-----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, JjJZInKv/B/ZX0aZvfmPvBGtkxlrQ7w0znjGYOGfCnQ4WHm/qm7nlyGHOw/Yftek tGuR0COjMwVYG5sRplOUxw== 0000950152-97-008110.txt : 19971117 0000950152-97-008110.hdr.sgml : 19971117 ACCESSION NUMBER: 0000950152-97-008110 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NYSE 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/A SEC ACT: SEC FILE NUMBER: 001-11302 FILM NUMBER: 97721530 BUSINESS ADDRESS: STREET 1: 127 PUBLIC SQ CITY: CLEVELAND STATE: OH ZIP: 44114-1306 BUSINESS PHONE: 2166893000 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/A 1 KEYCORP 10-Q/A 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q/A [] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 1997 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From ______ To ______ Commission File Number 0-850 [KEY CORP LOGO] ------------------------------------------------------ (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) This First Amendment to the Quarterly Report on Form 10-Q for the period ended September 30, 1997, is filed for the sole purpose of correcting an error in the electronic submission of the Registrant's Form 10-Q filed with the Commission on November 14, 1997, in which certain information was inadvertently omitted. All Items included that Form 10-Q are included in this First Amendment and are deemed to be amended. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Shares with a par value of $1 each 219,682,883 Shares - ----------------------------------------- ---------------------------------- (Title of class) (Outstanding at October 31, 1997) The number of pages of this report is 45. 2 KEYCORP TABLE OF CONTENTS PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number -------------------- ----------- Consolidated Balance Sheets -- September 30, 1997, December 31, 1996, and September 30, 1996 3 Consolidated Statements of Income -- Three months and nine months ended September 30, 1997 and 1996 4 Consolidated Statements of Changes in Shareholders' Equity -- Nine months ended September 30, 1997 and 1996 5 Consolidated Statements of Cash Flow -- Nine months ended September 30, 1997 and 1996 6 Notes to Consolidated Financial Statements 7 Independent Accountants' Review Report 19 Item 2. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations 20 ------------------------- PART II. OTHER INFORMATION Item 1. Legal Proceedings 43 ----------------- Item 6. Exhibits and Reports on Form 8-K 43 -------------------------------- Signature 43
2 3 PART I. FINANCIAL INFORMATION KEYCORP AND SUBSIDIARIES Consolidated Balance Sheets
SEPTEMBER 30, December 31, September 30, dollars in millions 1997 1996 1996 - --------------------------------------------------------------------------------------------------------------------------------- (UNAUDITED) (Unaudited) ASSETS Cash and due from banks $ 2,940 $ 3,444 $ 3,110 Short-term investments 1,217 696 501 Securities available for sale 7,563 7,728 7,113 Investment securities (fair value: $1,378, $1,637 and $1,689) 1,344 1,601 1,653 Loans 53,676 49,235 48,373 Less: Allowance for loan losses 900 870 870 - --------------------------------------------------------------------------------------------------------------------------------- Net loans 52,776 48,365 47,503 Premises and equipment 993 1,084 1,052 Goodwill 1,095 824 838 Corporate owned life insurance 1,583 1,515 1,301 Other assets 2,566 2,364 2,285 - --------------------------------------------------------------------------------------------------------------------------------- Total assets $72,077 $67,621 $65,356 ======= ======= ======= LIABILITIES Deposits in domestic offices: Noninterest-bearing $ 8,965 $ 9,524 $ 9,032 Interest-bearing 32,733 34,455 34,608 Deposits in foreign offices -- interest-bearing 2,172 1,338 883 - --------------------------------------------------------------------------------------------------------------------------------- Total deposits 43,870 45,317 44,523 Federal funds purchased and securities sold under repurchase agreements 6,662 6,925 5,592 Bank notes and other short-term borrowings 6,053 3,969 3,861 Other liabilities 2,099 1,816 1,740 Long-term debt 7,567 4,213 4,664 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities 66,251 62,240 60,380 Corporation-obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely debentures of the Corporation (See Note 8) 750 500 -- SHAREHOLDERS' EQUITY Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- -- 10% Cumulative Preferred Stock Class A, $125 stated value; authorized 1,400,000 shares, none issued -- -- -- Common Shares, $1 par value; authorized 900,000,000 shares; issued 245,944,390 shares 246 246 246 Capital surplus 1,531 1,484 1,488 Retained earnings 4,455 4,060 3,994 Loans to ESOP trustee (42) (49) (49) Net unrealized gains (losses) on securities available for sale, net of income taxes 8 (6) (37) Treasury stock, at cost (26,278,189, 22,490,353 and 18,882,718 shares) (1,122) (854) (666) - --------------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 5,076 4,881 4,976 - --------------------------------------------------------------------------------------------------------------------------------- Total liabilities, capital securities and shareholders' equity $72,077 $67,621 $65,356 ======= ======= ======= - ---------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 3 4 KEYCORP AND SUBSIDIARIES Consolidated Statements of Income (Unaudited)
Three months ended September 30, Nine months ended September 30, -------------------------------- ------------------------------- dollars in millions, except per share amounts 1997 1996 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans $1,191 $1,089 $3,417 $3,248 Taxable investment securities 3 4 9 11 Tax-exempt investment securities 15 20 51 58 Securities available for sale 127 119 397 372 Short-term investments 11 6 23 19 - --------------------------------------------------------------------------------------------------------------------------------- Total interest income 1,347 1,238 3,897 3,708 INTEREST EXPENSE Deposits 370 360 1,101 1,111 Federal funds purchased and securities sold under repurchase agreements 91 72 263 218 Bank notes and other short-term borrowings 73 55 194 144 Long-term debt 109 68 250 201 - --------------------------------------------------------------------------------------------------------------------------------- Total interest expense 643 555 1,808 1,674 - --------------------------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 704 683 2,089 2,034 Provision for loan losses 102 49 244 140 - --------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 602 634 1,845 1,894 NONINTEREST INCOME Service charges on deposit accounts 77 74 222 218 Trust and asset management income 66 61 194 180 Credit card fees 25 24 73 68 Insurance and brokerage income 22 18 64 52 Corporate owned life insurance income 20 15 60 42 Loan securitization income 15 18 19 45 Net securities gains -- -- -- 1 Other income 168 79 308 196 - --------------------------------------------------------------------------------------------------------------------------------- Total noninterest income 393 289 940 802 NONINTEREST EXPENSE Personnel 299 300 872 889 Net occupancy 54 55 164 163 Equipment 44 41 131 119 Amortization of intangibles 23 21 65 65 Professional fees 10 18 34 47 Marketing 22 30 65 68 Other expense 196 150 474 413 - --------------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 648 615 1,805 1,764 INCOME BEFORE INCOME TAXES 347 308 980 932 Income taxes 111 101 309 300 - --------------------------------------------------------------------------------------------------------------------------------- NET INCOME $ 236 $ 207 $ 671 $ 632 ======= ======= ======= ======= Net income applicable to Common Shares $236 $207 $671 $624 Per Common Share: Net income $1.08 $.90 $3.06 $2.70 Net income - fully diluted 1.06 .88 2.99 2.65 Weighted average Common Shares outstanding (000) 218,107 229,668 219,570 231,363 - ---------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 4 5 KEYCORP AND SUBSIDIARIES Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
Net Unrealized Loans to Gains (Losses) Treasury Preferred Common Capital Retained ESOP on Securities Stock dollars in millions, except per share amounts Stock Shares Surplus Earnings Trustee Available for Sale at Cost - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1995 $160 $246 $1,500 $3,633 $(51) $ 48 $(383) Net income 632 Cash dividends: Common Shares ($1.14 per share) (263) Cumulative Preferred Stock ($6.25 per share) (8) Redemption of 10% Cumulative Preferred Stock (160) Issuance of Common Shares: Acquisition - 270,263 shares 2 9 Employee benefit and dividend reinvestment plans - 3,193,154 net shares (14) 104 Repurchase of Common Shares - 10,104,566 shares (396) Net unrealized losses on securities available for sale, net of income taxes of $(38) (85) Loan payment from ESOP Trustee 2 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT SEPTEMBER 30, 1996 -- $246 $1,488 $3,994 $(49) $ (37) $(666) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1996 -- $246 $1,484 $4,060 $(49) $ (6) $ (854) Adjustment related to change in accounting for transfers of financial assets, net of deferred tax benefit of $(25) (43) Net income 671 Cash dividends on Common Shares ($1.26 per share) (275) Issuance of Common Shares: Acquisition - 3,336,118 shares 56 143 Employee benefit and dividend reinvestment plans - 1,856,064 net shares (9) 82 Repurchase of Common Shares - 8,980,018 shares (493) Net unrealized gains on securities available for sale, net of income taxes of $32 57 Loan payment from ESOP trustee 7 Foreign currency translation adjustments (1) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT SEPTEMBER 30, 1997 -- $246 $1,531 $4,455 $(42) $ 8 $(1,122) == ==== ====== ====== ==== ====== ======= - ------------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 5 6 KEYCORP AND SUBSIDIARIES Consolidated Statements of Cash Flow (Unaudited)
Nine months ended September 30, ------------------------------- in millions 1997 1996 - ------------------------------------------------------------------------------------------------------------------ OPERATING ACTIVITIES Net income $ 671 $ 632 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 244 140 Depreciation expense 115 105 Amortization of intangibles 65 65 Net gains from sales of subsidiaries/branches (89) (8) Net securities gains -- (1) Deferred income taxes 40 83 Net decrease in mortgage loans held for sale 132 558 Net increase in trading account assets (530) (68) Decrease in accrued restructuring charge 62 -- Other operating activities, net (617) (193) - ------------------------------------------------------------------------------------------------------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 93 1,313 INVESTING ACTIVITIES Net increase in loans, excluding sales, acquisitions and divestitures (5,281) (2,326) Loans sold 1,219 876 Purchases of investment securities (387) (627) Proceeds from sales of investment securities 10 9 Proceeds from prepayments and maturities of investment securities 597 620 Purchases of securities available for sale (1,535) (1,608) Proceeds from sales of securities available for sale 180 56 Proceeds from prepayments and maturities of securities available for sale 1,620 2,372 Net increase in other short-term investments (162) (125) Purchases of premises and equipment (169) (184) Proceeds from sales of premises and equipment 125 37 Proceeds from sales of other real estate owned 25 22 Purchases of corporate owned life insurance -- (145) Net proceeds from sales of subsidiaries/branches (241) 140 Cash used in acquisitions, net of cash acquired (1) (12) - ------------------------------------------------------------------------------------------------------------------ NET CASH USED IN INVESTING ACTIVITIES (4,000) (895) FINANCING ACTIVITIES Net decrease in deposits (118) (1,766) Net increase in short-term borrowings 1,800 1,028 Net proceeds from issuance of long-term debt 3,231 1,593 Payments on long-term debt (1,072) (872) Proceeds from the issuance of capital securities 250 -- Loan payment received from ESOP trustee 7 2 Purchases of treasury shares (493) (396) Redemption of 10% Cumulative Preferred Stock -- (160) Proceeds from issuance of common stock pursuant to employee benefit and dividend reinvestment plans 73 90 Cash dividends (275) (271) - ------------------------------------------------------------------------------------------------------------------ NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 3,403 (752) - ------------------------------------------------------------------------------------------------------------------ NET DECREASE IN CASH AND DUE FROM BANKS (504) (334) CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,444 3,444 - ------------------------------------------------------------------------------------------------------------------ CASH AND DUE FROM BANKS AT END OF PERIOD $ 2,940 $ 3,110 ======= ======= - ------------------------------------------------------------------------------------------------------------------ Additional disclosures relative to cash flow: Interest paid $ 1,754 $ 1,622 Income taxes paid 183 120 Net amount received on portfolio swaps 49 58 Noncash items: Transfer of loans to other real estate owned $ 19 $ 20 Transfer of other assets to securities available for sale 280 -- - ------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 6 7 KEYCORP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The unaudited consolidated interim financial statements include the accounts of KeyCorp and its subsidiaries ("Key"). All significant intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, the unaudited consolidated interim financial statements reflect all adjustments of a normal recurring nature and disclosures which are necessary for a fair presentation of the results for the interim periods presented, and should be read in conjunction with the audited consolidated financial statements and related notes included in Key's 1996 Annual Report to Shareholders. In addition, certain reclassifications have been made to prior year amounts to conform with the current year presentation. In the third quarter of 1997, a $50 million charge was recorded in connection with actions taken to sell certain properties or to alter certain leasing arrangements in response to Key's nationwide banking and related centralization efforts. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. On January 1, 1997, Key adopted Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extingushments of Liabilities." SFAS No. 125 requires that certain assets which are subject to prepayment and recorded in connection with a securitization be accounted for like investments in interest-only strips. Accordingly, Key reclassified approximately $280 million of these assets, which represent uncertificated residual interests in securitizations, to securities available for sale. At the time of the transfer, the carrying amount of these assets exceeded their fair value by approximately $68 million. This difference was recorded as a reduction to the carrying amount of the transferred assets and the related after tax adjustment of $43 million was made to net unrealized losses on securities in shareholders' equity. SFAS No. 125 is more fully discussed in Note 1, Summary of Significant Accounting Policies, of Key's 1996 Annual Report. In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128, "Earnings Per Share," which specifies the computation, presentation and disclosure requirements for earnings per share for entities with publicly held common stock or common stock equivalents. SFAS No. 128 replaces the presentation of primary earnings per share with the presentation of basic earnings per share. It also requires dual presentation of basic and diluted earnings per share on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic earnings per share computation to the corresponding amounts of the diluted earnings per share computation. SFAS No. 128 is effective for both interim and annual financial statements issued for periods ending after December 15, 1997, with earlier adoption prohibited. Key will adopt SFAS No. 128 in its December 31, 1997, financial statements, with no effect on prior period data. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 130 establishes reporting and display standards for comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances arising from nonowner sources. The purpose of the statement is to provide a basis for reporting a measure of all changes in equity of an enterprise that will result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. SFAS No. 130 is effective for both interim and annual financial statements issued for periods beginning after December 15, 1997, and also applies to financial statements presented for prior periods. SFAS No. 131 requires that financial and descriptive information be disclosed for each reportable operating segment based on the management approach. The management approach focuses on financial information that an enterprise's decision makers use to assess performance and make decisions about resource allocation. The statement also prescribes the enterprise-wide disclosures to be made about products, services, geographic areas and major customers. SFAS No. 131 is effective for annual financial statements issued for periods beginning after December 15, 1997, and for interim financial statements in the second year of application. Comparative information presented for earlier periods must be restated. Key will adopt SFAS No. 130 in its March 31, 1998, financial statements and expects to include the disclosures required by SFAS No. 131 in its December 31, 1998, financial statements. 7 8 2. MERGERS, ACQUISITIONS AND DIVESTITURES COMPLETED MERGERS AND ACQUISITIONS Mergers and acquisitions completed by Key during 1996 and the first nine months of 1997 (all of which were accounted for as purchase business combinations) are summarized below:
dollars in millions COMMON LOCATION DATE ASSETS SHARES ISSUED - --------------------------------------------------------------------------------------------------------------------- Champion Mortgage Co., Inc. 1 New Jersey August 1997 $317 3,336,118 Leasetec Corporation 1 Colorado July 1997 1,080 See note 2 Carleton, McCreary, Holmes & Co. 3 Ohio August 1996 1 See note 2 Knight Insurance Agency, Inc. 4 Massachusetts June 1996 8 -- - --------------------------------------------------------------------------------------------------------------------- 1 See the following text for more information regarding this transaction. 2 In accordance with a confidentiality clause in the purchase agreement, the terms, which are not material, have not been publicly disclosed. 3 Carleton McCreary, Holmes & Company ("Carleton") is an investment banking firm specializing in mergers and acquisitions and other financial advisory services for mid-sized and large corporations. 4 Knight Insurance Agency, Inc. ("Knight") is an education financing company doing business under the name "Knight College Resource Group."
