-----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, EJ32wf8ASBbF6okokhUJgrvHh7esnaTlIXn0+T/Bz5WSyDWmBLZxOOSWUVfxyIDd ldQNtAknhON0npWpP0MMpQ== 0000950152-02-006238.txt : 20020813 0000950152-02-006238.hdr.sgml : 20020813 20020813135557 ACCESSION NUMBER: 0000950152-02-006238 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020813 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-11302 FILM NUMBER: 02729013 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-Q 1 l95281ae10vq.txt KEYCORP 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2002 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From _______ To _______ Commission File Number 0-850 [KEYCORP LOGO] ------------------------------------------------------- (Exact name of registrant as specified in its charter) OHIO 34-6542451 - -------------------------------------- ---------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306 - --------------------------------------- ---------------------------- (Address of principal executive offices) (Zip Code) (216) 689-6300 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicated by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Shares with a par value of $1 each 426,529,863 Shares --------------------------------------------- ------------------------------ (Title of class) (Outstanding at July 31, 2002) KEYCORP TABLE OF CONTENTS PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS Page Number ------------ Consolidated Balance Sheets -- June 30, 2002, December 31, 2001 and June 30, 2001 3 Consolidated Statements of Income -- Three and six months ended June 30, 2002 and 2001 4 Consolidated Statements of Changes in Shareholders' Equity -- 5 Six months ended June 30, 2002 and 2001 Consolidated Statements of Cash Flow -- Six months ended June 30, 2002 and 2001 6 Notes to Consolidated Financial Statements 7 Independent Accountants' Review Report 31 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 32 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK 65 PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS 65 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 65 Item 5. OTHER INFORMATION 66 Item 6. EXHIBITS AND REPORTS ON FORM 8-K 67 Signature 68
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
- ----------------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS - ----------------------------------------------------------------------------------------------------------------------------------- JUNE 30, DECEMBER 31, JUNE 30, dollars in millions 2002 2001 2001 - ----------------------------------------------------------------------------------------------------------------------------------- (UNAUDITED) (UNAUDITED) ASSETS Cash and due from banks $ 2,929 $ 2,891 $ 2,781 Short-term investments 1,471 1,898 1,961 Securities available for sale 6,349 5,346 6,706 Investment securities (fair value: $1,129, $1,128 and $1,182) 1,119 1,119 1,171 Loans, net of unearned income of $1,746, $1,778 and $1,762 63,881 63,309 66,693 Less: Allowance for loan losses 1,539 1,677 1,231 - ----------------------------------------------------------------------------------------------------------------------------------- Net loans 62,342 61,632 65,462 Premises and equipment 659 687 694 Goodwill 1,105 1,101 1,141 Corporate-owned life insurance 2,359 2,313 2,265 Accrued income and other assets 4,445 3,951 3,657 - ----------------------------------------------------------------------------------------------------------------------------------- Total assets $ 82,778 $ 80,938 $ 85,838 ======== ======== ======== LIABILITIES Deposits in domestic offices: Money market deposit accounts $ 12,550 $ 12,845 $ 12,531 Savings deposits 2,025 1,918 1,952 NOW Accounts 634 616 535 Certificates of deposit ($100,0000 or more) 4,928 4,493 4,920 Other time deposits 12,995 13,657 14,048 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest bearing 33,132 33,529 33,986 Noninterest-bearing 9,095 9,667 8,376 Deposits in foreign office--interest-bearing 2,578 1,599 3,381 - ----------------------------------------------------------------------------------------------------------------------------------- Total deposits 44,805 44,795 45,743 Federal funds purchased and securities sold under repurchase agreements 5,110 3,735 5,919 Bank notes and other short-term borrowings 3,390 5,549 7,128 Accrued expense and other liabilities 4,742 4,862 4,627 Long-term debt 16,895 14,554 14,675 Corporation-obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely subordinated debentures of KeyCorp (See Note 11) 1,244 1,288 1,279 - ----------------------------------------------------------------------------------------------------------------------------------- Total liabilities 76,186 74,783 79,371 SHAREHOLDERS' EQUITY Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- -- Common shares, $1 par value; authorized 1,400,000,000 shares; issued 491,888,780 shares 492 492 492 Capital surplus 1,383 1,390 1,395 Retained earnings 6,214 5,856 6,159 Loans to ESOP trustee -- -- (13) Treasury stock, at cost (65,537,753, 67,883,724 and 66,930,892 shares) (1,530) (1,585) (1,560) Accumulated other comprehensive income (loss) 33 2 (6) - ----------------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 6,592 6,155 6,467 - ----------------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 82,778 $ 80,938 $ 85,838 ======== ======== ======== - -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 3
- ----------------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) - ----------------------------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ------------------------------------------------------------ dollars in millions, except per share amounts 2002 2001 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------------ INTEREST INCOME Loans $ 989 $ 1,321 $ 1,974 $ 2,739 Taxable investment securities 7 8 13 15 Tax-exempt investment securities 3 4 6 9 Securities available for sale 96 115 185 235 Short-term investments 7 19 16 39 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest income 1,102 1,467 2,194 3,037 INTEREST EXPENSE Deposits 231 388 481 848 Federal funds purchased and securities sold under repurchase agreements 24 52 47 122 Bank notes and other short-term borrowings 20 94 47 199 Long-term debt, including capital securities 144 220 282 467 - ----------------------------------------------------------------------------------------------------------------------------------- Total interest expense 419 754 857 1,636 - ----------------------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 683 713 1,337 1,401 Provision for loan losses 135 401 271 511 - ----------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 548 312 1,066 890 NONINTEREST INCOME Trust and investment services income 137 132 272 273 Investment banking and capital markets income 68 72 140 137 Service charges on deposit accounts 104 90 204 174 Corporate-owned life insurance income 26 27 52 54 Letter of credit and loan fees 29 30 57 59 Net securities gains 1 8 1 34 Other income 83 39 165 122 - ----------------------------------------------------------------------------------------------------------------------------------- Total noninterest income 448 398 891 853 NONINTEREST EXPENSE Personnel 361 345 724 709 Net occupancy 56 56 113 113 Computer processing 48 63 102 125 Equipment 36 40 70 78 Marketing 30 29 56 56 Amortization of intangibles 2 174 5 200 Professional fees 21 19 42 37 Other expense 111 132 214 238 - ----------------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 665 858 1,326 1,556 INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES 331 (148) 631 187 Income taxes 85 (12) 145 105 - ----------------------------------------------------------------------------------------------------------------------------------- INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 246 (136) 486 82 Cumulative effect of accounting changes, net of tax (See Note 1) -- (24) -- (25) - ----------------------------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) $ 246 $ (160) $ 486 $ 57 ========= ========= ========= ========= Per common share: Income (loss) before cumulative effect of accounting changes $ .58 $ (.32) $ 1.14 $ .19 Net income (loss) .58 (.38) 1.14 .14 Income (loss) before cumulative effect of accounting changes--assuming dilution .57 (.32) 1.13 .19 Net income (loss)-- assuming dilution .57 (.38) 1.13 .13 Weighted average common shares outstanding (000) 426,092 424,675 425,477 424,352 Weighted average common shares and potential common shares outstanding (000) 431,935 429,760 430,983 429,838 - -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 4
- ---------------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) - ---------------------------------------------------------------------------------------------------------------------------------- COMMON CAPITAL RETAINED dollars in millions, except per share amounts SHARES SURPLUS EARNINGS - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2000 $492 $1,402 $6,352 Net income 57 Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $14 (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 $3 Total comprehensive income Cash dividends declared on common shares ($.59 per share) (250) Issuance of common shares: Acquisition-- 370,830 shares Employee benefit and dividend reinvestment plans-- 1,333,158 net shares (7) - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT JUNE 30, 2001 $492 $1,395 $6,159 ===== ====== ====== - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2001 $492 $1,390 $5,856 Net income 486 Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $9 (a) Net unrealized gains on derivative financial instruments, net of income taxes of $5 Foreign currency translation adjustments Total comprehensive income Cash dividends declared on common shares ($.30 per share) (128) Issuance of common shares: Employee benefit and dividend reinvestment plans-- 2,345,971 net shares (7) - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT JUNE 30, 2002 $492 $1,383 $6,214 ===== ====== ====== - ----------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) - ---------------------------------------------------------------------------------------------------------------------------------- ACCUMULATED LOANS TO TREASURY OTHER ESOP STOCK, COMPREHENSIVE dollars in millions, except per share amounts TRUSTEE AT COST INCOME (LOSS) - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2000 $(13) $(1,600) $(10) Net income Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $14 (a) 20 Cumulative effect of change in accounting for derivative financial instruments, net of income taxes of ($12) (22) Net unrealized gains on derivative financial instruments, net of income taxes of $3 6 Total comprehensive income Cash dividends declared on common shares ($.59 per share) Issuance of common shares: Acquisition-- 370,830 shares 9 Employee benefit and dividend reinvestment plans-- 1,333,158 net shares 31 - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT JUNE 30, 2001 $(13) $(1,560) $(6) ==== ======= === - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2001 -- $(1,585) $ 2 Net income Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $9 (a) 16 Net unrealized gains on derivative financial instruments, net of income taxes of $5 9 Foreign currency translation adjustments 6 Total comprehensive income Cash dividends declared on common shares ($.30 per share) Issuance of common shares: Employee benefit and dividend reinvestment plans-- 2,345,971 net shares 55 - ---------------------------------------------------------------------------------------------------------------------------------- BALANCE AT JUNE 30, 2002 -- $(1,530) $ 33 === ======= ==== - ----------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED) - ------------------------------------------------------------------------------- COMPREHENSIVE dollars in millions, except per share amounts INCOME(b) - ------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2000 Net income $57 Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $14 (a) 20 Cumulative effect of change in accounting for derivative financial instruments, net of income taxes of ($12) (22) Net unrealized gains on derivative financial instruments, net of income taxes of $3 6 -------- Total comprehensive income $61 === Cash dividends declared on common shares ($.59 per share) Issuance of common shares: Acquisition-- 370,830 shares Employee benefit and dividend reinvestment plans-- 1,333,158 net shares - ------------------------------------------------------------------------------- BALANCE AT JUNE 30, 2001 - ------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 2001 Net income $486 Other comprehensive income (losses): Net unrealized gains on securities available for sale, net of income taxes of $9 (a) 16 Net unrealized gains on derivative financial instruments, net of income taxes of $5 9 Foreign currency translation adjustments 6 -------- Total comprehensive income $517 ===== Cash dividends declared on common shares ($.30 per share) Issuance of common shares: Employee benefit and dividend reinvestment plans-- 2,345,971 net shares - ------------------------------------------------------------------------------- BALANCE AT JUNE 30, 2002 - -------------------------------------------------------------------------------
(a) Net of reclassification adjustments. (b) For the three months ended June 30, 2002 and 2001, comprehensive income (loss) was $299 million and ($119) million, respectively. See Notes to Consolidated Financial Statements (Unaudited). 5
- ------------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED) - ------------------------------------------------------------------------------------------------------------------------------- SIX MONTHS ENDED JUNE 30, ------------------------- in millions 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 486 $ 57 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 271 511 Cumulative effect of accounting changes, net of tax -- 25 Depreciation expense and software amortization 116 144 Amortization of intangibles 5 200 Net securities gains (1) (34) Net losses from venture capital investments 1 24 Net gains from loan securitizations and sales (9) (13) Deferred income taxes 63 17 Net decrease in mortgage loans held for sale 68 68 Net increase in trading account assets (155) (288) Net decrease in accrued restructuring charges (19) (34) Other operating activities, net (310) (211) - ------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 516 466 INVESTING ACTIVITIES Net increase in loans, excluding acquisitions, sales and divestitures (1,849) (1,685) Purchases of loans -- (107) Proceeds from loan securitizations and sales 775 1,647 Purchases of investment securities (74) (187) Proceeds from sales of investment securities 18 22 Proceeds from prepayments and maturities of investment securities 75 185 Purchases of securities available for sale (2,803) (4,569) Proceeds from sales of securities available for sale 292 2,049 Proceeds from prepayments and maturities of securities available for sale 1,514 3,106 Net decrease in other short-term investments 582 211 Purchases of premises and equipment (44) (48) Proceeds from sales of premises and equipment 7 -- Proceeds from sales of other real estate owned 25 12 Cash used in acquisitions, net of cash acquired (15) (3) - ------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (1,497) 633 FINANCING ACTIVITIES Net increase (decrease) in deposits 2 (2,915) Net increase (decrease) in short-term borrowings (784) 1,140 Net proceeds from issuance of long-term debt, including capital securities 3,943 2,058 Payments on long-term debt, including capital securities (1,915) (1,557) Net proceeds from issuance of common stock 28 17 Cash dividends paid (255) (250) - ------------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 1,019 (1,507) - ------------------------------------------------------------------------------------------------------------------------------- NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 38 (408) CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 2,891 3,189 - ------------------------------------------------------------------------------------------------------------------------------- CASH AND DUE FROM BANKS AT END OF PERIOD $ 2,929 $ 2,781 ======= ======= - ------------------------------------------------------------------------------------------------------------------------------- Additional disclosures relative to cash flow: Interest paid $ 825 $ 1,726 Income taxes paid 159 94 Noncash items: Derivative assets resulting from adoption of new accounting standard -- $ 120 Derivative liabilities resulting from adoption of new accounting standard -- 152 - -------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The unaudited condensed consolidated interim financial statements include the accounts of KeyCorp and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Management believes that the unaudited condensed consolidated interim financial statements reflect all adjustments of a normal recurring nature and disclosures which are necessary for a fair presentation of the results for the interim periods presented. Some previously reported results have been reclassified to conform to current reporting practices. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. When you read these financial statements, you should also look at the audited consolidated financial statements and related notes included in Key's 2001 Annual Report to Shareholders. As used in these Notes, KEYCORP refers solely to the parent company and KEY refers to the consolidated entity consisting of KeyCorp and its subsidiaries. ACCOUNTING PRONOUNCEMENTS ADOPTED IN 2002 EXTINGUISHMENT OF DEBT. Effective April 1, 2002, Key adopted Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections." This new standard requires the recognition of gains and losses on the extinguishment of debt as income or loss from continuing operations rather than extraordinary items. Accordingly, gains or losses from extinguishments of debt for fiscal years beginning after May 15, 2002, shall not be reported as extraordinary items unless the extinguishment qualifies as an extraordinary item under the provisions of Accounting Principles Board Opinion ("APBO") No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." In addition, this standard amends SFAS No. 13, "Accounting for Leases," by requiring that certain modifications to capital leases be treated as sale-leaseback transactions and modifies the accounting for sub-leases when the original lessee remains a secondary obligor (or guarantor). The adoption of this standard did not have any impact on Key's financial condition and results of operations. GOODWILL AND OTHER INTANGIBLE ASSETS. "Goodwill" represents the amount by which the cost of net assets acquired exceeds their fair value. Key's "Other intangibles" currently represent primarily the net present value of future economic benefits to be derived from the purchase of core deposits. Effective January 1, 2002, Key adopted SFAS No. 142, "Goodwill and Other Intangible Assets." The new standard replaces APBO No. 17, "Intangible Assets," and eliminates the amortization of goodwill and intangible assets deemed to have indefinite lives. This change will reduce Key's noninterest expense and increase its net income by approximately $80 million, or $.19 per 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. Key has determined that its reporting units for purposes of this impairment testing are its major business groups consisting of Key Consumer Banking, Key Corporate Finance and Key Capital Partners. 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. In its transitional impairment testing, Key used a discounted cash flow methodology for determining the fair value of its reporting units. These fair values were reviewed for reasonableness using a relative valuation methodology. 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 of the 7 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. Any impairment losses that result from the initial application of SFAS No. 142 would be reported as a "cumulative effect of accounting change" on the income statement. Transitional impairment tests to determine the amount of any such losses must be completed no later than December 31, 2002. Key completed its transitional goodwill impairment testing during the first quarter of 2002, and determined that no impairment existed as of January 1, 2002. The annual goodwill impairment testing required by SFAS No. 142 will be performed in the fourth quarter of each year beginning in 2002. Any future impairment losses would be recorded as part of income from operations. For additional information pertaining to Key's intangible assets and the effect of adopting SFAS No. 142, see Note 8 ("Goodwill and Other Intangible Assets"), on page 20. IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. Effective January 1, 2002, Key adopted 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. The adoption of this standard did not have any impact on Key's financial condition and results of operations. CUMULATIVE EFFECT OF ACCOUNTING CHANGES In 2001, Key adopted new accounting 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, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." As a result, Key recorded a cumulative after-tax loss of $24 million in earnings for the second quarter of 2001. 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 and for hedging activities. 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. More information related to SFAS No. 140 and SFAS No. 133 is disclosed in Note 1 ("Summary of Significant Accounting Policies"), which begins on page 58 of Key's 2001 Annual Report to Shareholders. ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION ASSET RETIREMENT OBLIGATIONS. In August 2001, the Financial Accounting Standards Board 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. 8 2. EARNINGS PER COMMON SHARE Key calculates its basic and diluted earnings per common share as follows:
THREE MONTHS ENDED JUNE 30, --------------------------- dollars in millions, except per share amounts 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------------- EARNINGS Income (loss) before cumulative effect of accounting changes $246 $(136) Net income (loss) 246 (160) - ---------------------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON SHARES Weighted average common shares outstanding (000) 426,092 424,675 Effect of dilutive common stock options (000) 5,843 5,085 - ---------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares and potential common shares outstanding (000) 431,935 429,760 ======= ======= - ---------------------------------------------------------------------------------------------------------------------------------- EARNINGS PER COMMON SHARE Income (loss) per common share before cumulative effect of accounting changes $.58 $(.32) Net income (loss) per common share .58 (.38) Income (loss) per common share before cumulative effect of accounting changes -- assuming dilution(a) .57 (.32) Net income (loss) per common share--assuming dilution(a) .57 (.38) - ----------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, ------------------------- dollars in millions, except per share amounts 2002 2001 - --------------------------------------------------------------------------------------------------------------------------------- EARNINGS Income (loss) before cumulative effect of accounting changes $486 $82 Net income (loss) 486 57 - --------------------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON SHARES Weighted average common shares outstanding (000) 425,477 424,352 Effect of dilutive common stock options (000) 5,506 5,486 - --------------------------------------------------------------------------------------------------------------------------------- Weighted average common shares and potential common shares outstanding (000) 430,983 429,838 ======= ======= - --------------------------------------------------------------------------------------------------------------------------------- EARNINGS PER COMMON SHARE Income (loss) per common share before cumulative effect of accounting changes $1.14 $.19 Net income (loss) per common share 1.14 .14 Income (loss) per common share before cumulative effect of accounting changes -- assuming dilution(a) 1.13 .19 Net income (loss) per common share-- assuming dilution(a) 1.13 .13 - ---------------------------------------------------------------------------------------------------------------------------------
(a) Potential common shares outstanding have been excluded from the calculation of earnings per common share for the three months ended June 30, 2001, since the effect would be antidilutive. 3. ACQUISITIONS AND DIVESTITURE Business acquisitions and the divestiture that Key completed during 2001 and the first six months of 2002 are summarized below. ACQUISITIONS - ------------ CONNING ASSET MANAGEMENT On June 28, 2002, Key purchased substantially all of the mortgage loan and real estate business of Conning Asset Management, headquartered in Hartford, Connecticut. Conning's mortgage loan and real estate business originates, services and securitizes multi-family, retail, industrial and office property mortgage loans on behalf of pension fund and life insurance company investors. The business has net assets of $17 million and services approximately $4 billion in commercial mortgage loans through its St. Louis office. In accordance with a confidentiality clause in the purchase agreement, the terms, which are not material, have not been disclosed. 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. DIVESTITURE - ----------- 401(K) RECORDKEEPING BUSINESS On June 12, 2002, Key sold its 401(k) recordkeeping business. Key recognized a gain of $3 million ($2 million after tax), which is included in "other income" on the income statement. 9 4. LINE OF BUSINESS RESULTS Key has three major business groups that consist of 10 lines of business: KEY CONSUMER BANKING GROUP - -------------------------- RETAIL BANKING provides individuals with branch-based deposit, investment and credit products and personal finance services. SMALL BUSINESS provides small businesses with deposit, investment and credit products and business advisory services. INDIRECT LENDING offers automobile, marine and recreational vehicle (RV) loans to consumers through dealers, and finances inventory for automobile, marine and RV dealers. For students and their parents, it also provides education loans, insurance and interest-free payment plans. NATIONAL HOME EQUITY provides primarily prime and near-prime mortgage and home equity loan products to individuals. It originates these products outside of Key's retail branch system. It also works with mortgage brokers and home improvement contractors to provide home equity and home improvement solutions. KEY CORPORATE FINANCE GROUP - --------------------------- CORPORATE BANKING provides financing, cash and investment management and business advisory services to middle-market companies and large corporations. NATIONAL COMMERCIAL REAL ESTATE provides construction and interim lending, permanent debt placements and servicing, and equity and investment banking services to developers, brokers and owner-investors. This line of business deals exclusively with nonowner-occupied properties. NATIONAL EQUIPMENT FINANCE meets the equipment leasing needs of companies worldwide and provides equipment manufacturers, distributors and resellers with equipment financing options for their clients. Lease financing receivables and related revenues are assigned to Corporate Banking or National Commercial Real Estate if one of those businesses is principally responsible for maintaining the relationship with the client. KEY CAPITAL PARTNERS GROUP - -------------------------- VICTORY CAPITAL MANAGEMENT manages or advises on investment portfolios, nationally, for corporations, labor unions, not-for-profit organizations, governments and individuals. These portfolios may be managed in separate accounts, commingled funds or the Victory family of mutual funds. It also provides administrative services for retirement plans. HIGH NET WORTH offers financial, estate and retirement planning and asset management services. Its solutions address the high net worth clients' banking, brokerage, trust, portfolio management, insurance, charitable giving and related needs. CAPITAL MARKETS offers investment banking, capital raising, hedging strategies, trading and financial strategies to public and privately held companies, institutions and government organizations. 10 The table that spans pages 12 and 13 shows selected financial data for each major business group for the three- and six-month periods ended June 30, 2002 and 2001. This table is accompanied by additional supplementary information for each of the lines of business that comprise these groups. The financial information was derived from the internal financial reporting system that management uses to monitor and manage Key's financial performance. 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. The selected financial data are based on internal accounting policies designed to compile results on a consistent basis and in a manner that reflects 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 assumptions of the extent to which each line actually uses the services. - - 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 of Key's 2001 Annual Report to Shareholders. - - Income taxes are allocated based on the statutory Federal income tax rate of 35% (adjusted for tax-exempt interest income, income from corporate-owned life insurance 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 organization structure. The financial data reported for all periods presented in the following tables reflect the following changes that occurred during the first half of 2002: - - The Small Business line of business moved from Key Corporate Finance to Key Consumer Banking. - - Methodologies used to allocate certain overhead costs were refined. - - The use of revenue and expense sharing was discontinued. Under this approach, noninterest income and expense attributable to Key Capital Partners had been assigned to the other business groups if one of those groups was principally responsible for maintaining the relationship with the client that used Key Capital Partner's products and services. 11
THREE MONTHS ENDED JUNE 30, KEY CONSUMER KEY CORPORATE KEY CAPITAL BANKING GROUP FINANCE GROUP PARTNERS GROUP --------------------- -------------------- ------------------------ dollars in millions 2002 2001 2002 2001 2002 2001 - ----------------------------------------------------------------------------------------------------------------------------------- SUMMARY OF OPERATIONS Net interest income (taxable equivalent) $ 454 $ 459 $ 279 $ 274 $ 57 $ 55 Noninterest income 125 110 46 66 231 237 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue (taxable equivalent)(a) 579 569 325 340 288 292 Provision for loan losses 63 55 44 43 2 3 Depreciation and amortization expense 34 55 10 16 14 25 Noninterest expense 298 282 111 111 205 209 - ----------------------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes (taxable equivalent) and cumulative effect of accounting change 184 177 160 170 67 55 Allocated income taxes and taxable-equivalent adjustments 69 70 60 65 25 23 - ----------------------------------------------------------------------------------------------------------------------------------- Income (loss) before cumulative effect of accounting change 115 107 100 105 42 32 Cumulative effect of accounting change -- (24) -- -- -- -- - ----------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 115 $ 83 $ 100 $ 105 $ 42 $ 32 ======== ======== ======== ======== ======== ======== Percent of consolidated net income 47% N/M 40% N/M 17% N/M Percent of total segments net income 46 N/M 40 N/M 17 N/M - ----------------------------------------------------------------------------------------------------------------------------------- AVERAGE BALANCES Loans $ 27,935 $ 27,992 $ 29,582 $ 31,437 $ 4,970 $ 5,486 Total assets(a) 30,094 30,781 30,785 32,907 8,325 9,197 Deposits 33,979 35,597 3,094 3,024 3,590 3,803 - ----------------------------------------------------------------------------------------------------------------------------------- OTHER FINANCIAL DATA Net loan charge-offs $ 73 $ 88 $ 124 $ 76 $ 6 $ 7 Return on average allocated equity 23.33% 14.34% 14.25% 15.07% 17.62% 11.97% - -----------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, KEY CONSUMER KEY CORPORATE KEY CAPITAL BANKING GROUP FINANCE GROUP PARTNERS GROUP -------------------- ------------------- ----------------------- dollars in millions 2002 2001 2002 2001 2002 2001 - ----------------------------------------------------------------------------------------------------------------------------------- SUMMARY OF OPERATIONS Net interest income (taxable equivalent) $ 899 $ 902 $ 563 $ 535 $ 110 $ 108 Noninterest income 242 229 103 120 455 479 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue (taxable equivalent)(a) 1,141 1,131 666 655 565 587 Provision for loan losses 125 109 89 86 4 5 Depreciation and amortization expense 71 111 21 32 29 49 Noninterest expense 594 568 222 229 406 427 - ----------------------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes (taxable equivalent) and cumulative effect of accounting changes 351 343 334 308 126 106 Allocated income taxes and taxable-equivalent adjustments 132 136 125 118 47 44 - ----------------------------------------------------------------------------------------------------------------------------------- Income (loss) before cumulative effect of accounting changes 219 207 209 190 79 62 Cumulative effect of accounting changes -- (24) -- -- -- -- - ----------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 219 $ 183 $ 209 $ 190 $ 79 $ 62 ======== ======== ======== ======== ======== ======== Percent of consolidated net income 45% 321% 43% 333% 16% 109% Percent of total segments net income 45 42 42 43 16 14 - ----------------------------------------------------------------------------------------------------------------------------------- AVERAGE BALANCES Loans $ 27,628 $ 28,048 $ 29,671 $ 31,334 $ 4,875 $ 5,523 Total assets(a) 29,795 30,874 30,889 32,797 8,207 9,133 Deposits 34,145 35,863 3,112 3,040 3,631 3,853 - ----------------------------------------------------------------------------------------------------------------------------------- OTHER FINANCIAL DATA Net loan charge-offs $ 155 $ 155 $ 245 $ 117 $ 9 $ 8 Return on average allocated equity 22.41% 15.76% 14.99% 13.76% 16.63% 11.68% - -----------------------------------------------------------------------------------------------------------------------------------
(a) Substantially all revenue generated by Key's major business groups 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 business groups are located in the United States. (b) "Reconciling items" include charges related to the funding of unallocated nonearning assets of corporate support functions. These charges are part of net interest income and are allocated to the business segments through noninterest expense. Noninterest income for the three- and six-month periods ended June 30, 2001, includes a $40 million ($25 million after tax) loss recorded in connection with declines in leased vehicle residual values. (c) The provision for loan losses for the three- and six-month periods ended June 30, 2001, includes an additional provision of $300 million ($189 million after tax) recorded in connection with Key's decision to discontinue certain credit-only commercial relationships. 12
OTHER SEGMENTS TOTAL SEGMENTS RECONCILING ITEMS KEY - ------------------------ --------------------- --------------------------- --------------------- 2002 2001 2002 2001 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------- $ (47) $ (37) $ 743 $ 751 $ (22) $ (32) $ 721 $ 719 27 22 429 435 19 (37) 448 398 - ----------------------------------------------------------------------------------------------------------- (20) (15) 1,172 1,186 (3)(b) (69)(b) 1,169 1,117 1 1 110 102 25 299 (c) 135 401 -- -- 58 96 -- 151 (d) 58 247 8 7 622 609 (15) 2 607 611 - ----------------------------------------------------------------------------------------------------------- (29) (23) 382 379 (13) (521) 369 (142) (21) (19) 133 139 (10) (145) 123 (6) - ----------------------------------------------------------------------------------------------------------- (8) (4) 249 240 (3) (376) 246 (136) -- -- -- (24) -- -- -- (24) - ----------------------------------------------------------------------------------------------------------- $ (8) $ (4) $ 249 $ 216 $ (3) $ (376) $ 246 $ (160) ======== ======== ======== ======== ======== ======== ======== ======== (3)% N/M 101% N/M (1)% N/M 100% N/M (3) N/M 100 N/M N/A N/A N/A N/A - ----------------------------------------------------------------------------------------------------------- $ 1,312 $ 1,924 $ 63,799 $ 66,839 $ 129 $ 115 $ 63,928 $ 66,954 10,649 11,579 79,853 84,464 1,707(e) 1,523(e) 81,560 85,987 3,918 2,929 44,581 45,353 (77) (42) 44,504 45,311 - ----------------------------------------------------------------------------------------------------------- -- -- $ 203 $ 171 -- -- $ 203 $ 171 (8.34)% (3.11)% 16.28% 12.99% N/M N/M 15.16% (9.67)% - -----------------------------------------------------------------------------------------------------------
OTHER SEGMENTS TOTAL SEGMENTS RECONCILING ITEMS KEY - ------------------------ ------------------------- ----------------------- --------------------- 2002 2001 2002 2001 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------- $ (103) $ (71) $ 1,469 $ 1,474 $ (46) $ (60) $ 1,423 $ 1,414 60 60 860 888 31 (35) 891 853 - --------------------------------------------------------------------------------------------------------- (43) (11) 2,329 2,362 (15)(b) (95)(b) 2,314 2,267 2 2 220 202 51 309 (c) 271 511 -- -- 121 192 -- 152 (d) 121 344 14 12 1,236 1,236 (31) (24) 1,205 1,212 - --------------------------------------------------------------------------------------------------------- (59) (25) 752 732 (35) (532) 717 200 (43) (31) 261 267 (30) (149) 231 118 - --------------------------------------------------------------------------------------------------------- (16) 6 491 465 (5) (383) 486 82 -- (1) -- (25) -- -- -- (25) - --------------------------------------------------------------------------------------------------------- $ (16) $ 5 $ 491 $ 440 $ (5) $ (383) $ 486 $ 57 ======== ======== ======== ======== ======== ======== ======== ======== (3)% 9% 101% 772% (1)% (672)% 100% 100% (3) 1 100 100 N/A N/A N/A N/A - --------------------------------------------------------------------------------------------------------- $ 1,378 $ 1,982 $ 63,552 $ 66,887 $ 157 $ 106 $ 63,709 $ 66,993 10,618 11,834 79,509 84,638 1,708(e) 1,516(e) 81,217 86,154 3,432 3,291 44,320 46,047 (82) (33) 44,238 46,014 - --------------------------------------------------------------------------------------------------------- -- -- $ 409 $ 280 -- -- $ 409 $ 280 (8.48)% 2.08% 16.14% 13.27% N/M N/M 15.34% 1.73% - ---------------------------------------------------------------------------------------------------------
(d) Noninterest expense for the three- and six-month periods ended June 30, 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 other nonrecurring charges of $2 million ($1 million after tax). (e) Total assets represent primarily the unallocated portion of nonearning assets of corporate support functions. N/A = Not Applicable N/M = Not Meaningful 13 Supplementary information (Key Consumer Banking lines of business)
THREE MONTHS ENDED JUNE 30, RETAIL BANKING SMALL BUSINESS INDIRECT LENDING --------------------------- ---------------------- ---------------------- dollars in millions 2002 2001 2002 2001 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------ Total revenue (taxable equivalent) $ 327 $ 327 $ 98 $ 98 $ 94 $ 99 Provision for loan losses 14 12 9 9 28 28 Noninterest expense 204 213 42 43 45 43 Net income (loss) 68 62 30 29 13 (7) Net loan charge-offs 17 20 15 11 32 32 Return on average allocated equity 49.73% 41.08% 37.86% 33.49% 7.67% (2.45)% Average full-time equivalent employees 6,016 6,320 269 267 760 807 - ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, NATIONAL HOME EQUITY ------------------------- dollars in millions 2002 2001 - -------------------------------------------------------------------- Total revenue (taxable equivalent) $ 60 $ 45 Provision for loan losses 12 6 Noninterest expense 41 38 Net income (loss) 4 (1) Net loan charge-offs 9 25 Return on average allocated equity 3.97% (1.77)% Average full-time equivalent employees 1,389 1,268 - --------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, RETAIL BANKING SMALL BUSINESS INDIRECT LENDING --------------------------- ---------------------- ------------------------- dollars in millions 2002 2001 2002 2001 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------ Total revenue (taxable equivalent) $ 641 $ 652 $ 195 $ 188 $ 185 $ 205 Provision for loan losses 27 24 18 19 56 54 Noninterest expense 402 428 83 85 93 93 Net income (loss) 132 121 59 52 22 12 Net loan charge-offs 36 33 29 20 70 74 Return on average allocated equity 49.67% 39.82% 38.23% 30.89% 6.70% 2.49% Average full-time equivalent employees 6,027 6,338 266 273 757 807 - ------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, NATIONAL HOME EQUITY ------------------------- dollars in millions 2002 2001 - -------------------------------------------------------------------- Total revenue (taxable equivalent) $ 120 $ 86 Provision for loan losses 24 12 Noninterest expense 87 73 Net income (loss) 6 (2) Net loan charge-offs 20 28 Return on average allocated equity 2.59% (1.14)% Average full-time equivalent employees 1,399 1,256 - --------------------------------------------------------------------
Supplementary information (Key Corporate Finance lines of business)
THREE MONTHS ENDED JUNE 30, CORPORATE BANKING NATIONAL COMMERCIAL REAL ESTATE ------------------------------ -------------------------------------- dollars in millions 2002 2001 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------ Total revenue (taxable equivalent) $ 177 $ 201 $ 86 $ 95 Provision for loan losses 24 24 11 11 Noninterest expense 72 76 29 27 Net income (loss) 50 62 29 36 Net loan charge-offs 117 68 -- 1 Return on average allocated equity 11.90% 14.96% 16.61% 20.16% Average full-time equivalent employees 605 713 517 458 - ------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, NATIONAL EQUIPMENT FINANCE ----------------------------------- dollars in millions 2002 2001 - --------------------------------------------------------------------------------- Total revenue (taxable equivalent) $ 62 $ 44 Provision for loan losses 9 8 Noninterest expense 20 24 Net income (loss) 21 7 Net loan charge-offs 7 7 Return on average allocated equity 19.97% 6.80% Average full-time equivalent employees 606 697 - ---------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CORPORATE BANKING NATIONAL COMMERCIAL REAL ESTATE ---------------------------------------- --------------------------------------- dollars in millions 2002 2001 2002 2001 - --------------------------------------------------------------------------------------------------------------------------------- Total revenue (taxable equivalent) $ 365 $ 392 $ 176 $ 177 Provision for loan losses 50 48 21 21 Noninterest expense 144 159 58 54 Net income 107 115 61 63 Net loan charge-offs 221 105 3 3 Return on average allocated equity 12.73% 13.84% 17.24% 18.31% Average full-time equivalent employees 619 730 510 470 - ---------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, NATIONAL EQUIPMENT FINANCE -------------------------------------- dollars in millions 2002 2001 - ------------------------------------------------------------------------------------ Total revenue (taxable equivalent) $ 125 $ 86 Provision for loan losses 18 17 Noninterest expense 41 48 Net income 41 12 Net loan charge-offs 21 9 Return on average allocated equity 20.36% 5.96% Average full-time equivalent employees 607 691 - ------------------------------------------------------------------------------------
14 Supplementary information (Key Capital Partners lines of business)
THREE MONTHS ENDED JUNE 30, VICTORY CAPITAL MANAGEMENT HIGH NET WORTH ------------------------------ -------------------------------- dollars in millions 2002 2001 2002 2001 - --------------------------------------------------------------------------------------------------------------------------------- Total revenue (taxable equivalent) $ 57 $ 60 $ 148 $ 149 Provision for loan losses -- -- 2 3 Noninterest expense 38 40 119 130 Net income 12 12 17 9 Net loan charge-offs -- -- 6 7 Return on average allocated equity 38.15% 34.26% 13.80% 6.95% Average full-time equivalent employees 539 540 2,514 2,695 - ---------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, CAPITAL MARKETS ------------------------------ dollars in millions 2002 2001 - ------------------------------------------------------------------------------------ Total revenue (taxable equivalent) $ 83 $ 83 Provision for loan losses -- -- Noninterest expense 62 64 Net income 13 11 Net loan charge-offs -- -- Return on average allocated equity 12.61% 10.68% Average full-time equivalent employees 616 638 - ------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, VICTORY CAPITAL MANAGEMENT HIGH NET WORTH --------------------------------- ---------------------------------- dollars in millions 2002 2001 2002 2001 - --------------------------------------------------------------------------------------------------------------------------------- Total revenue (taxable equivalent) $ 110 $ 116 $ 293 $ 306 Provision for loan losses -- -- 4 5 Noninterest expense 77 86 240 263 Net income 21 18 31 22 Net loan charge-offs -- -- 9 8 Return on average allocated equity 32.88% 26.81% 12.42% 8.45% Average full-time equivalent employees 542 548 2,523 2,682 - ---------------------------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CAPITAL MARKETS ------------------------------- dollars in millions 2002 2001 - ----------------------------------------------------------------------------------- Total revenue (taxable equivalent) $ 162 $ 165 Provision for loan losses -- -- Noninterest expense 118 127 Net income 27 22 Net loan charge-offs -- -- Return on average allocated equity 13.23% 10.46% Average full-time equivalent employees 625 646 - -----------------------------------------------------------------------------------
15 5. SECURITIES Key classifies its securities into three categories: trading, investment and available for sale. TRADING ACCOUNT SECURITIES. These are debt and equity securities that are purchased and held by Key with the intent of selling them in the near term, and certain interests retained in loan securitizations. All of these assets are reported at fair value ($752 million at June 30, 2002, $597 million at December 31, 2001 and $1.0 billion at June 30, 2001) and included in "short-term investments" on the balance sheet. Realized and unrealized gains and losses on trading account securities are reported in "investment banking and capital markets 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 calculated for each specific security sold and included in "net securities gains " on the income statement. When Key retains an interest in loans it securitizes, it bears the 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. The amortized cost, unrealized gains and losses, and approximate fair value of Key's investment securities and securities available for sale were as follows:
JUNE 30, 2002 ------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE - --------------------------------------------------------------------------------------------------------------- INVESTMENT SECURITIES States and political subdivisions $ 186 $ 10 -- $ 196 Equity securities 933 -- -- 933 - --------------------------------------------------------------------------------------------------------------- Total investment securities 1,119 $ 10 -- $1,129 ====== ====== ====== ====== SECURITIES AVAILABLE FOR SALE U.S. Treasury, agencies and corporations $ 22 -- -- $ 22 States and political subdivisions 18 $ 1 -- 19 Collateralized mortgage obligations 5,092 99 $ 79 5,112 Other mortgage-backed securities 823 34 -- 857 Retained interests in securitizations 172 35 -- 207 Other securities 154 1 23 132 - --------------------------------------------------------------------------------------------------------------- Total securities available for sale $6,281 $ 170 $ 102 $6,349 ====== ====== ====== ====== - ---------------------------------------------------------------------------------------------------------------
16
DECEMBER 31, 2001 ------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE - --------------------------------------------------------------------------------------------------------------- INVESTMENT SECURITIES States and political subdivisions $ 225 $ 9 -- $ 234 Equity securities 894 -- -- 894 - --------------------------------------------------------------------------------------------------------------- Total investment securities $1,119 $ 9 -- $1,128 ====== ====== ====== ====== SECURITIES AVAILABLE FOR SALE U.S. Treasury, agencies and corporations $ 99 -- -- $ 99 States and political subdivisions 21 -- -- 21 Collateralized mortgage obligations 3,791 $ 86 $ 72 3,805 Other mortgage-backed securities 1,008 24 -- 1,032 Retained interests in securitizations 214 20 -- 234 Other securities 170 1 16 155 - --------------------------------------------------------------------------------------------------------------- Total securities available for sale $5,303 $ 131 $ 88 $5,346 ====== ====== ====== ====== - ---------------------------------------------------------------------------------------------------------------
JUNE 30, 2001 ------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE - --------------------------------------------------------------------------------------------------------------- INVESTMENT SECURITIES States and political subdivisions $ 262 $ 11 -- $ 273 Equity securities 909 -- -- 909 - --------------------------------------------------------------------------------------------------------------- Total investment securities $1,171 $ 11 -- $1,182 ====== ====== ====== ====== SECURITIES AVAILABLE FOR SALE U.S. Treasury, agencies and corporations $ 120 $ 1 -- $ 121 States and political subdivisions 28 -- -- 28 Collateralized mortgage obligations 4,877 80 $ 62 4,895 Other mortgage-backed securities 1,192 22 2 1,212 Retained interests in securitizations 252 13 -- 265 Other securities 183 6 4 185 - --------------------------------------------------------------------------------------------------------------- Total securities available for sale $6,652 $ 122 $ 68 $6,706 ====== ====== ====== ====== - ---------------------------------------------------------------------------------------------------------------
17 6. LOANS Key's loans by category are summarized as follows:
JUNE 30, DECEMBER 31, JUNE 30, in millions 2002 2001 2001 - ---------------------------------------------------------------------------------------------------------------- Commercial, financial and agricultural $18,071 $18,159 $19,812 Commercial real estate: Commercial mortgage 6,266 6,669 6,940 Construction 5,860 5,878 5,744 - ---------------------------------------------------------------------------------------------------------------- Total commercial real estate loans 12,126 12,547 12,684 Commercial lease financing 7,216 7,357 6,930 - ---------------------------------------------------------------------------------------------------------------- Total commercial loans 37,413 38,063 39,426 Real estate-- residential mortgage 2,117 2,315 3,998 Home equity 13,379 11,184 10,666 Consumer-- direct 2,185 2,342 2,448 Consumer-- indirect: Lease financing 1,386 2,036 2,693 Automobile 2,297 2,497 2,695 Marine 1,917 1,780 1,734 Other 912 1,036 1,142 - ---------------------------------------------------------------------------------------------------------------- Total consumer-- indirect loans 6,512 7,349 8,264 - ---------------------------------------------------------------------------------------------------------------- Total consumer loans 24,193 23,190 25,376 Loans held for sale: Real estate-- commercial mortgage 281 252 208 Real estate-- residential mortgage 19 116 82 Education 1,975 1,688 1,601 - ---------------------------------------------------------------------------------------------------------------- Total loans held for sale 2,275 2,056 1,891 - ---------------------------------------------------------------------------------------------------------------- Total loans $63,881 $63,309 $66,693 ======== ======== ======== - ----------------------------------------------------------------------------------------------------------------
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 June 30, 2002, see Note 14 ("Derivatives and Hedging Activities"), which begins on page 28. Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- in millions 2002 2001 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------------- Balance at beginning of period $1,607 $1,001 $1,677 $1,001 Charge-offs (236) (201) (469) (337) Recoveries 33 30 60 57 - --------------------------------------------------------------------------------------------------------------------------------- Net charge-offs (203) (171) (409) (280) Allowance related to loans sold -- -- -- (1) Provision for loan losses 135 401 271 511 - --------------------------------------------------------------------------------------------------------------------------------- Balance at end of period $1,539 $1,231 $1,539 $1,231 ====== ====== ====== ====== - ---------------------------------------------------------------------------------------------------------------------------------
18 7. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS Impaired loans, which account for the largest portion of Key's nonperforming assets, totaled $671 million at June 30, 2002, compared with $661 million at the end of 2001. Impaired loans averaged $678 million for the second quarter of 2002 and $420 million for the second quarter of 2001. Key's nonperforming assets were as follows:
JUNE 30, DECEMBER 31, JUNE 30, in millions 2002 2001 2001 - -------------------------------------------------------------------------------------------- Impaired loans $ 671 $ 661 $ 455 Other nonaccrual loans 286 249 342 - -------------------------------------------------------------------------------------------- Total nonperforming loans 957 910 797 Other real estate owned ("OREO") 40 38 27 Allowance for OREO losses (2) (1) (1) - -------------------------------------------------------------------------------------------- OREO, net of allowance 38 37 26 - -------------------------------------------------------------------------------------------- Total nonperforming assets $ 995 $ 947 $ 823 ===== ===== ===== - --------------------------------------------------------------------------------------------
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. At June 30, 2002, Key had $312 million of impaired loans with a specifically allocated allowance for loan losses of $144 million, and $359 million of impaired loans that were carried at their estimated fair value without a specifically allocated allowance. At December 31, 2001, impaired loans included $417 million of loans with a specifically allocated allowance of $180 million, and $244 million that were carried at their estimated fair value. 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. 19 8. GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, Key adopted SFAS No. 142, which eliminates the amortization of goodwill and intangible assets deemed to have indefinite lives. Key's total amortization expense for the three-month periods ended June 30, 2002 and 2001, was $2 million and $174 million, respectively. For the six-month periods ended June 30, 2002 and 2001, amortization expense was $5 million and $200 million, respectively. Amortization expense for the second quarter of 2001 includes a $150 million write-down of goodwill associated with Key's decision to downsize its automobile finance business. Estimated amortization expense for intangible assets subject to amortization for each of the next five years is as follows: 2002 - $11 million; 2003 - $10 million; 2004 - $6 million; 2005 - $1 million; and 2006 - $1 million. The calculation of Key's net income and earnings per common share, excluding goodwill amortization for the three- and six-month periods ended June 30, 2002, is presented below.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ------------------------------- --------------------------------- dollars in millions, except per share amounts 2002 2001 2002 2001 - -------------------------------------------------------------------------------------------------------------------------------- EARNINGS Net income (loss) $ 246 $ (160) $ 486 $ 57 Add: Goodwill amortization -- 171 -- 193 - -------------------------------------------------------------------------------------------------------------------------------- Adjusted net income $ 246 $ 11 $ 486 $ 250 ========= ========= ========= ========= - -------------------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON SHARES Weighted average common shares outstanding (000) 426,092 424,675 425,477 424,352 Weighted average common shares and potential common shares outstanding (000) 431,935 429,760 430,983 429,838 - -------------------------------------------------------------------------------------------------------------------------------- EARNINGS PER COMMON SHARE Net income (loss) per common share $ .58 $ (.38) $ 1.14 $ .14 Add: Goodwill amortization -- .40 -- .45 - -------------------------------------------------------------------------------------------------------------------------------- Adjusted net income per common share $ .58 $ .02 $ 1.14 $ .59 ========= ========= ========= ========= Adjusted net income per common share - assuming dilution $ .57 $ .02 $ 1.13 $ .58 ========= ========= ========= ========= - --------------------------------------------------------------------------------------------------------------------------------
The following table shows the gross carrying amount and the accumulated amortization of intangible assets that are subject to amortization.
