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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2003
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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 422,799,824 Shares
- ---------------------------------------------- ----------------------------
(Title of class) (Outstanding at April 30, 2003)
KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page Number
-----------
Item 1. Financial Statements
Consolidated Balance Sheets --
March 31, 2003, December 31, 2002 and March 31, 2002 3
Consolidated Statements of Income --
Three months ended March 31, 2003 and 2002 4
Consolidated Statements of Changes in Shareholders' Equity --
Three months ended March 31, 2003 and 2002 5
Consolidated Statements of Cash Flow --
Three months ended March 31, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Independent Accountants' Review Report 29
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 30
Item 3. Quantitative and Qualitative Disclosure of Market Risk 65
Item 4. Controls and Procedures 65
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 65
Item 6. Exhibits and Reports on Form 8-K 65
Signature 67
Management Certifications 68
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31, MARCH 31,
dollars in millions 2003 2002 2002
- ---------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
ASSETS
Cash and due from banks $ 3,074 $ 3,364 $ 2,483
Short-term investments 2,837 1,632 1,487
Securities available for sale 8,455 8,507 5,859
Investment securities (fair value: $140, $129 and $224) 132 120 216
Other investments 970 919 864
Loans, net of unearned income of $1,813, $1,776 and $1,803 62,719 62,457 63,956
Less: Allowance for loan losses 1,421 1,452 1,607
- ---------------------------------------------------------------------------------------------------------------------------------
Net loans 61,298 61,005 62,349
Premises and equipment 623 644 663
Goodwill 1,142 1,142 1,101
Other intangible assets 34 35 28
Corporate-owned life insurance 2,442 2,414 2,334
Accrued income and other assets 5,483 5,420 3,975
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 86,490 $ 85,202 $ 81,359
========== ============ ==========
LIABILITIES
Deposits in domestic offices:
NOW and money market deposit accounts $ 17,356 $ 16,249 $ 13,534
Savings deposits 2,095 2,029 2,014
Certificates of deposit ($100,000 or more) 4,667 4,749 4,505
Other time deposits 11,620 11,946 13,231
- ---------------------------------------------------------------------------------------------------------------------------------
Total interest-bearing 35,738 34,973 33,284
Noninterest-bearing 10,811 10,630 8,688
Deposits in foreign office -- interest-bearing 3,906 3,743 1,261
- ---------------------------------------------------------------------------------------------------------------------------------
Total deposits 50,455 49,346 43,233
Federal funds purchased and securities sold under repurchase agreements 3,721 3,862 7,338
Bank notes and other short-term borrowings 2,551 2,823 3,174
Accrued expense and other liabilities 5,346 5,471 4,683
Long-term debt 16,269 15,605 15,256
Corporation-obligated mandatorily redeemable preferred capital securities of subsidiary
trusts holding solely subordinated debentures of KeyCorp (See Note 9) 1,250 1,260 1,273
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 79,592 78,367 74,957
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value; authorized 25,000,000 shares, none issued -- -- --
Common shares, $1 par value; authorized 1,400,000,000 shares;
issued 491,888,780 shares 492 492 492
Capital surplus 1,449 1,449 1,385
Retained earnings 6,536 6,448 6,096
Treasury stock, at cost (69,108,570, 67,945,135 and 66,434,962 shares) (1,621) (1,593) (1,551)
Accumulated other comprehensive income (loss) 42 39 (20)
- ---------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 6,898 6,835 6,402
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 86,490 $ 85,202 $ 81,359
========== ============ ==========
- ---------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements(Unaudited).
3
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions, except per share amounts 2003 2002
- ------------------------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $ 904 $ 985
Tax-exempt investment securities 2 3
Securities available for sale 101 89
Short-term investments 8 9
Other investments 6 6
- ------------------------------------------------------------------------------------------------------------
Total interest income 1,021 1,092
INTEREST EXPENSE
Deposits 188 250
Federal funds purchased and securities sold under repurchase agreements 16 23
Bank notes and other short-term borrowings 16 27
Long-term debt, including capital securities 120 138
- ------------------------------------------------------------------------------------------------------------
Total interest expense 340 438
- ------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME 681 654
Provision for loan losses 130 136
- ------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 551 518
NONINTEREST INCOME
Trust and investment services income 132 158
Service charges on deposit accounts 92 100
Investment banking and capital markets income 34 49
Letter of credit and loan fees 31 28
Corporate-owned life insurance income 27 26
Electronic banking fees 19 18
Net securities gains 4 --
Other income 58 64
- ------------------------------------------------------------------------------------------------------------
Total noninterest income 397 443
NONINTEREST EXPENSE
Personnel 363 363
Net occupancy 59 57
Computer processing 44 54
Equipment 32 34
Marketing 25 26
Professional fees 25 21
Other expense 109 106
- ------------------------------------------------------------------------------------------------------------
Total noninterest expense 657 661
INCOME BEFORE INCOME TAXES 291 300
Income taxes 74 60
- ------------------------------------------------------------------------------------------------------------
NET INCOME $ 217 $ 240
========= ==========
Per common share:
Net income $ .51 $ .56
Net income -- assuming dilution .51 .56
Weighted average common shares outstanding (000) 425,275 424,855
Weighted average common shares and potential common
shares outstanding (000) 428,090 430,019
- ------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
ACCUMULATED
TREASURY OTHER
COMMON CAPITAL RETAINED STOCK, COMPREHENSIVE COMPREHENSIVE
dollars in millions, except per share amounts SHARES SURPLUS EARNINGS AT COST INCOME (LOSS) INCOME
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2001 $ 492 $ 1,390 $ 5,856 $ (1,585) $ 2
Net income 240 $ 240
Other comprehensive income (losses):
Net unrealized losses on securities available
for sale, net of income taxes of ($13) ( a) (24) (24)
Net unrealized gains on derivative financial instruments,
net of income taxes of $1 3 3
Foreign currency translation adjustments (1) (1)
------------
Total comprehensive income $ 218
============
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 1,448,762 net shares (5) 34
- --------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2002 $ 492 $ 1,385 $ 6,096 $ (1,551) $ (20)
====== ======= ======== ======== ==============
- --------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 2002 $ 492 $ 1,449 $ 6,448 $(1,593) $ 39
Net income 217 $ 217
Other comprehensive income (losses):
Net unrealized losses on securities available
for sale, net of income taxes of ($15) (a) (26) (26)
Net unrealized gains on derivative financial instruments,
net of income taxes of $7 13 13
Foreign currency translation adjustments 16 16
------------
Total comprehensive income $ 220
============
Deferred compensation obligation 1
Cash dividends declared on common shares ($.305 per share) (129)
Issuance of common shares:
Employee benefit and dividend reinvestment
plans-- 836,565 net shares (1) 20
Repurchase of common shares - 2,000,000 shares (48)
- --------------------------------------------------------------------------------------------------------------------
BALANCE AT MARCH 31, 2003 $ 492 $ 1,449 $ 6,536 $ (1,621) $ 42
====== ======= ======== ======== ==============
- --------------------------------------------------------------------------------------------------------------------
(a) Net of reclassification adjustments.
See Notes to Consolidated Financial Statements (Unaudited).
5
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 217 $ 240
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 130 136
Depreciation expense and software amortization 50 61
Net securities gains (4) --
Net (gains) losses from principal investments 3 (1)
Net gains from loan securitizations and sales (15) (6)
Deferred income taxes 74 (6)
Net (increase) decrease in mortgage loans held for sale (19) 167
Net increase in trading account assets (158) (95)
Net decrease in accrued restructuring charges (3) (7)
Other operating activities, net (171) (159)
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 104 330
INVESTING ACTIVITIES
Net (increase) decrease in other short-term investments (1,047) 506
Purchases of securities available for sale (2,457) (1,511)
Proceeds from sales of securities available for sale 1,631 84
Proceeds from prepayments and maturities of securities available for sale 813 936
Purchases of investment securities (18) (7)
Proceeds from prepayments and maturities of investment securities 7 15
Purchases of other investments (90) (28)
Proceeds from sales of other investments 33 13
Proceeds from prepayments and maturities of other investments 26 2
Net increase in loans, excluding acquisitions, sales and divestitures (533) (1,476)
Purchases of loans (419) --
Proceeds from loan securitizations and sales 493 450
Purchases of premises and equipment (10) (15)
Proceeds from sales of premises and equipment 1 5
Proceeds from sales of other real estate owned 11 7
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (1,559) (1,019)
FINANCING ACTIVITIES
Net increase (decrease) in deposits 1,110 (1,555)
Net increase (decrease) in short-term borrowings (413) 1,228
Net proceeds from issuance of long-term debt, including capital securities 1,871 2,055
Payments on long-term debt, including capital securities (1,234) (1,336)
Purchases of treasury shares (48) --
Net proceeds from issuance of common stock 8 16
Cash dividends paid (129) (127)
- ----------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,165 281
- ----------------------------------------------------------------------------------------------------------------------------
NET DECREASE IN CASH AND DUE FROM BANKS (290) (408)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD 3,364 2,891
- ----------------------------------------------------------------------------------------------------------------------------
CASH AND DUE FROM BANKS AT END OF PERIOD $ 3,074 $ 2,483
========= ========
- ----------------------------------------------------------------------------------------------------------------------------
Additional disclosures relative to cash flow:
Interest paid $ 325 $ 396
Income taxes paid 5 9
Noncash items:
Transfer of investment securities to other investments -- $ 864
Transfer of investment securities to securities available for sale -- 64
- ----------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements (Unaudited).
