-----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, BsUQt3b/pPsmDKdFAt0Ss3Rt/CqnZjVOT1/RfdSw9EegIssEMouIb3CzUAscIwEP vmGnCp2x8j5G+85PQuadZQ== 0000950152-98-004651.txt : 19980518 0000950152-98-004651.hdr.sgml : 19980518 ACCESSION NUMBER: 0000950152-98-004651 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980515 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 SEC ACT: SEC FILE NUMBER: 001-11302 FILM NUMBER: 98624392 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 1 KEYCORP 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From ______ To ______ Commission File Number 0-850 [KEYCORP LOGO] ------------------------------------------------------ (Exact name of registrant as specified in its charter) OHIO 34-6542451 - ----------------------------------------- -------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 127 PUBLIC SQUARE, CLEVELAND, OHIO 44114-1306 - ----------------------------------------- -------------------------------- (Address of principal executive offices) (Zip Code) (216) 689-6300 ------------------------------------------------------ (Registrant's telephone number, including area code) 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 440,071,075 Shares ------------------------------------------- -------------------------------- (Title of class) (Outstanding at April 30, 1998) The number of pages of this report is 46. 2 KEYCORP TABLE OF CONTENTS PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page Number -------------------- ----------- Consolidated Balance Sheets -- March 31, 1998, December 31, 1997 and March 31, 1997 3 Consolidated Statements of Income -- Three months ended March 31, 1998 and 1997 4 Consolidated Statements of Changes in Shareholders' Equity -- Three months ended March 31, 1998 and 1997 5 Consolidated Statements of Cash Flow -- Three months ended March 31, 1998 and 1997 6 Notes to Consolidated Financial Statements 7 Independent Accountants' Review Report 18 Item 2. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations 19 ------------------------- PART II. OTHER INFORMATION Item 1. Legal Proceedings 45 ----------------- Item 6. Exhibits and Reports on Form 8-K 45 -------------------------------- Signature 45
2 3 PART I. FINANCIAL INFORMATION KEYCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31, MARCH 31, dollars in millions 1998 1997 1997 - ----------------------------------------------------------------------------------------------------------------------------------- (UNAUDITED) (UNAUDITED) ASSETS Cash and due from banks $ 3,287 $ 3,651 $ 3,242 Short-term investments 1,171 1,928 502 Securities available for sale 7,115 7,708 7,971 Investment securities (fair value: $1,213, $1,262 and $1,657) 1,182 1,230 1,628 Loans, net of unearned income of $1,235, $1,197 and $857 54,900 53,380 49,724 Less: Allowance for loan losses 900 900 870 - ----------------------------------------------------------------------------------------------------------------------------------- Net loans 54,000 52,480 48,854 Premises and equipment 924 985 1,057 Goodwill 1,052 1,071 811 Other intangible assets 99 105 130 Corporate owned life insurance 1,921 1,895 1,535 Other assets 2,447 2,646 2,163 - ----------------------------------------------------------------------------------------------------------------------------------- Total assets $73,198 $73,699 $67,893 ======= ======= ======= LIABILITIES Deposits in domestic offices: Noninterest-bearing $ 9,083 $ 9,368 $ 8,986 Interest-bearing 32,253 32,005 34,318 Deposits in foreign offices - interest-bearing 325 3,700 935 - ----------------------------------------------------------------------------------------------------------------------------------- Total deposits 41,661 45,073 44,239 Federal funds purchased and securities sold under repurchase agreements 6,468 6,979 7,509 Bank notes and other short-term borrowings 7,442 5,967 4,261 Other liabilities 2,498 2,303 1,936 Long-term debt 9,041 7,446 4,774 - ----------------------------------------------------------------------------------------------------------------------------------- Total liabilities 67,110 67,768 62,719 Corporation-obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely debentures of the Corporation (See Note 8) 750 750 500 SHAREHOLDERS' EQUITY Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- -- Common Shares, $1 par value; authorized 900,000,000 shares; issued 491,888,780, 491,888,780 and 245,944,390 shares 492 492 246 Capital surplus 1,284 1,283 1,479 Retained earnings 4,743 4,611 4,180 Loans to ESOP trustee (42) (42) (49) Treasury stock, at cost (52,573,384, 53,824,950 and 26,362,727 shares) (1,147) (1,174) (1,065) Accumulated other comprehensive income 8 11 (117) - ----------------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 5,338 5,181 4,674 - ----------------------------------------------------------------------------------------------------------------------------------- Total liabilities, capital securities and shareholders' equity $73,198 $73,699 $67,893 ======= ======= ======= - -----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 3 4 KEYCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ---------------------------- dollars in millions, except per share amounts 1998 1997 - --------------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans $1,165 $1,095 Taxable investment securities 3 3 Tax-exempt investment securities 13 18 Securities available for sale 129 134 Short-term investments 17 5 - --------------------------------------------------------------------------------------------------------------- Total interest income 1,327 1,255 INTEREST EXPENSE Deposits 347 353 Federal funds purchased and securities sold under repurchase agreements 93 88 Bank notes and other short-term borrowings 98 57 Long-term debt 125 68 - --------------------------------------------------------------------------------------------------------------- Total interest expense 663 566 - --------------------------------------------------------------------------------------------------------------- NET INTEREST INCOME 664 689 Provision for loan losses 77 67 - --------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 587 622 NONINTEREST INCOME Service charges on deposit accounts 78 71 Trust and asset management income 77 64 Investment banking and capital markets income 47 18 Credit card fees 15 23 Insurance and brokerage income 22 21 Corporate owned life insurance income 23 19 Loan securitization income 10 1 Net securities gains 2 -- Gains from sales of branches/subsidiaries 29 -- Other income 53 42 - --------------------------------------------------------------------------------------------------------------- Total noninterest income 356 259 NONINTEREST EXPENSE Personnel 294 290 Net occupancy 56 56 Equipment 43 43 Amortization of intangibles 23 21 Marketing 28 21 Professional fees 17 11 Other expense 139 133 - --------------------------------------------------------------------------------------------------------------- Total noninterest expense 600 575 INCOME BEFORE INCOME TAXES 343 306 Income taxes 108 94 - --------------------------------------------------------------------------------------------------------------- NET INCOME $ 235 $ 212 ======== ======= Per Common Share: Net income $.53 $.48 Net Income - assuming dilution .53 .47 Weighted average Common Shares outstanding (000) 438,589 443,340 Weighted average Common Shares and potential Common Shares outstanding (000) 444,836 448,558 - ---------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited). 4 5 KEYCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
LOANS TO TREASURY COMMON CAPITAL RETAINED ESOP STOCK dollars in millions, except per share amounts SHARES SURPLUS EARNINGS TRUSTEE AT COST - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1996 $246 $1,484 $4,060 $(49) $ (854) Net income 212 Other comprehensive income: Adjustment related to change in accounting for transfers of financial assets, net of deferred tax benefit of $(25) Net unrealized losses on securities available for sale, net of income taxes of $(38) (1) Total comprehensive income Cash dividends on Common Shares ($.21 per share) (92) Issuance of Common Shares under employee benefit and dividend reinvestment plans-1,007,626 net shares (5) 47 Repurchase of Common Shares-4,880,000 shares (258) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT MARCH 31, 1997 $246 $1,479 $4,180 $(49) $(1,065) ===== ======= ======= ===== ======== - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1997 $492 $1,283 $4,611 $(42) $(1,174) Net income 235 Other comprehensive income: Net unrealized losses on securities available for sale, net of income taxes of $(2) (1) Total comprehensive income Cash dividends on Common Shares ($.235 per share) (103) Issuance of Common Shares under employee benefit and dividend reinvestment plans-1,251,566 net shares 1 27 - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE AT MARCH 31, 1998 $492 $1,284 $4,743 $(42) $(1,147) ===== ======= ======= ===== ======== - ------------------------------------------------------------------------------------------------------------------------------------ ACCUMULATED OTHER COMPREHENSIVE COMPREHENSIVE dollars in millions, except per share amounts INCOME INCOME - -------------------------------------------------------------------------------- ------------------ BALANCE AT DECEMBER 31, 1996 $ (6) Net income $212 Other comprehensive income: Adjustment related to change in accounting for transfers of financial assets, net of deferred tax benefit of $(25) (43) (43) Net unrealized losses on securities available for sale, net of income taxes of $(38) (1) (68) (68) ------------------ Total comprehensive income $101 ==== Cash dividends on Common Shares ($.21 per share) Issuance of Common Shares under employee benefit and dividend reinvestment plans-1,007,626 net shares Repurchase of Common Shares-4,880,000 shares - -------------------------------------------------------------------------------- BALANCE AT MARCH 31, 1997 $(117) ====== - -------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 $ 11 Net income $235 Other comprehensive income: Net unrealized losses on securities available for sale, net of income taxes of $(2) (1) (3) (3) ------------------ Total comprehensive income $232 ==== Cash dividends on Common Shares ($.235 per share) Issuance of Common Shares under employee benefit and dividend reinvestment plans-1,251,566 net shares - -------------------------------------------------------------------------------- BALANCE AT MARCH 31, 1998 $ 8 ===== - --------------------------------------------------------------------------------
(1) Net of reclassification adjustments. See Notes to Consolidated Financial Statements (Unaudited). 5 6 KEYCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ---------------------------- in millions 1998 1997 - -------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $ 235 $ 212 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 77 67 Depreciation expense 35 39 Amortization of intangibles 23 21 Net gains from sales of branches/subsidiaries (29) -- Net securities gains (2) -- Deferred income taxes 60 2 Net (increase) decrease in mortgage loans held for sale (263) 17 Net (increase) decrease in trading account assets 150 (83) Decrease in accrued restructuring charge (11) (36) Other operating activities, net 309 68 - -------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 584 307 INVESTING ACTIVITIES Net increase in loans, excluding acquisitions, sales and divestitures (1,423) (1,101) Loans sold 71 528 Purchases of investment securities (26) (122) Proceeds from sales of investment securities 11 7 Proceeds from prepayments and maturities of investment securities 78 91 Purchases of securities available for sale (21) (867) Proceeds from sales of securities available for sale 18 (37) Proceeds from prepayments and maturities of securities available for sale 597 690 Net decrease in other short-term investments 607 277 Purchases of premises and equipment (16) (60) Proceeds from sales of premises and equipment 42 30 Proceeds from sales of other real estate owned 2 4 Net cash paid for sales of branches/subsidiaries (89) -- - -------------------------------------------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (149) (560) FINANCING ACTIVITIES Net decrease in deposits (3,271) (1,078) Net increase in short-term borrowings 965 876 Net proceeds from issuance of long-term debt 1,693 650 Payments on long-term debt (102) (89) Purchases of treasury shares -- (258) Proceeds from issuance of common stock pursuant to employee benefit and dividend reinvestment plans 19 42 Cash dividends (103) (92) - -------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (799) 51 - -------------------------------------------------------------------------------------------------------------------- NET DECREASE IN CASH AND DUE FROM BANKS (364) (202) CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,651 3,444 - -------------------------------------------------------------------------------------------------------------------- CASH AND DUE FROM BANKS AT END OF PERIOD $ 3,287 $ 3,242 ======= ======= - -------------------------------------------------------------------------------------------------------------------- Additional disclosures relative to cash flow: Interest paid $637 $539 Income taxes received 22 21 Net amount received on portfolio swaps 3 18 Noncash items: 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 1997 Annual Report to Shareholders. In addition, certain reclassifications have been made to prior year amounts to conform with the current year presentation. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. As of January 1, 1998, Key adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." 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 new statement requires Key's unrealized gains or losses on securities available for sale, which prior to adoption were reported as a separate component of shareholders' equity, to be included in other comprehensive income. Since SFAS No. 130 requires only the disclosure and presentation in a prescribed format of information customarily presented elsewhere in the financial statements, it had no impact on Key's financial position or results of operations. Prior year financial statements have been reclassified to conform with the new requirements. Comprehensive income is presented in the Statement of Changes in Shareholders' Equity on page 5. In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 131,"Disclosures about Segments of an Enterprise and Related Information." 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. Key expects that its reportable operating segments will be its major lines of business. 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 include the disclosures required by SFAS No. 131 in its December 31, 1998, financial statements. 2. EARNINGS PER COMMON SHARE The computation of Key's basic and diluted earnings per Common Share is as follows:
THREE MONTHS ENDED MARCH 31, --------------------------------------- dollars in millions, except per share amounts 1998 1997 - ---------------------------------------------------------------------------------------------------------------------- NET INCOME $235 $212 ==== ==== - ---------------------------------------------------------------------------------------------------------------------- WEIGHTED AVERAGE COMMON SHARES Weighted average Common Shares outstanding (000) 438,589 443,340 Potential Common Shares outstanding (000) (1) 6,247 5,218 - ---------------------------------------------------------------------------------------------------------------------- Weighted average Common Shares and potential Common Shares outstanding (000) 444,836 448,558 ======= ======= - ---------------------------------------------------------------------------------------------------------------------- EARNINGS PER COMMON SHARE Net income per Common Share $ .53 $ .48 Net income per Common Share - assuming dilution .53 .47 - ----------------------------------------------------------------------------------------------------------------------
(1) Dilutive common stock options. 7 8 3. MERGERS, ACQUISITIONS AND DIVESTITURES COMPLETED MERGERS AND ACQUISITIONS Business combinations completed by Key during 1997 (both of which were accounted for as purchases) are summarized below. There were no such transactions during the three-month period ended March 31, 1998.