JUNE 30, 2002 DECEMBER 31, 2001 ------------------------------------------ -------------------------------------- GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED in millions AMOUNT AMORTIZATION AMOUNT AMORTIZATION - ----------------------------------------------------------------------------------------------------------------------------------- Intangible assets subject to amortization: Core deposit intangibles $215 $192 $215 $187 Other intangible assets 8 6 9 6 - ----------------------------------------------------------------------------------------------------------------------------------- Total $223 $198 $224 $193 ==== ==== ==== ==== - -----------------------------------------------------------------------------------------------------------------------------------
At June 30, 2002, the carrying amount of goodwill by major business group was as follows: Key Consumer Banking - $446 million; Key Corporate Finance - $204 million; and Key Capital Partners - $455 million. At December 31, 2001, the carrying amount of goodwill by major business group was as follows: Key Consumer Banking - $446 million; Key Corporate Finance - $200 million; and Key Capital Partners - $455 million. For additional information pertaining to the new accounting guidance, see the section entitled "Accounting Pronouncements Adopted in 2002" included in Note 1 ("Basis of Presentation") starting on page 7. 20 9. LONG-TERM DEBT The components of Key's long-term debt, presented net of unamortized discount where applicable, were as follows:
JUNE 30, DECEMBER 31, JUNE 30, dollars in millions 2002 2001 2001 - -------------------------------------------------------------------------------------------------------------- Senior medium-term notes due through 2005(a) $ 1,584 $ 1,286 $ 796 Subordinated medium-term notes due through 2003(a) 85 85 85 Senior euro medium-term notes due through 2003(b) 50 50 50 7.50% Subordinated notes due 2006(c) 250 250 250 6.75% Subordinated notes due 2006(c) 200 200 200 8.125% Subordinated notes due 2002(c) -- 200 200 8.00% Subordinated notes due 2004(c) 125 125 125 6.625% Subordinated notes due 2017(c) 25 -- -- 8.404% Notes due through 2001 -- -- 13 All other long-term debt(i) 17 16 12 - -------------------------------------------------------------------------------------------------------------- Total parent company(j) 2,336 2,212 1,731 Senior medium-term bank notes due through 2039(d) 4,704 4,525 5,655 Senior euro medium-term bank notes due through 2007(e) 5,472 3,989 3,752 6.50% Subordinated remarketable securities due 2027(f) 311 311 312 6.95% Subordinated notes due 2028(f) 300 300 300 7.125% Subordinated notes due 2006(f) 250 250 250 7.25% Subordinated notes due 2005(f) 200 200 200 6.75% Subordinated notes due 2003(f) 200 200 200 7.50% Subordinated notes due 2008(f) 165 165 165 7.00% Subordinated notes due 2011(f) 607 506 506 7.30% Subordinated notes due 2011(f) 107 107 107 7.85% Subordinated notes due 2002(f) 93 93 93 7.55% Subordinated notes due 2006(f) 75 75 75 7.375% Subordinated notes due 2008(f) 70 70 70 Lease financing debt due through 2006(g) 484 519 548 Federal Home Loan Bank advances due through 2030(h) 1,168 762 506 All other long-term debt(i) 353 270 205 - -------------------------------------------------------------------------------------------------------------- Total subsidiaries 14,559 12,342 12,944 - ------------------------------------------------------------------------------------------------------------- Total long-term debt $16,895 $14,554 $14,675 ======= ======= ======= - --------------------------------------------------------------------------------------------------------------
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 June 30, 2002, see Note 14 ("Derivatives and Hedging Activities"),which begins on page 28. (a) At June 30, 2002, December 31, 2001 and June 30,2002, the senior medium-term notes had weighted average interest rates of 2.69%, 2.51% and 4.48%, respectively, and the subordinated medium-term notes had a weighted average interest rate of 7.42%, 7.42% and 7.42% at each respective date. These notes had a combination of fixed and floating interest rates. (b) Senior euro medium-term notes had a weighted average interest rate of 2.11% at June 30, 2002. These notes, which are obligations of KeyCorp, 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 2.73%, 2.45% and 4.30%, at June 30, 2002, December 31, 2001 and June 30, 2001, respectively. These notes had a combination of fixed and floating interest rates. (e) Senior euro medium-term notes had weighted average interest rates of 2.15%, 2.58%, and 4.78%, at June 30, 2002, December 31, 2001 and June 30, 2001, respectively. These notes, which are obligations of KeyBank National Association, had fixed interest rates and floating interest rates based on LIBOR. 21 (f) These notes and securities are all obligations of KeyBank National Association, with the exception of the 7.55% notes, which are obligations of Key Bank USA, National Association. None of the subordinated instruments may be redeemed prior to their maturity dates. (g) Lease financing debt had weighted average interest rates of 7.17% at June 30, 2002, 7.41% at December 31, 2001 and 7.81% at June 30, 2001. This category of debt consists of primarily nonrecourse debt collateralized by leased equipment under operating, direct financing and sales type leases. (h) Long-term advances from the Federal Home Loan Bank had weighted average interest rates of 1.97% at June 30, 2002, 2.19% at December 31, 2001 and 4.05% at June 30, 2001. These advances, which had a combination of fixed and floating interest rates, were secured by $1.8 billion, $1.1 billion, and $759 million of real estate loans and securities at June 30, 2002, December 31, 2001 and June 30, 2001, respectively. (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 6.77%, 6.72%, and 6.84% at June 30, 2002, December 31, 2001 and June 30, 2001, respectively. (j) At June 30, 2002, unused capacity under KeyCorp's registration with the Securities and Exchange Commission included $1.2 billion under a shelf registration and $575 million allocated for the issuance of medium-term notes. 10. RESTRUCTURING CHARGES In November 1999, KeyCorp instituted a competitiveness initiative to improve Key's operating efficiency and profitability. 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 in 2000. As of March 31, 2002, Key had substantially completed the implementation of all projects related to the second and final phase, which started during the second half of 2000. This phase focused 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 March 31, 2002, nearly 4,100 positions had been eliminated. Changes in the components of the restructuring charge liability associated with the above actions are as follows:
DECEMBER 31, RESTRUCTURING CASH JUNE 30, in millions 2001 CHARGES (CREDITS) PAYMENTS 2002 - --------------------------------------------------------------------------------------------------------- Severance $27 $(7) $ 9 $11 Site consolidations 33 2 3 32 Equipment and other 1 -- -- 1 - --------------------------------------------------------------------------------------------------------- Total $61 $(5) $12 $44 === === === === - ---------------------------------------------------------------------------------------------------------
22 11. CAPITAL SECURITIES KeyCorp has five fully-consolidated 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 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 CAPITAL AMOUNT OF OF CAPITAL SECURITIES, COMMON DEBENTURES, SECURITIES AND dollars in millions NET OF DISCOUNT (a) SECURITIES NET OF DISCOUNT (b) DEBENTURES (c) - ---------------------------------------------------------------------------------------------------------------------------------- June 30, 2002 KeyCorp Institutional Capital A $ 389 $11 $ 361 7.826% KeyCorp Institutional Capital B 167 4 154 8.250 KeyCorp Capital I 237 8 244 2.778 KeyCorp Capital II 205 8 203 6.875 KeyCorp Capital III 246 8 233 7.750 - ---------------------------------------------------------------------------------------------------------------------------------- Total $1,244 $39 $1,195 6.749% ====== === ====== - ---------------------------------------------------------------------------------------------------------------------------------- December 31, 2001 $1,288 $39 $1,282 6.824% ====== === ====== - ---------------------------------------------------------------------------------------------------------------------------------- June 30, 2001 $1,279 $39 $1,282 7.263% ====== === ====== - ----------------------------------------------------------------------------------------------------------------------------------
MATURITY OF CAPITAL SECURITIES AND dollars in millions DEBENTURES - --------------------------------------------------------------- June 30, 2002 KeyCorp Institutional Capital A 2026 KeyCorp Institutional Capital B 2026 KeyCorp Capital I 2028 KeyCorp Capital II 2029 KeyCorp Capital III 2029 - --------------------------------------------------------------- Total -- - --------------------------------------------------------------- December 31, 2001 -- - --------------------------------------------------------------- June 30, 2001 -- - ---------------------------------------------------------------
(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 June 30, 2002, December 31, 2001 and June 30, 2001, are basis adjustments of $88 million, $45 million and $36 million, respectively, related to fair value hedges. See Note 14 ("Derivatives and Hedging Activities"), which begins on page 28, for an explanation of 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 June 30, 2002, December 31, 2001 and June 30, 2001, are weighted average rates. 23 12. 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 has 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. 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. On February 20, 2002, KeyBank filed a Motion for Partial Lifting of the July 23, 2001, Stay in which it asked the Court to allow the case to proceed against the parties other than Reliance. The Court granted KeyBank's motion on May 17, 2002. 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 run-off 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 June 30, 2002, total approximately $202 million, and management currently estimates that approximately $106 million of additional claims may be filed through year-end 2006. During this time frame, a number of factors could affect KeyBank's actual loss experience, which may be higher or lower than management's current estimates. 24 Key is recording as a receivable a portion of the amount of the claims as and when filed estimated to be appropriate to reflect the collectibility risk associated with the insurance litigation. Any recovery from the litigation may be more or less than the receivable. 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. 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 varied, generally the plaintiffs 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 since entered into settlement agreements with the plaintiffs in all nine lawsuits, pursuant to which those plaintiffs' claims against McDonald were dismissed. The terms of the 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 its lead insurance carrier filed declaratory judgment actions against each other. Key's action includes claims for breach of contract and for bad faith. 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 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, and on March 31, 2002, KeyCorp filed a Motion to Enforce the Settlement Agreement in the United States District Court for the Northern District of Ohio. That Motion is pending before the Court, and a hearing is currently scheduled to take place in late August 2002. If the settlement agreement were not to be enforced, the aggregate balance sheet exposure for all claims relating to the coverage dispute would be approximately $40 million. This exposure along with additional damages would then be pursued in the underlying litigation against the carriers. 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. 25 13. 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. These instruments include those related to loan securitizations, as well as derivatives and hedging activities. 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 applications for credit are reviewed and approved, credit limits are established and, when necessary, demands for collateral are made. 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 related to the financial instruments discussed in this note. 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 obtain a loan commitment from Key. 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. In addition to loans referred directly to the conduit, 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 June 30, 2002, Key's commitments to provide liquidity and credit enhancement totaled $348 million and $34 million, respectively. There were no balances outstanding under either of the commitment facilities at June 30, 2002. Management periodically evaluates Key's potential exposure related to these commitments. The balance of assets outstanding in the conduit was $326 million at June 30, 2002. Of this amount, $140 million represents the balance of the beneficial interests in the Federally guaranteed education loans acquired by the conduit in 2001. The remaining amount represents primarily loans purchased by the conduit from other financial institutions. All of the assets in the conduit were performing in accordance with their contractual terms at June 30, 2002. RECOURSE AGREEMENT WITH FEDERAL NATIONAL MORTGAGE ASSOCIATION. KeyBank National Association ("KBNA") 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, KBNA 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 June 30, 2002, the principal balance outstanding of loans sold by KBNA as a participant in this program was approximately $1.2 billion. 26 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 June 30, 2002, Key guaranteed equity of $674 million plus various specified returns on that equity. KAHC has established a reserve of an amount that management believes will be sufficient to cover estimated losses under the guarantees. OTHER OFF-BALANCE SHEET RISK. KeyBank National Association and Key Bank USA, National Association are members of MasterCard International Inc. ("MasterCard") and Visa U.S.A. Inc. ("Visa"). MasterCard's charter documents and bylaws state that MasterCard has the ability to assess members for certain liabilities, including litigation liabilities. Visa's charter documents state that Visa has the ability to fix fees payable by members in connection with the operations of Visa. Descriptions of pending lawsuits and MasterCard's and Visa's position regarding the potential impact of those lawsuits on members are set forth on MasterCard's and Visa's respective websites and in MasterCard's public filings with the Securities and Exchange Commission. Key is not a party to any significant litigation by third parties against MasterCard or Visa. The following table shows the contractual amount of each class of lending-related, off-balance sheet financial instrument remaining as of the date indicated. 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.
JUNE 30, DECEMBER 31, JUNE 30, in millions 2002 2001 2001 - --------------------------------------------------------------------------------------------------- Loan commitments: Home equity $ 5,411 $ 4,965 $ 4,863 Commercial real estate and construction 2,061 2,487 2,465 Commercial and other 23,080 24,936 22,182 - --------------------------------------------------------------------------------------------------- Total loan commitments 30,552 32,388 29,510 Other commitments: Standby letters of credit 3,555 3,503 3,334 Commercial letters of credit 102 106 126 - --------------------------------------------------------------------------------------------------- Total loan and other commitments $34,209 $35,997 $32,970 ======= ======= ======= - ---------------------------------------------------------------------------------------------------
27 14. 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 of Key's 2001 Annual Report to Shareholders. 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 as a charge to earnings during 2001. At June 30, 2002, Key had $430 million of derivative assets recorded in "accrued income and other assets" and $141 million of derivative liabilities recorded in "accrued expense and other liabilities" on the balance sheet. 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 the first half of 2002, Key recognized a net gain of approximately $3 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 that could result from changes in interest rates 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. 28 As a result of actions announced in May 2001, 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 did not make. During the first half of 2002, Key recognized a net loss of approximately $1 million in connection with the ineffective portion of its cash flow hedging instruments. There was no impact on earnings during the first half of 2002 related to the exclusion of portions of hedging instruments from the assessment of hedge effectiveness. The change in "accumulated other comprehensive income (loss)" resulting from cash flow hedges is as follows:
RECLASSIFICATION DECEMBER 31, 2002 OF GAINS JUNE 30, in millions 2001 HEDGING ACTIVITY TO NET INCOME 2002 - --------------------------------------------------------------------------------------------------------------- Accumulated other comprehensive income (loss) resulting from cash flow hedges $(2) $13 $ (4 ) $7 - ---------------------------------------------------------------------------------------------------------------
Key expects to reclassify approximately $27 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. TRADING PORTFOLIO FUTURES CONTRACTS AND INTEREST RATE SWAPS, CAPS AND FLOORS. Key uses these instruments for dealer activities, which are generally limited to Key's commercial loan clients, and enters into other positions with third parties to mitigate the interest rate risk of the client positions. The transactions entered into with clients are generally limited to conventional interest rate 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 and futures are included in "investment banking and capital markets income" on the income statement. The following table shows net trading income recognized on interest rate swap and foreign exchange forward contracts. SIX MONTHS ENDED JUNE 30, ------------------------- in millions 2002 2001 - -------------------------------------------------------------------------- Interest rate swap contracts $5 $8 Foreign exchange forward contracts 18 22 - -------------------------------------------------------------------------- 29 COUNTERPARTY 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 expected positive replacement value of contracts. 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 June 30, 2002, Key was party to swaps with 36 different counterparties. Among these were swaps entered into to offset the risk of client swaps. Key had aggregate credit exposure of $261 million to 12 of these counterparties, with the largest credit exposure to an individual counterparty amounting to approximately $91 million. As of the same date, Key's aggregate credit exposure on its interest rate caps totaled $33 million. Management has established a reserve of an amount that it believes will be sufficient to cover estimated losses related to customer derivatives. 30 INDEPENDENT ACCOUNTANTS' REVIEW REPORT SHAREHOLDERS AND BOARD OF DIRECTORS KEYCORP We have reviewed the unaudited condensed consolidated balance sheets of KeyCorp and subsidiaries ("Key") as of June 30, 2002 and 2001, and the related condensed consolidated statements of income for the three- and six-month periods then ended, and the condensed consolidated statements of changes in shareholders' equity and cash flow for the six-month periods ended June 30, 2002 and 2001. These financial statements are the responsibility of Key's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States. We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated balance sheet of Key as of December 31, 2001, and the related consolidated statements of income, changes in shareholders' equity, and cash flow for the year then ended (not presented herein) and in our report dated January 14, 2002, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2001, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ Ernst & Young LLP Cleveland, Ohio July 12, 2002 31 MANAGEMENT'S DISCUSSION AND ANALYSIS INTRODUCTION - ------------ This Management's Discussion and Analysis generally reviews the financial condition and results of operations of KeyCorp and its subsidiaries for the quarterly and year-to-date periods ended June 30, 2002 and 2001. Some tables may cover more periods 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 3 through 30. ACCOUNTING POLICIES Key's business is dynamic and complex. Consequently, management must exercise judgment in choosing and applying accounting policies and methodologies in many areas. These choices are important; not only are they necessary to comply with accounting principles generally accepted in the United States, they also reflect the exercise of management's judgment in determining the most appropriate manner in which to record and report Key's overall financial performance. In management's opinion, some of these areas have a more significant impact than others on Key's financial reporting. This is because they apply to areas of relatively greater business importance, to matters for which there is a range of possible outcomes 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 and tax exposures. 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 of Key's 2001 Annual Report to Shareholders. A detailed description of contingent obligations arising from litigation is contained in Note 12 ("Legal Proceedings"), which begins on page 24 of this report. In the normal course of business, Key is routinely subject to examinations and challenges from tax authorities regarding the amount of taxes due in connection with investments it has made and the businesses in which it is engaged. In connection with a current examination, the Internal Revenue Service is challenging Key's tax treatment of certain leveraged lease investments originated in the years under examination. This and other challenges by tax authorities may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. Management believes that these challenges will be resolved without having any material effect on Key's financial condition and results of operations. All accounting policies are important, and all policies contained in Note 1 of the Annual Report should be reviewed for a greater understanding of how Key's financial performance is recorded and reported. Furthermore, valuation methodologies employed by management often involve a significant degree of judgment, particularly when observable liquid markets do not exist for the items being valued. The outcome of valuations performed by management have a direct bearing on the carrying amounts of certain assets, such as principal investments, residual interests retained in securitizations and goodwill. The valuation methodology used by management for principal investments is summarized in Note 1 ("Summary of Significant Accounting Policies") under the heading "Securities," on page 58 of Key's 2001 Annual Report to Shareholders. The valuation methodology used for retained interests is summarized in the same note under the heading "Loan Securitizations" on page 59 of the Annual Report. The valuation methodology used in the testing for goodwill impairment is summarized in Note 1 ("Basis of Presentation") under the heading "Goodwill and other intangible assets," on page 7 of this report. In recent months, corporate improprieties related to revenue recognition have received a great deal of attention in the media. Although the risk of intentional or unintentional misstatements exists in all companies, the likelihood of such misstatements occurring in the financial services industry is mitigated by the fact that most of the revenue (i.e., interest accruals) recorded is driven by nondiscretionary formulas. In addition, Key's management has established and maintains a comprehensive system of internal control to protect Key's assets and the integrity of its financial statements. While no such system is foolproof, ours is designed so that the financial information we publish is accurate, complete, timely and presents our performance fairly. 32 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 business group. 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. Items that account for the difference between Key's core and reported financial results for the three- and six-month periods ended June 30, 2001, are summarized in Figure 1 on page 35. - - 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," which begins on page 63. - - 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 may contain "forward-looking statements" about issues like anticipated earnings, anticipated levels of net loan charge-offs and nonperforming assets and anticipated improvement in profitability and competitiveness. 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 disruptions, which may have adverse effects on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities. 33 - - 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. HIGHLIGHTS OF KEY'S PERFORMANCE - ------------------------------- FINANCIAL PERFORMANCE During the second quarter of 2001, we announced a series of strategic initiatives designed to sharpen our business focus and strengthen our financial performance by emphasizing the importance of core relationship businesses and a more conservative credit culture. Specific actions include exiting the automobile leasing business, de-emphasizing indirect prime automobile lending, discontinuing nonrelationship lending in the leveraged financing and nationally syndicated lending businesses, and increasing the allowance for loan losses. As a result of the above actions, we recorded several significant charges that had an adverse effect on Key's financial performance for the second quarter of 2001. The nonrecurring 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. These charges are reviewed in greater detail throughout the remainder of this discussion. The primary measures of Key's financial performance for the second quarter and first six months of 2002 are summarized below. Performance measures for the same periods in 2001 reflect the effects of the two large core charges recorded in the second quarter, but exclude the goodwill write-down and other items summarized in Figure 1 that are considered to be nonrecurring (or noncore). - - Net income for the second quarter of 2002 was $246 million, or $.57 per common share, up from net income of $240 million, or $.56 per share, for the previous quarter and core net income of $28 million, or $.07 per share, for the second quarter of 2001. For the first six months of the year, Key's net income was $486 million, or $1.13 per common share, compared with core net income of $245 million, or $.57 per share for the first half of last year. - - Key's return on average equity was 15.16% for the second quarter of 2002. This result compares with a return of 15.53% for the prior quarter and a core return of 1.69% for the year-ago quarter. For the first six months of the year, Key's return on average equity was 15.34%, compared with a core return of 7.45% for the first half of 2001. - - Key's second quarter return on average total assets was 1.21%. This result is up from a return of 1.20% for the previous quarter and a core return of .13% for the second quarter of 2001. For the first six months of the year, Key's return on average total assets was 1.21%, up from a core return of .57% for the comparable period in 2001. 34 FIGURE 1. SIGNIFICANT NONRECURRING ITEMS
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- --------------------------- dollars in millions, except per share amounts 2002 2001 2002 2001 - ----------------------------------------------------------------------------------------------------------------------------------- Net income (loss) as reported $ 246 $ (160) $ 486 $ 57 Nonrecurring items (net of tax): Goodwill write-down (automobile finance business) -- 150 -- 150 Cumulative effect of accounting change--EITF 99-20 -- 24 -- 24 Additional litigation reserves -- 13 -- 13 Restructuring and other special charges -- 1 -- 1 - ----------------------------------------------------------------------------------------------------------------------------------- Net income - core $ 246 $ 28 $ 486 $ 245 ======= ======= ======= ======= Net income (loss) per diluted common share $ .57 $ (.38) $ 1.13 $ .13 Net income per diluted common share--core .57 .07 1.13 .57 Return on average total assets 1.21% (.75)% 1.21% .13% Return on average total assets--core 1.21 .13 1.21 .57 Return on average equity 15.16 (9.67) 15.34 1.73 Return on average equity--core 15.16 1.69 15.34 7.45 - -----------------------------------------------------------------------------------------------------------------------------------
Relative to both the second quarter of 2001 and the first quarter of 2002, Key's second quarter earnings reflect positive results from the actions taken last year. Despite continued softness in the economy, Key's taxable-equivalent net interest income rose from that reported for the second quarter of 2001. A 21 basis point improvement in net interest margin more than compensated for a 5% reduction in average earning assets stemming from the impact of some strategic downsizing of the loan portfolio, loan sales and weaker loan demand. Noninterest income rose by $50 million, reflecting the $40 million charge recorded a year ago to establish a reserve for losses incurred on the residual values of leased vehicles. On a core basis, noninterest expense fell by $21 million, including a $20 million reduction associated with the adoption of new accounting guidance for goodwill. The provision for loan losses decreased by $266 million due to the additional $300 million provision recorded in the year-ago quarter as part of management's decision to discontinue nonrelationship lending in the leveraged financing and nationally syndicated lending businesses and to facilitate sales of distressed loans in other portfolios. Relative to the first quarter of 2002, Key's second quarter earnings reflect a moderate increase in revenue, a level of noninterest expense that was essentially unchanged and our first quarter-to-quarter decrease in nonperforming loans in three years. Our favorable performance in terms of expense control is attributable largely to the success of our competitiveness initiative discussed on page 36. The primary reasons that Key's specific revenue and expense components changed from those of the three- and six month periods ended June 30, 2001, are reviewed in detail in the remainder of this discussion. Figure 2 on page 37 summarizes Key's financial performance on a reported basis for each of the past five quarters and the first six months of 2002 and 2001. 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 current 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 intend to focus on national businesses such as commercial real estate lending, asset management, home equity lending and equipment leasing. 35 - - 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 intend to 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 intend to continue to leverage technology both to reduce costs and enhance the service quality provided to our clients. 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. - - 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; --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 was 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 annual operating expenses by approximately $100 million by outsourcing certain nonstrategic support functions, consolidating sites in a number of our businesses and reducing management layers. As of March 31, 2002, we had substantially completed the implementation of all projects related to the second and final phase of the initiative, referred to as PEG (Perform, Excel, Grow). In this phase, our goal was to reduce costs by an incremental net annual rate of $200 million by: - - 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 additional noncore activities. Management believes that Key will achieve the anticipated annual net cost savings from the overall initiative when all planned actions are fully implemented before the end of 2002. 36 Management had anticipated that the actions taken in the competitiveness initiative would 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 March 31, 2002, nearly 4,100 positions had been eliminated. Since the inception of the competitiveness initiative, we have recorded related net charges of $274 million. Note 10 ("Restructuring Charges") on page 22, provides more information about Key's restructuring charges. FIGURE 2. SELECTED FINANCIAL DATA
2002 2001 ------------------------------- ---------------------- dollars in millions, except per share amounts SECOND FIRST FOURTH - ----------------------------------------------------------------------------------------------------------------------------- FOR THE PERIOD Interest income $ 1,102 $ 1,092 $ 1,210 Interest expense 419 438 510 Net interest income 683 654 700 Provision for loan losses 135 136 723 Noninterest income 448 443 418 Noninterest expense 665 661 702 Income (loss) before income taxes and cumulative effect of accounting changes 331 300 (307) Income (loss) before cumulative effect of accounting changes 246 240 (174) Net income (loss) 246 240 (174) Net income (loss) -- core 246 240 (174) - ----------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE Income (loss) before cumulative effect of accounting changes $ .58 $ .56 $ (.41) Income (loss) before cumulative effect of accounting changes --- assuming dilution .57 .56 (.41) Net income (loss) .58 .56 (.41) Net income (loss)--core .58 .56 (.41) Net income (loss)--assuming dilution .57 .56 (.41) Net income (loss)--assuming dilution--core .57 .56 (.41) Cash dividends paid .30 .30 .295 Book value at period end 15.46 15.05 14.52 Market price: High 29.40 27.26 24.52 Low 25.95 22.92 20.49 Close 27.30 26.65 24.34 Weighted average common shares (000) 426,092 424,855 423,596 Weighted average common shares and potential common shares (000) 431,935 430,019 428,280 - ----------------------------------------------------------------------------------------------------------------------------- AT PERIOD END Loans $ 63,881 $ 63,956 $ 63,309 Earning assets 72,820 72,382 71,672 Total assets 82,778 81,359 80,938 Deposits 44,805 43,233 44,795 Long-term debt 16,895 15,256 14,554 Shareholders' equity 6,592 6,402 6,155 Full-time equivalent employees 20,929 21,076 21,230 KeyCenters 905 911 911 - ----------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average total assets 1.21% 1.20% (.84)% Return on average total assets -- core 1.21 1.20 (.84) Return on average equity 15.16 15.53 (10.57) Return on average equity-- core 15.16 15.53 (10.57) Net interest margin (taxable equivalent) 3.98 3.93 3.98 - ----------------------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS AT PERIOD END Equity to assets 7.96% 7.87% 7.60% Tangible equity to tangible assets 6.69 6.57 6.29 Tier 1 risk-based capital 8.23 7.92 7.43 Total risk-based capital 12.29 12.02 11.41 Leverage 8.14 8.13 7.65 - -----------------------------------------------------------------------------------------------------------------------------
2001 SIX MONTHS ENDED JUNE 30, -------------------------------- ------------------------------------ dollars in millions, except per share amounts THIRD SECOND 2002 2001 - ---------------------------------------------------------------------------------------------------------------------------------- FOR THE PERIOD Interest income $ 1,380 $ 1,467 $ 2,194 $ 3,037 Interest expense 656 754 857 1,636 Net interest income 724 713 1,337 1,401 Provision for loan losses 116 401 271 511 Noninterest income 454 398 891 853 Noninterest expense 683 858 1,326 1,556 Income (loss) before income taxes and cumulative effect of accounting changes 379 (148) 631 187 Income (loss) before cumulative effect of accounting changes 249 (136) 486 82 Net income (loss) 249 (160) 486 57 Net income (loss) -- core 249 28 486 245 - ---------------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE Income (loss) before cumulative effect of accounting changes $ .59 $ (.32) $ 1.14 $ .19 Income (loss) before cumulative effect of accounting changes --- assuming dilution .58 (.32) 1.13 .19 Net income (loss) .59 (.38) 1.14 .14 Net income (loss) -- core .59 .07 1.14 .58 Net income (loss)-- assuming dilution .58 (.38) 1.13 .13 Net income (loss)-- assuming dilution -- core .58 .07 1.13 .57 Cash dividends paid .295 .295 .60 .59 Book value at period end 15.53 15.22 15.46 15.22 Market price: High 28.15 26.43 29.40 29.25 Low 22.20 22.10 22.92 22.10 Close 24.14 26.05 27.30 26.05 Weighted average common shares (000) 424,802 424,675 425,477 424,352 Weighted average common shares and potential common shares (000) 430,346 429,760 430,983 429,838 - ---------------------------------------------------------------------------------------------------------------------------------- AT PERIOD END Loans $ 64,506 $ 66,693 $ 63,881 $ 66,693 Earning assets 73,943 76,531 72,820 76,531 Total assets 84,419 85,838 82,778 85,838 Deposits 45,372 45,743 44,805 45,743 Long-term debt 15,114 14,675 16,895 14,675 Shareholders' equity 6,575 6,467 6,592 6,467 Full-time equivalent employees 21,297 21,742 20,929 21,742 KeyCenters 911 926 905 926 - ---------------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average total assets 1.16% (.75)% 1.21 % .13% Return on average total assets -- core 1.16 .13 1.21 .57 Return on average equity 15.20 (9.67) 15.34 1.73 Return on average equity -- core 15.20 1.69 15.34 7.45 Net interest margin (taxable equivalent) 3.85 3.77 3.96 3.70 - ---------------------------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS AT PERIOD END Equity to assets 7.79% 7.53% 7.96% 7.53% Tangible equity to tangible assets 6.51 6.25 6.69 6.25 Tier 1 risk-based capital 7.81 7.71 8.23 7.71 Total risk-based capital 11.77 11.81 12.29 11.81 Leverage 7.90 7.68 8.14 7.68 - ----------------------------------------------------------------------------------------------------------------------------------
37 LINE OF BUSINESS RESULTS This section summarizes the financial performance and related strategic developments of each of Key's three major business groups: Key Consumer Banking, Key Corporate Finance and Key Capital Partners. To better understand this discussion, see Note 4 ("Line of Business Results"), which begins on page 10. Note 4 includes a brief description of the products and services offered by each of the groups, as well as more detailed financial information pertaining to the groups and their related lines of business. Figure 3 summarizes the contribution made by each major business group to Key's taxable-equivalent revenue and net income for the three- and six-month periods ended June 30, 2002 and 2001. The specific lines of business that comprise each of the groups are shown in the tables that accompany the discussions that follow. FIGURE 3. MAJOR BUSINESS GROUPS - TAXABLE-EQUIVALENT REVENUE AND NET INCOME
THREE MONTHS ENDED JUNE 30, CHANGE ----------------------------------- ------------------------------- dollars in millions 2002 2001 AMOUNT PERCENT - ----------------------------------------------------------------------------------------------------------- REVENUE (TAXABLE EQUIVALENT) Key Consumer Banking $ 579 $ 569 $ 10 1.8% Key Corporate Finance 325 340 (15) (4.4) Key Capital Partners 288 292 (4) (1.4) Other Segments (20) (15) (5) (33.3) ---------------- ----------------- -------------- -------------- Total segments 1,172 1,186 (14) (1.2) Reconciling items(c) (3) (69) 66 95.7 ---------------- ----------------- -------------- -------------- Total $1,169 $1,117 $ 52 4.7 ================ ================= ============== NET INCOME (LOSS)(a) Key Consumer Banking(b) $ 115 $ 107 $ 8 7.5% Key Corporate Finance 100 105 (5) (4.8) Key Capital Partners 42 32 10 31.3 Other Segments (8) (4) (4) (100.0) ---------------- ----------------- -------------- -------------- Total segments 249 240 9 3.8 Reconciling items(c) (3) (400) 397 99.3 ---------------- ----------------- -------------- -------------- Total $ 246 $ (160) $406 N/M ================ ================= ============== - -----------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CHANGE -------------------------------- ------------------------------ dollars in millions 2002 2001 AMOUNT PERCENT - ----------------------------------------------------------------------------------------------------- REVENUE (TAXABLE EQUIVALENT) Key Consumer Banking $1,141 $1,131 $ 10 .9% Key Corporate Finance 666 655 11 1.7 Key Capital Partners 565 587 (22) (3.7) Other Segments (43) (11) (32) (290.9) --------------- -------------- ------------- ------------- Total segments 2,329 2,362 (33) (1.4) Reconciling items(c) (15) (95) 80 84.2 --------------- -------------- ------------- ------------- Total $2,314 $2,267 $ 47 2.1 =============== ============== ============= NET INCOME (LOSS)(a) Key Consumer Banking(b) $ 219 $ 207 $ 12 5.8% Key Corporate Finance 209 190 19 10.0 Key Capital Partners 79 62 17 27.4 Other Segments (16) 6 (22) (366.7) --------------- -------------- ------------- ------------- Total segments 491 465 26 5.6 Reconciling items(c) (5) (408) 403 98.8 --------------- -------------- ------------- ------------- Total $ 486 $ 57 $ 429 752.6 =============== ============== ============= - -----------------------------------------------------------------------------------------------------
(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 the three- and six-month periods ended June 30, 2001, exclude a one-time 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 (See note (c) below). (c) Reconciling items in the second quarter of 2001 include an additional provision for loan losses of $300 million ($189 million after tax) recorded in connection with Key's decision to discontinue certain nonrelationship commercial lending, a goodwill write-down of $150 million associated with Key's decision to downsize its automobile finance business, a $40 million ($25 million after tax) loss recorded in connection with declines in leased vehicle residual values, a $20 million ($13 million after tax) increase in litigation reserves and other nonrecurring charges of $2 million ($1 million after tax). 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 38 FIGURE 4. KEY CONSUMER BANKING GROUP DATA
THREE MONTHS ENDED JUNE 30, CHANGE ----------------------------------- ----------------------------- dollars in millions 2002 2001 AMOUNT PERCENT - ---------------------------------------------------------------------------------------------------------------- REVENUE (TAXABLE EQUIVALENT) Retail Banking $327 $327 -- --% Small Business 98 98 -- -- Indirect Lending 94 99 $ (5) (5.1) National Home Equity 60 45 15 33.3 ---------------- ---------------- ------------ ------------- Total $579 $569 $ 10 1.8 ================ ================ ============ NET INCOME (LOSS)(a) Retail Banking $ 68 $ 62 $ 6 9.7% Small Business 30 29 1 3.4 Indirect Lending 13 16 (3) (18.8) National Home Equity 4 -- 4 N/M ---------------- ---------------- ------------ ------------- Total $115 $107 $ 8 7.5 ================ ================ ============ - ----------------------------------------------------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, CHANGE ------------------------------ ----------------------------- dollars in millions 2002 2001 AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------- REVENUE (TAXABLE EQUIVALENT) Retail Banking $ 641 $ 652 $(11) (1.7)% Small Business 195 188 7 3.7 Indirect Lending 185 205 (20) (9.8) National Home Equity 120 86 34 39.5 ---------------- -------------- ------------ ------------- Total $1,141 $1,131 $ 10 .9 ================ ============== ============ NET INCOME (LOSS)(a) Retail Banking $ 132 $ 121 $ 11 9.1 % Small Business 59 52 7 13.5 Indirect Lending 22 35 (13) (37.1) National Home Equity 6 (1) 7 N/M ---------------- -------------- ------------ ------------- Total $ 219 $ 207 $ 12 5.8 ================ ============== ============ - -------------------------------------------------------------------------------------------------------
(a) Results for the three- and six-month periods ended June 30, 2001, exclude a one-time 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. N/M = Not Meaningful
ADDITIONAL KEY CONSUMER BANKING DATA (2Q02) Average home equity loans: $11.9 billion National Home Equity average loan-to-value ratio: 76% Average core deposits: $30.9 billion National Home Equity first lien positions: 83% 489,632 on-line clients (28% penetration) 905 KeyCenters and 2,284 ATMs 8,434 average full-time equivalent employees
Net income for Key Consumer Banking was $115 million for the second quarter of 2002, representing an $8 million increase from the year-ago quarter. The improvement is attributable to an increase in noninterest income and a reduction in noninterest expense, offset in part by a decrease in taxable-equivalent net interest income and a higher provision for loan losses. Taxable-equivalent net interest income decreased by $5 million, or 1%, from the second quarter of 2001 due to a less favorable interest rate spread on deposits and a decline in average deposits outstanding. The adverse effect of these factors was partially offset by a more favorable spread on earning assets. Noninterest income grew by $15 million, or 14%, due primarily to a $9 million increase in income from service charges on deposit accounts contributed by the Retail Banking and Small Business lines of business. This growth resulted from new pricing implemented in mid-2001 in connection with PEG (Perform, Excel, Grow), Key's competitiveness improvement initiative. Also contributing to the growth in noninterest income are lower losses from retained interests in previously securitized assets and from trading activities. Noninterest expense was down $5 million, or 1%, from the second quarter of 2001. This improvement reflects an approximate $9 million reduction in goodwill amortization, which resulted from the adoption of new accounting guidance on January 1, as well as lower costs for software amortization. These reductions were partially offset by higher costs related to personnel, marketing and activities associated with a higher volume of home equity lending. An $8 million, or 15%, increase in the provision for loan losses reflects the growth in lending in the National Home Equity line of business. 39 FIGURE 5. KEY CORPORATE FINANCE GROUP DATA
THREE MONTHS ENDED JUNE 30, CHANGE SIX MONTHS ENDED JUNE 30, CHANGE --------------------------- ------------------- ------------------------- ------------------- dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT - --------------------------------------------------------------------------------------------------------------------- -------- REVENUE (TAXABLE EQUIVALENT) Corporate Banking $177 $201 $(24) (11.9)% $365 $392 $(27) (6.9)% National Commercial Real Estate 86 95 (9) (9.5) 176 177 (1) (.6) National Equipment Finance 62 44 18 40.9 125 86 39 45.3 ---- ---- ---- ----- ---- ---- ---- ----- Total $325 $340 $(15) (4.4) $666 $655 $ 11 1.7 ==== ==== ==== ==== ==== ==== NET INCOME Corporate Banking $ 50 $ 62 $(12) (19.4)% $107 $115 $ (8) (7.0)% National Commercial Real Estate 29 36 (7) (19.4) 61 63 (2) (3.2) National Equipment Finance 21 7 14 200.0 41 12 29 241.7 ---- ---- ---- ---- ---- ---- ---- --- Total $100 $105 $ (5) (4.8) $209 $190 $ 19 10.0 ==== ==== ==== ==== ==== ==== - --------------------------------------------------------------------------------------------------------------------- --------
ADDITIONAL KEY CORPORATE FINANCE DATA (2Q02) Average loans and leases: $29.6 billion Average deposits: $3.1 billion 1,728 average full-time equivalent employees Net income for Key Corporate Finance was $100 million for the second quarter of 2002, compared with $105 million for the same period last year. The decrease is due to a reduction in noninterest income, partially offset by an increase in taxable-equivalent net interest income and lower noninterest expense. Taxable-equivalent net interest income grew by $5 million, or 2%, due primarily to a more favorable interest rate spread on earning assets and an increase in the taxable-equivalent adjustment related to income derived from the equipment leasing portfolio. At the same time, noninterest income decreased by $20 million, or 30%. In the Corporate Banking line of business, additional income from a significant increase in service charges on deposit accounts was more than offset by lower income from trading activities. The overall reduction in noninterest income also reflects declines in gains from loan sales in the National Commercial Real Estate line and from the residual values of leased equipment in the National Equipment Finance line. A $6 million, or 5%, decrease in noninterest expense was driven by an approximate $4 million reduction in goodwill amortization resulting from the January 1 adoption of new accounting guidance. FIGURE 6. KEY CAPITAL PARTNERS GROUP DATA
THREE MONTHS SIX MONTHS ENDED ENDED JUNE 30, CHANGE JUNE 30, CHANGE ------------------------ ------------------- ------------------- ---------------------- dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT - ----------------------------------------------------------------------------------------------------------------------------------- REVENUE (TAXABLE EQUIVALENT) Victory Capital Management $ 57 $ 60 $ (3) (5.0)% $110 $116 $ (6) (5.2)% High Net Worth 148 149 (1) (.7) 293 306 (13) (4.2) Capital Markets 83 83 -- -- 162 165 (3) (1.8) ---- ---- ---- ---- ---- ---- ---- ---- Total $288 $292 $ (4) (1.4) $565 $587 $(22) (3.7) ==== ==== ==== ==== ==== ==== NET INCOME Victory Capital Management $ 12 $ 12 -- -- % $ 21 $ 18 $ 3 16.7% High Net Worth 17 9 $ 8 88.9 31 22 9 40.9 Capital Markets 13 11 2 18.2 27 22 5 22.7 ---- ---- ---- ---- ---- ---- ---- ---- Total $ 42 $ 32 10 31.3 $ 79 $ 62 $ 17 27.4 ==== ==== ==== ==== ==== ==== - -----------------------------------------------------------------------------------------------------------------------------------
ADDITIONAL KEY CAPITAL PARTNERS DATA (2Q02) Assets under management: $70.7 billion 815 High Net Worth sales personnel Nonmanaged and brokerage assets: $72.0 billion 3,669 average full-time equivalent employees Net new asset inflows: $919 million