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The unaudited condensed consolidated interim financial statements include the
accounts of KeyCorp and its subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation.
The Financial Accounting Standards Board ("FASB") issued FASB Interpretation No.
46 in January 2003. The "Accounting Pronouncements Pending Adoption" section of
this note, on page 10, and Note 7 ("Variable Interest Entities"), which begins
on page 19, provide information on Interpretation No. 46. This interpretation
changes the method for evaluating when to consolidate an entity depending on
whether the entity is a voting interest entity or a variable interest entity. It
was effective immediately for entities created after January 31, 2003, and
applies to previously existing entities in quarters beginning after June 15,
2003.
Key currently evaluates whether to consolidate entities in which it invested
prior to February 1, 2003, based on the nature and amount of equity contributed
by third parties, the decision-making power granted to those parties and the
extent of their control over the entity's operating and financial policies.
Entities that Key controls, generally through majority ownership, are
consolidated and are considered subsidiaries.
Unconsolidated investments in entities in which Key has significant influence
over operating and financing decisions (usually defined as a voting or economic
interest of 20 to 50%) are accounted for by the equity method. Unconsolidated
investments in entities in which Key has a voting or economic interest of less
than 20% are generally carried at cost. Investments held by KeyCorp's
broker/dealer and investment company subsidiaries (principal investments) are
carried at estimated fair value.
Key uses special purpose entities ("SPEs"), including securitization trusts, in
the normal course of business for funding purposes. SPEs established by Key as
qualifying SPEs under the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities," are not consolidated. Nonqualifying
SPEs established before February 1, 2003, are evaluated for consolidation by Key
based on the nature and amount of equity contributed by third parties, the risks
and rewards the parties assume and the control the respective parties exercise
over the SPE's activities. Securitization trusts sponsored by Key are not
consolidated since they are qualifying SPEs. Additional information on SFAS No.
140 is summarized in Note 1 ("Summary of Significant Accounting Policies") of
Key's 2002 Annual Report to Shareholders under the heading "Loan
Securitizations" on page 59.
Key also does not consolidate an asset-backed commercial paper conduit for which
it is a referral agent. The conduit is owned by a third party and administered
by an unaffiliated financial institution. Key shares the risks and rewards of
the conduit's activities with multiple third parties. Additional information on
the conduit is summarized in Note 7 ("Variable Interest Entities"), which begins
on page 19 and in Note 10 ("Contingent Liabilities and Guarantees"), which
begins on page 23.
Management believes that the unaudited condensed consolidated interim financial
statements reflect all adjustments of a normal recurring nature and disclosures
which are necessary for a fair presentation of the results for the interim
periods presented. Some previously reported results have been reclassified to
conform to current reporting practices. The results of operations for the
interim periods are not necessarily indicative of the results of operations to
be expected for the full year. When you read these financial statements, you
should also look at the audited consolidated financial statements and related
notes included in Key's 2002 Annual Report to Shareholders.
As used in these Notes, KEYCORP refers solely to the parent company and KEY
refers to the consolidated entity consisting of KeyCorp and its subsidiaries.
7
STOCK-BASED COMPENSATION
Through December 31, 2002, Key accounted for stock options issued to employees
using the intrinsic value method. This method required that compensation expense
be recognized to the extent that the fair value of the stock exceeded the
exercise price of the option at the grant date. Key's employee stock options
generally have fixed terms and exercise prices that are equal to or greater than
the fair value of Key's common shares at the grant date, so Key generally had
not recognized compensation expense related to stock options.
In September 2002, KeyCorp's Board of Directors approved management's
recommendation to change Key's method of accounting for stock options granted to
eligible employees and directors. Effective January 1, 2003, Key adopted the
fair value method of accounting as outlined in SFAS No. 123, "Accounting for
Stock-Based Compensation." Additional information pertaining to this accounting
change is summarized on page 9 under the heading "Accounting Pronouncements
Adopted in 2003."
SFAS No. 123 requires companies like Key that have used the intrinsic value
method to account for employee stock options to provide pro forma disclosures of
the net income and earnings per share effect of stock options using the fair
value method. Management estimates the fair value of options granted using the
Black-Scholes option-pricing model. This model was originally developed to
estimate the fair value of exchange-traded equity options, which (unlike
employee stock options) have no vesting period or transferability restrictions.
As a result, the Black-Scholes model is not a perfect indicator of the value of
an option, but it is commonly used for this purpose.
The Black-Scholes model requires several assumptions, which management developed
and updates based on historical trends and current market observations. These
assumptions include:
- - an average option life of 6.0 years for the first three months of 2003
and 5.0 years for the first three months of 2002;
- - a future dividend yield of 5.10% for the first three months of 2003 and
4.87% for the first three months of 2002;
- - share price volatility of .293 for the first three months of 2003 and
.276 for the first three months of 2002; and
- - a weighted average risk-free interest rate of 3.3% for the first three
months of 2003 and 4.1% for the first three months of 2002.
The level of accuracy achieved in deriving the estimated fair values is directly
related to the accuracy of the underlying assumptions.
The model assumes that the estimated fair value of an option is amortized over
the option's vesting period and would be included in personnel expense on the
income statement. The pro forma effect of applying the fair value method of
accounting to all forms of stock-based compensation (e.g., stock options, stock
purchase plans, restricted stock, etc.) for the first three months of 2003 and
2002 is shown in the following table. The information presented may not be
indicative of the effect in future periods.
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions, except per share amounts 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 217 $ 240
Add: Stock-based employee compensation expense included in
reported net income, net of related tax effects 2 1
Deduct: Total stock-based employee compensation expense determined under
fair value-based method for all awards, net of related tax effects 5 7
- ----------------------------------------------------------------------------------------------------------------------------
Net income -- pro forma $ 214 $ 234
========= ========
Per common share:
Net income $ .51 $ .56
Net income -- pro forma .50 .55
Net income assuming dilution .51 .56
Net income assuming dilution -- pro forma .50 .54
- ----------------------------------------------------------------------------------------------------------------------------
8
ACCOUNTING PRONOUNCEMENTS ADOPTED IN 2003
ACCOUNTING FOR AND DISCLOSURE OF GUARANTEES. In November 2002, the FASB issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others." This
interpretation requires a guarantor to recognize, at the inception of a
guarantee, a liability for the fair value of obligations undertaken. The
liability that must be recognized is specifically related to the obligation to
stand ready to perform over the term of the guarantee. The initial recognition
and measurement provisions of this guidance became effective on a prospective
basis for guarantees issued or modified on or after January 1, 2003.
For guarantees subject to the liability recognition provisions of this
interpretation for which Key receives a fee, the initial fair value stand ready
obligation is recognized at an amount equal to the fee. For guarantees for which
no fee is received, the fair value of the stand ready obligations is determined
using expected present value measurement techniques, unless observable
transactions for identical or similar guarantees are available. The subsequent
accounting for these stand ready obligations depends on the nature of the
underlying guarantees. Key accounts for its release from risk for a particular
guarantee either upon expiration or settlement, or by a systematic and rational
amortization method depending on the risk profile of the particular guarantee.
This new accounting guidance also expands the disclosures that a guarantor must
make about its obligations under certain guarantees. These disclosure
requirements took effect for financial statements of interim or annual periods
ending after October 15, 2002. The required disclosures for Key are provided in
Note 10 ("Contingent Liabilities and Guarantees"), which begins on page 23.
The adoption of Interpretation No. 45 did not have any material effect on Key's
financial condition or results of operations.
COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES. In July 2002, the FASB issued
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities." This new standard took effect for exit or disposal activities
(e.g., activities related to ceasing a line of business, relocating operations,
etc.) initiated after December 31, 2002. SFAS No. 146 substantially changes the
rules for recognizing costs, such as lease or other contract termination costs
and one-time employee termination benefits associated with exit or disposal
activities arising from corporate restructurings. Generally, these costs must be
recognized when incurred. Previously, those costs could be recognized earlier,
for example, when a company committed to an exit or disposal plan. Key adopted
SFAS No. 146 for restructuring activities initiated on or after January 1, 2003.
The adoption of SFAS No. 146 did not significantly affect Key's financial
condition or results of operations.
ASSET RETIREMENT OBLIGATIONS. In August 2001, the FASB issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." The new standard was effective
for fiscal years beginning after June 15, 2002. SFAS No. 143 addresses the
accounting for legal obligations associated with the retirement of tangible
long-lived assets and requires a liability to be recognized for the fair value
of these obligations in the period they are incurred. Related costs are
capitalized as part of the carrying amounts of the assets to be retired and are
amortized over the assets' useful lives. Key adopted SFAS No. 143 as of January
1, 2003. The adoption of this accounting guidance did not significantly affect
Key's financial condition or results of operations.
ACCOUNTING FOR STOCK-BASED COMPENSATION. Under SFAS No. 123, "Accounting for
Stock-Based Compensation," companies may either recognize the compensation cost
associated with stock options as expense over the respective vesting periods or
disclose the pro forma impact on earnings in their financial statements. Key has
historically followed the latter approach, but in September 2002, KeyCorp's
Board of Directors approved management's recommendation to recognize the
compensation cost for stock options. Effective January 1, 2003, Key adopted the
fair value method of accounting as outlined in SFAS No. 123. Management is
applying the change in accounting prospectively (prospective method) to all
awards as permitted under the transition provisions in SFAS No. 148, "Accounting
for Stock-Based Compensation Transition and Disclosure," which was issued in
December 2002. SFAS No. 148 amends SFAS No. 123 to provide alternative methods
of transition for an entity that voluntarily changes to the fair value method of
accounting for stock compensation. These alternative methods include: (i) the
prospective method; (ii) the
9
modified prospective method; and, (iii) the retroactive restatement method. This
accounting guidance also amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock compensation and the effect of the
method used on reported financial results. The required interim disclosures for
Key are provided under the heading "Stock-Based Compensation" on page 8.
Based on the valuation and anticipated mid-year timing of option grants in 2003,
management estimates that the accounting change will reduce Key's diluted
earnings per common share by approximately $.02 in 2003. The effect on Key's
earnings per common share in subsequent years will depend on the number and
timing of options granted and the assumptions used to estimate their fair value.
ACCOUNTING PRONOUNCEMENTS PENDING ADOPTION
CONSOLIDATION OF VARIABLE INTEREST ENTITIES. In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities," which
significantly changes how Key and other companies determine when to consolidate
other entities. Under this guidance, entities are classified as either voting
interest entities or variable interest entities ("VIEs"). A voting interest
entity is evaluated for consolidation under existing accounting standards, which
focus on the equity owner with voting control, while a VIE is consolidated by
its primary beneficiary. The primary beneficiary is the party that holds
variable interests that expose it to a majority of the entity's expected losses
and/or residual returns. Variable interests include equity interests,
subordinated debt, derivative contracts, leases, service agreements, guarantees,
standby letters of credit, loan commitments and other instruments.
Interpretation No. 46 was effective immediately for entities created after
January 31, 2003, and applies to previously existing entities in quarters
beginning after June 15, 2003. It requires additional disclosures by primary
beneficiaries and other significant variable interest holders. Management is
currently evaluating Key's involvement with entities created prior to February
1, 2003, to identify those that must be consolidated or only disclosed in
accordance with this guidance. The most significant impact of this new guidance
will be on Key's balance sheet since consolidating additional entities will
increase assets and liabilities and change leverage and capital ratios, as well
as asset concentrations. While the consolidation of previously unconsolidated
entities under Interpretation No. 46 will represent an accounting change, it
will not affect Key's legal rights or obligations to these entities. Additional
information is summarized in Note 7 ("Variable Interest Entities"), which begins
on page 19, and in Note 10 ("Contingent Liabilities and Guarantees"), which
begins on page 23.
2. EARNINGS PER COMMON SHARE
Key calculates its basic and diluted earnings per common share as follows:
THREE MONTHS ENDED MARCH 31,
----------------------------
dollars in millions, except per share amounts 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 217 $ 240
========== ==========
- -------------------------------------------------------------------------------------------------------------------------
WEIGHTED AVERAGE COMMON SHARES
Weighted average common shares outstanding (000) 425,275 424,855
Effect of dilutive common stock options (000) 2,815 5,164
- -------------------------------------------------------------------------------------------------------------------------
Weighted average common shares and potential
common shares outstanding (000) 428,090 430,019
========== ==========
- -------------------------------------------------------------------------------------------------------------------------
EARNINGS PER COMMON SHARE
Net income per common share $ .51 $ .56
Net income per common share-- assuming dilution .51 .56
- -------------------------------------------------------------------------------------------------------------------------
10
3. ACQUISITIONS AND DIVESTITURE
Business acquisitions and the divestiture that Key completed during 2002 are
summarized below. There were no such transactions completed during the first
quarter of 2003.
ACQUISITIONS
UNION BANKSHARES, LTD.
On December 12, 2002, Key purchased Union Bankshares, Ltd., the holding company
for Union Bank & Trust, a seven-branch bank headquartered in Denver, Colorado.
Key paid $22.63 per Union Bankshares common share for a total cash consideration
of $66 million. Goodwill of approximately $34 million and core deposit
intangibles of $13 million were recorded. Union Bankshares, Ltd. had assets of
$475 million at the date of acquisition. On January 17, 2003, Union Bank & Trust
was merged into Key Bank National Association ("KBNA").
CONNING ASSET MANAGEMENT
On June 28, 2002, Key purchased substantially all of the mortgage loan and real
estate business of Conning Asset Management, headquartered in Hartford,
Connecticut. Conning's mortgage loan and real estate business originates,
securitizes and services multi-family, retail, industrial and office property
mortgage loans on behalf of pension fund and life insurance company investors.
At the date of acquisition, the business had net assets of $17 million and
serviced approximately $4 billion in commercial mortgage loans through its St.
Louis office. In accordance with a confidentiality clause in the purchase
agreement, the terms, which are not material, have not been disclosed.
DIVESTITURE
401(k) RECORDKEEPING BUSINESS
On June 12, 2002, Key sold its 401(k) recordkeeping business. Key recognized a
gain of $3 million ($2 million after tax) on the transaction.
11
4. LINE OF BUSINESS RESULTS
CONSUMER BANKING
RETAIL BANKING provides individuals with branch-based deposit and investment
products, personal finance services and loans, including residential mortgages,
home equity and various types of installment loans.
SMALL BUSINESS provides businesses that have annual sales revenues of $10
million or less with deposit, investment and credit products, and business
advisory services.
CONSUMER FINANCE consists of two primary business units: Indirect Lending and
National Home Equity.
Indirect Lending offers automobile and marine loans to consumers through
dealers, and finances inventory for automobile and marine dealers. This business
unit also provides education loans, insurance and interest-free payment plans
for students and their parents.
National Home Equity provides both prime and nonprime mortgage and home equity
loan products to individuals. These products originate outside of Key's retail
branch system. This business unit also works with mortgage brokers and home
improvement contractors to provide home equity and home improvement solutions.
CORPORATE AND INVESTMENT BANKING
CORPORATE BANKING provides a full array of products and services to large
corporations, middle-market companies, financial institutions and government
organizations. These products and services include: financing, treasury
management, investment banking, derivatives and foreign exchange, equity and
debt trading, and syndicated finance.
KEYBANK REAL ESTATE CAPITAL provides construction and interim lending, permanent
debt placements and servicing, and equity and investment banking services to
developers, brokers and owner-investors. This line of business deals exclusively
with nonowner-occupied properties (i.e., generally properties for which the
owner occupies less than 60% of the premises).
KEY EQUIPMENT FINANCE meets the equipment leasing needs of companies worldwide
and provides equipment manufacturers, distributors and resellers with financing
options for their clients. Lease financing receivables and related revenues are
assigned to Corporate Banking or KeyBank Real Estate Capital if one of those
businesses is principally responsible for maintaining the relationship with the
client.