CHAMPION MORTGAGE CO., INC. On August 29, 1997, Key acquired Champion Mortgage Co., Inc. ("Champion"), a home equity finance company headquartered in Parsippany, New Jersey. Under the terms of the merger agreement, 3,336,118 Common Shares, with a value of approximately $200 million, were exchanged for all of the outstanding shares of Champion common stock in a transaction structured as a tax-free exchange and accounted for as a purchase. The merger agreement also provides an opportunity for Champion's shareholders to receive additional consideration in the form of Key Common Shares valued at up to $100 million in the event that certain performance targets related to significant increases in profitability and origination volumes established at the date of closing are achieved over the next three years. In connection with the transaction, Key recorded goodwill of approximately $195 million, which is being amortized using the straight-line method over a period of 25 years. At closing, Champion became a wholly owned subsidiary of Key Bank USA, National Association ("KeyBank USA"), a wholly owned subsidiary of the parent company. LEASETEC CORPORATION On July 1, 1997, Key acquired an 80% interest (with an option to purchase the remaining 20%) in Leasetec Corporation ("Leasetec"), a privately held equipment leasing company headquartered in Boulder, Colorado with operations in the United States and overseas. In connection with the transaction, which was accounted for as a purchase, Key recorded goodwill of approximately $126 million, which is being amortized using the straight-line method over a period of 25 years. COMPLETED DIVESTITURES KEYBANK NATIONAL ASSOCIATION (WYOMING) On July 14, 1997, Key sold KeyBank National Association (Wyoming) ("KeyBank Wyoming"), its 28 branch Wyoming bank subsidiary. KeyBank Wyoming had assets of approximately $1.1 billion at the time of the transaction. A $53 million ($35 million after tax) gain was realized on the KeyBank Wyoming sale and included in other income on the income statement. SOCIETY FIRST FEDERAL SAVINGS BANK On June 1, 1996, Key sold Society First Federal Savings Bank ("SFF"), its Florida savings association subsidiary. SFF had assets of approximately $1.2 billion at the time of the transaction. Key continues to provide private banking services in Florida through KeyBank National Association. An $8 million ($5 million after tax) gain was realized on the SFF sale and included in other income on the income statement. 8 9 TRANSACTIONS PENDING AS OF SEPTEMBER 30, 1997 BRANCH DIVESTITURES On November 26, 1996, Key announced its intention to divest approximately 140 branch offices (including the 28 branches associated with the sale of KeyBank Wyoming). During the first nine months of 1997, including the KeyBank Wyoming transaction, 49 such branches with deposits of approximately $1.3 billion were sold resulting in aggregate gains of $89 million ($58 million after tax) which were recorded in other income on the income statement. As of October 31, 1997, contracts had been entered into to sell a total of 68 other branch offices with deposits of approximately $1.1 billion. The sales of these remaining branches are expected to close in the fourth quarter of 1997 and the first half of 1998. 3. SECURITIES AVAILABLE FOR SALE The amortized cost, unrealized gains and losses, and approximate fair values of securities available for sale were as follows:
SEPTEMBER 30, 1997 --------------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE - ----------------------------------------------------------------------------------------------------------------------- U.S. Treasury, agencies and corporations $ 572 $ 2 -- $ 574 States and political subdivisions 50 -- -- 50 Collateralized mortgage obligations 3,376 14 $ 8 3,382 Other mortgage-backed securities 3,130 52 17 3,165 Other securities 423 2 33 392 - ----------------------------------------------------------------------------------------------------------------------- Total $7,551 $70 $58 $7,563 ======= ==== ==== ====== - ----------------------------------------------------------------------------------------------------------------------- December 31, 1996 --------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair in millions Cost Gains Losses Value - ----------------------------------------------------------------------------------------------------------------------- U.S. Treasury, agencies and corporations $ 857 $ 3 $ 1 $ 859 States and political subdivisions 36 -- -- 36 Collateralized mortgage obligations 3,169 3 23 3,149 Other mortgage-backed securities 3,570 44 35 3,579 Other securities 104 1 -- 105 - ----------------------------------------------------------------------------------------------------------------------- Total $7,736 $51 $59 $7,728 ======= ==== ==== ====== - ----------------------------------------------------------------------------------------------------------------------- September 30, 1996 --------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair in millions Cost Gains Losses Value - ----------------------------------------------------------------------------------------------------------------------- U.S. Treasury, agencies and corporations $ 1,135 $ 3 $ 7 $ 1,131 States and political subdivisions 29 -- -- 29 Collateralized mortgage obligations 2,488 1 31 2,458 Other mortgage-backed securities 3,416 34 63 3,387 Other securities 107 1 -- 108 - ----------------------------------------------------------------------------------------------------------------------- Total $7,175 $39 $101 $7,113 ======= ==== ===== ====== - -----------------------------------------------------------------------------------------------------------------------
9 10 Debt securities that Key has the positive intent and ability to hold to maturity are classified as securities held to maturity and are carried at cost, adjusted for amortization of premiums and accretion of discounts using the level yield method. Securities held to maturity and equity securities that do not have readily determinable fair values are presented as investment securities on the balance sheet. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading account assets, reported at fair value ($567 million and $101 million as of September 30, 1997 and 1996, respectively) and included in short-term investments on the balance sheet. Realized and unrealized gains and losses on such assets are reported in other income on the income statement. Debt and equity securities that Key has not classified as investment securities or trading account assets are classified as securities available for sale and, as such, are reported at fair value, with net unrealized gains and losses, net of deferred taxes, reported as a component of shareholders' equity. At September 30, 1997, shareholders' equity was increased by $8 million, representing the net unrealized gain on securities available for sale, net of deferred tax expense. 4. INVESTMENT SECURITIES The amortized cost, unrealized gains and losses and approximate fair values of investment securities were as follows:
SEPTEMBER 30, 1997 --------------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE - ----------------------------------------------------------------------------------------------------------------------- States and political subdivisions $1,105 $34 -- $1,139 Other securities 239 -- -- 239 - ----------------------------------------------------------------------------------------------------------------------- Total $1,344 $34 -- $1,378 ======= ==== ==== ====== - ----------------------------------------------------------------------------------------------------------------------- December 31, 1996 --------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair in millions Cost Gains Losses Value - ----------------------------------------------------------------------------------------------------------------------- States and political subdivisions $1,401 $37 $1 $1,437 Other securities 200 -- -- 200 - ----------------------------------------------------------------------------------------------------------------------- Total $1,601 $37 $1 $1,637 ======= ==== === ====== - ----------------------------------------------------------------------------------------------------------------------- September 30, 1996 --------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair in millions Cost Gains Losses Value - ----------------------------------------------------------------------------------------------------------------------- States and political subdivisions $1,434 $37 $1 $1,470 Other securities 219 -- -- 219 - ----------------------------------------------------------------------------------------------------------------------- Total $1,653 $37 $1 $1,689 ======= ==== === ====== - -----------------------------------------------------------------------------------------------------------------------
10 11 5. LOANS Loans are summarized as follows:
SEPTEMBER 30, December 31, September 30, in millions 1997 1996 1996 - ---------------------------------------------------------------------------------------------------------- Commercial, financial and agricultural $13,797 $12,309 $12,115 Real estate-- commercial mortgage 7,109 7,151 7,033 Real estate-- construction 2,055 1,666 1,719 Commercial lease financing 3,645 2,671 2,498 - ---------------------------------------------------------------------------------------------------------- Total commercial loans 26,606 23,797 23,365 Real estate-- residential mortgage 6,154 6,229 6,921 Home equity 5,416 4,793 4,113 Credit card 1,476 1,799 1,669 Consumer-- direct 2,238 2,245 1,993 Consumer-- indirect 8,821 8,062 7,947 - ---------------------------------------------------------------------------------------------------------- Total consumer loans 24,105 23,128 22,643 Loans held for sale 2,965 2,310 2,365 - ---------------------------------------------------------------------------------------------------------- Total $53,676 $49,235 $48,373 ======= ======= ======= - ----------------------------------------------------------------------------------------------------------
Changes in the allowance for loan losses are summarized as follows:
Three months ended September 30, Nine months ended September 30, -------------------------------- ------------------------------- in millions 1997 1996 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------- Balance at beginning of period $880 $870 $ 870 $ 876 Charge-offs (105) (72) (282) (216) Recoveries 20 23 65 78 - ------------------------------------------------------------------------------------------------------------------------------- Net charge-offs (85) (49) (217) (138) Provision for loan losses 102 49 244 140 Allowance acquired (sold), net 3 -- 3 (8) - ------------------------------------------------------------------------------------------------------------------------------- Balance at end of period $900 $870 $ 900 $ 870 ===== ===== ====== ===== - -------------------------------------------------------------------------------------------------------------------------------
11 12 6. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS At September 30, 1997, the recorded investment in impaired loans was $184 million. Included in this amount is $84 million of impaired loans for which the specifically allocated allowance for loan losses is $21 million, and $100 million of impaired loans which are carried at their estimated fair value without a specifically allocated allowance for loan losses. At the end of 1996, the recorded investment in impaired loans was $209 million, of which $81 million had a specifically allocated allowance of $26 million and $128 million were carried at their estimated fair value. The average recorded investment in impaired loans for the third quarter of 1997 and 1996 was $186 million and $175 million, respectively. Nonperforming assets were as follows:
SEPTEMBER 30, December 31, September 30, in millions 1997 1996 1996 - -------------------------------------------------------------------------------------------------- Impaired loans $184 $209 $185 Other nonaccrual loans 180 139 158 Restructured loans -- 1 1 - -------------------------------------------------------------------------------------------------- Total nonperforming loans 364 349 344 Other real estate owned (OREO) 67 56 59 Allowance for OREO losses (22) (8) (10) - -------------------------------------------------------------------------------------------------- OREO, net of allowance 45 48 49 Other nonperforming assets 2 3 3 - -------------------------------------------------------------------------------------------------- Total nonperforming assets $411 $400 $396 ===== ===== ==== - --------------------------------------------------------------------------------------------------
Key considers all nonaccrual loans to be impaired loans, except for smaller-balance, homogeneous nonaccrual loans (shown in the preceding table as "Other nonaccrual loans") excluded in accordance with the provisions of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." A loan is not deemed impaired during a period of delay in payment of less than 90 days if Key expects to collect all amounts due, including interest accrued at the contractual interest rate, for the period of delay. Impaired loans are evaluated individually. Where collateral exists, the extent of impairment is determined based on the estimated fair value of the underlying collateral. If collateral does not exist, or is insufficient to support the carrying amount of the loan, management looks to other means of collection. Where the estimated fair value of the collateral and the present value of the estimated future cash flows from other means of collection do not support the carrying amount of the loan, management charges off that portion of the loan balance which it believes will not ultimately be collected. In instances where collateral or other sources of repayment are sufficient, yet uncertainty exists regarding the ultimate repayment, an allowance is specifically allocated for in the allowance for loan losses. Key excludes smaller-balance, homogeneous nonaccrual loans from impairment evaluation. Generally these include loans to finance residential mortgages, automobiles, recreational vehicles, boats and mobile homes. Key applies historical loss experience rates to these loans, adjusted based on management's assessment of emerging credit trends and other factors. The resulting loss estimates are specifically allocated for by loan type in the allowance for loan losses. In general, such loans are charged off when payment is 120-180 days past due. 12 13 7. LONG-TERM DEBT The components of long-term debt, presented net of unamortized discount where applicable, were as follows:
SEPTEMBER 30, December 31, September 30, dollars in millions 1997 1996 1996 - --------------------------------------------------------------------------------------------------------------------- Senior medium-term notes due through 2005 1 $ 493 $ 584 $ 924 Subordinated medium-term notes due through 2005 2 183 183 183 7.50% Subordinated notes due 2006 250 250 250 6.75% Subordinated notes due 2006 200 200 200 8.125% Subordinated notes due 2002 199 199 199 8.00% Subordinated notes due 2004 125 125 125 8.40% Subordinated capital notes due 1999 75 75 75 8.404% Notes due 1997 through 2001 42 49 49 All other long-term debt 15 16 18 - --------------------------------------------------------------------------------------------------------------------- Total parent company 1,582 1,681 2,023 Senior medium-term bank notes due through 2000 3 3,202 1,165 1,275 Senior euro medium-term bank notes due through 2002 4 780 -- -- 7.25% Subordinated notes due 2005 200 200 200 7.85% Subordinated notes due 2002 200 200 200 6.75% Subordinated notes due 2003 200 200 199 7.50% Subordinated notes due 2008 165 165 165 7.125% Subordinated notes due 2006 250 250 250 7.55% Subordinated notes due 2006 75 75 75 7.375% Subordinated notes due 2008 70 70 70 Lease financing debt 5 605 -- -- Federal Home Loan Bank Advances 164 193 193 All other long-term debt 74 14 14 - --------------------------------------------------------------------------------------------------------------------- Total subsidiaries 5,985 2,532 2,641 - --------------------------------------------------------------------------------------------------------------------- Total $7,567 $4,213 $4,664 ======= ======= ====== - --------------------------------------------------------------------------------------------------------------------- 1 The weighted average rate on the senior medium-term notes due through 2005 was 6.56%, 6.57% and 6.50% at September 30, 1997, December 31, 1996 and September 30, 1996, respectively. 2 The weighted average rate on the subordinated medium-term notes due through 2005 was 6.85%, 6.80% and 6.81% at September 30, 1997, December 31, 1996 and September 30, 1996, respectively. 3 The weighted average rate on the senior medium-term notes due through 2000 was 5.75%, 6.17% and 6.68% at September 30, 1997, December 31, 1996 and September 30, 1996, respectively. 4 The weighted average rate on the euro medium-term notes due through 2002 was 5.83% at September 30, 1997. 5 Represents primarily nonrecourse debt collateralized by lease equipment under operating, direct financing and sales type leases.
13 14 8. CAPITAL SECURITIES The corporation-obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely debentures of the Corporation ("capital securities") were issued by three business trusts, KeyCorp Institutional Capital A ("Capital A"), KeyCorp Institutional Capital B ("Capital B") and KeyCorp Institutional Capital C ("Capital C"), all of whose common securities are owned by the parent company. Capital A and Capital B were formed in the fourth quarter of 1996 and Capital C was formed in the second quarter of 1997. The proceeds from the issuances of the capital securities and common securities were used to purchase debentures of the parent company. Capital A and Capital B hold solely junior subordinated deferrable interest debentures of the parent company. Capital C holds solely coupon adjusted pass-through security debentures of the parent company. Both the debentures and related income statement effects are eliminated in Key's financial statements. The parent company has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (i) accrued and unpaid distributions required to be paid on the capital securities; (ii) the redemption price with respect to any capital securities called for redemption by Capital A, Capital B or Capital C; and (iii) payments due upon a voluntary or involuntary liquidation, winding-up or termination of Capital A, Capital B or Capital C. The capital securities, common securities and related debentures are summarized as follows:
Interest Rate Maturity Principal of Capital of Capital Capital Common Amount of Securities and Securities and dollars in millions Securities 1 Securities Debentures 2 Debentures Debentures - ------------------------------------------------------------------------------------------------------------------------------- September 30, 1997 Capital A $350 $11 $361 7.826% 2026 Capital B 150 4 154 8.250 2026 Capital C 250 8 258 6.625 2029 - ------------------------------------------------------------------------------------------------------------------------------ Total $750 $23 $773 7.510%3 -- ==== === ===== - ------------------------------------------------------------------------------------------------------------------------------ December 31, 1996 $500 $15 $515 7.953%3 -- ==== === ===== - ------------------------------------------------------------------------------------------------------------------------------ 1 The capital securities are mandatorily redeemable upon the respective maturity dates of the debentures or upon earlier redemption as provided in the indenture. Each issue of capital securities carries an interest rate identical to that of the respective debenture. The interest rate related to the capital securities issued by Capital C may be adjusted upon the remarketing of the capital securites on the coupon adjustment date (June 1, 1999). The capital securities issued by Capital A and Capital B qualify as Tier I capital under Federal Reserve Board Guidelines. 2 The parent company has the right to redeem the debentures purchased by Capital A, Capital B and Capital C: (i) in whole or in part, on or after December 1, 2006, December 15, 2006 and June 1, 2009, respectively, (ii) in whole at any time within 90 days following the occurrence and during the continuation of a tax event or a capital treatment event (as defined in the applicable offering circular); and (iii) for Capital C, in whole or in part on the coupon adjustment date. If the debentures are redeemed prior to maturity, the redemption price will be expressed as a certain percentage of, or factor added to, the principal amount, plus any accrued but unpaid interest. 3 Weighted average rate.