40 Net income for Key Capital Partners was $42 million for the second quarter of 2002, up from $32 million in the second quarter of last year. The improvement is attributable to a substantial decrease in noninterest expense and growth in taxable-equivalent net interest income. These positive results more than offset a decline in noninterest income. Taxable-equivalent net interest income increased by $2 million, or 4%, from the second quarter of 2001, despite the $1.4 billion reduction in average loans outstanding that resulted from the 2001 sale of residential mortgage loans associated with the High Net Worth line of business. The increase is due primarily to the lower cost of short-term borrowings and strong growth in home equity lending. A $6 million, or 3%, decrease in noninterest income is attributable mainly to lower income from derivatives and from foreign exchange in the Capital Markets line, a decrease in income from trading activities in the High Net Worth line and a general decline in fee income that is based on the value of assets under management. These decreases were offset in part by a $3 million gain from the divestiture of the 401(k) business in the second quarter of 2002. Noninterest expense decreased by $15 million, or 6%, from the year-ago quarter, due primarily to an approximate $6 million reduction that resulted from the change in accounting for goodwill, and to reduced software amortization. 41 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 different 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 7, which spans pages 43 and 44, shows the various components of Key's balance sheet that affect interest income and expense, and their respective yields or rates over the past five quarters. Net interest income for the second quarter of 2002 was $721 million, compared with $719 million reported a year ago. This growth reflected an improved net interest margin, which increased 21 basis points to 3.98%. 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. At the same time, average earning assets decreased by 5% to $72.6 billion, due primarily to declines in both commercial loans and consumer loans, other than home equity loans. 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 commercial lease financing yields increased and 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 the second quarter of 2002 totaled $72.6 billion, which was $4.0 billion, or 5%, lower than the second quarter 2001 level. This decrease came principally from the loan portfolio and was attributable to a number of factors, including Key's decisions in May 2001 to exit or scale back certain types of lending. Another factor was loan sales, including the September 2001 sale of $1.4 billion of residential mortgage loans. Weak loan demand resulting from the general economic slowdown has also contributed to the net decline in loans. The size and composition of Key's loan portfolio has been affected by several actions taken in the first six months of 2002 and during 2001: - - During the third quarter of 2001, we sold the aforementioned $1.4 billion of residential mortgage loans, which were 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. These portfolios, in the aggregate, have declined by approximately $2.7 billion since the date of the announcement through June 30, 2002. 42 FIGURE 7. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
SECOND QUARTER 2002 ---------------------------------------------- AVERAGE YIELD/ dollars in millions BALANCE INTEREST RATE - ------------------------------------------------------------------------------------------------------------------ ASSETS Loans(a), (b) Commercial, financial and agricultural $18,213 $ 244 5.37% Real estate -- commercial mortgage 6,414 91 5.70 Real estate -- construction 5,870 72 4.93 Commercial lease financing 7,206 126 6.96 - ------------------------------------------------------------------------------------------------------------------ Total commercial loans 37,703 533 5.66 Real estate -- residential 2,148 38 7.04 Home equity 13,072 229 7.03 Consumer -- direct 2,210 45 8.21 Consumer -- indirect lease financing 1,514 33 8.84 Consumer -- indirect other 5,131 118 9.19 - ------------------------------------------------------------------------------------------------------------------ Total consumer loans 24,075 463 7.71 Loans held for sale 2,150 30 5.58 - ------------------------------------------------------------------------------------------------------------------ Total loans 63,928 1,026 6.43 Taxable investment securities 934 7 3.20 Tax-exempt investment securities(a) 205 4 8.31 - ------------------------------------------------------------------------------------------------------------------ Total investment securities 1,139 11 4.12 Securities available for sale(a),(c) 5,951 95 6.45 Short-term investments 1,561 8 1.97 - ------------------------------------------------------------------------------------------------------------------ Total earning assets 72,579 1,140 6.30 Allowance for loan losses (1,579) Accrued income and other assets 10,560 - ------------------------------------------------------------------------------------------------------------------ $81,560 ======= LIABILITIES AND SHAREHOLDERS' EQUITY Money market deposit accounts $12,535 27 .87 Savings deposits 2,014 3 .67 NOW accounts 697 2 1.02 Certificates of deposit ($100,000 or more) (d) 4,816 56 4.69 Other time deposits 13,085 131 4.02 Deposits in foreign office 2,638 12 1.76 - ------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 35,785 231 2.59 Federal funds purchased and securities sold under repurchase agreements 5,541 24 1.71 Bank notes and other short-term borrowings(d) 2,995 20 2.73 Long-term debt, including capital securities(d),(e) 17,230 144 3.37 - ------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 61,551 419 2.73 Noninterest-bearing deposits 8,719 Accrued expense and other liabilities 4,783 Common shareholders' equity 6,507 - ------------------------------------------------------------------------------------------------------------------ $81,560 ======= Interest rate spread (TE) 3.57% - ------------------------------------------------------------------------------------------------------------------ Net interest income (TE) and net interest margin (TE) $721 3.98% ---- ===== Capital securities $1,236 $20 Taxable-equivalent adjustment(a) 38 - ------------------------------------------------------------------------------------------------------------------
FIRST QUARTER 2002 --------------------------------------------- AVERAGE YIELD/ dollars in millions BALANCE INTEREST RATE - ----------------------------------------------------------------------------------------------------------------- ASSETS Loans(a), (b) Commercial, financial and agricultural $18,016 $ 242 5.44% Real estate -- commercial mortgage 6,598 93 5.74 Real estate -- construction 5,856 72 5.01 Commercial lease financing 7,275 132 7.25 - ----------------------------------------------------------------------------------------------------------------- Total commercial loans 37,745 539 5.77 Real estate -- residential 2,241 41 7.21 Home equity 11,863 212 7.26 Consumer -- direct 2,289 46 8.14 Consumer -- indirect lease financing 1,852 41 8.74 Consumer -- indirect other 5,231 120 9.21 - ----------------------------------------------------------------------------------------------------------------- Total consumer loans 23,476 460 7.89 Loans held for sale 2,267 32 5.70 - ----------------------------------------------------------------------------------------------------------------- Total loans 63,488 1,031 6.55 Taxable investment securities 916 6 2.43 Tax-exempt investment securities(a) 219 5 8.52 - ----------------------------------------------------------------------------------------------------------------- Total investment securities 1,135 11 3.61 Securities available for sale(a),(c) 5,317 89 6.76 Short-term investments 2,041 9 1.76 - ----------------------------------------------------------------------------------------------------------------- Total earning assets 71,981 1,140 6.38 Allowance for loan losses (1,657) Accrued income and other assets 10,547 - ----------------------------------------------------------------------------------------------------------------- $80,871 ======== LIABILITIES AND SHAREHOLDERS' EQUITY Money market deposit accounts $12,659 30 .95 Savings deposits 1,947 3 .71 NOW accounts 715 2 1.03 Certificates of deposit ($100,000 or more)(d) 4,516 57 5.10 Other time deposits 13,443 149 4.51 Deposits in foreign office 2,136 9 1.69 - ----------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits 35,416 250 2.86 Federal funds purchased and securities sold under repurchase agreements 5,584 23 1.70 Bank notes and other short-term borrowings(d) 4,028 27 2.68 Long-term debt, including capital securities(d),(e) 16,103 138 3.46 - ----------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 61,131 438 2.90 Noninterest-bearing deposits 8,553 Accrued expense and other liabilities 4,918 Common shareholders' equity 6,269 - ----------------------------------------------------------------------------------------------------------------- $80,871 ======== Interest rate spread (TE) 3.48% - ----------------------------------------------------------------------------------------------------------------- Net interest income (TE) and net interest margin (TE) $702 3.93% ---- ==== Capital securities $ 1,298 $ 21 Taxable-equivalent adjustment(a) 48 - -----------------------------------------------------------------------------------------------------------------
(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 14 ("Derivatives and Hedging Activities"), which begins on page 28, for an explanation of fair value hedges. (e) Rate calculation excludes ESOP debt. TE = Taxable Equivalent 43 FIGURE 7. AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES (CONTINUED)
FOURTH QUARTER 2001 THIRD QUARTER 2001 SECOND QUARTER 2001 - -------------------------------------- -------------------------------------------- ------------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE - -------------------------------------------------------------------------------------- ------------------------------------- $18,462 $ 271 5.83% $19,338 $ 324 6.63 % $20,030 $ 361 7.24% 6,737 106 6.23 6,813 123 7.20 6,837 135 7.91 5,971 85 5.65 5,859 101 6.87 5,504 108 7.81 7,109 128 7.18 6,995 117 6.68 6,990 120 6.86 - ------------------------------------------------------------------------------------------------------------------------------------ 38,279 590 6.12 39,005 665 6.77 39,361 724 7.37 2,384 44 7.46 3,826 71 7.42 4,065 79 7.81 11,046 217 7.82 10,777 228 8.38 10,459 228 8.74 2,361 52 8.66 2,409 56 9.34 2,458 60 9.74 2,210 47 8.55 2,557 54 8.30 2,778 57 8.27 5,359 128 9.51 5,494 132 9.60 5,593 134 9.61 - ------------------------------------------------------------------------------------------------------------------------------------ 23,360 488 8.32 25,063 541 8.58 25,353 558 8.83 2,113 34 6.48 2,130 38 7.17 2,240 43 7.69 - ------------------------------------------------------------------------------------------------------------------------------------ 63,752 1,112 6.94 66,198 1,244 7.47 66,954 1,325 7.93 904 4 1.86 925 8 3.44 911 8 3.41 241 6 8.69 258 5 8.65 297 6 8.79 - ------------------------------------------------------------------------------------------------------------------------------------ 1,145 10 3.30 1,183 13 4.57 1,208 14 4.74 6,120 103 6.78 6,565 114 6.99 6,572 115 6.99 1,689 11 2.55 1,741 15 3.57 1,812 19 4.19 - ------------------------------------------------------------------------------------------------------------------------------------ 72,706 1,236 6.76 75,687 1,386 7.29 76,546 1,473 7.71 (1,159) (1,204) (988) 10,920 10,396 10,429 - ------------------------------------------------------------------------------------------------------------------------------------ $82,467 $84,879 $85,987 ======= ======= ======= $12,396 37 1.20 $12,522 55 1.72 $12,296 67 2.22 1,911 4 .79 1,936 5 1.01 1,969 5 1.06 653 2 1.26 611 2 1.41 610 3 1.50 4,788 61 5.08 4,800 67 5.53 5,571 81 5.85 13,659 169 4.91 13,703 184 5.33 14,479 209 5.77 2,418 14 2.21 3,399 30 3.57 2,173 23 4.27 - ------------------------------------------------------------------------------------------------------------------------------------ 35,825 287 3.18 36,971 343 3.68 37,098 388 4.20 4,272 24 2.20 6,078 52 3.37 5,177 52 4.06 5,563 42 2.99 6,230 61 3.95 8,016 94 4.67 16,167 157 3.88 15,991 200 4.97 16,068 220 5.49 - ------------------------------------------------------------------------------------------------------------------------------------ 61,827 510 3.28 65,270 656 3.99 66,359 754 4.56 8,750 8,262 8,213 5,359 4,848 4,779 6,531 6,499 6,636 - ------------------------------------------------------------------------------------------------------------------------------------ $82,467 $84,879 $85,987 ======= ======= ======= 3.48% 3.30% 3.15% - ------------------------------------------------------------------------------------------------------------------------------------ $726 3.98% $730 3.85% $719 3.77% ==== ==== ==== ==== ==== ===== $1,333 $21 $1,305 $21 $1,292 $23 26 6 6 - ------------------------------------------------------------------------------------------------------------------------------------
44 - - We sold commercial mortgage loans of $478 million during the first half of 2002 and $1.7 billion during 2001. Since certain of these loans have been 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 13 ("Other Financial Instruments with Off-Balance Sheet Risk") under the section entitled "Recourse agreement with Federal National Mortgage Association," on page 26. Our business of originating and servicing commercial mortgage loans has grown, in part, as a result of acquiring Conning Asset Management in the second quarter of 2002 and both Newport Mortgage Company, L.P. and National Realty Funding L.C. in 2000. - - We sold education loans of $186 million during the first six months of 2002 and $1.2 billion ($491 million through securitizations) during 2001. Figure 8 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 52, contains more discussion about changes in earning assets and funding sources. FIGURE 8. COMPONENTS OF NET INTEREST INCOME CHANGES
FROM THREE MONTHS ENDED JUNE 30, 2001 IN THREE MONTHS ENDED JUNE 30, 2002 ----------------------------------------------------------- AVERAGE YIELD/ NET in millions VOLUME RATE CHANGE - ----------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans $(58) $(241) $(299) Taxable investment securities -- (1) (1) Tax-exempt investment securities (2) -- (2) Securities available for sale (10) (10) (20) Short-term investments (2) (9) (11) - ----------------------------------------------------------------------------------------------------------------------- Total interest income (taxable equivalent) (72) (261) (333) INTEREST EXPENSE Money market deposit accounts 1 (41) (40) Savings deposits -- (2) (2) NOW accounts -- (1) (1) Certificates of deposit ($100,000 or more) (10) (15) (25) Other time deposits (19) (59) (78) Deposits in foreign office 4 (15) (11) - ----------------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits (24) (133) (157) Federal funds purchased and securities sold under repurchase agreements 3 (31) (28) Bank notes and other short-term borrowings (44) (30) (74) Long-term debt, including capital securities 15 (91) (76) - ----------------------------------------------------------------------------------------------------------------------- Total interest expense (50) (285) (335) - ----------------------------------------------------------------------------------------------------------------------- Net interest income (taxable equivalent) $(22) $ 24 $ 2 ===== ===== ==== - -----------------------------------------------------------------------------------------------------------------------
FROM SIX MONTHS ENDED JUNE 30, 2001 TO SIX MONTHS ENDED JUNE 30, 2002 ------------------------------------------------------------ AVERAGE YIELD/ NET in millions VOLUME RATE CHANGE - ------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans $(129) $(561) $(690) Taxable investment securities -- (2) (2) Tax-exempt investment securities (4) (1) (5) Securities available for sale (39) (11) (50) Short-term investments 2 (25) (23) - ------------------------------------------------------------------------------------------------------------------- Total interest income (taxable equivalent) (170) (600) (770) INTEREST EXPENSE Money market deposit accounts 5 (110) (105) Savings deposits -- (9) (9) NOW accounts 1 1 2 Certificates of deposit ($100,000 or more) (30) (30) (60) Other time deposits (40) (112) (152) Deposits in foreign office (3) (40) (43) - ------------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits (67) (300) (367) Federal funds purchased and securities sold under repurchase agreements 8 (83) (75) Bank notes and other short-term borrowings (81) (71) (152) Long-term debt, including capital securities 26 (211) (185) - ------------------------------------------------------------------------------------------------------------------- Total interest expense (114) (665) (779) - ------------------------------------------------------------------------------------------------------------------- Net interest income (taxable equivalent) $(56) $ 65 $ 9 ===== ===== ==== - -------------------------------------------------------------------------------------------------------------------
The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each. MARKET RISK MANAGEMENT The values of some financial instruments vary not only with changes in external interest rates, but also with changes in foreign exchange rates, factors influencing valuations in the equity securities markets, 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 present 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 exposure. 45 FACTORS CONTRIBUTING TO INTEREST RATE EXPOSURE. Key uses interest rate exposure models to quantify the potential impact on earnings and economic value of equity arising from a variety of future interest rate scenarios. The many interest rate scenarios modeled 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 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. 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. 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 June 30, 2002, 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 and no change over the following six months. As of June 30, 2002, 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 .39% 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 ..82% over the next twelve months. 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 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%. Certain 46 short-term interest rates were limited to reductions of less than 2% since interest rates cannot decrease below zero in the economic value of equity model. Key is operating within these guidelines. MANAGEMENT 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 manage 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 based 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 14 ("Derivatives and Hedging Activities"), starting on page 28. 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 proprietary trading positions in financial assets and liabilities. The fair values of these trading portfolio items are included in "accrued income and other assets" or "accrued expense and other liabilities" on the balance sheet. For more information about these items, see Note 14 ("Derivatives and Hedging Activities"), which begins on page 28. 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 June 30, 2002, Key's aggregate daily VAR was $1.8 million, compared with $1.4 million at June 30, 2001. Aggregate daily VAR averaged $1.6 million for the first six months of 2002, compared with an average of $1.3 million for the same period last year. VAR modeling augments other controls that Key uses to mitigate the market risk exposure of the trading portfolio. These controls include loss and portfolio size limits that are based on market liquidity and the level of activity and volatility of trading products. NONINTEREST INCOME Noninterest income for the second quarter of 2002 totaled $448 million, up $50 million, or 13%, from the same period last year. For the first six months of the year, noninterest income was $891 million, representing an increase of $38 million, or 4%, from the first half of 2001. 47 Key's noninterest income for the second quarter of 2001 includes a $40 million charge (included in miscellaneous income) to establish a reserve for losses incurred on the residual values of leased vehicles. Excluding this strategic charge, noninterest income for the second quarter of 2002 grew by $10 million, or 2%, from the year-ago quarter. The improvement is due primarily to a $14 million increase in service charges on deposit accounts, attributable largely to new pricing implemented in mid-2001 in connection with Key's competitiveness initiative. Noninterest income also benefited from a $5 million increase in trust and investment services income. These favorable results were offset in part by a $7 million reduction in net securities gains. Adjusting for the $40 million charge discussed above, Key's noninterest income for the first six months of 2002 was essentially unchanged from the amount for the comparable period last year. A $30 million increase in service charges on deposit accounts was more than offset by a $33 million decline in net securities gains. Figure 9 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 from the prior year. FIGURE 9. NONINTEREST INCOME
THREE MONTHS SIX MONTHS ENDED JUNE 30, CHANGE ENDED JUNE 30, CHANGE --------------- ------------------ ----------------- ------------------- dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------------- ------------------- Trust and investment services income $137 $132 $5 3.8% $272 $273 $(1) (.4)% Investment banking and capital markets income 68 72 (4) (5.6) 140 137 3 2.2 Service charges on deposit accounts 104 90 14 15.6 204 174 30 17.2 Corporate-owned life insurance income 26 27 (1) (3.7) 52 54 (2) (3.7) Letter of credit and loan fees 29 30 (1) (3.3) 57 59 (2) (3.4) Net securities gains 1 8 (7) (87.5) 1 34 (33) (97.1) Other income: Electronic banking fees 20 18 2 11.1 38 35 3 8.6 Insurance income 15 12 3 25.0 28 26 2 7.7 Loan securitization servicing fees 2 5 (3) (60.0) 5 9 (4) (44.4) Net gains from loan securitizations and sales 3 8 (5) (62.5) 9 13 (4) (30.8) Miscellaneous income 43 (4) 47 N/M 85 39 46 117.9 - ----------------------------------------------------------------------------------------------------------------------------------- Total other income 83 39 44 112.8 165 122 43 35.2 - ----------------------------------------------------------------------------------------------------------------------------------- Total noninterest income $448 $398 $50 12.6% $891 $853 $38 4.5 % ==== ==== === ==== ==== === - -----------------------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful TRUST AND INVESTMENT SERVICES INCOME. Trust and investment services provide Key's largest source of noninterest income. Its primary components are as shown in Figure 10. In 2002, the level of revenue derived from these services has been adversely affected by continued softness in the economy, since a significant portion of this income is based on the value of assets under management. FIGURE 10. TRUST AND INVESTMENT SERVICES INCOME
THREE MONTHS SIX MONTHS ENDED JUNE 30, CHANGE ENDED JUNE 30, CHANGE ------------------ -------------------- ---------------- ------------------- dollars in millions 2002 2001 AMOUNT PERCENT 2002 2001 AMOUNT PERCENT - ----------------------------------------------------------------------------------------------------------------------------------- Personal asset management and custody fees $41 $44 $(3) (6.8)% $81 $90 $(9) (10.0)% Institutional asset management and custody fees 20 22 (2) (9.1) 40 44 (4) (9.1) Bond services 10 9 1 11.1 20 19 1 5.3 Brokerage commission income 29 21 8 38.1 57 47 10 21.3 All other fees 37 36 1 2.8 74 73 1 1.4 - ----------------------------------------------------------------------------------------------------------------------------------- Total trust and investment services income $137 $132 $ 5 3.8 % $272 $273 $(1) (.4)% ==== ==== ==== ==== ==== ==== - -----------------------------------------------------------------------------------------------------------------------------------
At June 30, 2002, Key's bank, trust and registered investment advisory subsidiaries had assets under management of $70.7 billion, compared with $74.4 billion at June 30, 2001. 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 11. The value of total assets under management decreased by a net 5% over the past twelve months. This decrease reflects the adverse effect of a decline in the market value of assets under management at June 30, 2002, offset in part by the positive effect of net new asset inflows of approximately $296 million during the same period. As shown in Figure 11, more than one-half of the assets Key manages are invested in more stable fixed income or money market funds. The performance of the majority of Key's product types exceeded the performance of their respective benchmarks. 48 FIGURE 11. ASSETS UNDER MANAGEMENT
2002 2001 ------------------------- ----------------------------------------- in millions Second First Fourth Third Second - ------------------------------------------------------------------------------------------------------------------------------------ Assets under management by investment type: Equity $31,064 $34,497 $34,799 $32,067 $35,903 Fixed income 18,905 18,536 17,326 16,929 15,363 Money market 20,756 19,413 19,957 21,223 23,177 - ------------------------------------------------------------------------------------------------------------------------------------ Total $70,725 $72,446 $72,082 $70,219 $74,443 ======= ======= ======= ======= ======= Proprietary mutual funds included in assets under management: Equity $3,709 $4,080 $3,973 $3,676 $4,351 Fixed income 1,262 1,211 1,190 1,178 1,106 Money market 12,568 13,094 13,801 14,870 14,950 - ------------------------------------------------------------------------------------------------------------------------------------ Total $17,539 $18,385 $18,964 $19,724 $20,407 ======= ======= ======= ======= ======= - ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT BANKING AND CAPITAL MARKETS INCOME. As shown in Figure 12, income derived from dealer trading and derivatives decreased significantly, while both investment banking and principal investing results showed considerable improvement from the prior year. 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 gains (losses) and fair value of direct and indirect investments contained in Key's principal investing portfolio are summarized in Figure 13. Investments in technology-rich companies, which have been particularly hard hit by the effects of the weak economy, accounted for only $40 million, or 6%, of the fair value of Key's portfolio at June 30, 2002. FIGURE 12. INVESTMENT BANKING AND CAPITAL MARKETS INCOME
Three months Six months ended June 30, Change ended June 30, Change ---------------- ------------------- -------------- ----------------- dollars in millions 2002 2001 Amount Percent 2002 2001 Amount Percent - ---------------------------------------------------------------------------------------------------------------------------------- Dealer trading and derivatives income $28 $41 $(13) (31.7)% $ 68 $91 $(23) (25.3)% Investment banking income 34 28 6 21.4 55 48 7 14.6 Net losses from principal investing (2) (8) 6 75.0 (1) (24) 23 95.8 Foreign exchange income 8 11 (3) (27.3) 18 22 (4) (18.2) - ---------------------------------------------------------------------------------------------------------------------------------- Total investment banking and capital markets income $68 $72 $(4) (5.6)% $140 $137 $ 3 2.2% === === === ==== ==== === - ----------------------------------------------------------------------------------------------------------------------------------
FIGURE 13. PRINCIPAL INVESTING PORTFOLIO JUNE 30, 2002 ORIGINAL UNREALIZED FAIR in millions INVESTMENT LOSSES VALUE - ----------------------------------------------------------------------------- Direct investments $443 $22 $421 Indirect investments 264 34 230 - ----------------------------------------------------------------------------- Total $707 $56 $651 ==== === ==== - ----------------------------------------------------------------------------- December 31, 2001 $699 $79 $620 - ----------------------------------------------------------------------------- June 30, 2001 $700 $8 $692 - ----------------------------------------------------------------------------- SERVICE CHARGES ON DEPOSIT ACCOUNTS. Service charges on deposits account for the largest increase in fee income relative to the prior year. The growth of these fees is attributable primarily to strategies implemented in connection with Key's competitiveness initiative. SECURITIES TRANSACTIONS. During the first half of 2001, Key realized $34 million of net securities gains from the sales of securities held in the available-for-sale portfolio. The securities sold were primarily equity securities issued by financial service companies. Net gains from the sales of securities during the first half of 2002 were not significant. 49 NONINTEREST EXPENSE Noninterest expense for the second quarter of 2002 totaled $665 million, down $193 million, or 22%, from the second quarter of 2001. For the first six months of the year, noninterest expense was $1.3 billion, representing a decrease of $230 million, or 15%, from the first half of last year. As shown in Figure 14, noninterest expense for the second quarter of 2001 includes a number of significant nonrecurring items that hinder the comparison of results between reporting periods. These items include a $150 million write-down of goodwill associated with Key's decision to downsize its automobile finance business and additional litigation reserves of $20 million. Core noninterest expense, which excludes significant nonrecurring items, decreased by $21 million, or 3%, from the year-ago quarter. Lower costs associated with computer processing (down $15 million) and the amortization of intangibles (down $22 million, including approximately $20 million related to the change in accounting for goodwill) more than offset a $16 million increase in personnel expense. For the year-to-date period, core noninterest expense improved by $58 million, or 4%, reflecting a decrease in amortization expense related to intangibles (down $45 million, including approximately $40 million related to the change in accounting for goodwill) and a reduction in computer processing expense (down $23 million). These positive results were partially offset by a $15 million rise in personnel expense. For more information pertaining to the accounting change for goodwill, see the section entitled "Amortization of intangibles," on page 51. Figure 14 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 from the prior year. FIGURE 14. NONINTEREST EXPENSE
Three months Six months ended June 30, Change ended June 30, Change ---------------- -------------------- ------------------ ------------------- dollars in millions 2002 2001 Amount Percent 2002 2001 Amount Percent - ----------------------------------------------------------------------------------------------------------------------------------- Personnel $361 $345 $ 16 4.6 % $724 $709 $ 15 2.1 % Net occupancy 56 56 - - 113 113 - - Computer processing 48 63 (15) (23.8) 102 125 (23) (18.4) Equipment 36 40 (4) (10.0) 70 78 (8) (10.3) Marketing 30 29 1 3.4 56 56 - - Amortization of intangibles 2 24 (22) (91.7) 5 50 (45) (90.0) Professional fees 21 19 2 10.5 42 37 5 13.5 Other expense: Postage and delivery 14 16 (2) (12.5) 29 33 (4) (12.1) Telecommunications 9 12 (3) (25.0) 17 23 (6) (26.1) Equity- and gross receipts-based taxes 7 7 - - 13 15 (2) (13.3) OREO expense, net 2 2 - - 3 4 (1) (25.0) Miscellaneous expense 79 73 6 8.2 152 141 11 7.8 - ----------------------------------------------------------------------------------------------------------------------------------- Total other expense 111 110 1 .9 214 216 (2) (.9) - ----------------------------------------------------------------------------------------------------------------------------------- Total core noninterest expense 665 686 (21) (3.1) 1,326 1,384 (58) (4.2) Goodwill write-down (automobile finance business) - 150 (150) (100.0) - 150 (150) (100.0) Additional litigation reserves - 20 (20) (100.0) - 20 (20) (100.0) Restructuring and other special charges - 2 (2) (100.0) - 2 (2) (100.0) - ----------------------------------------------------------------------------------------------------------------------------------- Total significant nonrecurring items - 172 (172) (100.0) - 172 (172) (100.0) - ----------------------------------------------------------------------------------------------------------------------------------- Total noninterest expense $665 $858 $(193) (22.5)% $1,326 $1,556 $(230) (14.8)% ==== ==== ===== ====== ====== ===== Full-time equivalent employees at period end 20,929 21,742 (813) (3.7)% 20,929 21,742 (813) (3.7)% - -----------------------------------------------------------------------------------------------------------------------------------
PERSONNEL. Personnel expense, the largest category of Key's noninterest expense, rose by a modest $15 million, or 2%, from the first six months of 2001. Essentially all of the increase occurred in the second quarter and is due primarily to a rise in the cost of benefits, the effect of annual merit increases and higher incentive compensation related to certain revenue producing activities. The level of Key's personnel expense continues to reflect the benefits derived from our successful competitiveness initiative. Through this initiative we have improved efficiency and reduced the level of personnel required to conduct our 50 business. At June 30, 2002, the number of full-time equivalent employees was 20,929, compared with 21,230 at the end of 2001 and 21,742 a year ago. Figure 15 shows the major components of Key's personnel expense. FIGURE 15. PERSONNEL EXPENSE
Three months Six months ended June 30, Change ended June 30, Change ---------------- -------------------- ------------------- --------------------- dollars in millions 2002 2001 Amount Percent 2002 2001 Amount Percent - ------------------------------------------------------------------------------------------------------------------------------- Salaries $215 $214 $1 .5% $431 $425 $6 1.4% Employee benefits 55 45 10 22.2 118 102 16 15.7 Incentive compensation 91 86 5 5.8 175 182 (7) (3.8) - ------------------------------------------------------------------------------------------------------------------------------- Total core personnel expense $361 $345 $16 4.6% $724 $709 $15 2.1% ==== ==== === ==== ==== === - -------------------------------------------------------------------------------------------------------------------------------
COMPUTER PROCESSING. The decrease in computer processing expense for both the quarterly and year-to-date periods is due primarily to a lower level of computer software amortization. This reduction is attributable in part to improved software capitalization discipline instituted a few years ago. AMORTIZATION OF INTANGIBLES. On January 1, 2002, Key stopped amortizing goodwill, consistent with the industry-wide adoption of new accounting guidance. This change reduced the company's noninterest expense by approximately $40 million for the first six months of 2002. In accordance with the new guidance, Key completed its transitional goodwill impairment testing during the first quarter of 2002, and determined that no impairment existed as of January 1, 2002. For more information pertaining to the new accounting guidance, see the section entitled "Accounting Pronouncements Adopted in 2002," included in Note 1 ("Basis of Presentation"), starting on page 7. INCOME TAXES The provision for income taxes was $85 million for the second quarter of 2002, compared with a tax benefit of $12 million for the comparable period in 2001. The effective tax rate (which is the provision or benefit for income taxes as a percentage of the respective income or loss, before income taxes) was 25.7% for the second quarter of 2002 compared with 8.1% for the second quarter of 2001. The tax benefit recorded a year ago is largely attributable to several significant nonrecurring charges, which resulted in a loss for the quarter. Most of these charges (including a $150 million write-down of nondeductible goodwill) are associated with the implementation of strategic actions announced in May 2001. Because Key recorded a pretax loss in the second quarter of 2001, the effect of the goodwill write-down was to reduce the overall tax benefit and thereby decrease the effective tax rate by 36%. The effective tax rate for the second quarter of 2002 is substantially below Key's combined statutory Federal and state rate of 37% due primarily to portions of our equipment leasing portfolio that are subject to a lower income tax rate. Other factors that account for the difference between the effective and statutory tax rates include tax deductions associated with dividends paid to Key's 401(k) savings plan, income from investments in tax-advantaged assets (such as tax-exempt securities and corporate-owned life insurance) and credits associated with investments in low-income housing projects. For the first six months of 2002, the provision for income taxes was $145 million compared with $105 million for the first half of last year. The effective tax rates for these periods were 23.0% and 56.1%, respectively. Excluding the $150 million write-down of nondeductible goodwill, the effective tax rate for the first six months of 2001 was approximately 31.2%. The decline from the adjusted effective tax rate is attributable to the portions of our equipment leasing portfolio that are now subject to a lower tax rate, as well as legislative changes in 2002 that resulted in a higher tax deduction for dividends paid to Key's 401(k) savings plan. In addition, Key ceased amortizing goodwill effective January 1, 2002, in accordance with new accounting guidance specified by SFAS No.142. 51 FINANCIAL CONDITION LOANS At June 30, 2002, total loans outstanding were $63.9 billion, compared with $63.3 billion at the end of 2001 and $66.7 billion a year ago. Among the factors that contributed to the 4% decrease in our loans over the past year are: - - loan sales completed to improve the profitability of Key's overall portfolio, or to accommodate our funding needs; - - weaker loan demand stemming from the sluggish economy; and - - our May 2001 decision to exit the automobile leasing business, de-emphasize indirect prime automobile lending and discontinue certain credit-only commercial relationships. 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 loan origination capabilities. In addition, Key has completed several acquisitions, which have improved its ability to generate and securitize new loans, especially in the area of commercial real estate. These acquisitions include the purchase of Conning Asset Management in June 2002, and both Newport Mortgage Company, L.P. and National Realty Funding L.C. in 2000. Over the past two years, we have also sold loans and referred new business to an asset-backed commercial paper conduit. These sales and referrals have been curtailed in 2002 in favor of funding on Key's balance sheet. The conduit arrangement allows us to generate referral revenue when the loans are not funded on the balance sheet. For more information about the conduit, see Note 13 ("Other Financial Instruments with Off-Balance Sheet Risk"), starting on page 26. The level of Key's loans outstanding (excluding loans held for sale) would have been unchanged over the past twelve months if we had not securitized and/or sold $4.0 billion of loans during that period. On the commercial side, growth in our real estate and lease financing portfolios was more than offset by a net decline in all other commercial portfolios, reflecting continued weakness in the economy and our decision to discontinue nonrelationship lending in the leveraged financing and nationally syndicated lending businesses. At June 30, 2002, Key's commercial real estate portfolio included mortgage loans of $6.3 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 $65 million. The average size of a construction loan was $8 million. The largest construction loan was $37 million. Key conducts its commercial real estate lending business through two primary sources: a 12-state banking franchise and National Commercial Real Estate (a national line of business that cultivates relationships both within and beyond the branch system). At June 30, our national line of business accounted for approximately 64% 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. 52 FIGURE 16. COMMERCIAL REAL ESTATE LOANS
JUNE 30, 2002 GEOGRAPIC REGION ----------------------------------------------------- TOTAL PERCENT OF dollars in millions EAST MIDWEST CENTRAL WEST AMOUNT TOTAL - -------------------------------------------------------------------------------------------------------------------------------- Nonowner-occupied: Multi-family properties $ 504 $ 619 $ 535 $ 750 $ 2,408 19.9% Retail properties 306 806 154 212 1,478 12.2 Office buildings 185 207 167 234 793 6.5 Residential properties 67 117 123 403 710 5.9 Warehouses 78 270 127 170 645 5.3 Manufacturing facilities 29 37 5 7 78 .6 Hotels/Motels 8 14 1 9 32 .3 Other 415 716 92 549 1,772 14.6 - -------------------------------------------------------------------------------------------------------------------------------- 1,592 2,786 1,204 2,334 7,916 65.3 Owner-occupied 544 1,774 509 1,383 4,210 34.7 - -------------------------------------------------------------------------------------------------------------------------------- Total $2,136 $4,560 $1,713 $3,717 $12,126 100.0% ====== ====== ====== ====== ======= ====== - --------------------------------------------------------------------------------------------------------------------------------
Consumer loans increased (assuming no loan sales) by $691 million, or 3%, from the second quarter of 2001. The growth of the home equity portfolio during the past year more than offset declines of $708 million in installment loans, $1.3 billion in automobile lease financing receivables and $454 million in residential real estate mortgage loans. The declines in installment loans and automobile 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 $3.2 billion, largely as a result of our focused efforts to grow this business, facilitated by a period of lower interest rates. Key's home equity portfolio is derived from both our Retail Banking line of business (62% of the home equity portfolio at June 30, 2002), 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 76%. First lien positions comprised 83% of the portfolio for this line of business at June 30, 2002. 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 the second half of 2002. Figure 17 summarizes Key's home equity loan portfolio by source at the end of each of the last five quarters, as well as certain asset quality statistics and the yields achieved on the portfolio as a whole. The portfolio has grown by 25% since June 30, 2001. Loans generated by the Retail KeyCenters channel have grown by 36%, while loans generated by the National Home Equity line of business have grown by 11%. FIGURE 17. HOME EQUITY LOANS
2002 2001 ---------------------------- --------------------------------------------- dollars in millions SECOND FIRST FOURTH THIRD SECOND - ------------------------------------------------------------------------------------------------------------------------------- SOURCE OF LOANS OUTSTANDING AT PERIOD END Champion Mortgage Company $2,153 $2,031 $1,886 $1,608 $1,600 Key Home Equity Services division 2,845 2,870 2,867 3,008 2,919 - ------------------------------------------------------------------------------------------------------------------------------- National Home Equity line of business 4,998 4,901 4,753 4,616 4,519 Retail KeyCenters and other sources 8,381 7,761 6,431 6,210 6,147 - ------------------------------------------------------------------------------------------------------------------------------- Total $13,379 $12,662 $11,184 $10,826 $10,666 ======= ======= ======= ======= ======= - ------------------------------------------------------------------------------------------------------------------------------- Nonperforming loans at period end $ 107 $ 95 $ 60 $ 93 $ 98 Net charge-offs for the period 13 14 50 16 25 Yield for the period 7.03% 7.26% 7.82% 8.38% 8.74% - -------------------------------------------------------------------------------------------------------------------------------
53 SALES, SECURITIZATIONS AND DIVESTITURES. During the past twelve months, Key sold $1.4 billion of residential mortgage loans, $1.2 billion of commercial real estate loans, $806 million of education loans ($491 million through securitizations) and $496 million of other types of loans. Since 1999, only education loans have been securitized by Key. 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. Figure 18 summarizes Key's loan sales (including securitizations) for the first six months of 2002 and all of 2001. FIGURE 18. LOANS SOLD AND DIVESTED
COMMERCIAL COMMERCIAL RESIDENTIAL HOME in millions COMMERCIAL REAL ESTATE LEASE FINANCING REAL ESTATE EQUITY EDUCATION TOTAL - ---------------------------------------------------------------------------------------------------------------------------------- 2002 - ------------------ Second quarter $31 $159 $18 $20 $24 $70 $322 First quarter -- 319 -- -- 9 116 444 - ---------------------------------------------------------------------------------------------------------------------------------- Total $31 $478 $18 $20 $33 $186 $766 === ==== === === === ==== ==== 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 === ===== === ===== ==== ====== ====== - ----------------------------------------------------------------------------------------------------------------------------------
Figure 19 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 $497 million of the $21.3 billion of loans administered or serviced at June 30, 2002. 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 any securitized assets retained. The commercial real estate loans shown in Figure 19 are serviced by Conning Asset Management and National Realty Funding L.C. Other financial institutions originated most of these loans. Approximately $145 million of the assets held in the asset-backed commercial paper conduit, for which Key serves as a referral agent, are also included in Figure 19. For more information regarding the conduit, see Note 13 ("Other Financial Instruments with Off-Balance Sheet Risk"), starting on page 26. FIGURE 19. LOANS ADMINISTERED OR SERVICED
JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, in millions 2002 2002 2001 2001 2001 - --------------------------------------------------------------------------------------------------------------------------------- Education loans $4,095 $4,258 $4,433 $4,604 $4,305 Automobile loans 87 108 131 199 254 Home equity loans 596 668 768 890 965 Commercial real estate loans 16,483(a) 11,621 10,471 9,368 9,293 Commercial loans 5 349 913 901 951 - --------------------------------------------------------------------------------------------------------------------------------- Total securitized $21,266 $17,004 $16,716 $15,962 $15,768 ======== ======== ======== ======== ======== - ---------------------------------------------------------------------------------------------------------------------------------
(a) Includes $4.1 billion of servicing assets purchased in the June 28, 2002, acquisition of Conning Asset Management. 54 SECURITIES At June 30, 2002, the securities portfolio totaled $7.4 billion and included $6.3 billion of securities available for sale and $1.1 billion of investment securities. In comparison, the total portfolio at December 31, 2001, was $6.5 billion, including $5.4 billion of securities available for sale and $1.1 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. SECURITIES AVAILABLE FOR SALE. The majority of Key's securities available for sale 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 June 30, 2002, Key had $6.0 billion invested in collateralized mortgage obligations and other mortgage-backed securities in the available-for-sale portfolio, compared with $4.8 billion at December 31, 2001. Substantially all of these securities were issued or backed by Federal agencies. Figure 20 shows the composition, yields and remaining maturities of Key's securities available for sale. For more information about retained interests in securitizations, and gross unrealized gains and losses by type of security, see Note 5 ("Securities"), which begins on page 16. FIGURE 20. SECURITIES AVAILABLE FOR SALE
U.S. TREASURY, STATES AND COLLATERALIZED MORTGAGE- RETAINED AGENCIES AND POLITICAL MORTGAGE BACKED INTERESTS IN dollars in millions CORPORATIONS SUBDIVISIONS OBLIGATIONS(a) SECURITIES(a) SECURITIZATIONS(a) - ------------------------------------------------------------------------------------------------------------------------------ JUNE 30, 2002 Remaining maturity: One year or less $ 2 -- $ 661 $ 16 -- After one through five years 6 $13 3,307 793 $207 After five through ten years 5 6 981 21 -- After ten years 9 -- 163 27 -- - ------------------------------------------------------------------------------------------------------------------------------ Fair value $22 $19 $5,112 $857 $207 Amortized cost 22 18 5,092 823 172 Weighted average yield 5.50% 4.72% 6.07% 6.95% 20.14% Weighted average maturity 5.6 YEARS 4.5 YEARS 3.6 YEARS 2.7 YEARS 3.9 YEARS - ------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2001 Fair value $99 $21 $3,805 $1,032 $234 Amortized cost 99 21 3,791 1,008 214 - ------------------------------------------------------------------------------------------------------------------------------ JUNE 30, 2001 Fair value $121 $28 $4,895 $1,212 $265 Amortized cost 120 28 4,877 1,192 252 - ------------------------------------------------------------------------------------------------------------------------------
WEIGHTED OTHER AVERAGE dollars in millions SECURITIES TOTAL YIELD(b) - ------------------------------------------------------------------------------------- JUNE 30, 2002 Remaining maturity: One year or less $ 5 $ 684 6.98% After one through five years 10 4,336 6.38 After five through ten years 6 1,019 6.53 After ten years 111(c) 310 8.79 - ------------------------------------------------------------------------------------- Fair value $132 $6,349 -- Amortized cost 154 6,281 6.57% Weighted average yield 5.10(b)% 6.57% -- Weighted average maturity 9.3 YEARS 3.6 YEARS -- - ------------------------------------------------------------------------------------- DECEMBER 31, 2001 Fair value $155 $5,346 -- Amortized cost 170 5,303 7.26% - ------------------------------------------------------------------------------------- JUNE 30, 2001 Fair value $185 $6,706 -- Amortized cost 183 $6,652 7.20% - -------------------------------------------------------------------------------------
(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 $131 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 investments in the common stocks of financial services companies) with no stated maturity. 55 INVESTMENT SECURITIES. Equity securities (including principal investing assets) accounted for more than 75% of Key's investment securities portfolio at June 30, 2002, and December 31, 2001. Figure 21 shows the composition, yields and remaining maturities of Key's investment securities. FIGURE 21. INVESTMENT SECURITIES
STATES AND WEIGHTED POLITICAL EQUITY AVERAGE dollars in millions SUBDIVISIONS SECURITIES TOTAL YIELD(a) - ----------------------------------------------------------------------------------------------------------- JUNE 30, 2002 Remaining maturity: One year or less $73 -- $ 73 7.54% After one through five years 79 -- 79 9.61 After five through ten years 33 -- 33 8.41 After ten years 1 $933(b) 934 5.54 - ----------------------------------------------------------------------------------------------------------- Amortized cost $186 $933 $1,119 7.44% Fair value 196 933 1,129 -- Weighted average yield 8.59% 5.50(a)% 7.44% -- Weighted average maturity 2.6 YEARS 10.0 YEARS 8.8 YEARS -- - ----------------------------------------------------------------------------------------------------------- DECEMBER 31, 2001 Amortized cost $225 $894 $1,119 7.24% Fair value 234 894 1,128 -- - ----------------------------------------------------------------------------------------------------------- JUNE 30, 2001 Amortized cost $262 $909 $1,171 7.92% Fair value 273 909 1,182 -- - -----------------------------------------------------------------------------------------------------------