INVESTMENT MANAGEMENT SERVICES
INVESTMENT MANAGEMENT SERVICES consists of two primary business units: Victory
Capital Management and McDonald Financial Group.
Victory Capital Management manages or gives advice regarding investment
portfolios for a national client base, including corporations, labor unions,
not-for-profit organizations, governments and individuals. These portfolios may
be managed in separate accounts, common funds or the Victory family of mutual
funds.
McDonald Financial Group offers financial, estate and retirement planning and
asset management services to assist high-net-worth clients with their banking,
brokerage, trust, portfolio management, insurance, charitable giving and related
needs. This unit also provides banking services to public sector institutions.
OTHER SEGMENTS
Other segments consists primarily of Treasury, Principal Investing and the net
effect of funds transfer pricing.
RECONCILING ITEMS
Total assets included under "Reconciling Items" represent primarily the
unallocated portion of nonearning assets of corporate support functions. Charges
related to the funding of these assets are part of net interest income and are
allocated to the business segments through noninterest expense. Reconciling
Items also
12
include certain items that are not allocated to the business segments because
they are not reflective of their normal operations.
The table that spans pages 14 and 15 shows selected financial data for each
major business group for the three months ended March 31, 2003 and 2002. This
table is accompanied by additional supplementary information for each of the
lines of business that comprise these groups. The information was derived from
the internal financial reporting system that management uses to monitor and
manage Key's financial performance. Accounting principles generally accepted in
the United States guide financial accounting, but there is no authoritative
guidance for "management accounting"--the way management uses its judgment and
experience to make reporting decisions. Consequently, the line of business
results Key reports may not be comparable with line of business results
presented by other companies.
The selected financial data are based on internal accounting policies designed
to compile results on a consistent basis and in a manner that reflects the
underlying economics of the businesses. As such:
- - Net interest income is determined by assigning a standard cost for
funds used to assets or a standard credit for funds provided to
liabilities based on their maturity, prepayment and/or repricing
characteristics. The net effect of this funds transfer pricing is
included in the "Other Segments" columns.
- - Indirect expenses, such as computer servicing costs and corporate
overhead, are allocated based on assumptions of the extent to which
each line actually uses the services.
- - Key's consolidated provision for loan losses is allocated among the
lines of business based primarily on their actual net charge-offs
(excluding those discussed on page 57 that are recorded in the
nonreplenished allowance), adjusted periodically for loan growth and
changes in risk profile. The level of the consolidated provision is
based on the methodology that management uses to estimate Key's
consolidated allowance for loan losses. This methodology is described
in Note 1 ("Summary of Significant Accounting Policies") under the
heading "Allowance for Loan Losses" on page 58 of Key's 2002 Annual
Report to Shareholders.
- - Income taxes are allocated based on the statutory federal income tax
rate of 35% (adjusted for tax-exempt interest income, income from
corporate-owned life insurance and tax credits associated with
investments in low-income housing projects) and a blended state income
tax rate (net of the federal income tax benefit) of 2.5%.
- - Capital is assigned based on management's assessment of economic risk
factors (primarily credit, operating and market risk).
Developing and applying the methodologies that management uses to allocate items
among Key's lines of business is a dynamic process. Accordingly, financial
results may be revised periodically to reflect accounting enhancements, changes
in the risk profile of a particular business or changes in Key's organization
structure. The financial data reported for all periods presented in the tables
reflect a number of changes, which occurred during the first quarter of 2003:
- - Key reorganized and renamed some of its business groups and lines of
business. Key's Capital Markets line of business moved from the
Investment Management Services group (formerly Key Capital Partners) to
the Corporate Banking line within the Corporate and Investment Banking
group (formerly Key Corporate Finance). Also within Corporate and
Investment Banking, Key changed the name of its National Commercial
Real Estate line of business to KeyBank Real Estate Capital, and
changed the name of its National Equipment Finance line of business to
Key Equipment Finance. In addition, Key consolidated the reporting of
its National Home Equity and Indirect Lending lines of business into
one line of business named Consumer Finance.
- - Methodologies used to allocate certain overhead and funding costs were
refined.
13
CORPORATE AND INVESTMENT
CONSUMER BANKING INVESTMENT BANKING MANAGEMENT SERVICES
------------------------ ----------------------- ---------------------
THREE MONTHS ENDED MARCH 31,
dollars in millions 2003 2002 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
SUMMARY OF OPERATIONS
Net interest income (TE) $ 450 $ 434 $ 279 $ 284 $ 59 $ 53
Noninterest income 114 117 110 121 133 160
- -------------------------------------------------------------------------------------------------------------------------
Total revenue (TE) (a) 564 551 389 405 192 213
Provision for loan losses 78 81 50 52 2 3
Depreciation and amortization expense 34 39 9 11 10 14
Other noninterest expense 299 302 160 159 148 159
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (TE) 153 129 170 183 32 37
Allocated income taxes and TE adjustments 57 48 64 69 12 14
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 96 $ 81 $ 106 $ 114 $ 20 $ 23
========== ========== ========= ========== =========== ======
Percent of consolidated net income 44 % 34 % 49 % 48 % 9 % 10 %
Percent of total segments net income 45 37 50 52 9 10
- -------------------------------------------------------------------------------------------------------------------------
AVERAGE BALANCES
Loans $ 28,434 $ 27,318 $ 28,385 $ 29,842 $ 4,958 $4,699
Total assets(a) 30,863 29,660 32,822 33,060 5,913 5,771
Deposits 34,360 34,311 4,039 3,134 5,216 3,671
- -------------------------------------------------------------------------------------------------------------------------
OTHER FINANCIAL DATA
Net loan charge-offs $ 78 $ 81 $ 79 $ 122 $ 3 $ 3
Return on average allocated equity 18.37 % 16.20 % 13.00 % 14.18 % 13.02 % 15.22 %
Average full-time equivalent employees 8,519 8,514 2,262 2,248 2,944 3,206
- -------------------------------------------------------------------------------------------------------------------------
Supplementary information (Consumer Banking lines of business)
RETAIL BANKING SMALL BUSINESS CONSUMER FINANCE
-------------------------- --------------------- ------------------------
THREE MONTHS ENDED MARCH 31,
dollars in millions 2003 2002 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 320 $ 311 $ 94 $ 90 $ 150 $ 150
Provision for loan losses 16 18 17 14 45 49
Noninterest expense 205 207 42 43 86 91
Net income 62 54 22 21 12 6
Average loans 9,571 7,856 4,374 4,303 14,489 15,159
Average deposits 29,932 30,493 4,076 3,499 352 319
Net loan charge-offs 16 18 17 14 45 49
Return on average allocated equity 40.49 % 40.71 % 24.85 % 26.70 % 4.27 % 2.08 %
Average full-time equivalent employees 6,192 6,173 378 320 1,949 2,021
- --------------------------------------------------------------------------------------------------------------------------
Supplementary information (Corporate and Investment Banking lines of business)
CORPORATE BANKING KEYBANK REAL ESTATE CAPITAL KEY EQUIPMENT FINANCE
-------------------------- ----------------------------- ------------------------
THREE MONTHS ENDED MARCH 31,
dollars in millions 2003 2002 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenue (taxable equivalent) $ 234 $ 249 $ 84 $ 90 $ 71 $ 66
Provision for loan losses 40 36 4 3 6 13
Noninterest expense 112 117 32 30 25 23
Net income 51 59 30 36 25 19
Average loans 14,261 16,365 7,497 7,832 6,627 5,645
Average deposits 3,362 2,568 665 558 12 8
Net loan charge-offs 69 106 4 3 6 13
Return on average allocated equity 10.25 % 11.56 % 15.08 % 18.99 % 20.99 % 18.26 %
Average full-time equivalent employees 1,021 1,103 635 510 606 635
- ----------------------------------------------------------------------------------------------------------------------------------
14
OTHER SEGMENTS TOTAL SEGMENTS RECONCILING ITEMS KEY
- ------------------------ ----------------------- ------------------------- ------------------------
2003 2002 2003 2002 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------
$ (59) $ (39) $ 729 $ 732 $ (26) $ (30) $ 703 $ 702
34 33 391 431 6 12 397 443
- -------------------------------------------------------------------------------------------------------------
(25) (6) 1,120 1,163 (20) (18) 1,100 1,145
-- -- 130 136 -- -- 130 136
-- -- 53 64 -- -- 53 64
8 6 615 626 (11) (29) 604 597
- -------------------------------------------------------------------------------------------------------------
(33) (12) 322 337 (9) 11 313 348
(23) (15) 110 116 (14) (8) 96 108
- -------------------------------------------------------------------------------------------------------------
$ (10) $ 3 $ 212 $ 221 $ 5 $ 19 $ 217 $ 240
========== ========== ======== ========== =========== ========== ========== ==========
(4) % -- % 98 % 92 % 2 % 8 % 100 % 100 %
(4) 1 100 100 N/A N/A N/A N/A
- -------------------------------------------------------------------------------------------------------------
$ 962 $ 1,444 $ 62,739 $ 63,303 $ 106 $ 185 $ 62,845 $ 63,488
12,796 10,594 82,394 79,085 1,520 1,786 83,914 80,871
3,207 2,941 46,822 44,057 (72) (88) 46,750 43,969
- -------------------------------------------------------------------------------------------------------------
-- -- $ 160 $ 206 -- -- $ 160 $ 206
(11.05) % 2.97 % 13.40 % 14.20 % N/M N/M 12.91 % 15.53 %
35 31 13,760 13,999 6,687 7,080 20,447 21,079
- -------------------------------------------------------------------------------------------------------------
(a) Substantially all revenue generated by Key's major business groups is
derived from clients resident in the United States. Substantially all
long-lived assets, including premises and equipment, capitalized software
and goodwill, held by Key's major business groups are located in the United
States.