9. RESTRUCTURING CHARGE During the fourth quarter of 1996, the parent company recorded a $100 million ($66 million after tax, $.29 per Common Share) restructuring charge in connection with strategic actions to be taken over the next year to complete its transformation to a nationwide, bank-based financial services company. The primary actions taken or to be taken include: (i) the formation of a nationwide bank from Key's network of banks in 13 states and four regions of the United States (KeyBank USA and KeyBank National Association (New Hampshire) ("KeyBank New Hampshire") did not take part in this consolidation), (ii) the consolidation of nearly 140 of Key's branch offices, known as KeyCenters, into other KeyCenters, and (iii) the reduction of approximately 2,700 positions, or 10% of Key's employment base, distributed throughout the organization at substantially all levels of responsibility. 14 15 Included in the restructuring charge were accruals for expenses, primarily consisting of severance payments ($54 million), consolidation costs related to banking offices identified for closure ($18 million) and costs related to the write-off of certain obsolete software previously developed for internal use ($28 million). As of September 30, 1997, Key had completed the consolidation of 119 of the 140 KeyCenters identified for merger into other KeyCenters and reduced its employment base by the approximate 10% projected at the announcement date. Remaining reserves at September 30, 1997, totaled $38 million. Changes in the restructuring reserve are summarized as follows:
Consolidation Obsolete in millions Severance Costs Software Total - ------------------------------------------------------------------------------------------------------------------------ Balance at January 1, 1997 $ 54 $18 $ 28 $100 Cash payments (25) (2) - (27) Noncash charges -- (7) (28) (35) - ------------------------------------------------------------------------------------------------------------------------ Balance at September 30, 1997 $ 29 $9 -- $ 38 ===== === === ===== - ------------------------------------------------------------------------------------------------------------------------
10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK Key, mainly through its affiliate banks, is party to various financial instruments with off-balance sheet risk. The banks use these financial instruments in the normal course of business to meet the financing needs of their customers and to manage their exposure to market risk. Market risk is the possibility that Key's net interest income will be adversely affected as a result of changes in interest rates or other economic factors. The primary financial instruments used include commitments to extend credit, standby and commercial letters of credit, interest rate swaps, caps and floors, futures and foreign exchange forward contracts. All of the interest rate swaps, caps and floors, and foreign exchange forward contracts held are over-the-counter instruments. These financial instruments may be used for lending-related, asset and liability management and trading purposes, as discussed in the remainder of this note. In addition to the market risks inherent in the use of these financial instruments, each contains an element of credit risk. Credit risk is the possibility that Key will incur a loss due to a counterparty's failure to perform its contractual obligations. FINANCIAL INSTRUMENTS HELD OR ISSUED FOR LENDING-RELATED PURPOSES These instruments involve, to varying degrees, credit risk in addition to amounts recognized in Key's balance sheet. Key mitigates its exposure to credit risk through internal controls over the extension of credit. These controls include the process of credit approval and review, the establishment of credit limits and, when deemed necessary, securing collateral. The banks' commitments to extend credit are agreements with customers to provide financing at predetermined terms as long as the customer continues to meet specified criteria. Loan commitments serve to meet the financing needs of the banks' customers and generally carry variable rates of interest, have fixed expiration dates or other termination clauses, and may require the payment of fees. Since the commitments may expire without being drawn upon, the total amount of the commitments does not necessarily represent the future cash outlay to be made by Key. The credit-worthiness of each customer is evaluated on a case-by-case basis. The estimated fair values of these commitments and the standby letters of credit discussed below are not material. Key does not have any significant concentrations of credit risk. Standby letters of credit enhance the credit-worthiness of the banks' customers by assuring the customers' financial performance to third parties in connection with specified transactions. Amounts drawn under standby letters of credit generally carry variable rates of interest, and the credit risk involved is essentially the same as that involved in the extension of loan facilities. 15 16 The following is a summary of the contractual amount of each class of lending-related off-balance sheet financial instrument outstanding wherein Key's maximum possible accounting loss equals the contractual amount of the instruments:
SEPTEMBER 30, December 31, September 30, in millions 1997 1996 1996 - ----------------------------------------------------------------------------------------------------------------- Loan commitments: Credit card lines $ 7,928 $ 8,078 $ 7,253 Home equity 3,924 3,239 3,081 Commercial real estate and construction 1,104 1,593 1,527 Commercial and other 13,180 10,327 10,233 - ----------------------------------------------------------------------------------------------------------------- Total loan commitments 26,136 23,237 22,094 Other commitments: Standby letters of credit 1,467 1,385 1,285 Commercial letters of credit 120 202 206 Loans sold with recourse 271 30 30 - ----------------------------------------------------------------------------------------------------------------- Total loan and other commitments $27,994 $24,854 $23,615 ======== ======== ======= - -----------------------------------------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES Key manages its exposure to market risk, in part, by using off-balance sheet instruments. Instruments used for this purpose modify the repricing or maturity characteristics of specified on-balance sheet assets and liabilities. The instruments must be both effective at reducing the risk associated with the exposure being managed, and designated as a risk management transaction at the inception of the derivative contract. In addition, to be considered effective, a high degree of interest rate correlation must exist between the derivative and the specified assets or liabilities being managed at inception and over the life of the derivative contract. Primary among the financial instruments used by both the parent company and its subsidiary banks to manage exposure to market risk are interest rate swap contracts. Interest rate swaps used for this purpose are designated as portfolio swaps. The notional amount of the interest rate swap contracts represents only an agreed-upon amount on which calculations of interest payments to be exchanged are based, and is significantly greater than the amount at risk. Credit risk on these instruments is the possibility that the counterparty will not meet the terms of the swap contract and is measured as the cost of replacing, at current market rates, contracts in an unrealized gain position. Key deals exclusively with counterparties with high credit ratings, enters into bilateral collateral arrangements and generally arranges master netting agreements. These agreements include legal rights of setoff that provide for the net settlement of the subject contracts with the same counterparty in the event of default. In addition, the credit risk exposure to the counterparty on each interest rate swap is monitored by a credit committee. Based upon credit reviews of the counterparties, limits on the total credit exposure Key may have with each counterparty and the amount of collateral required, if any, are determined. Although Key is exposed to credit-related losses in the event of nonperformance by the counterparties, based on management's assessment as of September 30, 1997, all counterparties were expected to meet their obligations. At September 30, 1997, Key had 18 different counterparties to portfolio swaps and swaps entered into to offset the risk of customer swaps. Key had aggregate credit exposure of $54 million to twelve of these counterparties, with the largest credit exposure to an individual counterparty amounting to $14 million. Conventional interest rate swap contracts involve the receipt of amounts based on a fixed or variable rate in exchange for payments based on variable or fixed rates, without an exchange of the underlying notional amount. Under an indexed amortizing swap contract, the notional amount remains constant for a specified period of time after which, based upon the level of an index at each review date, the swap contract will mature, the notional amount will begin to amortize, or the swap will continue in effect until its contractual maturity. Otherwise, the characteristics of these swaps are similar to those of conventional swap contracts. At September 30, 1997, Key was party to $1.3 billion and $2.5 billion of indexed amortizing swaps that used a London Interbank Offered Rate ("LIBOR") index and a Constant Maturity Treasuries ("CMT") index, respectively, for the review date measurement. Under basis swap contracts, interest payments based on different floating indices are exchanged. 16 17 The following table summarizes the notional amount, fair value, maturity and weighted average rate received and paid for the various types of portfolio interest rate swaps used by Key:
SEPTEMBER 30, 1997 December 31, 1996 ------------------------------------------------------------------- ------------------------ WEIGHTED AVERAGE RATE NOTIONAL FAIR MATURITY ---------------------------- Notional Fair dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY Amount Value - --------------------------------------------------------------------------------------------------------------------------------- Receive fixed/pay variable-- indexed amortizing 1 $ 4,065 $ 9 1.6 6.80% 5.73% $ 5,078 $(8) Receive fixed/pay variable-- conventional 3,750 43 6.1 6.69 5.79 3,505 21 Pay fixed/receive variable-- conventional 3,260 (6) 1.1 5.73 6.12 3,312 (5) Basis swaps 200 -- .4 5.76 5.74 400 -- - ------------------------------------------------------------------------------------------------------------------------------- Total portfolio swaps $11,275 $46 2.9 6.44% 5.86% $12,295 $ 8 ======== ==== ======== ==== - ------------------------------------------------------------------------------------------------------------------------------- 1 MATURITY IS BASED UPON EXPECTED AVERAGE LIVES RATHER THAN CONTRACTUAL TERMS.
Based on the weighted average rates in effect at September 30, 1997, the spread on portfolio interest rate swaps, excluding the amortization of net deferred gains on terminated swaps, provided a positive impact on net interest income (since the weighted average rate received exceeded the weighted average rate paid by 58 basis points). The aggregate positive fair value of $46 million at the same date was derived through the use of discounted cash flow models, which contemplate interest rates using the applicable forward yield curve, and represents an estimate of the unrealized gain that would be recognized if the portfolio were to be liquidated at that date. Interest from portfolio swaps is recognized on an accrual basis over the lives of the respective contracts as an adjustment of the interest income or expense of the asset or liability whose risk is being managed. Gains and losses realized upon the termination of interest rate swaps prior to maturity are deferred and amortized, generally using the straight-line method over the projected remaining life of the related swap contract at its termination and recorded as an adjustment of the yield on the respective on-balance sheet instrument that was being managed. During the first nine months of 1997, swaps with a notional amount of $220 million were terminated, resulting in no deferred gain or loss. During the same period last year, swaps with a notional amount of $800 million were terminated, resulting in a deferred gain of $.3 million. A summary of Key's deferred swap gains and (losses) is as follows:
dollars in millions - -------------------------------------------------------------------------------- Weighted Average Deferred Remaining Asset/Liability Managed Gains/(Losses) Amortization (Years) - -------------------------------------------------------------------------------- Loans $ (1) 1.1 Debt 15 5.6 - -------------------------------------------------------------------------------- Total $14 === - --------------------------------------------------------------------------------
Key also uses interest rate caps and floors, and futures contracts to manage the risk associated with the potential impact of adverse movements in interest rates on specified long-term debt and other short-term borrowings. Interest rate caps and floors involve the payment of a premium by the buyer to the seller for the right to receive an interest differential equal to the difference between the current interest rate and an agreed-upon interest rate ("strike rate") applied to a notional amount. Key generally purchases or enters into net purchases (a combination of buying and selling) of caps and floors for asset and liability management purposes. Futures contracts are commitments to either purchase or sell designated financial instruments at future dates for specified prices. Key had caps and floors with a notional amount and fair value of $4.3 billion (of which $1.6 billion are forward-starting) and $17 million, respectively, at September 30, 1997. There were no futures contracts outstanding at the same date. For the third quarter of 1997, interest rate swaps (including the impact of both the spread on the swap portfolio and the amortization of deferred gains and losses resulting from terminated swaps) and interest rate caps and floors increased net interest income by $12 million. For the same period last year, these instruments contributed $19 million to net interest income. 17 18 FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES Key's affiliate banks also use interest rate swap, cap and floor, and future contracts for dealer activities (which are generally limited to the banks' commercial loan customers) and enter into other positions with third parties that are intended to mitigate the interest rate risk of the customer positions. Interest rate swap contracts entered into with customers are typically limited to conventional swaps, as previously described. The customer swaps, caps and floors, and futures, as well as the third party positions, are recorded at their estimated fair values, and adjustments to fair value are included in other income on the income statement. Key had futures contracts with a notional amount and negative fair value of $9.9 billion and $(5) million, respectively, at September 30, 1997. Key also enters into foreign exchange forward contracts to accommodate the business needs of its customers and for proprietary trading purposes. These contracts provide for the delayed delivery or purchase of foreign currency. The foreign exchange risk associated with such contracts is mitigated by entering into other foreign exchange contracts with third parties. Adjustments to the fair value of all such foreign exchange forward contracts are included in other income on the income statement. At September 30, 1997, credit exposure from financial instruments held or issued for trading purposes was limited to the aggregate fair value of each contract with a positive fair value, or $82 million. The risk of counterparties defaulting on their obligations is monitored on an ongoing basis. The affiliate banks contract with counterparties of good credit standing and enter into master netting agreements when possible in an effort to manage credit risk. Trading income recognized on interest rate and foreign exchange forward contracts totaled $23 million and $12 million, respectively, for the first nine months of 1997 and $13 million and $10 million, respectively, for the first nine months of 1996. A summary of the notional amount and the respective fair value of derivative financial instruments held or issued for trading purposes at September 30, 1997, and on average for the nine-month period then ended, is presented below. The positive fair values represent assets to Key and are recorded in other assets, while the negative fair values represent liabilities and are recorded in other liabilities on the balance sheet. The $8.3 billion notional amount of customer swaps presented in the table includes $4.7 billion of interest rate swaps that receive a fixed rate and pay a variable rate and $3.6 billion of interest rate swaps that pay a fixed rate and receive a variable rate. As of September 30, 1997, these swaps had an expected average life of 5.4 years, carried a weighted average rate received of 6.44% and had a weighted average rate paid of 6.25%.
September 30, 1997 Nine months ended September 30, 1997 ----------------------- ----------------------------------------- Notional Fair Average Average in millions Amount Value Notional Amount Fair Value - ------------------------------------------------------------------------------------------------------------------- Interest rate contracts: Customer swaps: Assets $6,178 $ 76 $4,827 $ 52 Liabilities 2,134 (33) 2,046 (24) Caps and floors purchased 2,687 4 2,574 2 Caps and floors written 2,771 (4) 2,647 (3) Foreign exchange forward contracts: Assets 619 18 539 20 Liabilities 572 (16) 494 (19) - ------------------------------------------------------------------------------------------------------------------- 1 Excludes the effect of foreign spot contracts.