dollars in millions COMMON LOCATION DATE ASSETS SHARES ISSUED - -------------------------------------------------------------------------------------------------------------- Champion Mortgage Co., Inc. New Jersey August 1997 $ 317 3,336,118(1) Leasetec Corporation Colorado July 1997 1,080 See note(2) - --------------------------------------------------------------------------------------------------------------
1 Pre-split Common Shares. 2 In accordance with a confidentiality clause in the purchase agreement, the terms, which are not material, have not been publicly disclosed. 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 agreement, 3,336,118 pre-split 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 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 three-year period following the closing. 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"), an 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 KEY MERCHANT SERVICES, LLC On January 21, 1998, Key sold a 51% interest in Key Merchant Services, LLC ("Key Merchant"), a wholly owned subsidiary formed to provide merchant services to businesses, to NOVA Information Systems, Inc. ("NOVA"). A $23 million gain ($14 million after tax) was recognized at the time of closing. Under the terms of the agreement with NOVA, Key can receive additional consideration at the end of each of the next three years (through 2000), provided certain revenue-related performance targets are met. In accordance with a confidentiality clause in the agreement, the terms, which are not material, have not been disclosed. 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 and deposits of approximately $1.1 billion and $931 million, respectively, at the time of the transaction. A $53 million ($35 million after tax) gain was realized on the KeyBank Wyoming sale and included in gains from sales of branches/subsidiaries on the income statement. 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 three months of 1998, 13 such branches with deposits of approximately $140 million were sold, resulting in aggregate gains of $6 million ($4 million after tax) which were recorded in gains from sales of branches/subsidiaries on the income statement. During the last three quarters of 1997, excluding the KeyBank Wyoming transaction, 76 such branches with deposits of 8 9 approximately $1.3 billion were sold, resulting in aggregate gains of $98 million ($62 million after tax) which were recorded in gains from sales of branches/subsidiaries on the income statement. As of April 30, 1998, contracts have been entered into to sell a total of 33 other branch offices with deposits of approximately $571 million. The sales of these remaining branches are expected to close during the second quarter of 1998. 4. SECURITIES Debt securities that Key has the positive intent and ability to hold to maturity are classified as securities held to maturity and 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 ($385 million, $535 million and $120 million at March 31, 1998, December 31, 1997 and March 31, 1997, 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 unrealized gains and losses, net of income taxes, reported as a component of shareholders' equity. Gains and losses from sales of securities available for sale are computed using the specific identification method and included in net securities gains (losses) on the income statement. The amortized cost, unrealized gains and losses and approximate fair value of securities were as follows:
MARCH 31, 1998 ----------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------------- SECURITIES AVAILABLE FOR SALE U.S. Treasury, agencies and corporations $ 141 $ 2 -- $ 143 States and political subdivisions 63 1 -- 64 Collateralized mortgage obligations 3,660 11 $ 5 3,666 Other mortgage-backed securities 2,762 43 14 2,791 Residual interests in securitizations 414 -- 32 382 Other securities 61 8 -- 69 - ------------------------------------------------------------------------------------------------------------------- Total securities available for sale $ 7,101 $ 65 $ 51 $ 7,115 ======= ===== ===== ====== INVESTMENT SECURITIES States and political subdivisions $ 918 $ 31 -- $ 949 Other securities 264 -- -- 264 - ------------------------------------------------------------------------------------------------------------------- Total investment securities $ 1,182 $ 31 -- $ 1,213 ======= ===== ==== ====== - ------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1997 ----------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------------- SECURITIES AVAILABLE FOR SALE U.S. Treasury, agencies and corporations $ 202 $ 2 -- $ 204 States and political subdivisions 52 -- -- 52 Collateralized mortgage obligations 4,045 9 $ 3 4,051 Other mortgage-backed securities 2,908 53 10 2,951 Residual interests in securitizations 418 -- 44 374 Other securities 75 1 -- 76 - ------------------------------------------------------------------------------------------------------------------- Total securities available for sale $ 7,700 $ 65 $ 57 $ 7,708 ======= ==== ==== ====== INVESTMENT SECURITIES States and political subdivisions $ 973 $ 32 -- $ 1,005 Other securities 257 -- -- 257 - ------------------------------------------------------------------------------------------------------------------- Total investment securities $ 1,230 $ 32 -- $ 1,262 ======= ==== ==== ====== - -------------------------------------------------------------------------------------------------------------------
9 10
MARCH 31, 1997 ----------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR in millions COST GAINS LOSSES VALUE - ------------------------------------------------------------------------------------------------------------------- SECURITIES AVAILABLE FOR SALE U.S. Treasury, agencies and corporations $ 529 $ 2 $ 8 $ 523 States and political subdivisions 41 -- -- 41 Collateralized mortgage obligations 3,720 1 60 3,661 Other mortgage-backed securities 3,467 25 77 3,415 Residual interests in securitizations 300 -- 66 234 Other securities 96 1 -- 97 - ------------------------------------------------------------------------------------------------------------------- Total securities available for sale $8,153 $29 $211 $7,971 ======= ==== ===== ====== INVESTMENT SECURITIES States and political subdivisions $1,401 $31 $2 $1,430 Other securities 227 -- -- 227 - ------------------------------------------------------------------------------------------------------------------- Total investment securities $1,628 $31 $2 $1,657 ======= ==== === ====== - -------------------------------------------------------------------------------------------------------------------
5. LOANS Loans, net of unearned income, are summarized as follows:
MARCH 31, DECEMBER 31, MARCH 31, in millions 1998 1997 1997 - ------------------------------------------------------------------------------------------------------------ Commercial, financial and agricultural $14,526 $14,023 $12,826 Real estate-- commercial mortgage 6,953 6,952 7,107 Real estate-- construction 2,511 2,231 1,747 Commercial lease financing 4,092 3,990 2,595 - ------------------------------------------------------------------------------------------------------------ Total commercial loans 28,082 27,196 24,275 Real estate-- residential mortgage 6,107 6,204 6,164 Home equity 5,482 5,421 4,868 Credit card 1,449 1,521 1,748 Consumer--direct 2,201 2,188 2,227 Consumer--indirect 8,268 7,989 7,930 - ------------------------------------------------------------------------------------------------------------ Total consumer loans 23,507 23,323 22,937 Loans held for sale 3,311 2,861 2,512 - ------------------------------------------------------------------------------------------------------------ Total loans $54,900 $53,380 $49,724 ======== ======== ======= - ------------------------------------------------------------------------------------------------------------
Portfolio interest rate swaps are used to manage interest rate risk by modifying the repricing and maturity characteristics of certain loans. Additional information pertaining to the notional amount, fair value and weighted average rate of such swaps as of March 31, 1998, is presented in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 14. 10 11 Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED MARCH 31, in millions 1998 1997 - ---------------------------------------------------------------------------------------- Balance at beginning of period $ 900 $870 Charge-offs (100) (89) Recoveries 23 22 - ---------------------------------------------------------------------------------------- Net charge-offs (77) (67) Provision for loan losses 77 67 - ---------------------------------------------------------------------------------------- Balance at end of period $ 900 $870 ===== ==== - ----------------------------------------------------------------------------------------
6. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS At March 31, 1998, impaired loans totaled $189 million. Included in this amount are $84 million of impaired loans for which the specifically allocated allowance for loan losses is $26 million, and $105 million of impaired loans which are carried at their estimated fair value without a specifically allocated allowance for loan losses. At the end of the prior year, impaired loans totaled $196 million, of which $91 million had a specifically allocated allowance of $26 million and $105 million were carried at their estimated fair value. The average investment in impaired loans for the first quarter of 1998 and 1997 was $193 million and $192 million, respectively. Nonperforming assets were as follows:
MARCH 31, DECEMBER 31, MARCH 31, in millions 1998 1997 1997 - --------------------------------------------------------------------------------------------------------------- Impaired loans $189 $196 $193 Other nonaccrual loans 184 185 178 - --------------------------------------------------------------------------------------------------------------- Total nonperforming loans 373 381 371 Other real estate owned ("OREO") 67 66 62 Allowance for OREO losses (24) (21) (10) - --------------------------------------------------------------------------------------------------------------- OREO, net of allowance 43 45 52 Other nonperforming assets 5 5 2 - --------------------------------------------------------------------------------------------------------------- Total nonperforming assets $421 $431 $425 ===== ===== ==== - ---------------------------------------------------------------------------------------------------------------
Impaired loans are evaluated individually. The fair value of collateral, if any, or estimates of the present value of the estimated future cash flows on the loan are used to determine the extent of impairment. When such amounts do not support the carrying amount of the loan, the amount which management deems uncollectible is charged to the allowance for loan losses. 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 (shown in the above table as "Other nonaccrual loans") from impairment evaluation. Generally, this portfolio includes 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. 11 12 7. LONG-TERM DEBT The components of long-term debt, presented net of unamortized discount where applicable, were as follows:
MARCH 31, DECEMBER 31, MARCH 31, dollars in millions 1998 1997 1997 - ------------------------------------------------------------------------------------------------------------------ Senior medium-term notes due through 2005(1) $ 469 $ 493 $ 507 Subordinated medium-term notes due through 2005(1) 182 183 183 7.50% Subordinated notes due 2006(2) 250 250 250 6.75% Subordinated notes due 2006(2) 200 200 200 8.125% Subordinated notes due 2002(2) 199 199 199 8.00% Subordinated notes due 2004 125 125 125 8.40% Subordinated capital notes due 1999(3) 75 75 75 8.404% Notes due through 2001 42 42 49 All other long-term debt(9) 14 14 15 - ------------------------------------------------------------------------------------------------------------------ Total parent company(10) 1,556 1,581 1,603 Senior medium-term bank notes due through 2002(4) 4,369 3,103 1,804 Senior euro medium-term bank notes due through 2007(5) 864 840 -- 6.95% Subordinated notes due 2028(6) 300 -- -- 7.25% Subordinated notes due 2005(6) 200 200 200 7.85% Subordinated notes due 2002(6) 200 200 200 6.75% Subordinated notes due 2003(6) 200 200 200 7.50% Subordinated notes due 2008(6) 165 165 165 7.125% Subordinated notes due 2006(6) 250 250 250 7.55% Subordinated notes due 2006(6) 75 75 75 7.375% Subordinated notes due 2008(6) 70 70 70 Lease financing debt due through 2003(7) 496 549 -- Federal Home Loan Bank advances due through 2014(8) 264 163 193 All other long-term debt(9) 32 50 14 - ------------------------------------------------------------------------------------------------------------------ Total subsidiaries(11) 7,485 5,865 3,171 - ------------------------------------------------------------------------------------------------------------------ Total long-term debt $9,041 $7,446 $4,774 ====== ====== ====== - ------------------------------------------------------------------------------------------------------------------
Portfolio interest rate swaps, caps and floors are used to manage interest rate risk by modifying the repricing and maturity characteristics of certain long-term debt. Additional information pertaining to the notional amount, fair value and weighted average rate of such financial instruments as of March 31, 1998, is presented in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 14. 1 At March 31, 1998, December 31, 1997 and March 31, 1997, the senior medium-term notes had weighted average interest rates of 6.82%, 6.64% and 6.56%, respectively, and the subordinated medium-term notes had weighted average interest rates of 6.95%, 6.90% and 7.07%, respectively. These notes had a combination of both fixed and floating interest rates. 2 The 7.50%, 6.75% and 8.125% subordinated notes may not be redeemed or prepaid prior to maturity. 3 The 8.40% subordinated capital notes may, at maturity, be exchanged for common stock, preferred stock or other eligible securities having a market value equal to the principal amount of the notes. 4 At March 31, 1998, December 31, 1997 and March 31, 1998, senior medium-term bank notes of subsidiaries had weighted average interest rates of 5.33%, 5.51% and 6.54% respectively. These notes had a combination of both fixed and floating interest rates. 5 At March 31, 1998 and December 31, 1997, the senior euro medium-term bank notes had weighted average interest rates of 5.93% and 5.91%, respectively. These notes are obligations of KeyBank National Association ("KeyBank N. A.") and had fixed and floating interest rates based on the three-month London Interbank Offered Rate ("LIBOR"). As of March 31, 1998, the $5.0 billion Euronote Program had an unused capacity of $4.1 billion. 6 The subordinated notes are all obligations of KeyBank N. A., with the exception of the 7.55% note which is an obligation of KeyBank USA. These notes may not be redeemed prior to their respective maturity dates. 7 At March 31, 1998 and December 31, 1997, lease financing debt had a weighted average interest rate of 7.12% and represented primarily nonrecourse debt collateralized by lease equipment under operating, direct financing and sales type leases. 12 13 8 At March 31, 1998, long-term advances from the Federal Home Loan Bank ("FHLB") had adjustable and fixed interest rates ranging from 5.23% to 12.125%. Real estate loans and securities of $368 million, $218 million and $257 million at March 31, 1998, December 31, 1997 and March 31, 1997, respectively, collateralize FHLB advances. 9 Other long-term debt at March 31, 1998, December 31, 1997 and March 31, 1997, consisted of industrial revenue bonds, capital lease obligations and various secured and unsecured obligations of corporate subsidiaries and had weighted average interest rates of 8.03%, 8.06% and 7.48%, respectively. 10 At March 31, 1998, unused capacity under the parent company's shelf registration totaled $1.3 billion, including $750 million reserved for future issuance as medium-term notes. 11 As of March 31, 1998, the Bank Note Program had an unused capacity of $8.2 billion. 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 - ---------------------------------------------------------------------------------------------------------------------------- March 31, 1998 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, 1997 $750 $23 $773 7.510%(3) -- ==== === ==== - ---------------------------------------------------------------------------------------------------------------------------- March 31, 1997 $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 securities on the coupon adjustment date (June 1, 1999). The capital securities issued by Capital A and Capital B constitute minority interests in the equity accounts of consolidated subsidiaries and, therefore, qualify as Tier 1 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. 13 14 9. SHAREHOLDERS' EQUITY On January 15, 1998, Key announced a two-for-one stock split effected by means of a 100% stock dividend payable March 6, 1998, to shareholders of record as of February 18, 1998. Except where express reference is made to Common Shares on a pre-split basis, all relevant Common Share amounts and per Common Share data in this report have been adjusted to reflect the split. 10. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK Key, mainly through its lead bank (KeyBank N. A.), is party to various financial instruments with off-balance sheet risk. It uses these financial instruments in the normal course of business to meet the financing needs of its customers and to manage its exposure to market risk. Market risk includes 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 risk 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 meet 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. Key's 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 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 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 Key's 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. 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. 14 15
MARCH 31, DECEMBER 31, MARCH 31, in millions 1998 1997 1997 - ------------------------------------------------------------------------------------------------------------------- Loan commitments: Credit card lines $ 7,053 $ 8,205 $ 8,407 Home equity 4,334 3,977 3,352 Commercial real estate and construction 1,367 1,073 1,659 Commercial and other 19,179 15,867 10,944 - ------------------------------------------------------------------------------------------------------------------- Total loan commitments 31,933 29,122 24,362 Other commitments: Standby letters of credit 2,133 1,431 1,351 Commercial letters of credit 137 109 171 Loans sold with recourse 25 27 263 - ------------------------------------------------------------------------------------------------------------------- Total loan and other commitments $34,228 $30,689 $26,147 ======= ======= ======= - -------------------------------------------------------------------------------------------------------------------
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR ASSET AND LIABILITY MANAGEMENT PURPOSES Key manages its exposure to interest rate risk, in part, by using off-balance sheet financial instruments, commonly referred to as derivatives. Instruments used for this purpose modify the repricing or maturity characteristics of specified on-balance sheet assets and liabilities. The 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 Key to manage exposure to interest rate risk are interest rate swaps, caps and floors, otherwise referred to as portfolio swaps, caps and floors. The following table summarizes the notional amount, fair value, maturity, weighted average rate received and paid, and weighted average strike price for the various types of portfolio swaps, caps and floors used by Key.