TE = Taxable Equivalent, N/A = Not Applicable, N/M = Not Meaningful
15
5. SECURITIES
Key classifies its securities into four categories: trading, available for sale,
investment and other investments.
TRADING ACCOUNT SECURITIES. These are debt and equity securities that are
purchased and held by Key with the intent of selling them in the near term, and
certain interests retained in loan securitizations. All of these assets are
reported at fair value ($959 million at March 31, 2003, $801 million at December
31, 2002, and $692 million at March 31, 2002) and are included in "short-term
investments" on the balance sheet. Realized and unrealized gains and losses on
trading account securities are reported in "investment banking and capital
markets income" on the income statement.
SECURITIES AVAILABLE FOR SALE. These include securities that Key intends to hold
for an indefinite period of time and that may be sold in response to changes in
interest rates, prepayment risk, liquidity needs or other factors. Securities
available for sale are reported at fair value and include debt and marketable
equity securities with readily determinable fair values. Unrealized gains and
losses (net of income taxes) deemed temporary are recorded in shareholders'
equity as a component of "accumulated other comprehensive income (loss)."
Unrealized gains and losses on specific securities deemed to be "other than
temporary" are included in "net securities gains (losses)" on the income
statement. Also included in "net securities gains (losses)" are actual gains and
losses resulting from sales of specific securities.
When Key retains an interest in loans it securitizes, it bears risk that the
loans will be prepaid (which would reduce expected interest income) or not paid
at all. Key accounts for these retained interests (which include both
certificated and uncertificated interests) as debt securities, classifying them
as available for sale or as trading account assets.
"Other securities" held in the available for sale portfolio primarily are
marketable equity securities, including an internally managed portfolio of
common stock investments in financial services companies.
INVESTMENT SECURITIES. These are debt securities that Key has the intent and
ability to hold until maturity. Debt securities are carried at cost, adjusted
for amortization of premiums and accretion of discounts using the interest
method. This method produces a constant rate of return on the basis of the
adjusted carrying amount.
OTHER INVESTMENTS. Principal investments - investments in equity and mezzanine
instruments made by Key's Principal Investing unit - represent the majority of
other investments and are carried at fair value. They include direct and
indirect investments predominately in privately-held companies. Direct
investments are those made in a particular company, while indirect investments
are made through funds that include other investors. Changes in estimated fair
values and actual gains and losses on sales of principal investments are
included in "investment banking and capital markets income" on the income
statement.
In addition to principal investments, other investments include equity
securities that do not have readily determinable fair values. These securities
include certain real estate-related investments that are carried at estimated
fair value, as well as other types of securities that are generally carried at
cost. The carrying amount of the securities carried at cost is adjusted for
declines in value that are considered to be "other than temporary." These
adjustments are included in "net securities gains " on the income statement.
The amortized cost, unrealized gains and losses, and approximate fair value of
Key's investment securities, securities available for sale and other investments
are presented in the following tables. Gross "unrealized" gains and losses are
represented by the difference between the amortized cost and the fair values of
securities on the balance sheet as of the dates indicated. Accordingly, the
amount of these gains and losses may change in the future as market conditions
improve or worsen.
16
MARCH 31, 2003
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
U.S. Treasury, agencies and corporations $ 15 -- -- $ 15
States and political subdivisions 113 $ 8 -- 121
Other securities 4 -- -- 4
- ---------------------------------------------------------------------------------------------
Total investment securities $ 132 $ 8 -- $ 140
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 23 $ 1 -- $ 24
States and political subdivisions 27 1 -- 28
Collateralized mortgage obligations 7,283 103 $ 76 7,310
Other mortgage-backed securities 698 32 -- 730
Retained interests in securitizations 148 45 -- 193
Other securities 200 -- 30 170
- ---------------------------------------------------------------------------------------------
Total securities available for sale $ 8,379 $ 182 $ 106 $ 8,455
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Principal investments $ 687 $ 70 $ 59 $ 698
Other securities 272 -- -- 272
- ---------------------------------------------------------------------------------------------
Total other investments $ 959 $ 70 $ 59 $ 970
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
DECEMBER 31, 2002
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 120 $ 9 -- $ 129
- ---------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 22 $ 1 -- $ 23
States and political subdivisions 35 -- -- 35
Collateralized mortgage obligations 7,143 129 $ 65 7,207
Other mortgage-backed securities 815 37 -- 852
Retained interests in securitizations 166 43 -- 209
Other securities 208 -- 27 181
- ---------------------------------------------------------------------------------------------
Total securities available for sale $ 8,389 $ 210 $ 92 $ 8,507
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Principal investments $ 702 $ 36 $ 61 $ 677
Other securities 242 -- -- 242
- ---------------------------------------------------------------------------------------------
Total other investments $ 944 $ 36 $ 61 $ 919
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
March 31, 2002
-------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
in millions COST GAINS LOSSES VALUE
- ---------------------------------------------------------------------------------------------
INVESTMENT SECURITIES
States and political subdivisions $ 216 $ 8 -- $ 224
- ---------------------------------------------------------------------------------------------
SECURITIES AVAILABLE FOR SALE
U.S. Treasury, agencies and corporations $ 97 -- -- $ 97
States and political subdivisions 20 -- -- 20
Collateralized mortgage obligations 4,409 $ 67 $ 97 4,379
Other mortgage-backed securities 900 23 -- 923
Retained interests in securitizations 195 27 -- 222
Other securities 233 -- 15 218
- ---------------------------------------------------------------------------------------------
Total securities available for sale $ 5,854 $ 117 $ 112 $ 5,859
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
OTHER INVESTMENTS
Principal investments $ 719 -- $ 83 $ 636
Other securities 228 -- -- 228
- ---------------------------------------------------------------------------------------------
Total other investments $ 947 -- $ 83 $ 864
========= ========== ========== ========
- ---------------------------------------------------------------------------------------------
17
6. LOANS
Key's loans by category are summarized as follows:
MARCH 31, DECEMBER 31, MARCH 31,
in millions 2003 2002 2002
- ---------------------------------------------------------------------------------------
Commercial, financial and agricultural $ 17,292 $ 17,425 $ 18,247
Commercial real estate:
Commercial mortgage 6,029 6,015 6,531
Construction 5,437 5,659 5,884
- ---------------------------------------------------------------------------------------
Total commercial real estate loans 11,466 11,674 12,415
Commercial lease financing 7,848 7,513 7,318
- --------------------------------------------------------------------------------------
Total commercial loans 36,606 36,612 37,980
Real estate-- residential mortgage 1,862 1,968 2,195
Home equity 14,144 13,804 12,662
Consumer-- direct 2,100 2,161 2,256
Consumer-- indirect:
Automobile lease financing 680 873 1,669
Automobile loans 2,127 2,181 2,367
Marine 2,197 2,088 1,821
Other 619 667 968
- ---------------------------------------------------------------------------------------
Total consumer-- indirect loans 5,623 5,809 6,825
- ---------------------------------------------------------------------------------------
Total consumer loans 23,729 23,742 23,938
Loans held for sale:
Commercial, financial and agricultural -- 41 --
Real estate-- commercial mortgage 237 193 186
Real estate-- residential mortgage 32 57 15
Education 2,115 1,812 1,837
- ---------------------------------------------------------------------------------------
Total loans held for sale 2,384 2,103 2,038
- ---------------------------------------------------------------------------------------
Total loans $ 62,719 $ 62,457 $ 63,956
========= ============ =========
- ---------------------------------------------------------------------------------------
Key uses interest rate swaps to manage interest rate risk; these swaps modify
the repricing and maturity characteristics of certain loans. For more
information about such swaps at March 31, 2003, see Note 20 ("Derivatives and
Hedging Activities"), which begins on page 84 of Key's 2002 Annual Report to
Shareholders.