18 19 INDEPENDENT ACCOUNTANTS' REVIEW REPORT SHAREHOLDERS AND BOARD OF DIRECTORS KEYCORP We have reviewed the unaudited consolidated balance sheets of KeyCorp and subsidiaries ("Key") as of September 30, 1997 and 1996, and the related consolidated statements of income for the three and nine-month periods then ended, and the consolidated statements of changes in shareholders' equity and cash flow for the nine-month periods ended September 30, 1997 and 1996. These financial statements are the responsibility of Key's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Key as of December 31, 1996, 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 15, 1997, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 1996, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ Ernst & Young LLP Cleveland, Ohio October 14, 1997 19 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION This section of the report, including the highlights summarized below, provides a discussion and analysis of the financial condition and results of operations of Key for the periods presented. It should be read in conjunction with the unaudited consolidated interim financial statements and notes thereto, presented on pages 3 through 18. This report contains forward-looking statements which are subject to numerous assumptions, risks and uncertainties. Statements pertaining to future periods are subject to uncertainty because of the possibility of changes in underlying factors and assumptions. Actual results could differ materially from those contained in or implied by such forward-looking statements for a variety of factors including: sharp and/or rapid changes in interest rates; significant changes in the economic scenario from the current anticipated scenario which could materially change anticipated credit quality trends and the ability to generate loans; significant delay in or inability to execute strategic initiatives designed to grow revenues and/or control expenses; and significant changes in accounting, tax, or regulatory practices or requirements. Key's record earnings results for the third quarter of 1997 reflected growth in fee revenue businesses, strong loan growth and the impact of strategic actions taken to complete Key's transformation to a nationwide bank-based financial services company and to implement expense control initiatives. These planned actions, which were announced in November 1996, include the consolidation of Key's bank subsidiaries (other than KeyBank USA) into one nationwide banking institution (completed June 30, 1997, for all banks with the exception of KeyBank New Hampshire), the consolidation of nearly 140 branch offices (known as KeyCenters), and a reduction of approximately 10% of Key's employment base. At the same time, Key also announced its plans to divest another 140 KeyCenters. The above actions have been or will be taken with several objectives, including that of improving the efficiency ratio (exclusive of acquisitions) to the targeted level of 55% by the end of 1997, with further improvement thereafter. As of September 30, 1997, Key had merged 119 of the 140 KeyCenters to be consolidated and sold or reached agreements to sell 104 of the additional 140 KeyCenters targeted for sale. The sale of KeyBank Wyoming, Key's 28 branch Wyoming bank subsidiary, and the sales of 13 other KeyCenters closed during the third quarter. In addition, operations have been streamlined through a workforce reduction of 2,645 full-time equivalent employees, representing substantially all of the 10% reduction projected at the announcement date. As a result of these factors and revenue growth, during the third quarter Key's efficiency ratio improved 91 basis points to 56.75%, almost 400 basis points better than the 60.71% for the third quarter of 1996. In connection with its efforts to form one nationwide banking institution and related centralization efforts, Key also undertook a comprehensive review of its real estate operations and occupancy cost structure. As a result, during the third quarter Key recorded a $50 million ($33 million after tax) charge in connection with efforts to exit excess real estate. The elimination of this excess capacity is expected to generate annual cost savings of approximately $15 million. During the first nine months of 1997, Key also continued its efforts to reallocate resources (including those made available or generated by its above-mentioned divestitures of KeyCenters in areas of low-growth potential) to businesses with higher earnings potential. Specifically, during the first quarter Key launched a new subsidiary, Key Corporate Capital Inc., to expand corporate and specialty finance businesses on a nationwide basis. As part of Key's Corporate Banking line of business, this new unit targets certain client segments and geographic markets, including: media and telecommunications, healthcare, structured finance and lease financing. In addition, Key entered into an alliance with Standard Chartered Bank of the United Kingdom to provide expanded international banking services to Key's clients doing business in Asia. Business developed through the alliance presented no material exposure to loss from October 1997 developments in Asian economies. During the third quarter, Key entered into agreements with several preeminent insurance carriers to provide its small business clients with access to a full array of healthcare, commercial, and property and casualty insurance. In the third quarter, Key increased the size and scope of its leasing business by completing its acquisition of Leasetec, a privately held equipment leasing company headquartered in Boulder, Colorado, which specializes in the leasing of information technology and telecommunications equipment to large corporate clients. Key also completed its acquisition of Champion, headquartered in Parsippany, New Jersey, and one of the largest home equity finance companies in the markets served by Champion. 20 21 In addition to the above actions, during the first nine months of 1997 management continued to actively manage Key's balance sheet and capital. Specific steps included the securitization and sale of home equity loans and auto loans totaling $205 million and $671 million, respectively, and the sale of $365 million of out-of-franchise credit card receivables. Management will continue to explore opportunities for sales and/or other arrangements with respect to its credit card and other portfolios throughout the remainder of 1997. During the fourth quarter of 1996 and the second quarter of 1997, management augmented its flexibility to continue its management of Key's capital through the issuance of $500 million and $250 million, respectively, of tax-advantaged capital securities. The securities issued in 1996 receive Tier I capital treatment. During the third quarter of 1997, there were no repurchases of Key Common Shares under the 12,000,000 Common Shares repurchase program authorized by Key's Board of Directors in November 1996. As a result, the total number of shares repurchased under that program remained at 8,263,900. Under a separate authorization, 2,477,318 Key Common Shares were repurchased during the third quarter and reissued as part of the total 3,336,118 shares issued in the Champion transaction. The other 858,800 shares issued in the Champion transaction had been repurchased in the second quarter of 1997. The preceding items are discussed in greater detail in the remainder of this discussion and in the notes to the consolidated interim financial statements referred to previously. PERFORMANCE OVERVIEW The selected financial data set forth in Figure 1 presents certain information highlighting the financial performance of Key for each of the last five quarters and the year-to-date periods ended September 30, 1997 and 1996. Each of the items referred to in this performance overview and in Figure 1 is more fully described in the following discussion or in the notes to the consolidated interim financial statements presented on pages 7 through 18. Net income for the third quarter of 1997 reached a record high of $236 million, or $1.08 per Common Share, up from $207 million, or $.90 per Common Share, in the third quarter of 1996. This represents a 20% increase in earnings per Common Share from the year-ago quarter. In the third quarter of 1996, Key incurred a one-time charge of $17 million ($11 million after tax) to provide for an assessment mandated by Congress to recapitalize the Savings Association Insurance Fund ("SAIF"). Excluding that one-time charge, earnings for the 1996 third quarter were $218 million, or $.95 per Common Share. For the first nine months of 1997, earnings were $671 million, or $3.06 per Common Share, compared with $632 million, or $2.70 per Common Share, for the same period last year. On an annualized basis, the return on average common equity for the third quarter of 1997 was 19.41%, up from 16.73% for the 1996 third quarter. The annualized returns on average total assets were 1.34% and 1.28% for the third quarters of 1997 and 1996, respectively. Contributing to the increase in quarterly earnings were a $19 million increase in taxable-equivalent net interest income and a $104 million improvement in noninterest income (including a $65 million increase in net gains from divestitures). These positive factors were partially offset by a $53 million rise in the provision for loan losses and a $33 million increase in noninterest expense. Included in noninterest expense in the 1997 third quarter was a $50 million charge recorded in connection with efforts to exit excess real estate resulting from Key's nationwide banking and related centralization efforts and $14 million of distributions on capital securities (which more closely resemble dividend or interest payments than overhead expense). Excluding these items and the SAIF assessment recorded last year, noninterest expense was down $14 million from the comparable period a year ago. The efficiency ratio, which measures the extent to which recurring revenues are absorbed by operating expenses, improved to 56.75% for the third quarter of 1997 compared with 57.66% and 60.71% for the second quarter of 1997 and the third quarter of 1996, respectively. This reflected continued progress made by Key in its restructuring efforts and implementation of expense control initiatives. For the first nine months of 1997, net income totaled $671 million, or $3.06 per Common Share, up from $632 million, or $2.70 per Common Share, for the same period last year. On an annualized basis, the return on average common equity for the first nine months of 1997 was 18.78%, up from 16.76% for the comparable year-ago period. The annualized returns on average total assets were 1.32% and 1.30% for the first nine months of 1997 and 1996, respectively. Affecting comparative results were increases of $50 million in taxable-equivalent net interest income and $138 million in noninterest income (including a $70 million increase in net gains from divestitures). The positive impact of these factors was moderated by a $104 million increase in the provision for loan losses and a $41 million increase in 21 22 noninterest expense. Excluding the $35 million of distributions on capital securities recorded during the first nine months of 1997, as well as the real estate and SAIF charges discussed above, noninterest expense was down $27 million from the first nine months of last year. FIGURE 1 SELECTED FINANCIAL DATA
1997 1996 Nine months ended September 30, --------------------------------- ------------------ ------------------------------- dollars in millions, except per share amounts Third Second First Fourth Third 1997 1996 - ------------------------------------------------------------------------------------------------------------------------------- FOR THE PERIOD Interest income $ 1,347 $ 1,295 $ 1,255 $ 1,243 $ 1,238 $ 3,897 $ 3,708 Interest expense 643 599 566 560 555 1,808 1,674 Net interest income 704 696 689 683 683 2,089 2,034 Provision for loan losses 102 75 67 57 49 244 140 Noninterest income 393 288 259 285 289 940 802 Noninterest expense 648 582 575 700 615 1,805 1,764 Income before income taxes 347 327 306 211 308 980 932 Net income 236 223 212 151 207 671 632 Net income applicable to Common Shares 236 223 212 151 207 671 624 - ------------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE Net income $ 1.08 $ 1.02 $ .96 $ .67 $ .90 $ 3.06 $ 2.70 Net income - fully diluted 1.06 1.00 .94 .65 .88 2.99 2.65 Cash dividends .42 .42 .42 .38 .38 1.26 1.14 Book value at period end 23.11 22.04 21.29 21.84 21.91 23.11 21.91 Market price: High 65.44 58.44 56.38 54.25 44.38 65.44 44.38 Low 55.25 47.88 48.63 43.69 36.25 47.88 33.38 Close 63.63 55.88 48.75 50.50 44.00 63.63 44.00 Weighted average Common Shares (000) 218,107 218,973 221,670 225,562 229,668 219,570 231,363 - ------------------------------------------------------------------------------------------------------------------------------- AT PERIOD END Loans $ 53,676 $ 51,644 $ 49,724 $ 49,235 $ 48,373 $ 53,676 $ 48,373 Earning assets 63,800 61,508 59,825 59,260 57,640 63,800 57,640 Total assets 72,077 69,672 67,893 67,621 65,356 72,077 65,356 Deposits 43,870 44,626 44,239 45,317 44,523 43,870 44,523 Long-term debt 7,567 5,182 4,774 4,213 4,664 7,567 4,664 Common shareholders' equity 5,076 4,814 4,674 4,881 4,976 5,076 4,976 Total shareholders' equity 5,076 4,814 4,674 4,881 4,976 5,076 4,976 Full-time equivalent employees 25,622 25,882 26,603 27,689 28,337 25,622 28,337 Full-service banking offices 1,088 1,130 1,161 1,205 1,218 1,088 1,218 - ------------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average total assets 1.34% 1.32% 1.30% .92% 1.28% 1.32% 1.30% Return on average common equity 19.41 18.85 18.07 12.53 16.73 18.78 16.76 Return on average total equity 19.41 18.85 18.07 12.53 16.73 18.78 16.62 Efficiency1 56.75 57.66 58.92 60.92 60.71 57.75 60.81 Overhead2 37.76 41.02 43.71 44.89 44.40 40.81 45.66 Net interest margin (TE) 4.58 4.69 4.75 4.80 4.82 4.67 4.78 - ------------------------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS AT PERIOD END Equity to assets3 7.04% 6.91% 6.88% 7.22% 7.61% 7.04% 7.61% Tangible equity to tangible assets3 5.46 5.67 5.58 5.88 6.20 5.46 6.20 Tier I risk-adjusted capital 6.73 7.14 7.47 7.98 7.49 6.73 7.49 Total risk-adjusted capital 11.10 11.66 12.31 13.01 12.50 11.10 12.50 Leverage 6.33 6.65 6.68 6.93 6.38 6.33 6.38 - ------------------------------------------------------------------------------------------------------------------------------- The comparability of the information presented above is affected by certain mergers, acquisitions and divestitures completed by KeyCorp in the time periods presented. For further information concerning these transactions, refer to Note 2, Mergers, Acquisitions and Divestitures, beginning on page 8. 1 Calculated as noninterest expense (excluding certain nonrecurring charges and distributions on capital securities) divided by taxable-equivalent net interest income plus noninterest income (excluding net securities transactions and gains on branch sales). 2 Calculated as noninterest expense (excluding certain nonrecurring charges and distributions on capital securities) less noninterest income (excluding net securities transactions and gains on branch sales) divided by taxable-equivalent net interest income. 3 Including capital securities receiving Tier I treatment, these ratios at September 30, 1997 are 7.74% and 6.16%, respectively, at June 30, 1997, are 7.63% and 6.39%, respectively, at March 31, 1997, are 7.62% and 6.32%, respectively and at December 31, 1996, are 7.96% and 6.63%, respectively. TE = Taxable Equivalent
22 23 CASH BASIS FINANCIAL DATA The selected financial data presented in Figure 2 presents certain information highlighting the performance of Key for each of the last five quarters, adjusted to exclude the amortization of goodwill and nonqualifying intangibles, and related balances resulting from business combinations recorded by Key under the purchase method of accounting. Had these business combinations qualified for accounting under the pooling of interests method, no intangible assets would have been recorded. Since the amortization of goodwill and other intangibles does not result in a cash expense, the economic value to shareholders under either accounting method is essentially the same. Moreover, such amortization does not impact Key's liquidity and funds management activities. Cash basis financial data are particularly relevant since they provide an additional basis for measuring a company's ability to support future growth, pay dividends and repurchase shares. They also may improve the comparability of financial results with prior periods by removing the effect of amortization of goodwill and other intangibles that are considered nonqualifying in regulatory capital computations. Cash basis financial data, as defined above and presented in Figure 2, have not been adjusted to exclude the impact of other noncash items such as depreciation, provision for loan losses, restructuring charges, etc. This is the only section of this report in which Key's financial results are discussed on a cash basis. The amortization of goodwill resulting from the third quarter 1997 acquisitions of Leasetec and Champion is expected to reduce Key's recorded net income per Common Share by approximately $.06 on an annual basis. FIGURE 2. CASH BASIS SELECTED FINANCIAL DATA
1997 1996 ---------------------------------- ----------------------- dollars in millions, except per share amounts THIRD SECOND FIRST Fourth Third - ---------------------------------------------------------------------------------------------------------------- FOR THE PERIOD Noninterest expense $ 628 $ 563 $ 556 $ 681 $ 597 Income before income taxes 367 346 325 230 326 Net income 253 239 228 167 222 Net income applicable to Common Shares 253 239 228 167 222 - ---------------------------------------------------------------------------------------------------------------- PER COMMON SHARE Net income $ 1.16 $ 1.09 $ 1.03 $ .74 $ .96 Net income - fully diluted 1.14 1.07 1.01 .72 .94 Weighted average Common Shares (000) 218,107 218,973 221,670 225,562 229,668 - ---------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average total assets 1.45% 1.43% 1.41% 1.04% 1.39% Return on average common equity 26.82 25.03 24.16 17.29 22.31 Return on average total equity 26.82 25.03 24.16 17.29 22.31 Efficiency1 54.81 55.74 56.93 58.98 58.88 - ---------------------------------------------------------------------------------------------------------------- GOODWILL AND NONQUALIFYING INTANGIBLES Goodwill average balance $ 977 $ 803 $ 816 $ 830 $ 839 Nonqualifying intangibles average balance 106 111 116 121 126 Goodwill amortization (after tax) 14 13 13 13 12 Nonqualifying intangibles amortization (after tax) 3 3 3 3 3 - ----------------------------------------------------------------------------------------------------------------
The comparability of the information presented above is affected by certain mergers, acquisitions and divestitures completed by KeyCorp in the time periods presented. For further information concerning these transactions, refer to Note 2, Mergers, Acquisitions and Divestitures, beginning on page 8. 1 Calculated as noninterest expense (excluding certain nonrecurring charges, the amortization of goodwill and nonqualifying intangibles and distributions on capital securities) divided by taxable-equivalent net interest income plus noninterest income (excluding net securities transactions and gains on branch sales). RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income, which is comprised of interest and loan-related fee income less interest expense, is the principal source of earnings for Key. Net interest income is affected by a number of factors including the level, pricing, mix and maturity of earning assets and interest-bearing liabilities (both on and off-balance sheet), interest rate fluctuations and asset quality. To facilitate comparisons in the following discussion, net interest income is presented on a taxable-equivalent basis, which restates tax-exempt income to an amount that would yield the same after-tax income had the income been subject to taxation at the statutory Federal income tax rate. 23 24 The information presented in Figure 3 provides a summary of the effect on net interest income of changes in yields/rates and average balances for the quarterly and year-to-date periods from the same periods in the prior year. Various components of the balance sheet and their respective yields and rates which affect interest income and expense are illustrated in Figure 4. A more in-depth discussion of changes in earning assets and funding sources is presented in the Financial Condition section beginning on page 33. For the third quarter of 1997, net interest income was $715 million, up $19 million, or 3% from the same period last year. Growth in average earning assets (primarily loans) of 9% more than offset a 24 basis point decrease in the net interest margin, which continued to decline in the third quarter of 1997 and was 11 basis points lower than the prior quarter. The net interest margin is computed by dividing annualized taxable-equivalent net interest income by average earning assets. Average earning assets for the third quarter totaled $62.3 billion, which was $4.9 billion higher than the third quarter 1996 level and $2.0 billion, or an annualized 13%, above the second quarter of 1997. The growth from the year-ago quarter reflected a $4.7 billion, or 12%, increase in targeted loans (such as commercial, home equity, credit card and consumer installment loans), accompanied by a stable residential mortgage portfolio. This marked the fourth consecutive quarter of earning asset growth following a period of planned decreases in both residential mortgage loans and securities. Key's strategy with respect to its loan portfolio is discussed in greater detail in the Loan section beginning on page 33. The decrease in the net interest margin as compared with the year-ago quarter was due primarily to the growth of targeted loans at interest rate spreads lower than the third quarter 1996 net interest margin. This reflected increased reliance on money market funding of incremental loan growth, in part due to the reduction in core deposits resulting from branch divestitures. The negative impact of this factor was partially offset by the issuance of $500 million and $250 million of capital securities in the fourth quarter of 1996 and second quarter of 1997, respectively. The distributions related to these tax-advantaged capital securities are classified as noninterest expense in accordance with guidelines established by the Securities and Exchange Commission. Key uses portfolio interest rate swaps and interest rate caps and floors (as defined in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 15) in the management of its interest rate sensitivity position. The notional amount of portfolio interest rate swaps decreased to $11.3 billion at September 30, 1997, from $12.3 billion at year-end 1996. Over the same period, the notional amount of interest rate caps and floors rose to $4.3 billion at September 30 from $1.4 billion at December 31, 1996. For the third quarter of 1997, interest rate swaps (including the impact of both the spread on the swap portfolio and the amortization of deferred gains and losses resulting from terminated swaps) and interest rate caps and floors contributed $12 million and 8 basis points to net interest income and the net interest margin, respectively. For the same period last year, these instruments increased net interest income by $19 million and the net interest margin by 13 basis points. The manner in which interest rate swaps and caps and floors are used in Key's overall program of asset and liability management is described in the following Asset and Liability Management section. 24 25 FIGURE 3 COMPONENTS OF NET INTEREST INCOME CHANGES