MARCH 31, 1998 ---------------------------------------------------------------------------- WEIGHTED AVERAGE RATE NOTIONAL FAIR MATURITY ----------------------------------- dollars in millions AMOUNT VALUE (YEARS) RECEIVE PAY STRIKE - ------------------------------------------------------------------------------------------------------------------------------------ Interest rate swaps: Receive fixed/pay variable-indexed amortizing(1) $ 2,325 $ 12 1.0 6.89% 5.67% N/A Receive fixed/pay variable-conventional 3,901 108 5.9 6.66 5.84 N/A Pay fixed/receive variable-conventional 3,281 (19) 2.2 5.71 6.18 N/A Basis swaps 1,304 (9) 1.7 5.35 5.66 N/A - ------------------------------------------------------------------------------------------------------------------------------------ Total 10,811 92 -- 6.26% 5.89% -- Interest rate caps, collars and corridors: Caps purchased - one to three month LIBOR based(2) 2,995 6 1.6 N/A N/A 5.81 % Collars - one to three month LIBOR based 350 1 4.4 N/A N/A 4.75 AND 6.50 Collar - thirty year US Treasury based 250 (12) 1.2 N/A N/A 6.06 AND 8.25 1% payout corridor(3) 200 -- 1.6 N/A N/A 6.00 TO 7.00 - ------------------------------------------------------------------------------------------------------------------------------------ Total 3,795 (5) -- -- -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Total $14,606 $ 87 -- -- -- -- ======= ====== - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 1997 ---------------------------------------- NOTIONAL FAIR dollars in millions AMOUNT VALUE - ------------------------------------------------------------------------------------------------ Interest rate swaps: Receive fixed/pay variable-indexed amortizing(1) $ 3,449 $ 12 Receive fixed/pay variable-conventional 3,626 100 Pay fixed/receive variable-conventional 2,990 (7) Basis swaps 1,110 (3) - ------------------------------------------------------------------------------------------------ Total 11,175 102 Interest rate caps, collars and corridors: Caps purchased - one to three month LIBOR based(2) 2,845 11 Collars - one to three month LIBOR based 100 -- Collar - thirty year US Treasury based 250 (15) 1% payout corridor(3) 200 1 - ------------------------------------------------------------------------------------------------ Total 3,395 (3) - ------------------------------------------------------------------------------------------------ Total $14,570 $ 99 ======= ==== - ------------------------------------------------------------------------------------------------
1 Maturity is based upon expected average lives rather than contractual terms. 2 Includes $350 million and $1.0 billion of forward starting caps as of March 31, 1998 and December 31, 1997, respectively. 3 Payout is indexed to three-month LIBOR. N/A = Not Applicable Interest rate swap contracts involve the exchange of interest payments calculated based on an agreed-upon amount (notional amount) and are generally used to mitigate Key's exposure to interest rate risk on certain loans, deposits, short-term borrowings and long-term debt. 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. With respect to interest rate caps and floors, Key generally purchases caps, enters into collars (a combination of simultaneously purchasing a cap and 15 16 selling a floor), and enters into corridors (a combination of simultaneously purchasing a cap at a specified strike price and selling a cap at a higher strike price); these instruments are used to manage the risk of adverse movements in interest rates on specified long-term debt and short-term borrowings. The notional amount associated with the execution of swaps, caps and floors is significantly greater than the amount at risk. Credit risk on swaps, caps and floors results from the possibility that the counterparty will not meet the terms of the 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. With regard to its swap contracts, Key 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 March 31, 1998, all counterparties were expected to meet their obligations. At March 31, 1998, Key had 41 different counterparties to portfolio swaps and swaps entered into to offset the risk of customer swaps. Key had aggregate credit exposure of $101 million to 19 of these counterparties, with the largest credit exposure to an individual counterparty amounting to $21 million. As of the same date, Key's aggregate credit exposure on its interest rate caps and floors totaled $8 million. Portfolio 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 portfolio caps and floors increased net interest income by $10 million in the first quarter of 1998 and $21 million in the first quarter of 1997. 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 March 31, 1998, Key was party to $790 million and $1.5 billion of indexed amortizing swaps that used a 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. In addition, Key had $516 million of conventional pay fixed forward starting swaps which are not included in the preceding table. These swaps had a fair value of $.3 million, a weighted average maturity of 3.6 years, and based upon interest rates at March 31, 1998, would receive a weighted average variable rate of 5.89% and pay a weighted average fixed rate of 5.99%. Based on the weighted average rates in effect at March 31, 1998, the spread on portfolio 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 37 basis points). The aggregate fair value of $92 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 as an adjustment to the carrying amount of the asset or liability. The deferred gain or loss is amortized using the straight-line method over the shorter of the projected remaining life of the related contract at its termination or the underlying asset or liability. During the first quarter of 1998, swaps with a notional amount of $268 million were terminated, resulting in a net deferred loss of $1 million. During the same period last year, swaps with a notional amount of $200 million were terminated, resulting in no deferred gain or loss. At March 31, 1998, Key had a net deferred swap gain of $13 million with a weighted average life of 5.1 years related to the management of debt and a net deferred loss of $1 million with a weighted average life of 3.7 years related to the management of loans. In addition to interest rate swaps, caps and floors, Key uses treasury-based interest rate locks as a component of its interest rate risk management strategy. These rate locks are being used to reduce the price risk related to the anticipated purchase and securitization of certain indirect consumer loans. At March 31, 1998, the rate locks had a notional amount of $1.2 billion, a weighted average maturity of less than one month and a fair value of less than $1 million. 16 17 FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES Key also uses interest rate swaps, caps and floors, and futures contracts for dealer activities (which are generally limited to the banks' commercial loan customers) and enters 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 investment banking and capital markets income on the income statement. Foreign exchange forward contracts are used by Key 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 investment banking and capital markets income on the income statement. Key also enters into treasury options and treasury futures options for proprietary trading purposes. Adjustments to the fair value of all such options are included in investment banking and capital markets income on the income statement. At March 31, 1998, 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 $202 million. The risk of counterparties defaulting on their obligations is monitored on an ongoing basis. Key contracts with counterparties with high credit ratings and enters 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 $12 million and $5 million, respectively, for the first three months of 1998 and $7 million and $4 million, respectively, for the first three months of 1997. A summary of the notional amount and the respective fair value of derivative financial instruments held or issued for trading purposes at March 31, 1998, and on average for the three-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 $12.3 billion notional amount of customer swaps presented in the table includes $5.4 billion of interest rate swaps that receive a fixed rate and pay a variable rate, $3.9 billion of interest rate swaps that pay a fixed rate and receive a variable rate and $3.0 billion of basis swaps. As of March 31, 1998, these swaps had an expected average life of 6.2 years, carried a weighted average rate received of 6.39% and had a weighted average rate paid of 6.21%.
MARCH 31, 1998 THREE MONTHS ENDED MARCH 31, 1998 ------------------------ ------------------------------------------- NOTIONAL FAIR AVERAGE AVERAGE in millions AMOUNT VALUE NOTIONAL AMOUNT FAIR VALUE - ------------------------------------------------------------------------------------------------------------------- Interest rate contracts: Swap assets $8,597 $145 $8,168 $155 Swap liabilities 3,727 (74) 3,740 (90) Caps and floors purchased 794 1 810 1 Caps and floors sold 968 (1) 990 (1) Futures purchased 295 -- 474 1 Futures sold 6,362 (2) 6,233 (4) Foreign exchange forward contracts: Assets 880 25 899 25 Liabilities 875 (24) 891 (24) Treasury based option contracts: Options purchased 4,005 31 3,276 26 Options sold 4,073 (33) 3,162 (27) - -------------------------------------------------------------------------------------------------------------------
17 18 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 March 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders' equity and cash flow for the three-month periods then ended. 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, 1997, 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 13, 1998, 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, 1997, 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 April 14, 1998 18 19 KEYCORP AND SUBSIDIARIES 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 17. 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 manage expenses; consummation of significant business combinations or divestitures; unforseen business risks related to Year 2000 computer systems issues; and significant changes in accounting, tax, or regulatory practices or requirements. Key's earnings results for the first quarter of 1998 reflected the continuation of trends evident throughout 1997 - strong commercial loan growth, revenue growth through diverse fee income sources, successful noninterest expense management, stable credit quality and continued reduction in the net interest margin. The level of Key's noninterest expense is largely the result of strategic actions taken in 1997 to complete its transformation to a nationwide bank-based financial services company, as well as efforts made over the same period to streamline operations. Included in these efforts is the planned divestiture of 140 KeyCenters first announced in November 1996. As of March 31, 1998, Key had sold or reached agreements to sell all of the 140 KeyCenters initially targeted for sale, as well as 10 additional KeyCenters. The sales of 13 KeyCenters closed during the first quarter. During the first quarter of 1998, Key continued to evolve as a bank-based financial services company by broadening the scope of products and services it offers and by continuing to reallocate its resources (including those made available or generated by its above-mentioned divestitures of KeyCenters) to businesses with higher earnings potential. Specifically, during the first quarter, Key entered into a joint venture with NOVA, an Atlanta-based merchant transaction processor which provides transaction processing and electronic payment services to merchant clients nationwide. This joint venture, in which Key retained a 49% interest in its proprietary merchant processing business, enables Key to participate in the same business, but with growth prospects expected to be enhanced by NOVA's greater scale and focus on the business as a specialty. Key also capitalized on its 1997 acquisition of Leasetec by entering into an agreement to form a joint venture with Compaq Capital Corporation to provide customized equipment leasing and financing programs to Compaq's customers in the United Kingdom, Europe and Asia. In addition, in April Key acquired more than $800 million of marine/recreational vehicle installment loans originated through another bank's dealer distribution network. Key's marine/recreational portfolio, which aggregated $2.6 billion at March 31, 1998, is the largest such portfolio held by any bank holding company in the United States. The preceding items are described 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. 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 17. Unless otherwise stated, all earnings per share data included in this section and throughout the remainder of this discussion are presented on a diluted basis. 19 20 Net income for the first quarter of 1998 was $235 million, up 11% from $212 million in the first quarter of 1997. On a diluted per Common Share basis, Key's first quarter 1998 earnings were $.53, representing a 13% increase from $.47 recorded in the year-ago quarter. On an annualized basis, the return on average equity for the first quarter of 1998 was 18.25%, up from 18.07% for the same period last year. The annualized returns on average total assets were 1.32% and 1.30% for the first quarters of 1998 and 1997, respectively. The increase in earnings relative to the first three months of 1997 resulted from a $97 million improvement in noninterest income. The growth in noninterest income was partially offset by a $27 million decrease in taxable-equivalent net interest income, due to a 52 basis point decline in the net interest margin which more than offset a $4.9 billion increase in average earning assets. Other factors partially offsetting the growth in noninterest income were a $25 million rise in noninterest expense and a $10 million increase in the provision for loan losses (equivalent to the increase in net loan charge-offs). Included in noninterest expense in the first quarter of 1998 were $6 million ($2 million in the first quarter of 1997) of Year 2000 computer information system compliance expenses and distributions on capital securities (which more closely resemble interest payments than overhead) of $14 million and $10 million in the first quarter of 1998 and 1997, respectively. Excluding these charges, noninterest expense increased by only $17 million from the first quarter of 1997, despite the mid-1997 acquisitions of Champion and Leasetec. These added approximately $18 million of noninterest expense and $23 million of revenue in the first quarter of 1998. The efficiency ratio, which measures the extent to which recurring revenues are absorbed by operating expenses, rose slightly to 57.39% for the first quarter of 1998 from 56.81% for the fourth quarter of 1997, and improved from 58.92% for the first quarter of 1997. The increase in the efficiency ratio from the prior quarter was due to declines in Key's net interest income and noninterest income, while the improvement from the first quarter of last year reflected Key's consolidation efforts, revenue growth and successful expense management initiatives. 20 21 FIGURE 1 SELECTED FINANCIAL DATA
1998 1997 ----------- ----------------------------------------------------- dollars in millions, except per share amounts FIRST FOURTH THIRD SECOND FIRST - ----------------------------------------------------------------------------------------------------------------------- FOR THE PERIOD Interest income $1,327 $1,365 $1,347 $1,295 $1,255 Interest expense 663 660 643 599 566 Net interest income 664 705 704 696 689 Provision for loan losses 77 76 102 75 67 Noninterest income 356 366 393 288 259 Noninterest expense 600 630 648 582 575 Income before income taxes 343 365 347 327 306 Net income 235 248 236 223 212 - ----------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE Net income $ .53 $ .56 $ .54 $ .51 $ .48 Net income-assuming dilution .53 .56 .53 .51 .47 Cash dividends .235 .21 .21 .21 .21 Book value at period end 12.15 11.83 11.55 11.02 10.64 Market price: High 39.25 36.59 32.72 29.22 28.19 Low 31.56 28.50 27.63 23.94 24.32 Close 37.81 35.41 31.82 27.94 24.38 Weighted average Common Shares (000) 438,589 438,746 436,214 437,946 443,340 Weighted average Common Shares and potential Common Shares (000) 444,836 445,152 442,050 442,480 448,558 - ----------------------------------------------------------------------------------------------------------------------- AT PERIOD END Loans $54,900 $53,380 $53,676 $51,644 $49,724 Earning assets 64,368 64,246 63,800 61,508 59,825 Total assets 73,198 73,699 72,077 69,672 67,893 Deposits 41,661 45,073 43,870 44,626 44,239 Long-term debt 9,041 7,446 7,567 5,182 4,774 Shareholders' equity 5,338 5,181 5,076 4,814 4,674 Full-time equivalent employees 24,650 24,595 25,622 25,882 26,603 Full-service banking offices 1,006 1,015 1,088 1,130 1,161 - ----------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average total assets 1.32% 1.38% 1.34% 1.32% 1.30% Return on average equity 18.25 19.16 19.41 18.85 18.07 Efficiency(1) 57.39 56.81 56.75 57.66 58.92 Overhead(2) 35.36 36.17 37.76 41.02 43.71 Net interest margin (TE) 4.23 4.50 4.58 4.69 4.75 - ----------------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS AT PERIOD END Equity to assets(3) 7.98% 7.71% 7.74% 7.63% 7.62% Tangible equity to tangible assets(3) 6.51 6.21 6.16 6.39 6.32 Tier 1 risk-adjusted capital 6.81 6.65 6.73 7.14 7.47 Total risk-adjusted capital 11.38 10.83 11.10 11.66 12.31 Leverage 6.61 6.40 6.33 6.65 6.68 - -----------------------------------------------------------------------------------------------------------------------
