in the first quarter of 2000. Since the sale of the credit card portfolio closed in January 2000, Key was able to estimate the amount of net credit card charge-offs with a high level of precision. 43 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES Figure 24 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
December 31, 2001 2000 1999 ------------------------- ------------------------- ---------------------- Percent of Percent of Percent of Loan Type to Loan Type to Loan Type to dollars in millions Amount Total Loans Amount Total Loans Amount Total Loans - ------------------------------------------------------------------------------------------------------------------------------------ Commercial, financial and agricultural $1,289 28.7% $ 742 30.0% $509 28.8% Real estate-- commercial mortgage 45 10.5 35 10.3 34 10.6 Real estate-- construction 39 9.3 27 7.7 16 7.1 Commercial lease financing 89 11.6 45 10.7 39 10.4 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 1,462 60.1 849 58.7 598 56.9 Real estate-- residential mortgage 4 3.7 2 6.3 1 6.7 Home equity 59 17.7 20 14.8 7 11.8 Credit card -- -- -- -- -- -- Consumer-- direct 24 3.7 15 3.8 8 4.0 Consumer-- indirect lease financing 8 3.2 9 4.5 6 5.0 Consumer-- indirect other 117 8.4 104 8.6 55 10.0 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 212 36.7 150 38.0 77 37.5 Loans held for sale 3 3.2 2 3.3 18 5.6 Unallocated -- -- -- -- 237 -- - ------------------------------------------------------------------------------------------------------------------------------------ Total $1,677 100.0% $1,001 100.0% $930 100.0% ====== ===== ====== ===== ==== ===== - ------------------------------------------------------------------------------------------------------------------------------------ 1998 1997 ------------------------- ------------------------- Percent of Percent of Loan Type to Loan Type to Amount Total Loans Amount Total Loans - ------------------------------------------------------------------------------------------------------------------------------------ Commercial, financial and agricultural $357 27.5% $224 26.3% Real estate-- commercial mortgage 32 11.8 104 13.0 Real estate-- construction 15 5.6 33 4.2 Commercial lease financing 49 9.0 26 8.3 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 453 53.9 387 51.8 Real estate-- residential mortgage 7 8.2 8 11.6 Home equity 5 11.8 4 10.2 Credit card 44 2.3 45 2.8 Consumer-- direct 15 3.8 15 4.1 Consumer-- indirect lease financing 5 4.2 3 2.9 Consumer-- indirect other 77 11.2 63 11.2 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 153 41.5 138 42.8 Loans held for sale 1 4.6 1 5.4 Unallocated 293 -- 374 -- - ------------------------------------------------------------------------------------------------------------------------------------ Total $900 100.0% $900 100.0% ==== ===== ==== ===== - ------------------------------------------------------------------------------------------------------------------------------------
RUN-OFF LOAN PORTFOLIO. In May 2001, management segregated $300 million of Key's allowance for loan losses in connection with the decision to eliminate nonrelationship lending in the leveraged financing and nationally syndicated lending businesses. An additional $190 million was added to this allowance in the fourth quarter. The segregated allowance is being used to exit approximately $2.7 billion in related commitments (which were moved to a separate run-off portfolio) and for losses incurred in connection with loan sales. Approximately $1.7 billion of these commitments (including $1.023 billion of loans outstanding) were remaining as of December 31. The majority of the loans are performing in accordance with their contractual terms. As write-downs on the run-off portfolio occur over time, we do not expect to replenish the related allowance. 44 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES Figure 25 summarizes certain asset quality indicators, segregated between Key's continuing and run-off loan portfolios. Additional information pertaining to the run-off portfolio is presented in Figure 26. FIGURE 25 ASSET QUALITY INDICATORS - CONTINUING AND RUN-OFF LOAN PORTFOLIOS
Year Ended December 31, 2001 December 31, 2001 ----------------------------------------------------------- ---------------------- Allowance for Loan Losses Net Loan Charge-offs Loans ------------------------- Nonperforming -------------------- dollars in millions Outstanding Amount % of Loans Loans Amount % of Loans - ----------------------------------------------------------------------------------------------------------------------------------- Continuing loan portfolio $62,286 $1,402 2.25% $679 $458 .71% Run-off loan portfolio 1,023 275 26.88 231 215 N/M - ------------------------------------------------------------------------------------------------------------------------------------ Total loan portfolio $63,309 $1,677 2.65% $910 $673 1.02% ======= ====== ==== ==== - ------------------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful FIGURE 26 RUN-OFF LOAN PORTFOLIO SUMMARY OF CHANGES IN COMMITMENTS AND LOANS OUTSTANDING
Total Loans in millions Commitments Outstanding - ------------------------------------------------------------------------------------------------------------------------------------ Balance at May 17, 2001 $2,648 $1,611 Charge-offs (215) (215) Loans sold (115) (115) Payments/expirations (624) (258) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2001 $1,694 $1,023 ====== ====== - ------------------------------------------------------------------------------------------------------------------------------------ Summary of Changes in Nonperforming Loans and Nonreplenishing Allowance for Loan Losses(a) Nonperforming Nonreplenishing in millions Loans Allowance - ------------------------------------------------------------------------------------------------------------------------------------ Balance at May 17, 2001 $ 257 $ 300 Provision for loan losses N/A 190 Loans placed on nonaccrual status 278 N/A Charge-offs (214) (215) Loans sold (90) N/A - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 2001 $ 231 $ 275 ====== ====== - ------------------------------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and loans sold. N/A = Not Applicable NET LOAN CHARGE-OFFS. Net loan charge-offs for 2001 were $673 million, or 1.02% of average loans, compared with $414 million, or .63% of average loans, for 2000 and $318 million, or .51% of average loans, for 1999. The composition of Key's loan charge-offs and recoveries by type of loan is shown in Figure 27. Net charge-offs increased in 2001 because of continued weakness in the economy and Key's aggressive efforts to resolve credits within the commercial loan run-off portfolio. As shown in Figure 26, this portfolio accounted for $215 million of total net charge-offs recorded during 2001. In addition, net charge-offs within the home equity portfolio rose by $81 million, reflecting the growth of this portfolio, the accelerated disposition of certain nonperforming loans and the impact of continued economic weakness. 45 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 27 SUMMARY OF LOAN LOSS EXPERIENCE
Year ended December 31, dollars in millions 2001 2000 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------------ Average loans outstanding during the year $65,976 $65,294 $62,401 $57,422 $51,415 - ------------------------------------------------------------------------------------------------------------------------------------ Allowance for loan losses at beginning of year $1,001 $ 930 $ 900 $ 900 $ 870 Loans charged off: Commercial, financial and agricultural 296 152 108 59 55 Real estate-- commercial mortgage 35 31 6 27 16 Real estate-- construction 8 1 -- 2 3 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial real estate loans 43 32 6 29 19 Commercial lease financing 62 14 20 12 9 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 401 198 134 100 83 Real estate-- residential mortgage 17 8 8 11 11 Home equity 99 19 10 6 4 Credit card 1 17 89 104 113 Consumer-- direct 47 57 41 44 41 Consumer-- indirect lease financing 27 23 13 8 4 Consumer-- indirect other 192 200 125 111 122 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 383 324 286 284 295 - ------------------------------------------------------------------------------------------------------------------------------------ 784 522 420 384 378 Recoveries: Commercial, financial and agricultural 26 25 28 25 28 Real estate-- commercial mortgage 4 4 4 6 10 Real estate-- construction -- -- 1 2 2 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial real estate loans 4 4 5 8 12 Commercial lease financing 5 2 3 1 1 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 35 31 36 34 41 Real estate-- residential mortgage 8 4 4 4 3 Home equity 1 2 1 1 -- Credit card 1 5 14 10 9 Consumer-- direct 8 8 8 6 7 Consumer-- indirect lease financing 9 6 3 1 1 Consumer-- indirect other 49 52 36 31 24 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 76 77 66 53 44 - ------------------------------------------------------------------------------------------------------------------------------------ 111 108 102 87 85 - ------------------------------------------------------------------------------------------------------------------------------------ Net loans charged off (673) (414) (318) (297) (293) Provision for loan losses 1,350 490 348 297 320 Allowance related to loans acquired (sold), net (1) (5) -- -- 3 - ------------------------------------------------------------------------------------------------------------------------------------ Allowance for loan losses at end of year $1,677 $1,001 $ 930 $ 900 $ 900 ====== ====== ===== ===== ===== - ------------------------------------------------------------------------------------------------------------------------------------ Net loan charge-offs to average loans 1.02% .63% .51% .52% .57% Allowance for loan losses to year-end loans 2.65 1.50 1.45 1.45 1.69 Allowance for loan losses to nonperforming loans 184.29 154.00 208.05 234.38 233.77 - ------------------------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS. Figure 28 shows the composition of Key's nonperforming assets. These assets totaled $910 million at December 31, 2001, and represented 1.49% of loans, other real estate owned (known as "OREO") and other nonperforming assets, compared with $672 million, or 1.00%, at December 31, 2000. The economic slowdown can be expected to continue to impact Key's loan portfolio in general, although the erosion in credit quality that we have experienced is concentrated in several distinct commercial portfolios of limited size. At December 31, 2001, two lines of business, Structured Finance and Healthcare, accounted for $164 million and $160 million, respectively, of Key's nonperforming loans. Although these two lines comprised less than 5% of the total loan portfolio, they accounted for 36% of total nonperforming loans. Key's exposure to the three industries most affected by the events of September 11 (commercial airlines, property and casualty insurance carriers, and hotel/motel) is nominal. At December 31, 2001, our 20 largest nonperforming loans totaled $283 million, representing 31% of total loans on nonperforming status. As shown in Figure 26, the run-off loan portfolio (whose nonperforming loans are also included in Figure 28) accounted for $231 million, or 25%, of Key's total nonperforming loans at the end of the year. 46
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 28 SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS DECEMBER 31, dollars in millions 2001 2000 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------------------------- Commercial, financial and agricultural $ 409 $ 301 $ 175 $ 144 $ 162 Real estate -- commercial mortgage 187 90 102 79 88 Real estate -- construction 83 28 7 6 21 - --------------------------------------------------------------------------------------------------------------------------------- Total commercial real estate loans(a) 270 118 109 85 109 Commercial lease financing 94 48 28 29 5 - --------------------------------------------------------------------------------------------------------------------------------- Total commercial loans 773 467 312 258 276 Real estate-- residential mortgage 42 52 44 60 58 Home equity 50 80 50 26 15 Consumer -- direct 9 8 6 6 8 Consumer -- indirect lease financing 10 7 3 3 -- Consumer -- indirect other 26 36 32 31 28 - --------------------------------------------------------------------------------------------------------------------------------- Total consumer loans 137 183 135 126 109 - --------------------------------------------------------------------------------------------------------------------------------- Total nonperforming loans 910 650 447 384 385 OREO 38 23 27 56 66 Allowance for OREO losses (1) (1) (3) (18) (21) - --------------------------------------------------------------------------------------------------------------------------------- OREO, net of allowance 37 22 24 38 45 Other nonperforming assets -- -- 2 1 5 - --------------------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $ 947 $ 672 $ 473 $ 423 $ 435 ======= ======= ======= ======= ======= - --------------------------------------------------------------------------------------------------------------------------------- Accruing loans past due 90 days or more $ 250 $ 236 $ 219 $ 159 $ 128 Accruing loans past due 30 through 89 days 1,096 963 916 753 749 - --------------------------------------------------------------------------------------------------------------------------------- Nonperforming loans to year-end loans 1.44% .97% .70% .62% .72% Nonperforming assets to year-end loans plus OREO and other nonperforming assets 1.49 1.00 .74 .68 .81 - ---------------------------------------------------------------------------------------------------------------------------------
(a) See Figure 16 on page 40 and the accompanying discussion on page 38 for more information related to Key's commercial real estate portfolio. Further information pertaining to the credit exposure inherent in the largest sector of Key's loan portfolio, commercial, financial and agricultural loans, is presented in Figure 29. The types of activity that caused the change in Key's nonperforming loans during 2001 are summarized in Figure 30. FIGURE 29 COMMERCIAL, FINANCIAL AND AGRICULTURAL LOANS
DECEMBER 31, 2001 NONPERFORMING LOANS -------------------------------- TOTAL LOANS % OF LOANS dollars in millions COMMITMENTS OUTSTANDING AMOUNT OUTSTANDING - ---------------------------------------------------------------------------------------------------------------------- Industry classification: Manufacturing $10,455 $ 4,478 $ 148 3.3% Services 5,787 2,670 95 3.6 Financial services 5,595 1,007 3 .3 Retail trade 4,014 2,190 40 1.8 Wholesale trade 3,014 1,416 26 1.8 Property management 2,567 1,149 9 .8 Public utilities 1,307 262 12 4.6 Communications 1,288 572 2 .3 Agriculture/forestry/fishing 1,280 829 26 3.1 Building contractors 1,274 558 22 3.9 Public administration 710 326 -- -- Transportation 700 464 5 1.1 Insurance 576 131 -- -- Mining 374 217 1 .5 Individuals 217 131 1 .8 Other 2,078 1,759 19 1.1 - ---------------------------------------------------------------------------------------------------------------------- Total $41,236 $18,159 $ 409 2.3% ======= ======= ======= - ----------------------------------------------------------------------------------------------------------------------
47 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 30 SUMMARY OF CHANGES IN NONPERFORMING LOANS
2001 QUARTERS ---------------------------------------------------- in millions FULL YEAR FOURTH THIRD SECOND FIRST - ------------------------------------------------------------------------------------------------------------------------ BALANCE AT BEGINNING OF PERIOD $ 650 $ 885 $ 797 $ 713 $ 650 Loans placed on nonaccrual status 1,441 407 324 455 255 Charge-offs (672) (220) (173) (170) (109) Loans sold (260) (83) (35) (137) (5) Payments (208) (65) (20) (61) (62) Transfers to OREO (29) (12) (8) (2) (7) Loans returned to accrual status (12) (2) -- (1) (9) - ------------------------------------------------------------------------------------------------------------------------ BALANCE AT END OF PERIOD $ 910 $ 910 $ 885 $ 797 $ 713 ======= ======= ======= ======= ======= - ------------------------------------------------------------------------------------------------------------------------
DEPOSITS AND OTHER SOURCES OF FUNDS "Core deposits" -- domestic deposits other than certificates of deposit of $100,000 or more -- are Key's primary source of funding. During 2001, core deposits averaged $37.5 billion, and represented 50% of the funds Key used to support earning assets, compared with $37.3 billion and 50% during 2000, and $36.9 billion and 51% during 1999. The composition of Key's deposits is shown in Figure 5, which spans pages 30 and 31. During 2001, the level of Key's core deposits was relatively unchanged from the prior year as the growth of time deposits, which slowed considerably, was offset by a decline in the level of savings deposits. Time deposits grew by 2% in 2001, following an increase of 17% in 2000. The growth rate of these deposits declined because, like our competitors, Key reduced the rates paid for them as the Federal Reserve reduced interest rates in general. At the same time, Key's money market deposit accounts increased slightly, since clients view these investments as relatively liquid and stable in a weak economy. In 2000, money market deposit accounts, 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 the Long Island franchise. At the same time, Key's time deposits grew significantly as a result of our marketing efforts and client preferences for investments that offer higher returns. In 2000, the deposits in Key's Retail Banking division grew by 7% from the prior year and allowed us to moderate our dependence on higher-cost funds. Purchased funds, comprising large certificates of deposit, deposits in the foreign branch and short-term borrowings, averaged $20.0 billion during 2001, compared with $20.2 billion during 2000 and $17.8 billion in 1999. As shown in Figure 5, Key has relied more heavily on certificates of deposit and foreign branch deposits to fund earning assets over the past two years. In addition, Key continues to consider loan securitizations as a funding alternative when market conditions are favorable. Key securitized and sold education loans totaling $491 million in 2001 and $1.0 billion in 2000. At December 31, 2001, Key had $6.9 billion in time deposits of $100,000 or more. Figure 31 shows the maturity distribution of these deposits. FIGURE 31 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE DECEMBER 31, 2001 DOMESTIC FOREIGN in millions OFFICES OFFICE TOTAL - ------------------------------------------------------------------------------- Remaining maturity: Three months or less $2,136 $1,599 $3,735 After three through twelve months 1,580 -- 1,580 After twelve months 1,571 -- 1,571 - ------------------------------------------------------------------------------- Total $5,287 $1,599 $6,886 ====== ====== ====== - ------------------------------------------------------------------------------- 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 RISK. Management recognizes that there are circumstances that could adversely affect Key's liquidity or materially affect the cost of funds. One such circumstance involves the occurrence of events that are systemic in nature, such as terrorism or war, natural disasters, political events, or the default or bankruptcy of a major corporation, mutual fund or hedge fund. Examples of these events are the September 11 attacks on the World Trade Center and Pentagon, and the Fall, 1998 Russian and Long-term Capital Management defaults. Another circumstance is a significant downgrade in the public credit rating of Key by a rating agency due to a deterioration in asset quality, a large charge to earnings, a significant merger or acquisition or other events. In addition, market speculation or rumors about Key may cause normal funding sources to withdraw credit until further information becomes available. LIQUIDITY FOR KEY. 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. 48 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES - - 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 that we receive a relatively consistent stream of payments from borrowers. We also selectively securitize and package loans for sale. - - Our 911 full-service KeyCenters in 12 states generate a sizable volume of core deposits. We monitor deposit flows and use alternative 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 December 31, 2001. LIQUIDITY FOR THE PARENT COMPANY. KeyCorp meets its liquidity requirements principally through regular dividends from affiliate banks. In 2001, affiliate banks paid KeyCorp a total of $500 million in dividends; KeyCorp also received a $700 million distribution of surplus in the form of cash from KeyBank National Association. As of January 1, 2002, the affiliate banks had an additional $449 million available to pay dividends to KeyCorp without prior regulatory approval. KeyCorp generally maintains excess funds 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 2001, Key's affiliate banks raised $5.6 billion under Key's bank note program. Of the notes issued during the year, $1.9 billion have original maturities in excess of one year and are included in long-term debt. The remaining notes have original maturities of one year or less and are included in short-term borrowings. Key's current bank note program provides for the issuance of both long- and short-term debt of up to $20.0 billion ($19.0 billion by KeyBank National Association and $1.0 billion by Key Bank USA, National Association). At December 31, 2001, KeyBank National Association had $11.8 billion of debt outstanding and $8.2 billion available for future issuance under this program. 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 $10.0 billion in the aggregate. The notes are offered exclusively to non-U.S. investors and can be denominated in U.S. dollars and many foreign currencies. There were $4.0 billion of borrowings outstanding under this facility as of December 31, 2001, $340 million of which were issued during 2001. At the end of the year, $5.7 billion was available for future issuance under this program. COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp has a commercial paper program and a revolving credit agreement with an unaffiliated financial institution that provide funding availability of up to $500 million and $400 million, respectively. As of December 31, 2001, $25 million of borrowings were outstanding under the commercial paper program; no amount was outstanding under the revolving credit agreement. PARENT COMPANY NOTE PROGRAM AND OTHER SECURITIES. KeyCorp has registered with the Securities and Exchange Commission to provide for the issuance of up to $2.2 billion of securities which could include long- or short-term debt, or equity securities. At December 31, 2001, $2.2 billion of this capacity remained unused, including $1.0 billion which is reserved for issuance as medium-term notes. Key has favorable debt ratings as shown in Figure 32 below. As long as those debt ratings are maintained, management believes that, under normal conditions in the capital markets, any eventual offering of securities would be marketable to investors at a competitive cost. FIGURE 32 DEBT RATINGS SENIOR SUBORDINATED SHORT-TERM LONG-TERM LONG-TERM CAPITAL DECEMBER 31, 2001 BORROWINGS DEBT DEBT SECURITIES - ------------------------------------------------------------------------------ KEYCORP - ------------------ Standard & Poor's A-2 A- BBB+ BBB Moody's P-1 A2 A3 "Baal" KEYBANK NATIONAL ASSOCIATION - ------------------ Standard & Poor's A-1 A A- N/A Moody's P-1 A1 A2 N/A - ------------------------------------------------------------------------------ N/A = Not Applicable Figure 33 summarizes Key's significant cash obligations and contractual amounts of off-balance sheet lending commitments at December 31, 2001, by the specific time periods in which related payments are due or commitments expire.