(a) Weighted average yields are calculated based on amortized cost and exclude equity securities of $823 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 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 June 30, 2002, was $1.5 billion, or 2.41% of loans. This compares with $1.2 billion, or 1.85% of loans, at June 30, 2001. The allowance includes $144 million (for 2002) and $129 million (for 2001) that is specifically allocated for impaired loans. For more information about impaired loans, see Note 7 ("Impaired Loans and Other Nonperforming Assets") on page 19. At June 30, 2002, the allowance for loan losses was 160.82% of nonperforming loans, compared with 154.45% at June 30, 2001. 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 of Key's 2001 Annual Report to 56 Shareholders. 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 also facilitated the implementation of Key's decision to discontinue certain types of commercial lending. RUN-OFF LOAN PORTFOLIO. In May 2001, management set apart $300 million of Key's allowance for loan losses as part of its decision to discontinue nonrelationship lending in the leveraged financing and nationally syndicated lending businesses and to facilitate sales of distressed loans in other portfolios. An additional $190 million was added to this allowance in the fourth quarter. The resulting segregated allowance is being used to exit what initially amounted to approximately $2.7 billion in related commitments (including $1.6 billion of loans outstanding), which were moved to a separate run-off portfolio, and for losses incurred in connection with the sales of distressed loans in the continuing portfolio. As losses are charged to this segregated allowance over time, we do not intend to replenish it. Within the run-off portfolio, approximately $1.1 billion of commitments (including $724 million of loans outstanding) remained as of June 30. The majority of the loans are performing in accordance with their contractual terms. Figure 22 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 23. FIGURE 22. ASSET QUALITY INDICATORS -- CONTINUING AND RUN-OFF LOAN PORTFOLIOS
THREE MONTHS ENDED JUNE 30, 2002 JUNE 30, 2002 -------------------------------------------------------------- ---------------------------- Allowance for Loan Losses Net Loan Charge-offs Loans ------------------------- Nonperforming ----------------------------- dollars in millions Outstanding Amount % of Loans Loans Amount % of Loans - ------------------------------------------------------------------------------------------------------------------------------------ Continuing loan portfolio $63,157 $1,402 2.22% $825 $135 .86% Run-off loan portfolio 724 137 18.91 132 68(a) N/M - ------------------------------------------------------------------------------------------------------------------------------------ Total loan portfolio $63,881 $1,539 2.41% $957 $203 1.27% ======= ====== ==== ==== - ------------------------------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to the sales of distressed loans in the continuing portfolio. N/M = Not Meaningful FIGURE 23. RUN-OFF LOAN PORTFOLIO
SUMMARY OF CHANGES IN COMMITMENTS AND LOANS OUTSTANDING TOTAL LOANS in millions COMMITMENTS OUTSTANDING - ---------------------------------------------------------------------------------------------------------------- Balance at December 31, 2001 $1,694 $1,023 Charge-offs (102) (102) Payments, expirations and other changes, net (449) (197) - ---------------------------------------------------------------------------------------------------------------- Balance at June 30, 2002 $1,143 $ 724 ====== ===== - ---------------------------------------------------------------------------------------------------------------- SUMMARY OF CHANGES IN NONPERFORMING LOANS AND NONREPLENISHING ALLOWANCE FOR LOAN LOSSES(a) NONPERFORMING NONREPLENISHING in millions LOANS ALLOWANCE - ---------------------------------------------------------------------------------------------------------------- Balance at December 31, 2001 $ 231 $ 275 Loans placed on nonaccrual status 39 N/A Charge-offs (102) (138) Payments and other changes, net (36) N/A - ---------------------------------------------------------------------------------------------------------------- Balance at June 30, 2002 $ 132 $ 137 ===== ===== - ----------------------------------------------------------------------------------------------------------------
(a) Includes activity related to the run-off loan portfolio and to the sales of distressed loans in the continuing portfolio. N/A = Not Applicable 57 NET LOAN CHARGE-OFFS. Net loan charge-offs for the second quarter of 2002 were $203 million, or 1.27% of average loans, compared with $171 million, or 1.02% of average loans, for the same period last year. For the first six months of 2002, net loan charge-offs totaled $409 million, or 1.29% of average loans, compared with $280 million, or .84%, for the first half of 2001. The composition of Key's loan charge-offs and recoveries by type of loan is shown in Figure 24. The increase in net charge-offs for both the quarterly and year-to-date periods occurred in the commercial loan portfolio, reflecting the effects of continued weakness in the economy and Key's continuing efforts to resolve distressed credits. As shown in Figure 23, we used $138 million of Key's nonplenishing allowance during the first half of 2002 ($68 million during the second quarter) to absorb losses arising from the run-off loan portfolio and from sales of distressed loans in the continuing portfolio. In the aggregate, the middle market, structured finance and healthcare portfolios account for approximately one-half of total net charge-offs for the second quarter, but represented only 19% of Key's total loans at June 30, 2002. The structured finance and healthcare portfolios are also discussed in the section entitled "Nonperforming assets," beginning on page 59. FIGURE 24. SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ---------------------------------------------------------------------- dollars in millions 2002 2001 2002 2001 - ------------------------------------------------------------------------------------------------------------------------------ Average loans outstanding during the period $63,928 $66,954 $63,709 $66,993 - ------------------------------------------------------------------------------------------------------------------------------ Allowance for loan losses at beginning of period $1,607 $1,001 $1,677 $1,001 Loans charged off: Commercial, financial and agricultural 114 91 211 144 Real estate -- commercial mortgage 13 5 48 8 Real estate -- construction 12 2 12 2 - ------------------------------------------------------------------------------------------------------------------------------ Total commercial real estate loans(a) 25 7 60 10 Commercial lease financing 18 10 38 13 - ------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 157 108 309 167 Real estate -- residential mortgage(a) 2 5 3 7 Home equity 15 26 29 32 Consumer -- direct 13 12 27 24 Consumer -- indirect lease financing 6 7 13 13 Consumer -- indirect other 43 44 88 94 - ------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 79 94 160 170 - ------------------------------------------------------------------------------------------------------------------------------ 236 202 469 337 Recoveries: Commercial, financial and agricultural 9 7 19 14 Real estate -- commercial mortgage(a) 2 2 3 2 Commercial lease financing 3 3 4 4 - ------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 14 12 26 20 Real estate -- residential mortgage -- 1 1 3 Home equity 2 1 2 1 Consumer -- direct 2 2 4 4 Consumer -- indirect lease financing 2 2 4 4 Consumer -- indirect other 13 13 23 25 - ------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 19 19 34 37 - ------------------------------------------------------------------------------------------------------------------------------ 33 31 60 57 - ------------------------------------------------------------------------------------------------------------------------------ Net loans charged off (203) (171) (409) (280) Provision for loan losses 135 401 271 511 Allowance related to loans sold, net -- -- -- (1) - ------------------------------------------------------------------------------------------------------------------------------ Allowance for loan losses at end of period $1,539 $1,231 $1,539 $1,231 ====== ====== ====== ====== - ------------------------------------------------------------------------------------------------------------------------------ Net loan charge-offs to average loans 1.27% 1.02% 1.29% .84% Allowance for loan losses to period-end loans 2.41 1.85 2.41 1.85 Allowance for loan losses to nonperforming loans 160.82 154.45 160.82 154.45 - ------------------------------------------------------------------------------------------------------------------------------
(a) See Figure 16 on page 53 and the accompanying discussion on page 52 for more information related to Key's commercial real estate portfolio. 58 NONPERFORMING ASSETS. Figure 25 shows the composition of Key's nonperforming assets. These assets totaled $995 million at June 30, 2002, and represented 1.56% of loans, other real estate owned (known as "OREO") and other nonperforming assets, compared with $947 million, or 1.49%, at December 31, 2001, and $823 million, or 1.23%, at June 30, 2001. FIGURE 25. SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
JUNE 30, MARCH 31, DECEMBER 31, SEPTEMBER 30, JUNE 30, dollars in millions 2002 2002 2001 2001 2001 - --------------------------------------------------------------------------------------------------------------------------------- Commercial, financial and agricultural $471 $ 470 $409 $399 $384 Real estate-- commercial mortgage 179 156 187 169 128 Real estate-- construction 61 77 83 70 35 - --------------------------------------------------------------------------------------------------------------------------------- Total commercial real estate loans(a) 240 233 270 239 163 Commercial lease financing 76 100 94 83 83 - --------------------------------------------------------------------------------------------------------------------------------- Total commercial loans 787 803 773 721 630 Real estate-- residential mortgage 34 33 32 24 24 Home equity 107 95 60 93 98 Consumer-- direct 6 9 9 9 8 Consumer-- indirect lease financing 7 8 10 13 11 Consumer-- indirect other 16 25 26 25 26 - --------------------------------------------------------------------------------------------------------------------------------- Total consumer loans 170 170 137 164 167 - --------------------------------------------------------------------------------------------------------------------------------- Total nonperforming loans 957 973 910 885 797 OREO 40 41 38 26 27 Allowance for OREO losses (2) (2) (1) (1) (1) - --------------------------------------------------------------------------------------------------------------------------------- OREO, net of allowance 38 39 37 25 26 Other nonperforming assets -- -- -- 3 -- - --------------------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $995 $1,012 $947 $913 $823 ==== ====== ==== ==== ==== - --------------------------------------------------------------------------------------------------------------------------------- Accruing loans past due 90 days or more $186 $203 $ 250 $ 332 $280 Accruing loans past due 30 through 89 days 780 897 1,096 1,084 937 - --------------------------------------------------------------------------------------------------------------------------------- Nonperforming loans to period-end loans 1.50% 1.52% 1.44% 1.37% 1.20% Nonperforming assets to period-end loans plus OREO and other nonperforming assets 1.56 1.58 1.49 1.41 1.23 - ---------------------------------------------------------------------------------------------------------------------------------
(a) See Figure 16 on page 53 and the accompanying discussion on page 52 for more information related to Key's commercial real estate portfolio. 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 disproportionately concentrated in several distinct commercial portfolios of limited size. At June 30, 2002, two portfolios, structured finance and healthcare, accounted for $138 million and $117 million, respectively, of Key's nonperforming loans. Although these two portfolios comprised less than 5% of Key's total loans, they accounted for 27% of total nonperforming loans. At June 30, 2002, our 20 largest nonperforming loans totaled $298 million, representing 31% of total loans on nonperforming status. As shown in Figure 23, at June 30, 2002, the run-off loan portfolio accounted for $132 million, or 14%, of Key's total nonperforming loans presented in Figure 25. Key's nonperforming loans decreased from the first quarter of 2002, representing the first quarter-to-quarter decline in three years. The second quarter sale of $18 million of nonperforming commercial loans contributed to this decline. 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 26. The types of activity that caused the change in Key's nonperforming loans during the last five quarters are summarized in Figure 27. 59 FIGURE 26. COMMERCIAL, FINANCIAL AND AGRICULTURAL LOANS
NONPERFORMING LOANS --------------------------------- JUNE 30, 2002 TOTAL LOANS % OF LOANS dollars in millions COMMITMENTS OUTSTANDING AMOUNT OUTSTANDING - --------------------------------------------------------------------------------------------------------------- Industry classification: Manufacturing $9,899 $4,320 $183 4.2% Services 5,898 2,626 97 3.7 Financial services 4,175 966 11 1.1 Retail trade 4,116 2,360 51 2.2 Wholesale trade 2,937 1,470 15 1.0 Property management 2,487 1,082 5 .5 Public utilities 1,540 373 1 .3 Communications 1,191 615 33 5.4 Agriculture/forestry/fishing 1,147 706 18 2.5 Building contractors 1,204 554 29 5.2 Public administration 746 280 -- -- Transportation 685 447 5 1.1 Insurance 553 156 -- -- Mining 333 221 1 .5 Individuals 200 120 1 .8 Other 2,119 1,775 21 1.2 - --------------------------------------------------------------------------------------------------------------- Total $39,230 $18,071 $471 2.6% ======= ======= ==== - ---------------------------------------------------------------------------------------------------------------
FIGURE 27. SUMMARY OF CHANGES IN NONPERFORMING LOANS 2002 2001 ---------------------- ------------------------------------------- in millions SECOND FIRST FOURTH THIRD SECOND - ----------------------------------------------------------------------------------------------------------------------------- Balance at beginning of period $ 973 $ 910 $885 $797 $713 Loans placed on nonaccrual status 254 294 407 324 455 Charge-offs (203) (206) (220) (173) (170) Loans sold (18) -- (83) (35) (137) Payments (49) (22) (65) (20) (61) Transfers to OREO -- (3) (12) (8) (2) Loans returned to accrual status -- -- (2) -- (1) - ----------------------------------------------------------------------------------------------------------------------------- Balance at end of period $ 957 $ 973 $910 $885 $797 ===== ===== ==== ==== ==== - -----------------------------------------------------------------------------------------------------------------------------
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 the second quarter of 2002, core deposits averaged $37.1 billion, and represented 51% of the funds Key used to support earning assets, compared with $37.6 billion and 49% during the same period last year. The composition of Key's deposits is shown in Figure 7, which spans pages 43 and 44. The slight decline in the level of Key's core deposits over the past twelve months is due primarily to a lower level of time deposits. Time deposits decreased by 10% 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 and noninterest-bearing deposits grew, reflecting client preferences for investments that provide high levels of liquidity in a low interest rate environment. 60 Purchased funds, comprising large certificates of deposit, deposits in the foreign branch and short-term borrowings, averaged $16.0 billion during the second quarter of 2002, compared with $20.9 billion a year ago. As shown in Figure 7, Key has reduced its reliance on both certificates of deposit and short-term borrowings as funding sources. This is attributable in part to loan sales, slow demand for loans and from the decision made in May 2001 to scale back or discontinue certain types of lending. In addition, Key continues to consider loan securitizations as a funding alternative when market conditions are favorable. No securitizations were completed during the first half of 2002. 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, at a reasonable cost, in a timely manner and without adverse consequences. 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 hypothetical circumstance may be 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. - - Key's portfolio of investment securities generates payments at maturity and prepayments (often at a premium). - - 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. - - We have a proven ability to access the securitization markets for a variety of loan types. - - Our 905 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 June 30, 2002. LIQUIDITY FOR THE PARENT COMPANY. KeyCorp meets its liquidity requirements principally through regular dividends from affiliate banks. During the first half of 2002, affiliate banks paid KeyCorp a total of $387 million in dividends. As of June 30, 2002, the affiliate banks had an additional $557 million available to 61 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 the first six months of 2002, Key's affiliate banks raised $2.1 billion under Key's bank note program. Of these notes issued during the year, $1.6 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 June 30, 2002, $18.9 billion was 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 $5.5 billion of borrowings outstanding under this facility as of June 30, 2002, $1.4 billion of which were issued during the current year. At the end of the second quarter, $4.3 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 unaffiliated financial institutions that provide funding availability of up to $500 million and $400 million, respectively. As of June 30, 2002, no amount was outstanding under either facility. 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. Of the amount registered, $1.0 billion has been allocated for the issuance of medium-term notes. At June 30, 2002, unused capacity under the shelf registration totaled $1.2 billion and $575 million of the amount allocated for medium-term notes was available for future issuance. Key has favorable debt ratings as shown in Figure 28 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 28. DEBT RATINGS
SENIOR SUBORDINATED SHORT-TERM LONG-TERM LONG-TERM CAPITAL JUNE 30, 2002 BORROWINGS DEBT DEBT SECURITIES - ------------------------------------------------------------------------------------------------------------------- KEYCORP - ------------------------------------- Standard & Poor's A-2 A- BBB+ BBB Moody's P-1 A2 A3 Baa1 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 32 on page 49 of Key's 2001 Annual Report to Shareholders summarizes Key's significant cash obligations and contractual amounts of off-balance sheet lending-related commitments at December 31, 2001, by the specific time periods in which related payments are due or commitments expire. These commitments have not changed significantly since the end of last year. 62 CAPITAL SHAREHOLDERS' EQUITY. Total shareholders' equity at June 30, 2002, was $6.6 billion, up $437 million from the balance at December 31, 2001. Growth in retained earnings and the issuance of common shares out of the treasury stock account in connection with employee stock purchase, 401(k), dividend reinvestment and stock option programs are responsible for the increase. 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 the first six months of 2002, Key did not repurchase any of its common shares. At June 30, 2002, a remaining balance of 16,764,400 shares may be repurchased under the September 2000 authorization. At June 30, 2002, Key had 65,537,753 treasury shares. Management expects to reissue those shares over time to support the employee stock purchase, 401(k), stock option and dividend reinvestment plans, and for other corporate purposes. During the first half of 2002, Key reissued 2,345,971 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 7.96% at June 30, 2002, compared with 7.60% at December 31, 2001, and 7.53% at June 30, 2001. Banking industry regulators prescribe minimum capital ratios for bank holding companies and their banking subsidiaries. Risk-based capital guidelines require a minimum level of capital as a percent of "risk-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 June 30, 2002, Key's Tier 1 capital ratio was 8.23%, and its total capital ratio was 12.29%. 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 June 30, 2002, KeyCorp had a leverage ratio of 8.14%. 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 June 30, 2002, 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 June 30, 2002. 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 29 presents the details of Key's regulatory capital position at June 30, 2002, December 31, 2001 and June 30, 2001. 63 FIGURE 29. CAPITAL COMPONENTS AND RISK-WEIGHTED ASSETS JUNE 30, DECEMBER 31, JUNE 30, dollars in millions 2002 2001 2001 - --------------------------------------------------------------------------------------------------------------------------- TIER 1 CAPITAL Common shareholders' equity(a) $6,527 $6,117 $6,451 Qualifying capital securities 1,156 1,243 1,243 Less: Goodwill 1,105 1,101 1,141 Other assets(b) 49 37 42 - --------------------------------------------------------------------------------------------------------------------------- Total Tier 1 capital 6,529 6,222 6,511 - --------------------------------------------------------------------------------------------------------------------------- TIER 2 CAPITAL Allowance for loan losses(c) 987 1,040 1,051 Net unrealized holding gains(d) -- -- 1 Qualifying long-term debt 2,233 2,286 2,402 - --------------------------------------------------------------------------------------------------------------------------- Total Tier 2 capital 3,220 3,326 3,454 - --------------------------------------------------------------------------------------------------------------------------- Total risk-based capital $9,749 $9,548 $9,965 ====== ====== ====== RISK-WEIGHTED ASSETS Risk-weighted assets on balance sheet $68,273 $67,783 $70,899 Risk-weighted off-balance sheet exposure 12,611 17,480 14,645 Less: Goodwill 1,105 1,101 1,141 Other assets(b) 248 37 42 Plus: Market risk-equivalent assets 312 217 215 Net unrealized holding gains(d) -- -- 1 - --------------------------------------------------------------------------------------------------------------------------- Gross risk-weighted assets 79,843 84,342 84,577 Less: Excess allowance for loan losses(c) 552 637 180 - --------------------------------------------------------------------------------------------------------------------------- Net risk-weighted assets $79,291 $83,705 $84,397 ======= ======= ======= AVERAGE QUARTERLY TOTAL ASSETS $81,560 $82,467 $85,987 ======= ======= ======= CAPITAL RATIOS Tier 1 risk-based capital ratio 8.23% 7.43% 7.71% Total risk-based capital ratio 12.29 11.41 11.81 Leverage ratio(e) 8.14 7.65 7.68 - ---------------------------------------------------------------------------------------------------------------------------
(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) "Other assets" deducted from Tier 1 capital consist of intangible assets (excluding goodwill) recorded after February 19, 1992, and deductible portions of purchased mortgage servicing rights and of nonfinancial equity investments. "Other assets" deducted from risk-weighted assets consist of intangible assets (excluding goodwill) recorded after February 19, 1992, deductible portions of purchased mortgage servicing rights and nonfinancial equity investments. (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). 64 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK The information presented in the Market Risk Management section beginning on page 45 of the Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The information presented in Note 12 ("Legal Proceedings"), beginning on page 24, of the Notes to Consolidated Financial Statements is incorporated herein by reference. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the 2002 Annual Meeting of Shareholders of KeyCorp held on May 23, 2002, five directors were elected for three-year terms expiring in 2005, and shareholders adopted resolutions to amend KeyCorp's Regulations to reduce the size of KeyCorp's Board of Directors to no fewer than 14 and no more than 17 directors and to permit electronic communications and provide for other recent changes in Ohio Corporation Law, and to ratify the appointment by the Board of Directors of Ernst & Young LLP as independent auditors for KeyCorp for the fiscal year ending December 31, 2002. The shareholders rejected a proposed amendment to KeyCorp's Regulations to require the annual election of all directors. Director nominees for terms expiring in 2005 were: Edward P. Campbell, Charles R. Hogan, Dr. Shirley A. Jackson, Bill R. Sanford, and Dennis W. Sullivan. Directors whose term in office as a director continued after the Annual Meeting of Shareholders were: Cecil D. Andrus, William G. Bares, Dr. Carol A. Cartwright, Alexander M. Cutler, Henry S. Hemingway, Douglas J. McGregor, Henry L. Meyer III, Steven A. Minter, Ronald B. Stafford, Thomas C. Stevens, and Peter G. Ten Eyck. On July 18, 2002, the Board of Directors elected Eduardo R. Menasce as a Director effective July 19, 2002. The vote on each issue was as follows:
FOR AGAINST ABSTAIN ---------------------------------------------- Election of Directors: Edward P. Campbell 366,113,383 * 11,481,400 Charles R. Hogan 365,394,453 * 12,200,330 Dr. Shirley A. Jackson 361,390,943 * 16,203,840 Bill R. Sanford 363,109,707 * 14,485,076 Dennis W. Sullivan 364,101,221 * 13,493,562 Amendment to Regulations to 367,949,602 7,195,997 2,449,185 reduce the size of the Board of Directors to no fewer than 14 and no more than 17 directors Amendment to Regulations to 366,947,678 7,583,715 3,063,391 permit electronic communications and provide for other recent changes in Ohio Corporation Law Amendment to Regulations to 158,262,012 143,537,457 6,491,890*** require annual election of all directors**
65
Ratification of Ernst & Young as 362,076,221 13,152,730 2,365,833 independent auditors of KeyCorp
* Proxies provide that shareholders may either cast a vote for, or abstain from voting for, directors. ** This matter required the affirmative vote of holders of shares entitled to exercise three-quarters of the voting power of KeyCorp. The matter did not receive the requisite vote. ***In addition, there were 69,303,425 broker non-votes on this matter. ITEM 5. OTHER INFORMATION REGULATORY CAPITAL STANDARDS AND RELATED MATTERS. On April 1, 2002, a final rule regarding the regulatory capital treatment of certain equity investments made by banking organizations in companies engaged in nonfinancial activities became effective. It imposes marginal capital charges (applied by making deductions from Tier 1 capital) that 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% to 25% as such aggregate carrying amount increases from 15% to 25% of the banking organization's Tier 1 capital. Implementation of this new rule did not have any material adverse effect on Key's regulatory capital during the second quarter of 2002. FDIC DEPOSIT INSURANCE AND FINANCING CORPORATION BOND ASSESSMENTS. In May 2002, the House of Representatives passed H.R. 3717, the Federal Deposit Insurance Reform Act of 2002. This legislation is currently pending in the Senate Committee on Banking, Housing, and Urban Affairs. Under this legislation: (i) the Bank Insurance Fund ("BIF") and the Savings Association Insurance Fund ("SAIF") would merge into a single Deposit Insurance Fund ("DIF"), (ii) DIF coverage limits would significantly increase with an inflation adjustment index for future increases in coverage, (iii) a designated reserve ratio within a range of 1.15% to 1.40% would apply to DIF replacing the 1.25% designated reserve ratio applicable under current law to BIF and SAIF, with the Federal Deposit Insurance Corporation ("FDIC") determining at least annually the designated reserve ratio within the range that will apply to DIF, (iv) current deposit insurance assessments would be set in an amount the FDIC determines to be appropriate (including a maximum base assessment of $.01 per $100 of assessable deposits for insured depository institutions in the lowest risk category, so long as the DIF reserve ratio does not fall below 1.15%), (v) a one-time credit predicated upon the December 31, 1996, assessment base of eligible insured depository institutions would be available (with the amount of such credit being limited for institutions exhibiting financial, operational, or compliance weakness, including undercapitalization), (vi) the payment of dividends to insured depository institutions would be required whenever the DIF reserve ratio equals or exceeds specified percentages, (vii) an on-going system of credits to be applied against future assessments would be established on the same basis as the payment of dividends, and (viii) restoration plans for DIF would be required to be established and implemented by the FDIC whenever DIF's reserve ratio falls (or is projected to fall) below its then applicable designated reserve ratio. FINANCIAL MODERNIZATION LEGISLATION. Effective in May 2001, the Gramm-Leach-Bliley Act 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, these institutions 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 Securities and Exchange Commission ("SEC") issued interim final rules in May 2001 which include a temporary exemption for banks from the definitions of "broker" and "dealer." Because the SEC has given notice that it expects to amend its interim final regulations, the SEC has twice extended this temporary exemption. As a result of the 66 SEC's most recent extension in May 2002, banks are exempt from the definition of "broker" until May 2003 and from the definition of "dealer" until November 2002. The SEC does not expect banks to develop compliance systems to bring their operations into compliance with the interim final rules until the SEC has amended them. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits (3.2) Amended and Restated Regulations of KeyCorp effective May 23, 2002 (10.1) Form of Award of Restricted Stock (2002 __ 2003) (10.2) Form of Award of Restricted Stock (2002 __ 2004) (10.3) Award of Restricted Stock to Henry L. Meyer III (2002 __ 2003) (10.4) Award of Restricted Stock to Henry L. Meyer III (2002 __ 2004) (10.5) Form of Change of Control Agreement between KeyCorp and Certain Executive Officers of KeyCorp, effective January 17, 2002 (10.6) Amended Employment Agreement between KeyCorp and Henry L. Meyer III, dated July 18, 2002 (15) Acknowledgment Letter of Independent Auditors (99.1) Certification of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (99.2) Certification of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K April 17, 2002 - Item 5. Other Events, Item 7. Financial Statements and Exhibits and Item 9. Regulation FD Disclosure. Reporting that on April 17, 2002, the Registrant issued a press release announcing its earnings results for the three-month period ended March 31, 2002, and providing a slide presentation reviewed in the related conference call/webcast. No other reports on Form 8-K were filed during the three-month period ended June 30, 2002. 67 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. KEYCORP ------------------------------------ (Registrant) Date: August 13, 2002 /s/ Lee Irving ------------------------------------ By: Lee Irving Executive Vice President and Chief Accounting Officer 68 EX-3.2 3 l95281aexv3w2.txt AMENDED AND RESTATED REGULATIONS Exhibit 3.2 AMENDED AND RESTATED REGULATIONS OF KEYCORP (Effective May 23, 2002) ARTICLE I SHAREHOLDERS Section 1. Place of Meeting. All meetings of the shareholders of the Corporation shall be held at the office of the Corporation or at such other places, within or without the State of Ohio, and/or in by part means of communications equipment in the manner provided for in Section 9 of this Article I, as may from time to time be determined by the Board of Directors, the Chairperson of the Board, or the President and specified in the notice of such meeting. Section 2. Annual Meetings. The annual meeting of the shareholders of the Corporation for the election of directors, the consideration of reports to be laid before such meeting, and the transaction of such other business as may properly come before the meeting shall be held (i) on the third Wednesday in May in each year, if not a legal holiday under the laws of the place where the meeting is to be held, and, if a legal holiday, then on the next succeeding day not a legal holiday under the laws of such place, or (ii) on such other date and at such hour as may from time to time be determined by the Board of Directors, the Chairperson of the Board, or the President. Section 3. Special Meetings. Subject to the rights of the holders of any class or series of preferred stock of the Corporation, special meetings of the shareholders for any purpose or purposes may be called only by (i) the Chairperson of the Board, (ii) the President, or, in the case of the President's absence, death, or disability, the vice president authorized to exercise the authority of the President, (iii) the Board of Directors by action at a meeting or a majority of the Board of Directors acting without a meeting, or (iv) persons holding 50% of all shares outstanding and entitled to vote at the special meeting. Upon request in writing delivered either in person or by registered mail to the Chairperson of the Board, the President, or the Secretary by any persons entitled to call a meeting of shareholders, such officer shall forthwith cause to be given to the shareholders entitled thereto notice of a meeting to be held on a date not less than ten nor more than 60 days after the receipt of such request, as such officer may fix. If such notice is not given within 30 days after the delivery or mailing of such request, the persons calling the meeting may fix the time of the meeting and give notice thereof in the manner provided by law or as provided in these Regulations, or cause such notice to be given by any designated representative. Section 4. Notice of Meetings. (a) Written notice of each meeting of the shareholders, whether annual or special, shall be given, either by personal delivery, mail, overnight delivery service, or any other means of communication authorized by the shareholder to whom the notice is given, not less than seven nor more than 60 days before the date of the meeting to every shareholder of record entitled to notice of the meeting, by or at the direction of the Chairperson of the Board, the President or the Secretary or any other person or persons required or permitted by these Regulations to give such notice. Each such notice shall state (i) the date and hour, (ii) the place of the meeting, (iii) the means, if any, other than by physical presence, by which shareholders can be present and vote at the meeting through the use of communications equipment, and (iv) the purpose or purposes for which the meeting is called. (b) If mailed or sent by overnight delivery service, such notice shall be deemed given when deposited in the United States mail or with the overnight delivery service, as the case may be, postage or other shipping charges prepaid, and directed to the shareholder at such shareholder's address as it appears on the records of the Corporation. If sent by another means of communication authorized by the shareholder, such notice shall be deemed to be given when sent to the address furnished by the shareholder for those transmissions. (c) Notice of adjournment of a meeting of shareholders need not be given if the time and place to which it is adjourned, and the means, if any, other than by physical presence, by which shareholders can be present and vote at the meeting through the use of communications equipment are fixed and announced at the meeting. (d) Any authorization by a shareholder to send notices given pursuant to these Regulations by any means other than in person or by mail or overnight delivery service is revocable by written notice to the Corporation either by personal delivery or by mail, overnight delivery service, or any other means of communication authorized by the Corporation. If sent by another means of communication authorized by the Corporation, the notice shall be sent to the address furnished by the Corporation for those transmissions. Any authorization by a shareholder to send notices given pursuant to these Regulations by any means other than in person or by mail or overnight delivery service will be deemed to have been revoked by the shareholder if (i) the Corporation has attempted to make delivery of two consecutive notices in accordance with that authorization, and (ii) the Secretary or an Assistant Secretary of the Corporation, or other person responsible for giving of notice, has received notice that, or otherwise believes that, delivery has not occurred. However, an inadvertent failure to treat the inability to deliver notice as a revocation will not invalidate any meeting of shareholders or other action. 2 Section 5. Quorum. Except as otherwise required by law or by the Articles of Incorporation, the presence of holders of shares entitled to exercise not less than a majority of the voting power of the Corporation at the meeting in person, by proxy, or by the use of communications equipment shall constitute a quorum for the transaction of business at any meeting of the shareholders; provided, however, that no action required by law, the Articles of Incorporation, or these Regulations to be authorized or taken by the holders of a designated proportion of the shares of any particular class or of each class of the Corporation may be authorized or taken by a lesser proportion. Section 6. Proxies. Proxies may be used in conformity with Ohio law. Section 7. Adjournments. The holders of a majority of the voting shares represented at a meeting, whether or not a quorum is present, may adjourn such meeting from time to time. Section 8. Advance Notice of Shareholder Proposals. At any annual meeting of shareholders, proposals by shareholders and nominations for election as directors by shareholders shall only be considered if advance notice thereof has been timely given as provided in this Section 8 in the case of proposals by shareholders, and as provided in Section 2(b) of Article II in the case of nominations for election as directors by shareholders, and such proposals or nominations are otherwise proper for consideration under applicable law and the Articles of Incorporation of the Corporation. Notice of any proposal to be presented by any shareholder shall be given in writing to the Secretary of the Corporation, delivered to or mailed and received at the Corporation's principal executive offices, not less than 60 nor more than 90 days prior to the shareholders' meeting; provided, however, that in the event that less than 75 days' notice to the shareholders or prior public disclosure of the date of the meeting is given or made, the written notice of such shareholder's intent to make such proposal must be given to the Secretary not later than the close of business on the fifteenth day following the earlier of the day on which such notice of the date of the meeting was mailed or such public disclosure was made. Any shareholder who gives notice of any such proposal shall deliver therewith the text of the proposal to be presented and a brief written statement of the reasons why such shareholder favors the proposal and setting forth such shareholder's name and record address, the number and class of all shares of each class of stock of the Corporation beneficially owned (within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934) by such shareholder and any material interest of such shareholder in the proposal (other than as a shareholder). The person presiding at the meeting, in addition to making any other determinations that may be appropriate to the conduct of the meeting, shall determine whether such notice under this Section 8 or under Section 2(b) of Article II, as applicable, has been duly given and shall direct that proposals and nominees not be considered if such notice (together with all required information to be submitted by such shareholder under this Section 8 or under Section 2(b) of Article II, as applicable) has not been given. No proposals by shareholders or nominations for election as director shall be considered at any special meeting of shareholders unless such special meeting was called for the purpose of considering such proposal or nomination. If, pursuant to Rule 14a-8 promulgated under the Securities Exchange Act of 1934 (including as such Rule 14a-8 may be from time to time 3 amended or any rule promulgated in place thereof or covering the same subject matter; collectively being herein referred to as "Rule 14a-8") the Corporation is required to set forth a proposal of a shareholder in its proxy statement, the provisions of Rule 14a-8, to the extent applicable, shall prevail over any conflicting provisions of this Section 8 with respect to that shareholder proposal. Section 9. Participation in Meeting by Means of Communications Equipment. The Board of Directors may authorize shareholders and proxyholders who are not physically present at a meeting of shareholders to participate by use of communications equipment that permits the shareholder or proxyholder the opportunity to participate in the meeting and to vote on matters submitted to the shareholders, including an opportunity to read or hear the proceedings of the meeting and to speak or otherwise participate in the proceedings contemporaneously with those physically present. Any shareholder using communications equipment will be deemed present in person at the meeting. The Board of Directors may adopt guidelines and procedures for the use of communications equipment in connection with a meeting of shareholders to permit the Corporation to verify that a person is a shareholder or proxyholder and to maintain a record of any vote or other action. ARTICLE II BOARD OF DIRECTORS Section 1. Number, Classification, and Term of Office. The Board of Directors shall be divided into three classes. The respective terms of the three classes of directors are staggered so that at any time the term of one class will expire at the next annual meeting of shareholders thereafter occurring, the term of a second class will expire at the second annual meeting of shareholders thereafter occurring, and the term of a third class will expire at the third annual meeting of shareholders thereafter occurring. At each annual meeting of shareholders of the Corporation, the successors to the directors of the class whose term will expire in that year shall be elected to hold office for a term expiring at the annual meeting of shareholders occurring in the third year after the date of their election. In each instance directors shall hold office until their successors are chosen and qualified, or until the earlier death, retirement, resignation, or removal of any such director as provided in Section 11 of this Article II. As of the conclusion of the 2002 annual meeting of shareholders of the Corporation, the Board of Directors shall consist of 16 members, divided into three classes as follows: one class of six directors whose term will expire at the 2003 annual meeting of shareholders, and two classes of five directors whose terms will expire at the 2004 and 2005 annual meetings of shareholders, respectively. The Board of Directors or the shareholders may from time to time fix or change the size of the Board of Directors to a total number of no fewer than 14 and no more than 17 directors (the size of the Board as from time to time so established being herein referred to as the "entire authorized Board"). The Board of Directors may, subject to the limitation contained in the immediately preceding sentence regarding the number of directors, 4 fix or change the number of directors by the affirmative vote of a majority of the entire authorized Board. The shareholders may, subject to the limitation contained in the second sentence of this paragraph regarding the number of directors, fix or change the number of directors at a meeting of the shareholders called for the purpose of electing directors (i) by the affirmative vote of the holders of shares entitling them to exercise three-quarters of the voting power of the Corporation represented at the meeting and entitled to elect directors or (ii) if the proposed change in the number of directors is recommended by a majority of the entire authorized Board of Directors, by the affirmative vote of the holders of shares entitling them to exercise a majority of the voting power of the Corporation represented at the meeting and entitled to elect directors. If the Board of Directors or the shareholders change the number of directors as provided above in this paragraph, the three classes of the Board of Directors shall be divided into as equal a number of directors as possible, with the Board of Directors or the shareholders, as the case may be, fixing or determining the adjustment to be made in each class. No reduction in the number of directors shall of itself have the effect of shortening the term of any incumbent director. In the event that the Board of Directors increases the number of directors, it may fill the vacancy or vacancies created by the increase in the number of directors for the respective unexpired terms in accordance with the provisions of Section 12 of this Article II. In the event the shareholders increase the number of directors and fail to fill the vacancy or vacancies created thereby, the Board of Directors may fill such vacancy or vacancies for the respective unexpired terms in accordance with the provisions of Section 12 of this Article II. The number of directors and the number of directors of any class may not be fixed or changed by the shareholders or directors, except (i) by amending these Regulations in accordance with the provisions of Article X of these Regulations, (ii) pursuant to an agreement of merger or consolidation approved by two-thirds of the members of the entire authorized Board of Directors and adopted by the shareholders at a meeting held for such purpose by the affirmative vote of the holders of shares entitling them to exercise a majority of the voting power of the Corporation on such proposal, or (iii) as provided in the immediately preceding paragraph of this Section 1 or in the next following paragraph. The foregoing provisions of this Section 1 are subject to the automatic increase by two in the authorized number of directors and the right of the holders of any class or series of preferred stock of the Corporation to elect two directors of the Corporation during any time when dividends payable on such shares are in arrears, all as set forth in the Articles of Incorporation of the Corporation and/or the express terms of the preferred stock of the Corporation. Section 2. Nominations. Only persons who are nominated in accordance with the following procedures shall be eligible for election as directors. Subject to the rights of the holders of any class or series of preferred stock of the Corporation, nominations for the election of directors may be made only: (a) by the affirmative vote of a majority of the directors then in office, and 5 (b) by any shareholder of the Corporation entitled to vote for the election of directors at a meeting, but only if written notice of such shareholder's intent to make such nomination is given to the Secretary of the Corporation, delivered to or mailed and received at the Corporation's principal executive offices, not less than 60 nor more than 90 days prior to the meeting; provided, however, that in the event that less than 75 days' notice to the shareholders or prior public disclosure of the date of the meeting is given or made, the written notice of such shareholder's intent to make such nomination must be given to the Secretary not later than the close of business on the fifteenth day following the earlier of the day on which such notice of the date of the meeting was mailed or such public disclosure was made. Each such notice of a shareholder's intent to make a nomination shall set forth: (A) as to each person who is not an incumbent director when the shareholder proposes to nominate such person for election as a director, (1) the name, age, business, and residence address of such person, (2) the principal occupation or employment of such person for the last five years, (3) the class and number of shares of capital stock of the Corporation which are beneficially owned by such person, (4) all positions of such person as a director, officer, partner, employee, or controlling shareholder of any corporation or other business entity, (5) any prior position as a director, officer, or employee of a depository institution or any company controlling a depository institution, (6) any other information regarding such person that would be required pursuant to paragraphs (a), (e), and (f) of Item 401 of Regulation S-K adopted by the Securities and Exchange Commission (or the corresponding provisions of any regulations subsequently adopted by the Securities and Exchange Commission applicable to the Corporation) to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission had such person been nominated, or intended to be nominated, by the Board of Directors, and (7) the written consent of each nominee to serve as a director of the Corporation if so elected, and (B) as to the shareholder giving the notice, (1) the name and record address of such shareholder, (2) a representation that the shareholder is a holder of record of shares of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice, (3) a description of all arrangements or understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder, and (4) the class and number of shares of capital stock of the Corporation which are beneficially owned (within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended) by such shareholder. No person shall be eligible for election as a director unless nominated in compliance with the provisions of this Section 2. 