The comparability of the information presented above is affected by certain acquisitions and divestitures completed by Key in the time periods presented. For further information concerning these transactions, refer to Note 3, 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 from branch divestitures). 2 Calculated as noninterest expense (excluding certain nonrecurring charges and distributions on capital securities) less noninterest income (excluding net securities transactions and gains from branch divestitures) divided by taxable-equivalent net interest income. 3 Excluding certain capital securities receiving Tier 1 treatment, these ratios at March 31, 1998, are 7.29% and 5.81%, respectively; at December 31, 1997, are 7.03% and 5.52%, respectively; at September 30, 1997, are 7.04% and 5.46%, respectively; at June 30, 1997, are 6.91% and 5.67%, respectively; and at March 31, 1997, are 6.88% and 5.58%, respectively. TE = Taxable Equivalent 21 22 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 other intangibles considered nonqualifying in regulatory capital computations, 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 provide an additional basis for measuring a company's ability to support future growth, pay dividends and repurchase shares. 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, deferred income taxes, etc. This is the only section of this report in which Key's financial results are discussed on a cash basis. FIGURE 2 CASH BASIS SELECTED FINANCIAL DATA
1998 1997 ------------ ------------------------------------------------------- dollars in millions, except per share amounts FIRST FOURTH THIRD SECOND FIRST - ----------------------------------------------------------------------------------------------------------------------------- FOR THE PERIOD Noninterest expense $578 $611 $628 $563 $556 Income before income taxes 365 384 367 346 325 Net income 254 269 253 239 228 - ----------------------------------------------------------------------------------------------------------------------------- PER COMMON SHARE Net income $.58 $.61 $.58 $.55 $.51 Net income - assuming dilution .57 .60 .57 .54 .51 Weighted average Common Shares (000) 438,589 438,746 436,214 437,946 443,340 Weighted average Common Shares and potential Common Shares (000) 444,836 445,152 442,050 442,480 448,558 - ----------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average total assets 1.45% 1.52% 1.45% 1.43% 1.41% Return on average equity 25.37 27.07 26.82 25.03 24.16 Efficiency(1) 55.24 55.01 54.81 55.74 56.93 - ----------------------------------------------------------------------------------------------------------------------------- GOODWILL AND NONQUALIFYING INTANGIBLES Goodwill average balance $1,063 $1,083 $977 $803 $816 Nonqualifying intangibles average balance 99 108 106 111 116 Goodwill amortization (after tax) 16 18 14 13 13 Nonqualifying intangibles amortization (after tax) 3 3 3 3 3 - -----------------------------------------------------------------------------------------------------------------------------
The comparability of the information presented above is affected by certain acquisitions and divestitures completed by Key in the time periods presented. For further information concerning these transactions, refer to Note 3, 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 from branch divestitures). 22 23 LINE OF BUSINESS RESULTS Key's four major lines of business are Key Corporate Capital, Key Consumer Finance, Key Community Bank and Key Capital Partners ("KCP"). A summary of financial results and significant performance measures for each major line of business for the three-month periods ended March 31, 1998 and 1997, is presented in Figure 3. FIGURE 3 LINE OF BUSINESS RESULTS
Three months ended March 31, 1998 KEY KEY KEY KEY KEY CORPORATE CONSUMER COMMUNITY CAPITAL SUPPORT KEYCORP dollars in millions CAPITAL FINANCE BANK PARTNERS & ADMIN. CONSOLIDATED - -------------------------------------------------------------------------------------------------------------------------- SUMMARY OF OPERATIONS Net interest income (TE) $113 $132 $433 $ (5) -- $673 Provision for loan losses 8 51 27 -- $(9) 77 Noninterest income 16 31 156 144 9 356 Revenue sharing--KCP1 24 -- 58 (82) -- -- Noninterest expense 35 78 384 98 5 600 Expense sharing--KCP1 22 -- 27 (49) -- -- - -------------------------------------------------------------------------------------------------------------------------- Income before income taxes (TE) 88 34 209 8 13 352 Allocated income taxes and TE adjustment 31 13 64 3 6 117 - -------------------------------------------------------------------------------------------------------------------------- Net income $ 57 $ 21 $145 $ 5 $ 7 $235 ======= ======= ======= ======= ======= ======= Percent of consolidated net income 24% 9% 62% 2% 3% 100% - -------------------------------------------------------------------------------------------------------------------------- AVERAGE BALANCES Loans $11,709 $12,951 $29,286 -- -- $53,946 Earning assets 11,834 13,338 37,369 $ 1,408 -- 63,949 Deposits 498 1,071 40,060 5 -- 41,634 Allocated equity 895 1,252 2,959 116 -- 5,222 - -------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average allocated equity 25.78% 6.80% 19.87% 17.48% N/M 18.25% Efficiency 37.25 47.85 61.55 85.96 N/M 57.39 - --------------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 1997 KEY KEY KEY KEY KEY CORPORATE CONSUMER COMMUNITY CAPITAL SUPPORT KEYCORP dollars in millions CAPITAL FINANCE BANK PARTNERS & ADMIN. CONSOLIDATED - -------------------------------------------------------------------------------------------------------------------------- SUMMARY OF OPERATIONS Net interest income (TE) $85 $130 $487 $ (2) -- $700 Provision for loan losses 2 49 16 -- -- 67 Noninterest income 11 23 127 99 $(1) 259 Revenue sharing--KCP(1) 21 -- 42 (63) -- -- Noninterest expense 29 62 401 73 10 575 Expense sharing--KCP(1) 19 -- 25 (44) -- -- - -------------------------------------------------------------------------------------------------------------------------- Income before income taxes (TE) 67 42 214 5 (11) 317 Allocated income taxes and TE adjustment 23 16 67 2 (3) 105 - -------------------------------------------------------------------------------------------------------------------------- Net income $44 $ 26 $147 $ 3 $(8) $212 ======= ======= ======= ======= ======= ======= Percent of consolidated net income 21% 12% 69% 1% (3)% 100% - -------------------------------------------------------------------------------------------------------------------------- AVERAGE BALANCES Loans $9,392 $12,675 $27,148 -- -- $49,215 Earning assets 9,393 12,878 36,224 $ 548 -- 59,043 Deposits 420 884 42,498 1 -- 43,803 Allocated equity 646 998 3,007 107 -- 4,758 - -------------------------------------------------------------------------------------------------------------------------- PERFORMANCE RATIOS Return on average allocated equity 27.62% 10.57% 19.83% 11.37% N/M 18.07% Efficiency 41.03 40.52 63.41 85.29 N/M 58.92 - --------------------------------------------------------------------------------------------------------------------------
1 Represents the assignment of KCP revenue and expense to the lines of business principally responsible for maintaining the relevant customer relationships (See description of KCP on page 26). TE = Taxable Equivalent N/M = Not Meaningful The financial information discussed in the remainder of this section was derived from the internal profitability reporting system used by management to monitor and manage the financial performance of Key. The financial results and performance measures reported are based on internal management 23 24 accounting policies which have been developed so as to enable the results to be compiled on a consistent basis and to reflect the underlying economics of the businesses. These policies address the methodologies applied in connection with funds transfer pricing as well as the allocation of certain costs and capital. Funds transfer pricing was used in the determination of net interest income by assigning a standard cost for funds used (or a standard credit for funds provided) to assets and liabilities based on their maturity, prepayment and/or repricing characteristics. The net effect of transfer pricing is included in the Key Community Bank line of business where the securities portfolios are also maintained. Indirect expenses were allocated based on actual volume measurements and other criteria, as appropriate. The provision for loan losses was allocated in an amount based primarily upon the actual net charge-offs of each respective line of business, adjusted for loan growth and changes in risk profile. The level of the consolidated provision for loan losses was based upon the application of methodologies designed by management to assess the adequacy of the consolidated allowance by focusing on a number of specific factors. These factors are more fully discussed in the Asset Quality section of Key's Annual Report to Shareholders. Income taxes were allocated based on the statutory Federal income tax rate of 35% (adjusted for tax-exempt income from corporate owned life insurance, nondeductible goodwill amortization, and tax credits associated with investments in low-income housing projects) for the periods presented. Capital was assigned to each line of business based on management's assessment of economic risk factors (primarily credit, operating and market risk). The development and application of these methodologies is a dynamic process. Accordingly, financial results may be revised periodically to reflect management accounting enhancements, changes in risk profile or changes in the organization's structure. Further, unlike financial accounting, there is no authoritative guidance for management accounting similar to generally accepted accounting principles. Consequently, reported results are not necessarily comparable with those presented by other companies. During the first quarter of 1998, Key enhanced its capital allocation process, including the adoption of a refined methodology for estimating credit risk that applies more detailed risk factors to loans, considering both their grades and terms. This methodology is also reflected in the first quarter 1997 results of operations presented in Figure 3. A description of each of Key's major lines of business is presented below. KEY CORPORATE CAPITAL Key offers a complete range of financing, transaction processing and financial advisory services to corporations throughout the country through its Corporate Capital unit. It also operates one of the largest bank-affiliated equipment leasing companies with operations conducted both domestically and throughout Europe and Asia. Corporate Capital's business units are organized around specialized industry client segments, inclusive of healthcare, media/telecommunications, structured finance and commercial real estate. In serving these targeted segments, Key Corporate Capital provides a number of specialized services including international banking, corporate finance advisory services, investment banking and capital markets products, and 401(k) and trust custody products. Key is also one of the leading cash management providers in the country. During the first quarter of 1998, Key Corporate Capital contributed approximately 24% of Key's consolidated earnings with net income of $57 million, resulting in a return on average allocated equity of 25.78%. In the same period last year, net income was $44 million, or approximately 21% of Key's consolidated earnings, and the return on average allocated equity was 27.62%. The increase in earnings relative to the prior year reflected higher net interest income resulting from a 25% increase in total average loans due in large part to both commercial lending and lease financing, as well as the impact of the July 1997 acquisition of Leasetec. Also contributing to the improved earnings performance was growth in noninterest income, led by investment banking and capital markets income, and trust and asset management income. Most of the $6 million increase in noninterest expense compared with that of the first three months of 1997 was attributable to Leasetec, which added approximately $5 million to Key Corporate Capital's operating costs and $15 million in revenues. The $6 million increase in the provision for loan losses from the first quarter of 1997 reflected an anticipated increase in the level of net charge-offs. During the first quarter of 1998, Key Corporate Capital established a strategic alliance with Compaq Capital Corporation, forming a joint venture to provide customized equipment leasing and financing 24 25 programs to Compaq customers throughout the United Kingdom, Europe, and Asia. This new relationship reflects the benefits derived from the infrastructure and experience attained through the acquisition of Leasetec. KEY CONSUMER FINANCE Key Consumer Finance is responsible for Key's indirect, non-branch-based consumer loan and deposit products. This line of business specializes in credit cards, automobile loans and leases, marine and recreational vehicle loans, education loans, home equity loans and branchless deposit-generating activities. As of December 31, 1997, based on the volume of loans generated, Key Consumer Finance was the third largest education lender in the nation, ranked in the top ten in retail automobile financing and was one of the leading providers of financing for consumer purchases of marine and recreational vehicles. For the first quarter of 1998, Key Consumer Finance generated net income of $21 million, or approximately 9% of Key's consolidated earnings, and a return on average allocated equity of 6.80%. In the comparable prior year period, net income was $26 million, or approximately 12% of Key's consolidated earnings, and the return on average allocated equity was 10.57%. Primary factors affecting financial performance relative to the prior year were a higher level of noninterest expense, offset in part by growth in revenue, particularly noninterest income. The August 1997 acquisition of Champion accounted for $13 million of the $16 million increase in noninterest expense, while adding $9 million of revenue in the first quarter of 1998. Noninterest income rose by $8 million, an increase which was entirely attributable to loan securitization income, primarily servicing fees since no securitizations were completed during the first quarter of 1998. This reflected substantial growth in securitized loans which are serviced by Key to $4.7 billion at March 31, 1998, from $2.8 billion a year ago. The increase in noninterest income was moderated by a decline in credit card fees which resulted from the sale of $365 million of out-of-franchise credit card receivables during the first and third quarters of 1997. Net interest income was relatively unchanged from the first three months of last year as the impact of moderate loan growth was substantially offset by a lower net interest margin. Both loan growth and the net interest margin were adversely affected by the fourth quarter 1997 securitization of $949 million of prime credit automobile loans with low returns on equity and the sale of the credit card receivables discussed above. The automobile loan securitization is consistent with Key's goal of divesting assets which do not support its return on equity objective. In April, Key Consumer Finance acquired more than $800 million of marine/recreational vehicle installment loans originated through another bank's dealer distribution network. As a result of this transaction, Key now has one of the largest marine/recreational vehicle portfolios in the United States. Current legislation adopted by Congress in 1993 provides that, effective July 1, 1998, the interest rates that financial institutions may earn from certain government-guaranteed education loans will be based on a blended long-term interest rate plus 1%, rather than the 91-day Treasury bill rate plus 2.5% during in-school periods and 3.1% during repayment periods (the current basis). This represents a significant reduction in interest rates based on the current interest rate environment. If this legislation is not amended prior to July 1, 1998, it could have a substantial impact on the profitability and extent of Key's future education lending business. Various proposals to amend the legislation are currently being discussed in Congress though it is not clear whether a proposal will be enacted prior to July 1, 1998, and in what form. Management is currently in the process of evaluating the effect of the legislation on Key, including alternative lending strategies. Key's government-guaranteed education loans generated approximately 2% of Key's total interest on loans recorded during the first three months of 1998. KEY COMMUNITY BANK Key Community Bank is responsible for delivering a complete line of branch-based retail financial products and services to small businesses and consumers, addressing the more complex, diverse needs of the affluent client segment and maximizing relationship management in the commercial banking and public sector businesses. The delivery of these products and services is accomplished through 1,006 KeyCenters, a 24-hour telephone banking call center services group, more than 2,200 automated teller machines ("ATMs") that access 14 different networks and comprise one of the largest ATM networks in the United States, and a core team of relationship management professionals. In the first quarter of 1998, net income for Key Community Bank totaled $145 million, or approximately 62% of Key's consolidated earnings, compared with $147 million, or 69%, respectively, for the first quarter of 1997. Its return on average allocated equity was 19.87% in the first three months of 1998 and 19.83% 25 26 for the same period last year. The slight decrease in earnings relative to the prior year reflected a decline in net interest income and a higher provision for loan losses, which were substantially offset by growth in noninterest income and a reduction in noninterest expense. The $54 million decline in net interest income resulted from a lower net interest margin, which more than offset the benefits derived from a $2.1 billion, or 8%, increase in