FIGURE 33 CASH OBLIGATIONS AND OFF-BALANCE SHEET COMMITMENTS DECEMBER 31, 2001 AFTER AFTER WITHIN 1 THROUGH 3 THROUGH AFTER in millions 1 YEAR 3 YEARS 5 YEARS 5 YEARS TOTAL - -------------------------------------------------------------------------------------------------------------------------------- Long-term debt $ 4,361 $ 6,665 $ 1,951 $ 1,577 $14,554 Noncancelable leases 124 217 167 455 963 - -------------------------------------------------------------------------------------------------------------------------------- Total cash obligations $ 4,485 $ 6,882 $ 2,118 $ 2,032 $15,517 ======= ======= ======= ======= ======= Commercial, including real estate $18,334 $ 5,663 $ 2,786 $ 640 $27,423 Home equity 90 131 147 4,597 4,965 Letters of credit 1,720 1,004 683 202 3,609 - -------------------------------------------------------------------------------------------------------------------------------- Total lending-related off-balance sheet commitments $20,144 $ 6,798 $ 3,616 $ 5,439 $35,997 ======= ======= ======= ======= ======= - --------------------------------------------------------------------------------------------------------------------------------
49 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES For more information about Key's sources and uses of cash for the years ended December 31, 2001, 2000 and 1999, see the Consolidated Statements of Cash Flow on page 57. CAPITAL AND DIVIDENDS SHAREHOLDERS' EQUITY. Total shareholders' equity at December 31, 2001, was $6.2 billion, down $468 million from the balance at December 31, 2000. The decrease was due primarily to a lower level of retained earnings stemming from significant charges recorded in the second and fourth quarters of 2001. These charges were taken in connection with actions designed to improve Key's business performance and to better position the company to take advantage of an eventual economic rebound. The section entitled "Financial Performance," which begins on page 23, provides more information about these charges. Other factors contributing to the change in shareholders' equity during 2001 are shown in the Statement of Changes in Shareholders' Equity, presented on page 56. SHARE REPURCHASES. In September 2000, the Board of Directors authorized the repurchase of up to 25,000,000 common shares, including the 3,647,200 shares remaining at the time from an earlier repurchase program. These shares may be repurchased in the open market or through negotiated transactions. During 2001, Key repurchased a total of 2,035,600 of its common shares at an average price per share of $24.56. At December 31, 2001, a remaining balance of 16,764,400 shares may be repurchased under the September 2000 authorization. At December 31, 2001, Key had 67,883,724 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 2001, Key reissued 2,415,914 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 7.60% at December 31, 2001, and 7.59% at December 31, 2000. Banking industry regulators prescribe minimum capital ratios for bank holding companies and their banking subsidiaries. Note 12 ("Shareholders' Equity"), which begins on page 71, explains the implications of failing to meet specific capital requirements imposed by the banking regulators. Risk-based capital guidelines require a minimum level of capital as a percent of "risk-weighted 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-weighted assets of 4.00%, and total capital as a percent of risk-weighted assets of 8.00%. As of December 31, 2001, Key's Tier 1 capital ratio was 7.43%, and its total capital ratio was 11.41%. The leverage ratio is Tier 1 capital as a percentage of average quarterly 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 3.00%. All other bank holding companies must maintain a minimum ratio of 4.00%. As of December 31, 2001, KeyCorp had a leverage ratio of 7.65%. Federal bank regulators group FDIC-insured depository institutions into five categories, ranging from "critically undercapitalized" to "well capitalized." Both of Key's affiliate banks qualified as "well capitalized" at December 31, 2001, since each exceeded the prescribed thresholds of 10.00% for total capital, 6.00% for Tier 1 capital and 5.00% for the leverage ratio. If these provisions applied to bank holding companies, KeyCorp would also qualify as "well capitalized" at December 31, 2001. 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 34 presents the details of Key's regulatory capital position at December 31, 2001 and 2000. FIGURE 34 CAPITAL COMPONENTS AND RISK-WEIGHTED ASSETS DECEMBER 31, dollars in millions 2001 2000 - ------------------------------------------------------------------------- TIER 1 CAPITAL Common shareholders' equity(a) $ 6,117 $ 6,609 Qualifying capital securities 1,243 1,243 Less: Goodwill 1,101 1,324 Other assets(b) 37 44 - ------------------------------------------------------------------------- Total Tier 1 capital 6,222 6,484 - ------------------------------------------------------------------------- TIER 2 CAPITAL Allowance for loan losses(c) 1,040 1,001 Net unrealized holding gains(d) -- 16 Qualifying long-term debt 2,286 2,136 - ------------------------------------------------------------------------- Total Tier 2 capital 3,326 3,153 - ------------------------------------------------------------------------- Total risk-based capital $ 9,548 $ 9,637 ======= ======= RISK-WEIGHTED ASSETS Risk-weighted assets on balance sheet $67,783 $71,326 Risk-weighted off-balance sheet exposure 17,480 13,776 Less: Goodwill 1,101 1,324 Other assets(b) 37 44 Plus: Market risk-equivalent assets 217 225 Net unrealized holding gains(d) -- 16 - ------------------------------------------------------------------------- Gross risk-weighted assets 84,342 83,975 Less: Excess allowance for loan losses(c) 637 -- - ------------------------------------------------------------------------- Net risk-weighted assets $83,705 $83,975 ======= ======= AVERAGE QUARTERLY TOTAL ASSETS $81,329 $85,427 ======= ======= CAPITAL RATIOS Tier 1 risk-based capital ratio 7.43% 7.72% Total risk-based capital ratio 11.41 11.48 Leverage ratio(e) 7.65 7.71 - ------------------------------------------------------------------------- (a) Common shareholders' equity does not include net unrealized gains or losses on securities (except for net unrealized losses on marketable equity securities) and net gains or losses on cash flow hedges. (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 by regulation to 1.25% of gross risk-weighted assets, excluding those with low-level recourse. (d) Net unrealized holding gains included in Tier 2 capital are limited by regulation to 45% of net unrealized holding gains on available-for-sale equity securities with readily determinable fair values. (e) This ratio is Tier 1 capital divided by average quarterly total assets less goodwill and the nonqualifying intangible assets described in footnote (b). 50 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES KeyCorp's common shares are traded on the New York Stock Exchange under the symbol KEY. At December 31, 2001: - - Book value per common share was $14.52, based on 424,005,056 shares outstanding, compared with $15.65, based on 423,253,899 shares outstanding at December 31, 2000. - - In 2001, the quarterly dividend was $.295 per common share, up from $.28 per common share in 2000. On December 19, 2001, the quarterly dividend per common share was increased by 1.7% to $.30, effective with the March 2002 dividend payment. - - The closing sales price of a KeyCorp common share on the New York Stock Exchange was $24.34. This price was 168% of year-end book value per share, and would produce a dividend yield of 4.93% based on the quarterly dividend of $.30 per common share. - - There were 45,340 holders of record of KeyCorp common shares. Figure 35 shows the sales price ranges of the common shares, per common share net income (loss) and dividends paid by quarter for each of the last two years. FOURTH QUARTER RESULTS Some of the highlights of Key's fourth quarter results are summarized below. Key's financial performance for each of the past eight quarters is summarized in Figure 35. NET INCOME (LOSS). Key had a net loss of $174 million, or $.41 per common share, for the fourth quarter of 2001, compared with net income of $266 million, or $.62 per share, for the same period in 2000. The decline in Key's results reflects the adverse effects of a sluggish economy on Key's credit quality and capital markets-sensitive businesses, such as principal investing. Results for the fourth quarter of 2001 include core charges of approximately $410 million (after tax), or $.96 per share, taken to increase Key's allowance for loan losses and to strengthen the balance sheet. The section entitled "Financial performance," which begins on page 23, provides more information about these charges. On an annualized basis, Key's return on average total assets for the fourth quarter of 2001 was (.84)%, compared with a return of 1.24% for the fourth quarter of 2000. The annualized return on average equity was (10.57)% for the fourth quarter of 2001, compared with a return of 16.16% for the year-ago quarter. NET INTEREST INCOME. Net interest income was $700 million for the fourth quarter of 2001, down slightly from $702 million for the fourth quarter of 2000. A 27 basis point rise in Key's net interest margin to 3.98%, the highest level since the fourth quarter of 1998, was more than offset by a 4% decrease in average earning assets to $72.7 billion. The decrease in earning assets was due primarily to Key's May 2001 decision to exit the automobile leasing business, de-emphasize indirect prime automobile lending and discontinue certain nonrelationship commercial lending. Key's sale in September of $1.4 billion of residential mortgage loans with low interest rate spreads also contributed to the decrease. The net interest margin rose by 13 basis points from the third quarter of 2001 and accounted for nearly one-half of the 27 basis point improvement from the fourth quarter of 2000. Almost one-half of the fourth quarter increase, or 6 basis points, is attributable to an increase in the taxable-equivalent adjustment related to income derived from portions of our equipment leasing portfolio. This income is now subject to a lower income tax rate than the one previously used to calculate our tax expense accrual. Although a portion of the fourth quarter increase represents a cumulative catch-up adjustment, the application of the lower tax rate will provide continued future benefits. NONINTEREST INCOME. Key's noninterest income was $418 million for the fourth quarter of 2001 and includes $60 million of core charges for principal investing write-downs and an increase in our reserve for customer derivative losses. This compares with net income of $508 million a year ago. Lower income from investment banking and capital markets activities (down $28 million), net gains from sales of securities (down $20 million) and trust and investment services (down $13 million) accounted for the decrease. These unfavorable results were offset partially by a $21 million increase in service charges on deposit accounts. Also, traditional fee income in the fourth quarter of 2001 was supplemented by $10 million of additional revenue, representing the value of shares received as a result of the demutualization of an insurance company in which Key is a policyholder. Key contributed these shares to its charitable foundation. NONINTEREST EXPENSE. Noninterest expense for the fourth quarter of 2001 totaled $702 million, including the $10 million contribution discussed above. This compares with $705 million in the fourth quarter of 2000. Personnel expense decreased by $25 million, primarily because incentive compensation tied to revenue production declined, as did the total number of employees. The decline in personnel expense was partially offset by moderate increases in a number of other expense categories. PROVISION FOR LOAN LOSSES. Key's provision for loan losses was $723 million for the fourth quarter of 2001, compared with $108 million for the fourth quarter of 2000. Included in the fourth quarter 2001 amount is a provision of $590 million, of which $400 million was used to increase the allowance for loan losses for Key's continuing loan portfolio. The remaining $190 million was added to the portion of the allowance segregated in the second quarter in connection with Key's decision to eliminate certain nonrelationship lending, as discussed on page 44, under the heading "Run-off loan portfolio." The fourth quarter increase in the overall allowance is a result of continued weakness in the economy and the related adverse effects on Key's specific portfolios. Net loan charge-offs totaled $220 million and were 1.37% of average loans outstanding for the quarter, compared with $108 million and .64%, respectively, for the fourth quarter of 2000. For more information about Key's allowance for loan losses, see the section entitled "Allowance for loan losses," which begins on page 43. 51 MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
FIGURE 35 SELECTED QUARTERLY FINANCIAL DATA 2001 2000 ------------------------------------ ------------------------------------ dollars in millions, except per share amounts FOURTH THIRD SECOND FIRST FOURTH THIRD SECOND FIRST - ----------------------------------------------------------------------------------------------------------------------------------- FOR THE QUARTER Interest income $1,210 $1,380 $1,467 $1,570 $1,652 $1,596 $1,540 $1,489 Interest expense 510 656 754 882 950 912 867 818 Net interest income 700 724 713 688 702 684 673 671 Provision for loan losses 723 116 401 110 108 131 68 183 Noninterest income before net securities gains (losses) 419 452 390 429 489 455 473 805 Net securities gains (losses) (1) 2 8 26 19 (50) 2 1 Noninterest expense 702 683 858 698 705 787 698 727 Income (loss) before income taxes and cumulative effect of accounting changes (307) 379 (148) 335 397 171 382 567 Income (loss) before cumulative effect of accounting changes (174) 249 (136) 218 266 121 248 367 Net income (loss) (174) 249 (160) 217 266 121 248 367 Net income (loss) -- core (174) 249 28 217 272 245 249 243 - ----------------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE Income (loss) before cumulative effect of accounting changes $(.41) $.59 $(.32) $.51 $.63 $.28 $.57 $.83 Income (loss) before cumulative effect of accounting changes -- assuming dilution (.41) .58 (.32) .51 .62 .28 .57 .83 Net income (loss) (.41) .59 (.38) .51 .63 .28 .57 .83 Net income (loss) -- core (.41) .59 .07 .51 .64 .57 .57 .55 Net income (loss) -- assuming dilution (.41) .58 (.38) .51 .62 .28 .57 .83 Net income (loss) -- assuming dilution -- core (.41) .58 .07 .51 .63 .57 .57 .55 Cash dividends paid .295 .295 .295 .295 .28 .28 .28 .28 Book value at period end 14.52 15.53 15.22 15.79 15.65 15.26 15.09 14.84 Market price: High 24.52 28.15 26.43 27.58 28.50 27.06 23.00 22.25 Low 20.49 22.20 22.10 22.65 21.50 17.50 17.00 15.56 Close 24.34 24.14 26.05 25.80 28.00 25.31 17.63 19.00 Weighted average common shares (000) 423,596 424,802 424,675 424,024 425,054 429,584 434,112 441,834 Weighted average common shares and potential common shares (000) 423,596 430,346 424,675 429,917 430,634 431,972 436,022 443,757 - ----------------------------------------------------------------------------------------------------------------------------------- AT PERIOD END Loans $63,309 $64,506 $66,693 $67,027 $66,905 $66,299 $65,612 $64,064 Earning assets 71,672 73,943 76,531 77,027 77,316 75,786 74,748 73,953 Total assets 80,938 84,419 85,838 86,457 87,270 85,500 84,719 83,504 Deposits 44,795 45,372 45,743 45,965 48,649 47,809 49,076 46,036 Long-term debt 14,554 15,114 14,675 14,495 14,161 13,800 14,097 14,784 Shareholders' equity 6,155 6,575 6,467 6,702 6,623 6,520 6,507 6,493 Full-time equivalent employees 21,230 21,297 21,742 21,882 22,142 22,457 23,005 23,474 Branches 911 911 926 922 922 932 938 937 - ----------------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average total assets (.84)% 1.16% (.75)% 1.02% 1.24% .57% 1.20% 1.77% Return on average total assets -- core (.84) 1.16 .13 1.02 1.27 1.16 1.20 1.17 Return on average equity (10.57) 15.20 (9.67) 13.28 16.16 7.39 15.40 22.68 Return on average equity -- core (10.57) 15.20 1.69 13.28 16.53 14.97 15.46 15.02 Net interest margin (taxable equivalent) 3.98 3.85 3.77 3.63 3.71 3.68 3.68 3.68 - ----------------------------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS AT PERIOD END Equity to assets 7.60% 7.79% 7.53% 7.75% 7.59% 7.63% 7.68% 7.78% Tangible equity to tangible assets 6.29 6.51 6.25 6.29 6.12 6.10 6.12 6.16 Tier 1 risk-based capital 7.43 7.81 7.71 7.99 7.72 7.59 7.88 7.98 Total risk-based capital 11.41 11.77 11.81 12.32 11.48 11.34 11.74 12.04 Leverage 7.65 7.90 7.68 7.79 7.71 7.76 7.90 7.89 - -----------------------------------------------------------------------------------------------------------------------------------
Key completed several acquisitions and divestitures during the two-year period 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 year to the next. Note 3 ("Acquisitions and Divestitures"), which begins on page 63, has specific information about the business combinations and divestitures that Key completed in the past three years to help you understand how those transactions may have impacted Key's financial condition and results of operations. 52 KEYCORP AND SUBSIDIARIES REPORT OF MANAGEMENT Key's management is responsible for the preparation, content and integrity of the financial statements and other statistical data and analyses compiled for this annual report. The financial statements and related notes have been prepared in conformity with accounting principles generally accepted in the United States and reflect management's best estimates and judgments. Management believes that the financial statements and notes present fairly Key's financial position, results of operations and cash flows, and that the financial information presented elsewhere in this annual report is consistent with the financial statements. Management is responsible for establishing and maintaining a system of internal control to ensure the protection of assets and the integrity of the financial statements. This corporate-wide system of controls includes self- monitoring mechanisms, written policies and procedures, proper delegation of authority and organizational division of responsibility, and the careful selection and training of qualified personnel. Management also maintains a code of ethics that addresses conflicts of interest, compliance with laws and regulations, and prompt reporting of any failure or circumvention of controls, among other things. We generally certify compliance with Key's code of ethics annually. We have established an effective risk management function to periodically test the other internal controls, and we endeavor to correct control deficiencies as they are identified. Although any system of internal control can be compromised by human error or intentional circumvention of required procedures, management believes Key's system provides reasonable assurances that financial transactions are recorded properly, providing an adequate basis for reliable financial statements. The Board of Directors discharges its responsibility for Key's financial statements through its Audit and Risk Review Committee. This committee, which draws its members exclusively from the outside directors, also recommends the independent auditors. The Audit and Risk Review Committee meets regularly with the independent auditors to review the scope of their audits and audit reports and to discuss necessary action. Both the independent and internal auditors have direct access to and interaction with the Audit and Risk Review Committee. Management has assessed Key's internal control and procedures over financial reporting using criteria described in "Internal Control -- Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that assessment, management believes that Key maintained an effective system of internal control for financial reporting as of December 31, 2001. /s/ Henry L. Meyer III Henry L. Meyer III Chairman and Chief Executive Officer /s/ K. Brent Somers K. Brent Somers Senior Executive Vice President and Chief Financial Officer REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Shareholders and Board of Directors KeyCorp We have audited the accompanying consolidated balance sheets of KeyCorp and subsidiaries ("Key") as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in shareholders' equity, and cash flow for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of Key's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Key at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Cleveland, Ohio January 14, 2002 53 KEYCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, dollars in millions 2001 2000 - ------------------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 2,891 $ 3,189 Short-term investments 1,898 1,884 Securities available for sale 5,346 7,329 Investment securities (fair value: $1,128 and $1,208) 1,119 1,198 Loans, net of unearned income of $1,778 and $1,789 63,309 66,905 Less: Allowance for loan losses 1,677 1,001 - ------------------------------------------------------------------------------------------------------------------------------ Net loans 61,632 65,904 Premises and equipment 687 717 Goodwill 1,101 1,324 Other intangible assets 31 44 Corporate-owned life insurance 2,313 2,215 Accrued income and other assets 3,920 3,466 - ------------------------------------------------------------------------------------------------------------------------------ Total assets $80,938 $87,270 ======= ======= LIABILITIES Deposits in domestic offices: Money market deposit accounts $12,845 $12,066 Savings deposits 1,918 2,032 NOW Accounts 616 506 Certificates of deposit ($100,000 or more) 4,493 5,797 Other time deposits 13,657 15,118 - ------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing 33,529 35,519 Noninterest-bearing 9,667 9,076 Deposits in foreign office-- interest-bearing 1,599 4,054 - ------------------------------------------------------------------------------------------------------------------------------ Total deposits 44,795 48,649 Federal funds purchased and securities sold under repurchase agreements 3,735 4,936 Bank notes and other short-term borrowings 5,549 6,957 Accrued expense and other liabilities 4,862 4,701 Long-term debt 14,554 14,161 Corporation-obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely subordinated debentures of KeyCorp (see Note 11) 1,288 1,243 - ------------------------------------------------------------------------------------------------------------------------------ Total liabilities 74,783 80,647 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 Capital surplus 1,390 1,402 Retained earnings 5,856 6,352 Loans to ESOP trustee -- (13) Treasury stock, at cost (67,883,724 and 68,634,881 shares) (1,585) (1,600) Accumulated other comprehensive income (loss) 2 (10) - ------------------------------------------------------------------------------------------------------------------------------ Total shareholders' equity 6,155 6,623 - ------------------------------------------------------------------------------------------------------------------------------ Total liabilities and shareholders' equity $80,938 $87,270 ======= ======= ==============================================================================================================================
See Notes to Consolidated Financial Statements. 54
KEYCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME YEAR ENDED DECEMBER 31, dollars in millions, except per share amounts 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans $ 5,067 $ 5,699 $ 5,146 Taxable investment securities 27 26 15 Tax-exempt investment securities 17 23 31 Securities available for sale 451 446 424 Short-term investments 65 83 79 - ----------------------------------------------------------------------------------------------------------------------------- Total interest income 5,627 6,277 5,695 INTEREST EXPENSE Deposits 1,478 1,768 1,305 Federal funds purchased and securities sold under repurchase agreements 198 287 220 Bank notes and other short-term borrowings 302 428 426 Long-term debt, including capital securities 824 1,064 957 - ----------------------------------------------------------------------------------------------------------------------------- Total interest expense 2,802 3,547 2,908 - ----------------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 2,825 2,730 2,787 Provision for loan losses 1,350 490 348 - ----------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 1,475 2,240 2,439 NONINTEREST INCOME Trust and investment services income 550 608 599 Investment banking and capital markets income 189 372 354 Service charges on deposit accounts 387 341 330 Corporate-owned life insurance income 114 109 107 Letter of credit and loan fees 124 107 98 Net securities gains (losses) 35 (28) 29 Gains from branch divestitures -- -- 194 Gains from other divestitures -- 332 161 Other income 326 353 443 - ----------------------------------------------------------------------------------------------------------------------------- Total noninterest income 1,725 2,194 2,315 NONINTEREST EXPENSE Personnel 1,378 1,445 1,482 Net occupancy 232 223 239 Computer processing 252 240 236 Equipment 152 173 203 Marketing 112 110 106 Amortization of intangibles 245 101 104 Professional fees 88 89 70 Restructuring charges (4) 102 98 Other expense 486 434 532 - ----------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 2,941 2,917 3,070 INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES 259 1,517 1,684 Income taxes 102 515 577 - ----------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 157 1,002 1,107 Cumulative effect of accounting changes, net of tax (see Note 1) (25) -- -- - ----------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 132 $ 1,002 $ 1,107 ======= ======= ======= Per common share: Income before cumulative effect of accounting changes $ .37 $ 2.32 $ 2.47 Net income .31 2.32 2.47 Income before cumulative effect of accounting changes-- assuming dilution .37 2.30 2.45 Net income-- assuming dilution .31 2.30 2.45 Weighted average common shares outstanding (000) 424,275 432,617 448,168 Weighted average common shares and potential common shares outstanding (000) 429,573 435,573 452,363 - -----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements. 55
KEYCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY LOANS TO TREASURY COMMON CAPITAL RETAINED ESOP STOCK, dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1998 $ 492 $ 1,412 $ 5,192 $ (34) $ (923) Net income 1,107 Other comprehensive losses: Net unrealized losses on securities available for sale, net of income taxes of ($94)(a) Foreign currency translation adjustments Total comprehensive income Cash dividends declared on common shares ($1.04 per share) (467) Issuance of common shares: Acquisition-- 632,183 shares 6 15 Employee benefit and dividend reinvestment plans-- 2,249,181 net shares (6) 55 Repurchase of common shares-- 11,906,424 shares (344) ESOP transactions 1 10 - ----------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1999 492 1,412 5,833 (24) (1,197) Net income 1,002 Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $80(a) Foreign currency translation adjustments Total comprehensive income Cash dividends declared on common shares ($1.12 per share) (484) Issuance of common shares: Employee benefit and dividend reinvestment plans-- 2,480,161 net shares (10) 59 Repurchase of common shares-- 22,652,800 shares (462) ESOP transactions 1 11 - ----------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2000 492 1,402 6,352 (13) (1,600) Net income 132 Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $11(a) Cumulative effect of change in accounting for derivative financial instruments, net of income taxes of ($12) Net unrealized gains on derivative financial instruments, net of income taxes of $12 Foreign currency translation adjustments Total comprehensive income Cash dividends declared on common shares ($1.48 per share) (628) Issuance of common shares: Acquisition-- 370,830 shares 9 Employee benefit and dividend reinvestment plans-- 2,415,914 net shares (12) 56 Repurchase of common shares-- 2,035,600 shares (50) ESOP transactions 13 - ----------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2001 $ 492 $ 1,390 $ 5,856 -- $(1,585) ======= ======= ======= ======= ======== =================================================================================================================================== Accumulated Other Comprehensive Comprehensive dollars in millions, except per share amounts Income (Loss) Income - ---------------------------------------------------------------------- ------------- BALANCE AT DECEMBER 31, 1998 $ 28 Net income $ 1,107 Other comprehensive losses: Net unrealized losses on securities available for sale, net of income taxes of ($94)(a) (148) (148) Foreign currency translation adjustments (7) (7) ------- Total comprehensive income $ 952 ======= Cash dividends declared on common shares ($1.04 per share) Issuance of common shares: Acquisition-- 632,183 shares Employee benefit and dividend reinvestment plans-- 2,249,181 net shares Repurchase of common shares-- 11,906,424 shares ESOP transactions - --------------------------------------------------------------------- ------------- BALANCE AT DECEMBER 31, 1999 (127) Net income $ 1,002 Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $80(a) 132 132 Foreign currency translation adjustments (15) (15) ------- Total comprehensive income $ 1,119 ======= Cash dividends declared on common shares ($1.12 per share) Issuance of common shares: Employee benefit and dividend reinvestment plans-- 2,480,161 net shares Repurchase of common shares-- 22,652,800 shares ESOP transactions - --------------------------------------------------------------------- ------------- BALANCE AT DECEMBER 31, 2000 (10) Net income $ 132 Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $11(a) 13 13 Cumulative effect of change in accounting for derivative financial instruments, net of income taxes of ($12) (22) (22) Net unrealized gains on derivative financial instruments, net of income taxes of $12 20 20 Foreign currency translation adjustments 1 1 ------- Total comprehensive income $ 144 ======= Cash dividends declared on common shares ($1.48 per share) Issuance of common shares: Acquisition-- 370,830 shares Employee benefit and dividend reinvestment plans-- 2,415,914 net shares Repurchase of common shares-- 2,035,600 shares ESOP transactions - --------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2001 $ 2 ======= =====================================================================
(a) Net of reclassification adjustments. Reclassification adjustments represent net unrealized gains or losses as of December 31, of the prior year on securities available for sale that were sold during the current year. The reclassification adjustments were ($5) million [($4) million after tax] in 2001, ($11) million [($7) million after tax] in 2000 and $3 million ($2 million after tax) in 1999. See Notes to Consolidated Financial Statements. 56
KEYCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW YEAR ENDED DECEMBER 31, in millions 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 132 $ 1,002 $ 1,107 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,350 490 348 Cumulative effect of accounting changes, net of tax 25 -- -- Depreciation expense and software amortization 285 281 292 Amortization of intangibles 245 101 104 Net gains from divestitures -- (332) (355) Net securities (gains) losses (35) 28 (29) Net (gains) losses from venture capital investments 79 (70) (38) Net gains from loan securitizations and sales (49) (31) (86) Deferred income taxes (139) 335 466 Net (increase) decrease in mortgage loans held for sale (10) (164) 3 Net decrease in trading account assets 146 26 109 Net increase (decrease) in accrued restructuring charges (64) 31 88 Other operating activities, net (271) (114) (155) - ----------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 1,694 1,583 1,854 INVESTING ACTIVITIES Net increase in loans, excluding acquisitions, sales and divestitures (1,876) (7,215) (8,110) Purchases of loans (107) -- (7) Proceeds from loan securitizations and sales 4,916 4,978 4,776 Purchases of investment securities (271) (404) (294) Proceeds from sales of investment securities 56 129 17 Proceeds from prepayments and maturities of investment securities 250 211 292 Purchases of securities available for sale (4,290) (6,855) (4,750) Proceeds from sales of securities available for sale 349 2,450 419 Proceeds from prepayments and maturities of securities available for sale 5,859 3,859 3,176 Net (increase) decrease in other short-term investments (160) (49) 5 Purchases of premises and equipment (121) (103) (94) Proceeds from sales of premises and equipment 15 22 27 Proceeds from sales of other real estate owned 27 28 10 Net cash paid in connection with divestitures -- -- (576) Cash used in acquisitions, net of cash acquired (3) (375) -- - ----------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 4,644 (3,324) (5,109) FINANCING ACTIVITIES Net increase (decrease) in deposits (3,854) 5,416 1,985 Net decrease in short-term borrowings (2,609) (696) (1,560) Net proceeds from issuance of long-term debt, including capital securities 3,864 4,286 5,220 Payments on long-term debt, including capital securities (3,532) (5,985) (2,102) Loan payments received from ESOP trustee 13 11 10 Purchases of treasury shares (50) (462) (344) Net proceeds from issuance of common stock 33 28 33 Cash dividends paid (501) (484) (467) - ----------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (6,636) 2,114 2,775 - ----------------------------------------------------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS (298) 373 (480) CASH AND DUE FROM BANKS AT BEGINNING OF YEAR 3,189 2,816 3,296 - ----------------------------------------------------------------------------------------------------------------------------------- CASH AND DUE FROM BANKS AT END OF YEAR $ 2,891 $ 3,189 $ 2,816 ======= ======= ======= - ----------------------------------------------------------------------------------------------------------------------------------- Additional disclosures relative to cash flow: Interest paid $ 2,626 $ 3,572 $ 2,749 Income taxes paid 115 92 185 Noncash items: Derivative assets resulting from adoption of new accounting standard $ 120 -- -- Derivative liabilities resulting from adoption of new accounting standard 152 -- -- Cash dividends declared, but not paid 127 -- -- 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 Assets sold -- -- 523 Liabilities sold -- -- 1,335 ===================================================================================================================================
See Notes to Consolidated Financial Statements. 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION KeyCorp, an Ohio corporation and bank holding company headquartered in Cleveland, Ohio, is one of the nation's largest bank- based financial services companies. KeyCorp's subsidiaries provide retail and commercial banking, commercial leasing, investment management, consumer finance and investment banking products and services to individual, corporate and institutional clients through three major lines of business: Key Consumer Banking, Key Corporate Finance and Key Capital Partners. As of December 31, 2001, KeyCorp's banking subsidiaries operated 911 full-service branches, a telephone banking call center services group and 2,333 ATMs in 20 states. 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. USE OF ESTIMATES Key's accounting policies conform to accounting principles generally accepted in the United States and prevailing practices within the financial services industry. Management must make certain estimates and judgments when determining the amounts presented in Key's consolidated financial statements and the related notes. If these estimates prove to be inaccurate, actual results could differ from those reported. BASIS OF PRESENTATION The consolidated financial statements include the accounts of KeyCorp and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Some previously reported results have been reclassified to conform to current reporting practices. BUSINESS COMBINATIONS In a business combination accounted for as a pooling-of-interests, the assets, liabilities and shareholders' equity of Key and the combined company are carried forward at historical amounts. The results of operations are combined and financial statements from prior periods are restated to give effect to the combination. When Key accounts for a business combination as a purchase, the acquired company's net assets are recorded at fair value at the date of acquisition and the results of operations of the acquired company are combined with Key's results from that date forward. Purchase premiums and discounts, including intangible assets, are amortized over the remaining useful lives of the related assets or liabilities. The difference between the purchase price and the fair value of the net assets acquired is recorded as goodwill. The provisions of Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," became effective as of July 1, 2001, superseding the previous accounting for business combinations. Additional information pertaining to this new accounting standard is summarized under the heading "Accounting Pronouncements Adopted in 2001," which begins on page 61. STATEMENT OF CASH FLOW Cash and due from banks are considered "cash and cash equivalents" for financial reporting purposes. 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 ($597 million at December 31, 2001, and $743 million at December 31, 2000) 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 debt securities that Key has the intent and ability to hold until maturity and equity securities that do not have readily determinable fair values. The debt securities are carried at cost, adjusted for amortization of premiums and accretion of discounts using the interest method. This method produces a constant rate of return on the basis of the adjusted carrying amount. The equity securities consist mainly of investments held in Key's Principal Investing unit. Principal investments include direct and indirect investments predominantly in privately held companies. These investments are carried at estimated fair value as determined by management. Changes in estimated fair values and actual gains and losses on sales of these investments are included in "investment banking and capital markets income" on the income statement. 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. Unrealized gains and losses (net of income taxes) deemed temporary are recorded in shareholders' equity as a component of "accumulated other comprehensive income (loss)." Actual gains and losses on sales of these securities are computed for each specific security sold and included in "net securities gains (losses)" on the income statement. LOANS Loans are carried at the principal amount outstanding, net of unearned income, including net deferred loan fees and costs. Key defers certain nonrefundable loan origination and commitment fees and the direct costs of originating or acquiring loans. The net deferred amount is amortized over the estimated lives of the related loans as an adjustment to the yield. At December 31, 2001, loans held for sale include mortgage and education loans. These loans are carried at the lower of aggregate cost or fair value. Fair value is determined based on prevailing market prices for loans with similar characteristics. When a loan is placed in the held for sale category, amortization of the related deferred fees and costs is discontinued. The remaining unamortized fees and costs are recognized as part of the cost basis of the related loan at the time it is sold. 58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES Direct financing leases are carried at the aggregate of lease payments receivable plus estimated residual values, less unearned income. Unearned income on direct financing leases is amortized over the lease terms using methods that approximate the interest method. This method amortizes unearned income to produce a constant rate of return on the lease. Net gains on sales of lease residuals are included in "other income" on the income statement. IMPAIRED AND OTHER NONACCRUAL LOANS Key will generally stop accruing interest on a loan (i.e., designate the loan "nonaccrual") when payment is 90 days or more past due, unless the loan is well-secured and in the process of collection. Once a loan is designated as nonaccrual, the interest accrued but not collected is generally charged against the allowance for loan losses, and payments subsequently received are generally applied to principal. However, if management believes that all principal and interest on a nonaccrual loan ultimately are collectible, interest income may be recognized as received. Nonaccrual loans, other than smaller-balance homogeneous loans (i.e., loans to finance residential mortgages, automobiles, etc.), are designated "impaired." Impaired loans and other nonaccrual loans are returned to accrual status when management determines that the borrower's performance has improved and that both principal and interest are collectible. This generally requires a sustained period of timely principal and interest payments. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses represents management's estimate of probable credit losses inherent in the loan portfolio at the balance sheet date. Key determines and maintains an appropriate allowance for loan losses based on an analysis of the quality of the loan portfolio. This analysis is conducted at least quarterly and more often if deemed necessary. ALLOWANCE FOR IMPAIRED LOANS. 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 estimated present value of future cash flows and the fair value of any existing collateral. When expected cash flows or collateral values do not justify the carrying amount of the loan, the amount that management deems uncollectible (the impaired amount) is charged against the allowance for loan losses. Even when collateral value or other sources of repayment appear sufficient, if management remains uncertain about whether the loan will be repaid in full, an amount is specifically allocated in the allowance for loan losses. ALLOWANCE FOR NONIMPAIRED LOANS AND BINDING COMMITMENTS. Management establishes an allowance for nonimpaired loans and legally binding commitments by applying historical loss rates to existing loans with similar risk characteristics. The loss rates used to establish the allowance may be adjusted to reflect management's current assessment of the following factors: - - changes in national and local economic and business conditions; - - changes in experience, ability and depth of lending management and staff, in lending policies or in the mix and volume of the loan portfolio; - - the trend of the volume of past due, nonaccrual and other loans; and - - external forces, such as competition, legal developments and regulatory guidelines. LOAN SECURITIZATIONS Key sells education and other types of loans through securitizations. Securitized loans are removed from the balance sheet and a net gain or loss is recorded when the combined net sales proceeds and, if applicable, residual interests differ from the loans' allocated carrying amount. Net gains and losses resulting from securitizations are recorded in "other income" on the income statement. A servicing asset may also be recorded if Key either purchases or retains the right to service these loans and receives related fees that exceed the going market rate. Income earned under servicing or administration arrangements also is recorded in "other income." In some cases, Key retains a residual interest in securitized loans that may take the form of an interest-only strip, a residual asset, a servicing asset and/or a security. These retained interests are subject to the rules contained in SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." Under these rules, the previous carrying amount of the assets sold is allocated between the retained interests and the assets sold based on their relative fair values at the date of transfer. Fair value is determined by computing the present value of estimated cash flows, using a discount rate considered commensurate with the risks associated with the cash flows and the dates that Key expects to receive such cash flows. Other assumptions used in the determination of fair value are disclosed in Note 7 ("Retained Interests in Loan Securitizations") on page 68. The retained interests are accounted for like debt securities classified as available for sale or as trading account assets. On a quarterly basis, Key ensures that all retained interests are valued appropriately in the financial statements. Management reviews the historical performance of each retained interest and the assumptions used to project future cash flows. Assumptions are revised if past performance and future expectations dictate and the present value of cash flows is recalculated based on the revised assumptions. The present value of these cash flows is referred to as the retained interest fair value. For retained interests classified as trading account assets, any increase or decrease in the asset's fair value is recognized in "other income." Generally, if the carrying amount of a retained interest classified as securities available for sale exceeds its fair value, impairment is indicated and recognized in earnings. Conversely, if the fair value of the retained interest exceeds its carrying amount, the write-up to fair value is recorded in equity as a component of "accumulated other comprehensive income (loss)," and the yield on the retained interest is adjusted prospectively. See the section entitled "Recognition of interest income and impairment on certain investments," on page 62 for more information regarding the accounting guidance that governs the determination of impairment on Key's retained interests. 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES SERVICING ASSETS Servicing assets purchased or retained by Key in a sale or securitization of loans are reported at the lower of amortized cost or fair value ($73 million at December 31, 2001, and $49 million at December 31, 2000) and included in "accrued income and other assets" on the balance sheet. Fair value is initially measured by allocating the previous carrying amount of the assets sold or securitized to the retained interests and the assets sold based on their relative fair values at the date of transfer. Fair value is determined by estimating the present value of future cash flows associated with the serviced loans. The estimate is based on a number of assumptions, including the cost of servicing, discount rate, prepayment rate and default rate. The amortization of servicing assets is determined in proportion to, and over the period of, the estimated net servicing income and is recorded in "other income" on the income statement. PREMISES AND EQUIPMENT Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation and amortization. Management determines depreciation of premises and equipment using the straight-line method over the estimated useful lives of the particular assets. Leasehold improvements are amortized using the straight-line method over the terms of the leases. Accumulated depreciation and amortization on premises and equipment totaled $1.1 billion at December 31, 2001, and $980 million at December 31, 2000. INTANGIBLE ASSETS "Goodwill" represents the amount by which the cost of net assets acquired exceeds their fair value. Goodwill is amortized using the straight-line method over the period (up to 25 years) that management expects the acquired assets to have value. "Other intangibles" represent primarily the net present value of the future economic benefits to be derived from the purchase of core deposits. Other intangibles are amortized on either an accelerated or straight-line basis over periods ranging from 5 to 15 years. Accumulated amortization on goodwill and other intangible assets was $908 million at December 31, 2001, and $666 million at December 31, 2000. Key reviews goodwill and other intangibles for impairment when impairment indicators, such as significant changes in market conditions, changes in product mix or management focus, or a potential sale or disposition, arise. In most instances, Key has used the undiscounted cash flow method in testing for impairment. In May 2001, Key recorded a goodwill impairment charge of $150 million as a result of management's decision to downsize the automobile finance business. The current accounting guidance for goodwill and other intangible assets has been superseded by the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets," which became effective for Key as of January 1, 2002. In accordance with this new guidance, Key will cease goodwill amortization and will test goodwill for impairment at least annually using various valuation techniques recommended by the new standard. Additional information pertaining to SFAS No. 142 is summarized under the heading "Accounting Pronouncements Pending Adoption," on page 62. INTERNALLY DEVELOPED SOFTWARE Key relies on both company personnel and independent contractors to plan, develop, install, customize and enhance computer systems applications that support corporate and administrative operations. Software development costs, such as those related to program coding, testing, configuration and installation, are capitalized and included in "accrued income and other assets" on the balance sheet. The resulting asset ($134 million at December 31, 2001, and $208 million at December 31, 2000) is amortized using the straight-line method over its expected useful life (not to exceed five years). Costs incurred during the planning and post-development phase of an internal software project are expensed as incurred. Software that is considered impaired is written down to its fair value. Software that is no longer used is written off to earnings immediately. When management decides to replace unimpaired software, amortization of such software is accelerated to the expected replacement date. DERIVATIVES USED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES Key uses derivatives known as interest rate swaps and caps to manage interest rate risk. These instruments modify the repricing or maturity characteristics of specified on-balance sheet assets and liabilities. For example, an interest rate cap tied to variable rate debt would effectively prevent the interest rate on that debt from rising above a specified point. Key's accounting policies related to such derivatives reflect the accounting guidance in SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (as amended and interpreted), which became effective for Key as of January 1, 2001. Additional information pertaining to this new accounting standard is summarized under the heading "Accounting Pronouncements Adopted in 2001," on page 61. Prior to the effective date of the new accounting standard, to qualify for hedge accounting treatment, a derivative had to be effective at reducing the risk associated with the exposure being managed and had to be designated as a risk management transaction at the inception of the derivative contract. An instrument effectively reduced risk if there was 