6 Section 3. Quorum, Adjournments, and Manner of Acting. Except as otherwise required by law, the Articles of Incorporation of the Corporation, or these Regulations, a majority of the entire authorized Board of Directors shall constitute a quorum for the transaction of business at any meeting of the Board. Except as otherwise required by law, the Articles of Incorporation of the Corporation, or these Regulations, the affirmative vote of a majority of the directors present at any meeting at which a quorum is present shall be the act of the Board. In the absence of a quorum, a majority of the directors present at a meeting duly held may adjourn the meeting to another time and place. At any adjourned meeting at which a quorum is present, any business may be transacted which might have been transacted at the originally called meeting. Notwithstanding any contrary provisions of these Regulations, the affirmative vote of at least two-thirds of the entire authorized Board of Directors shall be required for the approval or recommendation of any of the following transactions: (a) any merger or consolidation of the Corporation (i) with any interested shareholder, as such term is defined in Chapter 1704 of the Ohio General Corporation Law, or (ii) with any other corporation (which term, as used in this paragraph, includes, in addition to a corporation, a limited liability company, partnership, business trust or other entity) if the merger or consolidation is caused by any interested shareholder, (b) any transaction as a result of which any person or entity will become an interested shareholder, (c) any merger or consolidation involving the Corporation with or into any other corporation if such other corporation, taken on a consolidated basis with its "parent", if any, and its and its parent's "subsidiaries" (as both terms are defined by Rule 12b-2 under the Securities Exchange Act of 1934, as amended), has assets having an aggregate book value equal to 50% or more of the aggregate book value of all the assets of the Corporation determined on a consolidated basis, (d) any liquidation or dissolution of the Corporation, (e) any sale, lease, exchange, mortgage, pledge, transfer, or other disposition (in one transaction or a series of transactions) to or with an interested shareholder of assets of the Corporation which assets have an aggregate book value equal to 10% or more of the aggregate book value of all the assets of the Corporation determined on a consolidated basis, (f) any sale, lease, exchange, mortgage, pledge, transfer, or other disposition (in one transaction or a series of transactions) to or with any person or entity of assets of the Corporation which assets have an aggregate book value equal to 25% or more of the aggregate book value of all the assets of the Corporation determined on a consolidated basis, (g) any transaction which results in the issuance or transfer by the Corporation to any person or entity of voting stock of the Corporation in an amount greater than 15% of the outstanding voting stock of the Corporation before giving effect to the issuance or transfer, (h) any transaction involving the Corporation which has the effect, directly or indirectly, of increasing the proportionate share of the stock or securities of any class or series of the Corporation which is owned by an interested shareholder, and (i) any transaction which results in the receipt by an interested shareholder, other than proportionately as a shareholder of the Corporation, of the benefit, directly or indirectly, of any loans, advances, guarantees, pledges, or other financial benefits provided through the Corporation. Section 4. Place of Meeting. The Board of Directors may hold its meetings at such place or places, if any, within or without the State of Ohio as the Board may from time to time 7 determine or as shall be specified or fixed in the respective notice or waivers of notices thereof. Section 5. Regular Meetings. Regular meetings of the Board of Directors shall be held at such places, if any, and times as the Board shall from time to time determine. Section 6. Special Meetings. Special meetings of the Board of Directors shall be held whenever called by the Chairperson of the Board or the President or by a majority of the directors then in office. Section 7. Notice of Meetings. (a) Notice of regular meetings of the Board of Directors or of any adjourned meeting thereof need not be given. (b) Notice of each special meeting of the Board shall be given to each director personally or by telephone, not later than the day before the meeting is to be held, or sent by telegraph, telex, facsimile, or other means of communication authorized by such director for this purpose, at least 2 days before the day on which the meeting is to be held. Notice need not be given to any director who shall, either before or after the meeting, submit a waiver of such notice, signed or otherwise authenticated by such director, or who shall attend such meeting without protesting prior to or at its commencement, the lack of notice to such director. Every notice shall state the time, place, if any, and means by which directors may participate in the meeting through the use of communications equipment, but need not state the purpose of the meeting. Section 8. Participation in Meeting by Means of Communications Equipment. Any one or more members of the Board of Directors or any committee thereof may participate in any meeting of the Board or of any such committee through the use of communications equipment to the extent allowed by Ohio law. Section 9. Action Without Meeting. Any action required or permitted to be taken at any meeting of the Board of Directors or any committee thereof may be authorized or taken without a meeting with the affirmative vote or approval of, and in a writing or writings signed by, all the directors or all the committee members, which writing or writings shall be filed with or entered upon the records of the Corporation. A telegram, cablegram, electronic mail, or an electronic or other transmission capable of authentication that appears to have been sent by a director or committee member is a signed writing for purposes of this Section 9. The date on which that telegram, cablegram, electronic mail, or an electronic or other transmission is sent is the date on which the writing shall be deemed to have been signed. Section 10. Resignations. Any director of the Corporation may resign at any time by oral statement to that effect made at a meeting of the Board of Directors or any committee thereof or by giving written notice to the Board of Directors, the Chairperson of the Board, the President, or the Secretary of the Corporation. Such resignation shall take effect at the 8 date of receipt of such notice or at any later date specified therein and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. Section 11. Removal of Directors. (a) The Board of Directors may remove any director and thereby create a vacancy on the Board: (i) if by order of court the director has been found to be of unsound mind or if the director is adjudicated a bankrupt or (ii) if within 60 days from the date of such director's election the director does not qualify by accepting (either in writing or by any other means of communication authorized by the Corporation) the election to such office or by acting at a meeting of directors. (b) All the directors, or all of the directors of a particular class, or any individual director, may be only removed from office by the affirmative vote of the holders of shares entitling them to exercise three-quarters of the voting power of the Corporation entitled to elect directors in place of those to be removed. In case of any such removal, a new director nominated in accordance with Section 2 of this Article II may be elected at the same meeting for the unexpired term of each director removed. Failure to elect a director to fill the unexpired term of any director removed shall be deemed to create a vacancy on the Board. Section 12. Vacancies. Any vacancies on the Board of Directors resulting from death, resignation, removal, or other cause may be filled by the affirmative vote of a majority of the directors then in office, even though less than a quorum of the Board of Directors, or by a sole remaining director. Newly created directorships resulting from any increase in the number of directors by action of the Board of Directors may be filled by the affirmative vote of a majority of the directors then in office, or if not so filled, by the shareholders at the next annual meeting thereof or at a special meeting called for that purpose in accordance with Section 3 of Article I of these Regulations. In the event the shareholders increase the authorized number of directors in accordance with these Regulations but fail at the meeting at which such increase is authorized, or an adjournment of that meeting, to elect the additional directors provided for, or if the shareholders fail at any meeting to elect the whole authorized number of directors, such vacancies may be filled by the affirmative vote of a majority of the directors then in office. Any director elected in accordance with the three preceding sentences of this Section 12 shall hold office for the remainder of the full term of the class of directors in which the new directorship was created or the vacancy occurred and until such director's successor shall have been elected and qualified. The provisions of this Section 12 shall not restrict the rights of holders of any class or series of preferred stock of the Corporation to fill vacancies in directors elected by such holders as provided by the express terms of the preferred stock. 9 ARTICLE III EXECUTIVE AND OTHER COMMITTEES Section 1. Executive Committee. The Board of Directors may, by resolution adopted by the affirmative vote of a majority of the entire authorized Board, designate annually (i) four or more of its members to constitute members of an Executive Committee of the Board of Directors of the Corporation (the "Executive Committee") and (ii) one or more of its members to be alternate members of the Executive Committee to take the place of any absent member or members at any meeting of the Executive Committee. The Executive Committee shall have and may exercise, between meetings of the Board, all the powers and authority of the Board in the management of the business and affairs of the Corporation, including, without limitation, the power and authority to declare a dividend and to authorize the issuance of stock, and may authorize the seal of the Corporation to be affixed to all papers which may require it, except that the Executive Committee shall not have such power or authority in reference to filling vacancies on the Board or on any committee of the Board, including the Executive Committee. The Board shall have power at any time by the affirmative vote of a majority of the entire authorized Board to change the membership of the Executive Committee, to fill all vacancies in it, and to discharge it, either with or without cause. Section 2. Other Committees. The Board of Directors may, by resolution adopted by the affirmative vote of a majority of the entire authorized Board, designate from among its members one or more other committees, each of which shall (i) consist of not less than three directors, together with such alternates as the Board of Directors may appoint to take the place of any absent member or members at any meeting of such committee, and (ii) except as otherwise prescribed by law, have such authority of the Board as may be specified in the resolution of the Board designating such committee. The Board shall have power at any time, by the affirmative vote of a majority of the entire authorized Board, to change the membership of, to fill all vacancies in, and to discharge any such committee, either with or without cause. Section 3. Procedure, Meetings, and Quorum. (a) Regular meetings of the Executive Committee or any other committee of the Board of Directors, of which no notice shall be necessary, may be held at such times and places, if any, as may be fixed by a majority of the members thereof. Special meetings of the Executive Committee or any other committee of the Board shall be called at the request of the Chairperson of the Board or the President or the Chairperson of any committee. Notice of each special meeting of the Executive Committee or any other committee of the Board shall be given in the same manner required for notices of special meetings of the Board of Directors as provided in Section 7 of Article II. Any special meeting of the Executive Committee or any other committee of the Board shall be a legal meeting without any notice thereof having been given, if all the members thereof shall be present thereat. Notice of any adjourned meeting of any committee of the Board need not be given. The Executive Committee or any other 10 committee of the Board may adopt such rules and regulations not inconsistent with the provisions of law, the Articles of Incorporation of the Corporation, or these Regulations for the conduct of its meetings as the Executive Committee or any other committee of the Board may deem proper. (b) A majority of the members of the Executive Committee or any other committee of the Board shall constitute a quorum for the transaction of business at any meeting, and the vote of a majority of the members thereof present at any meeting at which a quorum is present shall be the act of such committee. The Executive Committee or any other committee of the Board of Directors shall keep written minutes of its proceedings and shall report on such proceedings to the Board. ARTICLE IV OFFICERS Section 1. Election and Term of Office. The officers of the Corporation shall consist of a President, a Secretary, a Treasurer, and such other officers (including, without limitation, if so desired by the Board of Directors, a Chairperson of the Board, a Chief Executive Officer, a Chief Operating Officer, a Chief Financial Officer, and one or more Vice Presidents) and assistant officers, all with such titles, authorities, and duties as the Board of Directors may from time to time determine. The officers shall be elected by the Board of Directors. The Chairperson of the Board, if one is elected, shall be a director. Any two or more offices may be held by the same person, but no officer shall execute, acknowledge, or verify any instrument in more than one capacity if such instrument is required by law, the Articles of Incorporation of the Corporation, or these Regulations to be executed, acknowledged, or verified by two or more officers. Unless the directors expressly elect an officer for a longer or shorter term, each officer shall hold office until the next annual organization meeting of the directors following election of the officer (or, if neither such officer nor a successor is elected at such annual organization meeting, until such officer or such officer's successor is elected) or until the earlier resignation, removal from office, or death of the officer. Section 2. Authority and Duties of Officers. The officers of the Corporation shall have such authority and shall perform such duties as are customarily incident to their respective offices, or as may be determined by the Board of Directors, regardless of whether such authority and duties are customarily incident to such offices. Unless otherwise determined by the Board of Directors, the Chairperson of the Board, if any, shall preside at all meetings of the Board of Directors and at all meetings of the shareholders. In the event a Chairperson of the Board has not been elected or is otherwise absent, the President (or such other officer designated by the Board of Directors) shall preside at such meetings. Section 3. Removal. Any officer may at any time be removed, either with or without cause, by the Board of Directors or any authorized committee thereof or by any superior officer upon whom such power may be conferred by the Board or any authorized committee 11 thereof; provided however, that the removal of the most senior (in authority) officer of the Corporation shall require the affirmative vote of at least a majority of the entire authorized Board. The removal of any officer shall be without prejudice to the contract rights, if any, of such officer. Section 4. Resignation. Any officer may resign at any time by giving notice to the Board of Directors, the Chairperson of the Board, the President, or the Secretary of the Corporation. Any such resignation shall take effect at the date of receipt of such notice or at any later date specified therein and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective. Section 5. Vacancies. A vacancy in any office because of death, retirement, resignation, removal, or any other cause may be filled by the Board of Directors. ARTICLE V INDEMNIFICATION The Corporation shall indemnify, to the full extent permitted or authorized by the Ohio General Corporation Law as it may from time to time be amended, any person made or threatened to be made a party to any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, or investigative, by reason of the fact that he or she is or was a director, officer, or employee of the Corporation, or is or was serving at the request of the Corporation as a director, trustee, officer, or employee of a bank, other corporation, partnership, joint venture, trust, or other enterprise. In the case of a merger into this Corporation of a constituent corporation which, if its separate existence had continued, would have been required to indemnify directors, officers, or employees in specified situations prior to the merger, any person who served as a director, officer, or employee of the constituent corporation, or served at the request of the constituent corporation as a director, trustee, officer, or employee of a bank, other corporation, partnership, joint venture, trust, or other enterprise, shall be entitled to indemnification by this Corporation (as the surviving corporation) for acts, omissions, or other events or occurrences prior to the merger to the same extent he or she would have been entitled to indemnification by the constituent corporation if its separate existence had continued. The indemnification provided by this Article V shall not be deemed exclusive of any other rights to which any person seeking indemnification may be entitled under the Articles of Incorporation of the Corporation or these Regulations, or any agreement, vote of shareholders or disinterested directors, or otherwise, both as to action in his or her official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, trustee, officer, or employee and shall inure to the benefit of the heirs, executors, and administrators of such a person. 12 ARTICLE VI CAPITAL STOCK Section 1. Certificates for Shares. Certificates representing shares of stock of each class of the Corporation, whenever authorized by the Board of Directors, shall be in such form as shall be approved by the Board or by the Chairperson of the Board or President or a Vice President and the Secretary or an Assistant Secretary or the Treasurer or an Assistant Treasurer. The certificates representing shares of stock of each class shall be signed by, or in the name of, the Corporation by the Chairperson of the Board or the President or a Vice President and by the Secretary or an Assistant Secretary or the Treasurer or an Assistant Treasurer of the Corporation. Any or all such signatures may be facsimiles, engraved, stamped, or printed if countersigned by an incorporated transfer agent or registrar. Although any officer, transfer agent or registrar whose manual or facsimile signature is affixed to such a certificate ceases to be such officer, transfer agent, or registrar before such certificate has been delivered, such certificate nevertheless shall be effective in all respects when delivered. The Corporation may issue shares of any class of its capital stock without issuing certificates therefor. Section 2. Transfer of Shares. Transfers of shares of stock of each class of the Corporation shall be made only on the books of the Corporation by the holder thereof, or by such holder's attorney thereunto authorized by a power of attorney duly executed and filed with the Secretary of the Corporation or a transfer agent for such stock, if any, and on surrender of the certificate or certificates for such shares properly endorsed or accompanied by a duly executed stock transfer power and the payment of all taxes thereon. The person in whose name shares stand on the books of the Corporation shall be deemed the owner thereof for all purposes as regards the Corporation. No transfer of shares shall be valid as against the Corporation and its shareholders and creditors for any purpose until it shall have been entered in the stock records of the Corporation by an entry showing from and to whom transferred. Section 3. Lost, Destroyed, and Mutilated Certificates. The holder of any share of stock of the Corporation shall immediately notify the Corporation of any loss, theft, destruction, or mutilation of the certificate therefor; the Corporation may issue to such holder a new certificate or certificates for shares, upon the surrender of the mutilated certificate or, in the case of loss, theft, or destruction of the certificate, upon satisfactory proof of such loss, theft, or destruction; the Corporation, or the transfer agents and registrars for the stock, may, in their discretion, require the owner of the lost, stolen, or destroyed certificate, or such person's legal representative, to provide the Corporation a bond in such sum and with such surety or sureties as they may direct to indemnify the Corporation and such transfer agents and registrars against any claim that may be made on account of the alleged loss, theft, or destruction of any such certificate or the issuance of such new certificate. Section 4. Regulations. The Board of Directors may make such additional rules and regulations as it may deem expedient concerning the issue and transfer of certificates 13 representing shares of stock of each class of the Corporation and may make such rules and take such action as it may deem expedient concerning the issue of certificates in lieu of certificates claimed to have been lost, destroyed, stolen, or mutilated. ARTICLE VII RECORD DATES For any lawful purpose, including the determination of the shareholders who are entitled to receive notice of or to vote at a meeting of the shareholders, the Board of Directors may fix a record date in accordance with the provisions of the Ohio General Corporation Law. The record date for the purpose of the determination of the shareholders who are entitled to receive notice of or to vote at a meeting of the shareholders shall continue to be the record date for all adjournments of the meeting unless the Board of Directors or the persons who shall have fixed the original record date shall, subject to the limitations set forth in the Ohio General Corporation Law, fix another date and shall cause notice thereof and of the date to which the meeting shall have been adjourned to be given to shareholders of record as of the newly fixed date in accordance with the same requirements as those applying to a meeting newly called. The Board of Directors may close the share transfer books against transfers of shares during the whole or any part of the period provided for in this Article VII, including the date of the meeting of the shareholders and the period ending with the date, if any, to which adjourned. If no record date is fixed therefor, the record date for determining the shareholders who are entitled to receive notice of a meeting of the shareholders shall be the date next preceding the day on which notice is given, and the record date for determining the shareholders who are entitled to vote at a meeting of shareholders shall be the date next preceding the day on which the meeting is held. ARTICLE VIII CORPORATE SEAL The corporate seal of this Corporation shall be circular in form and shall contain the name of the Corporation. Failure to affix the seal to any instrument or document executed on behalf of the Corporation shall not affect the validity of such instrument or document unless otherwise expressly provided by law. ARTICLE IX OFFICES The headquarters and principal executive offices of the Corporation shall be located in the City of Cleveland, County of Cuyahoga, State of Ohio. The Corporation may also have 14 such other office or offices, and keep the books and records of the Corporation, except as may otherwise be required by law, at such other place or places, either within or without the State of Ohio, as the Board of Directors may from time to time determine or the business of the Corporation may require. ARTICLE X AMENDMENTS These Regulations may only be amended, repealed, or altered or new regulations may only be adopted (i) at a meeting of shareholders, by the affirmative vote of the holders of shares entitling them to exercise three-quarters of the voting power of the Corporation on such proposal, provided, however, if such amendment, repeal, alteration, or adoption is recommended by at least two-thirds of the entire authorized Board of Directors, the shareholder vote required shall be the affirmative vote of the holders of shares entitling them to exercise a majority of the voting power of the Corporation on such proposal, or (ii) without a meeting, by the written consent of the holders of shares entitling them to exercise 100% of the voting power of the Corporation on such proposal. It is the intent that these Regulations be enforced to the maximum extent permitted by law. If in any judicial proceeding, a court shall refuse to enforce any provision of these Regulations for the reason that such provision (or portion thereof) is deemed to be unenforceable or invalid under applicable law, then it is the intent that such otherwise unenforceable or invalid provision (or portion thereof) be enforced and valid to the maximum extent permitted by applicable law. The invalidity or unenforceability of any provision (or portion thereof) of these Regulations shall not invalidate or render unenforceable any other provision (or the balance of the otherwise enforceable or valid provision) of these Regulations, as each provision (and portion thereof) is intended to be severable. 15 EX-10.1 4 l95281aexv10w1.txt AWARD OF RESTRICTED STOCK Exhibit 10.1 KEYCORP AWARD OF RESTRICTED STOCK - --------------------- By action of the Compensation and Organization Committee ("Committee") of the Board of Directors of KeyCorp, taken pursuant to the KeyCorp Amended and Restated 1991 Equity Compensation Plan ("Plan") on January 17, 2002, you have been awarded __________ shares of Restricted Stock. (Unless otherwise indicated, the capitalized terms used herein shall have the same meaning as set forth in the Plan.) 1. One-half of the Restricted Stock ("the Time Lapse Restricted Shares") may not be sold, transferred, otherwise disposed of, pledged or otherwise hypothecated until the earlier of the following: a) December 31, 2003; or b) the date not more than two years on or after a Change of Control upon which your employment terminates under circumstances entitling you to receive severance benefits or salary continuation benefits under KeyCorp Separation Pay Plan or under any employment or change of control or similar arrangement or agreement. 2. The remaining one-half of the Restricted Stock ("the Performance Accelerated Restricted Shares") may not be sold, transferred, otherwise disposed of, pledged, or otherwise hypothecated until the earliest of the following shall occur: a) December 31, 2008; b) the percentage increase in KeyCorp's average daily stock price for the years 2002 through 2003 exceeds the percentage increase in the average daily stock price of the median of the banks which comprise the Standard & Poor's 500 Banks Index (If at any time the Standard & Poor's 500 Banks Index ceases to be published or is altered in such manner as to make its use as a comparative reference inappropriate, as determined by the Committee in its sole discretion, then the Committee shall (i) select such other index as is then available that the Committee deems most appropriate to use as a substitute for the Standard & Poor's 500 Banks Index and (ii) decide 1 whether to use that other index to determine whether the condition of this paragraph has been met); or c) the first day on which a Change of Control occurs on or before December 31, 2003. 3. If you shall die or become Disabled prior to the lapse of the restrictions on the Time Lapse Restricted Shares, then a pro rata number of the Time Lapse Restricted Shares shall be retained by you or your estate and become freely transferable upon death or Disability but the remainder shall immediately be forfeited upon your death or Disability, as the case may be. 4. The restrictions shall lapse upon a pro rata number of the Time Lapse Restricted Shares when you have been continuously employed by KeyCorp and reach age 65 and each year thereafter that you remain employed by KeyCorp on your birthday the restrictions shall lapse on the lesser of an additional one-third of the Time Lapse Restricted Shares or the number of Time Lapse Restricted Shares remaining in your award. 5. The Time Lapse Restricted Shares shall immediately be forfeited if you retire between the ages of 55 and 65 prior to the lapse of the restrictions; provided, however, that the Committee may in its sole discretion determine that a pro rata number of the Time Lapse Restricted Shares shall be retained by you and become freely transferable upon retirement but that the remainder shall immediately be forfeited upon your retirement. 6. If you retire at age 65 or older, die or become Disabled prior to the lapse of the restrictions on the Performance Accelerated Restricted Shares and such shares thereafter cease to be restricted because of the performance of KeyCorp's average daily stock price, then a pro rata number of the Performance Accelerated Restricted Shares shall be retained by you or your estate and become freely transferable if and when the restrictions lapse because of the performance of KeyCorp's average daily stock price but the remainder shall immediately be forfeited upon your retirement, death, or Disability, as the case may be, and if the restrictions do not lapse as a result of performance of KeyCorp's average daily stock price, the pro rata number of Performance Accelerated Restricted Shares retained by you or your estate shall be forfeited on December 31, 2003. 7. The Performance Accelerated Restricted Shares shall be forfeited if you retire between the ages of 55 and 65 prior to the lapse of the restrictions; provided, however, that the Committee may in its sole discretion determine that a pro rata number of shares shall be retained by you and become freely transferable if and when the performance of KeyCorp's average daily stock price meets the requirements of this Agreement but that the remainder of the shares shall immediately be forfeited upon your retirement, and if the restrictions do not lapse as a result of performance of KeyCorp's average daily stock price, the pro rata number 2 of Performance Accelerated Restricted Shares retained by you shall be forfeited on December 31, 2003. 8. For purposes of this Agreement, the pro rata number of shares of Restricted Stock granted to you shall be based on a fraction the numerator of which is the number of months beginning in January 2002 that are completed prior to your change of status and the denominator of which is 24. 9. The Restricted Stock shall be immediately forfeited if your employment with KeyCorp terminates prior to the date of the lapse of the restrictions as set forth earlier in this Agreement unless your employment terminates because of death, Disability, or retirement (in which case the specific provisions set forth earlier in this Agreement shall apply). 10. The Restricted Stock upon which the restrictions have lapsed nevertheless may not be sold or otherwise transferred until and unless you meet KeyCorp's Stock Ownership Guidelines or terminate your employment with KeyCorp; provided, however, that notwithstanding the foregoing you shall be permitted to sell the number of shares necessary to satisfy any withholding tax obligation that may arise in connection with the lapse of any restriction on the Restricted Stock. 11. If the lapse of the restrictions on the Restricted Stock would result in compensation to you that if earned would not be deductible by KeyCorp by reason of the disallowance rules of Section 162(m) of the Internal Revenue Code but would be deductible if deferred until a later year, then the Committee in its sole discretion may require that all or a portion of the Restricted Stock shall be exchanged for an award of equal value which shall be deferred into and remain in the KeyCorp Deferred Compensation Plan ("Deferred Plan") Common Stock Account pursuant to the provisions of the Deferred Plan; provided that if the Committee shall not require a deferral pursuant to this paragraph, then any provision in any KeyCorp Plan, Employment Agreement, or similar agreement or arrangement requiring a deferral by you because of Section 162(m) shall be deemed waived by KeyCorp with respect to the Restricted Stock. 12. You may elect to exchange Restricted Stock for an award of equal value which shall be deferred into the Deferred Plan Common Stock Account; provided, however, that such election shall be made at least one year prior to the lapse of the restrictions upon the Restricted Stock and provided further that the deferred award may not be transferred to another account in the Deferred Plan. 13. The Committee reserves the right to (at any time and from time to time) make adjustments in or alter the performance criteria (i.e., daily average stock price performance) set forth in this Agreement, in the Committee's sole discretion, to take into account changed circumstances which, in the Committee's judgment, make the performance criteria inapplicable, inappropriate, or otherwise undesirable. 3 Consistent with the provisions of the Plan, the determination by the Committee as to whether the performance criteria have been satisfied or should be adjusted or altered shall be final and conclusive. 14. If you are an officer for purposes of Section 16 of the Securities Exchange Act of 1934, you shall be permitted to satisfy, in whole or in part, any withholding tax obligation that may arise in connection with the lapse of any restriction on the Restricted Stock by delivering to KeyCorp in Common Shares an amount equal to the withholding tax obligation arising with respect to such lapse. 15. Notwithstanding any other provisions of this Agreement, if you engage in any "harmful activity" (as defined in Section 16 of the Plan) prior to or within six months after the termination of your employment with KeyCorp, then any and all shares of Restricted Stock which have vested on or after one year prior to termination of employment shall be immediately forfeited to KeyCorp and the sales price realized upon the sale of any such shares of Restricted Stock by you shall inure to and be payable to KeyCorp upon demand. 16. The provisions of Section 11 of the Plan entitled "Acceleration upon Change of Control" shall not apply to the Time Lapse Restricted Shares at any time and shall not apply to the Performance Accelerated Restricted Shares after December 31, 2003. January 17, 2002 ----------------------------- Thomas E. Helfrich Executive Vice President ACCEPTANCE The undersigned hereby acknowledges receipt of the Plan, agrees to be bound by the foregoing Agreement and agrees and consents to the terms, conditions, and provisions of the Agreement, Plan and the Award evidenced by this Agreement. ----------------------------- 4 EX-10.2 5 l95281aexv10w2.txt AWARD OF RESTRICTED STOCK Exhibit 10.2 KEYCORP AWARD OF RESTRICTED STOCK - --------------------- By action of the Compensation and Organization Committee ("Committee") of the Board of Directors of KeyCorp, taken pursuant to the KeyCorp Amended and Restated 1991 Equity Compensation Plan ("Plan") on January 17, 2002, you have been awarded __________ shares of Restricted Stock. (Unless otherwise indicated, the capitalized terms used herein shall have the same meaning as set forth in the Plan.) 1. One-half of the Restricted Stock ("the Time Lapse Restricted Shares") may not be sold, transferred, otherwise disposed of, pledged or otherwise hypothecated until the earlier of the following: a) December 31, 2004; or b) the date not more than two years on or after a Change of Control upon which your employment terminates under circumstances entitling you to receive severance benefits or salary continuation benefits under KeyCorp Separation Pay Plan or under any employment or change of control or similar arrangement or agreement. 2. The remaining one-half of the Restricted Stock ("the Performance Accelerated Restricted Shares") may not be sold, transferred, otherwise disposed of, pledged, or otherwise hypothecated until the earliest of the following shall occur: a) December 31, 2008; b) the percentage increase in KeyCorp's average daily stock price for the years 2002 through 2004 exceeds the percentage increase in the average daily stock price of the median of the banks which comprise the Standard & Poor's 500 Banks Index (If at any time the Standard & Poor's 500 Banks Index ceases to be published or is altered in such manner as to make its use as a comparative reference inappropriate, as determined by the Committee in its sole discretion, then the Committee shall (i) select such other index as is then available that the Committee deems most appropriate to use as a substitute for the Standard & Poor's 500 Banks Index and (ii) decide 1 whether to use that other index to determine whether the condition of this paragraph has been met); or c) the first day on which a Change of Control occurs on or before December 31, 2004. 3. If you shall die or become Disabled prior to the lapse of the restrictions on the Time Lapse Restricted Shares, then a pro rata number of the Time Lapse Restricted Shares shall be retained by you or your estate and become freely transferable upon death or Disability but the remainder shall immediately be forfeited upon your death or Disability, as the case may be. 4. The restrictions shall lapse upon a pro rata number of the Time Lapse Restricted Shares when you have been continuously employed by KeyCorp and reach age 65 and each year thereafter that you remain employed by KeyCorp on your birthday the restrictions shall lapse on the lesser of an additional one-third of the Time Lapse Restricted Shares or the number of Time Lapse Restricted Shares remaining in your award. 5. The Time Lapse Restricted Shares shall immediately be forfeited if you retire between the ages of 55 and 65 prior to the lapse of the restrictions; provided, however, that the Committee may in its sole discretion determine that a pro rata number of the Time Lapse Restricted Shares shall be retained by you and become freely transferable upon retirement but that the remainder shall immediately be forfeited upon your retirement. 6. If you retire at age 65 or older, die or become Disabled prior to the lapse of the restrictions on the Performance Accelerated Restricted Shares and such shares thereafter cease to be restricted because of the performance of KeyCorp's average daily stock price, then a pro rata number of the Performance Accelerated Restricted Shares shall be retained by you or your estate and become freely transferable if and when the restrictions lapse because of the performance of KeyCorp's average daily stock price but the remainder shall immediately be forfeited upon your retirement, death, or Disability, as the case may be, and if the restrictions do not lapse as a result of performance of KeyCorp's average daily stock price, the pro rata number of Performance Accelerated Restricted Shares retained by you or your estate shall be forfeited on December 31, 2004. 7. The Performance Accelerated Restricted Shares shall be forfeited if you retire between the ages of 55 and 65 prior to the lapse of the restrictions; provided, however, that the Committee may in its sole discretion determine that a pro rata number of shares shall be retained by you and become freely transferable if and when the performance of KeyCorp's average daily stock price meets the requirements of this Agreement but that the remainder of the shares shall immediately be forfeited upon your retirement, and if the restrictions do not lapse as a result of performance of KeyCorp's average daily stock price, the pro rata number 2 of Performance Accelerated Restricted Shares retained by you shall be forfeited on December 31, 2004. 8. For purposes of this Agreement, the pro rata number of shares of Restricted Stock granted to you shall be based on a fraction the numerator of which is the number of months beginning in January 2002 that are completed prior to your change of status and the denominator of which is 36. 9. The Restricted Stock shall be immediately forfeited if your employment with KeyCorp terminates prior to the date of the lapse of the restrictions as set forth earlier in this Agreement unless your employment terminates because of death, Disability, or retirement (in which case the specific provisions set forth earlier in this Agreement shall apply). 10. The Restricted Stock upon which the restrictions have lapsed nevertheless may not be sold or otherwise transferred until and unless you meet KeyCorp's Stock Ownership Guidelines or terminate your employment with KeyCorp; provided, however, that notwithstanding the foregoing you shall be permitted to sell the number of shares necessary to satisfy any withholding tax obligation that may arise in connection with the lapse of any restriction on the Restricted Stock. 11. If the lapse of the restrictions on the Restricted Stock would result in compensation to you that if earned would not be deductible by KeyCorp by reason of the disallowance rules of Section 162(m) of the Internal Revenue Code but would be deductible if deferred until a later year, then the Committee in its sole discretion may require that all or a portion of the Restricted Stock shall be exchanged for an award of equal value which shall be deferred into and remain in the KeyCorp Deferred Compensation Plan ("Deferred Plan") Common Stock Account pursuant to the provisions of the Deferred Plan; provided that if the Committee shall not require a deferral pursuant to this paragraph, then any provision in any KeyCorp Plan, Employment Agreement, or similar agreement or arrangement requiring a deferral by you because of Section 162(m) shall be deemed waived by KeyCorp with respect to the Restricted Stock. 12. You may elect to exchange Restricted Stock for an award of equal value which shall be deferred into the Deferred Plan Common Stock Account; provided, however, that such election shall be made at least one year prior to the lapse of the restrictions upon the Restricted Stock and provided further that the deferred award may not be transferred to another account in the Deferred Plan. 13. The Committee reserves the right to (at any time and from time to time) make adjustments in or alter the performance criteria (i.e., daily average stock price performance) set forth in this Agreement, in the Committee's sole discretion, to take into account changed circumstances which, in the Committee's judgment, make the performance criteria inapplicable, inappropriate, or otherwise undesirable. 3 Consistent with the provisions of the Plan, the determination by the Committee as to whether the performance criteria have been satisfied or should be adjusted or altered shall be final and conclusive. 14. If you are an officer for purposes of Section 16 of the Securities Exchange Act of 1934, you shall be permitted to satisfy, in whole or in part, any withholding tax obligation that may arise in connection with the lapse of any restriction on the Restricted Stock by delivering to KeyCorp in Common Shares an amount equal to the withholding tax obligation arising with respect to such lapse. 15. Notwithstanding any other provisions of this Agreement, if you engage in any "harmful activity" (as defined in Section 16 of the Plan) prior to or within six months after the termination of your employment with KeyCorp, then any and all shares of Restricted Stock which have vested on or after one year prior to termination of employment shall be immediately forfeited to KeyCorp and the sales price realized upon the sale of any such shares of Restricted Stock by you shall inure to and be payable to KeyCorp upon demand. 16. The provisions of Section 11 of the Plan entitled "Acceleration upon Change of Control" shall not apply to the Time Lapse Restricted Shares at any time and shall not apply to the Performance Accelerated Restricted Shares after December 31, 2004. January 17, 2002 --------------------------- Thomas E. Helfrich Executive Vice President ACCEPTANCE The undersigned hereby acknowledges receipt of the Plan, agrees to be bound by the foregoing Agreement and agrees and consents to the terms, conditions, and provisions of the Agreement, Plan and the Award evidenced by this Agreement. 4 EX-10.3 6 l95281aexv10w3.txt AWARD OF RESTRICTED STOCK - HENRY MEYER Exhibit 10.3 KEYCORP AWARD OF RESTRICTED STOCK Henry L. Meyer III By action of the Compensation and Organization Committee ("Committee") of the Board of Directors of KeyCorp, taken pursuant to the KeyCorp Chief Executive Officer Restricted Stock Plan ("Plan") on January 17, 2002, you have been awarded __________ shares of Restricted Stock. (Unless otherwise indicated, the capitalized terms used herein shall have the same meaning as set forth in the Plan.) 1. _____ shares of the Restricted Stock ("the Time Lapse Restricted Shares") may not be sold, transferred, otherwise disposed of, pledged or otherwise hypothecated until the earlier of the following: a) December 31, 2003; or b) the date not more than two years on or after a Change of Control upon which your employment terminates under circumstances entitling you to receive severance benefits or salary continuation benefits under KeyCorp Separation Pay Plan or under any employment or change of control or similar arrangement or agreement. 2. The remaining _____ shares of the Restricted Stock ("the Performance Accelerated Restricted Shares") may not be sold, transferred, otherwise disposed of, pledged, or otherwise hypothecated until the earliest of the following shall occur: a) December 31, 2008; b) the percentage increase in KeyCorp's average daily stock price for the years 2002 through 2003 exceeds the percentage increase in the average daily stock price of the median of the banks which comprise the Standard & Poor's 500 Banks Index (If at any time the Standard & Poor's 500 Banks Index ceases to be published or is altered in such manner as to make its use as a comparative reference inappropriate, as determined by the Committee in its sole discretion, then the Committee shall (i) select such other index as is then available that the Committee deems most appropriate to use as a substitute for the Standard & Poor's 500 Banks Index and (ii) decide 1 whether to use that other index to determine whether the condition of this paragraph has been met); or c) the first day on which a Change of Control occurs on or before December 31, 2003. 3. If you shall die or become Disabled prior to the lapse of the restrictions on the Time Lapse Restricted Shares, then a pro rata number of the Time Lapse Restricted Shares shall be retained by you or your estate and become freely transferable upon death or Disability but the remainder shall immediately be forfeited upon your death or Disability, as the case may be. 4. The Time Lapse Restricted Shares shall immediately be forfeited if you retire between the ages of 55 and 65 prior to the lapse of the restrictions; provided, however, that the Committee may in its sole discretion determine that a pro rata number of the Time Lapse Restricted Shares shall be retained by you and become freely transferable upon retirement but that the remainder shall immediately be forfeited upon your retirement. 5. If you die or become Disabled prior to the lapse of the restrictions on the Performance Accelerated Restricted Shares and such shares thereafter cease to be restricted because of the performance of KeyCorp's average daily stock price, then a pro rata number of the Performance Accelerated Restricted Shares shall be retained by you or your estate and become freely transferable if and when the restrictions lapse because of the performance of KeyCorp's average daily stock price but the remainder shall immediately be forfeited upon your death or Disability, as the case may be, and if the restrictions do not lapse as a result of performance of KeyCorp's average daily stock price, the pro rata number of Performance Accelerated Restricted Shares retained by you or your estate shall be forfeited on December 31, 2003. 6. The Performance Accelerated Restricted Shares shall be forfeited if you retire between the ages of 55 and 65 prior to the lapse of the restrictions; provided, however, that the Committee may in its sole discretion determine that a pro rata number of shares shall be retained by you and become freely transferable if and when the performance of KeyCorp's average daily stock price meets the requirements of this Agreement but that the remainder of the shares shall immediately be forfeited upon your retirement, and if the restrictions do not lapse as a result of performance of KeyCorp's average daily stock price, the pro rata number of Performance Accelerated Restricted Shares retained by you shall be forfeited on December 31, 2003. 7. For purposes of this Agreement, the pro rata number of shares of Restricted Stock granted to you shall be based on a fraction the numerator of which is the number of months beginning in January 2002 that are completed prior to your change of status and the denominator of which is 24. 2 8. The Restricted Stock shall be immediately forfeited if your employment with KeyCorp terminates prior to the date of the lapse of the restrictions as set forth earlier in this Agreement unless your employment terminates because of death, Disability, or retirement (in which case the specific provisions set forth earlier in this Agreement shall apply). 9. The Restricted Stock upon which the restrictions have lapsed nevertheless may not be sold or otherwise transferred until and unless you meet KeyCorp's Stock Ownership Guidelines or terminate your employment with KeyCorp; provided, however, that notwithstanding the foregoing you shall be permitted to sell the number of shares necessary to satisfy any withholding tax obligation that may arise in connection with the lapse of any restriction on the Restricted Stock. 10. If the lapse of the restrictions on the Restricted Stock would result in compensation to you that if earned would not be deductible by KeyCorp by reason of the disallowance rules of Section 162(m) of the Internal Revenue Code but would be deductible if deferred until a later year, then the Committee in its sole discretion may require that all or a portion of the Restricted Stock shall be exchanged for an award of equal value which shall be deferred into and remain in the KeyCorp Deferred Compensation Plan ("Deferred Plan") Common Stock Account pursuant to the provisions of the Deferred Plan; provided that if the Committee shall not require a deferral pursuant to this paragraph, then any provision in any KeyCorp Plan, Employment Agreement, or similar agreement or arrangement requiring a deferral by you because of Section 162(m) shall be deemed waived by KeyCorp with respect to the Restricted Stock. 11. You may elect to exchange Restricted Stock for an award of equal value which shall be deferred into the Deferred Plan Common Stock Account; provided, however, that such election shall be made at least one year prior to the lapse of the restrictions upon the Restricted Stock and provided further that the deferred award may not be transferred to another account in the Deferred Plan. 12. The Committee reserves the right to (at any time and from time to time) make adjustments in or alter the performance criteria (i.e., daily average stock price performance) set forth in this Agreement, in the Committee's sole discretion, to take into account changed circumstances which, in the Committee's judgment, make the performance criteria inapplicable, inappropriate, or otherwise undesirable. Consistent with the provisions of the Plan, the determination by the Committee as to whether the performance criteria have been satisfied or should be adjusted or altered shall be final and conclusive. 13. You shall be permitted to satisfy, in whole or in part, any withholding tax obligation that may arise in connection with the lapse of any restriction on the Restricted Stock by delivering to KeyCorp in Common Shares an amount equal to the withholding tax obligation arising with respect to such lapse. 3 14. Notwithstanding any other provisions of this Agreement, if you engage in any "harmful activity" (as defined in Section 16 of the Plan) prior to or within six months after the termination of your employment with KeyCorp, then any and all shares of Restricted Stock which have vested on or after one year prior to termination of employment shall be immediately forfeited to KeyCorp and the sales price realized upon the sale of any such shares of Restricted Stock by you shall inure to and be payable to KeyCorp upon demand. 15. The provisions of Section 11 of the Plan entitled "Acceleration upon Change of Control" shall not apply to the Time Lapse Restricted Shares at any time and shall not apply to the Performance Accelerated Restricted Shares after December 31, 2003. January 17, 2002 ------------------------------- Thomas E. Helfrich Executive Vice President ACCEPTANCE The undersigned hereby agrees to be bound by the foregoing Agreement and agrees and consents to the terms, conditions, and provisions of the Agreement, Plan and the Award evidenced by this Agreement. ------------------------------- Henry L. Meyer III 4 EX-10.4 7 l95281aexv10w4.txt AWARD OF RESTRICTED STOCK - HENRY MEYER Exhibit 10.4 KEYCORP AWARD OF RESTRICTED STOCK Henry L. Meyer III By action of the Compensation and Organization Committee ("Committee") of the Board of Directors of KeyCorp, taken pursuant to the KeyCorp Chief Executive Officer Restricted Stock Plan ("Plan") on January 17, 2002, you have been awarded __________ shares of Restricted Stock. (Unless otherwise indicated, the capitalized terms used herein shall have the same meaning as set forth in the Plan.) 1. _____ shares of the Restricted Stock ("the Time Lapse Restricted Shares") may not be sold, transferred, otherwise disposed of, pledged or otherwise hypothecated until the earlier of the following: a) December 31, 2004; or b) the date not more than two years on or after a Change of Control upon which your employment terminates under circumstances entitling you to receive severance benefits or salary continuation benefits under KeyCorp Separation Pay Plan or under any employment or change of control or similar arrangement or agreement. 