average loans outstanding. The lower net interest margin was due to a number of factors, including greater reliance placed on higher-cost funding to support the incremental increase in loan portfolios, the reduction in core deposits stemming from branch divestitures, and changes in the mix and pricing of the remaining core deposit base in response to customer preferences and competitive pressures. The $11 million increase in the provision for loan losses reflected both growth in loans as well as a higher level of net charge-offs. Noninterest income rose $45 million, or 27%, due in part to the increased focus on and diversification of fee income sources. The largest contributions to this growth came from trust and asset management income, investment banking and capital markets income, service charges on deposit accounts and ATM fees. Also included in first quarter 1998 noninterest income was a $23 million gain recognized in connection with the joint venture with NOVA. The $17 million reduction in noninterest expense was due primarily to lower personnel costs resulting from a decrease of approximately 1,800 in the employment base as part of Key's consolidation and expense control initiatives. During the first quarter of 1998, strategic developments centered around continued efforts to reconfigure Key's delivery systems. Specific activities included the sale of 13 branches in Maine, expansion of the ATM delivery network through the installation of 322 ATMs (representing the completion of the initial phase of installations to occur in ARCO convenience stores in California, Nevada, Arizona, Washington, and Oregon), the completion of the merchant processing joint venture with NOVA and the opening of in-store branches in Colorado. KEY CAPITAL PARTNERS KCP was formed at the end of 1997 to provide clients with asset management, investment banking and capital markets, insurance and brokerage expertise, and is expected to play a major role in developing fee income through its broad range of investment choices and customized products. Leveraging Key's corporate and community banking distribution channels and client relationships will be an essential factor in ensuring KCP's future growth and success. As indicated in Figure 3, a significant amount of noninterest income and expense generated by KCP is reported under either Key Corporate Capital or Key Community Bank. This reflects Key's management accounting practice of assigning such income and expense to whichever of those two lines of business is principally responsible for maintaining the relationships with the customers who also avail themselves of the products and services offered by KCP. On an all-inclusive basis (i.e., prior to the aforementioned assignments), KCP's net income totaled $26 million (representing 11% of Key's consolidated earnings) in the first quarter of 1998 and $15 million (representing 7% of Key's consolidated earnings) in the year-ago quarter. Noninterest income rose $45 million ($26 million after revenue sharing) from the prior year. The largest contribution to this improvement came from investment banking and capital markets income which increased $29 million, and accounted for approximately 33% of KCP's total noninterest income in the first quarter of 1998. In addition, revenues related to trust and asset management activities, which comprised the majority of KCP's noninterest income, grew by $13 million, representing an increase of 20%. The increase in noninterest income was partially offset by a $25 million increase in noninterest expense, primarily personnel expense which tends to rise as noninterest income rises due to incentive compensation arrangements. KEY SUPPORT AND ADMINISTRATION Key Support and Administration includes activities that are not directly attributable to one of the four major lines of business. Included in this category are certain nonbanking affiliates, eliminations of certain intercompany transactions and certain nonrecurring transactions. Also included are portions of certain assets, capital and support functions not specifically identifiable with the four major lines of business. Included in first quarter 1998 results was $6 million of gains from the divestiture of banking offices. These gains are more fully described elsewhere in this management's discussion. 26 27 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 (including off-balance sheet instruments described in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 14), 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. Various components of the balance sheet and their respective yields and rates which affect interest income and expense are illustrated in Figure 4. The information presented in Figure 5 provides a summary of the effect on net interest income of changes in yields/rates and average balances from the first quarter of 1997 to the first quarter of 1998. A more in-depth discussion of changes in earning assets and funding sources is presented in the Financial Condition section beginning on page 37. For the first quarter of 1998, net interest income was $673 million, down $27 million, or 4%, from the same period last year. This decrease reflected a 52 basis point reduction in the net interest margin to 4.23%, which more than offset an 8% increase in average earning assets (primarily loans) to $63.9 billion. Compared with the fourth quarter of 1997, net interest income declined by $43 million as the net interest margin fell 27 basis points, while average earning assets rose by $469 million during the first quarter of 1998. The net interest margin is computed by dividing annualized taxable-equivalent net interest income by average earning assets. The decrease in the margin since the year-ago quarter resulted from a number of factors. Primary among these are greater reliance placed on higher-cost funding to support the incremental increase in loan portfolios, the reduction in core deposits stemming from branch divestitures, the repricing of preexisting loan portfolios in a period of competitive interest rate spread compression, and changes in the mix and pricing of the remaining core deposit base in response to customer preferences and competitive pressures. Another factor contributing to the contraction of the margin was an increase in the cost of funds associated with the growth in noninterest-earning assets (such as corporate owned life insurance). The effects of these factors were especially pronounced during an unusually (by historical standards) prolonged period of flatness in the yield curve which has prevailed since the third quarter of 1997. Average earning assets for the first quarter totaled $63.9 billion, which was $4.9 billion, or 8%, higher than the first quarter 1997 level and $469 million, or an annualized 3%, above the fourth quarter of 1997. The growth from the year-ago quarter reflected a $4.7 billion, or 10%, increase in loans, with substantially all of the increase coming from the commercial portfolio. The growth in total loans relative to the prior quarter was moderated by Key's decision to sell nearly $1 billion of prime credit automobile loans in mid-December 1997. These were sold consistent with the goal of divesting assets which do not support Key's return on equity objective. Key's strategy with respect to its loan portfolio is discussed in greater detail in the Loan section on page 37. Key uses portfolio interest rate swaps, caps and floors (as defined in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 14) in the management of its interest rate sensitivity position. The notional amount of such swaps decreased to $10.8 billion at March 31, 1998, from $11.2 billion at year-end 1997. Over the same period, the notional amount of interest rate caps and floors rose $400 million to $3.8 billion. For the first quarter of 1998, 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 $10 million and 6 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 $21 million and the net interest margin by 14 basis points. The manner in which interest rate swaps, 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. 27 28 FIGURE 4 AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND YIELDS/RATES
FIRST QUARTER 1998 FOURTH QUARTER 1997 ------------------------------------ -------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ dollars in millions BALANCE INTEREST RATE BALANCE INTEREST RATE - ------------------------------------------------------------------------------------------------------------------------- ASSETS Loans (1,2) Commercial, financial and agricultural $14,066 $ 288 8.30% $13,435 $ 290 8.56% Real estate-- commercial mortgage 6,944 156 9.11 7,132 170 9.46 Real estate-- construction 2,347 52 8.99 2,214 54 9.68 Commercial lease financing 4,471 83 7.53 4,144 77 7.37 - ------------------------------------------------------------------------------------------------------------------------- Total commercial loans 27,828 579 8.44 26,925 591 8.71 Real estate-- residential 6,164 123 8.09 6,257 140 8.88 Credit card 1,482 54 14.78 1,487 55 14.67 Other consumer 15,380 349 9.20 15,990 373 9.25 - ------------------------------------------------------------------------------------------------------------------------- Total consumer loans 23,026 526 9.26 23,734 568 9.49 Loans held for sale 3,092 63 8.26 2,645 46 6.90 - ------------------------------------------------------------------------------------------------------------------------- Total loans 53,946 1,168 8.78 53,304 1,205 8.97 Taxable investment securities 256 3 4.53 243 3 4.90 Tax-exempt investment securities(1) 940 19 8.20 1,027 21 8.11 - ------------------------------------------------------------------------------------------------------------------------- Total investment securities 1,196 22 7.46 1,270 24 7.50 Securities available for sale(1,3) 7,457 129 7.02 7,502 130 6.87 Interest-bearing deposits with banks 29 1 12.54 34 1 12.31 Federal funds sold and securities purchased under resale agreements 912 11 4.89 811 9 4.40 Trading account assets 409 5 4.96 559 7 4.97 - ------------------------------------------------------------------------------------------------------------------------- Total short-term investments 1,350 17 5.11 1,404 17 4.80 - ------------------------------------------------------------------------------------------------------------------------- Total earning assets 63,949 1,336 8.47 63,480 1,376 8.60 Allowance for loan losses (889) (893) Other assets 9,062 8,903 - ------------------------------------------------------------------------------------------------------------------------- $72,122 $71,490 ======== ======= LIABILITIES AND SHAREHOLDERS' EQUITY Money market deposit accounts $11,159 90 3.27 $10,883 87 3.17 Savings deposits 3,499 18 2.09 3,789 20 2.09 NOW accounts 1,244 5 1.63 1,370 6 1.74 Certificates of deposit ($100,000 or more) 3,362 46 5.55 3,307 47 5.64 Other time deposits 12,716 171 5.45 13,084 180 5.46 Deposits in foreign offices 1,245 17 5.54 1,663 21 5.01 - ------------------------------------------------------------------------------------------------------------------------- Total interest-bearing deposits 33,225 347 4.24 34,096 361 4.20 Federal funds purchased and securities sold under repurchase agreements 7,117 93 5.30 7,335 96 5.19 Bank notes and other short-term borrowings 6,683 98 5.95 5,678 89 6.22 Long-term debt (4) 8,326 125 6.09 7,443 114 6.08 - ------------------------------------------------------------------------------------------------------------------------- Total interest-bearing liabilities 55,351 663 4.86 54,552 660 4.80 Noninterest-bearing deposits 8,409 8,750 Other liabilities 2,390 2,304 Capital securities 750 750 Common shareholders' equity 5,222 5,134 - ------------------------------------------------------------------------------------------------------------------------- $72,122 $71,490 ======== ======= Interest rate spread (TE) 3.61 3.80 - ------------------------------------------------------------------------------------------------------------------------- Net interest income (TE) and net interest margin (TE) $ 673 4.23% $ 716 4.50% ======= ===== ======== ===== Taxable-equivalent adjustment (1) $9 $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 28 29
THIRD QUARTER 1997 SECOND QUARTER 1997 FIRST QUARTER 1997 - ----------------------------------- ----------------------------------------------------------------------- AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE - ----------------------------------------------------------------------------------------------------------- $13,101 $286 8.66% $12,844 $282 8.81% $12,248 $268 8.87% 7,088 165 9.24 7,121 165 9.29 7,130 163 9.27 2,015 49 9.65 1,853 45 9.74 1,693 40 9.58 3,820 70 7.27 2,632 42 6.40 2,623 39 6.03 - ----------------------------------- ----------------------------------------------------------------------- 26,024 570 8.69 24,450 534 8.76 23,694 510 8.73 6,161 131 8.44 6,153 127 8.28 6,196 126 8.25 1,788 68 15.09 1,781 66 14.86 1,786 67 15.21 15,926 372 9.27 15,389 356 9.28 15,070 346 9.31 - ----------------------------------- ----------------------------------------------------------------------- 23,875 571 9.49 23,323 549 9.44 23,052 539 9.48 2,809 54 7.63 2,600 50 7.71 2,469 48 7.88 - ----------------------------------- ----------------------------------------------------------------------- 52,708 1,195 8.99 50,373 1,133 9.02 49,215 1,097 9.04 270 3 5.88 252 3 5.79 222 3 5.48 1,143 22 7.64 1,349 27 8.03 1,395 27 7.85 - ----------------------------------- ----------------------------------------------------------------------- 1,413 25 7.02 1,601 30 7.52 1,617 30 7.52 7,399 127 6.86 7,822 136 7.05 7,800 134 6.99 8 -- 3.94 17 -- 3.66 17 -- 4.11 535 6 4.45 337 5 5.95 299 4 5.43 264 5 7.51 143 2 5.61 95 1 5.63 - ----------------------------------- ----------------------------------------------------------------------- 807 11 5.41 497 7 5.65 411 5 5.04 - ----------------------------------- ----------------------------------------------------------------------- 62,327 1,358 8.64 60,293 1,306 8.69 59,043 1,266 8.70 (873) (866) (868) 8,658 8,351 8,179 - ----------------------------------- ----------------------------------------------------------------------- $70,112 $67,778 $66,354 ======= ======= ======= $10,714 82 3.04 $10,984 83 3.03 $11,008 81 2.98 4,161 22 2.10 4,519 25 2.22 4,819 27 2.27 1,547 8 2.05 1,644 9 2.20 1,682 9 2.17 3,166 46 5.76 3,341 47 5.64 3,699 50 5.48 13,389 183 5.42 13,584 181 5.34 13,037 171 5.32 2,065 29 5.57 2,361 33 5.61 1,150 15 5.31 - ----------------------------------- ----------------------------------------------------------------------- 35,042 370 4.19 36,433 378 4.16 35,395 353 4.04 6,939 91 5.20 6,461 84 5.21 7,028 88 5.08 5,001 73 5.79 4,350 64 5.90 3,912 57 5.91 6,879 109 6.33 4,772 73 6.20 4,486 68 6.22 - ----------------------------------- ----------------------------------------------------------------------- 53,861 643 4.74 52,016 599 4.62 50,821 566 4.52 8,551 8,432 8,408 2,125 1,998 1,867 750 588 500 4,825 4,744 4,758 - ----------------------------------- ----------------------------------------------------------------------- $70,112 $67,778 $66,354 ======= ======= ======= 3.90 4.07 4.18 - ----------------------------------------------------------------------------------------------------------- $715 4.58% $707 4.69% $700 4.75% ======= ===== ======= ===== ======= ===== $11 $11 $11 - -----------------------------------------------------------------------------------------------------------
29 30 FIGURE 5 COMPONENTS OF NET INTEREST INCOME CHANGE
FROM THREE MONTHS ENDED MARCH 31, 1997, TO THREE MONTHS ENDED MARCH 31, 1998 ---------------------------------------------------- AVERAGE YIELD/ NET in millions VOLUME RATE CHANGE - --------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans $103 $(32) $ 71 Tax-exempt investment securities (9) 1 (8) Securities available for sale (6) 1 (5) Short-term investments 12 -- 12 - --------------------------------------------------------------------------------------------------------- Total interest income (TE) 100 (30) 70 INTEREST EXPENSE Money market deposit accounts 1 8 9 Savings deposits (7) (2) (9) NOW accounts (2) (2) (4) Certificates of deposit ($100,000 or more) (5) 1 (4) Other time deposits (4) 4 -- Deposits in foreign offices 1 1 2 - --------------------------------------------------------------------------------------------------------- Total interest-bearing deposits (16) 10 (6) Federal funds purchased and securities sold under repurchase agreements 1 4 5 Bank notes and other short-term borrowings 41 -- 41 Long-term debt 58 (1) 57 - --------------------------------------------------------------------------------------------------------- Total interest expense 84 13 97 - --------------------------------------------------------------------------------------------------------- Net interest income (TE) $ 16 $(43) $(27) ====== ===== ===== - ---------------------------------------------------------------------------------------------------------
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 ASSET AND LIABILITY MANAGEMENT Market risk is the exposure to economic loss that arises from changes in the values of certain market risk sensitive instruments. Types of market risk include interest rate, foreign exchange and equity price risk; foreign exchange and equity price risk are not material to Key. Key manages its interest rate risk through an active program of asset and liability management pursuant to guidelines established by its Asset/Liability Management Policy Committee ("ALCO"). The ALCO has 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 risk 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, asset and liability prepayments, interest rates, on and off-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 over the same period from what net interest income would have been if such interest rates did not change. Based on the results of the simulation model using the 30 31 ALCO guidelines, as of March 31, 1998, Key would expect its net interest income to increase by approximately $23 million if short-term interest rates gradually decrease. Conversely, if short-term interest rates gradually increase, net interest income would be expected to decrease by approximately $22 million. As shown in Figure 6, Key has been operating well within the above guidelines. FIGURE 6 NET INTEREST INCOME AT RISK TO CHANGES IN INTEREST RATES