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. There were several rules that governed the hedge accounting treatment of derivatives: - - Changes in fair value of a derivative were not included in the financial statements. - - The net interest income or expense associated with a derivative was accrued and recognized as an adjustment to the interest income or interest expense of the asset or liability being managed. - - The interest receivable or payable from a derivative contract was recorded in "other assets" or "other liabilities" on the balance sheet. - - Premiums paid for a derivative were amortized as an adjustment to the interest income or expense of the asset or liability being managed. - - Realized gains and losses resulting from the early termination of a derivative contract were deferred as an adjustment to the carrying amount of the related asset or liability. Such gains or losses were 60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES amortized using the straight-line method over the shorter of the projected remaining life of the derivative contract on the date of termination or the projected remaining life of the underlying asset or liability on that date. DERIVATIVES USED FOR TRADING PURPOSES Derivatives that are not used for asset and liability management purposes are used for trading purposes. Key enters into contracts for such derivatives either to make a market for clients or for proprietary trading purposes. Derivatives used for trading purposes typically include financial futures, foreign exchange forward and spot contracts, written and purchased options (including currency options), and interest rate swaps, caps and floors. All derivatives used for trading purposes are recorded at fair value. Fair value is determined by estimating the present value of future cash flows. Derivatives with a positive fair value are included in "accrued income and other assets" on the balance sheet, and derivatives with a negative fair value are included in "accrued expense and other liabilities." Changes in fair value (including payments and receipts) are recorded in "investment banking and capital markets income" on the income statement. EMPLOYEE STOCK OPTIONS Key accounts for stock options issued to employees using the intrinsic value method. This method requires that compensation expense be recognized to the extent that the fair value of the stock exceeds the exercise price of the option at the grant date. Key's employee stock options generally have fixed terms and exercise prices that are equal to or greater than the fair value of Key's common shares at the grant date, so Key generally does not recognize compensation expense related to stock options. MARKETING COSTS Key expenses all marketing-related costs, including advertising costs, as incurred. RESTRUCTURING CHARGES Key may record restructuring charges in connection with certain events or transactions, including business combinations, changes in Key's strategic plan, changes in business conditions that may result in a decrease in or exit from affected businesses, or other factors. Such charges typically result from consolidating or relocating operations, or disposing of or abandoning operations or productive assets. Any of these events could result in a significant downsizing of the workforce. To qualify as restructuring charges, costs must be incremental and incurred as a direct result of a restructuring event or transaction. Restructuring charges do not include costs that are associated with or incurred to benefit future periods. Among the costs typically included in restructuring charges are those related to: - - employee severance and termination benefits; - - the consolidation of operations facilities; and - - losses resulting from the impairment or disposal of assets. ACCOUNTING PRONOUNCEMENTS ADOPTED IN 2001 DERIVATIVES AND HEDGING ACTIVITIES. Effective January 1, 2001, Key adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This new standard establishes the appropriate accounting and reporting for derivative instruments ("derivatives") and for hedging activities. SFAS No. 133 requires that all derivatives be recognized as either assets or liabilities on the balance sheet at fair value. The accounting for changes in the fair value (i.e., gains or losses) of derivatives depends on whether they have been designated and qualify as part of a hedging relationship, and further, on the type of hedging relationship. For derivatives that are not designated as hedging instruments, the gain or loss is recognized immediately in earnings. A derivative that is designated and qualifies as a hedging instrument must be designated as either a fair value hedge, a cash flow hedge or a hedge of a net investment in a foreign operation. Key does not have any derivatives that hedge net investments in foreign operations. A fair value hedge is used to hedge changes in the fair value of existing assets, liabilities and firm commitments against changes in interest rates or other economic factors. Key recognizes the gain or loss on the derivative, as well as the related loss or gain on the hedged item attributable to the hedged risk, in earnings during the period in which the fair value changed. Thus, to the extent that the hedge is perfectly effective, the change in the fair value of the hedged item will be offset, resulting in no net effect on earnings. A cash flow hedge is used to hedge the variability of future cash flows against changes in interest rates or other economic factors. The effective portion of a gain or loss on any cash flow hedge is reported as a component of "other comprehensive income (loss)" and reclassified into earnings in the same period or periods that the hedged transaction affects earnings. Any ineffective portion of the derivative gain or loss is recognized in earnings during the current period. As a result of adopting SFAS No. 133, Key recorded cumulative after-tax losses of $1 million in earnings and $22 million in "other comprehensive income (loss)" as of January 1, 2001. The cumulative loss included in earnings represents the fair value at January 1, 2001, of all derivatives that were then designated as fair value hedges and the unrealized gain or loss on the related hedged assets and liabilities. The cumulative loss included in "other comprehensive income (loss)" represented the effective portion of the fair value of all derivatives designated as cash flow hedges. TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES. Key adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," which took effect for all transactions entered into after March 31, 2001. SFAS No. 140 added three significant new rules to practices already in effect. These new rules: - - prescribe the test that determines whether a special purpose entity ("SPE") is a "qualifying" SPE, and prescribe the amount and type of derivative instruments a qualifying SPE can hold and the activities it may pursue; 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES - - provide more restrictive guidance regarding the circumstances under which a company that transfers assets to a qualifying SPE will be deemed to have relinquished control of such assets and may account for the transaction as a sale; and - - require extensive disclosures about collateral, assets securitized and accounted for as a sale, and retained interests in securitized assets. RECOGNITION OF INTEREST INCOME AND IMPAIRMENT ON CERTAIN INVESTMENTS. In July 2000, the Emerging Issues Task Force ("EITF"), a standard- setting group working under the auspices of the Financial Accounting Standards Board ("FASB"), reached a consensus in EITF 99-20 that provides guidance on how to record interest income and measure impairment on beneficial interests retained in a securitization transaction accounted for as a sale under SFAS No. 140 and on purchased beneficial interests in securitized financial assets. Assets subject to this accounting guidance are presented on the balance sheet as securities available for sale [see Note 5 ("Securities") starting on page 66] or as trading account assets. This guidance became effective for fiscal quarters beginning after March 15, 2001, causing Key to incur a cumulative after-tax loss of $24 million in earnings for the second quarter of 2001. This loss is presented on Key's income statement as a "cumulative effect of accounting change." BUSINESS COMBINATIONS. In July 2001, the FASB issued SFAS No. 141, "Business Combinations," which eliminates the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. Since June 30, 2001, Key has not initiated any business combinations that would have qualified for the pooling-of-interests method of accounting under previous accounting standards. The last business combination accounted for by Key as a pooling-of-interests occurred in December 1994. ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION GOODWILL AND OTHER INTANGIBLE ASSETS. In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which takes effect for fiscal years beginning after December 15, 2001. Under SFAS No. 142, companies are no longer permitted to amortize goodwill and intangible assets deemed to have indefinite lives. Management anticipates that implementing this change will reduce noninterest expense and increase net income by approximately $80 million, or $.19 per common share, for 2002. Under the new accounting standard, goodwill and certain intangible assets are subject to impairment testing, which must be conducted at least annually. The first step in this testing requires Key to determine the fair value of its reporting units by using various valuation techniques recommended by the standard. The fair value of each reporting unit is compared with its carrying amount. If the fair value of a particular reporting unit exceeds its carrying amount, no impairment is indicated and further testing is not required. If the carrying amount of any reporting unit exceeds its fair value, goodwill impairment may be indicated and the second step of this testing is required. Key would assume that the purchase price of the reporting unit is the fair value as determined in the first step and then allocate that purchase price to the fair value of the assets (excluding goodwill) and liabilities of the reporting unit. Any excess purchase price over the fair value of the reporting unit's assets and liabilities represents the implied fair value of goodwill. An impairment loss would be recognized, as a charge to earnings, to the extent that the carrying amount of the reporting unit's recorded goodwill exceeds the implied fair value of goodwill. All goodwill balances are subject to future annual impairment testing. Any impairment losses that result from the initial application of SFAS No. 142 would be accounted for as a "cumulative effect of accounting change" on Key's income statement. Transitional impairment tests to determine the amount of any such losses must be completed no later than December 31, 2002, but Key expects to complete this testing before March 31, 2002. Based on preliminary test results, management anticipates that a "transition impairment charge" will not be necessary since the fair values of Key's reporting units are believed to exceed their carrying amounts. Any subsequent impairment losses would be recorded as part of income from operations. ASSET RETIREMENT OBLIGATIONS. In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The new standard takes effect for fiscal years beginning after June 15, 2002. SFAS No. 143 addresses the accounting for obligations associated with the retirement of tangible long-lived assets and requires a liability to be recognized for the fair value of these obligations in the period they are incurred. Related costs are capitalized as part of the carrying amounts of the assets to be retired and amortized over the assets' useful lives. Key will adopt SFAS No. 143 as of January 1, 2003. Management is evaluating the extent to which it may affect Key's financial condition and results of operations. IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." The new standard maintains the previous accounting for the impairment or disposal of long-lived assets, but also establishes more restrictive criteria that have to be met to classify such an asset as "held for sale." SFAS No. 144 also increases the range of dispositions that qualify for reporting as discontinued operations, and changes the manner in which expected future operating losses from such operations are to be reported. Key adopted SFAS No. 144 as of January 1, 2002. ACCOUNTING GUIDANCE ISSUED DURING 2001 ACCOUNTING AND REPORTING FOR CERTAIN LOANS HELD FOR SALE. The primary Federal banking regulators issued Interagency Guidance in March 2001 that instructs institutions and examiners about the appropriate accounting and reporting treatment for certain loans that are sold directly from the loan portfolio or transferred to a held for sale account. The Securities and Exchange Commission has expressed views that support this guidance. Specifically, once a decision has been made to sell a nonperforming loan, normal credit evaluation procedures should continue until the loan is sold or transferred to a held for sale account. If the proceeds from the sale of a nonperforming loan held in the portfolio are less than its net carrying amount, the shortfall must be recorded as a loan charge-off unless it can be demonstrated that part or all of the shortfall was attributable to market-driven factors, such as changes in interest rates or foreign exchange rates. Market-driven losses must be reported in earnings, while credit risk related losses 62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES must be reported as charge-offs. Nonperforming loans transferred to a held for sale account must be revalued at each subsequent reporting date until sold, and reported at the lower of their amortized cost or fair value. Changes in the carrying amounts of these loans must be reported as a charge to earnings. This guidance did not have a significant impact on Key during 2001, nor would it have had a significant impact on prior periods had it been issued earlier. Key has applied this guidance in sales of certain nonperforming consumer (primarily home equity) loans. 2. EARNINGS PER COMMON SHARE Key calculates its basic and diluted earnings per common share as follows:
YEAR ENDED DECEMBER 31, dollars in millions, except per share amounts 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------------------- EARNINGS Income before cumulative effect of accounting changes $ 157 $ 1,002 $ 1,107 Net income 132 1,002 1,107 - ----------------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON SHARES Weighted average common shares outstanding (000) 424,275 432,617 448,168 Effect of dilutive common stock options (000) 5,298 2,956 4,195 - ----------------------------------------------------------------------------------------------------------------------------- Weighted average common shares and potential common shares outstanding (000) 429,573 435,573 452,363 ========= ========= ========= - ----------------------------------------------------------------------------------------------------------------------------- EARNINGS PER COMMON SHARE Income per common share before cumulative effect of accounting changes $ .37 $ 2.32 $ 2.47 Net income per common share .31 2.32 2.47 Income per common share before cumulative effect of accounting changes -- assuming dilution .37 2.30 2.45 Net income per common share-- assuming dilution .31 2.30 2.45 =============================================================================================================================
3. ACQUISITIONS AND DIVESTITURES Key completed the following acquisitions and divestitures during the past three years. ACQUISITIONS THE WALLACH COMPANY, INC. On January 2, 2001, Key purchased The Wallach Company, Inc., an investment banking firm headquartered in Denver, Colorado. Key paid the purchase price of approximately $11 million using a combination of cash and 370,830 Key common shares. Goodwill of approximately $9 million was recorded and, through December 31, 2001, was being amortized using the straight-line method over a period of 10 years. 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 $10 million was recorded and, through December 31, 2001, was 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, through December 31, 2001, was being amortized using the straight-line method over a period of 15 years. Effective January 1, 2002, Key ceased amortizing goodwill in accordance with new accounting rules prescribed by SFAS No. 142, "Goodwill and Other Intangible Assets." More information related to this new accounting standard is presented in Note 1 ("Summary of Significant Accounting Policies") under the heading "Accounting Pronouncements Pending Adoption," on page 62. DIVESTITURES CREDIT CARD PORTFOLIO On January 31, 2000, Key sold its credit card portfolio of $1.3 billion in receivables and nearly 600,000 active VISA and MasterCard accounts to Associates National Bank (Delaware). Key recognized a gain of $332 million ($207 million after tax), which is included in "gains from other 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), which is included in "gains from branch divestitures" on the income statement. 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 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), which is included in "gains from other divestitures" on the income statement. ELECTRONIC PAYMENT SERVICES, INC. On February 28, 1999, Electronic Payment Services, Inc., an electronic funds transfer processor in which Key held a 20% interest (accounted for using the equity method), 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). The gain is included in "gains from other divestitures" on the income statement. On June 17, 1999, Key sold the Concord EFS shares, accounted for as securities available for sale, and recognized an additional gain of $15 million ($9 million after tax), which is included in "net securities gains (losses)" on the income statement. 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 other divestitures" on the income statement. The agreement between Key and NOVA contains a confidentiality clause that prevents Key from disclosing the specific terms of this transaction, but those terms are not material. 4. LINE OF BUSINESS RESULTS
YEAR ENDED DECEMBER 31, KEY CONSUMER BANKING ------------------------------------------------------------------- HOME EQUITY AND RETAIL BANKING CONSUMER FINANCE -------------------------------- ------------------------------- dollars in millions 2001 2000 1999 2001 2000 1999 - ------------------------------------------------------------------------------------------------------------------------- SUMMARY OF OPERATIONS Net interest income (taxable equivalent) $ 926 $ 937 $ 931 $ 589 $ 521 $ 521 Noninterest income 406 369 333 -- 50 132 Revenue sharing(a) 51 70 66 2 2 2 - ------------------------------------------------------------------------------------------------------------------------- Total revenue(b) 1,383 1,376 1,330 591 573 655 Provision for loan losses 48 50 47 130 131 129 Depreciation and amortization expense 154 159 166 44 48 54 Noninterest expense 630 652 708 299 272 282 Expense sharing(a) 36 54 57 1 -- -- - ------------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes (taxable equivalent) and cumulative effect of accounting changes 515 461 352 117 122 190 Allocated income taxes and taxable-equivalent adjustments 200 180 138 49 53 78 - ------------------------------------------------------------------------------------------------------------------------- Income (loss) before cumulative effect of accounting changes 315 281 214 68 69 112 Cumulative effect of accounting changes -- -- -- (24) -- -- - ------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 315 $ 281 $ 214 $ 44 $ 69 $ 112 ======== ======== ======== ======== ======== ======== Percent of consolidated net income 239% 28% 19% 33% 7% 10% Percent of total segments' net income 35 29 24 5 7 13 - ------------------------------------------------------------------------------------------------------------------------- AVERAGE BALANCES Loans $ 7,673 $ 7,653 $ 7,299 $ 15,594 $ 14,974 $ 14,364 Total assets(b) 9,025 9,130 8,844 16,609 16,129 15,535 Deposits 31,538 31,620 29,908 181 142 129 - ------------------------------------------------------------------------------------------------------------------------- OTHER FINANCIAL DATA Expenditures for additions to long-lived assets(b) $ 36 $ 33 $ 15 $ 8 $ 8 $ 24 - -------------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, KEY CORPORATE FINANCE ------------------------------------ dollars in millions 2001 2000 1999 - ------------------------------------------------------------------------------------ SUMMARY OF OPERATIONS Net interest income (taxable equivalent) $ 1,404 $ 1,329 $ 1,222 Noninterest income 336 310 325 Revenue sharing(a) 133 132 113 - ------------------------------------------------------------------------------------ Total revenue(b) 1,873 1,771 1,660 Provision for loan losses 206 199 179 Depreciation and amortization expense 81 80 76 Noninterest expense 675 636 643 Expense sharing(a) 77 82 71 - ----------------------------------------------------------------------------------- Income (loss) before income taxes (taxable equivalent) and cumulative effect of accounting changes 834 774 691 Allocated income taxes and taxable-equivalent adjustments 319 297 262 - ----------------------------------------------------------------------------------- Income (loss) before cumulative effect of accounting changes 515 477 429 Cumulative effect of accounting changes -- -- -- - ----------------------------------------------------------------------------------- Net income (loss) $ 515 $ 477 $ 429 ======== ======== ======== Percent of consolidated net income 390% 48% 39% Percent of total segments' net income 56 50 48 - ----------------------------------------------------------------------------------- AVERAGE BALANCES Loans $ 35,504 $ 34,654 $ 31,546 Total assets(b) 37,312 36,524 33,294 Deposits 6,640 6,421 6,077 - ----------------------------------------------------------------------------------- OTHER FINANCIAL DATA Expenditures for additions to long-lived assets(b) $ 19 $ 24 $ 20 - -----------------------------------------------------------------------------------
(a) Represents revenue and expense generated by Key Capital Partners that gets assigned 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. These latter charges are part of net interest income and are allocated to the business segments through noninterest expense. Noninterest income for 2001 includes a $40 million ($25 million after tax) loss recorded in connection with declines in leased vehicle residual values and a $15 million ($9 million after tax) increase in the reserve for customer derivative losses. Noninterest income also includes a gain of $332 million ($207 million after tax) in 2000 from the sale of Key's credit card business and $357 million ($225 million after tax) in 1999 from divestitures. In addition, noninterest income includes $5 million ($3 million after tax) in 2000 and $74 million ($47 million after tax) in 1999 earned by since-divested businesses. These businesses also added $13 million ($8 million after tax) in 2000 and $175 million ($110 million after tax) in 1999 to net interest income. 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES Key's major lines of business are Key Consumer Banking, Key Corporate Finance and Key Capital Partners. KEY CONSUMER BANKING RETAIL BANKING (A DIVISION OF KEY CONSUMER BANKING) - -------------------------------------------------- Retail Banking delivers a complete line of branch-based financial products and services to consumers through 911 KeyCenters (retail banking branches). These KeyCenters are operated by relationship managers and supported by a telephone banking call center, 2,333 ATMs that access 12 different networks (comprising one of the largest ATM networks in the United States) and a leading-edge Internet banking service, Key.com.(R) HOME EQUITY AND CONSUMER FINANCE (A DIVISION OF KEY CONSUMER BANKING) - -------------------------------------------------------------------- Home Equity and Consumer Finance provides indirect, non-branch-based consumer loan products, including home equity loans, education loans, automobile loans and marine loans. As of December 31, 2001, based on the volume of loans generated, Home Equity and Consumer Finance was one of the foremost lenders for education, automobile purchases and purchases of marine vehicles in the United States. KEY CORPORATE FINANCE Key Corporate Finance offers a complete range of financing, transaction processing, electronic commerce and financial advisory services to corporations nationwide. It operates one of the largest bank-affiliated equipment leasing companies in the world, with operations in the United States, Canada, Europe, Asia and the Pacific Rim. Key Corporate Finance also offers investment banking, capital markets, 401(k) and trust custody products in cooperation with Key Capital Partners. Key Corporate Finance is organized around four primary lines of business: National Commercial Real Estate, National Equipment Finance, Corporate Banking and Small Business. Across Key's 12-state franchise, the Corporate Banking and Small Business lines have a significant market share with clients ranging from small businesses to large corporations. Nationally, Key Corporate Finance provides financial services to the commercial real estate and equipment leasing industries. It also serves the unique needs of firms operating in the media and telecommunications, healthcare and technology industries. Based on total transaction volume, it is one of the nation's leading providers of cash management services.