From Three Months Ended September 30, 1996 From Nine Months Ended September 30, 1996 To Three Months Ended September 30, 1997 To Nine Months Ended September 30, 1997 ------------------------------------------ ----------------------------------------- Average Yield/ Net Average Yield/ Net in millions Volume Rate Change Volume Rate Change - ------------------------------------------------------------------------------------------------------------------------------ INTEREST INCOME Loans $ 104 $ (1) $ 103 $ 175 $ (7) $ 168 Taxable investment securities -- (1) (1) -- (2) (2) Tax-exempt investment securities (6) (1) (7) (8) (2) (10) Securities available for sale 4 3 7 10 14 24 Short-term investments 5 -- 5 3 1 4 - ------------------------------------------------------------------------------------------------------------------------------ Total interest income (TE) 107 -- 107 180 4 184 INTEREST EXPENSE Money market deposit accounts (1) (14) (15) 20 (51) (31) Savings deposits (9) 13 4 (28) 41 13 NOW accounts (1) -- (1) (17) 4 (13) Certificates of deposit ($100,000 or more) -- 1 1 2 (7) (5) Other time deposits 1 7 8 (18) 10 (8) Deposits in foreign offices 12 1 13 33 1 34 - ------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 2 8 10 (8) (2) (10) Federal funds purchased and securities sold under repurchase agreements 16 3 19 40 5 45 Other short-term borrowings 19 (1) 18 55 (5) 50 Long-term debt 40 1 41 55 (6) 49 - ------------------------------------------------------------------------------------------------------------------------------ Total interest expense 77 11 88 142 (8) 134 - ------------------------------------------------------------------------------------------------------------------------------ Net interest income (TE) $ 30 $(11) $ 19 $ 38 $ 12 $ 50 ===== ==== ===== ===== ==== ===== - ------------------------------------------------------------------------------------------------------------------------------
The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each. TE = Taxable Equivalent 25 26 FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELD/RATES
THIRD QUARTER 1997 SECOND QUARTER 1997 -------------------------------------- -------------------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE - ------------------------------------------------------------------------------------------------------------------------------------ ASSETS Loans: 1, 2 Commercial, financial and agricultural $13,101 $ 286 8.66% $12,844 $ 282 8.81% Real estate-commercial mortgage 7,088 165 9.24 7,121 165 9.29 Real estate-construction 2,015 49 9.65 1,853 45 9.74 Commercial lease financing 3,820 70 7.27 2,632 42 6.40 - ------------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 26,024 570 8.69 24,450 534 8.76 Real estate-residential 6,161 131 8.44 6,153 127 8.28 Credit card 1,788 68 15.09 1,781 66 14.86 Other consumer 15,926 372 9.27 15,389 356 9.28 - ------------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 23,875 571 9.49 23,323 549 9.44 Loans held for sale 2,809 54 7.63 2,600 50 7.71 - ------------------------------------------------------------------------------------------------------------------------------------ Total loans 52,708 1,195 8.99 50,373 1,133 9.02 Taxable investment securities 270 3 5.88 252 3 5.79 Tax-exempt investment securities 1 1,143 22 7.64 1,349 27 8.03 - ------------------------------------------------------------------------------------------------------------------------------------ Total investment securities 1,413 25 7.02 1,601 30 7.52 Securities available for sale 1, 3 7,399 127 6.86 7,822 136 7.05 Interest-bearing deposits with banks 8 -- 3.94 17 -- 3.66 Federal funds sold and securities purchased under resale agreements 535 6 4.45 337 5 5.95 Trading account assets 264 5 7.51 143 2 5.61 - ------------------------------------------------------------------------------------------------------------------------------------ Total short-term investments 807 11 5.41 497 7 5.65 - ------------------------------------------------------------------------------------------------------------------------------------ Total earning assets 62,327 1,358 8.64 60,293 1,306 8.69 Allowance for loan losses (873) (866) Other assets 8,658 8,351 - ------------------------------------------------------------------------------------------------------------------------------------ $70,112 $67,778 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY Money market deposit accounts $10,714 67 2.48 $10,984 66 2.41 Savings deposits 4,161 37 3.53 4,519 42 3.73 NOW accounts 1,547 8 2.05 1,644 9 2.20 Certificates of deposit ($100,000 or more) 3,166 46 5.76 3,341 47 5.64 Other time deposits 13,389 183 5.42 13,584 181 5.34 Deposits in foreign offices 2,065 29 5.57 2,361 33 5.61 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing deposits 35,042 370 4.19 36,433 378 4.16 Federal funds purchased and securities sold under repurchase agreements 6,939 91 5.20 6,461 84 5.21 Bank notes and other short-term borrowings 5,001 73 5.79 4,350 64 5.90 Long-term debt 4 6,879 109 6.33 4,772 73 6.20 - ------------------------------------------------------------------------------------------------------------------------------------ Total interest-bearing liabilities 53,861 643 4.74 52,016 599 4.62 Noninterest-bearing deposits 8,551 8,432 Other liabilities 2,125 1,998 Capital securities 750 588 Preferred stock -- -- Common shareholders' equity 4,825 4,744 - ------------------------------------------------------------------------------------------------------------------------------------ $70,112 $67,778 ======== ======= Interest rate spread 3.90 4.07 - ------------------------------------------------------------------------------------------------------------------------------------ Net interest income (TE) and net interest margin (TE) $ 715 4.58% $ 707 4.69% ======= ===== ======= ===== Taxable-equivalent adjustment (1) $11 $11 - ------------------------------------------------------------------------------------------------------------------------------------ 1 Interest income on tax-exempt securities and loans has been adjusted to a taxable-equivalent basis using the statutory Federal income tax rate of 35%. 2 For purposes of these computations, nonaccrual loans are included in the average loan balances. 3 Yield is calculated on the basis of amortized cost. 4 Rate calculation excludes ESOP debt. TE = Taxable Equivalent
26 27
FIRST QUARTER 1997 Fourth Quarter 1996 Third Quarter 1996 - ------------------------------------------ ------------------------------------- ----------------------------------------------- AVERAGE YIELD/ Average Yield/ Average Yield/ BALANCE INTEREST RATE Balance Interest Rate Balance Interest Rate - ------------------------------------------ ------------------------------------- ----------------------------------------------- $12,248 $ 268 8.87 % $12,027 $ 270 8.93 % $11,934 $ 270 9.00 % 7,130 163 9.27 6,978 159 9.06 7,056 162 9.13 1,693 40 9.58 1,778 44 9.84 1,671 43 10.24 2,623 39 6.03 2,514 40 6.33 2,413 37 6.10 - ----------------------------------------------------------------------------------------------------------------------------------- 23,694 510 8.73 23,297 513 8.76 23,074 512 8.83 6,196 126 8.25 6,312 131 8.26 6,481 136 8.35 1,786 67 15.21 1,712 63 14.64 1,707 62 14.45 15,070 346 9.31 14,884 346 9.25 14,293 331 9.21 - ----------------------------------------------------------------------------------------------------------------------------------- 23,052 539 9.48 22,908 540 9.38 22,481 529 9.36 2,469 48 7.88 2,114 41 7.72 2,548 51 7.96 - ----------------------------------------------------------------------------------------------------------------------------------- 49,215 1,097 9.04 48,319 1,094 9.01 48,103 1,092 9.03 222 3 5.48 206 3 5.79 251 4 6.34 1,395 27 7.85 1,409 28 7.91 1,458 29 7.91 - ----------------------------------------------------------------------------------------------------------------------------------- 1,617 30 7.52 1,615 31 7.64 1,709 33 7.68 7,800 134 6.99 7,271 121 6.62 7,152 120 6.75 17 -- 4.11 18 1 4.49 18 -- 3.57 299 4 5.43 600 8 5.30 385 5 5.17 95 1 5.63 60 -- 6.63 60 1 5.21 - ----------------------------------------------------------------------------------------------------------------------------------- 411 5 5.04 678 9 5.28 463 6 5.16 - ----------------------------------------------------------------------------------------------------------------------------------- 59,043 1,266 8.70 57,883 1,255 8.63 57,427 1,251 8.67 (868) (866) (870) 8,179 8,046 7,923 - ----------------------------------------------------------------------------------------------------------------------------------- $66,354 $65,063 $64,480 ======== ======== ======= $11,008 65 2.39 $10,979 66 2.39 $10,851 82 3.01 4,819 43 3.62 5,110 45 3.50 5,463 33 2.40 1,682 9 2.17 1,702 9 2.10 1,733 9 2.07 3,699 50 5.48 3,448 51 5.88 3,133 45 5.71 13,037 171 5.32 13,497 177 5.22 13,338 175 5.22 1,150 15 5.31 793 10 5.02 1,189 16 5.35 - ----------------------------------------------------------------------------------------------------------------------------------- 35,395 353 4.04 35,529 358 4.01 35,707 360 4.01 7,028 88 5.08 6,087 77 5.03 5,694 72 5.03 3,912 57 5.91 3,568 53 5.91 3,669 55 5.96 4,486 68 6.22 4,567 72 6.27 4,359 68 6.28 - ----------------------------------------------------------------------------------------------------------------------------------- 50,821 566 4.52 49,751 560 4.48 49,429 555 4.47 8,408 8,615 8,467 1,867 1,793 1,661 500 111 -- -- -- -- 4,758 4,793 4,923 - ----------------------------------------------------------------------------------------------------------------------------------- $66,354 $65,063 $64,480 ======== ======== ======= 4.18 4.15 4.20 - ----------------------------------------------------------------------------------------------------------------------------------- $ 700 4.75 % $ 695 4.80 % $ 696 4.82 % ======= ==== ======= ==== ======= ==== $11 $12 $13 - -----------------------------------------------------------------------------------------------------------------------------------
27 28 ASSET AND LIABILITY MANAGEMENT ASSET/LIABILITY MANAGEMENT COMMITTEES Key manages its exposure to economic loss from fluctuations in interest rates through an active program of asset and liability management pursuant to guidelines established by its Asset/Liability Management Policy Committee ("ALCO"). The ALCO has the responsibility for approving the asset/liability management policies of Key, overseeing the formulation and implementation of strategies to improve balance sheet positioning and/or earnings, and reviewing the interest rate sensitivity positions of Key and each of its affiliate banks. SHORT-TERM INTEREST RATE EXPOSURE The primary tool utilized by management to measure and manage interest rate exposure is a net interest income simulation model. Use of the model to perform simulations of changes in interest rates over one- and two-year time horizons has enabled management to develop strategies for managing exposure to interest rate risk. In its simulations, management estimates the impact on net interest income of various pro forma changes in the overall level of interest rates. These estimates are based on a large number of assumptions related to loan and deposit growth, prepayments, interest rates, balance sheet management strategies and other factors. Management believes that both individually and in the aggregate these assumptions are reasonable, but the complexity of the simulation modeling process results in a sophisticated estimate, not a precise calculation of exposure. The ALCO guidelines provide that a gradual 200 basis point increase or decrease in short-term rates over the next twelve-month period should not result in more than a 2% impact on net interest income from what net interest income would have been if interest rates did not change. As shown in Figure 5, Key has been operating well within these guidelines. FIGURE 5 NET INTEREST INCOME AT RISK TO CHANGES IN INTEREST RATES [GRAPHIC]
FIGURE 5. NET INTEREST INCOME AT RISK TO CHANGES IN INTEREST RATES ESTIMATED CHANGE IN NET INTEREST INCOME Rise Decline Dec-95 -0.0124 0.0030 Mar-96 -0.0134 0.0089 Jun-96 -0.0113 0.0092 Sep-96 -0.0123 0.0060 Dec-96 -0.0128 0.0071 Mar-97 -0.0128 0.0090 Jun-97 -0.0113 0.0050 Sep-97 -0.0091 0.0024 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% Dec-95 Mar-96 Jun-96 Sep-96 Dec-96 Mar-97 Jun-97 Sep-97 GRADUAL 200 BASIS POINT DCREASE IN RATES OVER NEXT 12 MONTHS GRADUAL 200 BASIS POINT INCREASE IN RATES OVER NEXT 12 MONTHS
LONG-TERM INTEREST RATE EXPOSURE Short-term interest rate analysis is complemented by an economic value of equity model. This model provides the added benefit of measuring the exposure to interest rate changes outside the one- to two-year time frame measured by the simulation model. The economic value of Key's equity is determined by modeling the net present value of future cash flows for asset, liability, and off-balance sheet positions based on the implied forward yield curve. Economic value analysis has several limitations including: the economic values of asset, liability, and off-balance sheet positions do not represent the true fair values of the positions, since they do not consider factors such as credit risk and liquidity; indeterminate maturity assets and liabilities require that estimated cash flows be developed; the future structure of the balance sheet derived from ongoing loan and deposit activity by Key's core businesses is not factored into present value calculations; and the analysis requires assumptions about events that span an even longer time frame than that used in the simulation model. The ALCO guidelines provide that an immediate 200 basis point increase or decrease in interest rates should not result in more than a 1.75% change in the ratio of base case economic value of equity to base case economic value of assets. Key has been operating well within these guidelines. 28 29 RECENT MANAGEMENT ACTIONS During 1996, a number of actions were taken in connection with the execution of asset/liability management strategies designed to improve liquidity and reduce longer-term interest rate exposure. These actions included the sale of residential mortgage loans totaling $500 million and the securitization and sale of non-prime auto loans totaling $212 million. Other actions taken during 1996 included the continued run-off of lower-yielding securities and residential mortgage loans. During the first nine months of 1997, Key securitized and sold $205 million of home equity loans and an additional $671 million of auto loans. In addition, $365 million of out-of-franchise credit card receivables were sold. Management will continue to evaluate strategies to securitize and/or sell loans, taking into account the strategies' impacts on liquidity, capital and earnings. The above actions, along with the issuance of tax-advantaged capital securities of $500 million during the 1996 fourth quarter and $250 million in the second quarter of 1997, provided additional capital management flexibility. This was reflected in the repurchase of 14,620,000 and 8,980,018 Common Shares during 1996 and the first nine months of 1997, respectively. As was the case throughout 1996, Key continued to utilize both portfolio interest rate swaps, which are more fully discussed below, and interest rate caps and floors to manage its interest rate risk. In accordance with the previously described branch divestitures, during the month of March and in early April strategies were executed to minimize the interest rate risk associated with the anticipated loss of fixed rate deposits. These strategies included the issuance of $250 million of fixed rate bank notes and the execution of $650 million of forward-starting interest rate caps and $100 million of pay fixed swaps. PORTFOLIO INTEREST RATE SWAP CONTRACTS In addition to Key's securities portfolios and debt issuances, management has utilized interest rate swaps to manage interest rate risk by modifying the repricing or maturity characteristics of specified on-balance sheet assets and liabilities. Interest rate swaps used for this purpose are designated as portfolio swaps. The decision to use portfolio interest rate swaps versus on-balance sheet securities or debt to manage interest rate risk depends on various factors, including the mix and cost of funding sources, liquidity, and capital requirements. Further details pertaining to Key's swap portfolio are included in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 15. As shown in Note 10, the estimated fair value of Key's portfolio interest rate swaps increased $38 million during the first nine months of 1997 from a fair value of $8 million at December 31, 1996. The increase in fair value over the past nine months reflected the financial markets' expectations, as measured by the forward yield curve, for a future decrease in interest rates and the fact that Key's swap portfolio is primarily in a received fixed position. Swaps with a notional amount of $220 million were terminated during the first nine months of 1997, resulting in no deferred gain or loss. A summary of Key's deferred swap gains and losses at September 30, 1997, is also presented in Note 10. Each swap termination was made in response to a unique set of circumstances and for various reasons; however, the decision to terminate a swap contract is integrated strategically with asset and liability management and other appropriate processes. Portfolio swap activity for the nine-month period ended September 30, 1997, is summarized in Figure 6. FIGURE 6 PORTFOLIO SWAP ACTIVITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
Receive Fixed --------------------------------- Total Indexed Pay Fixed- Basis Portfolio in millions Amortizing Conventional Conventional Swaps Swaps - ------------------------------------------------------------------------------------------------------------------------ Balance at beginning of year $5,078 $3,505 $3,312 $400 $12,295 Additions -- 300 1,428 200 1,928 Maturities -- 55 1,280 400 1,735 Terminations 20 -- 200 -- 220 Amortization 993 -- -- -- 993 - ------------------------------------------------------------------------------------------------------------------------ Balance at end of period $4,065 $3,750 $3,260 $200 $11,275 ====== ====== ====== ==== ======= - ------------------------------------------------------------------------------------------------------------------------
A summary of the notional and fair values of portfolio swaps by interest rate management strategy is presented in Figure 7. The fair value at any given date represents the estimated income (if positive) or cost (if negative) that would be recognized if the portfolio were to be liquidated at that date. However, because the portfolio interest rate swaps are used to alter the repricing or maturity characteristics of specific assets and liabilities, the net unrealized gains and losses 29 30 related to the swaps are not recognized in earnings. Rather, interest from these swaps is recognized on an accrual basis as an adjustment of the interest income or expense from the asset or liability being managed. FIGURE 7 PORTFOLIO SWAPS BY INTEREST RATE STRATEGY