Rise Decline 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 Dec-97 -0.0107 0.0096 Mar-98 -0.0079 0.0082
[GRAPHIC] ESTIMATED CHANGE IN NET INTEREST INCOME Long-term Interest Rate Exposure - -------------------------------- Short-term interest rate risk analysis is complemented by an economic value of equity model. This model provides the added benefit of measuring 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; estimated cash flows are required for assets and liabilities with indeterminate maturities; 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 the sum of base case economic value of assets and net receive fixed interest rate swaps, caps and floors. Key has been operating well within these guidelines. Management of Interest Rate Exposure - ------------------------------------ Key utilizes the results of its short-term and long-term interest rate exposure models to formulate strategies to improve balance sheet positioning and/or earnings within interest rate risk, liquidity and capital guidelines established by the ALCO. In addition to the interest rate exposure measured using ALCO guidelines, the risk to earnings and economic value arising from various other pro forma changes in the overall level of interest rates is periodically measured. The variety of interest rate scenarios modeled, and their impact on earnings and economic value, quantifies the level of interest rate exposure arising from several sources, namely option risk, basis risk and gap risk. Option risk exists in the form of options (including caps and floors) embedded in certain products. These options permit the customer (either a loan customer or a depositor) to take advantage of changes in interest rates without penalty. Examples include floating-rate loans that contain an interest rate cap, fixed-rate loans that do not contain prepayment penalties and deposits that are withdrawable on demand. Basis risk refers to floating-rate assets and floating-rate liabilities that reprice simultaneously, but are tied to different indices. The risk arises when one index does not move consistently with another. Gap risk is the risk that assets, liabilities or related interest rate swaps, caps and floors will mature in different time frames. For example, floating-rate loans that reprice monthly may be funded with fixed-rate certificates of deposit that mature in one year. To manage interest rate risk, management regularly utilizes Key's securities portfolios, issues debt, and securitizes and sells certain consumer loans. In addition, management has utilized interest rate swaps, caps and floors to manage interest rate risk by modifying the repricing or maturity characteristics of specified 31 32 on-balance sheet assets and liabilities. Instruments used for this purpose are designated as portfolio swaps, caps and floors. The decision to use these instruments versus the on-balance sheet alternatives mentioned above depends on various factors, including the mix and cost of funding sources, liquidity and capital requirements. Further details pertaining to portfolio swaps, caps and floors are included in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 14. In addition to interest rate swaps, caps and floors, Key uses treasury-based interest rate locks as a component of its interest rate risk management strategy. These rate locks are being used to reduce the price risk related to the anticipated purchase and securitization of certain indirect consumer loans. At March 31, 1998, the rate locks had a notional amount of $1.2 billion, a weighted average maturity of less than one month and a fair value of less than $1 million. Portfolio Swaps, Caps and Floors - -------------------------------- As shown in Note 10, the estimated fair value of Key's portfolio swaps decreased to $92 million at March 31, 1998, from a fair value of $102 million at December 31, 1997, while the notional amount of such swaps was relatively unchanged. The decline in fair value over the past three months reflected the financial markets' expectations, as measured by the forward yield curve, for a future increase in interest rates and the fact that Key's swap portfolio is primarily in a receive fixed interest rate position. Swaps with a notional amount of $268 million were terminated during the first quarter of 1998, resulting in a net deferred loss of $1 million. Further information pertaining to the balance and remaining amortization period of Key's deferred swap gains and losses at March 31, 1998, 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 any swap contract is integrated strategically with asset and liability management and other appropriate processes. During 1997 and continuing through the first quarter of 1998, Key increased its use of portfolio caps in response to its reduced sensitivity to potential declines in interest rates and the heavier reliance placed on higher cost funding to support earning asset growth. These instruments are used primarily to protect against the adverse impact that a future rise in interest rates could have on variable rate short-term borrowings, while having no impact in the event of a decline in rates. Portfolio swaps, caps and floors activity for the three-month period ended March 31, 1998, is summarized in Figure 7. FIGURE 7 PORTFOLIO SWAPS, CAPS AND FLOORS ACTIVITY
RECEIVE FIXED ------------------------ TOTAL CAPS INDEXED PAY FIXED- BASIS PORTFOLIO AND in millions AMORTIZING CONVENTIONAL CONVENTIONAL SWAPS SWAPS FLOORS TOTAL - ------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 $3,449 $3,626 $2,990 $1,110 $11,175 $3,395 $14,570 Additions -- 301 411 394 1,106 500 1,606 Maturities -- 26 120 200 346 100 446 Terminations 268 -- -- -- 268 -- 268 Amortization 856 -- -- -- 856 -- 856 - ------------------------------------------------------------------------------------------------------------------------------- BALANCE AT MARCH 31, 1998 $2,325 $3,901 $3,281 $1,304 $10,811 $3,795 $14,606 ======= ======= ======= ======= ======= ======= ======= - -------------------------------------------------------------------------------------------------------------------------------
A summary of the notional amount and fair values of portfolio swaps, caps and floors by interest rate management strategy is presented in Figure 8. The fair value at any given date represents the estimated income (if positive) or cost (if negative) that would be recognized if the portfolios were to be liquidated at that date. However, because these instruments are used to alter the repricing or maturity characteristics of specific assets and liabilities, the net unrealized gains and losses are not recognized in earnings. Rather, interest from these swaps, caps and floors is recognized on an accrual basis as an adjustment of the interest income or expense from the asset or liability being managed. In addition to the items presented in Figures 8 and 9, as of March 31, 1998, Key had $516 million of conventional pay fixed forward starting swaps which will convert certain short term borrowings to fixed rate. These swaps had a fair value of $.3 million and a weighted average maturity of 3.6 years. 32 33 FIGURE 8 PORTFOLIO SWAPS, CAPS AND FLOORS BY INTEREST RATE MANAGEMENT STRATEGY
MARCH 31, 1998 DECEMBER 31, 1997 MARCH 31, 1997 --------------------- --------------------- ---------------------- NOTIONAL FAIR NOTIONAL FAIR NOTIONAL FAIR in millions AMOUNT VALUE AMOUNT VALUE AMOUNT VALUE - ----------------------------------------------------------------------------------------------------------------------------------- Convert variable rate loans to fixed $ 3,806 $28 $4,630 $25 $ 6,141 $(103) Convert fixed rate loans to variable 551 (13) 160 (1) -- -- Convert variable rate deposits and short-term borrowings to fixed 1,980 (4) 2,080 (4) 3,082 14 Convert variable rate long-term debt to fixed 750 (2) 750 (2) 300 1 Convert fixed rate long-term debt to variable 2,420 92 2,445 87 2,087 (30) Basis swaps - foreign currency 304 (9) 280 (3) -- -- Basis swaps - other 1,000 -- 830 -- 600 -- - ----------------------------------------------------------------------------------------------------------------------------------- Total portfolio swaps 10,811 92 11,175 102 12,210 (118) Modify characteristics of variable rate short-term borrowings 2,980 6 2,580 2 1,964 21 Modify characteristics of variable rate long-term debt 565 1 565 10 665 9 Modify characteristics of capital securities remarketing 250 (12) 250 (15) -- -- - ----------------------------------------------------------------------------------------------------------------------------------- Total portfolio caps and floors 3,795 (5) 3,395 (3) 2,629 30 - ----------------------------------------------------------------------------------------------------------------------------------- Total portfolio swaps, caps and floors $14,606 $87 $14,570 $99 $14,839 $(88) ======= ======= ======= ======= ======= ======= - -----------------------------------------------------------------------------------------------------------------------------------
The expected average maturities of the portfolio swaps, caps and floors at March 31, 1998, are summarized in Figure 9. FIGURE 9 EXPECTED AVERAGE MATURITIES OF PORTFOLIO SWAPS, CAPS AND FLOORS
March 31, 1998 RECEIVE FIXED ------------------------ TOTAL CAPS INDEXED PAY FIXED- BASIS PORTFOLIO AND in millions AMORTIZING CONVENTIONAL CONVENTIONAL SWAPS SWAPS FLOORS TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Mature in one year or less -- $ 321 $2,032 $ 930 $ 3,283 $ 870 $ 4,153 Mature after one through five years $2,325 942 896 350 4,513 2,925 7,438 Mature after five through ten years -- 2,403 201 24 2,628 -- 2,628 Mature after ten years -- 235 152 -- 387 -- 387 - ------------------------------------------------------------------------------------------------------------------------------------ Total portfolio swaps, caps and floors $2,325 $3,901 $3,281 $1,304 $10,811 $3,795 $14,606 ======= ======= ======= ======= ======== ======= ======== - ------------------------------------------------------------------------------------------------------------------------------------
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, would 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. TRADING PORTFOLIO Key's trading portfolio includes interest rate swap contracts entered into to accommodate the needs of its customers, and other positions with third parties that are intended to mitigate the interest rate risk of the customer positions, foreign exchange contracts entered into to accommodate the needs of its customers and financial assets and liabilities (trading positions) included in short-term investments and other liabilities, respectively, on the balance sheet. Further information pertaining to the off-balance sheet contracts is included in Note 10, Financial Instruments with Off-Balance Sheet Risk, beginning on page 14. During the second half of 1997, Key began using a value at risk ("VAR") model to estimate the adverse effect of changes in interest and foreign exchange rates on the fair value of its trading portfolio. VAR uses statistical methods to estimate the maximum potential one-day loss with a 95% confidence level. At March 31, 1998, Key's aggregate daily VAR was $.6 million and averaged $.6 million for the first quarter of 1998. As of the 1997 year end, Key's aggregate daily VAR was less than $.8 million and averaged less than $.5 million for the second half of 1997. VAR augments other controls used by Key to mitigate the market risk exposure of its trading portfolio. These controls are established by Key's Financial Markets 33 34 Committee and include, in addition to VAR, loss and position equivalent limits which are based on the level of activity and volatility of trading products and market liquidity. NONINTEREST INCOME As shown in Figure 10, noninterest income for the 1998 first quarter totaled $356 million, up $97 million, or 37%, from the same period last year. This improvement reflected growth in almost all major categories, including investment banking and capital markets income (up $29 million), gains from sales of branches/subsidiaries (up $29 million), trust and asset management income (up $13 million) and loan securitization income (up $9 million). The only major category experiencing a decrease was credit card fees, which declined by $8 million due primarily to the sales of $365 million of Key's credit card receivables during 1997. The increase in investment banking and capital markets income reflected higher revenues from dealer and trading activities, as well as increased gains recognized in connection with equity capital investments. Growth in trust and asset management income resulted from continued strong performance of both the stock and bond markets and new business. Additional detail pertaining to the composition of this noninterest income component is presented in Figure 11. Key did not execute any loan securitizations during the 1998 first quarter; the improvement in loan securitization income came primarily from servicing fees. This reflected growth in loans securitized and sold, which are either administered or serviced by Key, to $4.7 billion at March 31, 1998, from $2.8 billion a year ago. Additional information pertaining to the type and volume of these loans is included in the Loans section beginning on page 37. The acquisitions of Leasetec and Champion, which were completed during the third quarter of last year, contributed approximately $23 million (including $6 million of noninterest income) to the total increase in Key's revenue from the first quarter of 1997. Included in 1998 gains from the sales of branches/subsidiaries was $6 million in branch divestiture gains and a $23 million gain recognized in connection with the joint venture with NOVA. The agreement with NOVA also specifies that Key can receive additional consideration at the end of each of the next three years through the year 2000, provided that certain revenue-related performance targets are met. The $23 million gain was accompanied by related reductions in both merchant services revenue and noninterest expense (primarily personnel). The NOVA transaction is more fully disclosed in Note 3, Mergers, Acquisitions and Divestitures, beginning on page 8. FIGURE 10 NONINTEREST INCOME
THREE MONTHS ENDED MARCH 31, CHANGE ---------------------------- -------------------- dollars in millions 1998 1997 AMOUNT PERCENT - ----------------------------------------------------------------------------------------------------------------------- Service charges on deposit accounts $ 78 $ 71 $ 7 9.9% Trust and asset management income 77 64 13 20.3 Investment banking and capital markets income 47 18 29 161.1 Credit card fees 15 23 (8) (34.8) Insurance and brokerage income 22 21 1 4.8 Corporate owned life insurance income 23 19 4 21.1 Loan securitization income 10 1 9 900.0 Net securities gains 2 -- 2 N/M Gains from sales of branches/subsidiaries 29 -- 29 N/M Other income: Letter of credit and loan fees 17 11 6 54.5 Electronic banking fees 9 7 2 28.6 Mortgage banking income 2 2 -- -- Miscellaneous income 25 22 3 13.6 - ----------------------------------------------------------------------------------------------------------------------- Total other income 53 42 11 26.2 - ----------------------------------------------------------------------------------------------------------------------- Total noninterest income $356 $259 $97 37.5% ===== ===== ===== - -----------------------------------------------------------------------------------------------------------------------
N/M = Not Meaningful 34 35 FIGURE 11 TRUST AND ASSET MANAGEMENT
THREE MONTHS ENDED MARCH 31, CHANGE ---------------------------- ---------------------- dollars in millions 1998 1997 AMOUNT PERCENT - ------------------------------------------------------------------------------------------------------------------------- Personal asset management and custody fees $40 $34 $ 6 17.6% Institutional asset management and custody fees 21 17 4 23.5 Bond services -- 3 (3) (100.0) All other fees 16 10 6 60.0 - ------------------------------------------------------------------------------------------------------------------------- Total trust and asset management income $77 $64 $13 20.3% ==== ==== ==== dollars in billions - ------------------------------------------------------------------------------------------------------------------------- MARCH 31, Discretionary assets $ 64 $47 $17 36.2% Non-discretionary assets 50 47 3 6.4 - ------------------------------------------------------------------------------------------------------------------------- Total trust assets $114 $94 $20 21.3% ==== ==== ==== - -------------------------------------------------------------------------------------------------------------------------