KEY CAPITAL PARTNERS OTHER SEGMENTS TOTAL SEGMENTS - ----------------------------------- ----------------------------------- --------------------------------- 2001 2000 1999 2001 2000 1999 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------- $ 213 $ 206 $ 198 $ (151) $ (101) $ (66) $ 2,981 $ 2,892 $ 2,806 941 973 932 66 142 156 1,749 1,844 1,878 (186) (204) (181) -- -- -- -- -- -- - ----------------------------------------------------------------------------------------------------------------- 968 975 949 (85) 41 90 4,730 4,736 4,684 10 10 8 4 5 7 398 395 370 98 92 95 1 1 1 378 380 392 856 864 849 26 32 42 2,486 2,456 2,524 (114) (136) (128) -- -- -- -- -- -- - ----------------------------------------------------------------------------------------------------------------- 118 145 125 (116) 3 40 1,468 1,505 1,398 53 63 57 (89) (42) (26) 532 551 509 - ----------------------------------------------------------------------------------------------------------------- 65 82 68 (27) 45 66 936 954 889 -- -- -- (1) -- -- (25) -- -- - ----------------------------------------------------------------------------------------------------------------- $ 65 $ 82 $ 68 $ (28) $ 45 $ 66 $ 911 $ 954 $ 889 ======== ======== ======== ======== ======== ======== ======== ======== ======== 49% 8% 6% (21)% 4% 6% 690% 95% 80% 7 9 8 (3) 5 7 100 100 100 - ----------------------------------------------------------------------------------------------------------------- $ 5,268 $ 5,440 $ 4,514 $ 1,833 $ 2,280 $ 2,834 $ 65,872 $ 65,001 $ 60,557 9,012 9,048 8,016 11,585 11,511 11,697 83,543 82,342 77,386 3,706 3,492 3,181 3,446 3,773 1,670 45,511 45,448 40,965 - ----------------------------------------------------------------------------------------------------------------- $ 17 $ 21 $ 72 $ 8 $ 17 $ 21 $ 88 $ 103 $ 152 - -----------------------------------------------------------------------------------------------------------------
RECONCILING ITEMS KEY -------------------------------------- ------------------------------------ 2001 2000 1999 2001 2000 1999 - --------------------------------------------------------------------------------- $ (111) $ (134) $ 13 $ 2,870 $ 2,758 $ 2,819 (24) 350 437 1,725 2,194 2,315 -- -- -- -- -- -- - --------------------------------------------------------------------------------- (135)(c) 216(c) 450(c) 4,595 4,952 5,134 952(d) 95(d) (22)(d) 1,350 490 348 152(e) 2 4 530 382 396 (75)(e) 79(e) 150(e) 2,411 2,535 2,674 -- -- -- -- -- -- - --------------------------------------------------------------------------------- (1,164) 40 318 304 1,545 1,716 (385) (8) 100 147 543 609 - --------------------------------------------------------------------------------- (779) 48 218 157 1,002 1,107 -- -- -- (25) -- -- - --------------------------------------------------------------------------------- $ (779) $ 48 $ 218 $ 132 $ 1,002 $ 1,107 =========== ======== ======== ======== ======== ========= (590)% 5% 20% 100% 100% 100% N/A N/A N/A N/A N/A N/A - --------------------------------------------------------------------------------- $ 104 $ 293 $ 1,844 $ 65,976 $ 65,294 $ 62,401 1,360(f) 1,693(f) 3,560(f) 84,903 84,035 80,946 (56) (13) 1,015 45,455 45,435 41,980 - --------------------------------------------------------------------------------- $ 101 $ 97 $ 87 $ 189 $ 200 $ 239 - ---------------------------------------------------------------------------------
(d) The provision for loan losses for 2001 includes an additional $400 million ($252 million after tax) taken to increase the allowance for loan losses for Key's continuing loan portfolio and an additional $490 million ($309 million after tax) recorded primarily in connection with Key's decision to discontinue certain nonrelationship credit-only commercial lending. In 2000, the provision for loan losses includes an additional $121 million ($76 million after tax) that resulted from the implementation of an enhanced methodology for assessing credit risk, particularly in the commercial loan portfolio. In 1999, the provision includes an additional $30 million ($19 million after tax) related to an enhancement of the allowance methodology pertaining to the credit card portfolio. (e) Noninterest expense for 2001 includes a goodwill write-down of $150 million associated with Key's decision to downsize its automobile finance business, a $20 million ($13 million after tax) increase in litigation reserves and nonrecurring charges of $2 million ($1 million after tax) recorded in connection with strategic actions being taken to improve Key's operating efficiency and profitability. Noninterest expense for 2000 includes $127 million (80 million after tax) of nonrecurring charges recorded in connection with strategic actions being taken to improve Key's operating efficiency and profitability and $5 million ($3 million after tax) incurred by the since-divested credit card business. Noninterest expense in 1999 includes $152 million ($96 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 1999 also includes special contributions of $23 million ($15 million after tax) made to the charitable foundation that Key sponsors, $42 million ($26 million after tax) of various other nonrecurring charges and $74 million ($46 million after tax) incurred by since-divested businesses. (f) Total assets represent primarily the unallocated portion of nonearning assets of corporate support functions. N/A = Not Applicable 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES KEY CAPITAL PARTNERS Key Capital Partners offers specialized services to high-net-worth clients through the wealth management and private banking businesses. It also provides asset management, investment banking and capital markets expertise, and various other services, including brokerage, employee benefits and insurance. Key Capital Partners employs a range of distribution outlets, including Key's existing retail banking branches and commercial offices. The table that spans pages 64 and 65 shows selected financial data for each major line of business for the years ended December 31, 2001, 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 the businesses. As such: - - Net interest income is determined by assigning a standard cost for funds used (or a standard credit for funds provided) to assets and liabilities based on their maturity, prepayment and/or repricing characteristics. The net effect of this funds transfer pricing is included in the "Other Segments" columns. - - Indirect expenses, such as computer servicing costs and corporate overhead, are allocated based on the extent to which each line actually uses the service. - - The provision for loan losses reflects credit quality expectations over a normal business cycle. This "normalized provision for loan losses" does not necessarily coincide with actual net loan charge-offs at any given point in the cycle. The level of the consolidated provision is based upon the methodology that management uses to estimate Key's 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 59. - - Income taxes are 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%. - - Capital is assigned based on management's assessment of economic risk factors (primarily credit, operating and market risk). Developing and applying the methodologies that management uses 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 business or changes in Key's structure. The financial data presented in the accompanying table reflects the following changes that occurred during 2001: - - A number of businesses have been reclassified. The Key Electronic Services unit moved from Other Segments to Retail Banking; the Small Business unit moved from Retail Banking to Key Corporate Finance; the Community Development unit moved from Key Corporate Finance to Retail Banking; and the Principal Investing unit moved from Key Capital Partners to Other Segments. - - The methodology used to assign a provision for loan losses to each line of business was changed from one based primarily upon actual net charge-offs to a methodology based on the credit quality expectations within each line over a normal business cycle. - - The methodologies used to apply funds transfer pricing and to allocate certain balance sheet items and overhead costs were refined. Accounting principles generally accepted in the United States guide financial accounting, but there is no authoritative guidance for "management accounting" - -- the way management uses its judgment and experience to make reporting decisions. Consequently, the line of business results Key reports may not be comparable with results presented by other companies. 5. SECURITIES The amortized cost, unrealized gains and losses, and approximate fair value of Key's securities were as follows:
DECEMBER 31, 2001 2000 -------------------------------------------- ------------------------------------------------ GROSS GROSS GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE - ----------------------------------------------------------------------------------------------------------------------------------- INVESTMENT SECURITIES States and political subdivisions $ 225 $ 9 -- $ 234 $ 323 $ 10 -- $ 333 Other securities 894 -- -- 894 875 -- -- 875 - ----------------------------------------------------------------------------------------------------------------------------------- Total investment securities $1,119 $ 9 -- $1,128 $1,198 $ 10 -- $1,208 ====== ====== ==== ====== ====== ====== ====== ====== - ----------------------------------------------------------------------------------------------------------------------------------- SECURITIES AVAILABLE FOR SALE U.S. Treasury, agencies and corporations $ 99 -- -- $ 99 $ 984 -- -- $ 984 States and political subdivisions 21 -- -- 21 33 -- -- 33 Collateralized mortgage obligations 3,791 $ 86 $ 72 3,805 4,296 $ 63 $ 61 4,298 Other mortgage-backed securities 1,008 24 -- 1,032 1,355 12 12 1,355 Retained interests in securitizations 214 20 -- 234 334 -- 18 316 Other securities 170 1 16 155 307 42 6 343 - ----------------------------------------------------------------------------------------------------------------------------------- Total securities available for sale $5,303 $ 131 $ 88 $5,346 $7,309 $ 117 $ 97 $7,329 ====== ====== ====== ====== ====== ====== ====== ====== - -----------------------------------------------------------------------------------------------------------------------------------
66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES "Other securities" held in the investment securities portfolio are primarily principal investing assets, which are carried on the balance sheet at fair value. When Key retains an interest in loans it securitizes, it bears risk that the loans will be prepaid (which would reduce interest income) or not paid at all. Key accounts for these retained interests (which include both certificated and uncertificated interests) as debt securities, classifying them as available for sale or as trading account assets. "Other securities" held in the available for sale portfolio are primarily marketable equity securities, including an internally managed portfolio of bank common stock investments. Realized gains and losses related to securities available for sale were as follows: YEAR ENDED DECEMBER 31, in millions 2001 2000 1999 - -------------------------------------------------------------------------------- Realized gains $40 $ 59 $42 Realized losses 5 87 13 - -------------------------------------------------------------------------------- Net securities gains (losses) $35 $(28) $29 === === === - -------------------------------------------------------------------------------- At December 31, 2001, securities available for sale and investment securities with an aggregate amortized cost of approximately $4.7 billion were pledged to secure public and trust deposits, securities sold under repurchase agreements, and for other purposes required or permitted by law. The following table shows securities available for sale and investment securities by remaining contractual maturity. Included in securities available for sale are collateralized mortgage obligations, other mortgage-backed securities and retained interests in securitizations. All of these securities are presented based on their expected average lives. SECURITIES INVESTMENT AVAILABLE FOR SALE SECURITIES ---------------------- ------------------ DECEMBER 31, 2001 AMORTIZED FAIR AMORTIZED FAIR in millions COST VALUE COST VALUE - -------------------------------------------------------------------------------- Due in one year or less $1,584 $1,630 $ 94 $ 95 Due after one through five years 3,044 3,119 96 103 Due after five through ten years 269 251 79 81 Due after ten years 406 346 850 849 - -------------------------------------------------------------------------------- Total $5,303 $5,346 $1,119 $1,128 ====== ====== ====== ====== - -------------------------------------------------------------------------------- 6. LOANS Key's loans by category are summarized as follows: DECEMBER 31, in millions 2001 2000 - -------------------------------------------------------------------------------- Commercial, financial and agricultural $18,159 $20,100 Commercial real estate: Commercial mortgage 6,669 6,876 Construction 5,878 5,154 - -------------------------------------------------------------------------------- Total commercial real estate loans 12,547 12,030 Commercial lease financing 7,357 7,164 - -------------------------------------------------------------------------------- Total commercial loans 38,063 39,294 Real estate-- residential mortgage 2,315 4,212 Home equity 11,184 9,908 Consumer-- direct 2,342 2,539 Consumer-- indirect: Lease financing 2,036 3,005 Automobile 2,497 2,809 Marine 1,780 1,657 Other 1,036 1,252 - -------------------------------------------------------------------------------- Total consumer--indirect loans 7,349 8,723 - -------------------------------------------------------------------------------- Total consumer loans 23,190 25,382 Loans held for sale: Real estate-- commercial mortgage 252 316 Real estate-- residential mortgage 116 42 Education 1,688 1,871 - -------------------------------------------------------------------------------- Total loans held for sale 2,056 2,229 - -------------------------------------------------------------------------------- Total loans $63,309 $66,905 ======= ======= - -------------------------------------------------------------------------------- Key uses interest rate swaps to manage interest rate risk; these swaps modify the repricing and maturity characteristics of certain loans. For more information about such swaps at December 31, 2001, see Note 20 ("Derivatives and Hedging Activities"), which begins on page 80. Commercial and consumer lease financing receivables in the preceding table include contracts that represent direct financing leases, leveraged leases and operating leases. The composition of the net investment in the predominant form, direct financing leases, is as follows: DECEMBER 31, in millions 2001 2000 - -------------------------------------------------------------------------------- Direct financing lease receivable $ 6,899 $ 8,027 Unearned income (897) (1,097) Unguaranteed residual value 597 648 Deferred fees and costs 120 100 - -------------------------------------------------------------------------------- Net investment in direct financing leases $ 6,719 $ 7,678 ======= ======== - -------------------------------------------------------------------------------- Minimum future lease payments to be received at December 31, 2001, are as follows: 2002-- $1,496 million; 2003-- $1,413 million; 2004 -- $1,115 million; 2005 -- $873 million; 2006 -- $771 million; and all subsequent years -- $1,231 million. Changes in the allowance for loan losses are summarized as follows: YEAR ENDED DECEMBER 31, in millions 2001 2000 1999 - -------------------------------------------------------------------------------- Balance at beginning of year $ 1,001 $ 930 $ 900 Charge-offs (784) (522) (420) Recoveries 111 108 102 - -------------------------------------------------------------------------------- Net charge-offs (673) (414) (318) Allowance related to loans sold (1) (5) -- Provision for loan losses 1,350 490 348 - -------------------------------------------------------------------------------- Balance at end of year $ 1,677 $ 1,001 $ 930 ======= ======= ======= - -------------------------------------------------------------------------------- 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 7. RETAINED INTERESTS IN LOAN SECURITIZATIONS Key sells certain types of loans through securitizations. A securitization involves the sale of a pool of loan receivables to investors through either a public or private issuance of asset-backed securities. Generally, the assets are transferred to a trust that sells interests in the form of certificates of ownership. In some cases, Key retains an interest in the securitized loans. Certain assumptions and estimates are used to determine the fair value allocated to these retained interests at the date of transfer and at subsequent measurement dates. These assumptions and estimates include loan repayment rates, projected charge-offs and discount rates commensurate with the risks involved. Additional information pertaining to Key's residual interests is disclosed in Note 1 ("Summary of Significant Accounting Policies") under the heading "Loan Securitizations" on page 59. During 2001 and 2000, Key securitized and sold $523 million and $1.1 billion, respectively, of education loans (including accrued interest). The securitizations resulted in an aggregate gain of $11 million in 2001 and $18 million in 2000. In these transactions, Key retained residual interests in the form of servicing assets and interest-only strips. During 2001, Key retained a servicing asset of $4 million and an interest-only strip of $16 million. During 2000, Key retained servicing assets of $7 million and interest-only strips of $48 million. The primary assumptions and rates used to measure the fair value of these retained interests are essentially the same as those disclosed in the following table. In 2001 and 2000, Key received gross cash proceeds of $534 million and $1.1 billion, respectively, from new securitizations from the education lending securitization trusts. Primary economic assumptions used to measure the fair value of Key's retained interests and the sensitivity of the current fair value of residual cash flows to immediate adverse changes in those assumptions are as follows:
DECEMBER 31, 2001 EDUCATION HOME EQUITY AUTOMOBILE dollars in millions LOANS LOANS LOANS - --------------------------------------------------------------------------------------------------- Carrying amount (fair value) of retained interests $223 $106 $10 Weighted-average life (years) 1.6-5.1 2.3-2.9 .8 - --------------------------------------------------------------------------------------------------- PREPAYMENT SPEED ASSUMPTIONS (ANNUAL RATE) 7.99%-- 16.32% 23.83%-- 27.69% 1.59% Impact on fair value of 1% CPR (education and home equity) and .10% ABS (automobile) adverse change $(4) $(1) -- Impact on fair value of 2% CPR (education and home equity) and .20% ABS (automobile) adverse change (9) (3) -- - --------------------------------------------------------------------------------------------------- EXPECTED CREDIT LOSSES (STATIC RATE) .01%-- 1.58% 1.26%-- 2.27% 5.51% Impact on fair value of .10% (education) and .25% (home equity and automobile) adverse change $(5) $(5) $(1) Impact on fair value of .20% (education) and .50% (home equity and automobile) adverse change (11) (9) (2) - --------------------------------------------------------------------------------------------------- RESIDUAL CASH FLOWS DISCOUNT RATE (ANNUAL RATE) 8.50%-- 12.00% 7.50%-- 12.00% 9.00% Impact on fair value of 1% adverse change $(5) $(2) -- Impact on fair value of 2% adverse change (10) (4) -- - --------------------------------------------------------------------------------------------------- EXPECTED STATIC DEFAULT (STATIC RATE) 10.46%-- 16.04% N/A N/A Impact on fair value of 1% (education loans) adverse change $(5) N/A N/A Impact on fair value of 2% (education loans) adverse change (9) N/A N/A - --------------------------------------------------------------------------------------------------- VARIABLE RETURNS TO TRANSFEREES (a) (b) (c) - ---------------------------------------------------------------------------------------------------
These sensitivities are hypothetical and should be relied upon with caution. Sensitivity analysis for each asset type is based on the nature of the asset, the seasoning of the portfolio and the results experienced. Changes in fair value based on a 1% variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption; in reality, changes in one factor may cause changes in another. For example, increases in market interest rates may result in lower prepayments and increased credit losses, which might magnify or counteract the sensitivities. (a) Forward Libor plus contractual spread over Libor ranging from .07% to .75%, or Treasury plus contractual spread over Treasury ranging from .65% to 1.00% or fixed rate yield. (b) Forward Libor plus contractual spread over Libor ranging from .23% to .40%, or Treasury plus contractual spread over Treasury ranging from 2.40% to 2.95% or fixed rate yield. (c) Fixed rate yield. CPR = Constant Prepayment Rate ABS = Absolute Prepayment Speed N/A = Not Applicable Information about Key's managed loans, delinquencies and net credit losses is as follows:
DECEMBER 31, 2001 -------------------------------- LOAN LOANS PAST DUE NET CREDIT LOSSES in millions PRINCIPAL 60 DAYS OR MORE DURING 2001 - ------------------------------------------------------------------------------------------------------------ Education loans $ 6,121 $ 163 $ 13 Home equity loans 11,952 200 104 Automobile loans 2,628 41 106 - ------------------------------------------------------------------------------------------------------------ Total loans managed and securitized 20,701 404 223 Less: Loans securitized 5,332 238 20 Loans held for sale or securitization 1,688 -- -- - ------------------------------------------------------------------------------------------------------------ Loans held in portfolio $13,681 $ 166 $ 203 ======= ======= ======= - ------------------------------------------------------------------------------------------------------------
68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 8. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS At December 31, 2001, impaired loans totaled $661 million. This amount includes $417 million of impaired loans with a specifically allocated allowance for loan losses of $180 million, and $244 million of impaired loans that are carried at their estimated fair value without a specifically allocated allowance. At the end of 2000, impaired loans totaled $396 million, including $236 million of loans with a specifically allocated allowance of $107 million, and $160 million that were carried at their estimated fair value. Impaired loans averaged $535 million for 2001, and $337 million for 2000. Key's nonperforming assets were as follows: DECEMBER 31, in millions 2001 2000 - ---------------------------------------------------------------- Impaired loans $661 $396 Other nonaccrual loans 249 251 - ---------------------------------------------------------------- Total nonaccrual loans 910 647 Restructured loans(a) -- 3 - ---------------------------------------------------------------- Total nonperforming loans 910 650 OREO 38 23 Allowance for OREO losses (1) (1) - ---------------------------------------------------------------- OREO, net of allowance 37 22 Other nonperforming assets -- -- - ---------------------------------------------------------------- Total nonperforming assets $947 $672 ==== ==== - ---------------------------------------------------------------- (a) Excludes restructured loans on nonaccrual status. At December 31, 2001, Key did not have any significant commitments to lend additional funds to borrowers with restructured loans or loans on nonaccrual status. Key evaluates most impaired loans individually using the process described under the heading "Allowance for Loan Losses," on page 59. However, Key does not perform a specific impairment valuation for smaller-balance, homogeneous, nonaccrual loans (shown in the preceding table as "Other nonaccrual loans"). Generally, these include residential mortgages and automobile and marine loans. Instead, management applies historical loss experience rates to these loans, adjusted to reflect emerging credit trends and other factors, and then allocates a portion of the allowance for loan losses to each loan type. The following table shows the amount by which loans classified as nonperforming at December 31 reduced Key's expected interest income. Year ended December 31, in millions 2001 2000 1999 - ----------------------------------------------------------------- Interest income receivable under original terms $52 $62 $38 Less: Interest income recorded during the year 21 25 15 - ----------------------------------------------------------------- Net reduction to interest income $31 $37 $23 === === === - ----------------------------------------------------------------- 9. SHORT-TERM BORROWINGS Selected financial information pertaining to the components of Key's short-term borrowings is as follows:
dollars in millions 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------------------------- FEDERAL FUNDS PURCHASED Balance at year end $2,591 $3,267 $1,883 Average during the year 3,575 2,991 2,254 Maximum month-end balance 5,034 4,693 3,712 Weighted average rate during the year 4.00% 6.42% 5.01% Weighted average rate at December 31 1.72 6.68 5.54 - ----------------------------------------------------------------------------------------------------------------------------------- SECURITIES SOLD UNDER REPURCHASE AGREEMENTS Balance at year end $1,144 $1,669 $2,294 Average during the year 1,622 1,940 2,602 Maximum month-end balance 1,807 2,447 2,969 Weighted average rate during the year 3.39% 4.90% 4.11% Weighted average rate at December 31 1.80 6.01 4.45 - ----------------------------------------------------------------------------------------------------------------------------------- SHORT-TERM BANK NOTES Balance at year end $3,748 $4,345 $6,379 Average during the year 4,649 5,021 5,633 Maximum month-end balance 6,098 6,834 7,174 Weighted average rate during the year 5.01% 7.35% 5.54% Weighted average rate at December 31 2.16 8.28 6.46 - ----------------------------------------------------------------------------------------------------------------------------------- OTHER SHORT-TERM BORROWINGS Balance at year end $1,801 $2,612 $2,060 Average during the year 2,179 2,100 2,279 Maximum month-end balance 2,841 2,326 3,452 Weighted average rate during the year 2.39% 3.10% 4.04% Weighted average rate at December 31 2.18 3.31 3.43 - -----------------------------------------------------------------------------------------------------------------------------------
Key uses interest rate swaps and caps, which modify the repricing and maturity characteristics of certain short-term borrowings, to manage interest rate risk. For more information about such financial instruments at December 31, 2001, see Note 20 ("Derivatives and Hedging Activities"),which begins on page 80. 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES Key has several programs that support short-term financing needs. BANK NOTE PROGRAM. This program provides for the issuance of up to $20.0 billion ($19.0 billion by KeyBank National Association and $1.0 billion by Key Bank USA, National Association) of bank notes with original maturities of 30 days to 30 years. At December 31, 2001, the amount of bank notes available for issuance by KeyBank National Association under the program was $8.2 billion. EURO NOTE PROGRAM. KeyCorp, KeyBank National Association and Key Bank USA, National Association may issue both long- and short-term debt of up to $10.0 billion to non-U.S. investors. This facility had $4.0 billion of long-term borrowings outstanding and $5.7 billion available for future issuance as of December 31, 2001. COMMERCIAL PAPER AND REVOLVING CREDIT. KeyCorp's commercial paper program and revolving credit agreement provide funding availability of up to $500 million and $400 million, respectively. Borrowings outstanding under the commercial paper program totaled $25 million at December 31, 2001, and $315 million at December 31, 2000. There were no borrowings outstanding under the revolving credit agreement at December 31, 2001 and 2000. This agreement serves as a back-up facility for the commercial paper program. LINE OF CREDIT. KeyBank National Association has overnight borrowing capacity at the Federal Reserve Bank. At December 31, 2001, this capacity was approximately $16.5 billion and was secured by approximately $25.0 billion of primarily commercial loans. There were no borrowings outstanding under this facility at December 31, 2001 and 2000. PARENT COMPANY NOTE PROGRAM. This program provides for the issuance of up to $1.0 billion of notes with original maturities of 30 days to 30 years. At December 31, 2001, the amount of notes available for issuance under the program was $1.0 billion. 10. LONG-TERM DEBT The components of Key's long-term debt, presented net of unamortized discount where applicable, were as follows: DECEMBER 31, dollars in millions 2001 2000 - ----------------------------------------------------------------- Senior medium-term notes due through 2005(a) $ 1,286 $ 393 Subordinated medium-term notes due through 2005(a) 85 103 Senior euro medium-term notes due through 2003(b) 50 -- 7.50% Subordinated notes due 2006(c) 250 250 6.75% Subordinated notes due 2006(c) 200 200 8.125% Subordinated notes due 2002(c) 200 199 8.00% Subordinated notes due 2004(c) 125 125 8.404% Notes due through 2001 -- 13 All other long-term debt(i) 16 -- - ----------------------------------------------------------------- Total parent company(j) 2,212 1,283 Senior medium-term bank notes due through 2039(d) 4,525 5,979 Senior euro medium-term bank notes due through 2007(e) 3,989 3,955 6.50% Subordinated remarketable securities due 2027(f) 311 312 6.95% Subordinated notes due 2028(f) 300 300 7.125% Subordinated notes due 2006(f) 250 250 7.25% Subordinated notes due 2005(f) 200 200 6.75% Subordinated notes due 2003(f) 200 200 7.50% Subordinated notes due 2008(f) 165 165 7.00% Subordinated notes due 2011(f) 506 -- 7.30% Subordinated notes due 2011(f) 107 107 7.85% Subordinated notes due 2002(f) 93 93 7.55% Subordinated notes due 2006(f) 75 75 7.375% Subordinated notes due 2008(f) 70 70 Lease financing debt due through 2006(g) 519 581 Federal Home Loan Bank advances due through 2030(h) 762 452 All other long-term debt(i) 270 139 - ----------------------------------------------------------------- Total subsidiaries 12,342 12,878 - ----------------------------------------------------------------- Total long-term debt $14,554 $14,161 ======= ======= - ----------------------------------------------------------------- Key uses interest rate swaps and caps, which modify the repricing and maturity characteristics of certain long-term debt, to manage interest rate risk. For more information about such financial instruments at December 31, 2001, see Note 20 ("Derivatives and Hedging Activities"), which begins on page 80. (a) At December 31, 2001, the senior medium-term notes had a weighted average interest rate of 2.51%, and the subordinated medium-term notes had a weighted average interest rate of 7.42%. At December 31, 2000, the senior medium-term notes had a weighted average interest rate of 6.81%, and the subordinated medium-term notes had a weighted average interest rate of 7.32%. These notes had a combination of fixed and floating interest rates. (b) Senior euro medium-term notes had a weighted average interest rate of 2.33% at December 31, 2001. These notes had a floating interest rate based on the three-month London Interbank Offered Rate (known as "LIBOR"). (c) The notes may not be redeemed or prepaid prior to maturity. (d) Senior medium-term bank notes of subsidiaries had weighted average interest rates of 2.45% at December 31, 2001, and 6.72% at December 31, 2000. These notes had a combination of fixed and floating interest rates. (e) The senior euro medium-term notes had weighted average interest rates of 2.58% at December 31, 2001, and 6.89% at December 31, 2000. These notes, which are obligations of KeyBank National Association, had fixed and floating interest rates based on LIBOR. (f) These notes and securities are obligations of KeyBank National Association, with the exception of the 7.55% notes, which are obligations of Key Bank USA, National Association. None of the subordinated notes may be redeemed prior to their maturity dates. (g) Lease financing debt had weighted average interest rates of 7.41% at December 31, 2001, and 7.80% at December 31, 2000. This category comprises primarily nonrecourse debt for which equipment held under operating, direct financing or sales type leases serves as collateral. (h) Long-term advances from the Federal Home Loan Bank had weighted average interest rates of 2.19% at December 31, 2001, and 6.66% at December 31, 2000. These advances, which had a combination of fixed and floating interest rates, were secured by real estate loans and securities totaling $1.1 billion at December 31, 2001, and $678 million at December 31, 2000. (i) Other long-term debt, consisting of industrial revenue bonds, capital lease obligations, and various secured and unsecured obligations of corporate subsidiaries, had weighted average interest rates of 6.72% at December 31, 2001, and 7.91% at December 31, 2000. (j) At December 31, 2001, unused capacity under KeyCorp's shelf registration totaled $2.2 billion, including $1.0 billion reserved for issuance as medium-term notes. Scheduled principal payments on long-term debt over the next five years are as follows: in millions PARENT SUBSIDIARIES TOTAL - ------------------------------------------------------------ 2002 $500 $3,861 $4,361 2003 773 3,381 4,154 2004 490 2,021 2,511 2005 3 836 839 2006 450 662 1,112 - ------------------------------------------------------------ 70 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 11. CAPITAL SECURITIES KeyCorp has five subsidiary business trusts that have issued corporation-obligated mandatorily redeemable preferred capital securities ("capital securities"), which are carried as liabilities on Key's balance sheet. These securities provide an attractive source of funds since they are given Tier I capital treatment for financial reporting purposes, but have the same tax advantages as debt for Federal income tax purposes. As guarantor, KeyCorp unconditionally guarantees payment of: - - required distributions -- both accrued and unpaid -- on the capital securities; - - the redemption price when a capital security is redeemed; and - - amounts due if a trust is liquidated or terminated. KeyCorp owns the outstanding common stock of each of the 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 effects on the income statement because they are eliminated in consolidation. The capital securities, common stock and related debentures are summarized as follows:
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) Stock Net of Discount(b) Debentures(c) Debentures - --------------------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 2001 KeyCorp Institutional Capital A $ 372 $11 $ 361 7.826% 2026 KeyCorp Institutional Capital B 160 4 154 8.250 2026 KeyCorp Capital I 247 8 255 3.340 2028 KeyCorp Capital II 242 8 255 6.875 2029 KeyCorp Capital III 267 8 257 7.750 2029 - --------------------------------------------------------------------------------------------------------------------------------- Total $1,288 $39 $1,282 6.824% -- ====== === ====== - --------------------------------------------------------------------------------------------------------------------------------- December 31, 2000 $1,243 $39 $1,282 7.619% -- ====== === ====== - ---------------------------------------------------------------------------------------------------------------------------------
(a) The capital securities must be redeemed 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. Included in certain capital securities at December 31, 2001, are basis adjustments of $45 million related to fair value hedges. (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 be the greater of: (a) the principal amount, plus any accrued but unpaid interest or (b) 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 equal to three-month LIBOR plus 74 basis points; it reprices quarterly. The rates shown as the total at December 31, 2001 and 2000, are weighted average rates. 12. SHAREHOLDERS' EQUITY SHAREHOLDER RIGHTS PLAN KeyCorp has a shareholder rights plan, which was first adopted in 1989 and has since been amended. Under the plan, each shareholder received one Right -- representing the right to purchase a common share for $82.50 -- for each KeyCorp common share owned. All of the Rights expire on May 14, 2007, but KeyCorp may redeem Rights earlier for $.005 apiece, subject to certain limitations. Rights will become exercisable if a person or group acquires 15% or more of KeyCorp's outstanding shares. Until that time, the Rights will trade with the common shares; any transfer of a common share will also constitute a transfer of the associated Right. If the Rights become exercisable, they will begin to trade apart from the common shares. If one of a number of "flip-in events" occurs, each Right will entitle the holder to purchase a KeyCorp common share for $1.00 (the par value per share), and the Rights held by a 15% or more shareholder will become void. CAPITAL ADEQUACY KeyCorp and its banking subsidiaries must meet specific capital requirements imposed by banking industry regulators. Sanctions for failure to meet applicable capital requirements may include regulatory enforcement actions that restrict dividend payments, require increased capital, terminate Federal Deposit Insurance Corporation ("FDIC") deposit insurance, and mandate the appointment of a conservator or receiver in severe cases. As of December 31, 2001, KeyCorp and its banking subsidiaries met all necessary capital requirements. Federal bank regulators apply certain capital ratios to assign FDIC-insured depository institutions to one of five categories: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." At December 31, 2001 and 2000, the most recent regulatory notification categorized each of KeyCorp's subsidiary banks as "well capitalized." Management 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES believes that there have not been any changes in condition or events since those notifications that would cause the banks' categorizations to change. Unlike bank subsidiaries, bank holding companies are not categorized by capital adequacy. However, Key satisfied the criteria for a "well capitalized" institution at December 31, 2001 and 2000. The FDIC-defined capital categories serve a limited regulatory function and may not accurately represent the overall financial condition or prospects of Key or its affiliates. The following table presents Key and KeyBank National Association's actual capital amounts and ratios, minimum capital amounts and ratios prescribed by regulatory guidelines, and capital amounts and ratios required to qualify as "well capitalized" under the Federal Deposit Insurance Act.
To Qualify as Well To Meet Minimum Capitalized Capital Adequacy Under Federal Deposit Actual Requirements Insurance Act ------------------------ ------------------------ ------------------------- dollars in millions Amount Ratio Amount Ratio Amount Ratio - --------------------------------------------------------------------------------------------------------------------------------- December 31, 2001 TOTAL CAPITAL TO NET RISK-WEIGHTED ASSETS Key $9,548 11.41% $6,696 8.00% N/A N/A KeyBank National Association 7,970 10.63 5,993 8.00 $7,492 10.00% TIER 1 CAPITAL TO NET RISK-WEIGHTED ASSETS Key $6,222 7.43% $3,348 4.00% N/A N/A KeyBank National Association 5,170 6.90 2,997 4.00 $4,495 6.00% TIER 1 CAPITAL TO AVERAGE ASSETS Key $6,222 7.65% $2,440 3.00% N/A N/A KeyBank National Association 5,170 7.13 2,897 4.00 $3,622 5.00% - --------------------------------------------------------------------------------------------------------------------------------- December 31, 2000 TOTAL CAPITAL TO NET RISK-WEIGHTED ASSETS Key $9,637 11.48% $6,718 8.00% N/A N/A KeyBank National Association 8,491 11.03 6,158 8.00 $7,697 10.00% TIER 1 CAPITAL TO NET RISK-WEIGHTED ASSETS Key $6,484 7.72% $3,359 4.00% N/A N/A KeyBank National Association 6,030 7.83 3,079 4.00 $4,618 6.00% TIER 1 CAPITAL TO AVERAGE ASSETS Key $6,484 7.71% $2,522 3.00% N/A N/A KeyBank National Association 6,030 7.98 3,022 4.00 $3,778 5.00% - --------------------------------------------------------------------------------------------------------------------------------- N/A = Not Applicable
13. STOCK OPTIONS Key's compensation plans allow for the granting of stock options, stock appreciation rights, limited stock appreciation rights, restricted stock and performance shares to eligible employees and directors. Under all of the option plans, exercise prices cannot be less than the fair value of Key's common stock on the grant date. Generally, options become exercisable at the rate of 33% per year beginning one year from their grant date and expire no later than 10 years from their grant date. At December 31, 2001, KeyCorp had 8,480,101 common shares available for future grant, compared with 8,465,078 at December 31, 2000. The following table summarizes activity, pricing and other information about Key's stock options.
2001 2000 ------------------------------ -------------------------------- Weighted Average Weighted Average Options Price Per Option Options Price Per Option - -------------------------------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 34,291,153 $23.72 29,481,297 $24.72 Granted 7,377,680 28.02 9,345,858 19.53 Exercised 2,212,746 14.96 1,931,652 14.50 Lapsed or canceled 5,209,764 27.27 2,604,350 26.82 - -------------------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 34,246,323 $24.66 34,291,153 $23.72 - -------------------------------------------------------------------------------------------------------------------------------- Exercisable at end of year 19,501,856 $24.80 20,662,121 $19.74 - --------------------------------------------------------------------------------------------------------------------------------
72 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES The following table summarizes the range of exercise prices and other related information pertaining to Key's stock options at December 31, 2001.