Changes in the allowance for loan losses are summarized as follows:
THREE MONTHS ENDED MARCH 31,
----------------------------
in millions 2003 2002
- ------------------------------------------------------------------------
Balance at beginning of period $ 1,452 $ 1,677
Charge-offs (190) (233)
Recoveries 29 27
- ------------------------------------------------------------------------
Net charge-offs (161) (206)
Provision for loan losses 130 136
- ------------------------------------------------------------------------
Balance at end of period $ 1,421 $ 1,607
========= =========
- ------------------------------------------------------------------------
18
7. VARIABLE INTEREST ENTITIES
A variable interest entity ("VIE") is a partnership, limited liability company,
trust or other legal entity that is not controlled through a voting equity
interest and/or does not have enough equity at risk invested to finance its
activities without subordinated financial support from another party. FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities," addresses
the consolidation of VIEs. This interpretation is summarized in Note 1 ("Basis
of Presentation"), under the heading "Accounting Pronouncements Pending
Adoption" on page 10. Under Interpretation No. 46, VIEs are consolidated by the
party (the primary beneficiary) who is exposed to the majority of the VIE's
expected losses and/or residual returns.
Key's securitization trusts are exempt from consolidation under Interpretation
No. 46 because they are qualifying special purpose entities as defined by SFAS
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities."
As required by Interpretation No. 46, Key is assessing its relationships and
arrangements with legal entities formed prior to February 1, 2003, to identify
VIEs in which Key holds a significant variable interest and to determine if Key
is the primary beneficiary of these entities and should therefore consolidate
them.
Based on the review performed to date, Key expects to consolidate the following
two VIE groups beginning in the third quarter of 2003.
COMMERCIAL PAPER CONDUITS. Key, among others, refers third party assets and
borrowers and provides liquidity and credit enhancement to an asset-backed
commercial paper conduit. The conduit had assets of $408 million at March 31,
2003. As currently structured, Key will be required to consolidate the conduit
in the third quarter of 2003; however, management is assessing restructuring
alternatives that may enable the conduit to meet the criteria for
nonconsolidation.
In addition, Key holds a subordinated note in and provides referral services and
liquidity to one program within another asset-backed commercial paper conduit.
This program, which is in the process of being liquidated, had assets of $61
million at March 31, 2003.
At March 31, 2003, Key's maximum exposure to loss from its interests in these
conduits totaled $78 million, which represents a $68 million committed credit
enhancement facility and a $10 million subordinated note.
Additional information pertaining to Key's involvement with conduits is
summarized in Note 1 ("Basis of Presentation"), which begins on page 7 and in
Note 10 ("Contingent Liabilities and Guarantees") under the heading "Guarantees"
on page 24 and the heading "Other Off-Balance Sheet Risk" on page 26.
LOW-INCOME HOUSING TAX CREDIT ("LIHTC") GUARANTEED FUNDS. Key Affordable Housing
Corporation ("KAHC") forms limited partnerships (funds) which invest in LIHTC
projects. Interests in these funds are offered to qualified investors, who pay a
fee to KAHC for a guaranteed return. Key also earns syndication and asset
management fees from these funds. At March 31, 2003, the guaranteed funds had
unamortized equity of $663 million. Additional information on the return
guaranty agreement with LIHTC investors is summarized in Note 10 ("Contingent
Liabilities and Guarantees") under the heading "Guarantees" on page 24.
Key's maximum exposure to loss from its relationships with guaranteed LIHTC
funds was $834 million at March 31, 2003, which represents undiscounted future
payments due to investors for the return on and of their investments. KAHC has
established a reserve in the amount of $33 million at March 31, 2003, which
management believes will be sufficient to absorb future estimated losses under
the guarantees.
As required by Interpretation No. 46, assets, liabilities and noncontrolling
interests of newly consolidated entities will initially be recorded at their
carrying amounts. If determining the carrying amounts is impractical, fair
values at the date Interpretation No. 46 first applies may be used. Any
difference between
19
the net assets added to Key's balance sheet and the amount of any previously
recognized interest in the newly consolidated entities will be recognized as a
cumulative effect of an accounting change.
Due to the complexity of Interpretation No. 46 and evolving interpretations of
its provisions, Key has not yet completed its analysis of the impact of this
guidance on the entity groups described below. However, based on the review
performed to date, it is reasonably possible that Key will have to disclose
significant interests in these entities or consolidate them as primary
beneficiary when Interpretation No. 46 is implemented in the third quarter of
2003.
LIHTC NONGUARANTEED FUNDS. KAHC sells investments in certain LIHTC funds without
guaranteeing a return to the investors. Key earns syndication and asset
management fees for services provided to these nonguaranteed funds. At March 31,
2003, assets of nonguaranteed LIHTC funds were estimated to be $311 million.
LIHTC INVESTMENTS. Key makes investments directly in LIHTC projects through the
Retail Banking line of business. As a limited partner in these unconsolidated
projects, Key is allocated tax credits and deductions associated with the
underlying properties. At March 31, 2003, Key's investments in these projects
totaled $304 million.
COMMERCIAL REAL ESTATE INVESTMENTS. Through the KeyBank Real Estate Capital line
of business, Key provides real estate financing for new construction,
acquisition and rehabilitation projects. In certain of these unconsolidated
projects, Key has provided or committed funds through limited partnership
interests, mezzanine investments or standby letters of credit. At March 31,
2003, these investments and facilities totaled $160 million.
As Key continues its implementation efforts, additional entities may be
identified that will need to be consolidated or disclosed.
20
8. IMPAIRED LOANS AND OTHER NONPERFORMING ASSETS
Impaired loans, which account for the largest portion of Key's nonperforming
assets, totaled $553 million at March 31, 2003, compared with $610 million at
December 31, 2002. Impaired loans averaged $581 million for the first quarter
of 2003 and $673 million for the first quarter of 2002.
Key's nonperforming assets were as follows:
MARCH 31, DECEMBER 31, MARCH 31,
in millions 2003 2002 2002
- ----------------------------------------------------------------------------
Impaired loans $ 553 $ 610 $ 685
Other nonaccrual loans 351 333 288
- ----------------------------------------------------------------------------
Total nonperforming loans 904 943 973
Other real estate owned ("OREO") 62 48 41
Allowance for OREO losses (3) (3) (2)
- ----------------------------------------------------------------------------
OREO, net of allowance 59 45 39
Other nonperforming assets 5 5 --
- ----------------------------------------------------------------------------
Total nonperforming assets $ 968 $ 993 $ 1,012
========= ============ =========
- ----------------------------------------------------------------------------
At March 31, 2003, Key did not have any significant commitments to lend
additional funds to borrowers with loans on nonperforming status.
When expected cash flows or collateral values do not justify the carrying amount
of an impaired loan, the loan is assigned a specific allowance. Management
calculates the extent of the impairment, which is the carrying amount of the
loan less the estimated present value of future cash flows and the fair value of
any existing collateral. The amount that management deems uncollectible (the
impaired amount) is charged against the allowance for loan losses. Even when
collateral value or other sources of repayment appear sufficient, if management
remains uncertain about whether the loan will be repaid in full, an amount is
specifically allocated in the allowance for loan losses. At March 31, 2003, Key
had $348 million of impaired loans with a specifically allocated allowance for
loan losses of $142 million, and $205 million of impaired loans that were
carried at their estimated fair value without a specifically allocated
allowance. At December 31, 2002, impaired loans included $377 million of loans
with a specifically allocated allowance of $179 million, and $233 million that
were carried at their estimated fair value.
Key does not perform a specific impairment valuation for smaller-balance,
homogeneous, nonaccrual loans (shown in the preceding table as "Other nonaccrual
loans"). These typically are consumer loans, including residential mortgages,
home equity loans and various types of installment loans. Management applies
historical loss experience rates to these loans, adjusted to reflect emerging
credit trends and other factors, and then allocates a portion of the allowance
for loan losses to each loan type.