NONINTEREST EXPENSE As shown in Figure 12, noninterest expense for the first quarter of 1998 totaled $600 million, up $25 million, or 4%, from the first quarter of 1997 with the largest increases coming from marketing expense (up $7 million) and professional fees (up $6 million). The 1997 acquisitions of Leasetec and Champion, accounted for approximately $18 million of the total increase in noninterest expense from the first three months of 1997. Also contributing to the increase in noninterest expense from the year-ago quarter was $4 million in distributions accrued on capital securities (tax-advantaged preferred securities) issued by Key during the second quarter of 1997. These securities are more fully described in Note 8, Capital Securities, on page 13. Noninterest expense for first quarter of 1998 also reflected a $4 million increase in costs incurred in connection with efforts being undertaken by Key to modify computer information systems to be Year 2000 compliant. As of March 31, 1998, Key had recognized approximately $24 million of the estimated $40 million of expense that it expects to incur (primarily for internal and external programmers) to substantially complete this project by the end of 1998. Further information pertaining to the Year 2000 issue is included below. The efficiency ratio, which provides a measure of the extent to which recurring revenues are used to pay operating expenses, was 57.39% for the first quarter compared with 58.92% in the first quarter of 1997 and 56.81% for the prior quarter. The slight increase from the fourth quarter of 1997 was the result of declines in Key's net interest income and noninterest income. Included in other expense are equity-and gross receipts-based taxes which are assessed in lieu of an income tax in certain states in which Key operates. These taxes, which are shown in Figure 12, represented 88, 104 and 76 basis points of Key's efficiency ratio for the first quarter of 1998, the first quarter of 1997 and the fourth quarter of 1997, respectively. The extent to which such taxes impact the level of noninterest expense will vary among companies based on the geographic locations in which they conduct their business. Year 2000 - --------- The Year 2000 issue refers to computer systems that were originally programmed using two digits rather than four digits to identify the applicable year. When the year 2000 occurs, these systems could interpret the year as 1900 rather than 2000. Unless hardware, system software and applications are corrected to be Year 2000 compliant, computers and the devices they control could generate miscalculations and create operational problems. In addition, financial institutions may experience increases in problem loans and credit losses in the event that borrowers fail to properly respond to this issue. Various systems could be affected ranging from complex computer systems to telephone systems, ATMs and elevators. To address this issue, in 1995, Key developed a comprehensive plan, including the formation of a team consisting of internal resources and third-party experts. Key prioritized the various systems (including those maintained by its business partners and suppliers) that could be affected by the Year 2000, and 35 36 efforts to ensure compliance of core systems deemed critical to Key have been accelerated. The cost of the project (currently estimated to be $40 million) and timing of its implementation are based on management's best estimates, which were derived using numerous assumptions about future events, including the continued availability of certain resources and other factors. Key is monitoring the efforts of its business partners, suppliers and customers involved in addressing the potential problem and expects to complete substantially all of the necessary work by the end of 1998, allowing 1999 as a year of final testing and refinement. As of March 31, 1998, compliance efforts had been completed for approximately 29% of the core systems identified. Key believes the efforts described above will ensure its systems are adequately prepared for the Year 2000. FIGURE 12 NONINTEREST EXPENSE
THREE MONTHS ENDED MARCH 31, CHANGE ----------------------------- -------------------- dollars in millions 1998 1997 AMOUNT PERCENT - --------------------------------------------------------------------------------------------------- Personnel $294 $290 $ 4 1.4% Net occupancy 56 56 -- -- Equipment 43 43 -- -- Amortization of intangibles 23 21 2 9.5 Marketing 28 21 7 33.3 Professional fees 17 11 6 54.5 Other expense: Distributions on capital securities 14 10 4 40.0 Equity-and gross receipts-based taxes 9 10 (1) (10.0) OREO expense, net(1) 1 1 -- -- FDIC insurance assessments 2 1 1 100.0 Year 2000 expense 6 2 4 200.0 Miscellaneous 107 109 (2) (1.8) - --------------------------------------------------------------------------------------------------- Total other expense 139 133 6 4.5 - --------------------------------------------------------------------------------------------------- Total noninterest expense $600 $575 $ 25 4.3% ======= ======= ======= Full-time equivalent employees at period end 24,650 26,603 Efficiency ratio(2) 57.39% 58.92% Overhead ratio(3) 35.36 43.71 - ---------------------------------------------------------------------------------------------------
1 OREO expense is net of income of $1 million for the first quarter of 1998 and 1997. 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 from branch divestitures). 3 Calculated as noninterest expense (excluding certain nonrecurring charges and distributions on capital securities) less noninterest income (excluding net securities transactions and gains from branch divestitures) divided by taxable-equivalent net interest income. 36 37 INCOME TAXES The provision for income taxes was $108 million for the three-month period ended March 31, 1998, up from $94 million for the same period in 1997. The effective tax rate (provision for income taxes as a percentage of income before income taxes) for the 1998 first quarter was 31.6% compared with 30.6% for the first quarter of 1997. Primary factors contributing to the increase in the effective tax rate were a lower proportion of tax credits and tax-exempt income to pretax earnings in the current year, and the favorable settlement of an IRS audit related to an entity acquired in 1992 recorded during the first quarter of 1997. 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 March 31, 1998, total loans outstanding were $54.9 billion, up from $53.4 billion at December 31, 1997, and $49.7 billion at March 31, 1997. 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 10. The $5.2 billion, or 10%, increase in loans outstanding from the March 31, 1997, 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 acquired Leasetec and Champion, which added total loans outstanding of approximately $1.0 billion and $225 million, respectively. The sales and divestitures which occurred during 1998 and 1997 are summarized in Figure 13 and included the impact of planned bank and branch divestitures, as well as the securitization and/or sale of education loans, automobile loans and other loans which do not meet certain return on equity, credit or other internal standards. Key generally sells or securitizes education loans when a borrower enters repayment status. In addition, home equity loans originated by Champion and all non-prime automobile loans were targeted for securitization in 1997. In addition to bank and branch divestitures, activity since March 31, 1997, included the sale of $1.1 billion of education loans (of which $744 million was associated with securitizations), the sale of automobile loans totaling $1.3 billion and the sale of $249 million of home equity loans. All of the automobile loan sales and $205 million of the home equity loan sales were associated with securitizations. Included in the automobile loan sales was $949 million of prime credit loans with low returns on equity. This particular portfolio was sold during the fourth quarter of 1997 in keeping with Key's strategy of divesting assets which do not support its return on equity objective. Also moderating the increase in total loans over the past year was the sale of $324 million of out-of-franchise credit card receivables which had an historically high level of delinquency. Management will continue to explore opportunities for sales and/or other arrangements with respect to its credit card and certain other portfolios in efforts to improve financial returns and manage credit risk over the remainder of 1998. Excluding the net impact of acquisitions, sales and divestitures, loan portfolios (other than one-to-four family mortgages and loans held for sale) increased $5.3 billion, or 13%, since March 31, 1997, and were up $1.2 billion, or an annualized 11% from the 1997 year end. Over the past year, the largest increase came from commercial loans which rose by $3.2 billion, due primarily to higher levels of commercial, financial and agricultural loans (up $1.9 billion), real estate-construction loans (up $772 million) and lease financing receivables (up $490 million). Additionally, consumer loans rose by $2.2 billion, and included increases of $1.5 billion in installment loans and $668 million in home equity loans. 37 38 FIGURE 13 LOANS SOLD AND DIVESTED
CREDIT CARD in millions EDUCATION AUTOMOBILE HOME EQUITY RECEIVABLES ALL OTHER TOTAL - ------------------------------------------------------------------------------------------------------------------------- 1998 - ---------------------- FIRST QUARTER $71 -- -- -- $20(1) $91 - ------------------------------------------------------------------------------------------------------------------------- $71 -- -- -- $20 $91 ==== ==== === 1997 - ---------------------- Fourth quarter $ 879 $1,046 $ 44 -- $147(1) $2,116 Third quarter 100 112 205 $324 491(1) 1,232 Second quarter 52 103 -- -- -- 155 First quarter 31 456 -- 41 -- 528 - ------------------------------------------------------------------------------------------------------------------------- Total $1,062 $1,717 $249 $365 $638 $4,031 ======= ======= ===== ===== ===== ====== - -------------------------------------------------------------------------------------------------------------------------
1 Part of branch divestitures, including the sale of KeyBank Wyoming in the third quarter of 1997. The $1.5 billion increase in loans from the December 31, 1997, level also reflected strong growth in loan portfolios other than one-to-four family mortgages and loans held for sale. Excluding the small impact of loan sales and branch divestitures shown in Figure 13, such loans increased $1.2 billion, or an annualized 11%, during the first quarter of 1998. Commercial loans accounted for $894 million of the increase with the largest growth coming from commercial, financial and agricultural loans (up $509 million) and construction loans (up $280 million). On the same basis, the aggregate annualized growth rate of average outstanding balances in the commercial loan portfolio was 14% for the first quarter of 1998 and exceeded 12% in each of the prior three quarters. Consumer loans contributed $293 million to the first quarter increase in loans, due principally to growth in the installment portfolio. Shown in Figure 14 are loans which have been securitized/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 strip securities, is recorded as interest income on securities available for sale. FIGURE 14 LOANS SECURITIZED/SOLD AND ADMINISTERED OR SERVICED
MARCH 31, DECEMBER 31, MARCH 31, in millions 1998 1997 1997 - -------------------------------------------------------------------------------------- Student loans $2,540 $2,611 $2,014 Automobile loans 1,493 1,601 754 Home equity loans 625 735 ___ - -------------------------------------------------------------------------------------- Total $4,658 $4,947 $2,768 ======= ======= ====== - --------------------------------------------------------------------------------------
SECURITIES At March 31, 1998, the securities portfolio totaled $8.3 billion, consisting of $7.1 billion of securities available for sale and $1.2 billion of investment securities. This compares with a total portfolio of $8.9 billion, comprised of $7.7 billion of securities available for sale and $1.2 billion of investment securities, at December 31, 1997. The composition of the two securities portfolios by type of security, as of each of these respective dates, is presented in Note 4, Securities, starting on page 9. The decrease in collateralized mortgage obligations and other mortgage backed securities since the 1997 year end was due primarily to scheduled amortization, as well as prepayments which occurred in connection with refinancings completed in the continued low interest rate environment. Certain information pertaining to the composition, yields, and maturities of the securities available for sale and investment securities portfolios is presented in Figures 15 and 16, respectively. 38 39 FIGURE 15 SECURITIES AVAILABLE FOR SALE
Other U.S. Treasury, States and Collateralized Mortgage- Residual Agencies and Political Mortgage Backed Interest in dollars in millions Corporations Subdivisions Obligations(1) Securities(1) Securitizations - ------------------------------------------------------------------------------------------------------------------------------------ MARCH 31, 1998 Maturity: One year or less $ 52 $ 2 $ 989 $ 19 -- After one through five years 53 7 2,595 1,581 $170 After five through ten years 16 44 82 1,089 212 After ten years 22 11 -- 102 -- - ------------------------------------------------------------------------------------------------------------------------------------ Fair value $143 $64 $3,666 $2,791 $382 Amortized cost 141 63 3,660 2,762 414 Weighted average yield 7.02% 6.53% 6.75% 7.27% 8.10% Weighted average maturity 3.8 years 7.5 years 2.2 years 5.5 years 5.7 years - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 1997 Fair value $204 $52 $4,051 $2,951 $374 Amortized cost 202 52 4,045 2,908 418 - ------------------------------------------------------------------------------------------------------------------------------------ MARCH 31, 1997 Fair value $523 $41 $3,661 $3,415 $234 Amortized cost 529 41 3,720 3,467 300 - ------------------------------------------------------------------------------------------------------------------------------------ Weighted Other Average Securities Total Yield(2) - -------------------------------------------------------------------------------------------- Maturity: One year or less $20 $1,082 6.56% After one through five years 18 4,424 7.15 After five through ten years 2 1,445 7.01 After ten years 29(3) 164 6.93 - -------------------------------------------------------------------------------------------- Fair value $69 $7,115 -- Amortized cost 61 7,101 7.03% Weighted average yield 5.70% 7.03% -- Weighted average maturity 6.8 years 3.8 years -- - -------------------------------------------------------------------------------------------- DECEMBER 31, 1997 Fair value $76 $7,708 -- Amortized cost 75 7,700 7.19% - -------------------------------------------------------------------------------------------- MARCH 31, 1997 Fair value $97 $7,971 -- Amortized cost 96 8,153 6.67% - --------------------------------------------------------------------------------------------
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. FIGURE 16 INVESTMENT SECURITIES
States and Weighted Political Other Average dollars in millions Subdivisions Securities Total Yield(1) - ------------------------------------------------------------------------------------------------------------ MARCH 31, 1998 Maturity: One year or less $305 -- $ 305 7.39% After one through five years 420 $ 93 513 8.22 After five through ten years 155 -- 155 9.90 After ten years 38 171 209 6.10 - ------------------------------------------------------------------------------------------------------------ Amortized cost $918 $264 $1,182 7.84% Fair value 949 264 1,213 -- Weighted average yield 8.45% 5.70% 7.84% -- Weighted average maturity 3.0 years 7.2 years 3.9 years -- - ------------------------------------------------------------------------------------------------------------ DECEMBER 31, 1997 Amortized cost $973 $257 $1,230 7.59% Fair value 1,005 257 1,262 -- - ------------------------------------------------------------------------------------------------------------ MARCH 31, 1997 Amortized cost $1,401 $227 $1,628 7.56% Fair value 1,430 227 1,657 -- - ------------------------------------------------------------------------------------------------------------
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 Key has established groups dedicated to evaluating and monitoring the level of risk in its credit-related assets; formulating underwriting standards and guidelines for line management; developing commercial and consumer credit policies and systems; establishing credit-related concentration limits; reviewing loans, leases and other corporate assets to evaluate credit quality; and reviewing the adequacy of the allowance for loan losses ("Allowance"). Geographic diversity throughout Key is a significant factor in managing credit risk. 39 40 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. FIGURE 17 SUMMARY OF LOAN LOSS EXPERIENCE
THREE MONTHS ENDED MARCH 31, ---------------------------- dollars in millions 1998 1997 - ----------------------------------------------------------------------------------------------------------- Average loans outstanding during the period $53,946 $49,215 - ----------------------------------------------------------------------------------------------------------- Allowance for loan losses at beginning of period $900 $870 Loans charged off: Commercial, financial and agricultural 16 12 Real estate--commercial mortgage 4 3 Real estate--construction -- 1 Commercial lease financing 1 3 - ----------------------------------------------------------------------------------------------------------- Total commercial loans 21 19 Real estate--residential mortgage 4 3 Home equity 2 1 Credit card 27 29 Consumer--direct 11 8 Consumer--indirect 35 29 - ----------------------------------------------------------------------------------------------------------- Total consumer loans 79 70 - ----------------------------------------------------------------------------------------------------------- 100 89 Recoveries: Commercial, financial and agricultural 6 8 Real estate--commercial mortgage 2 3 - ----------------------------------------------------------------------------------------------------------- Total commercial loans 8 11 Real estate--residential mortgage 1 1 Credit card 2 2 Consumer--direct 2 2 Consumer--indirect 10 6 - ----------------------------------------------------------------------------------------------------------- Total consumer loans 15 11 - ----------------------------------------------------------------------------------------------------------- 23 22 - ----------------------------------------------------------------------------------------------------------- Net loans charged off (77) (67) Provision for loan losses 77 67 - ----------------------------------------------------------------------------------------------------------- Allowance for loan losses at end of period $900 $870 ===== ==== - ----------------------------------------------------------------------------------------------------------- Net loan charge-offs to average loans .58% .55% Allowance for loan losses to period end loans 1.64 1.75 Allowance for loan losses to nonperforming loans 241.29 234.50 - -----------------------------------------------------------------------------------------------------------