Weighted Weighted Average Weighted Range of Options Average Price Remaining Options Average Price Exercise Prices Outstanding Per Option Life (Years) Exercisable Per Option - --------------------------------------------------------------------------------------------------------------------------------- $4.13-$14.99 3,892,959 $14.15 2.1 3,832,037 $14.16 15.00-19.99 6,480,166 17.50 6.3 2,777,670 17.31 20.00-24.99 4,410,234 21.70 8.1 1,802,625 21.74 25.00-29.99 9,257,245 27.68 8.2 2,166,690 26.51 30.00-34.99 9,882,719 31.38 6.6 8,599,834 31.48 35.00-50.00 323,000 43.44 6.8 323,000 43.44 - --------------------------------------------------------------------------------------------------------------------------------- Total 34,246,323 $24.66 6.7 19,501,856 $24.80 =================================================================================================================================
SFAS No. 123, "Accounting for Stock-Based Compensation," requires companies like Key that use the "intrinsic value method" to account for employee stock options to provide pro forma disclosures of the net income and earnings per share effect of stock options using the "fair value method." Under the intrinsic value method, the excess of the fair value of the stock over the exercise price is recorded as expense on the date at which both the number of shares the recipient is entitled to receive and the exercise price are known. Management estimated the fair value of options granted using the Black-Scholes option-pricing model. This model was originally developed to estimate the fair value of exchange-traded equity options, which (unlike employee stock options) have no vesting period or transferability restrictions. As a result, the Black-Scholes model is not a perfect indicator of the value of an option, but it is commonly used for this purpose. The Black-Scholes model requires several assumptions, which management developed based on historical trends and current market observations. These assumptions include: - - an average option life of 3.9 years in 2001, 4.7 years in 2000 and 4.3 years in 1999; - - a future dividend yield of 4.22% in 2001, 5.83% in 2000 and 3.4% in 1999; - - share price volatility of .330 in 2001, .267 in 2000 and .256 in 1999; and - - a weighted average risk-free interest rate of 5.0% in 2001, 6.6% in 2000 and 4.9% in 1999. If these assumptions are not accurate, the estimated fair values used to derive the information presented in the following table also will be inaccurate. Moreover, the model assumes that the estimated fair value of an option is amortized over the option's vesting period and would be included in personnel expense on the income statement. The pro forma impact of applying the fair value method of accounting for the years shown below may not be indicative of the pro forma impact in future years. YEAR ENDED DECEMBER 31, in millions, except per share amounts 2001 2000 1999 - ----------------------------------------------------------------------- Net income $132 $1,002 $1,107 Net income -- pro forma 107 985 1,085 Per common share: Net income $.31 $2.32 $2.47 Net income -- pro forma .25 2.28 2.42 Net income assuming dilution .31 2.30 2.45 Net income assuming dilution -- pro forma .25 2.24 2.39 - ----------------------------------------------------------------------- 14. RESTRUCTURING CHARGES During 2001, KeyCorp recorded a restructuring charge credit of $4 million ($2 million after tax) in connection with a competitiveness initiative instituted in November 1999 to improve Key's operating efficiency and profitability. Restructuring charges previously recorded under this initiative totaled $104 million ($66 million after tax) in 2000 and $98 million ($62 million after tax) in 1999. In the first phase of the initiative, Key outsourced certain technology and corporate support functions, consolidated sites in a number of Key's businesses and reduced the number of management layers. This phase was completed last year. The second and final phase, which started during the second half of 2000, is focusing on: - - simplifying Key's business structure by consolidating 22 business lines into 10; - - 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 initiative, Key estimated that it would reduce its workforce by approximately 4,000 positions. Those reductions were to occur at all levels throughout the organization. At December 31, 2001, nearly 3,900 positions had been eliminated. Management expects to eliminate the remaining positions -- both staffed and vacant -- by the end of the first quarter of 2002. 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES Changes in the components of the restructuring charge liability associated with the actions discussed on page 73 are as follows:
December 31, Restructuring Cash December 31, in millions 2000 Charges (Credits) Payments 2001 - -------------------------------------------------------------------------------------------------------------------- Severance $ 62 $(7) $28 $27 Site consolidations 60 4 31 33 Equipment and other 2 (1) -- 1 - -------------------------------------------------------------------------------------------------------------------- Total $124 $(4) $59 $61 ==== === === === ====================================================================================================================
15. EMPLOYEE BENEFITS PENSION PLANS Net periodic and total pension income for all funded and unfunded plans includes the following components. YEAR ENDED DECEMBER 31, in millions 2001 2000 1999 - -------------------------------------------------------------------------------- Service cost of benefits earned $ 37 $ 37 $ 28 Interest cost on projected benefit obligation 53 53 47 Expected return on plan assets (95) (90) (82) Amortization of unrecognized net transition asset (2) (5) (5) Amortization of prior service cost 1 2 2 Amortization of losses 1 1 3 - -------------------------------------------------------------------------------- Net periodic pension income (5) (2) (7) Curtailment gain -- (2) -- - -------------------------------------------------------------------------------- Total pension income $ (5) $ (4) $ (7) ==== ==== ==== =============================================================================== The curtailment gain in the above table resulted from Key's competitiveness initiative and related reduction in workforce. Changes in the projected benefit obligation ("PBO") related to Key's pension plans are summarized as follows: YEAR ENDED DECEMBER 31, in millions 2001 2000 - ------------------------------------------------------------------------------- PBO at beginning of year $715 $725 Service cost 37 37 Interest cost 53 53 Actuarial (gains) losses 57 (21) Curtailments -- (1) Benefit payments (75) (78) - -------------------------------------------------------------------------------- PBO at end of year $787 $715 ==== ==== - -------------------------------------------------------------------------------- Changes in the fair value of pension plan assets ("FVA") are summarized as follows: YEAR ENDED DECEMBER 31, in millions 2001 2000 - -------------------------------------------------------------------------------- FVA at beginning of year $ 1,062 $ 1,007 Actual return (loss) on plan assets (121) 125 Employer contributions 9 8 Benefit payments (75) (78) - -------------------------------------------------------------------------------- FVA at end of year $ 875 $ 1,062 ======= ======= - -------------------------------------------------------------------------------- The funded status of the pension plans at September 30 (the actuarial measurement date), reconciled to the amounts recognized in the consolidated balance sheets at December 31, 2001 and 2000, is as follows: DECEMBER 31, in millions 2001 2000 - -------------------------------------------------------------------------------- Funded status(a) $ 88 $ 346 Unrecognized net (gain) loss 156 (114) Unrecognized prior service benefit (4) (3) Unrecognized net transition asset -- (3) Benefits paid subsequent to measurement date 3 2 - -------------------------------------------------------------------------------- Net prepaid pension cost $ 243 $ 228 ======= ======= - -------------------------------------------------------------------------------- (a) The excess of the fair value of plan assets over the projected benefit obligation. Key provides certain nonqualified supplemental executive retirement programs that are unfunded and reflected in the above table. At December 31, 2001, the projected benefit obligation for these unfunded plans was $132 million (compared with $109 million at the end of 2000), and the accumulated benefit obligation was $128 million (compared with $103 million at the end of 2000). The amount of accrued pension cost for these plans was $89 million at December 31, 2001, and $85 million at December 31, 2000. 74 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES In order to determine the actuarial present value of benefit obligations and net pension income, management assumed the following weighted average rates. YEAR ENDED DECEMBER 31, 2001 2000 1999 - ----------------------------------------------------------------- Discount rate 7.25% 7.75% 7.50% Compensation increase rate 4.00 4.00 4.00 Expected return on plan assets 9.75 9.75 9.75 - ----------------------------------------------------------------- OTHER POSTRETIREMENT BENEFIT PLANS Key sponsors a contributory postretirement healthcare plan. Retirees' contributions are adjusted annually to reflect certain cost-sharing provisions and benefit limitations. Key also sponsors life insurance plans covering certain grandfathered employees. These plans are principally noncontributory. Net periodic and total postretirement benefits cost includes the following components. YEAR ENDED DECEMBER 31, in millions 2001 2000 1999 - ------------------------------------------------------------------------ Service cost of benefits earned $ 3 $ 3 $ 3 Interest cost on accumulated postretirement benefit obligation 8 7 7 Expected return on plan assets (2) (2) (1) Amortization of transition obligation 4 5 5 - ----------------------------------------------------------------------- Net postretirement benefits cost 13 13 14 Curtailment (gain) loss (1) 5 2 - ----------------------------------------------------------------------- Total postretirement benefits cost $ 12 $ 18 $ 16 ==== ==== ==== - ----------------------------------------------------------------------- The curtailment activity in the above table resulted from the previously mentioned competitiveness initiative and workforce reduction. Changes in the accumulated postretirement benefit obligation ("APBO") are summarized as follows: YEAR ENDED DECEMBER 31, in millions 2001 2000 - -------------------------------------------------------------------------------- APBO at beginning of year $ 106 $ 106 Service cost 3 3 Interest cost 8 7 Plan participants' contributions 4 4 Actuarial losses 9 1 Plan amendments -- 2 Curtailments -- (3) Benefit payments (16) (14) - -------------------------------------------------------------------------------- APBO at end of year $ 114 $ 106 ======= ======= - -------------------------------------------------------------------------------- Changes in the fair value of postretirement plan assets are summarized as follows: YEAR ENDED DECEMBER 31, in millions 2001 2000 - -------------------------------------------------------------------------------- FVA at beginning of year $ 38 $ 31 Employer contributions 19 15 Plan participants' contributions 4 3 Benefit payments (16) (12) Actual return (loss) on plan assets (6) 1 - -------------------------------------------------------------------------------- FVA at end of year $ 39 $ 38 ======= ======= - -------------------------------------------------------------------------------- The funded status of the postretirement plans at September 30 (the actuarial measurement date), reconciled to the amounts recognized in the consolidated balance sheets at December 31, 2001 and 2000, is as follows: YEAR ENDED DECEMBER 31, in millions 2001 2000 - ------------------------------------------------------------------------------- Funded status(a) $ (76) $ (69) Unrecognized net (gain) loss 12 (5) Unrecognized prior service cost 3 3 Unrecognized transition obligation 44 46 Contributions/benefits paid subsequent to measurement date 9 10 - ------------------------------------------------------------------------------- Accrued postretirement benefit cost $ (8) $ (15) ======= ======= - ------------------------------------------------------------------------------- (a) The excess of the accumulated postretirement benefit obligation over the fair value of plan assets. The assumed weighted average healthcare cost trend rate for 2002 is 5.9% for both Medicare-eligible retirees and non-Medicare-eligible retirees. The rate is assumed to decrease gradually to 5.5% by the year 2003 and remain constant thereafter. Increasing or decreasing the assumed healthcare cost trend rate by one percentage point each future year would not have a material impact on net postretirement benefits cost or obligations since the postretirement plans have cost-sharing provisions and benefit limitations. To determine the accumulated postretirement benefit obligation and the net postretirement benefits cost, management assumed the following weighted average rates: YEAR ENDED DECEMBER 31, 2001 2000 1999 - -------------------------------------------------------------------------------- Discount rate 7.25% 7.75% 7.50% Expected return on plan assets 5.71 5.71 5.73 - -------------------------------------------------------------------------------- EMPLOYEE 401(K) SAVINGS PLAN A substantial majority of Key's employees are covered under a savings plan that is qualified under Section 401(k) of the Internal Revenue Code. Key's plan permits employees to contribute from 1% to 10% of eligible compensation, with up to 6% being eligible for matching contributions in the form of Key common shares. The plan also permits Key to distribute a discretionary profit-sharing component. Total expense associated with the plan was $42 million in 2001, $51 million in 2000 and $46 million in 1999. 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 16. INCOME TAXES Income taxes included in the consolidated statements of income are summarized below. Key files a consolidated Federal income tax return. YEAR ENDED DECEMBER 31, in millions 2001 2000 1999 - -------------------------------------------------------------------------------- Currently payable: Federal $222 $147 $104 State 19 33 7 - -------------------------------------------------------------------------------- 241 180 111 Deferred: Federal (133) 307 421 State (6) 28 45 - -------------------------------------------------------------------------------- (139) 335 466 - -------------------------------------------------------------------------------- Total income tax expense(a) $102 $515 $577 ==== ==== ==== - -------------------------------------------------------------------------------- (a) Income tax expense (benefit) on securities transactions totaled $14 million in 2001, ($10) million in 2000 and $10 million in 1999. Income tax expense in the above table excludes equity- and gross receipts-based taxes, which are assessed in lieu of an income tax in certain states in which Key operates. These taxes are recorded in noninterest expense on the income statement and totaled $29 million in 2001, $33 million in 2000 and $35 million in 1999. Significant components of Key's deferred tax assets and liabilities are as follows: DECEMBER 31, in millions 2001 2000 - -------------------------------------------------------------------------------- Provision for loan losses $ 604 $ 372 Restructuring charges 22 48 Write-down of OREO 5 3 Other 294 212 - -------------------------------------------------------------------------------- Total deferred tax assets 925 635 Leasing income reported using the operating method for tax purposes 1,853 2,245 Net unrealized securities gains 18 8 Depreciation -- 6 Other 606 73 - -------------------------------------------------------------------------------- Total deferred tax liabilities 2,477 2,332 - -------------------------------------------------------------------------------- Net deferred tax liabilities $ 1,552 $ 1,697 ======= ======= - -------------------------------------------------------------------------------- The following table shows how Key arrived at total income tax expense and the effective tax rate.
YEAR ENDED DECEMBER 31, 2001 2000 1999 ----------------- ------------------ ----------------- dollars in millions Amount Rate Amount Rate Amount Rate - ----------------------------------------------------------------------------------------------------------------------------- Income before income taxes times 35% statutory Federal tax rate $ 90 35.0% $ 531 35.0% $ 589 35.0% State income tax, net of Federal tax benefit 9 3.4 40 2.6 34 2.0 Amortization of nondeductible intangibles 78 30.1 27 1.8 27 1.6 Tax-exempt interest income (15) (5.9) (18) (1.2) (20) (1.2) Corporate-owned life insurance income (42) (16.3) (40) (2.7) (38) (2.3) Tax credits (42) (16.1) (36) (2.4) (28) (1.6) Other 24 9.2 11 .8 13 .8 - ----------------------------------------------------------------------------------------------------------------------------- Total income tax expense $ 102 39.4% $ 515 33.9% $ 577 34.3% ===== ===== ===== ===== ===== ===== - -----------------------------------------------------------------------------------------------------------------------------
17. COMMITMENTS, CONTINGENT LIABILITIES AND OTHER DISCLOSURES LEGAL PROCEEDINGS RESIDUAL VALUE INSURANCE LITIGATION. Key Bank USA, National Association ("KeyBank") obtained two insurance policies from Reliance Insurance Company ("Reliance") insuring the residual value of certain automobiles leased through KeyBank. The two policies ("the Policies"), the "4011 Policy" and the "4019 Policy," together covered leases entered into during the period January 1, 1997 to January 1, 2001. The 4019 Policy contains an endorsement stating that Swiss Reinsurance America Corporation ("Swiss Re") will assume and reinsure 100% of Reliance's obligations under the 4019 Policy in the event that Reliance Group Holdings' ("Reliance's parent") so-called "claims-paying ability" were to fall below investment grade. KeyBank also entered into an agreement with Swiss Re and Reliance whereby Swiss Re agreed to issue to KeyBank an insurance policy on the same terms and conditions as the 4011 Policy in the event that the financial condition of Reliance Group Holdings fell below a certain level. Around May 2000, the conditions under both the 4019 Policy and the Swiss Re agreement were triggered. The 4011 Policy was canceled and replaced as of May 1, 2000, by a policy issued by North American Specialty Insurance Company (a subsidiary or affiliate of Swiss Re) ("the NAS Policy"). Tri-Arc Financial Services, Inc. ("Tri-Arc") acted as agent for Reliance, Swiss Re and NAS. Since February 2000, KeyBank has been filing claims under the Policies, but none of these claims have been paid. In July 2000, KeyBank filed a claim for arbitration against Reliance, Swiss Re, NAS and Tri-Arc seeking, among other things, a declaration of the scope of coverage under the Policies and for damages. On January 8, 2001, Reliance filed an action (litigation) against KeyBank in Federal District Court in Ohio seeking rescission or reformation of the Policies claiming that they do not reflect the intent of the parties with respect to the scope of coverage and how and when claims were to be paid. Key filed an answer and counterclaim against Reliance, Swiss Re, NAS and Tri-Arc seeking, among other things, declaratory relief as to the scope of coverage under the Policies, damages for breach of contract, failure to act in good faith, and punitive damages. The parties have agreed to proceed with this court action and to dismiss the arbitration without prejudice. 76 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES On May 29, 2001, the Commonwealth Court of Pennsylvania entered an order placing Reliance in a court supervised "rehabilitation" and purporting to stay all litigation against Reliance. On July 23, 2001, the Federal District Court in Ohio stayed the litigation to allow the Rehabilitator to complete her task. On October 3, 2001, the Court in Pennsylvania entered an order placing Reliance into liquidation and canceling all Reliance insurance policies as of November 2, 2001. On November 20, 2001, the Federal District Court in Ohio entered an order which, among other things, required Reliance to report to the Court on the progress of the liquidation. On January 15, 2002, Reliance filed a status report requesting the continuance of the stay for an indefinite period. Management believes that KeyBank has valid insurance coverage or claims for damages relating to the residual value of automobiles leased through KeyBank during the four-year period ending January 1, 2001. With respect to each individual lease, however, it is not until the lease expires and the vehicle is sold that KeyBank can determine the existence and amount of any actual loss on the lease -- i.e., the difference between the residual value provided for in the lease agreement and the vehicle's actual market value at lease expiration. KeyBank's actual total losses for which it will file claims will depend to a large measure upon the viability of, and pricing within, the market for used cars throughout the lease runoff period, which extends through 2006. Accordingly, the total expected loss on the portfolio cannot be determined with certainty at this time. Claims filed by KeyBank through December 31, 2001, total approximately $89 million, and management currently estimates that approximately $225 million of additional claims may be filed through year-end 2006. During this time frame, a number of factors will affect KeyBank's actual loss experience, which may be higher or lower than management's current estimates. Key is recording as a receivable the amount of the claims as and when filed, less an amount Key has estimated to be an appropriate reserve to reflect the collectibility risk associated with the insurance litigation. NSM LITIGATION. In March 1998, McDonald Investments Inc. ("McDonald"), now a subsidiary of KeyCorp, participated in an offering to institutional investors of approximately $452 million of debt securities and related warrants of Nakornthai Strip Mill Public Company Ltd. ("NSM"), a Thailand public company, and certain NSM affiliates. The offering was part of the financing of NSM's steel mini-mill located in Chonburi, Thailand. McDonald served as a financial advisor to NSM and was an initial purchaser in the offering. On December 24, 1998, holders of NSM securities gave a Notice of Default alleging a number of defaults under the terms of the securities. In 1999, certain purchasers of the NSM securities commenced litigation against McDonald and several other parties, claiming that McDonald, the other initial purchasers and certain other of NSM's third party service providers violated certain state and federal securities and other laws. The complaints in those lawsuits were based on alleged misstatements and omissions in the Offering Memorandum for the securities, and on certain other information allegedly provided and oral statements allegedly made 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. Nine separate lawsuits were brought against McDonald and others by purchasers of the NSM securities: two in Federal court in Minnesota; two in Federal court in New York; two in California; and one in each of Connecticut, Illinois and New Jersey. The aggregate amount of securities alleged to have been purchased by the plaintiffs in these nine lawsuits was approximately $260 million. While the relief claimed in the lawsuits has varied, generally the plaintiffs have sought rescission of the sale of the securities, compensatory damages, punitive damages, pre- and post-judgment interest, legal fees and expenses. McDonald filed responses to each complaint denying liability and has been vigorously defending these actions. McDonald has entered into settlement agreements with the plaintiffs in seven of the nine lawsuits, pursuant to which those plaintiffs' claims against McDonald were dismissed. The terms of those settlement agreements, including the consideration paid by McDonald, are confidential. Key sought coverage from its insurance carriers for certain liabilities and expenses related to the settled claims (above certain self-insurance layers that were exhausted and expensed), which coverage was subsequently denied by the carriers. As a result, Key and the insurance carriers filed declaratory judgment actions against each other. In January 2002, the insurance carriers and Key agreed to a monetary settlement of their dispute, which would have (when aggregated with litigation reserves previously established for these lawsuits) provided coverage for amounts paid by Key in settlement of the seven settled NSM lawsuits. However, in the course of finalizing the settlement documentation, the insurance carriers informed Key that in their view a settlement of all material terms was not reached and, accordingly, the settlement agreement is not valid. Management believes that the settlement agreement is valid. In the ordinary course of business, Key is subject to legal actions that involve claims for substantial monetary relief. Based on information presently known to management and Key's counsel, management does not believe there is any legal action to which KeyCorp or any of its subsidiaries is a party, or involving any of their properties, that, individually or in the aggregate, will have a material adverse effect on Key's financial condition. RESTRICTIONS ON CASH, DUE FROM BANKS, SUBSIDIARY DIVIDENDS AND LENDING ACTIVITIES Federal law requires depository institutions to maintain a prescribed amount of cash or noninterest-bearing balances with the Federal Reserve Bank. KeyCorp's banking subsidiaries maintained average reserve balances aggregating $330 million in 2001 to fulfill these requirements. KeyCorp's principal source of cash flow, including the cash needed to pay dividends on its common shares and to service its debt, is dividends from its banking and other subsidiaries. Various Federal and state statutes and regulations limit the amount of dividends KeyCorp's banking subsidiaries can pay without prior regulatory approval. At January 1, 2002, KeyCorp's banking subsidiaries could have declared dividends of approximately $449 million in the aggregate without obtaining such approval. Federal law also restricts loans and advances from banking subsidiaries to their parent companies (and to nonbank subsidiaries of their parent companies), and requires those transactions to be secured. At December 31, 2001, KeyCorp and its subsidiaries were in compliance with these legal restrictions. 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES OBLIGATIONS UNDER NONCANCELABLE LEASES Key is obligated under various noncancelable leases for land, buildings and other property, consisting principally of data processing equipment. Rental expense under all operating leases totaled $132 million in 2001, $136 million in 2000 and $162 million in 1999. Minimum future rental payments under noncancelable leases at December 31, 2001, are as follows: 2002 -- $124 million; 2003 -- $116 million; 2004 -- $101 million; 2005 -- $87 million; 2006 -- $80 million; all subsequent years -- $455 million. 18. FAIR VALUE DISCLOSURES OF FINANCIAL INSTRUMENTS The carrying amount and estimated fair value of Key's financial instruments are shown below in accordance with the requirements of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments."