21
9. CAPITAL SECURITIES
KeyCorp has six fully-consolidated subsidiary business trusts that have issued
corporation-obligated mandatorily redeemable preferred capital securities
("capital securities"). These securities are carried as liabilities on Key's
balance sheet. They provide an attractive source of funds since they constitute
Tier I capital for regulatory reporting purposes, but have the same tax
advantages as debt for federal income tax purposes. As guarantor, KeyCorp
unconditionally guarantees payment of:
- - required distributions on the capital securities;
- - the redemption price when a capital security is redeemed; and
- - amounts due if a trust is liquidated or terminated.
KeyCorp owns the outstanding common stock of each of the trusts. The trusts used
the proceeds from the issuance of their capital securities and common stock to
buy debentures issued by KeyCorp. These debentures are the trusts' only assets;
the interest payments from the debentures finance the distributions paid on the
capital securities. Key's financial statements do not reflect the debentures or
the related effects on the income statement because they are eliminated in
consolidation.
The capital securities, common stock and related debentures are summarized as
follows:
PRINCIPAL INTEREST RATE MATURITY
CAPITAL AMOUNT OF OF CAPITAL OF CAPITAL
SECURITIES, COMMON DEBENTURES, SECURITIES AND SECURITIES AND
dollars in millions NET OF DISCOUNT (a) SECURITIES NET OF DISCOUNT (b) DEBENTURES (c) DEBENTURES
- ---------------------------------------------------------------------------------------------------------------------------
March 31, 2003
KeyCorp Institutional Capital A $ 410 $ 11 $ 361 7.826 % 2026
KeyCorp Institutional Capital B 176 4 154 8.250 2026
KeyCorp Capital I 225 8 233 2.120 2028
KeyCorp Capital II 182 8 166 6.875 2029
KeyCorp Capital III 247 8 207 7.750 2029
Union Bankshares Capital Trust I 10 1 11 9.000 2028
- --------------------------------------------------------------------------------------------------------------------------
Total $1,250 $ 40 $ 1,132 6.715 % --
====== ====== ========
- --------------------------------------------------------------------------------------------------------------------------
December 31, 2002 $1,260 $ 40 $ 1,136 6.779 % --
====== ====== ========
- --------------------------------------------------------------------------------------------------------------------------
March 31, 2002 $1,273 $ 39 $ 1,271 6.680 % --
====== ====== ========
- --------------------------------------------------------------------------------------------------------------------------
(a) The capital securities must be redeemed when the related debentures mature,
or earlier if provided in the governing indenture. Each issue of capital
securities carries an interest rate identical to that of the related
debenture. The capital securities constitute minority interests in the
equity accounts of KeyCorp's consolidated subsidiaries and, therefore,
qualify as Tier 1 capital under Federal Reserve Board guidelines. Included
in certain capital securities at March 31, 2003, December 31, 2002 and
March 31,2002, are basis adjustments of $158 million, $164 million and $41
million, respectively, related to fair value hedges. See Note 20
("Derivatives and Hedging Activities"), which begins on page 84 of Key's
2002 Annual Report to Shareholders, for an explanation of fair value
hedges.
(b) KeyCorp has the right to redeem its debentures: (i) in whole or in part, on
or after December 1, 2006 (for debentures owned by Capital A), December 15,
2006 (for debentures owned by Capital B), July 1, 2008 (for debentures
owned by Capital I), March 18, 1999 (for debentures owned by Capital II),
July 16, 1999 (for debentures owned by Capital III), and December 17, 2003
(for debentures owned by Union Bankshares Capital Trust I); and (ii) in
whole at any time within 90 days after and during the continuation of a
"tax event" or a "capital treatment event" (as defined in the applicable
offering circular). If the debentures purchased by Capital A or Capital B
are redeemed before they mature, the redemption price will be the principal
amount, plus a premium, plus any accrued but unpaid interest. If the
debentures purchased by Capital I or Union Bankshares Capital Trust I are
redeemed before they mature, the redemption price will be the principal
amount, plus any accrued but unpaid interest. If the debentures purchased
by Capital II or Capital III are redeemed before they mature, the
redemption price will be the greater of: (a) the principal amount, plus any
accrued but unpaid interest or (b) the sum of the present values of
principal and interest payments discounted at the Treasury Rate (as defined
in the applicable offering circular), plus 20 basis points (25 basis points
for Capital III), plus any accrued but unpaid interest. When debentures are
redeemed in response to tax or capital treatment events, the redemption
price generally is slightly more favorable to Key.
(c) The interest rates for Capital A, Capital B, Capital II, Capital III and
Union Bankshares Capital Trust I are fixed. Capital I has a floating
interest rate equal to three-month LIBOR plus 74 basis points; it reprices
quarterly. The rates shown as the total at March 31, 2003, December 31,
2002 and March 31, 2002, are weighted average rates.
During the first three months of 2003, the subsidiary business trusts
repurchased an aggregate of $5 million of their outstanding capital securities
and KeyCorp repurchased a like amount of the related debentures. Management
intends to replace the capital securities at some future date with capital
securities that will yield a lower cost.
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10. CONTINGENT LIABILITIES AND GUARANTEES
LEGAL PROCEEDINGS
RESIDUAL VALUE INSURANCE LITIGATION. Key Bank USA, National Association ("Key
Bank USA") obtained two insurance policies from Reliance Insurance Company
("Reliance") insuring the residual value of certain automobiles leased through
Key Bank USA. The two policies ("the Policies"), the "4011 Policy" and the "4019
Policy," together covered leases entered into during the period from January 1,
1997 to January 1, 2001.
The 4019 Policy contains an endorsement stating that Swiss Reinsurance America
Corporation ("Swiss Re") will assume and reinsure 100% of Reliance's obligations
under the 4019 Policy in the event Reliance Group Holdings' ("Reliance's
parent") so-called "claims-paying ability" were to fall below investment grade.
Key Bank USA also entered into an agreement with Swiss Re and Reliance whereby
Swiss Re agreed to issue to Key Bank USA an insurance policy on the same terms
and conditions as the 4011 Policy in the event the financial condition of
Reliance Group Holdings fell below a certain level. Around May 2000, the
conditions under both the 4019 Policy and the Swiss Re agreement were triggered.
The 4011 Policy was canceled and replaced as of May 1, 2000, by a policy issued
by North American Specialty Insurance Company (a subsidiary or affiliate of
Swiss Re) ("the NAS Policy"). Tri-Arc Financial Services, Inc. ("Tri-Arc") acted
as agent for Reliance, Swiss Re and NAS. Since February 2000, Key Bank USA has
been filing claims under the Policies, but none of these claims has been paid.
In July 2000, Key Bank USA filed a claim for arbitration against Reliance, Swiss
Re, NAS and Tri-Arc seeking, among other things, a declaration of the scope of
coverage under the Policies and for damages. On January 8, 2001, Reliance filed
an action (litigation) against Key Bank USA in Federal District Court in Ohio
seeking rescission or reformation of the Policies because they allegedly do not
reflect the intent of the parties with respect to the scope of coverage and how
and when claims were to be paid. Key filed an answer and counterclaim against
Reliance, Swiss Re, NAS and Tri-Arc seeking, among other things, declaratory
relief as to the scope of coverage under the Policies, damages for breach of
contract and failure to act in good faith, and punitive damages. The parties
agreed to proceed with this court action and to dismiss the arbitration without
prejudice.
On May 29, 2001, the Commonwealth Court of Pennsylvania entered an order placing
Reliance in a court supervised "rehabilitation" and purporting to stay all
litigation against Reliance. On July 23, 2001, the Federal District Court in
Ohio stayed the litigation to allow the rehabilitator to complete her task. On
October 3, 2001, the Court in Pennsylvania entered an order placing Reliance
into liquidation and canceling all Reliance insurance policies as of November 2,
2001. On November 20, 2001, the Federal District Court in Ohio entered an order
that, among other things, required Reliance to report to the Court on the
progress of the liquidation. On January 15, 2002, Reliance filed a status report
requesting the continuance of the stay for an indefinite period. On February 20,
2002, Key Bank USA filed a Motion for Partial Lifting of the July 23, 2001, Stay
in which it asked the Court to allow the case to proceed against the parties
other than Reliance. The Court granted Key Bank USA's motion on May 17, 2002. As
of February 19, 2003, all claims against Tri-Arc were dismissed through a
combination of court action and voluntary dismissal by Key Bank USA.