SEPTEMBER 30, 1997 December 31, 1996 September 30, 1996 ------------------------ --------------------------- ----------------------- NOTIONAL FAIR Notional Fair Notional Fair in millions AMOUNT VALUE Amount Value Amount Value - ----------------------------------------------------------------------------------------------------------------------------------- Convert variable rate loans to fixed $ 5,430 $ 1 $ 6,443 $(20) $ 6,688 $(80) Convert fixed rate loans to variable 180 (1) -- -- -- -- Convert variable rate deposits and short-term borrowings to fixed 2,480 (3) 3,082 (4) 2,033 (2) Convert variable rate long-term debt to fixed 600 (2) 230 (1) 280 (1) Convert fixed rate long-term debt to variable 2,385 51 2,140 33 2,149 (2) Basis swaps 200 -- 400 -- 400 -- - ----------------------------------------------------------------------------------------------------------------------------------- Total portfolio swaps $11,275 $46 $12,295 $ 8 $11,550 $(85) ======== ==== ======== ======= ======== ===== - -----------------------------------------------------------------------------------------------------------------------------------
The expected average maturities of the portfolio swaps at September 30, 1997, are summarized in Figure 8. FIGURE 8 EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS AT SEPTEMBER 30, 1997
Receive Fixed ---------------------------------- Total Indexed Pay Fixed- Basis Portfolio in millions Amortizing Conventional Conventional Swaps Swaps - --------------------------------------------------------------------------------------------------------------------------- Due in one year or less $ 853 $ 512 $1,550 $200 $ 3,115 Due after one through five years 3,123 305 1,710 -- 5,138 Due after five through ten years 89 2,698 -- -- 2,787 Due after ten years -- 235 -- -- 235 - --------------------------------------------------------------------------------------------------------------------------- Total portfolio swaps $4,065 $3,750 $3,260 $200 $11,275 ======= ======= ======= ===== ======= - ---------------------------------------------------------------------------------------------------------------------------
Key also uses interest rate caps and floors, and futures contracts to manage the risk associated with the potential impact of adverse movements in interest rates. Futures contracts are commitments to either purchase or sell designated financial instruments at future dates for specific prices. Key had caps and floors with a notional amount and fair value of $4.3 billion and $17 million, respectively, at September 30, 1997. There were no futures contracts outstanding at the same date. In June 1996, the FASB issued an Exposure Draft of a proposed SFAS, "Accounting for Derivatives and Similar Financial Instruments and for Hedging Activities." If adopted in its present form, an effect of this SFAS would be to disqualify the use of hedge accounting for indexed amortizing swaps currently accounted for by Key as hedging instruments and, therefore, likely alter Key's use of such instruments in the future. It is not currently practicable to estimate the potential effects of any final standard, which may differ from its present form. CUSTOMER INTEREST RATE SWAP CONTRACTS While not directly related to asset and liability management, in addition to portfolio swaps, Key has entered into interest rate swap contracts to accommodate the needs of its customers, typically commercial loan customers, and other positions with third parties that are intended to mitigate the interest rate risk of the customer positions. Adjustments to the fair values of such swaps are included in other income on the income statement. Further information pertaining to these contracts, as well as caps and floors, and futures contracts used for trading purposes is included in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 15. 30 31 NONINTEREST INCOME As shown in Figure 9, noninterest income for the 1997 third quarter totaled $393 million, up $104 million, or 36%, from the same period last year. Included in third quarter results were net gains of $76 million ($79 million in branch divestiture gains and a $3 million loss on the sale of Key's out-of-franchise credit card portfolio) in 1997 and an $11 million gain on the sale of a credit card portfolio in 1996. Excluding these items, noninterest income rose $39 million, or 14%, from last year's third quarter. The improvement over the prior year reflected growth across almost all major categories, including increases in trust and asset management income and corporate owned life insurance (both up $5 million) and insurance and brokerage income (up $4 million). Additional detail pertaining to the composition of trust and asset management income is presented in Figure 10. Excluding the branch divestiture gains and credit card transactions, other noninterest income was up $24 million, reflecting a $12 million increase in investment banking income and a $6 million increase in ATM surcharge fees. Investment banking income consists of trading profits derived from capital markets activities (including derivatives and foreign exchange fees), corporate finance fees, institutional brokerage commissions and gains recognized from mezzanine and equity capital investments. The growth in income contributed by the above categories was partially offset by a $3 million decrease in loan securitization income, due largely to a reduced volume of loan securitizations in the 1997 third quarter and the impact of the accounting change brought about by the January 1, 1997, adoption of SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This new accounting standard served to reduce loan securitization income in the third quarter by reclassifying a portion of such revenue to interest income and by deferring an additional portion which is expected to be recognized as interest income over the life of the respective securitizations. SFAS No. 125 is discussed in greater detail in Note 1, Summary of Significant Accounting Policies, in Key's 1996 Annual Report. Additional information pertaining to the type and volume of securitized loans which are either administered or serviced by Key and not recorded on its balance sheet is included in the Loans section beginning on page 33. For the first nine months of 1997, noninterest income totaled $940 million, up $138 million, or 17%, from the comparable 1996 period. Included in 1997 results were $89 million in branch divestiture gains. For the same period last year, results included an $11 million gain from the sale of a credit card portfolio and an $8 million gain from the sale of a Florida savings bank. Excluding these items, noninterest income was up $68 million, or 9%, from the prior year. As shown in Figure 9, the growth from the prior year came principally from higher levels of income from corporate owned life insurance (up $18 million), trust and asset management income (up $14 million), insurance and brokerage income (up $12 million) and other income (up $42 million). The $26 million decrease in loan securitization income relative to last year was due primarily to the factors described in the preceding paragraph. The $42 million increase in other income included a $23 million increase in investment banking income and a $15 million increase in ATM surcharge fees. The positive impact of these items was offset in part by a $16 million decline in mortgage banking income, reflecting the 1996 transition to a telephone based method of processing loan originations. FIGURE 9 NONINTEREST INCOME
Three Months ended Nine Months ended September 30, Change September 30, Change ----------------- ----------------------- -------------------- ---------------------- dollars in millions 1997 1996 Amount Percent 1997 1996 Amount Percent - ------------------------------------------------------------------------------------------------------------------------------------ Service charges on deposit accounts $ 77 $ 74 $ 3 4.1 % $222 $218 $ 4 1.8 % Trust and asset management income 66 61 5 8.2 194 180 14 7.8 Credit card fees 25 24 1 4.2 73 68 5 7.4 Insurance and brokerage income 22 18 4 22.2 64 52 12 23.1 Corporate owned life insurance 20 15 5 33.3 60 42 18 42.9 Loan securitization income 15 18 (3) (16.7) 19 45 (26) (57.8) Net securities gains -- -- -- -- -- 1 (1) (100.0) Other income: Investment banking income 38 26 12 46.2 77 54 23 42.6 Letter of credit fees 8 4 4 100.0 17 11 6 54.5 Mortgage banking income -- 6 (6) (100.0) 4 20 (16) (80.0) Miscellaneous income 122 43 79 183.7 210 111 99 89.2 - ------------------------------------------------------------------------------------------------------------------------------------ Total other income 168 79 89 112.7 308 196 112 57.1 - ------------------------------------------------------------------------------------------------------------------------------------ Total noninterest income $393 $289 $ 104 36.0 % $940 $802 $ 138 17.2 % ==== ==== ===== ==== ==== ===== - ------------------------------------------------------------------------------------------------------------------------------------
31 32 FIGURE 10 TRUST AND ASSET MANAGEMENT INCOME
Three months ended Nine months ended September 30, Change September 30, Change ------------------ ----------------- ----------------- -------------------- dollars in millions 1997 1996 Amount Percent 1997 1996 Amount Percent - ---------------------------------------------------------------------------------------------------------------- Personal asset management and custody fees $ 37 $36 $ 1 2.8 % $ 106 $107 $ (1) (0.9)% Institutional asset management and custody fees 18 17 1 5.9 53 47 6 12.8 Bond services 1 3 (2) (66.7) 5 10 (5) (50.0) All other fees 10 5 5 (100.0) 30 16 14 87.5 - ---------------------------------------------------------------------------------------------------------------- Total trust and asset management income $ 66 $61 $ 5 8.2 % $ 194 $180 $ 14 7.8 % ==== === === ===== ==== ==== - ---------------------------------------------------------------------------------------------------------------- AT SEPTEMBER 30, dollars in billions - -------------------------------------------------------------------------- Discretionary $ 49 $49 -- -- Non-discretionary 53 44 $ 9 20.5 % - -------------------------------------------------------------------------- Total trust assets $102 $93 $ 9 9.7 % ==== ==== === - --------------------------------------------------------------------------
NONINTEREST EXPENSE As shown in Figure 11, noninterest expense for the third quarter of 1997 totaled $648 million compared with $615 million for the third quarter of 1996. Included in third quarter 1997 expense was a $50 million charge recorded in connection with actions taken to sell certain properties or to alter certain leasing arrangements in response to Key's nationwide banking and related centralization efforts, as well as $14 million of distributions accrued on capital securities (tax-advantaged preferred securities) issued by Key during the second quarter of 1997 and the fourth quarter of last year. These securities are more fully described in Note 8, Capital Securities, beginning on page 14. In the prior year, third quarter results included a one-time charge of $17 million to provide for an assessment mandated by legislation passed by Congress on September 30, 1996, to recapitalize the SAIF. Excluding the above items, noninterest expense was $14 million, or 2%, below the year-ago quarter. This improvement was due in large part to the progress made with respect to the restructuring efforts announced last November which center around the formation of a single nationwide community bank (completed June 30, 1997, for all banks with the exception of KeyBank New Hampshire), as well as the implementation of expense control initiatives. Further information pertaining to specific actions taken in connection with the restructuring and expense control initiatives is included in the Introduction beginning on page 20. The $14 million reduction in core noninterest expense relative to the third quarter of last year was attributable primarily to decreases of $8 million in both marketing expense and professional fees. These improvements were offset in part by the impact of the Leasetec and Champion acquisitions and incentive accruals related to various investment banking activities. Also included in noninterest expense for the third quarter of 1997 was $4 million of expense incurred in connection with efforts being undertaken by Key to modify computer information systems to be year 2000 compliant (properly read date-sensitive information when the calendar year changes to 2000). As of September 30, 1997, Key had incurred and recognized approximately $10 million of the estimated $40 million of expense that it expects to incur to complete this project by the end of 1998. Noninterest expense totaled $1.8 billion for the first nine months of 1997, up $41 million, or 2%, from the same period last year. Excluding the real estate disposition charge and $35 million of distributions accrued on capital securities during 1997, and the one-time SAIF assessment in 1996, noninterest expense was down $27 million, or 2%, from the comparable year-ago period. This improvement reflected reductions in personnel expense and professional fees of $17 million and $13 million, respectively. Reduction in staff was a major reason for the decrease in personnel costs, as full-time equivalent employees totaled 25,622 at September 30, 1997, down from 28,337 at September 30, 1996. This reflected the impact of Key's restructuring and expense control initiatives (including branch mergers). Expenses incurred to become year 2000 compliant totaled $9 million for the first nine months of 1997. The efficiency ratio, which provides a measure of the extent to which recurring revenues are used to pay operating expenses, improved to 56.75% for the third quarter, from 57.66% in the previous quarter and 60.71% for the third quarter of 1996. The continued improvement during the third quarter of 1997 reflects the increasing benefits and effectiveness of Key's expense control strategies and growth in revenues. 32 33 FIGURE 11 NONINTEREST EXPENSE
Three Months ended Nine Months ended September 30, Change September 30, Change ------------------ -------------------- ------------------- ------------------ dollars in millions 1997 1996 Amount Percent 1997 1996 Amount Percent - --------------------------------------------------------------------------------------------------------------------------------- Personnel $299 $300 $(1) (.3) % $ 872 $ 889 $(17) (1.9) % Net occupancy 54 55 (1) (1.8) 164 163 1 .6 Equipment 44 41 3 7.3 131 119 12 10.1 Amortization of intangibles 23 21 2 9.5 65 65 -- -- Professional fees 10 18 (8) (44.4) 34 47 (13) (27.7) Marketing 22 30 (8) (26.7) 65 68 (3) (4.4) Other expense: Distributions on capital securities 14 -- 14 N/M 35 -- 35 N/M Equity and gross receipts based taxes 10 8 2 25.0 28 27 1 3.7 OREO expense, net1 (3) 2 (5) N/M (1) 3 (4) N/M FDIC insurance assessments 1 20 (19) (95.0) 4 25 (21) (84.0) Miscellaneous 174 120 54 45.0 408 358 50 14.0 - --------------------------------------------------------------------------------------------------------------------------------- Total other expense 196 150 46 30.7 474 413 61 14.8 - --------------------------------------------------------------------------------------------------------------------------------- Total noninterest expense $648 $615 $33 5.4 % $1,805 $1,764 $41 2.3 % ===== ===== ==== ====== ====== === Full-time equivalent employees at period end 25,622 28,337 25,622 28,337 Efficiency ratio2 56.75 % 60.71 % 57.75 % 60.71 % Overhead ratio3 37.76 44.40 40.81 45.66 - --------------------------------------------------------------------------------------------------------------------------------- 1 OREO expense is net of income of $1 million for both the third quarter of 1997 and 1996, respectively. 2 Calculated as noninterest expense (excluding certain nonrecurring charges and distributions on capital securities) divided by taxable-equivalent net interest income plus noninterest income (excluding net securities transactions and gains on branch sales). 3 Calculated as noninterest expense (excluding certain nonrecurring charges and distributions on capital securities) less noninterest income (excluding net securities transactions and gains on branch sales) divided by taxable-equivalent net interest income. N/M = Not Meaningful
INCOME TAXES The provision for income taxes was $111 million for the three-month period ended September 30, 1997, up from $101 million for the same period in 1996. The effective tax rate (provision for income taxes as a percentage of income before income taxes) for the 1997 third quarter was 32.0% compared with 32.8% for the third quarter of 1996. For the first nine months of 1997, the provision for income taxes was $309 million compared with $300 million for the first nine months of last year. The effective tax rate for these periods was 31.5% and 32.2%, respectively. Compared with the prior year, the lower effective income tax rate for both the quarterly and year-to-date periods was primarily attributable to increases in income from corporate owned life insurance and credits associated with investments in low-income housing projects. The effective income tax rate remains below the statutory Federal rate of 35% due primarily to continued investment in tax-advantaged assets (such as tax-exempt securities and corporate owned life insurance) and the recognition of credits associated with investments in low-income housing projects. FINANCIAL CONDITION LOANS At September 30, 1997, total loans outstanding were $53.7 billion, up from $49.2 billion at December 31, 1996, and $48.4 billion at September 30, 1996. The composition of the loan portfolio by loan type, as of each of these respective dates, is presented in Note 5, Loans, beginning on page 11. The $5.3 billion, or 11%, increase in loans outstanding from the September 30, 1996, level was due primarily to internal growth, but also included the net impact of acquisitions, sales and divestitures. During the third quarter of 1997, Key completed its acquisitions of Leasetec and Champion which added total loans outstanding of approximately $1.0 billion and $225 million, respectively. The sales and divestitures which occurred over the past year included the impact of the planned branch divestitures, as well as Key's continued strategy of securitizing and/or selling student loans, auto loans and other loans which do not meet certain return on equity, credit or other internal standards. For example, Key generally sells or securitizes student loans when a borrower enters repayment status. A summary of the loans sold and divested during 1997 and 1996 is presented in Figure 12. In addition to the branch divestitures, activity since September 30, 1996, included the sale of $586 million of student loans (of which $403 million was associated with securitizations), the sale of auto loans totaling $742 million and the sale of $205 million of home equity loans. All of the auto and home equity sales were associated with securitizations. Another factor moderating the increase in total loans over the past year was the sale of $365 million of out-of-franchise credit card receivables. Management will continue to explore opportunities for sales and/or other arrangements with respect to its credit card and other portfolios over the remainder of 1997. 33 34 Excluding the net impact of acquisitions, sales and divestitures, loan portfolios targeted for growth (which exclude one-to-four family mortgages and loans held for sale) increased $5.5 billion, or 14%, since September 30, 1996, and were up $1.5 billion, or an annualized 14%, from the prior quarter. Over the past 12 months, the largest improvement came from commercial loans which contributed $2.5 billion to the increase, due primarily to higher levels of commercial, financial and agricultural loans (up $1.8 billion) and real estate-construction loans (up $341 million). Additionally, consumer loans rose by $2.9 billion, and included increases of $1.1 billion in home equity loans and $172 million in credit card receivables. FIGURE 12 LOANS SOLD AND DIVESTED
Loans Sold ------------------------------------------------------------------------ Home Equity Mortgage Student Loans Loans Held Loans Held Credit Card Loans in millions Auto Loans Held for Sale for Sale for Sale Receivables Divested Total - ---------------------------------------------------------------------------------------------------------------------- 1996 - ------------------- First quarter $ 38 $ 44 -- $500 -- -- $ 582 Second quarter 47 99 -- -- -- $762 1 908 Third quarter 56 464 -- -- $101 -- 621 Fourth quarter 71 403 -- -- -- -- 474 - ---------------------------------------------------------------------------------------------------------------------- Total $212 $1,010 -- $500 $101 $762 $2,585 ==== ====== ==== ==== ==== ====== 1997 - ------------------- First quarter $456 $31 -- -- $41 -- $ 528 Second quarter 103 52 -- -- -- -- 155 Third quarter 112 100 $205 -- 324 $491 2 1,232 - ---------------------------------------------------------------------------------------------------------------------- Total $671 $183 $205 -- $365 $491 $1,915 ==== ==== ==== ==== ==== ====== - ---------------------------------------------------------------------------------------------------------------------- 1 Residential mortgage loans divested as part of the SFF transaction. 2 Branch divestitures and the sale of KeyBank Wyoming.