DECEMBER 31, 2001 2000 -------------------------- ---------------------------- Carrying Fair Carrying Fair in millions Amount Value Amount Value - -------------------------------------------------------------------------------------------------------------- ASSETS Cash and short-term investments(a) $ 4,789 $ 4,789 $ 5,073 $ 5,073 Securities available for sale(b) 5,346 5,346 7,329 7,329 Investment securities(b) 1,119 1,128 1,198 1,208 Loans, net of allowance(c) 61,632 62,938 65,904 67,495 Servicing assets(a) 73 73 49 49 LIABILITIES Deposits with no stated maturity(a) $25,047 $25,047 $23,680 $23,680 Time deposits(d) 19,748 20,067 24,969 25,317 Short-term borrowings(a) 9,284 9,284 11,893 11,893 Long-term debt(d) 14,554 14,268 14,161 14,342 CAPITAL SECURITIES(d) 1,288 1,157 1,243 1,056 - ---------------------------------------------------------------------------------------------------------------
Valuation Methods and Assumptions - --------------------------------- (a) Fair value equals or approximates carrying amount. (b) Fair values of securities available for sale and investment securities generally were based on quoted market prices. Where quoted market prices were not available, fair values were based on quoted market prices of similar instruments. (c) Fair values of most loans were estimated using discounted cash flow models. Lease financing receivables and loans held for sale were included in the estimated fair value of loans at their carrying amounts. (d) Fair values of time deposits, long-term debt and capital securities were estimated based on discounted cash flows. The estimated fair values of residential real estate mortgage loans (carrying amount of $2.3 billion at December 31, 2001, and $4.2 billion at December 31, 2000, and included in the amount shown for "Loans, net of allowance") and deposits do not take into account the fair values of long-term client relationships, which are integral parts of the related financial instruments. The estimated fair values of these instruments would be significantly higher if they included the fair values of these relationships. For financial instruments with a remaining average life to maturity of less than six months, carrying amounts were used as an approximation of fair values. If management used different assumptions (on matters such as discount rates and cash flow) and estimation methods, the estimated fair values shown in the table could change significantly. Accordingly, these estimates do not necessarily reflect the amounts Key's financial instruments would command in a current market exchange. Similarly, because SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, the fair value amounts shown in the table do not, by themselves, represent the underlying value of Key itself. Interest rate swaps and caps were valued based on discounted cash flow models. The aggregate fair values of assets and liabilities at December 31, 2001, were $1.1 billion and $899 million, respectively, compared with $473 million and $314 million, respectively, as of December 31, 2000. Foreign exchange forward contracts were valued based on quoted market prices and had a fair value that approximated their carrying amount at December 31, 2001 and 2000. These instruments are discussed in greater detail in Note 20 ("Derivatives and Hedging Activities"), beginning on page 80. 78 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 19. OTHER 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. Many financial instruments with such risk to which Key is a party are discussed in other notes to these financial statements. Notes 7, 17 and 20 address such matters. The other major types of financial instruments with off-balance sheet risk are primarily loan commitments and standby letters of credit. These financial instruments generally help Key meet clients' financing needs. However, they also 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. These are agreements to provide financing on 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 may exceed Key's eventual cash outlay. STANDBY LETTERS OF CREDIT. These instruments obligate Key to pay a third-party beneficiary when a customer fails to repay an outstanding loan or debt instrument, or fails to perform some contractual nonfinancial obligation. 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. ASSET-BACKED COMMERCIAL PAPER CONDUIT. Key serves as a referral agent to an asset-backed commercial paper conduit ("conduit"), which is owned by a third party and administered by an unaffiliated financial institution. In connection with this arrangement, Key receives fees for the referral of high-grade loans and structured assets, and for making commitments to provide liquidity and credit enhancement. Key provides liquidity and credit enhancement to the conduit in the form of a committed liquidity facility and credit agreement. The commitment to provide credit enhancement specifies that in the event of default, Key will provide financial relief to the conduit in an amount that is based on defined criteria that consider the level of credit risk involved and other factors. During 2001, Key sold $434 million of federally guaranteed education loans to a qualified special purpose entity, which issued beneficial interests that were acquired by the conduit. At December 31, 2001, Key's commitments to provide liquidity and credit enhancement totaled $994 million and $456 million, respectively. There were no balances outstanding under either of the commitment facilities at the end of the year. Management periodically evaluates Key's potential exposure related to these commitments. The balance of assets outstanding in the conduit was $1.1 billion at December 31, 2001. Of this amount, $157 million represents the balance of the beneficial interests in the federally guaranteed education loans acquired by the conduit in 2001. All of the assets in the conduit were performing in accordance with their contractual terms at December 31, 2001. RECOURSE AGREEMENT WITH FEDERAL NATIONAL MORTGAGE ASSOCIATION. KeyBank National Association ("KeyBank") participates as a lender in the Federal National Mortgage Association ("FNMA") Delegated Underwriting and Servicing ("DUS") program. As a condition to FNMA's delegation of responsibility for originating, underwriting and servicing mortgages, KeyBank has agreed to assume a limited portion of the risk of loss on each mortgage loan sold. Accordingly, a reserve for such potential losses has been established and is maintained in an amount estimated by management to be appropriate in light of the recourse risk. As of December 31, 2001, KeyBank had sold approximately $1.1 billion of loans as a participant in this program. RETURN GUARANTY AGREEMENT WITH LOW-INCOME HOUSING TAX CREDIT ("LIHTC") INVESTORS. Key Affordable Housing Corporation ("KAHC"), a subsidiary of KeyBank, offers limited partnership interests to qualified investors. Partnerships formed by KAHC invest in low-income residential rental properties that qualify for Federal LIHTCs under Section 42 of the Internal Revenue Code. In certain partnerships, investors pay a fee to KAHC for a guaranteed return. The guaranteed return is incumbent on the financial performance of the property and the property's ability to maintain its LIHTC status throughout the fifteen-year compliance period. Key meets its obligations pertaining to the guaranteed returns generally through the distribution of tax credits and deductions associated with the specific properties. At December 31, 2001, Key guaranteed equity of $696 million plus a specified return on that equity. KAHC has established a reserve in an amount estimated by management to be sufficient to cover its obligations under the guarantees in the event that the properties do not perform as expected. 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 instruments are not material; observable liquid markets do not exist for the majority of these instruments. DECEMBER 31, in millions 2001 2000 - ------------------------------------------------------------------------------- Loan commitments: Home equity $ 4,965 $ 4,727 Commercial real estate and construction 2,487 2,211 Commercial and other 24,936 25,376 - ------------------------------------------------------------------------------- Total loan commitments 32,388 32,314 Other commitments: Standby letters of credit 3,503 3,555 Commercial letters of credit 106 116 - ------------------------------------------------------------------------------- Total loan and other commitments $35,997 $35,985 ======= ======= - ------------------------------------------------------------------------------- 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 20. DERIVATIVES AND HEDGING ACTIVITIES Key, mainly through its lead bank, KeyBank National Association, is party to various derivative instruments. These instruments are used for asset and liability management and trading purposes. Generally, these instruments help Key meet clients' financing needs and manage exposure to "market risk" -- the possibility that economic value or net interest income will be adversely affected by changes in interest rates or other economic factors. However, like other financial instruments, these derivatives 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 derivatives that Key uses are interest rate swaps, caps and futures, and foreign exchange forward contracts. All foreign exchange forward contracts and interest rate swaps and caps held are over-the-counter instruments. ACCOUNTING TREATMENT AND VALUATION Effective January 1, 2001, Key adopted SFAS No. 133, which establishes accounting and reporting standards for derivatives and hedging activities. The new standards are summarized in Note 1 ("Summary of Significant Accounting Policies") under the heading "Accounting Pronouncements Adopted in 2001," on page 61. As a result of adopting SFAS No. 133, Key recorded cumulative after-tax losses of $1 million in earnings and $22 million in "other comprehensive income (loss)" as of January 1, 2001. Of the $22 million loss, an estimated $13 million was reclassified to earnings during 2001. At December 31, 2001, Key had $233 million of derivative assets recorded in "accrued income and other assets" and $231 million of derivative liabilities recorded in "accrued expense and other liabilities" on the balance sheet. These balances compare with $120 million and $152 million, respectively, recorded upon adoption of SFAS No. 133. The following section includes information pertaining to derivatives and hedging activities for 2001 (subsequent to adopting SFAS No. 133) and 2000 (prior to adopting SFAS No. 133). ASSET AND LIABILITY MANAGEMENT FAIR VALUE HEDGING STRATEGIES. Key uses interest rate swap contracts known as "receive fixed/pay variable" swaps to modify its exposure to interest rate risk. These contracts convert specific fixed-rate deposits, short-term borrowings and long-term debt to variable rate obligations. As a result, Key receives fixed-rate interest payments in exchange for variable rate payments over the lives of the contracts without exchanges of the underlying notional amounts. During 2001, Key recognized a net loss of approximately $1 million related to the ineffective portion of its fair value hedging instruments. The ineffective portion recognized is included in "other income" on the income statement. CASH FLOW HEDGING STRATEGIES. Key also enters into "pay fixed/receive variable" interest rate swap contracts that effectively convert a portion of its floating-rate debt to fixed-rate to reduce the potential adverse impact of interest rate increases on future interest expense. These contracts allow Key to exchange variable-rate interest payments for fixed-rate payments over the lives of the contracts without exchanges of the underlying notional amounts. Similarly, Key has converted certain floating-rate commercial loans to fixed-rate loans by entering into interest rate swap contracts. Key also uses "pay fixed/receive variable" interest rate swaps to manage the interest rate risk associated with anticipated sales or securitizations of certain commercial real estate loans. These swaps protect against a possible short-term decline in the value of the loans between the time they are originated and the time they are securitized or sold. Key's general policy is to sell or securitize these loans within one year of their origination. As a result of actions announced in May, Key revised its projections of future debt needs. Consequently, during the second quarter of 2001, Key reclassified a $3 million gain from "accumulated other comprehensive income (loss)" to "other income" on the income statement. This reclassification relates to a cash flow hedge of a previously forecasted debt issuance that Key will not make. During 2001, Key did not recognize any significant net loss in connection with the ineffective portion of its cash flow hedging instruments. There was no impact on earnings during 2001 related to the exclusion of portions of hedging instruments from the assessment of hedge effectiveness. Any loss resulting from hedge ineffectiveness was recorded in "other income" on the income statement. The change in "accumulated other comprehensive income (loss)" resulting from cash flow hedges is as follows:
CUMULATIVE EFFECT DECEMBER 31, OF ADOPTING 2001 RECLASSIFICATION DECEMBER 31, in millions 2000 SFAS 133 HEDGING ACTIVITY TO EARNINGS 2001 - --------------------------------------------------------------------------------------------------------------------------------- Accumulated other comprehensive income (loss) resulting from cash flow hedges -- $(22) $(13) $33 $(2) - ---------------------------------------------------------------------------------------------------------------------------------
Key expects to reclassify approximately $22 million of net gains on derivative instruments from "accumulated other comprehensive income (loss)" to earnings during the next twelve months. Reclassifications will coincide with the income statement impact of the hedged item through the payment of variable-rate interest on debt, the receipt of variable-rate interest on commercial loans and the sale or securitization of commercial real estate loans. 80 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES The following table summarizes the features of the various types of portfolio swaps and caps that Key held at the end of 2000 prior to the adoption of SFAS No. 133.
DECEMBER 31, 2000 ------------------------------------------------------------------ WEIGHTED AVERAGE RATE -------------------------------- NOTIONAL FAIR MATURITY dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY STRIKE - ----------------------------------------------------------------------------------------------------------------------------- Interest rate swaps: Receive fixed/pay variable-- indexed amortizing(a) $ 45 $ 1 .8 7.98% 6.76% N/A Receive fixed/pay variable-- conventional 4,330 75 6.6 6.68 6.76 N/A Receive fixed/pay variable-- forward starting 88 3 10.1 5.62 5.41 N/A Pay fixed/receive variable-- conventional 4,636 (46) 3.7 6.75 6.31 N/A Pay fixed/receive variable-- forward starting 116 (5) 10.0 6.18 6.48 N/A Basis swaps 6,625 (75) 1.6 6.67 6.78 N/A - ----------------------------------------------------------------------------------------------------------------------------- Total 15,840 (47) -- 6.69% 6.63% -- Interest rate caps and collars: Caps purchased-- one- to three-month LIBOR-based -- -- -- N/A N/A -- Collar-- one- to three-month LIBOR-based 250 -- .1 N/A N/A 4.75 and 6.50 - ----------------------------------------------------------------------------------------------------------------------------- Total 250 -- -- -- -- -- - ----------------------------------------------------------------------------------------------------------------------------- Total $16,090 $ (47) -- -- -- -- ======= ======== - -----------------------------------------------------------------------------------------------------------------------------
(a) Maturity is based upon expected average lives rather than contractual terms. N/A = Not Applicable During 2000, Key terminated swaps with a notional amount of $4.5 billion, resulting in a net deferred loss of $12 million. At December 31, 2000, Key had a cumulative net deferred swap gain of $9 million with a weighted average life of 4.9 years related to the management of debt, and a cumulative net deferred loss of $2 million with a weighted average life of 4.5 years related to the management of available-for-sale securities. TRADING PORTFOLIO 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 futures contracts and interest rate swaps, caps and floors 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 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 options are included in "investment banking and capital markets income" on the income statement. The following table shows trading income recognized on interest rate swap, foreign exchange forward, and option and futures contracts. YEAR ENDED DECEMBER 31, in millions 2001 2000 1999 - ------------------------------------------------------------------------------ Interest rate contracts $17 $32 $40 Foreign exchange forward contracts 40 35 30 Option and futures contracts -- 3 4 - -------------------------------------------------------------------------------- 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 related 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 whether any collateral may be required. At December 31, 2001, Key was party to swaps with 38 different counterparties. Among these were swaps entered into to offset the risk of client swaps. Key had aggregate credit exposure of $542 million to 27 of these counterparties, with the largest credit exposure to an individual counterparty amounting to $150 million. As of the same date, Key's aggregate credit exposure on its interest rate caps totaled $31 million. Based on management's assessment, as of December 31, 2001, all counterparties were expected to meet their obligations. 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES 21. CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY
CONDENSED BALANCE SHEETS DECEMBER 31, in millions 2001 2000 - -------------------------------------------------------------------------------------------------------------------------- ASSETS Interest-bearing deposits with KeyBank National Association $ 1,054 $ 547 Loans and advances to subsidiaries: Banks 99 99 Nonbank subsidiaries 669 575 - -------------------------------------------------------------------------------------------------------------------------- 768 674 Investment in subsidiaries: Banks 5,744 6,733 Nonbank subsidiaries 2,004 2,010 - -------------------------------------------------------------------------------------------------------------------------- 7,748 8,743 Accrued income and other assets 780 883 - -------------------------------------------------------------------------------------------------------------------------- Total assets $10,350 $10,847 ======= ======= LIABILITIES Accrued expense and other liabilities $ 580 $ 453 Short-term borrowings 121 1,206 Long-term debt: Subsidiary trusts 1,282 1,282 Unaffiliated companies 2,212 1,283 - -------------------------------------------------------------------------------------------------------------------------- 3,494 2,565 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities 4,195 4,224 SHAREHOLDERS' EQUITY(a) 6,155 6,623 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $10,350 $10,847 ======= ======= - -------------------------------------------------------------------------------------------------------------------------- (a) See page 56 for KeyCorp's Statements of Changes in Shareholders' Equity. CONDENSED STATEMENTS OF INCOME Year ended December 31, in millions 2001 2000 1999 - -------------------------------------------------------------------------------------------------------------------------- INCOME Dividends from subsidiaries: Banks $ 500 $ 1,440 $ 900 Nonbank subsidiaries 107 57 46 Interest income from subsidiaries 77 62 47 Gain from sale of Electronic Payment Services, Inc. -- -- 134 Other income 49 46 17 - -------------------------------------------------------------------------------------------------------------------------- 733 1,605 1,144 EXPENSES Interest on long-term debt with subsidiary trusts 92 98 87 Interest on other borrowed funds 132 133 96 Restructuring charges (4) 102 98 Personnel and other expense 56 59 123 - -------------------------------------------------------------------------------------------------------------------------- 276 392 404 Income before income tax benefit and equity in net income less dividends from subsidiaries 457 1,213 740 Income tax benefit 28 103 74 - -------------------------------------------------------------------------------------------------------------------------- 485 1,316 814 Equity in net income less dividends from subsidiaries (353) (314) 293 - -------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 132 $ 1,002 $ 1,107 ======= ======= ======= - --------------------------------------------------------------------------------------------------------------------------
82 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
CONDENSED STATEMENTS OF CASH FLOW YEAR ENDED DECEMBER 31, in millions 2001 2000 1999 - ----------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 132 $ 1,002 $ 1,107 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of intangibles 20 24 18 Net gains from divestitures -- -- (134) Net securities gains (28) (7) (15) Deferred income taxes (20) 10 (27) Equity in net income less dividends from subsidiaries 353 314 (293) Net increase in other assets (69) (213) (69) Net increase in other liabilities 125 133 4 Net increase (decrease) in accrued restructuring charges (68) 33 88 Other operating activities, net 39 (35) (75) - ----------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 484 1,261 604 INVESTING ACTIVITIES Purchases of securities available for sale (50) (192) (30) Proceeds from prepayments and maturities of securities available for sale 195 10 154 Net (increase) decrease in interest-bearing deposits (507) 136 (370) Net increase in loans and advances to subsidiaries (136) (83) (123) (Increase) decrease in investments in subsidiaries 670 (846) (23) - ----------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 172 (975) (392) FINANCING ACTIVITIES Net increase (decrease) in short-term borrowings (1,063) 665 411 Net proceeds from issuance of long-term debt 1,142 290 510 Payments on long-term debt (230) (334) (365) Loan payment received from ESOP trustee 13 11 10 Purchases of treasury shares (50) (462) (344) Proceeds from issuance of common stock pursuant to employee benefit and dividend reinvestment plans 33 28 33 Cash dividends paid (501) (484) (467) - ----------------------------------------------------------------------------------------------------------------------------------- NET CASH USED IN FINANCING ACTIVITIES (656) (286) (212) - ----------------------------------------------------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS -- -- -- CASH AND DUE FROM BANKS AT BEGINNING OF YEAR -- -- -- - ----------------------------------------------------------------------------------------------------------------------------------- CASH AND DUE FROM BANKS AT END OF YEAR -- -- -- ====== ====== ====== - -----------------------------------------------------------------------------------------------------------------------------------
KeyCorp paid interest on borrowed funds amounting to $224 million in 2001, $231 million in 2000 and $183 million in 1999. 83 EX-21 8 l92910aex21.txt EXHIBIT 21 EXHIBIT 21 KEYCORP SUBSIDIARIES OF THE REGISTRANT AT FEBRUARY 28, 2002
JURISDICTION OF INCORPORATION SUBSIDIARIES(a) OR ORGANIZATION PARENT COMPANY - ---------------------------------------------- ---------------- ---------------------------------- KeyBank National Association United States KeyCorp
(a) Subsidiaries of KeyCorp other than KeyBank National Association are not listed above since, in the aggregate, they would not constitute a significant subsidiary. KeyBank National Association is 100% owned by KeyCorp. 16 EX-23 9 l92910aex23.txt EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of KeyCorp of our report dated January 14, 2002, included in the 2001 Annual Report to Shareholders of KeyCorp. We also consent to the incorporation by reference in the following Registration Statements of KeyCorp and in the related Prospectuses of our report dated January 14, 2002, with respect to the consolidated financial statements incorporated herein by reference in this Annual Report (Form 10-K) for the year ended December 31, 2001: Form S-3 No. 33-58405 Form S-3 No. 333-10577 (Post-Effective Amendment No. 1 and No. 2) Form S-3 No. 333-55959 Form S-3 No. 333-59175 Form S-3 No. 333-64601 Form S-3 No. 333-76619 (Post-Effective Amendment No. 1) Form S-3 No. 333-88063 Form S-3 No. 333-85189 Form S-3 No. 333-50802 Form S-3 No. 333-56258 Form S-3 No. 333-63104 Form S-3 No. 333-73380 (Post-Effective Amendment No. 1) Form S-4 No. 33-31569 Form S-4 No. 33-44657 Form S-4 No. 33-51717 Form S-4 No. 33-55573 Form S-4 No. 33-57329 Form S-4 No. 33-61539 Form S-4 No. 333-19151 Form S-4 No. 333-61025 Form S-8 No. 2-97452 Form S-8 No. 33-21643 Form S-8 No. 333-49609 Form S-8 No. 333-49633 Form S-8 No. 333-65391 Form S-8 No. 333-70669 Form S-8 No. 333-70703 Form S-8 No. 333-70775 Form S-8 No. 333-72189 Form S-8 No. 333-92881 Form S-8 No. 333-45320 Form S-8 No. 333-45322 Form S-8 No. 33-31569 (Post Effective Amendment No. 1 to Form S-4) Form S-8 No. 33-44657 (Post-Effective Amendment No. 1 to Form S-4) Form S-8 No. 33-51717 (Post-Effective Amendment No. 1 to Form S-4) Form S-8 No. 333-61025 (Post-Effective Amendment No. 1 to Form S-4)
/s/ Ernst & Young LLP Cleveland, Ohio March 25, 2002 17 EX-24 10 l92910aex24.txt EXHIBIT 24 Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ William G. Bares --------------------------------- Typed Name: William G. Bares --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Albert C. Bersticker --------------------------------- Typed Name: Albert C. Bersticker --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Douglas J. McGregor --------------------------------- Typed Name: Douglas J. McGregor --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Bill R. Sanford --------------------------------- Typed Name: Bill R. Sanford --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Kenneth M. Curtis --------------------------------- Typed Name: Kenneth M. Curtis --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Carol Cartwright --------------------------------- Typed Name: Carol Cartwright --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ E. P. Campbell --------------------------------- Typed Name: E. P. Campbell --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Ronald B. Stafford --------------------------------- Typed Name: Ronald B. Stafford --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ D.W. Sullivan --------------------------------- Typed Name: D.W. Sullivan --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Steven A. Minter --------------------------------- Typed Name: Steven A. Minter --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Cecil D. Andrus --------------------------------- Typed Name: Cecil D. Andrus --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Henry Hemingway --------------------------------- Typed Name: Henry Hemingway --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Henry L. Meyer III --------------------------------- Typed Name: Henry L. Meyer III --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Charles R. Hogan --------------------------------- Typed Name: Charles R. Hogan --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Peter G. Ten Eyck --------------------------------- Typed Name: Peter G. Ten Eyck --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Alexander M. Cutler --------------------------------- Typed Name: Alexander M. Cutler --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Thomas C. Stevens --------------------------------- Typed Name: Thomas C. Stevens --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ Lee Irving --------------------------------- Typed Name: Lee Irving --------------------------------- Exhibit 24 KEYCORP POWER OF ATTORNEY The undersigned, an officer or director, or both an officer and director, of KeyCorp, an Ohio corporation, which anticipates filing with the United States Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, its Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (the "Annual Report"), hereby constitutes and appoints Steven N. Bulloch, K. Brent Somers, and Thomas C. Stevens, and each of them, as attorney for the undersigned, with full power of substitution and resubstitution, for and in the name, place, and stead of the undersigned, to sign and file the Annual Report and exhibits thereto, and any and all amendments thereto, with full power and authority to do and perform any and all acts and things requisite and necessary to be done, hereby ratifying and approving the acts of such attorney or any such substitute or substitutes. IN WITNESS WHEREOF, the undersigned has hereto set his or her hand as of March 14, 2002. /s/ K. Brent Somers --------------------------------- Typed Name: K. Brent Somers --------------------------------- -----END PRIVACY-ENHANCED MESSAGE-----