2. The remaining _____ shares of the Restricted Stock ("the Performance Accelerated Restricted Shares") may not be sold, transferred, otherwise disposed of, pledged, or otherwise hypothecated until the earliest of the following shall occur: a) December 31, 2008; b) the percentage increase in KeyCorp's average daily stock price for the years 2002 through 2004 exceeds the percentage increase in the average daily stock price of the median of the banks which comprise the Standard & Poor's 500 Banks Index (If at any time the Standard & Poor's 500 Banks Index ceases to be published or is altered in such manner as to make its use as a comparative reference inappropriate, as determined by the Committee in its sole discretion, then the Committee shall (i) select such other index as is then available that the Committee deems most appropriate to use as a substitute for the Standard & Poor's 500 Banks Index and (ii) decide 1 whether to use that other index to determine whether the condition of this paragraph has been met); or c) the first day on which a Change of Control occurs on or before December 31, 2004. 3. If you shall die or become Disabled prior to the lapse of the restrictions on the Time Lapse Restricted Shares, then a pro rata number of the Time Lapse Restricted Shares shall be retained by you or your estate and become freely transferable upon death or Disability but the remainder shall immediately be forfeited upon your death or Disability, as the case may be. 4. The Time Lapse Restricted Shares shall immediately be forfeited if you retire between the ages of 55 and 65 prior to the lapse of the restrictions; provided, however, that the Committee may in its sole discretion determine that a pro rata number of the Time Lapse Restricted Shares shall be retained by you and become freely transferable upon retirement but that the remainder shall immediately be forfeited upon your retirement. 5. If you die or become Disabled prior to the lapse of the restrictions on the Performance Accelerated Restricted Shares and such shares thereafter cease to be restricted because of the performance of KeyCorp's average daily stock price, then a pro rata number of the Performance Accelerated Restricted Shares shall be retained by you or your estate and become freely transferable if and when the restrictions lapse because of the performance of KeyCorp's average daily stock price but the remainder shall immediately be forfeited upon your death or Disability, as the case may be, and if the restrictions do not lapse as a result of performance of KeyCorp's average daily stock price, the pro rata number of Performance Accelerated Restricted Shares retained by you or your estate shall be forfeited on December 31, 2004. 6. The Performance Accelerated Restricted Shares shall be forfeited if you retire between the ages of 55 and 65 prior to the lapse of the restrictions; provided, however, that the Committee may in its sole discretion determine that a pro rata number of shares shall be retained by you and become freely transferable if and when the performance of KeyCorp's average daily stock price meets the requirements of this Agreement but that the remainder of the shares shall immediately be forfeited upon your retirement, and if the restrictions do not lapse as a result of performance of KeyCorp's average daily stock price, the pro rata number of Performance Accelerated Restricted Shares retained by you shall be forfeited on December 31, 2004. 7. For purposes of this Agreement, the pro rata number of shares of Restricted Stock granted to you shall be based on a fraction the numerator of which is the number of months beginning in January 2002 that are completed prior to your change of status and the denominator of which is 36. 2 8. The Restricted Stock shall be immediately forfeited if your employment with KeyCorp terminates prior to the date of the lapse of the restrictions as set forth earlier in this Agreement unless your employment terminates because of death, Disability, or retirement (in which case the specific provisions set forth earlier in this Agreement shall apply). 9. The Restricted Stock upon which the restrictions have lapsed nevertheless may not be sold or otherwise transferred until and unless you meet KeyCorp's Stock Ownership Guidelines or terminate your employment with KeyCorp; provided, however, that notwithstanding the foregoing you shall be permitted to sell the number of shares necessary to satisfy any withholding tax obligation that may arise in connection with the lapse of any restriction on the Restricted Stock. 10. If the lapse of the restrictions on the Restricted Stock would result in compensation to you that if earned would not be deductible by KeyCorp by reason of the disallowance rules of Section 162(m) of the Internal Revenue Code but would be deductible if deferred until a later year, then the Committee in its sole discretion may require that all or a portion of the Restricted Stock shall be exchanged for an award of equal value which shall be deferred into and remain in the KeyCorp Deferred Compensation Plan ("Deferred Plan") Common Stock Account pursuant to the provisions of the Deferred Plan; provided that if the Committee shall not require a deferral pursuant to this paragraph, then any provision in any KeyCorp Plan, Employment Agreement, or similar agreement or arrangement requiring a deferral by you because of Section 162(m) shall be deemed waived by KeyCorp with respect to the Restricted Stock. 11. You may elect to exchange Restricted Stock for an award of equal value which shall be deferred into the Deferred Plan Common Stock Account; provided, however, that such election shall be made at least one year prior to the lapse of the restrictions upon the Restricted Stock and provided further that the deferred award may not be transferred to another account in the Deferred Plan. 12. The Committee reserves the right to (at any time and from time to time) make adjustments in or alter the performance criteria (i.e., daily average stock price performance) set forth in this Agreement, in the Committee's sole discretion, to take into account changed circumstances which, in the Committee's judgment, make the performance criteria inapplicable, inappropriate, or otherwise undesirable. Consistent with the provisions of the Plan, the determination by the Committee as to whether the performance criteria have been satisfied or should be adjusted or altered shall be final and conclusive. 13. You shall be permitted to satisfy, in whole or in part, any withholding tax obligation that may arise in connection with the lapse of any restriction on the Restricted Stock by delivering to KeyCorp in Common Shares an amount equal to the withholding tax obligation arising with respect to such lapse. 3 14. Notwithstanding any other provisions of this Agreement, if you engage in any "harmful activity" (as defined in Section 16 of the Plan) prior to or within six months after the termination of your employment with KeyCorp, then any and all shares of Restricted Stock which have vested on or after one year prior to termination of employment shall be immediately forfeited to KeyCorp and the sales price realized upon the sale of any such shares of Restricted Stock by you shall inure to and be payable to KeyCorp upon demand. 15. The provisions of Section 11 of the Plan entitled "Acceleration upon Change of Control" shall not apply to the Time Lapse Restricted Shares at any time and shall not apply to the Performance Accelerated Restricted Shares after December 31, 2004. January 17, 2002 --------------------------------- Thomas E. Helfrich Executive Vice President ACCEPTANCE The undersigned hereby agrees to be bound by the foregoing Agreement and agrees and consents to the terms, conditions, and provisions of the Agreement, Plan and the Award evidenced by this Agreement. --------------------------------- Henry L. Meyer III 4 EX-10.5 8 l95281aexv10w5.txt AGREEMENT Exhibit 10.5 AGREEMENT THIS AGREEMENT ("Agreement") is made as of the 17th day of January, 2002, between KEYCORP, an Ohio corporation ("Key"), and _______________________ (the "Executive"). Key is entering into this Agreement in recognition of the importance of the Executive's services to the continuity of management of Key and based upon its determination that it will be in the best interests of Key and its Subsidiaries to encourage the Executive's continued attention and dedication to the Executive's duties in the potentially disruptive circumstances of a possible Change of Control of Key. (As used in this Agreement, the terms "Subsidiaries" and "Change of Control" and certain other capitalized terms have the meanings ascribed to them in Section 8, at the end of this Agreement.) Key and the Executive agree, effective as of the date first set forth above, as follows: 1. Basic Severance Benefits. The benefits described in Sections 1.1, 1.2, and 1.3 below are subject to the limitations set forth in Sections 5.1 (which requires an election among applicable agreements providing severance benefits if more than one such agreement would apply in the particular circumstances of the termination of the Executive's employment and stipulates that any payments received under this Agreement are in lieu of other claims or rights), 5.2 (regarding withholding), and 5.3 (requiring the execution of a waiver and release by the Executive). 1.1 If Employment is Terminated Without Cause, etc., Within Two Years of a Change of Control. If, within two years following the occurrence of a Change of Control, the Executive's employment with Key and its Subsidiaries is terminated by Key or its Subsidiary for any reason other than Cause, Disability, or death or by the Executive after a Reduction of Compensation or a Mandatory Relocation has occurred: (a) Lump Sum Payment. Key shall pay to the Executive, within 30 business days after the Termination Date, a lump sum severance benefit equal to three times the sum of (i) one year's Base Salary (at the highest rate in effect at any time during the one year period ending on the date of the Change of Control) plus (ii) Average Annual Incentive Compensation; and (b) Retirement and Savings Plans. Effective as of the Termination Date, the Executive's interest in all Relevant Plans shall become fully vested and nonforfeitable and the Executive's right to and interest in all subsequent accruals provided for in the remainder of this Section 1.1(b) under any of the Relevant Plans shall also be fully vested and nonforfeitable. For the period beginning on the day after the Termination Date and ending on the third anniversary of the Termination Date (the "Section 1.1 Benefit Period"), Key shall cause the Executive to continue to be covered by and to participate in all of the Relevant Plans in the same manner and to the same extent as if the Executive continued in the full-time employ of Key throughout the Section 1.1 Benefit Period, except that, if Key determines that such coverage or participation in any one or more of the Relevant Plans is Impermissible, the Executive shall continue to be covered by and participate as aforesaid in all of the Relevant Plans as to which such coverage or participation is not Impermissible and, with respect to each Relevant Plan as to which such continued coverage or participation is Impermissible, Section 1.4(b) shall apply. With respect to each Discontinued Plan, Section 1.4(c) shall apply. 1.2 If Employment is Terminated by Executive for Good Reason During a Window Period. Except as provided in the last sentence of this Section 1.2, if the Executive's employment with Key and its Subsidiaries is terminated by the Executive for Good Reason during a Window Period: (a) Lump Sum Payment. Key shall pay to the Executive, within 30 business days after the Termination Date, a lump sum severance benefit equal to one and one half times the sum of (i) one year's Base Salary (at the highest rate in effect at any time during the one year period ending on the date of the Change of Control) plus (ii) Average Annual Incentive Compensation, and (b) Retirement and Savings Plans. Effective as of the Termination Date, the Executive's interest in all Relevant Plans shall become fully vested and nonforfeitable and the Executive's right to and interest in all subsequent accruals provided for in the remainder of this Section 1.2(b) under any of the Relevant Plans shall also be fully vested and nonforfeitable. For the period beginning on the day after the Termination Date and ending eighteen months, to the day, after the Termination Date (the "Section 1.2 Benefit Period"), Key shall cause the Executive to continue to be covered by and to participate in all of the Relevant Plans in the same manner and to the same extent as if the Executive continued in the full-time employ of Key throughout the Section 1.2 Benefit Period, except that, if Key determines that such coverage or participation in any one or more of the Relevant Plans is Impermissible, the Executive shall continue to be covered by and participate as aforesaid in all of the Relevant Plans as to which such coverage or participation is not Impermissible and, with respect to each Relevant Plan as to which such continued coverage or participation is Impermissible, Section 1.4(b) shall apply. With respect to each Discontinued Plan, Section 1.4(c) shall apply. This Section 1.2 shall not apply if, at the Termination Date, (x) there has been either any Reduction of Compensation or any Mandatory Relocation (in which event Section 1.1 would apply to the termination) or (y) Key or any Subsidiary has Cause to terminate the Executive's employment (in which case no lump sum severance or retirement benefits would be payable or provided under either of Sections 1.1 or 1.2). 1.3 Payment of Cost of COBRA Health Benefits. If the Executive becomes entitled to payment of a lump sum severance benefit under either of Sections 1.1 or 1.2 of this Agreement and the Executive elects to continue to receive health benefits pursuant to an election that Key or any Subsidiary is required to provide to the Executive in order to comply with Section 4980B(f) of the Internal Revenue Code (commonly referred to as "COBRA continuation coverage") during the period specified in Section 4980B(f) (the "COBRA continuation period"), Key will pay the cost of continuing those benefits from the Termination Date through the first to occur of (a) the end of the COBRA continuation period or (b) the date on which the Executive becomes employed (other than on a part-time or temporary basis) by any other person or entity. 2 1.4 Provisions Applicable to Continued Retirement and Savings Plan Participation. (a) If the Executive becomes entitled to payment of a lump sum severance benefit under either of Section 1.1 or Section 1.2, the rules set forth in the remainder of this Section 1.4(a) shall be applicable for purposes of all Relevant Plans: (i) the entire Section 1.1 Benefit Period or Section 1.2 Benefit Period (each, a "Benefit Period"), as the case may be, shall be included in determining the Executive's years of service, (ii) amounts received by the Executive under clause (a)(i) of either of Section 1.1 or Section 1.2, as the case may be, shall be deemed to be base salary received by the Executive ratably during the applicable Benefit Period, and (iii) amounts received by the Executive under clause (a)(ii) of either of Section 1.1 or Section 1.2, as the case may be, to the extent allocable to short term incentive compensation that was taken into account in determining Average Annual Incentive Compensation, shall be deemed to be short term incentive compensation received by the Executive ratably during the applicable Benefit Period. (b) If either Section 1.1(b) or Section 1.2(b) becomes applicable and at any time during the applicable Benefit Period, Key determines in good faith that continuing the Executive's coverage by and participation in any of the Relevant Plans during the applicable Benefit Period is Impermissible, the Executive shall not be covered by and participate in such affected plan or plans during the applicable Benefit Period, but Key shall provide to the Executive under this Agreement, as a supplemental retirement benefit, payments and benefits that put the Executive in the same position that the Executive would have been in had the Executive continued to be covered by and to participate in all such affected plans throughout the applicable Benefit Period (taking into account the rules set forth in Section 1.4(a) above) to the same extent as the Executive was a participant immediately before the Termination Date, with the supplemental payments and benefits under this sentence being payable to the Executive (or, if applicable, to the Executive's spouse, estate, or designated beneficiary) at the same time and with the same payment options as would be applicable under the affected plan or plans in question. (c) If either Section 1.1(b) or Section 1.2(b) becomes applicable and any of the Relevant Plans are Discontinued Plans, as to each such Discontinued Plan, Key shall provide to the Executive under this Agreement, as a supplemental retirement benefit, payments and benefits that put the Executive in the same position that the Executive would have been in had the Discontinued Plan continued through the end of the applicable Benefit Period without having become a Discontinued Plan and had the Executive continued to be covered by and to participate in that Discontinued Plan throughout the applicable Benefit Period (taking into account the rules set forth in Section 1.4(a) above) to the same extent as the Executive was a participant immediately before the date of the Change of Control, with the supplemental payments and benefits under this sentence being payable to the Executive (or, if applicable, to the Executive's spouse, estate, or designated beneficiary) 3 at the same time and with the same payment options as would be applicable under the Discontinued Plan, provided however, that to the extent the Discontinued Plan has been substituted for by another Relevant Plan, the amount payable by Key under this Section 1.4(c) shall be offset by the amounts actually paid under that substitute plan. 2. Certain Compensation Guaranties During Two Years following a Change of Control. For so long as the Executive remains in the employ of Key or one of its Subsidiaries during the period beginning on the day after any Change of Control and continuing through the second anniversary of that Change of Control (the period of the Executive's employment during such two year period being the "Guaranteed Compensation Period"), the Executive shall be entitled to the Incentive Compensation Guaranty set forth in Section 2.1 and to the Option/SAR Guaranty set forth in Section 2.2. 2.1 Guaranteed Level of Incentive Compensation. Except as otherwise provided in Section 2.3, Key shall cause the Executive to receive, during the Guaranteed Compensation Period, as incentive compensation, an amount that, on an annualized basis, is at least equal to the Executive's Average Annual Incentive Compensation. The guaranty set forth in the immediately preceding sentence (the "Incentive Compensation Guaranty") establishes a minimum amount of incentive compensation that must be paid to the Executive with respect to the Executive's employment during the Guaranteed Compensation Period. Except as and to the extent otherwise permitted by any of the provisions of Section 2.3: (a) Key shall make payments to the Executive in cash that satisfy the Incentive Compensation Guaranty quarterly in arrears, within 30 days after the end of each calendar quarter for each quarter or portion thereof during the Guaranteed Compensation Period; (b) If the Executive's employment terminates for any reason other than Cause, Key shall pay all unpaid guaranteed incentive compensation with respect to the Guaranteed Compensation Period to the Executive in a lump sum by not later than 30 business days after the Termination Date; and (c) If the Executive's employment is terminated by Key for Cause, Key shall not be required to pay to the Executive any amount of incentive compensation on account of the Incentive Compensation Guaranty that was not required to have been paid before the Termination Date. 2.2 Guaranteed Participation in Stock Option and SAR Plans. During the Guaranteed Compensation Period, the Executive shall participate fully (and at a level at least substantially equivalent to that of comparable senior executives of Key) in each and every stock option and stock appreciation right plan in which similarly situated executives of Key and its Subsidiaries generally participate. The guaranty of full participation set forth in this Section 2.2 is hereinafter sometimes referred to as the "Option/SAR Guaranty." 2.3 Exceptions to and Alternative Means of Satisfying the Incentive Compensation Guaranty. For purposes of the exceptions and alternative means of satisfying the Incentive Compensation Guaranty that are set forth in this Section 2.3, the Incentive Compensation 4 Guaranty shall be deemed to be made up of two parts, the "Short Term Part" and the "Long Term Part," each of which shall bear the same proportion, respectively, to the entire Incentive Compensation Guaranty as Average Short Term Incentive Compensation and Average Long Term Incentive Compensation bear, respectively, to Average Annual Incentive Compensation. (a) Bona fide Short Term Incentive Compensation Plan Exception. If (i) Key maintains a bona fide short term incentive compensation plan that would satisfy the Short Term Part if the Executive received short term incentive compensation under that plan at the Executive's target level; (ii) Key, in administering that plan in good faith and without discriminating against the Executive, utilizes a performance factor that is intended to rate for the short term compensation cycle in question either the corporation's overall performance or the overall performance of the business unit in which the Executive works; (iii) that performance factor is uniformly applied (either in establishing an incentive compensation pool or against each participant's target) to all participants in the plan or to all participants in the plan that work in the business unit in which the Executive works, as the case may be; and (iv) the application of that factor reduces the short term incentive compensation payable under that plan to a level below the Executive's target level; then payment of the short term incentive compensation, if any, due to the Executive at the reduced level under that plan shall satisfy Key's obligation under the Short Term Part for that particular short term compensation cycle. (b) Annual Payment Exception. If Key maintains a bona fide short term incentive compensation plan that would satisfy the Short Term Part if the Executive received short term incentive compensation under that plan at the Executive's target level and that plan provides for payment of all amounts earned at regularly scheduled times not less frequently than once a year, Key may satisfy the Short Term Part by paying incentive compensation to the Executive under that plan (at not less than the Executive's target level or as reduced if permitted by 2.3(a) above) at those regularly scheduled times, except that if Executive's employment terminates for any reason other than Cause, Key shall make payments under that plan, pro rated to include all periods within the Compensation Guaranty Period as to which the Executive has not yet received incentive compensation under that plan, within 30 business days after the Termination Date. (c) Issuance of Restricted Stock Alternative. As an alternative to paying Executive cash to satisfy the Long Term Part, Key may continue to make LTIC Restricted Stock Grants to the Executive each year during the Guaranteed Compensation Period that: (i) are made during the same calendar quarter of the year as the calendar quarter during which Key made such grants in the year immediately preceding the Change Year (but if Key made such grants during more than one calendar quarter in the year immediately preceding the Change Year, then the new grant shall be made during the same calendar quarter of the year as the calendar quarter during which Key made grants to the highest number of officers in the year immediately preceding the Change Year); 5 (ii) have a Fair Market Value that on an annual basis is at least equal to the Executive's Average Long Term Incentive Compensation; (iii) provide for time lapsed vesting of the restricted stock subject to the grant so that the entire grant will be fully vested not later than the third anniversary of the date of grant if the Executive continues to be employed through that date; and (iv) have the further provision that, upon any termination of the Executive's employment other than a termination for Cause (including, without limitation, any termination by reason of death, disability, voluntary or involuntary retirement, or resignation), if, as of the Termination Date, less than a proportionate part of the Common Shares subject to the LTIC Restricted Stock Grant granted to the Executive during the Guaranteed Compensation Period has vested, then an additional portion of those Common Shares shall vest immediately on the Termination Date so that, in the aggregate, a proportionate part has vested as of the Termination Date. For these purposes, "a proportionate part" means the full number of Common Shares in the LTIC Restricted Stock Grant multiplied by a fraction, the numerator of which is the number of days between (x) January 1 of the calendar year in which the LTIC Restricted Stock Grant was made and (y) the last day of the Guaranteed Compensation Period, inclusive, and the denominator of which is 1095 (i.e., 365 times three). If Key makes LTIC Restricted Stock Grants as provided in this 2.3(c) Key will have satisfied the Long Term Part. 3. Other Benefits. 3.1 Reimbursement of Certain Expenses After a Change of Control. (a) From and after a Change of Control, Key shall pay, as incurred, all expenses of the Executive, including the reasonable fees of counsel engaged by the Executive, of defending any action brought to have this Agreement declared invalid or unenforceable. (b) From and after a Change of Control, Key shall pay, as incurred, all expenses of the Executive, including the reasonable fees of counsel engaged by the Executive, of prosecuting any action to compel Key to comply with the terms of this Agreement upon receipt from Executive of an undertaking to repay Key for such expenses if, and only if, it is ultimately determined by a court of competent jurisdiction that the Executive had no reasonable grounds for bringing that action (which determination need not be made simply because the Executive fails to succeed in the action). (c) From and after a Change of Control, expenses (including attorney's fees) incurred by the Executive in defending any action, suit, or proceeding commenced or threatened (whether before or after the Change of Control) against the Executive for any action or failure to act as an employee, officer, or director of Key or any Subsidiary shall be paid by Key, as they are incurred, in advance of final disposition of the action, suit, or proceeding upon receipt of an undertaking by or on behalf of the Executive in which the Executive agrees to reasonably cooperate with Key or the Subsidiary, as the case may be, 6 concerning the action, suit, or proceeding, and (i) if the action, suit, or proceeding is commenced or threatened against the Executive for any action or failure to act as a director, to repay the amount if it is proved by clear and convincing evidence in a court of competent jurisdiction that the Executive's action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to Key or a Subsidiary or undertaken with reckless disregard for the best interests of Key or a Subsidiary, or (ii) if the action, suit, or proceeding is commenced or threatened against the Executive for any action or failure to act as an officer or employee, to repay the amount if it is ultimately determined that the Executive is not entitled to be indemnified. The obligation of Key to advance expenses provided for in this Section 3.1(c) shall not be deemed exclusive of any other rights to which the Executive may be entitled under the articles of incorporation or regulations of Key or of any Subsidiary, any agreement, vote of shareholders or disinterested directors, or otherwise. 3.2 Indemnification. From and after a Change of Control, Key shall indemnify the Executive, to the full extent permitted or authorized by the Ohio General Corporation Law as it may from time to time be amended, if the Executive is (whether before or after the Change of Control) made or threatened to be made a party to any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, or investigative, by reason of the fact that the Executive is or was a director, officer, or employee of Key or any Subsidiary, or is or was serving at the request of Key or any Subsidiary as a director, trustee, officer, or employee of a bank, corporation, partnership, joint venture, trust, or other enterprise. The indemnification provided by this Section 3.2 shall not be deemed exclusive of any other rights to which the Executive may be entitled under the articles of incorporation or the regulations of Key or of any Subsidiary, or any agreement, vote of shareholders or disinterested directors, or otherwise, both as to action in the Executive's official capacity and as to action in another capacity while holding such office, and shall continue as to the Executive after the Executive has ceased to be a director, trustee, officer, or employee and shall inure to the benefit of the heirs, executors, and administrators of the Executive. 3.3 Disability. If, after a Change of Control and prior to the Termination Date, the Executive is unable to perform services for Key or any Subsidiary for any period by reason of disability of the Executive, Key will pay and provide to the Executive all compensation and benefits to which the Executive would have been entitled had the Executive continued to be actively employed by Key or any Subsidiary through the earliest of the following dates: (a) the first date on which the Executive is no longer so disabled to such an extent that the Executive is unable to perform services for Key or any Subsidiary (whereupon the Executive shall be restored to his duties and this Agreement shall apply in accordance with its terms), (b) the date on which the Executive becomes eligible for payment of long term disability benefits under a long term disability plan generally applicable to executives of Key or a Subsidiary, (c) the date on which Key has paid and provided 24 months of compensation and benefits to the Executive during the Executive's disability, or (d) the date of the Executive's death. 3.4 Gross-Up of Payments Deemed to be Excess Parachute Payments. 7 (a) Key and the Executive acknowledge that, following a Change of Control, one or more payments or distributions to be made by Key to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement, under some other plan, agreement, or arrangement, or otherwise) (a "Payment") may be determined to be an "excess parachute payment" that is not deductible by Key for federal income tax purposes and with respect to which the Executive will be subject to an excise tax because of Sections 280G and 4999, respectively, of the Internal Revenue Code (hereinafter referred to respectively as "Section 280G" and "Section 4999"). If the Executive's employment is terminated after a Change of Control occurs, the Accounting Firm, which, subject to any inconsistent position asserted by the Internal Revenue Service, shall make all determinations required to be made under this Section 3.4, shall determine whether any Payment would be an excess parachute payment and shall communicate its determination, together with detailed supporting calculations, to Key and to the Executive within 30 days after the Termination Date or such earlier time as is requested by Key. Key and the Executive shall cooperate with each other and the Accounting Firm and shall provide necessary information so that the Accounting Firm may make all such determinations. Key shall pay all of the fees of the Accounting Firm for services performed by the Accounting Firm as contemplated in this Section 3.4. (b) If the Accounting Firm determines that any Payment gives rise, directly or indirectly, to liability on the part of the Executive for excise tax under Section 4999 (and/or any penalties and/or interest with respect to any such excise tax), Key shall make additional cash payments to the Executive, from time to time and at the same time as any Payment constituting an excess parachute payment is paid or provided to the Executive, in such amounts as are necessary to put the Executive in the same position, after payment of all federal, state, and local taxes (whether income taxes, excise taxes under Section 4999 or otherwise, or other taxes) and any and all penalties and interest with respect to any such excise tax, as the Executive would have been in after payment of all federal, state, and local income taxes if the Payments had not given rise to an excise tax under Section 4999 and no such penalties or interest had been imposed. (c) If the Internal Revenue Service determines that any Payment gives rise, directly or indirectly, to liability on the part of the Executive for excise tax under Section 4999 (and/or any penalties and/or interest with respect to any such excise tax) in excess of the amount, if any, previously determined by the Accounting Firm, Key shall make further additional cash payments to the Executive not later than the due date of any payment indicated by the Internal Revenue Service with respect to these matters, in such amounts as are necessary to put the Executive in the same position, after payment of all federal, state, and local taxes (whether income taxes, excise taxes under Section 4999 or otherwise, or other taxes) and any and all penalties and interest with respect to any such excise tax, as the Executive would have been in after payment of all federal, state, and local income taxes if the Payments had not given rise to an excise tax under Section 4999 and no such penalties or interest had been imposed. (d) If Key desires to contest any determination by the Internal Revenue Service with respect to the amount of excise tax under Section 4999, the Executive shall, upon receipt 8 from Key of an unconditional written undertaking to indemnify and hold the Executive harmless (on an after tax basis) from any and all adverse consequences that might arise from the contesting of that determination, cooperate with Key in that contest at Key's sole expense. Nothing in this clause (d) shall require the Executive to incur any expense other than expenses with respect to which Key has paid to the Executive sufficient sums so that after the payment of the expense by the Executive and taking into account the payment by Key with respect to that expense and any and all taxes that may be imposed upon the Executive as a result of the Executive's receipt of that payment, the net effect is no cost to the Executive. Nothing in this clause (d) shall require the Executive to extend the statute of limitations with respect to any item or issue in the Executive's tax returns other than, exclusively, the excise tax under Section 4999. If, as the result of the contest of any assertion by the Internal Revenue Service with respect to excise tax under Section 4999, the Executive receives a refund of a Section 4999 excise tax previously paid and/or any interest with respect thereto, the Executive shall promptly pay to Key such amount as will leave the Executive, net of the repayment and all tax effects, in the same position, after all taxes and interest, that the Executive would have been in if the refunded excise tax had never been paid. 4. No Set-Off; No Obligation to Seek Other Employment or to Otherwise Mitigate Damages; No Effect Upon Other Plans. Key's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense, or other claim whatsoever that Key or any of its Subsidiaries may have against the Executive. The Executive shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise. Except as provided in Section 1.3, the amount of any payment provided for under this Agreement shall not be reduced by any compensation or benefits earned by the Executive as the result of employment by another employer or otherwise after the termination of the Executive's employment. Neither the provisions of this Agreement, nor the execution of the waiver and release referred to in Section 5.3 below, nor the making of any payment provided for hereunder shall reduce any amounts otherwise payable, or in any way diminish the Executive's rights, under any incentive compensation plan, stock option or stock appreciation rights plan, deferred compensation plan, restricted stock plan or agreement, retirement or supplemental retirement plan, stock purchase and savings plan, disability or insurance plan, or other similar contract, plan, or arrangement of Key or any Subsidiary, all of which will continue to be governed by their respective terms. 5. Certain Limitations on Benefits. 5.1 Election of Benefits Required; Payments in Lieu of Other Claims or Rights. If (a) the Executive is a party to either or both of an employment agreement (which includes any letter agreement regarding Executive's employment with Key or any Subsidiary) or severance agreement with Key or any Subsidiary (singularly or collectively, the "Prior Agreement"), and (b) the Executive's employment is terminated under circumstances giving rise to a right on the part of the Executive to receive continuing compensation, separation pay, or other severance benefits under the Prior Agreement and under this Agreement, the Executive shall have the right to elect to have either the Prior Agreement (if and only to the extent the Prior Agreement is applicable) or this Agreement (if and only to the extent this Agreement is 9 applicable), but not both, apply to the termination. If this Section 5.1 applies: (x) Key shall not make any payments arising out of the termination of the Executive's employment, either under the Prior Agreement or under this Agreement, until after the Executive has delivered to Key a signed notice of election to receive payments under the Prior Agreement or under this Agreement, and (y) if the Executive elects to receive payments under the Prior Agreement, the provisions of Sections 3.1, 3.2, and 3.4 of this Agreement shall nevertheless continue to be applicable, but without duplication of payments. If the Executive receives any payments under Section 1.1(a) or Section 1.2(a), as the case may be, of this Agreement as a result of the termination of the Executive's employment following a Change of Control, those payments shall be in lieu of any and all other claims or rights that the Executive may have for severance, separation, and/or salary continuation pay upon that termination of the Executive's employment. 5.2 Taxes; Withholding of Taxes. Without limiting either the right of Key or its Subsidiary to withhold taxes pursuant to this Section 5.2 or the obligation of Key to make gross-up payments pursuant to Section 3.4, the Executive shall be responsible for all income, excise, and other taxes (federal, state, city, or other) imposed on or incurred by the Executive as a result of receiving the payments provided in this Agreement, including, without limitation, the payments provided under Section 1 of this Agreement. Key or its Subsidiary may withhold from any amounts payable under this Agreement all federal, state, city, or other taxes as Key shall determine to be required pursuant to any law or government regulation or ruling. Without limiting the generality of the foregoing, Key or its Subsidiary may withhold from any amount payable under either of Sections 1.1 or 1.2 of this Agreement amounts sufficient to satisfy any tax withholding requirements that may arise out of any payment made to the Executive by Key or any Subsidiary under Section 1.3 of this Agreement. 5.3 Waiver and Release. Key may condition the payment of any amounts otherwise due under Section 1 of this Agreement upon (a) the execution by the Executive of a waiver and release in the form attached to this Agreement as Exhibit A, with blanks appropriately filled and, in the case of clause (e) contained therein, completed with the number of days that Key determines is required under applicable law, but in no event more than 45 days, and (b) the observation of such waiting periods, if any, before and after execution of the waiver and release by the Executive as are required by law, such as, for example, the waiting periods required for a waiver and release to be effective with respect to claims under the Age Discrimination in Employment Act, provided that Key delivers to the Executive such a waiver and release, appropriately completed, within seven days of the date on which the Executive's employment is terminated. 6. Term of this Agreement. This Agreement shall be effective upon the date first above written and shall thereafter apply to any Change of Control occurring on or before December 31, 2003. Unless this Agreement is terminated earlier pursuant to Section 6.1, on December 31, 2003 and on December 31 of each succeeding year thereafter (a "Renewal Date"), the term of this Agreement shall be automatically extended for an additional year unless either party has given notice to the other, at least one year in advance of that Renewal Date, that the Agreement shall not apply to any Change of Control occurring after that Renewal Date. 10 6.1 Termination of Agreement Upon Termination of Employment Before a Change of Control. This Agreement shall automatically terminate and cease to be of any further effect on the first date occurring before a Change of Control on which the Executive is no longer employed by Key or any Subsidiary, except that, for purposes of this Agreement, any termination of employment of the Executive that is effected before and in contemplation of a Change of Control that occurs after the date of the termination shall be deemed to be a termination of the Executive's employment as of immediately after that Change of Control and this Agreement shall be deemed to be in effect immediately after that Change of Control. 6.2 No Termination of Agreement after a Change of Control. If a Change of Control occurs while this Agreement remains in effect, this Agreement shall remain effective indefinitely thereafter with respect to any and all consequences flowing from that Change of Control under the terms of this Agreement. However, after a Change of Control, Key may terminate this Agreement with respect to any further Change of Control that might occur after a future Renewal Date by giving notice, at least one year in advance of that future Renewal Date, as contemplated above in this Section 6, that the Agreement shall not apply to any Change of Control occurring after that future Renewal Date. 7. Miscellaneous. 7.1 Successor to Key. Key shall not consolidate with or merge into any other corporation, or transfer all or substantially all of its assets to another corporation or bank, unless such other corporation or bank shall assume this Agreement in a signed writing and deliver a copy thereof to the Executive. Upon such assumption the successor corporation or bank shall become obligated to perform the obligations of Key under this Agreement and the term "Key" as used in this Agreement shall be deemed to refer to such successor corporation or bank. 7.2 Notices. For purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, and addressed, in the case of notices to Key or a Subsidiary, as follows: KeyCorp 127 Public Square Cleveland, Ohio 44114 Attention: Secretary and, in the case of notices to the Executive, properly addressed to the Executive at the Executive's most recent home address as shown on the records of Key or its Subsidiary, or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 7.3 Employment Rights. Nothing expressed or implied in this Agreement shall create any right or duty on the part of Key or the Executive to have the Executive continue as an officer of Key or a Subsidiary or to remain in the employment of Key or a Subsidiary. 11 7.4 Administration. Key shall be responsible for the general administration of this Agreement and for making payments under this Agreement. All fees and expenses billed by the Accounting Firm for services contemplated under this Agreement shall be the responsibility of Key. 7.5 Source of Payments. Any payment specified in this Agreement to be made by Key may be made, at the election of Key, directly by Key or through any Subsidiary of Key. All payments under this Agreement shall be made solely from the general assets of Key or one of its Subsidiaries (or from a grantor trust, if any, established by Key for purposes of making payments under this Agreement and other similar agreements), and the Executive shall have the rights of an unsecured general creditor of Key with respect thereto. 7.6 Claims Review Procedure. Whenever Key decides for whatever reason to deny, whether in whole or in part, a claim for benefits under this Agreement by the Executive, Key shall transmit a written notice of its decision to the Executive, which notice shall be written in a manner calculated to be understood by the Executive and shall contain a statement of the specific reasons for the denial of the claim and a statement advising the Executive that, within 60 days of the date on which the Executive receives such notice, the Executive may obtain review of the decision of Key in accordance with the procedures hereinafter set forth. Within such 60-day period, the Executive or the Executive's authorized representative may request that the claim denial be reviewed by filing with Key a written request therefor, which request shall contain the following information: (a) the date on which the request was filed with Key, (b) the specific portions of the denial of the Executive's claim that the Executive requests Key to review, and (c) any written material that the Executive desires Key to examine. Within 30 days of the date specified in clause (a) of this Section 7.6, Key shall conduct a full and fair review of its decision to deny the Executive's claim for benefits and deliver to the Executive its written decision on review, written in a manner calculated to be understood by the Executive, specifying the reasons and the Agreement provisions upon which its decision is based. Nothing in this Section 7.6 shall be construed as limiting or restricting the Executive's right to institute legal proceedings in a court of competent jurisdiction to enforce this Agreement after complying with the procedures set forth in this Section 7.6 or as limiting or restricting the scope of the court's review (which review shall be de novo); provided, further, that the failure of the Executive to comply with the procedures set forth in this Section 7.6 shall not bar or prohibit the subsequent compliance by the Executive with those procedures and thereafter the Executive shall have the right to institute legal proceedings to enforce this Agreement. 7.7 Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement which shall remain in full force and effect. 12 7.8 Modification, Waiver, Etc. No provision of this Agreement may be modified, waived, or discharged unless such waiver, modification, or discharge is agreed to in a writing signed by the Executive and Key. No waiver by either party hereto at any time of any breach by the other party of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same time or at any prior or subsequent time. No agreement or representation, oral or otherwise, express or implied, with respect to the subject matter hereof has been made by either party that is not set forth expressly in this Agreement. This Agreement shall inure to the benefit of and be enforceable by the Executive's personal representatives, executors, administrators, successors, heirs, and designees. This Agreement shall be governed by and construed in accordance with the laws of the State of Ohio. 7.9 Savings Clause. If any payments otherwise payable to the Executive under this Agreement are prohibited or limited by any statute or regulation in effect at the time the payments would otherwise be payable, including, without limitation, any regulation issued by the Federal Deposit Insurance Corporation (the "FDIC") that limits executive change of control payments that can be made by an FDIC insured institution or its holding company if the institution is financially troubled (any such limiting statute or regulation a "Limiting Rule"): (a) Key will use its best efforts to obtain the consent of the appropriate governmental agency (whether the FDIC or any other agency) to the payment by Key to the Executive of the maximum amount that is permitted (up to the amounts that would be due to the Executive absent the Limiting Rule); and (b) the Executive will be entitled to elect to have apply, and therefore to receive benefits directly under, either (i) this Agreement (as limited by the Limiting Rule) or (ii) any generally applicable Key severance, separation pay, and/or salary continuation plan that may be in effect at the time of the Executive's termination. Following any such election, the Executive will be entitled to receive benefits under the agreement or plan elected only if and to the extent the agreement or plan is applicable and subject to its specific terms. 7.10 Agreement Supersedes Similar Agreement Previously Entered Into. This Agreement supersedes a similar agreement originally entered into between Key and the Executive as of ___________________, and that agreement (as amended, if it has been heretofore amended) is no longer of any force or effect. 8. Definitions. 8.1 Accounting Firm. The term "Accounting Firm" means the independent auditors of Key for the fiscal year preceding the year in which the Change of Control occurred and such firm's successor or successors; provided, however, if such firm is unable or unwilling to serve and perform in the capacity contemplated by this Agreement, Key shall select another national accounting firm of recognized standing to serve and perform in that capacity under this Agreement, except that such other accounting firm shall not be the then independent 13 auditors for Key or any of its affiliates (as defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended (the "1934 Act")). 8.2 Average Annual Incentive Compensation. The term "Average Annual Incentive Compensation" means the sum of Average Short Term Incentive Compensation, as defined in Section 8.4 below, and Average Long Term Incentive Compensation, as defined in Section 8.3 below. For purposes of this Agreement: (a) except as provided in (c) below, incentive compensation means any cash based incentive compensation, including bonuses and is calculated before any reduction on account of deferrals; (b) notwithstanding the fact that they are made in restricted stock rather than in cash, any LTIC Restricted Stock Grant shall be deemed to be long term incentive compensation; (c) special hiring bonuses paid or awarded to a newly hired executive in connection with that hiring or extraordinary bonuses to an incumbent executive, outside and beyond Key's regular incentive compensation program, such as special retention awards to induce an executive to stay with Key, shall not be treated as incentive compensation; (d) short term incentive compensation means incentive compensation for periods of time of one year or less; (e) targeted short term incentive compensation means: (i) if the short term incentive compensation plan, program, or arrangement in question designates a targeted amount or a targeted level of achievement for the Executive or the Executive's job grade, it means that targeted amount or level; (ii) if the short term incentive compensation plan, program, or arrangement in question has only one level of payout for the Executive or the Executive's job grade (other than zero), it means that level (i.e.: the level other than zero); (iii) if the short term incentive compensation plan, program, or arrangement in question does not designate a targeted amount or level of achievement for the Executive or the Executive's job grade but does have multiple anticipated levels of possible payout or achievement for the Executive or the Executive's job grade, it means (in each case excluding from consideration any level that results in zero payout) the middle level of payout or achievement for the Executive or the Executive's job grade (or if there are an even number of levels, the average of the two levels if there are only two levels or the average of the middle two levels if there are four or more levels); and (iv) in all other cases, the amount anticipated or projected to be paid under the plan, program, or arrangement in question at the time the performance period in question commenced. 