The $4.4 billion increase in loans from the December 31, 1996, level reflected strong growth in targeted loan portfolios. The aggregate annualized growth rate of average outstanding balances in these portfolios was 20%, 11% and 7% for the third, second and first quarters of 1997, respectively. Excluding the net impact of acquisitions, sales and divestitures, targeted loans rose $4.0 billion due primarily to higher levels of commercial loans (up $2.1 billion, including $1.6 billion of commercial, financial and agricultural loans) and consumer loans (up $2.0 billion, including $623 million of home equity loans). At September 30, 1997, targeted loans comprised 83% of total loans and 62% of total assets compared with 83% of total loans and 60% of total assets at December 31, 1996. Shown in Figure 13 are loans which have been securitized and sold and are either administered or serviced by Key, but not recorded on its balance sheet. Income recognized in connection with such transactions is derived from two sources. Noninterest income earned from servicing or administering the loans is recorded as loan securitization income, while income earned on assets subject to prepayment, recorded in connection with securitizations and accounted for like investments in interest-only strips, is recorded as interest income on securities available for sale. 34 35 The increase from December 31, 1996, to September 30, 1997, in loans shown in Figure 13 is due primarily to the acquisition of Champion. FIGURE 13 LOANS SECURITIZED/SOLD AND ADMINISTERED OR SERVICED
SEPTEMBER 30, December 31, September 30, in millions 1997 1996 1996 - ------------------------------------------------------------------------------------------------ Student loans $1,908 $2,089 $1,778 Auto loans 847 386 375 Home equity loans 869 -- -- - ------------------------------------------------------------------------------------------------ Total $3,624 $2,475 $2,153 ====== ====== ====== - ------------------------------------------------------------------------------------------------
SECURITIES At September 30, 1997, the securities portfolio totaled $8.9 billion, consisting of $7.6 billion of securities available for sale and $1.3 billion of investment securities. This compares with a total portfolio of $9.3 billion, comprised of $7.7 billion of securities available for sale and $1.6 billion of investment securities, at December 31, 1996. The composition of the two securities portfolios by type of security, as of each of these respective dates, is presented in Note 3, Securities Available for Sale, and Note 4, Investment Securities, presented on pages 9 and 10, respectively. The increase in collateralized mortgage obligations since year end 1996 is in part the result of programs instituted in the fourth quarter of 1996 to better manage securities used to meet the collateral requirements of the affiliate banks. Previously, lower-yielding securities with shorter maturities had been relied upon for this purpose. Certain information pertaining to the composition, yields, and maturities of the securities available for sale and investment securities portfolios is presented in Figures 14 and 15, respectively. FIGURE 14. SECURITIES AVAILABLE FOR SALE AT SEPTEMBER 30, 1997
Other U.S. Treasury States and Collateralized Mortgage- Weighted Agencies and Political Mortgage- Backed Other Average dollars in millions Corporations Subdivisions Obligations1 Securities1 Securities1 Total Yield2 - ------------------------------------------------------------------------------------------------------------------------------------ Maturity: One year or less $436 $ 2 $ 456 $ 6 $ 1 $ 901 5.99 % After one through five years 100 11 2,872 1,264 205 4,452 6.83 After five through ten years 14 32 54 1,754 140 1,994 6.86 After ten years 24 5 -- 141 46 216 3 6.44 - ------------------------------------------------------------------------------------------------------------------------------------ Fair value $574 $50 $3,382 $3,165 $392 $7,563 -- Amortized cost 572 50 3,376 3,130 423 7,551 6.70 % Weighted average yield 5.98 % 5.94 % 6.65 % 7.43 % 2.82 % 6.70 % -- Weighted average maturity 1.3 years 7.5 years 2.7 years 6.1 years 4.6 years 4.1 years -- - ------------------------------------------------------------------------------------------------------------------------------------ 1 Maturity is based upon expected average lives rather than contractual terms. 2 Weighted average yields are calculated on the basis of amortized cost. Such yields have been adjusted to a taxable-equivalent basis using the statutory Federal income tax rate of 35%. 3 Includes equity securities with no stated maturity.
35 36 FIGURE 15 INVESTMENT SECURITIES AT SEPTEMBER 30, 1997
States and Weighted Political Other Average dollars in millions Subdivisions Securities Total Yield 1 - ------------------------------------------------------------------------------------------------------- Maturity: One year or less $ 414 -- $ 414 7.04 % After one through five years 469 $ 100 569 10.93 After five through ten years 168 -- 168 10.00 After ten years 54 139 193 2.58 - ------------------------------------------------------------------------------------------------------- Amortized cost $1,105 $239 $1,344 8.42 % Fair value 1,139 239 1,378 -- Weighted average yield 8.27 % 9.13 % 8.42 % -- Weighted average maturity 3.0 years 2.7 years 2.9 years -- - ------------------------------------------------------------------------------------------------------- 1 Weighted average yields are calculated on the basis of amortized cost. Such yields have been adjusted to a taxable-equivalent basis using the statutory Federal income tax rate of 35%.
ASSET QUALITY Through its Credit Policy, Credit Administration and Loan Review Groups, Key evaluates and monitors the level of risk in its credit-related assets; formulates underwriting standards and guidelines for line management; develops commercial and consumer credit policies and systems; establishes credit-related concentration limits; reviews loans, leases and other corporate assets to evaluate credit quality; and reviews the adequacy of the allowance for loan losses ("Allowance"). Geographic diversity throughout Key is a significant factor in managing credit risk. Management has developed methodologies designed to assess the adequacy of the Allowance. The Allowance allocation methodologies applied at Key focus on changes in the size and character of the loan portfolio, changes in the levels of impaired and other nonperforming and past due loans, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing and prospective economic conditions and historical losses on a portfolio basis. In addition, indirect risk in the form of off-balance sheet exposure for unfunded commitments is taken into consideration. Management continues to target and maintain an Allowance equal to the allocated requirement plus an unallocated portion, as appropriate. Management believes this is an appropriate posture in light of current and expected economic conditions and trends, the geographic and industry mix of the loan portfolio and similar risk-related matters. As shown in Figure 16, net loan charge-offs for the third quarter of 1997 were $85 million, or .64% of average loans, compared with $49 million, or .40% of average loans, for the same period last year. The higher level of net charge-offs was concentrated in the consumer-indirect, commercial, financial and agricultural and credit card portfolios. Key has a relatively small credit card portfolio which comprises approximately 3% of its total average loans outstanding. The $19 million increase in consumer-indirect net charge-offs (primarily indirect auto loans) reflected the impact of a strategy adopted by Key in 1996 to expand its consumer customer base to include various credit risk profiles. This strategy also includes risk-adjusted pricing to address the relative credit risk of various strata of the customer base. In addition, Key's consumer portfolio was impacted by the continuing nationwide deterioration in consumer credit quality, as indicated by an increasingly high number of bankruptcies. Net charge-offs in the commercial portfolio were up $7 million, primarily due to the resolution of a few large commercial accounts. As a result of the higher level of net charge-offs, the provision for loan losses was increased to $102 million for the third quarter of 1997 from $75 million for the prior quarter and $49 million for the third quarter of last year. This increase reflected management's intention to continue to maintain the provision for loan losses at a level equal to or above net charge-offs. On a year-to-date basis, net charge-offs were $217 million, or .57% of average loans, for the first nine months of 1997 compared with $138 million, or .38% of average loans, for the same period last year. The provision for loan losses for the first nine months of 1997 was $244 million compared with $140 million for the first nine months of 1996. The $79 million rise in net charge-offs for the year-to-date period was attributable primarily to increases of $41 million and $33 million in the consumer-indirect and credit card portfolios, respectively. 36 37 FIGURE 16 SUMMARY OF LOAN LOSS EXPERIENCE
Three months ended September 30 Nine months ended September 30 --------------------------------- ------------------------------------- dollars in millions 1997 1996 1997 1996 - ---------------------------------------------------------------- ------------- --------------- --------------- Average loans outstanding during the period $52,708 $48,103 $50,778 $48,182 - ------------------------------------------------------------------------------------------------------------------------------ Allowance for loan losses at beginning of period $880 $870 $ 870 $876 Loans charged off: Commercial, financial and agricultural 17 15 39 54 Real estate-commercial mortgage 8 3 13 10 Real estate-construction -- 2 2 2 Commercial lease financing 2 -- 5 4 - ------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 27 20 59 70 Real estate-residential mortgage 3 3 8 7 Home equity 2 -- 3 1 Credit card 25 21 86 57 Consumer-direct 9 8 27 22 Consumer-indirect 39 20 99 59 - ------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 78 52 223 146 - ------------------------------------------------------------------------------------------------------------------------------ 105 72 282 216 Recoveries: Commercial, financial and agricultural 7 8 23 31 Real estate-commercial mortgage 2 2 7 6 Real estate-construction 2 1 2 1 Commercial lease financing -- -- -- 1 - ------------------------------------------------------------------------------------------------------------------------------ Total commercial loans 11 11 32 39 Real estate-residential mortgage -- -- 2 2 Credit card 2 4 6 10 Consumer-direct 1 2 5 6 Consumer-indirect 6 6 20 21 - ------------------------------------------------------------------------------------------------------------------------------ Total consumer loans 9 12 33 39 - ------------------------------------------------------------------------------------------------------------------------------ 20 23 65 78 - ------------------------------------------------------------------------------------------------------------------------------ Net loans charged off (85) (49) (217) (138) Provision for loan losses 102 49 244 140 Allowance acquired/sold, net 3 -- 3 (8) - ------------------------------------------------------------------------------------------------------------------------------ Allowance for loan losses at end of period $900 $870 $900 $870 ==== ==== ==== ==== - ------------------------------------------------------------------------------------------------------------------------------ Net loan charge-offs to average loans .64 % .40 % .57% .38 % Allowance for loan losses to period end loans 1.68 1.80 1.68 1.80 Allowance for loan losses to nonperforming loans 247.25 252.91 247.25 252.91 - ------------------------------------------------------------------------------------------------------------------------------
The Allowance at September 30, 1997, was $900 million, or 1.68% of loans, up $30 million from $870 million, or 1.77% of loans, at December 31, 1996, and $870 million, or 1.80% of loans, at September 30, 1996. At September 30, 1997, the Allowance was 247.25% of nonperforming loans, compared with 249.28% at December 31, 1996 and 252.91% at September 30, 1996. Although this percentage is not a primary factor used by management in determining the adequacy of the Allowance, it has general short to medium-term relevance. There have been no significant changes in the allocation of the Allowance since year end. The composition of nonperforming assets is shown in Figure 17. These assets totaled $411 million at September 30, 1997, and represented .77% of loans, OREO and other nonperforming assets compared with $400 million, or .81%, at year end 1996 and $396 million, or .82%, at September 30, 1996. The $15 million increase in nonperforming loans since year end 1996 was geographically broad based and spread across a number of product types in the commercial (up $35 million) and consumer (up $5 million) loan portfolios. These increases were partially offset by a $24 million decline in the level of nonperforming residential real estate loans. Additional information pertaining to changes in impaired and other nonaccrual loans and the percentage of nonperforming loans to period end loans by type within Key's geographically dispersed banking regions is presented in Figures 18 and 19, respectively. The September 30, 1997, percentage of nonperforming real estate construction loans to period end loans in the Rocky Mountain Region included one credit of approximately $17 million which was placed on nonperforming status during the third quarter. 37 38 FIGURE 17 SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
SEPTEMBER 30, December 31, September 30, dollars in millions 1997 1996 1996 - ------------------------------------------------------------------------------------------------------------- Commercial, financial and agricultural $ 162 $ 120 $ 131 Real estate--commercial mortgage 77 84 82 Real estate--construction 24 19 14 Commercial lease financing 3 8 16 Real estate--residential mortgage 56 80 75 Consumer 42 37 25 - ------------------------------------------------------------------------------------------------------------- Total nonaccrual loans 364 348 343 Restructured loans -- 1 1 - ------------------------------------------------------------------------------------------------------------- Total nonperforming loans 364 349 344 OREO 67 56 59 Allowance for OREO losses (22) (8) (10) - ------------------------------------------------------------------------------------------------------------- OREO, net of allowance 45 48 49 Other nonperforming assets 2 3 3 - ------------------------------------------------------------------------------------------------------------- Total nonperforming assets $ 411 $ 400 $ 396 ===== ===== ===== - ------------------------------------------------------------------------------------------------------------- Accruing loans past due 90 days or more $ 138 $ 103 $ 105 - ------------------------------------------------------------------------------------------------------------- Nonperforming loans to period end loans .68 % .71 % .71 % Nonperforming assets to period end loans plus OREO and other nonperforming assets .77 .81 .82 - -------------------------------------------------------------------------------------------------------------
FIGURE 18 SUMMARY OF CHANGES IN IMPAIRED AND OTHER NONACCRUAL LOANS
Three months ended Nine months ended September 30, September 30, --------------------------------- ---------------------------------- in millions 1997 1996 1997 1996 - --------------------------------------------------------------------------------------------------------------------------------- Balance at beginning of period $372 $325 $348 $330 Loans placed on nonaccrual 49 75 169 244 Charge-offs1 (26) (15) (52) (59) Payments (14) (32) (61) (98) Loans sold (6) -- (6) (38) Transfers to OREO (3) (6) (19) (19) Loans returned to accrual (8) (4) (15) (17) - --------------------------------------------------------------------------------------------------------------------------------- Balance at end of period $364 $343 $364 $343 ===== ===== ===== ==== - --------------------------------------------------------------------------------------------------------------------------------- 1 Represents the gross charge-offs taken against nonaccrual loans; excluded are charge-offs taken against accruing loans, credit card receivables, and interest reversals.
FIGURE 19 PERCENTAGE OF NONPERFORMING LOANS TO PERIOD END LOANS BY TYPE AT SEPTEMBER 30, 1997
Commercial, Real Estate- Commercial Real Estate- Financial and Commercial Real Estate- Lease Residential Agricultural Mortgage Construction Financing Mortgage2 Consumer1 Total - --------------------------------------------------------------------------------------------------------------------------------- Northeast Region 1.56% 1.87% .41% .03% NA% .20% 1.06% Great Lakes Region .33 .75 .44 .16 NA .17 .36 Rocky Mountain Region 2.38 1.22 4.82 .02 NA .51 1.69 Northwest Region .55 .94 .42 .06 NA .20 .51 Financial Services - - - .07 NA .22 .15 - --------------------------------------------------------------------------------------------------------------------------------- Total 1.17% 1.09% 1.15% .08% .91% .26% .68% - -------------------------------------------------------------------------------------------------------------------------------- 1 EXCLUDES CREDIT CARD RECEIVABLES. 2 NA = INFORMATION NOT AVAILABLE ON A REGIONAL BASIS.