As shown in Figure 17, net loan charge-offs in the first three months of 1998 were $77 million, or .58% of average loans, compared with $67 million, or .55% of average loans, for the same period last year. The increase in net charge-offs was evenly split between the commercial and consumer portfolios. The higher level of commercial loan net charge-offs was concentrated in the commercial, financial and agricultural portfolio and reflected significant growth in outstanding loans over the past year. Contributing to the increase in consumer loan net charge-offs, which occurred primarily in the direct and indirect installment 40 41 portfolios, was the continued weakness in consumer credit quality. Overall, the level of net loan charge-offs has been fairly consistent over the past five quarters and is expected to benefit from the fourth quarter 1997 sale of $949 million of prime credit automobile loans. As a result of the higher level of net charge-offs, the provision for loan losses was increased to $77 million for the first quarter of 1998 from $76 million for the prior quarter and $67 million for the first quarter of last year. This increase reflected management's current intention to maintain the provision for loan losses at a level equal to or above net charge-offs. The Allowance at March 31, 1998, was $900 million, or 1.64% of loans, compared with $870 million, or 1.75% of loans, at March 31, 1997. Included in both the 1998 and 1997 Allowance was $26 million and $33 million, respectively, which was specifically allocated for impaired loans. For a further discussion of impaired loans see Note 6, Impaired Loans and Other Nonperforming Assets, on page 11. At March 31, 1998, the Allowance was 241.29% of nonperforming loans, compared with 236.22% at December 31, 1997, and 234.50% at March 31, 1997. There have been no significant changes in the allocation of the Allowance since year end. The composition of nonperforming assets is shown in Figure 18. These assets totaled $421 million at March 31, 1998, and represented .77% of loans, OREO and other nonperforming assets compared with $431 million, or .81%, at year end 1997 and $425 million, or .85%, at March 31, 1997. The level of nonperforming assets has remained consistent over the past five quarters, ranging from a high of $433 million at June 30, 1997, to a low of $411 million at September 30, 1997. FIGURE 18 SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
MARCH 31, DECEMBER 31, MARCH 31, dollars in millions 1998 1997 1997 - ----------------------------------------------------------------------------------------------------------------------- Commercial, financial and agricultural $152 $162 $135 Real estate--commercial mortgage 77 88 88 Real estate--construction 20 21 19 Commercial lease financing 14 5 16 Real estate--residential mortgage 62 58 64 Consumer 48 47 49 - ----------------------------------------------------------------------------------------------------------------------- Total nonperforming loans (1) 373 381 371 OREO 67 66 62 Allowance for OREO losses (24) (21) (10) - ----------------------------------------------------------------------------------------------------------------------- OREO, net of allowance 43 45 52 Other nonperforming assets 5 5 2 - ----------------------------------------------------------------------------------------------------------------------- Total nonperforming assets $421 $431 $425 ===== ===== ==== - ----------------------------------------------------------------------------------------------------------------------- Accruing loans past due 90 days or more $159 $132 $113 - ----------------------------------------------------------------------------------------------------------------------- Nonperforming loans to period end loans .68% .71% .75% Nonperforming assets to period end loans plus OREO and other nonperforming assets .77 .81 .85 - -----------------------------------------------------------------------------------------------------------------------
1 Includes impaired loans of $189 million, $196 million and $193 million at March 31, 1998, December 31, 1997 and March 31, 1997, respectively. 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 first quarter of 1998, these deposits averaged $37.0 billion and represented 58% of Key's funds supporting earning assets, compared with $39.0 billion and 66%, respectively, during the first three months of 1997. Over the past year the decrease in core deposits was due primarily to declines in the levels of both savings deposits and NOW accounts. This resulted primarily from the sale of KeyBank Wyoming in July 1997 and the divestiture of 89 other branch offices since March 31, 1997. The divested branches (including KeyBank Wyoming) had deposits of approximately $2.4 billion. Also contributing to both the decrease and change in the mix of core deposits were investment alternatives pursued by customers in response to the continued strength of the stock and bond 41 42 markets. The increase in money market deposit accounts over the past two quarters reflects these customer preferences as well as actions taken by management to reprice such deposits. Purchased funds, which are comprised of large certificates of deposit, deposits in foreign offices and short-term borrowings, averaged $18.4 billion during the first quarter of 1998, up $2.6 billion, or 17%, from the comparable prior year period. As illustrated in Figure 4, the increase was attributable to higher levels of short-term borrowings and deposits in foreign offices, which rose by $2.9 billion and $95 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 well into 1998 due in large part to the impact of the bank and branch divestitures which are expected to be completed near the close of the second quarter. FIGURE 19 MATURITY DISTRIBUTION OF TIME DEPOSITS OF $100,000 OR MORE
March 31, 1998 DOMESTIC FOREIGN in millions OFFICES OFFICES TOTAL - ---------------------------------------------------------------------------------------- Time remaining to maturity: Three months or less $1,863 $325 $2,188 Over three through six months 634 -- 634 Over six through twelve months 549 -- 549 Over twelve months 424 -- 424 - ---------------------------------------------------------------------------------------- Total $3,470 $325 $3,795 ======= ===== ====== - ----------------------------------------------------------------------------------------
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 KeyCenters in 13 states. The affiliate banks monitor deposit flows and evaluate alternate pricing structures with respect to their deposit base. This process is supported by Key's Funds & Investment Management Group, which 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 $980 million and is secured by $1.4 billion of KeyBank USA's credit card receivables at March 31, 1998. There were no borrowings outstanding under this line of credit as of March 31, 1998. During the first quarter of 1998, Key's affiliate banks raised $4.1 billion under Key's Bank Note Program, which provides for the issuance of up to $13 billion ($12 billion by KeyBank N.A. and $1 billion by KeyBank USA). Of the notes issued during the first quarter, $1.6 billion have original maturities in excess of one year and are included in long-term debt, while $2.5 billion have original maturities of one year or less and are included in short-term borrowings. At March 31, 1998, the program had an unused capacity of $8.2 billion. During the second quarter of 1997, Key diversified its funding sources by establishing a Euronote Program under which the parent company, KeyBank N.A. 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 $864 million of borrowings outstanding under this facility as of March 31, 1998, $24 million of which was issued during the first quarter. The parent company has a commercial paper program and a four-year revolving credit agreement; both facilities provide funding availability of $500 million. The proceeds from the commercial paper program 42 43 may be used for general corporate purposes and have been used to fund certain non-prime automobile lending activities in conjunction with securitizations. There were no borrowings outstanding under either of these facilities as of March 31, 1998. The parent company also has a universal shelf registration statement on file with the SEC, which provides for the possible issuance of up to $1.3 billion of debt and equity securities. At March 31, 1998, unused capacity under the shelf registration totaled $1.3 billion, including $750 million 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 March 31, 1998, were as follows:
Senior Subordinated Commercial Long-Term Long-Term Paper Debt Debt --------------- ----------------- ----------------- Duff & Phelps D-1 A+ A Standard & Poor's A-2 A- BBB+ Moody's P-1 A1 A2
Further information pertaining to Key's sources and uses of cash for the three-month periods ended March 31, 1998 and 1997, is presented in the Consolidated Statements of Cash Flow on page 6. CAPITAL AND DIVIDENDS Total shareholders' equity at March 31, 1998, was $5.3 billion, up $157 million, or 3%, from the December 31, 1997, balance and $664 million, or 14%, from the end of the first quarter of 1997. The increase from the end of the prior year and from the year-ago quarter was due primarily to retained net income, offset in part by dividends paid to shareholders. The increase over the past 12 months was also moderated by a net increase in treasury stock resulting from the share repurchases which occurred during the last three quarters of 1997. Other factors contributing to the change in shareholders' equity during the first three months of 1998 are shown in the Statement of Changes in Shareholders' Equity presented on page 5. In January 1998, the Board of Directors approved a share repurchase program which authorized the repurchase from that date of up to 5,000,000 Common Shares (10,000,000 shares on a post-split basis), with no expiration date for the authority. Under the program, shares may be repurchased from time to time in the open market or through negotiated transactions. During the first quarter of 1998, Key did not repurchase any shares under this program and reissued 1,251,566 Treasury Shares for employee benefit and dividend reinvestment plans. The 52,573,384 Treasury Shares at March 31, 1998, 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. 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 7.98% at March 31, 1998, compared with 7.71% at December 31, 1997, and 7.62% at March 31, 1997. Excluding certain capital securities receiving Tier 1 treatment, these ratios are 7.29%, 7.03% and 6.88%, respectively. Banking industry regulators define minimum capital ratios for bank holding companies and their banking subsidiaries. Based on risk-adjusted capital rules and definitions prescribed by the banking regulators, Key's Tier 1 and total risk-adjusted capital ratios at March 31, 1998, were 6.81% and 11.38%, respectively. These compare favorably with the minimum requirements of 4.0% for Tier 1 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 March 31, 1998, Key's leverage ratio was 6.61%, substantially higher than the minimum requirement. Figure 20 presents the details of Key's regulatory capital position at March 31, 1998, December 31, 1997, and March 31, 1997. 43 44 FIGURE 20 CAPITAL COMPONENTS AND RISK-ADJUSTED ASSETS
MARCH 31, DECEMBER 31, MARCH 31, dollars in millions 1998 1997 1997 - ------------------------------------------------------------------------------------------------- TIER 1 CAPITAL Common shareholders' equity(1) $5,330 $5,170 $4,791 Qualifying capital securities 500 500 500 Less: Goodwill (1,052) (1,071) (811) Other intangible assets(2) (89) (95) (112) - ------------------------------------------------------------------------------------------------- Total Tier 1 capital 4,689 4,504 4,368 - ------------------------------------------------------------------------------------------------- TIER 2 CAPITAL Allowance for loan losses(3) 861 847 733 Qualifying long-term debt 2,285 1,982 2,102 - ------------------------------------------------------------------------------------------------- Total Tier 2 capital 3,146 2,829 2,835 - ------------------------------------------------------------------------------------------------- Total capital $7,835 $7,333 $7,203 ======== ======== ======== RISK-ADJUSTED ASSETS Risk-adjusted assets on balance sheet $58,209 $58,412 $52,659 Risk-adjusted off-balance sheet exposure 11,844 10,501 6,893 Less: Goodwill (1,052) (1,071) (811) Other intangible assets(2) (89) (95) (112) - ------------------------------------------------------------------------------------------------- Gross risk-adjusted assets 68,912 67,747 58,629 Less: Excess allowance for loan losses(3) (39) (53) (137) - ------------------------------------------------------------------------------------------------- Net risk-adjusted assets $68,873 $67,694 $58,492 ======== ======== ======== AVERAGE QUARTERLY TOTAL ASSETS $72,122 $71,490 $66,354 ======== ======== ======== CAPITAL RATIOS Tier 1 risk-adjusted capital ratio 6.81% 6.65% 7.47% Total risk-adjusted capital ratio 11.38 10.83 12.31 Leverage ratio(4) 6.61 6.40 6.68 - -------------------------------------------------------------------------------------------------
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 deductible portions of purchased mortgage servicing rights. 3 The allowance for loan losses included in Tier 2 capital is limited to 1.25% of gross risk-adjusted assets. 4 Tier 1 capital as a percentage of average quarterly assets, less goodwill and other non-qualifying intangible assets as defined in 2 above. 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 March 31, 1998, since they exceeded the well-capitalized thresholds of 10%, 6% and 5% for the total capital, Tier 1 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 also qualify as "well capitalized" at March 31, 1998. The FDIC-defined capital categories may not constitute an accurate representation of the overall financial condition or prospects of Key or its affiliate banks. On January 15, 1998, Key announced a two-for-one stock split effected by means of a 100% stock dividend payable March 6, 1998, to shareholders of record as of February 18, 1998. All relevant Common Share amounts and per share data in this report have been adjusted to reflect the split. At the Annual Meeting of Shareholders held May 7, 1998, shareholders increased the authorized number of Key Common Shares from 900,000,000 to 1,400,000,000 Common Shares. Additionally, on January 15, 44 45 1998, the Board voted to cancel and retire all 1,400,000 authorized shares of Key's 10% Cumulative Preferred Stock, Class A, none of which were outstanding. 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 (15) Acknowledgment Letter of Independent Auditors (27) Financial Data Schedule (filed electronically only) (b) Reports on Form 8-K January 21, 1998 - Item 5. Other Events and Item 7. Financial Statements and Exhibits. Reporting that the Registrant issued two press releases on January 15, 1998. The first announced the earnings results for the three-month and twelve-month period ended December 31, 1997. The second announced: (i) a declaration of a quarterly cash dividend in the amount of $.47 per common share ($.235 per common share on a post-split basis), (ii) a two-for-one stock split by means of a 100% stock dividend payable on common shares, and (iii) a repurchase authorization of up to 5 million (10 million on a post-split basis) common shares from time to time. March 6, 1998 - Item 5. Other events. Reporting that the Board of Directors declared a stock split on January 15, 1998, to be effected in the form of a 100% stock dividend payable on March 6, 1998, to shareholders of record on February 18, 1998. Also reporting that the Registration Statement on Form S-3 (Reg. No. 333-37287) filed on October 6, 1997, is deemed to cover the additional Common Shares resulting from the payment of the stock dividend. No other reports on Form 8-K were filed during the three-month period ended March 31, 1998. 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: May 14, 1998 /s/ Lee Irving -------------------------------------- By: Lee Irving Executive Vice President and Chief Accounting Officer 45 EX-15 2 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 April 14, 1998, relating to the unaudited consolidated interim financial statements of Key, included in the Quarterly Report on Form 10-Q for the quarter ended March 31, 1998. Form S-3 No. 33-10634 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-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. 333-49609 Form S-8 No. 333-49633 Form S-8 No. 33-31569 (Post-Effective Amendment No. 1 to Form S-4) Form S-8 No. 33-44657 (Post-Effective Amendment No. 1 to Form S-4) Form S-8 No. 33-51717 (Post-Effective Amendment No. 1 to Form S-4) 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 May 11, 1998 46 EX-27 3 EXHIBIT 27
9 1,000,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 3,287 120 667 385 7,115 1,182 1,213 54,900 900 73,198 41,661 13,910 2,498 9,041 0 0 492 5,596 73,198 1,165 162 0 1,327 347 316 664 77 2 600 343 343 0 0 235 0.53 0.53 4.23 373 159 0 0 900 100 23 900 900 0 0
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