14 For purposes of calculating Average Annual Incentive Compensation under this Section 8.2, in determining the amount of incentive compensation (short or long term) payable to or targeted for the Executive for any past or current incentive compensation period or cycle, if the incentive compensation was for a partial period or cycle (such as where an executive becomes a participant in an incentive plan after the incentive compensation period or cycle has commenced so that the award payable to or targeted for the executive is prorated), such incentive compensation payable to or targeted for the Executive shall be determined as if the Executive had participated throughout the complete incentive compensation period or cycle in question. For example, if, with respect to a 12-month plan that would have paid the Executive short term incentive compensation of $12X if the Executive had been a participant for the full plan year, the Executive became a participant when only seven months were left in the plan year and the Executive was therefore paid incentive compensation of only $7X, the Executive would be treated for purposes of this Section 8.2 as if the Executive had been a participant for the full plan year and had been paid incentive compensation of $12X under the plan. 8.3 Average Long Term Incentive Compensation. The term "Average Long Term Incentive Compensation" means: (a) if the Change Year is 2002, the dollar value of the 2002 LTIC Restricted Stock Grant; (b) if the Change Year is 2003, the higher of: (i) the dollar value of the 2002 LTIC Restricted Stock Grant, and (ii) the dollar value of the 2003 LTIC Restricted Stock Grant; and (c) if the Change Year is 2004 or any later year, the higher of (i) the average of the dollar value of the LTIC Restricted Stock Grants made to the Executive in each of the two years immediately preceding the Change Year (e.g., the average of the 2003 LTIC Restricted Stock Grant and the 2004 LTIC Restricted Stock Grant if the Change Year is 2005), or, if for any reason an LTIC Restricted Stock Grant was made to Executive in only one of those two immediately preceding years, the dollar value of the LTIC Restricted Stock Grant for that single year, and (ii) the dollar value of the LTIC Restricted Stock Grant for the Change Year; except that, if the Executive first became employed by Key or a Subsidiary during the Change Year or during the year immediately preceding the Change Year and pursuant to an offer letter or agreement the terms of which were approved by the Committee, "Average Long Term Incentive Compensation" shall be not less than the dollar value of the LTIC Restricted Stock Grant target specified in that offer letter or agreement. For purposes of this Section 8.3 the dollar value of any LTIC Restricted Stock Grant means the aggregate Fair Market Value of the restricted Common Shares subject to that grant as of the date the grant is made, without regard to changes in Key's stock price after the date of grant or to any restrictions on those Common Shares. 15 8.4 Average Short Term Incentive Compensation. The term "Average Short Term Incentive Compensation" means the higher of: (a) the average of the short term incentive compensation payable to the Executive for each of the last two years immediately preceding the Change Year or, if, for any reason, short term incentive compensation was payable to the Executive for only one of those two years, the amount of short term incentive compensation payable to the Executive for that year, and (b) the Executive's targeted short term incentive compensation for the Change Year or for the year immediately preceding the Change Year, whichever is higher, except that if the Executive first became a participant in Key's short term incentive compensation program during the Change Year, Average Short Term Incentive Compensation means the Executive's targeted short term incentive compensation for the Change Year. 8.5 Base Salary. The term "Base Salary" means the salary payable to the Executive from time to time before any reduction for voluntary contributions to the KeyCorp 401(k) Plan or any other deferral. Base Salary does not include imputed income from payment by Key of country club membership fees or other noncash benefits. 8.6 Cause. The employment of the Executive by Key or any of its Subsidiaries shall have been terminated for "Cause" if, after a Change of Control and prior to the termination of employment, any of the following has occurred: (a) the Executive shall have been convicted of a felony, (b) the Executive commits an act or series of acts of dishonesty in the course of the Executive's employment which are materially inimical to the best interests of Key or a Subsidiary and which constitutes the commission of a felony, all as determined by the vote of three fourths of all of the members of the Board of Directors of Key (other than the Executive, if the Executive is a Director of Key) which determination is confirmed by a panel of three arbitrators appointed and acting in accordance with the rules of the American Arbitration Association for the purpose of reviewing that determination, (c) Key or any Subsidiary has been ordered or directed by any federal or state regulatory agency with jurisdiction to terminate or suspend the Executive's employment and such order or directive has not been vacated or reversed upon appeal, or (d) after being notified in writing by the Board of Directors of Key to cease any particular Competitive Activity, the Executive shall intentionally continue to engage in such Competitive Activity while the Executive remains in the employ of Key or a Subsidiary. If (x) Key or any Subsidiary terminates the employment of the Executive during the two year period beginning on the date of a Change of Control and at a time when it has "Cause" therefor under clause (c), above, (y) the order or directive is subsequently vacated or reversed 16 on appeal and the vacation or reversal becomes final and no longer subject to further appeal, and (z) Key or the Subsidiary fails to offer to reinstate the Executive to employment within ten days of the date on which the vacation or reversal becomes final and no longer subject to further appeal, Key or the Subsidiary will be deemed to have terminated the Executive without Cause during the two year period beginning on the date of the Change of Control. 8.7 Change of Control. A "Change of Control" shall be deemed to have occurred if, at any time while this Agreement is in effect pursuant to Section 6 hereof, there is a Change of Control under any of clauses (a), (b), (c), or (d) below. For these purposes, Key will be deemed to have become a subsidiary of another corporation if any other corporation (which term shall, for all purposes of this Section 8.7, 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 Key or any successor to Key. (a) A Change of Control will have occurred under this clause (a) if Key is a party to a transaction pursuant to which Key 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 Key becomes a subsidiary in the transaction) of the ultimate parent of Key represent or were issued in exchange for voting securities of Key outstanding immediately prior to the transaction, or (ii) immediately after giving effect to that transaction, individuals who were directors of Key on the day before the first public announcement of (x) the pendency of the transaction or (y) the intention of any person or entity to cause the transaction to occur, cease for any reason to constitute at least 51% of the directors of the surviving or resulting corporation or (if Key becomes a subsidiary in the transaction) of the ultimate parent of Key. (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 Key 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 Key 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 Key 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 Key Board of Directors any person or entity makes a public announcement of a bona fide intention (A) to engage in a transaction with Key that, if consummated, would result in a Change Event (as defined below in this clause (c)), or (B) to "solicit" (as 17 defined in Rule 14a-1 under the 1934 Act) proxies in connection with a proposal that is not approved or recommended by the Key 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 Key (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 Key (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 Key'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 Key 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 Key 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 Key in a transaction or series of transactions by any person (as defined earlier in this subclause (x)). (y) Key is a party to a transaction pursuant to which Key is merged with or into, or is consolidated with, or becomes the subsidiary of another corporation and, after giving effect to such transaction, less than 50% of the then outstanding voting securities of the surviving or resulting corporation or (if Key becomes a subsidiary in the transaction) of the ultimate parent of Key represent or were issued in exchange for voting securities of Key outstanding immediately prior to such transaction or less than 51% of the directors of the surviving or resulting corporation or (if Key becomes a subsidiary in the transaction) of the ultimate parent of Key were directors of Key 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 Key. 18 (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 Key. 8.8 Change Year. The term "Change Year" means the year in which a Change of Control occurred or, if more than one Change of Control has occurred, the year in which the earliest Change of Control occurred. 8.9 Common Shares. The term "Common Shares" means common shares of Key. 8.10 Committee. The term "Committee" means the Compensation and Organization Committee of the Board of Directors of Key or any successor to that committee. 8.11 Competitive Activity. The Executive shall be deemed to have engaged in "Competitive Activity" if the Executive: (a) engages in any business or business activity in which Key or any of its Subsidiaries engages, including, without limitation, engaging in any business activity in the banking or financial services industry (other than as a director, officer, or employee of Key or any of its Subsidiaries), or (b) serves as a director, officer, or employee of any bank, bank holding company, savings and loan association, building and loan association, savings and loan holding company, insurance company, investment banking or securities company, mutual fund company, or other financial services company other than Key or any of its Subsidiaries (each of the foregoing being hereinafter referred to as a "Financial Services Company"), or renders services of a consultative or advisory nature or otherwise to any such Financial Services Company; provided, however, this clause (b) shall not prohibit or restrict the Executive from serving in any such capacity with the consent of Key. 8.12 Disability. For purposes of this Agreement, the Executive's employment will have been terminated by Key or its Subsidiary by reason of "Disability" of the Executive only if (a) as a result of bodily injury or sickness, the Executive has been unable to perform the Executive's normal duties for Key or its Subsidiary for a period of 180 consecutive days, and (b) the Executive begins to receive payments under the KeyCorp Long Term Disability Benefit Plan not later than 30 days after the Termination Date. 8.13 Discontinued Plan. The term "Discontinued Plan" means any Retirement Plan and/or Savings Plan that: (a) the Executive was covered by and participating in immediately before the occurrence of a Change of Control, and (b) was, between the date of the Change of Control and the Termination Date, either terminated or altered in such a way as to substantially reduce the benefits provided to the Executive thereunder without having been substituted for by a similar plan providing substantially similar benefits to the Executive. 19 8.14 Fair Market Value. The term "Fair Market Value" with respect to Common Shares means: (a) if the Common Shares are traded on a national exchange, the mean between the high and low sales price per Common Share on the 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 report 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. 8.15 Good Reason. The Executive shall be deemed to have "Good Reason" to terminate the Executive's employment under this Agreement during a Window Period if, at any time after the occurrence of a Change of Control and before the end of the Window Period, either or both of the events listed in clauses (a) and (b) of this Section 8.15 occurs without the written consent of the Executive: (a) following notice by the Executive to Key and an opportunity by Key to cure, the Executive determines in good faith that the Executive's position, responsibilities, duties, or status with Key are at any time materially less than or reduced from those in effect before the Change of Control or that the Executive's reporting relationships with superior executive officers have been materially changed from those in effect before the Change of Control; or (b) Key's headquarters is relocated outside of the greater Cleveland metropolitan area (but this clause (b) shall apply only if Key's headquarters was the Executive's principal place of employment before the Change of Control). For purposes of clause (a), Key will be deemed to have had an opportunity to cure and to have failed to effect a cure if the circumstance otherwise constituting Good Reason persists (as determined in good faith by the Executive, whose determination shall be conclusive) for more than seven calendar days after the Executive has given notice to Key of the existence of that circumstance. 8.16 Impermissible. The term "Impermissible," when used in the context of the Executive's continued coverage by and participation in any of the Retirement Plans or Savings Plans shall mean that such a continuation would violate the provisions of any such plan, would cause any such plan that is or is intended to be qualified under Section 401(a) of the Internal Revenue Code to fail to be so qualified, would require shareholder approval, or would be unlawful. 8.17 LTIC Restricted Stock Grant. The term "LTIC Restricted Stock Grant" means the grant, if any, of restricted stock made by the Committee to the Executive during any 20 particular year as part of Key's ongoing compensation program. For greater clarity, for purposes of this Agreement: (a) The grants of restricted stock made by the Committee to certain officers of Key and its Subsidiaries in 2002, each of which provides for vesting of one-half of the restricted stock subject to the grant (the "Time Lapse Restricted Shares") on December 31, 2004 (or earlier in certain circumstances involving the officer's termination following a Change of Control) and for vesting of the remaining one-half of the restricted stock subject to the grant (the "Performance Accelerated Restricted Shares") on December 31, 2008 (or earlier if a stock price performance test specified in the resolution is met or if a Change of Control occurs on or before December 31, 2004) do constitute LTIC Restricted Stock Grants. (b) On January 17, 2002, in addition to those grants referred to in (a) above, the Committee made similar but smaller grants to certain executives. Each of these smaller grants (i) includes Time Lapse Restricted Shares that vest on December 31, 2003 (or earlier), rather than on December 31, 2004 (or earlier), (ii) is not, for purposes of this Agreement, considered to be an LTIC Restricted Stock Grant, and (iii) is to be ignored when calculating the Executive's Average Long Term Incentive Compensation. (c) The LTIC Restricted Stock Grant, if any, made to the Executive in 2002 is referred to in this Agreement as the "2002 LTIC Restricted Stock Grant." The terms "2003 LTIC Restricted Stock Grant," "2004 LTIC Restricted Stock Grant," etc. similarly refer to LTIC Restricted Stock Grants, if any, made to the Executive by resolution adopted by the Committee in the specified year. (d) An extraordinary grant or award of restricted stock made to a newly hired executive in connection with that hiring (i.e., any signing or hiring bonus) and a grant or award made to an incumbent executive outside of Key's regular restricted stock program (e.g., a special retention grant or award) shall be treated as not being an LTIC Restricted Stock Grant and shall not be taken into account when calculating Average Long Term Incentive Compensation. 8.18 Mandatory Relocation. A "Mandatory Relocation" shall have occurred if, at any time after a Change of Control, the Executive is required to relocate the Executive's principal place of employment for Key or its Subsidiary without the Executive's written consent more than 35 miles from where the Executive was located prior to the Change of Control. 8.19 Reduction of Compensation. A "Reduction of Compensation" shall have occurred if any one or more of the following occurs: (a) the Base Salary of the Executive is reduced at any time after a Change of Control; (b) following notice by the Executive to Key and an opportunity by Key to cure, Key fails to satisfy the Short Term Incentive Compensation Guaranty; (c) following notice by the Executive to Key and an opportunity by Key to cure, Key fails to satisfy the Long Term Incentive Compensation Guaranty; or 21 (d) following notice by the Executive to Key and an opportunity by Key to cure, Key fails to satisfy the Option/SAR Guaranty. For purposes of clauses (b), (c) and (d), Key will be deemed to have had an opportunity to cure and to have failed to effect a cure if the failure to satisfy the Short Term Incentive Compensation Guaranty, the Long Term Incentive Compensation Guaranty, and/or the Option/SAR Guaranty, as the case may be, persists (as determined in good faith by the Executive) for more than seven calendar days after the Executive has given notice to Key of the existence of that failure. 8.20 Relevant Plans. The term "Relevant Plans" means: (a) all Retirement Plans and Savings Plans that the Executive was covered by and participating in immediately before the Termination Date, and (b) all Discontinued Plans. Reference to a "Relevant Plan," in the singular, means any of the Relevant Plans. 8.21 Retirement Plans. The term "Retirement Plans" means the KeyCorp Cash Balance Pension Plan and the Supplemental Retirement Plan, each as from time to time amended, restated, or otherwise modified, and any plan that, after the date of this Agreement, succeeds, replaces, or is substituted for any such plan, and all retirement plans of any nature maintained by Key or any of its Subsidiaries in which the Executive was participating prior to the Termination Date. Reference to a "Retirement Plan," in the singular, means any of the Retirement Plans. 8.22 Savings Plans. The term "Savings Plans" means and includes the KeyCorp 401(k) Savings Plan and the KeyCorp Excess 401(k) Savings Plan, in both cases, as from time to time amended, restated, or otherwise modified, including any plan that, after the date of this Agreement, succeeds, replaces, or is substituted for either such plan, and all salary reduction, savings, profit-sharing, or stock bonus plans (including, without limitation, all plans involving employer matching contributions, whether or not constituting a qualified cash or deferred arrangement under Section 401(k) of the Internal Revenue Code), maintained by Key or any of its Subsidiaries in which the Executive was participating prior to the Termination Date. Reference to a "Savings Plan," in the singular, shall mean any of the Savings Plans. 8.23 Supplemental Retirement Plan. The term "Supplemental Retirement Plan" means the KeyCorp Supplemental Retirement Plan, the KeyCorp Excess Cash Balance Pension Plan, the KeyCorp Supplemental Retirement Plan for Key Executives, the KeyCorp Supplemental Retirement Benefit Plan, and the KeyCorp Executive Supplemental Pension Plan, each as from time to time amended, restated, or otherwise modified, and any plan that, after the date of this Agreement, succeeds, replaces, or is substituted for any of such plans. 8.24 Subsidiary. A "Subsidiary" means any corporation, bank, partnership, or other entity a majority of the voting control of which is directly or indirectly owned or controlled at the time in question by Key. 22 8.25 Termination Date. The term "Termination Date" means the date on which the Executive's employment with Key and its Subsidiaries terminates. 8.26 Window Period. The term "Window Period," with respect to any particular Change of Control, means the three-month period beginning on the date that falls on the same day of the month as the date of the Change of Control in the fifteenth month after the month in which the Change of Control occurs. If at any time there has been more than one Change of Control, there shall be a separate Window Period with respect to each such Change of Control. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. KEYCORP By ____________________________________ Henry L. Meyer III Chairman and Chief Executive Officer THE "EXECUTIVE" _______________________________________ ______________________ EX-10.6 9 l95281aexv10w6.txt AMENDED EMPLOYMENT AGREEMENT Exhibit 10.6 AMENDED EMPLOYMENT AGREEMENT THIS AMENDED EMPLOYMENT AGREEMENT (this "Agreement") is made at Cleveland, Ohio, as of July 18, 2002, between KEYCORP, an Ohio corporation ("Key"), and HENRY L. MEYER III ("Meyer"). The original version of this Agreement was entered into by Key and Meyer as of May 15, 1997, and was amended as of each of November 20, 1997, July 21, 1999, and February 1, 2001. Further amendments are incorporated below in this Agreement which replaces and supersedes both the original version and those prior amendments. Meyer has been elected as Chairman of the Board of Directors, President, and Chief Executive Officer of Key. Key is entering into this Agreement in recognition of the importance of Meyer's services to the continuity of management of Key and based upon its determination that it will be in the best interests of Key and its Subsidiaries to encourage Meyer's continued attention and dedication to his duties on behalf of Key on into the future. (As used in this Agreement, the term "Subsidiaries" and certain other capitalized terms have the meanings ascribed to them in Section 25, at the end of this Agreement.) Key and Meyer agree, effective as of the date first set forth above (the "Effective Date"), as follows: 1. Employment, Term. Key engages and employs Meyer to render such services in the administration and operation of its affairs as, from time to time, may be specified by its Board of Directors in a manner consistent with his status as Chairman of the Board of Directors, President, and Chief Executive Officer, all in accordance with the terms and conditions of this Agreement, for a constantly renewing three year term, commencing on the Effective Date, so that the remaining term of employment under this Agreement shall always be three years, unless: (a) either party gives written notice to the other that the term shall no longer constantly renew (in which case, the term of employment under this Agreement will expire on the third anniversary of the giving of such notice) or (b) Meyer's employment under this Agreement is earlier terminated in accordance with the provisions of one of Sections 6.2 through 6.7 of this Agreement. Thus, for example, on July 19, 2002, the term of employment under this Agreement will be for three years until July 19, 2005; automatically, without any action by either party, the term will renew and extend itself on July 20, 2002 so as to be a three year term of employment until July 20, 2005; and so on with the term automatically extending on a daily basis so as always to be a three year term until either notice is given under clause (a) above or Meyer's employment is earlier terminated in accordance with the provisions of one of Sections 6.2 through 6.7 of this Agreement. 2. Full-Time Services. Meyer will devote all his time and efforts to the service of Key, except for (a) usual vacation periods and reasonable periods of illness, (b) services as an officer and director of any Subsidiary of Key, and (c) services as a director or trustee of other corporations or organizations that are not in competition with Key or any Subsidiary, except that, Meyer shall obtain the prior approval of the Chairman of the Compensation and Organization Committee of Key's Board of Directors before accepting a position as director or trustee of any for profit entity, other than Lincoln Electric Holdings, Inc. (whether the entity is in corporate or other form). 3. Executive Officer. Except as provided in the last sentence of this Section 3, Meyer shall hold the offices of Chairman of the Board of Directors, President, and Chief Executive Officer of Key throughout the period of his employment under this Agreement. Meyer and Key may, at some point in time after the Effective Date, mutually agree that a different executive officer of Key should hold the title of President and report to Meyer while Meyer remains as Chairman of the Board of Directors and Chief Executive Officer of Key. 4. Compensation. For all services to be rendered by Meyer to Key under this Agreement, including services as an officer, director, Chairman of the Board of Directors, or member of any committee of Key or of any Subsidiary, or any other services specified by the Board of Directors, Key shall pay to Meyer, in equal monthly or more frequent installments, Base Salary at a rate of not less than $950,000 per annum. The rate of Meyer's Base Salary shall be subject to increase from time to time at the discretion of the Compensation and Organization Committee of the Board of Directors and shall not be subject to decrease except and then only to the extent that there is an across-the-board salary reduction applicable to the executive officers of Key generally. In addition to being paid such Base Salary, Meyer shall participate fully in any incentive compensation, retirement, savings, stock option, restricted stock, disability, and other employee benefit and welfare plan or arrangement allowed or provided by Key in which he would otherwise be eligible for participation as an executive officer and employee of Key, and, to the extent not provided, Key shall pay or provide for the payment of benefits commensurate with Meyer's annual compensation. 5. Certain Compensation Guaranties During Two Years following a Change of Control. For so long as Meyer remains in the employ of the Surviving Entity or one of its Subsidiaries during the period beginning on the day after any Change of Control and continuing through the second anniversary of that Change of Control (the period of Meyer's employment during that two year period being the "Guaranteed Compensation Period"), Meyer shall be entitled to the Incentive Compensation Guaranty set forth in Section 5.1 and to the Option/SAR Guaranty set forth in Section 5.2. For purposes of determining Meyer's entitlement to benefits under the Supplemental Retirement Plan, amounts received by Meyer in satisfaction of the Incentive Compensation Guaranty set forth in Section 5.1, to the extent allocable to long term incentive compensation that was taken into account in determining Average Annual Incentive Compensation, shall be deemed to be long term incentive compensation received by Meyer during the Guaranteed Compensation Period. 5.1 Guaranteed Level of Incentive Compensation. Except as otherwise provided in Section 5.3, the Surviving Entity shall cause Meyer to receive, during the Guaranteed Compensation Period, as incentive compensation, an amount that, on an annualized basis, is at least equal to Meyer's Average Annual Incentive Compensation. The guaranty set forth in the immediately preceding sentence (the "Incentive Compensation Guaranty") establishes a minimum amount of incentive compensation that must be paid to Meyer with respect to Meyer's employment during the Guaranteed 2 Compensation Period. Except as and to the extent otherwise permitted by any of the provisions of Section 5.3: (a) The Surviving Entity shall make payments to Meyer in cash that satisfy the Incentive Compensation Guaranty quarterly in arrears, within 30 days after the end of each calendar quarter for each quarter or portion thereof during the Guaranteed Compensation Period; (b) If Meyer's employment is terminated for any reason other than Cause, all unpaid guaranteed incentive compensation with respect to the Guaranteed Compensation Period shall be paid to Meyer by the Surviving Entity in a lump sum within 30 business days following the Termination Date; and (c) If Meyer's employment is terminated by the Surviving Entity for Cause, the Surviving Entity shall not be required to pay to Meyer any amount of incentive compensation otherwise payable at any time on or after the Termination Date. 5.2 Guaranteed Participation in Stock Option and SAR Plans. During the Guaranteed Compensation Period, Meyer shall participate fully (at a level that is at least comparable to the level at which he participated in the last calendar year that ended before the date of the Change of Control and is at least equal to the highest targeted level at which other executive officers of the Surviving Entity participate) in each and every stock option and stock appreciation right plan in which executive officers of the Surviving Entity generally participate. The guaranty of full participation set forth in this Section 5.2 is hereinafter sometimes referred to as the "Option/SAR Guaranty." 5.3 Exceptions to and Alternative Means of Satisfying the Incentive Compensation Guaranty. For purposes of the exceptions and alternative means of satisfying the Incentive Compensation Guaranty that are set forth in this Section 5.3, the Incentive Compensation Guaranty shall be deemed to be made up of two parts, the "Short Term Part" and the "Long Term Part," each of which shall bear the same proportion, respectively, to the entire Incentive Compensation Guaranty as Average Short Term Incentive Compensation and Average Long Term Incentive Compensation bear, respectively, to Average Annual Incentive Compensation. (a) Bona fide Short Term Incentive Compensation Plan Exception. If (i) the Surviving Entity maintains a bona fide short term incentive compensation plan that (x) would satisfy the Short Term Part if Meyer received short term incentive compensation under that plan at Meyer's target level (as the target level is specified under that plan) and (y) specifies a target level for Meyer that is the highest target level for any executive employed by the Surviving Entity; (ii) the Surviving Entity, in administering that plan in good faith and without discriminating against Meyer, utilizes a performance factor that is intended to rate the corporation's overall performance for the short term compensation cycle in question; (iii) that performance factor is uniformly applied (either in establishing an incentive compensation pool or against each participant's target) to all 3 participants in the plan; and (iv) the application of that factor reduces the short term incentive compensation payable under that plan to a level below Meyer's target level; then payment of the short term incentive compensation, if any, due to Meyer at the reduced level under that plan shall satisfy the Surviving Entity's obligation under the Short Term Part for that particular short term compensation cycle. (b) Annual Payment Exception. If the Surviving Entity maintains a bona fide short term incentive compensation plan that would satisfy the Short Term Part if Meyer received short term incentive compensation under that plan at Meyer's target level and that plan provides for payment of all amounts earned at regularly scheduled times not less frequently than once a year, the Surviving Entity may satisfy the Short Term Part by paying incentive compensation to Meyer under that plan (at not less than Meyer's target level or as reduced if permitted by 5.3(a) above) at those regularly scheduled times, except that if Meyer's employment terminates for any reason other than Cause, the Surviving Entity shall make payments under that plan, pro rated to include all periods within the Compensation Guaranty Period as to which Meyer has not yet received incentive compensation under that plan, within 30 business days after the Termination Date. (c) Issuance of Restricted Stock Alternative. As an alternative to paying Meyer cash to satisfy the Long Term Part, the Surviving Entity may continue to make LTIC Restricted Stock Grants to Meyer each year during the Guaranteed Compensation Period that: (i) are made during the same calendar quarter of the year as the calendar quarter during which Key made such a grant to Meyer in the last calendar year that ended before the beginning of the Guaranteed Compensation Period; (ii) have a Fair Market Value that on an annual basis is at least equal to Meyer's Average Long Term Incentive Compensation; (iii) provide for time lapsed vesting of the restricted stock subject to the grant so that the entire grant will be fully vested not later than the third anniversary of the date of grant if Meyer continues to be employed through that date; and (iv) have the further provision that, upon any termination of Meyer's employment other than a termination for Cause (including, without limitation, any termination by reason of death, disability, voluntary or involuntary retirement, or resignation), if, as of the Termination Date, less than a proportionate part of the Common Shares subject to the LTIC Restricted Stock Grant granted to Meyer during the Guaranteed Compensation Period has vested, then an additional portion of those Common Shares shall vest immediately on the Termination Date so that, in the aggregate, a proportionate part has vested as of the Termination 4 Date. For these purposes, "a proportionate part" means the full number of Common Shares in the LTIC Restricted Stock Grant multiplied by a fraction, the numerator of which is the number of days between (x) January 1 of the calendar year in which the LTIC Restricted Stock Grant was made and (y) the last day of the Guaranteed Compensation Period, inclusive, and the denominator of which is 1095 (i.e., 365 times three). If the Surviving Entity makes LTIC Restricted Stock Grants as provided in this 5.3(c), the Surviving Entity will have satisfied the Long Term Part. 6. Termination. 6.1 Three Years following Notice of Non-Renewal. If either party gives written notice to the other of his or its intention to discontinue the otherwise automatic renewal of the term of Meyer's employment hereunder (a "Non-Renewal Notice"), that term will terminate on the third anniversary of the giving of the Non-Renewal Notice, except that if a Change of Control occurs before that third anniversary date and while Meyer remains employed by Key pursuant to this Agreement, the Non-Renewal Notice shall be automatically abrogated and thereafter treated as though it had never been given unless Meyer gives written notice, not later than 30 days after the occurrence of the Change of Control, that he desires to have the Non-Renewal Notice (whether it was given by Key or by Meyer) continue in effect. If either party gives the other a Non-Renewal Notice as provided in the immediately preceding sentence, that Non-Renewal Notice remains in effect through the third anniversary of the giving of that notice, and Meyer's employment continues through that third anniversary, Meyer's employment under this Agreement shall terminate at 12:00 Midnight on that third anniversary. 6.2 Death or Disability. Meyer's employment hereunder will terminate immediately upon Meyer's death. Key may terminate Meyer's employment hereunder immediately upon giving notice of termination if Meyer is disabled, by reason of physical or mental impairment, to such an extent that he is unable to substantially perform his duties under this Agreement for 180 consecutive days. 6.3 For "Cause" Absent a Change of Control. At any time that is either before the occurrence of any Change of Control or after the second anniversary of the then most recent Change of Control, Key may terminate Meyer's employment hereunder for "Cause" if : (a) Meyer commits a felony (other than felonious operation of a motor vehicle); (b) Meyer commits an act or series of acts of dishonesty in the course of his employment that are materially inimical to the best interests of Key or a Subsidiary as determined by Majority Action of the Board of Directors and, if the act or acts are capable of being cured, Meyer fails to cure or take all reasonable steps to cure within 30 days of notice from the Board of Directors to Meyer; 5 (c) Key or any Subsidiary has been ordered or directed by any federal or state regulatory agency with jurisdiction to terminate or suspend Meyer's employment and such order or directive has not been vacated or reversed upon appeal; (d) Meyer continues to violate his obligation under Section 10.1 not to engage in Competitive Activities for more than ten days after the Board of Directors has by Majority Action advised him in writing to cease those activities; or (e) Other than for disability, Meyer abandons and consistently fails to attempt to perform his duties and responsibilities as specified from time to time by the Board of Directors for 90 consecutive days after the Board of Directors has by Majority Action advised him in writing of that failure. 6.4 For "Cause" Within Two Years After a Change of Control. From the date on which occurs any Change of Control and thereafter through the second anniversary of that Change of Control, the Surviving Entity and its Subsidiaries may terminate Meyer's employment under this Agreement for "Cause" only if : (a) Meyer is convicted of a felony (other than felonious operation of a motor vehicle); (b) Meyer commits an act or series of acts of dishonesty in the course of his employment that are materially inimical to the best interests of the Surviving Entity or any of its Subsidiaries and that constitutes the commission of a felony (other than felonious operation of a motor vehicle), all as determined in good faith by the vote of three quarters of the entire number of members of the Board of Directors, which determination is confirmed by a panel of three arbitrators appointed and acting in accordance with the rules of the American Arbitration Association for the purpose of reviewing that determination; (c) The Surviving Entity or any of its Subsidiaries has been ordered or directed by any federal or state regulatory agency with jurisdiction to terminate or suspend Meyer's employment and, notwithstanding the best efforts of the Surviving Entity and/or its relevant Subsidiary or Subsidiaries to oppose, initially, and to appeal, thereafter, the order or directive, that order or directive has not been vacated or reversed upon appeal; or (d) Meyer continues to violate his obligation under Section 10.1 not to engage in Competitive Activities for more than ten days after the Board of Directors has by Majority Action advised him in writing to cease those activities, that violation is material, and the fact that the violation both was material and so continued beyond that ten day period is confirmed by a panel of three arbitrators appointed and acting in accordance with the rules of the American Arbitration Association for the purpose of determining whether the violation both was material and so continued beyond that ten day period. 6 If (x) the Surviving Entity or any of its Subsidiaries terminates the employment of Meyer during the two year period beginning on the date of a Change of Control and at a time when it has "Cause" therefor under clause (c) above, (y) the order or directive is subsequently vacated or reversed on appeal and the vacation or reversal becomes final and no longer subject to further appeal, and (z) the Surviving Entity or any of its Subsidiaries fails to offer to reinstate Meyer to employment under this Agreement within ten days of the date on which the vacation or reversal becomes final and no longer subject to further appeal, the Surviving Entity and its Subsidiaries will be deemed to have terminated Meyer without Cause during the two year period beginning on the date of the Change of Control. 6.5 By Key Without Cause. Key may terminate Meyer's employment hereunder without Cause at any time by Majority Action of the Board of Directors. 6.6 By Meyer Following Constructive Termination at Any Time. Meyer may terminate his employment hereunder "on grounds of Constructive Termination" (and, if Meyer elects to terminate his employment in such circumstances, he will be deemed to have been "Constructively Terminated" and not to have "Voluntarily Resigned" or "Voluntarily Retired") if, at any time: (a) Meyer's Base Salary is reduced other than in connection with, and then only to the extent of, a general across-the-board salary reduction applicable to the executive officers of Key generally; (b) Meyer is excluded from full participation in any incentive, option, restricted stock, or other compensatory plan applicable to executive officers of Key generally; (c) Meyer is subject to Demotion or Removal; (d) Key requests Meyer's resignation or retirement at a time when Key does not have grounds to terminate Meyer's employment for Cause; or (e) Meyer's principal place of employment for Key is relocated outside of the Cleveland metropolitan area or Meyer is otherwise required by Key to relocate outside the Cleveland metropolitan area. 6.7 By Meyer Following Constructive Termination Within Two Years After a Change of Control. At any time during the period beginning on the date on which occurs any Change of Control and thereafter through the second anniversary of that Change of Control, Meyer may terminate his employment hereunder "on grounds of Constructive Termination" (and, if Meyer elects to terminate his employment in such circumstances, he will be deemed to have been "Constructively Terminated" and not to have "Voluntarily Resigned" or "Voluntarily Retired") if he could then terminate his employment on any of the grounds of Constructive Termination listed under Section 6.6 or if: 7 (a) Meyer's Base Salary is reduced from the highest level in effect at any time during the one year period ending on the date of the Change of Control; (b) Meyer is excluded from full participation in any incentive, option, restricted stock, or other compensatory plan that was available to him and in effect at any time during the one year period ending on the date of the Change of Control (the "Pre-Change of Control Compensatory Plans") unless Meyer is provided with substitute incentive, option, restricted stock, and other compensatory plans that provide to Meyer, in the aggregate, at least substantially equivalent compensatory opportunities as would have been provided had the Pre- Change of Control Compensatory Plans remained in effect with Meyer as a full participant therein; (c) Following notice by Meyer to the Surviving Entity and an opportunity by the Surviving Entity to cure, the Surviving Entity fails to satisfy the Incentive Compensation Guaranty or the Option/SAR Guaranty or Meyer is otherwise excluded from full participation in any incentive, option, restricted stock, or other compensation plan that is generally applicable to executive officers of the Surviving Entity after the Change of Control; (d) The headquarters of the Surviving Entity is located outside of the Cleveland metropolitan area; (e) Meyer determines in good faith that his responsibilities, duties, or authorities with the Surviving Entity are materially reduced from those in effect before the Change of Control and the reduction has not been cured within thirty days after Meyer gives notice to the Board of Directors of the Surviving Entity of his election to terminate his employment based upon that reduction; or (f) Meyer determines in good faith that as a result of the Change of Control he is unable to carry out the authorities, powers, functions, responsibilities, or duties as Chairman of the Board of Directors and Chief Executive Officer as those authorities, powers, functions, responsibilities, or duties attached to those positions were in effect before the Change of Control and the Board of Directors of the Surviving Entity fails to fully address those issues (as determined by Meyer in good faith) within thirty days after Meyer gives notice to the Board of Directors of his determination under this clause (f) and the basis of such determination. For purposes of clause (c), the Surviving Entity will be deemed to have had an opportunity to cure and to have failed to effect a cure if the failure to satisfy the Incentive Compensation Guaranty or the Option/SAR Guaranty, as the case may be, persists (as determined in good faith by Meyer) for more than thirty calendar days after Meyer has given notice to the Surviving Entity of the existence of that failure. 8 7. Severance Payments and Benefits upon Termination. 7.1 Termination by Key Without Cause, etc., or by Meyer Following Constructive Termination. If Meyer's employment is terminated by Key (or, if applicable, the Surviving Entity) for any reason other than Cause, disability, or death, or if Meyer is Constructively Terminated: (a) Base Salary through Termination Date. Key shall pay to Meyer, at the same time or times as would have been the case absent the termination, any unpaid Base Salary due or to become due to Meyer with respect to any period ending on or before the Termination Date. (b) Short Term Incentive Compensation through Termination Date. Key shall pay to Meyer, within 30 days after the Termination Date, as short term incentive compensation with respect to each short term incentive compensation plan in which Meyer is a participant, an amount equal to a pro rata portion of Meyer's targeted short term incentive compensation under that plan for the calendar year in which the Termination Date falls. For these purposes, a "pro rata portion" means the percentage figure determined by dividing the number of days between January 1 of the calendar year in question through the Termination Date, inclusive, by 365. Any amount paid by Key to Meyer pursuant to this Section 7.1(b) with respect to a particular short term incentive compensation plan in which Meyer is a participant shall reduce, but not below zero, the amount that Key is required to pay to Meyer under that plan as short term incentive compensation for the calendar year in which the Termination Date falls, but that short term incentive compensation plan shall in all other respects be governed by its terms. (c) Lump Sum Payment. Key shall pay to Meyer, within 30 days after the Termination Date, a lump sum severance benefit equal to three times the sum of (i) one year's Base Salary (at the highest rate in effect at any time before the Termination Date) plus (ii) his Average Annual Incentive Compensation; (d) Retirement and Savings Plan Participation. For the period beginning on the day after the Termination Date and ending on the third anniversary of the Termination Date (the "Continuing Benefit Period"), Key shall cause Meyer to continue to be covered by and to participate in all Retirement Plans and Savings Plans that he was entitled to be covered by and participating in as an officer of Key immediately before the Termination Date in the same manner and to the same extent as if Meyer continued in the full-time employ of Key throughout the Continuing Benefit Period, except where such coverage or participation is Impermissible. For these purposes: (i) the entire Continuing Benefit Period shall be included in determining Meyer's years of service, (ii) amounts received by Meyer under clause (c)(i) above shall be deemed to be base salary received by Meyer ratably during the Continuing Benefit Period, and (iii) amounts received by Meyer under clause (c)(ii) above shall be deemed to be incentive compensation 9 received by Meyer ratably during the Continuing Benefit Period and shall, if relevant, be allocated between short term incentive compensation and long term incentive compensation based on the degree to which awards of each type of incentive compensation were taken into account in determining Average Annual Incentive Compensation. If, at any time during the Continuing Benefit Period, Key determines in good faith that continuing Meyer's coverage by and participation in any of the Retirement Plans or any of the Savings Plans during the Continuing Benefit Period is Impermissible, Meyer shall not be covered by and participate in such affected plan or plans during the Continuing Benefit Period, but Key shall provide to Meyer under this Agreement, as a supplemental retirement benefit, payments and benefits that put Meyer in the same position that he would have been in had he continued to be covered by and participated in all such affected plan or plans throughout the Continuing Benefit Period to the same extent as he was a participant immediately before the Termination Date, with the supplemental payments and benefits under this sentence being payable to Meyer (or, if applicable, to his wife, estate, or designated beneficiary) at the same time and with the same payment options as would be applicable under the affected plan or plans in question. (e) Medical, Disability, and Group Term Life Coverage. Through the third anniversary of the Termination Date, Key shall continue to maintain in effect medical (including dental) coverage, disability coverage, and group term life insurance for the benefit of Meyer and his dependents at the same levels and subject to the same (by dollar amount) employee contribution requirement, if any, as had been in effect for the benefit of Meyer and his dependents before the Termination Date. After the third anniversary of the Termination Date, Meyer and his dependents shall be provided retiree medical benefits that are at least equal to those that Meyer and his dependents would have been entitled to under the Retiree Medical Benefits Plan if Meyer had retired from Key on the Termination Date after satisfying all eligibility requirements for retiree medical benefits under that plan. The retiree medical benefits shall be provided under the Retiree Medical Benefit Plan, with the cost thereof borne as between Key and Meyer and his dependents as provided in that plan, if and so long as that plan remains in effect and Meyer and his dependents are in fact eligible for the intended benefits thereunder. In all other circumstances, the retiree medical benefits shall be provided directly by Key, with the cost thereof borne as between Key and Meyer and his dependents in the same manner as would have been the case if the benefits had been provided under the Retiree Medical Benefits Plan rather than directly by Key. 7.2 Effect of Death While in Employ of Key. If Meyer dies while employed by Key: (a) Key shall pay to Meyer's estate any unpaid Base Salary due or to become due to Meyer with respect to any period ending before his death and Key shall 10 have no further obligations to Meyer for Base Salary for any period after Meyer's death. (b) Key shall continue to maintain medical (including dental) coverage in effect (i) for the benefit of Meyer's wife, for her lifetime, and (ii) for the benefit of each of Meyer's children, through the earlier of the date on which he or she attains age 23 or has ceased for more than 120 consecutive days to be a full time student, in each case at Key's sole cost and at the highest levels as had been in effect for the benefit of Meyer's wife and each of his children, as the case may be, at any time before the Termination Date. (c) Upon his death, Meyer's rights under any other plan or benefit of Key shall be governed by the respective terms thereof. 