38 39 DEPOSITS AND OTHER SOURCES OF FUNDS Core deposits, defined as domestic deposits other than certificates of deposit of $100,000 or more, are Key's primary source of funding. During the third quarter of 1997, these deposits averaged $38.4 billion and represented 62% of Key's funds supporting earning assets compared with $39.9 billion and 69%, respectively, for the third quarter of 1996. As shown in Figure 4 beginning on page 26, over the past year the decrease in core deposits was due primarily to steady declines in the levels of both savings deposits and NOW accounts. This reflected primarily the sale of KeyBank Wyoming in July 1997 and the divestiture of 21 other branch offices during the second and third quarters of this year. The divested branches (including KeyBank Wyoming) had deposits of approximately $1.3 billion. Purchased funds, which are comprised of large certificates of deposit, deposits in foreign offices and short-term borrowings, averaged $17.2 billion for the third quarter of 1997, up $3.5 billion, or 25%, from the comparable prior year period. As illustrated in Figure 4, the increase was attributable primarily to higher levels of short-term borrowings and deposits in foreign offices which rose by $2.6 billion and $876 million, respectively. Purchased funds have been more heavily relied upon to offset declines in the volume of core deposits and to fund earning asset growth. This trend is expected to continue through the remainder of 1997 due in large part to the impact of the planned branch divestitures. FIGURE 20 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE AT SEPTEMBER 30, 1997
Domestic Foreign in millions Offices Offices Total - ----------------------------------------------------------------------------------- Time remaining to maturity: Three months or less $1,464 $2,172 $3,636 Over three through six months 509 -- 509 Over six through twelve months 430 -- 430 Over twelve months 717 -- 717 - ----------------------------------------------------------------------------------- Total $3,120 $2,172 $5,292 ======= ======= ====== - -----------------------------------------------------------------------------------
LIQUIDITY Key actively analyzes and manages its liquidity, which represents the availability of funding to meet the needs of depositors, borrowers and creditors at a reasonable cost on a timely basis and without adverse consequences. The affiliate banks maintain liquidity in the form of short-term money market investments, securities available for sale, anticipated prepayments and maturities on securities, the maturity structure of their loan portfolios and the ability to securitize and package loans for sale. Liquidity is also enhanced by a sizable concentration of core deposits, previously discussed, which are generated by more than 1,000 full-service Key Centers in 14 states. The affiliate banks monitor deposit flows and evaluate alternate pricing structures with respect to their deposit base. This process is supported by a Central Funding Unit within Key's Funds & Investment Management Group. This group monitors the overall mix of funding sources in conjunction with the affiliate banks' deposit pricing and in response to the structure of the earning assets portfolio. In addition, the affiliate banks have access to various sources of money market funding (such as Federal funds purchased, securities sold under repurchase agreements and bank notes) and borrowings from the Federal Reserve system for short-term liquidity requirements should the need arise. One of the affiliate banks, KeyBank USA, has a line of credit with the Federal Reserve which provides for overnight borrowings of up to $1.1 billion and is secured by $1.4 billion of KeyBank USA's credit card receivables at September 30, 1997. There were no borrowings outstanding under this line of credit as of September 30, 1997. During the first nine months of 1997, Key's affiliate banks raised $6.6 billion under Key's Bank Note Program. Of the notes issued during the first nine months of 1997, $2.7 billion have original maturities in excess of one year and are included in long-term debt, while $3.9 billion have original maturities of one year or less and are included in other short-term borrowings. On October 7, 1997, Key commenced a new Bank Note Program which provides for the issuance of up to $13 billion ($12 billion by KeyBank National Association and $1 billion by KeyBank USA). During the second quarter of 1997, Key diversified its funding sources by establishing a Euronote Program under which the parent company, KeyBank National Association and KeyBank USA may issue both long and short-term debt of up to $5 billion in the aggregate. The notes will be offered exclusively to non-U.S. investors and can be denominated in dollars and most European currencies. There was $780 million of borrowings outstanding under this facility as of September 30, 1997, all of which were issued during the third quarter of 1997. 39 40 The parent company's Commercial Paper/Note Program provides for the availability of up to $500 million of additional short-term funding. The proceeds from this program may be used for general corporate purposes, and have been used to fund AutoFinance Group, Inc.'s lending activities in conjunction with securitizations of its auto loans. The parent company also has a revolving credit agreement with several unaffiliated banks under which the banks have agreed to lend collectively up to $500 million to the parent company. This credit agreement is used primarily as a backup source of liquidity for the Commercial Paper/Note Program. There were no borrowings outstanding under either of these facilities as of September 30, 1997. During the third quarter of 1996, the parent company filed a universal shelf registration statement with the SEC to provide for the possible issuance of up to $1.2 billion of debt and equity securities in addition to the unused capacity under a previous shelf registration. Accordingly, at September 30, 1997, unused capacity under the 1996 shelf registration totaled $1.3 billion, of which $750 million is reserved for future issuance as medium-term notes. The proceeds from the issuances under the shelf registration, the Bank Note Program and the Euronote Program described above may be used for general corporate purposes, including acquisitions. The liquidity requirements of the parent company, primarily for dividends to shareholders, servicing of debt and other corporate purposes are principally met through regular dividends from affiliate banks. Excess funds are maintained in short-term investments. The parent company has ready access to the capital markets as a result of its favorable debt ratings which, at September 30, 1997, were as follows:
Senior Subordinated Commercial Long-Term Long-Term Paper Debt Debt ---------------- ---------------- ----------------- Duff D-1+ AA- A+ & Phelps Standard A-2 A- BBB+ & Poor's Moody's P-1 A1 A2
Further information pertaining to Key's sources and uses of cash for the nine-month periods ended September 30, 1997 and 1996, is presented in the Consolidated Statements of Cash Flow on page 6. CAPITAL AND DIVIDENDS Total shareholders' equity at September 30, 1997, was $5.1 billion, down $195 million, or 4%, from the December 31, 1996, balance and $100 million, or 2%, from the end of the third quarter of 1996. The decrease from the end of the prior year and from the year-ago quarter was due primarily to the share repurchases discussed below and dividends paid to shareholders from current period net income. The decrease from the 1996 year end was partially offset by net unrealized securities gains of $57 million and net income retained for the current period. As of September 30, 1997, cumulative net unrealized securities gains totaled $8 million. This amount compares with losses of $6 million and $37 million at December 31, 1996, and September 30, 1996, respectively. Other factors contributing to the change in shareholders' equity during the first nine months of 1997 are shown in the Statement of Changes in Shareholders' Equity presented on page 5. In November 1996, the Board of Directors approved a share repurchase program which authorized the repurchase from that date of up to 12,000,000 Common Shares by the end of 1997. Under the program, shares have been repurchased from time to time in the open market or through negotiated transactions. During the first nine months of 1997, Key repurchased 5,643,900 shares at a total cost of $296 million (an average of $52.45 per share) and reissued 1,856,064 Treasury Shares for employee benefit and dividend reinvestment plans. Coupled with 2,620,000 shares repurchased in the fourth quarter of 1996, this brings the total number of shares repurchased under the 1997 program to 8,263,900, leaving authority to repurchase up to 3,736,100 Common Shares by the end of 1997. While Key may repurchase additional Common Shares by the end of 1997, it does not anticipate utilizing the full authority under the 12,000,000 Common Shares repurchase program and may request its Board to extend any remaining authority into 1998. Under a separate authorization, an additional 3,336,118 Key Common Shares were repurchased during the current year and reissued in the Champion acquisition. The 26,278,189 Treasury Shares at September 30, 1997, are expected to be reissued over time in connection with employee stock purchase, 401(k), stock option and dividend reinvestment plans and for other corporate purposes. 40 41 Capital adequacy is an important indicator of financial stability and performance. Overall, Key's capital position remains strong with a ratio of total shareholders' equity to total assets of 7.04% at September 30, 1997, compared with 7.22% at December 31, 1996, and 7.61% at September 30, 1996. Including the capital securities issued in the fourth quarter of 1996 and the second quarter of 1997, the ratio of total shareholders' equity to total assets at September 30, 1997, and December 31, 1996, is 7.74% and 7.96%, respectively. Banking industry regulators define minimum capital ratios for bank holding companies and their banking subsidiaries. Based on the risk-adjusted capital rules and definitions prescribed by the banking regulators, Key's Tier I and total risk-adjusted capital ratios at September 30, 1997, were 6.73% and 11.10%, respectively. These compare favorably with the minimum requirements of 4.0% for Tier I and 8.0% for total capital. The regulatory leverage ratio standard prescribes a minimum ratio of 3.0%, although most banking organizations are expected to maintain ratios of at least 100 to 200 basis points above the minimum. At September 30, 1997, Key's leverage ratio was 6.33%, substantially higher than the minimum requirement. Figure 21 presents the details of Key's regulatory capital position at September 30, 1997, December 31, 1996, and September 30, 1996. Under the Federal Deposit Insurance Act, the Federal bank regulators group FDIC-insured depository institutions into five broad categories based on certain capital ratios. The five categories are "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." All of Key's affiliate banks qualify as "well capitalized" at September 30, 1997, since they exceeded the well-capitalized thresholds of 10%, 6% and 5% for the total capital, Tier I capital and leverage ratios, respectively. Although these provisions are not directly applicable to Key under existing laws and regulations, based upon its ratios Key would qualify as "well capitalized" at September 30, 1997. The FDIC-defined capital categories may not constitute an accurate representation of the overall financial condition or prospects of Key or its affiliate banks. 41 42 FIGURE 21 CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
SEPTEMBER 30, December 31, September 30, dollars in millions 1997 1996 1996 - ------------------------------------------------------------------------------------------------------------------------ TIER I CAPITAL Common shareholders' equity1 $5,068 $4,887 $5,013 Qualifying capital securities 500 500 -- Less: Goodwill (1,095) (824) (838) Other intangible assets2 (108) (121) (124) - ------------------------------------------------------------------------------------------------------------------------ Total Tier I capital 4,365 4,442 4,051 - ------------------------------------------------------------------------------------------------------------------------ TIER II CAPITAL Allowance for loan losses3 812 698 678 Qualifying long-term debt 2,022 2,103 2,026 - ------------------------------------------------------------------------------------------------------------------------ Total Tier II capital 2,834 2,801 2,704 - ------------------------------------------------------------------------------------------------------------------------ Total capital $7,199 $7,243 $6,755 ======= ======= ====== RISK-ADJUSTED ASSETS Risk-adjusted assets on balance sheet $57,181 $52,228 $50,805 Risk-adjusted off-balance sheet exposure 8,990 4,541 4,403 Less: Goodwill (1,095) (824) (838) Other intangible assets2 (108) (121) (124) - ------------------------------------------------------------------------------------------------------------------------ Gross risk-adjusted assets 64,968 55,824 54,246 Less: Excess allowance for loan losses3 (88) (172) (192) - ------------------------------------------------------------------------------------------------------------------------ Net risk-adjusted assets $64,880 $55,652 $54,054 ======== ======== ======= AVERAGE QUARTERLY TOTAL ASSETS $70,112 $65,063 $64,480 ======== ======== ======= CAPITAL RATIOS5 Tier I risk-adjusted capital ratio 6.73% 7.98% 7.49% Total risk-adjusted capital ratio 11.10 13.01 12.50 Leverage ratio4 6.33 6.93 6.38 - ------------------------------------------------------------------------------------------------------------------------ 1 Common shareholders' equity excludes the impact of net unrealized gains or losses on securities, except for net unrealized losses on marketable equity securities. 2 Intangible assets (excluding goodwill and portions of purchased credit card relationships) recorded after February 19, 1992, and portions of purchased mortgage servicing rights deducted in regulatory capital computations. 3 The allowance for loan losses included in Tier II capital is limited to 1.25% of gross risk-adjusted assets. 4 Tier I capital as a percentage of average quarterly assets, less goodwill and other non-qualifying intangible assets as defined in 2 above.
42 43 PART II. OTHER INFORMATION Item 1. Legal Proceedings ----------------- In the ordinary course of business, Key is subject to legal actions which involve claims for substantial monetary relief. Based on information presently available to management and Key's counsel, management does not believe that any legal actions, individually or in the aggregate, will have a material adverse effect on the consolidated financial condition of Key. Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibits (11) Computation of Net Income Per Common Share (15) Acknowledgment Letter of Independent Auditors (27) Financial Data Schedule (filed electronically only) (b) Reports on Form 8-K July 18, 1997 - Item 5. Other Events and Item 7. Financial Statements, Pro Forma Financial Statements and Exhibits. Reporting that the Registrant issued a press release on July 17, 1997, announcing its earnings results for the three-month period ended June 30, 1997. No other reports on Form 8-K were filed during the three-month period ended September 30, 1997. SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. KEYCORP -------------------------------------- (Registrant) Date: November 14, 1997 /s/ Lee Irving -------------------------------------- By: Lee Irving Executive Vice President and Chief Accounting Officer 43 EX-11 2 EXHIBIT 11 1 EXHIBIT 11 KEYCORP COMPUTATION OF NET INCOME PER COMMON SHARE (dollars in millions, except per share amounts)
Three months ended Sept. 30, Nine months ended Sept. 30, ----------------------------------- ----------------------------------- 1997 1996 1997 1996 ---------------- ---------------- ---------------- ---------------- NET INCOME APPLICABLE TO COMMON SHARES Net income $236 $207 $671 $632 Less: Preferred dividend requirements -- -- -- 8 ---------------- ---------------- ---------------- ---------------- Net income applicable to Common Shares $236 $207 $671 $624 ================ ================ ================ ================ NET INCOME PER COMMON SHARE Weighted average Common Shares outstanding (000) 218,107 229,668 219,570 231,363 ================ ================ ================ ================ Net income applicable to Common Shares $236 $207 $671 $624 ================ ================ ================ ================ Net income per Common Share $1.08 $.90 $3.06 $2.70 ================ ================ ================ ================ NET INCOME PER COMMON SHARE -- PRIMARY Weighted average Common Shares outstanding (000) 218,107 229,668 219,570 231,363 Dilutive common stock options (000)1 4,744 3,280 4,204 3,332 ---------------- ---------------- ---------------- ---------------- Weighted average Common Shares and Common Share equivalents outstanding (000) 222,851 232,948 223,774 234,695 ================ ================ ================ ================ Net income applicable to Common Shares $236 $207 $671 $624 ================ ================ ================ ================ Net income per Common Share $1.06 $.89 $3.00 $2.66 ================ ================ ================ ================ NET INCOME PER COMMON SHARE -- FULLY DILUTED Weighted average Common Shares outstanding (000) 218,107 229,668 219,570 231,363 Dilutive common stock options (000)1 5,114 3,940 5,145 4,305 ---------------- ---------------- ---------------- ---------------- Weighted average Common Shares and Common Share equivalents outstanding (000) 223,221 233,608 224,715 235,668 ================ ================ ================ ================ Net income applicable to Common Shares $236 $207 $671 $624 ================ ================ ================ ================ Net income per Common Share $1.06 $.88 $2.99 $2.65 ================ ================ ================ ================ 1 Dilutive common stock options are based on the treasury stock method using average market price in computing net income per Common Share--primary, and the higher of period-end market price or average market price in computing net income per Common Share--fully diluted.
44 EX-15 3 EXHIBIT 15 1 EXHIBIT 15 ACKNOWLEDGMENT LETTER OF INDEPENDENT AUDITORS Shareholders and Board of Directors KeyCorp We are aware of the incorporation by reference in the following KeyCorp ("Key") Registration Statements of our review report, dated October 14, 1997, relating to the unaudited consolidated interim financial statements of Key, included in the Quarterly Report on Form 10-Q/A for the quarter ended September 30, 1997. Form S-3 No. 33-5064 Form S-3 No. 33-10634 Form S-3 No. 33-39733 Form S-3 No. 33-51652 Form S-3 No. 33-53643 Form S-3 No. 33-56881 Form S-3 No. 33-58405 Form S-3 No. 333-10577 Form S-3 No. 333-37287 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. 333-19153 Form S-8 No. 2-97452 Form S-8 No. 33-21643 Form S-8 No. 33-42691 Form S-8 No. 33-45518 Form S-8 No. 33-46278 Form S-8 No. 33-52293 Form S-8 No. 33-54819 Form S-8 No. 33-56745 Form S-8 No. 33-56879 Form S-8 No. 33-31569 (Post-Effective Amendment No. 1 to Form S-4) Form S-8 No. 33-31569 (Post-Effective Amendment No. 2 to Form S-4) Form S-8 No. 33-31569 (Post-Effective Amendment No. 3 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) Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part of the Registration Statements prepared or certified by accountants within the meaning of Section 7 or 11 of the Securities Act of 1933. /s/ Ernst & Young LLP Cleveland, Ohio November 10, 1997 45 EX-27 4 EXHIBIT 27
9 1,000,000 3-MOS DEC-31-1997 JUL-01-1997 SEP-30-1997 2,940 24 626 567 7,563 1,344 1,378 53,676 900 72,077 43,870 12,715 2,099 7,567 0 0 246 4,830 72,077 3,417 457 23 3,897 1,101 1,808 2,089 244 0 1,805 980 980 0 0 671 3.00 2.99 4.67 364 138 0 0 870 282 65 900 900 0 0
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