7.3 Effect of Disability While in Employ of Key. If, while Meyer is employed by Key, he becomes disabled, by reason of physical or mental impairment, to such an extent that he is unable to perform his duties under this Agreement: (a) Key may relieve Meyer of his duties under this Agreement for as long as Meyer is so disabled. (b) Key shall pay to Meyer all Base Salary and incentive compensation to which he would have been entitled under this Agreement and under applicable incentive compensation plans had he continued to be actively employed by Key to the earliest of (i) the date on which he becomes eligible for payment of long term disability benefits under the Long Term Disability Benefit Plan, (ii) the date of his death, or (iii) the third anniversary of the first date on which his employment hereunder could have been terminated by Key pursuant to the second sentence of Section 6.2, except that if, after Meyer has become so disabled and before he is terminated by Key pursuant to the second sentence of Section 6.2, Meyer recovers so that he is no longer so disabled to such an extent that he is unable to perform his duties under this Agreement, Meyer shall be restored to his duties under this Agreement and entitled to the benefits of and subject to this Agreement as if no period of disability had occurred. (c) The amounts payable to Meyer for any month under this Section 7.3 shall be reduced, but not below zero, by the full amount of the payments, if any, received by Meyer for that month (i) from all Retirement Plans, (ii) from the Long Term Disability Plan, and (iii) from any other disability plan the entire cost of which is borne by Key. (d) For purposes of all incentive compensation, retirement, savings, stock option, restricted stock, disability, and other employee benefit and welfare plans or arrangements allowed or provided by Key to executive officers, Meyer shall be treated in the same manner that Key treats other executive officers who become disabled. 11 (e) Except as provided in this Section 7.3, Key shall have no further obligations to Meyer for Base Salary or incentive compensation for any period during which Meyer is so disabled to such an extent that he is unable to perform his duties under this Agreement. (f) The payments provided for under this Section 7.3 shall be made as provided for in this Section notwithstanding any termination of Meyer's employment under the second sentence of Section 6.2. 7.4 Effect of Termination for Cause. If Meyer's employment is terminated for Cause, Key may, by giving written notice to Meyer, terminate all its obligations remaining to be performed or observed by it under this Agreement (other than the obligation to pay Base Salary to Meyer through the Termination Date and the obligations of Key under Sections 11, 12.3, and 14 and, to the extent then applicable by its terms, Section 15), except no termination of Key's obligations under this Agreement shall affect Meyer's rights under any plan or benefit of Key, all of which shall be governed by their respective terms. 7.5 Effect of Termination Upon Meyer's Voluntary Resignation or Voluntary Retirement. If Meyer's employment is terminated by Meyer's Voluntary Resignation or Voluntary Retirement, Key may, by giving written notice to Meyer, terminate all its obligations remaining to be performed or observed by it under this Agreement (other than the obligation to pay Base Salary to Meyer through the Termination Date, the obligations of Key under Sections 11, 12, and 14 and, to the extent then applicable by their respective terms, the obligations of Key under Sections 15, 16, and 17), except no termination of Key's obligations under this Agreement shall affect Meyer's rights under any plan or benefit of Key, all of which shall be governed by their respective terms. 8. No Set-Off; No Obligation to Seek Other Employment or to Otherwise Mitigate Damages; No Effect Upon Other Plans. Key's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense, or other claim whatsoever that Key or any of its Subsidiaries may have against Meyer, except that the prohibition on set-off, counterclaim, recoupment, defense, or other claim contained in this sentence shall not apply if Meyer's employment is terminated by Key for Cause at any time that is either before the occurrence of any Change of Control or after the second anniversary of the then most recent Change of Control. Meyer shall not be required to mitigate damages or the amount of any payment provided for under this Agreement by seeking other employment or otherwise. The amount of any payment provided for under this Agreement shall not be reduced by any compensation or benefits earned by Meyer as the result of employment by another employer or otherwise after the termination of Meyer's employment. Neither the provisions of this Agreement nor the making of any payment provided for hereunder, nor the termination of Key's obligations under this Agreement, shall reduce any amounts otherwise payable, or in any way diminish Meyer's rights, under any incentive compensation plan, stock option or stock appreciation rights plan, restricted stock plan or agreement, deferred compensation, retirement, or supplemental retirement plan, 12 stock purchase and savings plan, disability or insurance plan, or other similar contract, plan, or arrangement of Key or any Subsidiary, all of which shall be governed by their respective terms. 9. Payments Are in Lieu of Severance Payments. If Meyer becomes entitled to receive payments under this Agreement as a result of termination of his employment, those payments shall be in lieu of any and all other claims or rights that Meyer may have against Key for severance, separation, and/or salary continuation pay upon that termination of his employment. 10. Limitations on Competition. 10.1 During Employment. Meyer shall not engage in any Competitive Activity during the period of his employment with Key. 10.2 Two Years in Certain Circumstances. If Meyer's employment is terminated within two years after the occurrence of a Change of Control either by Key without Cause or by Meyer after he has been Constructively Terminated, Meyer shall not engage in any Competitive Activity during the two year period ending on the second anniversary of the Termination Date. 10.3 Three Years Following Any Other Termination. If Meyer's employment is terminated (whether by him, by Key, or otherwise) in any circumstances other than those expressly covered by Section 10.2 above, Meyer shall not engage in any Competitive Activity at any time during the three year period ending on the third anniversary of the Termination Date. 10.4 No Further Obligation to Make Payments or Provide Benefits Following Continuing Breach. If Meyer continues to violate the restriction set forth in Section 10.2 or 10.3, as may be applicable, after the Board of Directors has advised him by Majority Action in writing to cease those activities and that violation is material, Key shall thereupon be relieved of all further obligations to make payments and provide benefits to Meyer under any of the provisions contained in Section 7.1. Meyer shall not be required to repay to Key any payment received by him before he began to engage in any such Competitive Activity. 10.5 Other Remedies. In addition to other remedies provided by law or equity, upon a breach by Meyer of any prohibition on Competitive Activity contained in this Section 10, Key shall be entitled to have a court of competent jurisdiction enter an injunction against Meyer restraining him from any further breach of any such prohibition. 11. Indemnification. Key shall indemnify Meyer, to the full extent permitted or authorized by the Ohio General Corporation Law as it may from time to time be amended, if Meyer is made or threatened to be made a party to any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, or investigative, by reason of the fact that Meyer is or was a director, officer, or employee of Key or any Subsidiary, or is or was serving at the request of Key or any Subsidiary as a director, trustee, officer, or employee of a bank, corporation, partnership, joint venture, trust, or other enterprise. The indemnification 13 provided by this Section 11 shall not be deemed exclusive of any other rights to which Meyer may be entitled under the articles of incorporation or the regulations of Key or of any Subsidiary, or any agreement, vote of shareholders or disinterested directors, or otherwise, both as to action in Meyer's official capacity and as to action in another capacity while holding such office, and shall continue as to Meyer after Meyer has ceased to be a director, trustee, officer, or employee and shall inure to the benefit of the heirs, executors, and administrators of Meyer. 12. Reimbursement of Certain Expenses. 12.1 Key shall pay, as incurred, all expenses, including the reasonable fees of counsel engaged by Meyer, of defending any action brought to have this Agreement declared invalid or unenforceable. 12.2 Key shall pay, as incurred, all expenses, including the reasonable fees of counsel engaged by Meyer, of prosecuting any action to compel Key to comply with the terms of this Agreement upon receipt from Meyer of an undertaking to repay Key for such expenses if, and only if, it is ultimately determined by a court of competent jurisdiction that Meyer had no reasonable grounds for bringing that action (which determination need not be made simply because Meyer fails to succeed in the action). 12.3 Expenses (including attorney's fees) incurred by Meyer in defending any action, suit, or proceeding commenced or threatened against Meyer for any action or failure to act as an employee, officer, or director of Key or any Subsidiary shall be paid by Key, as they are incurred, in advance of final disposition of the action, suit, or proceeding upon receipt of an undertaking by or on behalf of Meyer in which he agrees to reasonably cooperate with Key or the Subsidiary, as the case may be, concerning the action, suit, or proceeding, and (a) if the action, suit, or proceeding is commenced or threatened against Meyer for any action or failure to act as a director, to repay the amount if it is proved by clear and convincing evidence in a court of competent jurisdiction that his action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to Key or a Subsidiary or with reckless disregard for the best interests of Key or a Subsidiary or (b) if the action, suit, or proceeding is commenced or threatened against Meyer for any action or failure to act as an officer or employee, to repay the amount if it is ultimately determined that he is not entitled to be indemnified. The obligation of Key to advance expenses provided for in this Section 12.3 shall not be deemed exclusive of any other rights to which Meyer may be entitled under the articles of incorporation or the regulations of Key or of any Subsidiary, or any agreement, vote of shareholders or disinterested directors, or otherwise. 13. Gross-Up of Payments Deemed to be Excess Parachute Payments. 13.1 Key and Meyer acknowledge that, following a Change of Control, one or more payments or distributions to be made by Key to or for the benefit of Meyer (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement, under some other plan, agreement, or arrangement, or otherwise) (a "Payment") may be determined to be an "excess parachute payment" that is not deductible by Key for Federal income tax purposes and with respect to which Meyer will 14 be subject to an excise tax because of Sections 280G and 4999, respectively, of the Internal Revenue Code (hereinafter referred to respectively as "Section 280G" and "Section 4999"). If Meyer's employment is terminated after a Change of Control occurs, the Accounting Firm, which, subject to any inconsistent position asserted by the Internal Revenue Service, shall make all determinations required to be made under this Section 13, shall determine whether any Payment would be an excess parachute payment and shall communicate its determination, together with detailed supporting calculations, to Key and to Meyer within 30 days after the Termination Date or such earlier time as is requested by Key. Key and Meyer shall cooperate with each other and the Accounting Firm and shall provide necessary information so that the Accounting Firm may make all such determinations. Key shall pay all of the fees of the Accounting Firm for services performed by the Accounting Firm as contemplated in this Section 13. 13.2 If the Accounting Firm determines that any Payment gives rise, directly or indirectly, to liability on the part of Meyer for excise tax under Section 4999 (and/or any penalties and/or interest with respect to any such excise tax), Key shall make additional cash payments to Meyer, from time to time and at the same time as any Payment constituting an excess parachute payment is paid or provided to Meyer, in such amounts as are necessary to put Meyer in the same position, after payment of all federal, state, and local taxes (whether income taxes, excise taxes under Section 4999 or otherwise, or other taxes) and any and all penalties and interest with respect to any such excise tax, as Meyer would have been in after payment of all federal, state, and local income taxes if the Payments had not given rise to an excise tax under Section 4999 and no such penalties or interest had been imposed. 13.3 If the Internal Revenue Service determines that any Payment gives rise, directly or indirectly, to liability on the part of Meyer for excise tax under Section 4999 (and/or any penalties and/or interest with respect to any such excise tax) in excess of the amount, if any, previously determined by the Accounting Firm, Key shall make further additional cash payments to Meyer not later than the due date of any payment indicated by the Internal Revenue Service with respect to these matters, in such amounts as are necessary to put Meyer in the same position, after payment of all federal, state, and local taxes (whether income taxes, excise taxes under Section 4999 or otherwise, or other taxes) and any and all penalties and interest with respect to any such excise tax, as Meyer would have been in after payment of all federal, state, and local income taxes if the Payments had not given rise to an excise tax under Section 4999 and no such penalties or interest had been imposed. 13.4 If Key desires to contest any determination by the Internal Revenue Service with respect to the amount of excise tax under Section 4999, Meyer shall, upon receipt from Key of an unconditional written undertaking to indemnify and hold Meyer harmless (on an after tax basis) from any and all adverse consequences that might arise from the contesting of that determination, cooperate with Key in that contest at Key's sole expense. Nothing in this Section 13.4 shall require Meyer to incur any expense other than expenses with respect to which Key has paid to Meyer sufficient sums so that after the payment of the expense by Meyer and taking into account the payment by Key with 15 respect to that expense and any and all taxes that may be imposed upon Meyer as a result of his receipt of that payment, the net effect is no cost to Meyer. Nothing in this Section 13.4 shall require Meyer to extend the statute of limitations with respect to any item or issue in his tax returns other than, exclusively, the excise tax under Section 4999. If, as the result of the contest of any assertion by the Internal Revenue Service with respect to excise tax under Section 4999, Meyer receives a refund of a Section 4999 excise tax previously paid and/or any interest with respect thereto, Meyer shall promptly pay to Key such amount as will leave Meyer, net of the repayment and all tax effects, in the same position, after all taxes and interest, that he would have been in if the refunded excise tax had never been paid. 14. Deferral of Payment of Compensation under Certain Circumstances. 14.1 Section Will Not Apply if a Change of Control Occurs. This Section 14 shall not apply to any compensation that, but for the application of this Section 14, would be payable by Key to Meyer in respect of the first calendar year in which a Change of Control occurs (the "Change Year") or in respect of any later calendar year. For example, if the Committee has given notice to Meyer, as contemplated by Section 14.2, that this Section 14 shall apply to compensation otherwise payable in respect of a particular calendar year and a Change of Control thereafter occurs during that calendar year, this Section 14 shall not apply to that compensation, notwithstanding the notice given by the Committee. 14.2 Section to Apply on an Annual Basis and Only If Timely Notice to that Effect Given by Committee. This Section 14 shall apply to any compensation that, but for this Section 14, is payable to Meyer in respect of any particular calendar year before the Change Year if, and only if, on or before March 31 of that particular calendar year, the Committee notifies Meyer in writing of the Committee's determination that this Section 14 shall so apply. If the Committee so determines and so provides Meyer with such a timely notice as to any such particular calendar year, this Section 14 shall apply according to its terms to all compensation that, but for this Section 14, becomes payable to Meyer in respect of that particular calendar year. Conversely, if the Committee does not so notify Meyer in writing on or before March 31 of any particular calendar year, this Section 14 will not apply to any compensation that, but for this Section 14, becomes payable to Meyer in respect of that particular calendar year. For purposes of this Section 14, compensation payable by Key to Meyer is "in respect of" a particular calendar year if it is compensation that, ignoring both (x) the effect, if any, of Section 162(m) and (y) the application of this Section 14, the compensation would be paid by Key to Meyer either during or shortly after that calendar year and would be deductible by Key in that calendar year (assuming, for these purposes, that Key has sufficient taxable income so that it can make use of all possible deductions during that calendar year). 14.3 Section 162(m). For purposes of this Section 14, the term "Section 162(m)" shall mean Section 162(m) of the Internal Revenue Code (which, as amended by the Revenue Reconciliation Act of 1993, prescribes rules disallowing deductions for certain "applicable employee remuneration" to any of five specified 16 "covered employees" of a publicly held corporation in excess of $1,000,000 per year), as from time to time amended, and the corresponding provisions of any similar law subsequently enacted, and to all regulations issued under that section and any such provisions. 14.4 Deferral. Except as otherwise provided in either of Section 14.5 or Section 14.6, below, if this Section 14 applies with respect to any particular calendar year by reason of timely notice having been given by the Committee to Meyer with respect to that calendar year as contemplated by Section 14.2 and Key determines that, after giving effect to all applicable elective deferrals of compensation, any amount of compensation (including any Base Salary and any incentive compensation payable under any incentive compensation plan in which Meyer is a participant) otherwise payable to Meyer under this Agreement at any particular time in respect of that particular calendar year (the "Scheduled Time"), (a) would not be deductible by Key if paid at the Scheduled Time by reason of the disallowance rules of Section 162(m), and (b) would be deductible by Key if deferred until and paid during a later year, that amount of compensation shall be deferred until, and paid during, the year that is determined by Key to be the first year following the year of deferral during which the compensation can be paid without disallowance of the deduction for payment of the compensation by reason of Section 162(m). If Key determines that in any year following the year of deferral a portion of, but not all of, the amounts deferred (together with interest thereon as provided in Section 14.7, below) can be paid without disallowance of the deduction, that portion that can be so paid shall be paid by Key during that year and the remainder, except as otherwise provided in Section 14.5 or Section 14.6, below, shall continue to be deferred until a later year. 14.5 Early Payout of Deferred Amount if Deferral is Determined to be Ineffective. If any amount of compensation is deferred under Section 14.4 with the expectation that it will be deductible by Key if paid in a later year and Key later determines that the compensation will not be deductible by Key even if payment thereof is deferred until a later year, then, within 30 days of the date on which that determination is made, the deferral with respect to that compensation shall terminate and Key shall pay that compensation to Meyer. 14.6 Payout Following Termination of Employment in All Events. On April 15 of the year immediately following the year in which Meyer ceases to be employed by Key, Key shall pay to Meyer, in a single lump sum, all amounts of compensation that have been deferred pursuant to this Section 14 and have not previously been paid so that, as of the close of business on that date, no amount of compensation will remain deferred under this Section 14 whether or not Key is entitled to a deduction with respect to the payment of that compensation. 17 14.7 Interest on Deferred Amounts. Upon payment of any amounts of compensation deferred for any period of time pursuant to this Section 14, Key shall pay to Meyer an additional amount equivalent to the interest that would have accrued on such deferred compensation if interest accrued thereon on a daily basis from the date on which that compensation would have been paid but for this Section 14 through the date on which that compensation is paid at a rate varying from month to month and equal to 50 basis points higher than the effective annual yield of the average of the Moody's Average Corporate Bond Yield Index for the previous month, as published by Moody's Investor Services, Inc. (or any successor published thereto), or, if such index is no longer published, a substantially similar index selected by the Accounting Firm, with interest compounded as of the end of each month. 14.8 Miscellaneous. Meyer's rights with respect to payment during his lifetime of any compensation deferred under this Section 14 shall not be subject to assignment. If Meyer dies before all compensation deferred under this Section 14 has been paid to him, any such unpaid compensation shall be paid, at the same time it would have been paid if Meyer had not died but had merely ceased to be an employee of Key on the date of his death (or, if earlier, on the last date he actually was an employee of Key), to his estate or, if Meyer shall so direct to Key in writing, to his wife or to a trust created by Meyer. The obligation of Key to make payments of compensation deferred pursuant to this Section 14 constitutes the unsecured promise of Key to make payments from its general assets as and when due and neither Meyer nor any person claiming through him shall have, as a result of this Section 14, any lien or claim on any assets of Key that is superior to the claims of the general creditors of Key. 15. Vesting of Supplemental Retirement Benefit. Upon any termination of Meyer's employment with Key other than (a) a termination by Key for Cause before Meyer attains age 55 or (b) by Meyer's Voluntary Resignation before he attains age 55, Meyer will be treated as having satisfied all of the requirements for eligibility for and as being fully vested in a supplemental retirement benefit under the Supplemental Retirement Plan. Nothing in this Section 15 shall be deemed to create an inference that Meyer is not otherwise eligible for or fully vested in a supplemental retirement benefit under the Supplemental Retirement Plan and whether or not he is so otherwise eligible for or fully vested in such a benefit will be determined pursuant to the terms of the Supplemental Retirement Plan without reference to this Section 15. 16. Vesting of, and Extension of Exercise Period for, Stock Options. All stock options (other than so-called "performance options," which are options that vest or become exercisable only if certain stock price and/or financial performance tests are achieved) granted to Meyer by Key after February 1, 2001 that remain outstanding on the Termination Date shall be deemed to have vested (to the extent not already vested) as of immediately prior to the termination of his employment unless Meyer's employment is terminated by Key for Cause, by Meyer's Voluntary Resignation before the fifth anniversary of the date of grant of the particular stock option, or as a result of death or disability. Each stock option (other than any performance option) granted to Meyer by Key after February 1, 2001 that remains outstanding and is vested on the Termination Date (whether pursuant to the immediately preceding sentence or otherwise) shall be exercisable after the Termination Date until that particular option's expiration date (which is the last date 18 that the option would be exercisable in accordance with its terms if Meyer had continued in Key's employment indefinitely) unless Meyer's employment is terminated by Key for Cause or by Meyer's Voluntary Resignation before the fifth anniversary of the date of grant of the particular stock option. In the case of incentive stock options granted to Meyer by Key after February 1, 2001, this Section 16 shall apply, recognizing however that failure to exercise the incentive stock option within the time periods after the Termination Date prescribed by the Internal Revenue Code may cause the option to fail to qualify for incentive stock option treatment under the Internal Revenue Code. If, in accordance with its terms and without regard to this Section 16, an option would vest earlier than is provided in this Section 16 or would be exercisable for a longer period than is provided in this Section 16, the terms of the option providing for earlier vesting and/or a longer period of exercisability, as the case may be, shall govern. Each stock option (other than performance options) granted to Meyer by Key after February 1, 2001 shall be deemed to contain the provisions of this Section 16 as a part of the award instrument evidencing such option. 17. Post-Termination Benefits. Following termination of his employment with Key for any reason other than Cause, Voluntary Resignation, or death, Key shall continue to provide to Meyer the following benefits: (a) Payment of monthly membership dues at one country club, one luncheon club, and one professional or cultural group or association located in the Greater Cleveland metropolitan area. (b) Payment of the cost of tax preparation assistance but only to the extent and as long as Key provides this benefit to its executive officers. (c) Payment of the cost of an executive physical examination but only to the extent and as long as Key provides this benefit to its executive officers. (d) Payment of an amount equal to the meeting fee and payment of reasonable expenses for a meeting of the Board of Directors if Meyer attends Key's annual meeting of shareholders. (e) Use of office space and secretarial support in Key facilities in Cleveland for a period of two years following the Termination Date. 18. Savings Clause. If any payments otherwise payable to Meyer under this Agreement are prohibited by any applicable statute or regulation in effect at the time the payments would otherwise be payable, including, without limitation, any regulation issued by the Federal Deposit Insurance Corporation (the "FDIC") that limits so called "golden parachute payments" that can be made by an FDIC insured institution or its holding company if the institution is financially troubled and certain so-called "indemnification payments" (any such statute or regulation being a "Limiting Rule"): (a) Key will use its best efforts to obtain the consent of the appropriate governmental agency (whether the FDIC or any other agency, and including using its best efforts to appeal any refusal by any such agency to grant its consent) to the 19 payment by Key to Meyer of the maximum amount that is permitted (up to the amounts that would be due to Meyer under this Agreement or otherwise absent the Limiting Rule); and (b) Meyer will be entitled to elect to have apply, and therefore to receive benefits directly under, either (i) this Agreement (as limited by the Limiting Rule) or (ii) any generally applicable Key plan or policy (including any severance, separation pay, and/or salary continuation plan that may be in effect at the time of Meyer's termination), up to the amounts that would be due to Meyer under this Agreement or otherwise absent the Limiting Rule. 19. Survival of Obligations. Except as is otherwise expressly provided in this Agreement, the respective obligations of Key and Meyer hereunder shall survive any termination of Meyer's employment under this Agreement. 20. Merger or Transfer of Assets of Key. Key will not consolidate with or merge into any other corporation, or transfer all or substantially all of its assets to another corporation, unless such other corporation shall assume this Agreement in a signed writing and deliver a copy thereof to Meyer. Upon such assumption the successor corporation shall become obligated to perform the obligations of Key under this Agreement, and the term "Key" as used in this Agreement shall be deemed to refer to such successor corporation. 21. Notices. Notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered in person (to the Secretary of Key in the case of notices to Key and to Meyer in the case of notices to Meyer) or mailed by United States registered mail, return receipt requested, postage prepaid, as follows: If to Key: KeyCorp 127 Public Square Cleveland, Ohio 44114-1306 Attention: Secretary If to Meyer: Mr. Henry L. Meyer III 3385 Roundwood Road Hunting Valley, Ohio 44022 or such other address as either party may have furnished to the other in writing in accordance herewith, except that notices of change of address shall be effective only upon receipt. 22. Validity. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement which shall remain in full force and effect. 23. Miscellaneous. No provision of this Agreement may be modified, waived, or discharged unless such waiver, modification, or discharge is agreed to in a writing signed by 20 Meyer and Key. No waiver by either party hereto at any time of any breach by the other party of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same time or at any prior or subsequent time. No agreement or representation, oral or otherwise, express or implied, with respect to the subject matter hereof has been made by either party which is not set forth expressly in this Agreement. This Agreement shall be governed by and construed in accordance with the laws of the State of Ohio. 24. Prior Agreement. This Agreement supersedes the agreement entered into between Meyer and Key as of October 15, 1996 that provided Meyer certain protection in the event of a Change of Control of Key. 25. Definitions. 25.1 Accounting Firm. The term "Accounting Firm" means the independent auditors of Key for the fiscal year preceding the earlier of (i) the year in which the Termination Date occurred, or (ii) the year, if any, in which occurred the first Change of Control occurring after the Effective Date, and such firm's successor or successors; provided, however, if such firm is unable or unwilling to serve and perform in the capacity contemplated by this Agreement, Key shall select another national accounting firm of recognized standing to serve and perform in that capacity under this Agreement, except that such other accounting firm shall not be the then independent auditors for Key or any of its affiliates (as defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended (the "1934 Act")). 25.2 Average Annual Incentive Compensation. The term "Average Annual Incentive Compensation" means the sum of Average Short Term Incentive Compensation, as defined in Section 25.4 below, and Average Long Term Incentive Compensation, as defined in Section 25.3 below. For purposes of this Agreement: (a) incentive compensation means any cash based incentive compensation, including bonuses and is calculated before any reduction on account of deferrals; (b) notwithstanding the fact that they are made in restricted stock rather than in cash, any LTIC Restricted Stock Grant shall be deemed to be long term incentive compensation; (c) short term incentive compensation means incentive compensation for periods of time of one year or less; (d) targeted short term incentive compensation means: (i) if the short term incentive compensation plan, program, or arrangement in question designates a targeted amount or a targeted level of achievement applicable to Meyer, it means that targeted amount or level; 21 (ii) if the short term incentive compensation plan, program, or arrangement in question has only one level of payout applicable to Meyer (other than zero), it means that level (i.e.: the level other than zero); (iii) if the short term incentive compensation plan, program, or arrangement in question does not designate a targeted amount or level of achievement applicable to Meyer but does have multiple anticipated levels of possible payout or achievement applicable to Meyer, it means (in each case excluding from consideration any level that results in zero payout) the middle level of payout or achievement applicable to Meyer (or if there are an even number of levels, the average of the two levels if there are only two levels or the average of the middle two levels if there are four or more levels); and (iv) in all other cases, the amount anticipated or projected to be paid under the plan, program, or arrangement in question at the time the performance period in question commenced. 25.3 Average Long Term Incentive Compensation. The term "Average Long Term Incentive Compensation" means: (a) if the Relevant Year is 2002, the dollar value of the 2002 LTIC Restricted Stock Grant; (b) if the Relevant Year is 2003, the higher of: (i) the dollar value of the 2002 LTIC Restricted Stock Grant, and (ii) the dollar value of the 2003 LTIC Restricted Stock Grant; and (c) if the Relevant Year is 2004 or any later year, the higher of (i) the average of the dollar value of the LTIC Restricted Stock Grants made to Meyer in each of the two years immediately preceding the Relevant Year (e.g., the average of the 2003 LTIC Restricted Stock Grant and the 2004 LTIC Restricted Stock Grant if the Relevant Year is 2005), or, if for any reason an LTIC Restricted Stock Grant was made to Meyer in only one of those two immediately preceding years, the dollar value of the LTIC Restricted Stock Grant for that single year, and (ii) the dollar value of the LTIC Restricted Stock Grant for the Relevant Year. For purposes of this Section 25.3, the dollar value of any LTIC Restricted Stock Grant means the aggregate Fair Market Value of the restricted Common Shares subject to that grant as of the date the grant is made, without regard to changes in Key's stock price after the date of grant or to any restrictions on those Common Shares. 22 25.4 Average Short Term Incentive Compensation. The term "Average Short Term Incentive Compensation" means the higher of: (a) the average of the short term incentive compensation payable to Meyer for each of the last two years immediately preceding the Relevant Year or, if for any reason short term incentive compensation was payable to Meyer for only one of those two years, the amount of short term incentive compensation payable to Meyer for that year, and (b) Meyer's targeted short term incentive compensation for the Relevant Year or for the year immediately preceding the Relevant Year, whichever is higher. 25.5 Base Salary. The term "Base Salary" means the salary payable to Meyer from time to time before any reduction for voluntary contributions to the KeyCorp 401(k) Plan or any other deferral under any other plan. Base Salary does not include imputed income from payment by Key of country club membership fees or other noncash benefits. 25.6 Board of Directors. The term "Board of Directors," when used other than with specific reference to another entity, means the Board of Directors of Key. 25.7 Change of Control. A "Change of Control" shall be deemed to have occurred if, at any time after the date of this Agreement and while Meyer remains in the employ of Key, there is a Change of Control under any of clauses (a), (b), (c), or (d) below. For these purposes, Key will be deemed to have become a subsidiary of another corporation if any other corporation (which term shall, for all purposes of this Section 25.7, 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 Key or any successor to Key. (a) A Change of Control will have occurred under this clause (a) if Key is a party to a transaction pursuant to which Key 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 Key becomes a subsidiary in the transaction) of the ultimate parent of Key represent or were issued in exchange for voting securities of Key outstanding immediately prior to the transaction, or (ii) immediately after giving effect to that transaction, individuals who were directors of Key on the day before the first public announcement of (x) the pendency of the transaction or (y) the intention of any person or entity to cause the transaction to occur, cease for any reason to constitute at least 51% of the directors of the surviving or resulting corporation or (if Key becomes a subsidiary in the transaction) of the ultimate parent of Key. 23 (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 Key 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 Key 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 Key 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 Board of Directors any person or entity makes a public announcement of a bona fide intention (A) to engage in a transaction with Key that, if consummated, would result in a Change Event (as defined below in this clause (c)), or (B) to "solicit" (as defined in Rule 14a-1 under the 1934 Act) proxies in connection with a proposal that is not approved or recommended by the 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 Key (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 Key (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 Key'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 Key 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 24 the beneficial owner of 25% or more of the outstanding voting stock of Key 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 Key in a transaction or series of transactions by any person (as defined earlier in this subclause (x)). (y) Key is a party to a transaction pursuant to which Key is merged with or into, or is consolidated with, or becomes the subsidiary of another corporation and, after giving effect to such transaction, less than 50% of the then outstanding voting securities of the surviving or resulting corporation or (if Key becomes a subsidiary in the transaction) of the ultimate parent of Key represent or were issued in exchange for voting securities of Key outstanding immediately prior to such transaction or less than 51% of the directors of the surviving or resulting corporation or (if Key becomes a subsidiary in the transaction) of the ultimate parent of Key were directors of Key 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 Key. (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 Key. 25.8 Committee. The term "Committee" means the Compensation and Organization Committee of the Board of Directors of Key or any successor to that committee. 25.9 Common Shares. The term "Common Shares" means common shares of Key. 25.10 Competitive Activity. Meyer shall be deemed to have engaged in "Competitive Activity" if he engages, without Key's prior written consent, in any business or business activity in which Key or any of its Subsidiaries engages, including, without limitation, engaging in any business activity in the banking or financial services industry (other than as a director, officer, or employee of Key or any of its Subsidiaries) or has an ownership interest in, or serves as a director, officer, agent, or employee of, or in any other capacity with, any Financial Services Company or renders services of a consultative, advisory, or other nature to any Financial Services Company. Notwithstanding the foregoing, Meyer will not be deemed to have engaged in Competitive Activity solely because of any one or more investments he may make in any one or more for profit entity or entities, none of which is a Financial Services Company, or solely because he owns stock in a publicly held Financial Services Company that constitutes not more than 1% of the outstanding stock of that Financial Services Company. 25 25.11 Day. A "day" as used in this Agreement means a calendar day unless business day is specifically referred to. 25.12 Demotion or Removal. Meyer shall be deemed to have been subjected to "Demotion or Removal:" (a) if Meyer ceases to be Chairman of the Board of Key (or, after a Change of Control, of the Surviving Entity) at any time before the expiration of the term of his employment pursuant to Section 6.1, other than as a result of the termination of his employment by Key for Cause or of his Voluntary Resignation or Voluntary Retirement, death, or disability, (b) if Meyer ceases to be or have the responsibilities, duties, or authorities of Chief Executive Officer of Key (or, after a Change of Control, of the Surviving Entity) at any time before the expiration of the term of his employment pursuant to Section 6.1, other than as a result of the termination of his employment by Key for Cause or of his Voluntary Resignation or Voluntary Retirement, death, or disability, or (c) if Meyer ceases to be a director of Key (or, after a Change of Control, of the Surviving Entity) at any time before the expiration of the term of his employment pursuant to Section 6.1, other than as a result of the termination of his employment by Key for Cause or of his Voluntary Resignation or Voluntary Retirement, death, or disability. 25.13 Fair Market Value. The term "Fair Market Value" with respect to Common Shares means: (a) if the Common Shares are traded on a national exchange, the mean between the high and low sales price per Common Share on the 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 report 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. 25.14 Financial Services Company. The term "Financial Services Company" means a bank, bank holding company, savings and loan association, building and loan association, savings and loan holding company, insurance company, investment banking, or securities company, or other financial services company, other than Key or any of its Subsidiaries. 26 25.15 Impermissible. The term "Impermissible," when used in the context of Meyer's continued coverage by and participation in any of the Retirement Plans or Savings Plans shall mean that such a continuation would violate the provisions of any such plan, would cause any such plan that is or is intended to be qualified under Section 401(a) of the Internal Revenue Code to fail to be so qualified, would require shareholder approval, or would be unlawful. 25.16 Long Term Disability Plan. The term "Long Term Disability Plan" means and includes the KeyCorp Long Term Disability Plan as from time to time amended, restated, or otherwise modified, including any long term disability plan or program that, after the Effective Date, succeeds, replaces, or is substituted for that plan and includes long term disability benefits or rights provided pursuant to or under insurance contracts maintained by Key applicable to executive officers of Key. 25.17 LTIC Restricted Stock Grant. The term "LTIC Restricted Stock Grant" means the grant, if any, of restricted stock made by the Committee to Meyer during any particular year as part of Key's ongoing compensation program. For greater clarity, for purposes of this Agreement: (a) The grant of 42,025 shares of restricted stock made by the Committee to Meyer pursuant to the KeyCorp Chief Executive Officer Restricted Stock Plan by resolution adopted January 17, 2002, which provided for vesting of one-half of the restricted stock subject to the grant (the "Time Lapse Restricted Shares") on December 31, 2004 (or earlier in certain circumstances involving Meyer's termination following a Change of Control) and for vesting of the remaining one- half of the restricted stock subject to the grant (the "Performance Accelerated Restricted Shares") on December 31, 2008 (or earlier if a stock price performance test specified in the resolution is met or if a Change of Control occurs on or before December 31, 2004) does constitute an LTIC Restricted Stock Grant. (b) By a further resolution adopted January 17, 2002, the Committee also granted to Meyer an additional 21,015 shares of restricted stock, also pursuant to the KeyCorp Chief Executive Officer Restricted Stock Plan. This smaller grant (i) includes Time Lapse Restricted Shares that vest on December 31, 2003 (or earlier), rather than on December 31, 2004 (or earlier), (ii) is not, for purposes of this Agreement, considered to be an LTIC Restricted Stock Grant, and (iii) is to be ignored when calculating Meyer's Average Long Term Incentive Compensation. (c) The 42,025 share LTIC Restricted Stock Grant made to Meyer in 2002 is referred to in this Agreement as the "2002 LTIC Restricted Stock Grant." The terms "2003 LTIC Restricted Stock Grant," "2004 LTIC Restricted Stock Grant," etc. similarly refer to LTIC Restricted Stock Grants, if any, made to Meyer by resolution adopted by the Committee in the specified year. 27 25.18 Majority Action. The term "Majority Action," when used in reference to the Board of Directors, means an action taken by the affirmative vote of a majority of the entire number of members of the Board of Directors. 25.19 Relevant Year. The term "Relevant Year" means the year in which the Termination Date occurs unless, during the two year period ending on the Termination Date, there has occurred one or more Changes of Control, in which case the term "Relevant Year" means the year in which occurred the first Change of Control that occurred during that two year period. 25.20 Retiree Medical Benefits Plan. The term "Retiree Medical Benefits Plan" means and includes the KeyCorp Medical Benefits Plan For Retirees as from time to time amended, restated, or otherwise modified, including any plan that, after the Effective Date, succeeds, replaces, or is substituted for that plan. 25.21 Retirement Plans. The term "Retirement Plans" means and includes the KeyCorp Cash Balance Pension Plan, which succeeded by merger the Retirement Plan for Employees of Society Corporation and Subsidiaries, and the Supplemental Retirement Plan, in all cases, as from time to time amended, restated, or otherwise modified, including any plan that, after the Effective Date, succeeds, replaces, or is substituted for any such plan, and all retirement plans of any nature maintained by Key or any of its Subsidiaries in which Meyer was participating prior to the Termination Date. Reference to a "Retirement Plan," in the singular, means any of the Retirement Plans. 25.22 Savings Plan. The term "Savings Plans" means and includes the KeyCorp 401(k) Savings Plan and the KeyCorp Excess 401(k) Savings Plan, in both cases, as from time to time amended, restated, or otherwise modified, including any plan that, after the Effective Date, succeeds, replaces, or is substituted for either such plan, and all salary reduction, savings, profit-sharing, or stock bonus plans (including, without limitation, all plans involving employer matching contributions, whether or not constituting a qualified cash or deferred arrangement under Section 401(k) of the Internal Revenue Code), maintained by Key or any of its Subsidiaries in which Meyer was participating prior to the Termination Date. Reference to a "Savings Plan," in the singular, shall mean any of the Savings Plans. 25.23 Subsidiary. The term "Subsidiary," as of any time, means any corporation, bank, partnership, or other entity a majority of the voting control of which is directly or indirectly owned or controlled at that time by Key or, after a Change of Control, by the Surviving Entity. 25.24 Surviving Entity. The term "Surviving Entity" means the entity surviving or resulting from any Change of Control involving Key or (if Key becomes a subsidiary in the transaction) the ultimate parent of Key. 25.25 Supplemental Retirement Plan. The term "Supplemental Retirement Plan" means the KeyCorp Supplemental Retirement Plan, which succeeded by merger the Amended and Restated Society Corporation Supplemental Retirement Plan, in all cases, 28 as from time to time amended, restated, or otherwise modified, including any plan that, after the Effective Date, succeeds, replaces, or is substituted for the KeyCorp Supplemental Retirement Plan. 25.26 Termination Date. The term "Termination Date" means the date on which Meyer's employment with Key and its Subsidiaries terminates. 25.27 Voluntary Resignation. The term "Voluntary Resignation" means a termination by Meyer of his employment with Key and its Subsidiaries before the expiration of the term of his employment pursuant to Section 6.1 by voluntarily resigning at his own instance without having been requested to so resign by Key, provided, however: (a) A resignation by Meyer will not be deemed to be a Voluntary Resignation if it occurs at a time when Meyer is entitled to terminate his employment on grounds of Constructive Termination; (b) Meyer will not be considered to have Voluntarily Resigned if he retires at any time on or after February 1, 2011; and (c) Meyer will not be considered to have Voluntarily Resigned if he retires at any time before February 1, 2011 with the approval of the Board of Directors or the Committee. 25.28 Voluntary Retirement. The term "Voluntary Retirement" means a termination by Meyer of his employment with Key and its Subsidiaries by voluntarily retiring at his own instance without having been requested to so retire by Key, except that any retirement by Meyer will not be deemed to be a Voluntary Retirement if it occurs at a time when Meyer is entitled to terminate his employment on grounds of Constructive Termination. IN WITNESS WHEREOF, Key and Meyer have executed this Agreement, Key by its duly authorized Vice Chairman of the Board, as of the date first written above. KEYCORP By: _____________________________ Thomas C. Stevens Vice Chairman of the Board _____________________________ HENRY L. MEYER III 29 EX-15 10 l95281aexv15.txt ACKNOWLEDGEMENT LETTER OR INDEPENDENT AUDITORS EXHIBIT 15 ACKNOWLEDGMENT LETTER OF INDEPENDENT AUDITORS Shareholders and Board of Directors KeyCorp We are aware of the incorporation by reference in the following KeyCorp ("Key") Registration Statements of our review report, dated July 12, 2002, relating to the unaudited condensed consolidated interim financial statements of Key, included in the Quarterly Report on Form 10-Q for the quarter ended June 30, 2002. Form S-3 No. 33-58405 Form S-3 No. 333-10577 (Post-Effective Amendments No. 1 and No. 2) Form S-3 No. 333-55959 Form S-3 No. 333-64601 Form S-3 No. 333-59175 Form S-3 No. 333-76619 (Post-Effective Amendment No. 1) Form S-3 No. 333-88063 Form S-3 No. 333-50802 Form S-3 No. 333-56258 Form S-3 No. 333-63104 Form S-3 No. 333-73380 (Amendment No. 1) Form S-3 No. 333-88934 (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 August 8, 2002 69 EX-99.1 11 l95281aexv99w1.txt CERTIFICATION CHIEF EXECUTIVE OFFICER Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. 1350, the undersigned officer of KeyCorp (the "COMPANY"), hereby certifies that the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (the "REPORT") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. August 13, 2002 /s/ Henry L. Meyer III ---------------------- Henry L. Meyer III Chief Executive Officer The foregoing certification is being furnished solely pursuant to 18 U.S.C. 1350 and is not being filed as part of the Report or as a separate disclosure document. EX-99.2 12 l95281aexv99w2.txt CERTIFICATION CHIEF FINANCIAL OFFICER Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to 18 U.S.C. 1350, the undersigned officer of KeyCorp (the "COMPANY"), hereby certifies that the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 (the "REPORT") fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. August 13, 2002 /s/ K. Brent Somers ------------------------ K. Brent Somers Chief Financial Officer The foregoing certification is being furnished solely pursuant to 18 U.S.C. 1350 and is not being filed as part of the Report or as a separate disclosure document. -----END PRIVACY-ENHANCED MESSAGE-----