Management believes that Key Bank USA has valid insurance coverage or claims for
damages relating to the residual value of automobiles leased through Key Bank
USA during the four-year period ending January 1, 2001. With respect to each
individual lease, however, it is not until the lease expires and the vehicle is
sold that Key Bank USA can determine the existence and amount of any actual loss
(i.e., the difference between the residual value provided for in the lease
agreement and the vehicle's actual market value at lease expiration). Key Bank
USA's actual total losses for which it will file claims will depend to a large
measure upon the viability of, and pricing within, the market for used cars
throughout the lease run-off period, which extends through 2006. The market for
used cars varies.
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Accordingly, the total expected loss on the portfolio for which Key Bank USA
will file claims cannot be determined with certainty at this time. Claims filed
by Key Bank USA through March 31, 2003, total approximately $296 million, and
management currently estimates that approximately $81 million of additional
claims may be filed through year-end 2006 bringing the total aggregate amount of
actual and potential claims to $377 million. As discussed previously, a number
of factors could affect Key Bank USA's actual loss experience, which may be
higher or lower than management's current estimates.
Key is filing insurance claims for the entire amount of its losses and is
recording as a receivable on its balance sheet a portion of the amount of the
insurance claims as and when they are filed. Management believes the amount
being recorded as a receivable due from the insurance carriers is appropriate to
reflect the collectibility risk associated with the insurance litigation;
however, litigation is inherently not without risk, and any actual recovery from
the litigation may be more or less than the receivable. While management does
not expect an adverse decision, if a court were to make an adverse final
determination, such result would cause Key to record a material one-time expense
during the period when such determination is made. An adverse determination
would not have a material effect on Key's financial condition, but could have a
material adverse effect on Key's results of operations in the quarter it occurs.
OTHER LITIGATION. In the ordinary course of business, Key is subject to legal
actions that involve claims for substantial monetary relief. Based on
information presently known to management, management does not believe there is
any legal action to which KeyCorp or any of its subsidiaries is a party, or
involving any of their properties, that, individually or in the aggregate, could
reasonably be expected to have a material adverse effect on Key's financial
condition or annual results of operations.
GUARANTEES
Key is a guarantor in various agreements with third parties. In accordance with
FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others,"
certain guarantees issued or modified on or after January 1, 2003, require the
recognition of a liability on Key's balance sheet for the "stand ready"
obligation associated with such guarantees. The accounting for guarantees
existing at December 31, 2002, was not revised. Thus, the stand ready obligation
related to the majority of Key's guarantees was not recorded on the balance
sheet at December 31, 2002. Additional information pertaining to Interpretation
No. 45 is summarized in Note 1 ("Basis of Presentation") under the heading
"Accounting Pronouncements Adopted in 2003" on page 9. The following table shows
the types of guarantees (as defined by Interpretation No. 45) that Key had
outstanding at March 31, 2003.
MAXIMUM POTENTIAL
UNDISCOUNTED LIABILITY
in millions FUTURE PAYMENTS RECORDED
- -------------------------------------------------------------------------------------------------------------
Financial Guarantees:
Standby letters of credit $4,671 $ 5
Credit enhancement for asset-backed commercial paper conduit 68 --
Recourse agreement with FNMA 273 4
Return guaranty agreement with LIHTC investors 834 33
Default guarantees 9 --
Written interest rate caps (a) 42 21
- -------------------------------------------------------------------------------------------------------------
Total $5,897 $ 63
====== ====
- -------------------------------------------------------------------------------------------------------------
(a) As of March 31, 2003, the weighted average interest rate of written
interest rate caps was 1.4%. Maximum potential undiscounted future payments
were calculated assuming a 10% interest rate.
STANDBY LETTERS OF CREDIT. These instruments obligate Key to pay a third-party
beneficiary when a customer fails to repay an outstanding loan or debt
instrument, or fails to perform some contractual nonfinancial obligation.
Standby letters of credit are issued by many of Key's lines of business to
address clients' financing needs. If amounts are drawn under standby letters of
credit, such amounts are treated as loans; they bear interest (generally at
variable rates) and pose the same credit risk to Key as a loan. At March 31,
2003, Key's standby letters of credit had a remaining weighted average life of
approximately 2 years, with remaining actual lives ranging from less than 1 year
to as many as 17 years.
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CREDIT ENHANCEMENT FOR ASSET-BACKED COMMERCIAL PAPER CONDUIT. Key provides
credit enhancement in the form of a committed facility to ensure the continuing
operations of an asset-backed commercial paper conduit, which is owned by a
third party and administered by an unaffiliated financial institution. The
commitment to provide credit enhancement extends until September 26, 2003, and
specifies that in the event of default by certain borrowers whose loans are held
by the conduit, Key will provide financial relief to the conduit in an amount
that is based on defined criteria that consider the level of credit risk
involved and other factors.
At March 31, 2003, Key's funding requirement under the credit enhancement
facility totaled $59 million. However, there were no drawdowns under the
facility during the three-month period ended March 31, 2003. Key has no recourse
or other collateral available to offset any amounts that may be funded under
this credit enhancement facility. Key's commitments to provide increased credit
enhancement to the conduit are periodically evaluated by management.
RECOURSE AGREEMENT WITH FEDERAL NATIONAL MORTGAGE ASSOCIATION. KBNA participates
as a lender in the Federal National Mortgage Association ("FNMA") Delegated
Underwriting and Servicing ("DUS") program. As a condition to FNMA's delegation
of responsibility for originating, underwriting and servicing mortgages, KBNA
has agreed to assume a limited portion of the risk of loss during the remaining
term on each commercial mortgage loan sold. Accordingly, a reserve for such
potential losses has been established and is maintained in an amount estimated
by management to approximate the fair value of the liability undertaken by KBNA.
At March 31, 2003, the outstanding commercial mortgage loans in this program had
a weighted average remaining term of 10 years and the unpaid principal balance
outstanding of loans sold by KBNA as a participant in this program was
approximately $1.4 billion. The maximum potential amount of undiscounted future
payments that may be required under this program is equal to 20% of the
principal balance of loans outstanding at March 31, 2003. If payment is required
under this program, Key would have an interest in the collateral underlying the
commercial mortgage loan on which the loss occurred.
RETURN GUARANTEE AGREEMENT WITH LOW-INCOME HOUSING TAX CREDIT ("LIHTC")
INVESTORS. Key Affordable Housing Corporation ("KAHC"), a subsidiary of KBNA,
offers limited partnership interests to qualified investors. Unconsolidated
partnerships formed by KAHC invest in low-income residential rental properties
that qualify for federal LIHTCs under Section 42 of the Internal Revenue Code.
In certain partnerships, investors pay a fee to KAHC for a guaranteed return
that is dependent on the financial performance of the property and the
property's ability to maintain its LIHTC status throughout the fifteen-year
compliance period. If these two conditions are not achieved, Key is obligated to
make any necessary payments to investors to provide the guaranteed return. KAHC
has the ability to affect changes in the management of the properties to improve
performance. However, other than the underlying income stream from the
properties, no recourse or collateral would be available to offset the guarantee
obligation. These guarantees have expiration dates that extend through 2018. Key
meets its obligations pertaining to the guaranteed returns generally through the
distribution of tax credits and deductions associated with the specific
properties.
As shown in the preceding table, KAHC had established a reserve in the amount of
$33 million at March 31, 2003, which management believes will be sufficient to
cover estimated future obligations under the guarantees. In accordance with
Interpretation No. 45, for any return guarantee agreements entered into or
modified with LIHTC investors on or after January 1, 2003, the amount of all
fees received in consideration for the guarantee has been recognized as the fair
value stand ready obligation.
VARIOUS TYPES OF DEFAULT GUARANTEES. Some lines of business provide or
participate in guarantees that obligate Key to perform if the debtor fails to
pay all or a portion of the subject indebtedness and/or related interest. These
guarantees are generally undertaken when Key is supporting or protecting its
underlying investment or where the risk profile of the debtor should provide an
investment return. The terms of these default guarantees range from less than 1
year to as many as 19 years. Although no collateral is held, Key would have
recourse against the debtors for any payments made under these default
guarantees.
WRITTEN INTEREST RATE CAPS. In the ordinary course of business, Key writes
interest rate caps for commercial loan clients that have variable rate loans
with Key. These caps are purchased by clients to limit their
25
exposure to interest rate increases and at March 31, 2003, had a weighted
average life of approximately 8.0 years.
Key is obligated to pay the interest rate counterparty if the applicable
benchmark interest rate exceeds a specified level (known as the "strike rate").
These instruments are accounted for as derivatives with the fair value liability
recorded in "other liabilities" on the balance sheet. Key's potential amount of
future payments under these obligations is mitigated by the fact that the
company enters into offsetting positions with third parties.
OTHER OFF-BALANCE SHEET RISK
Other off-balance sheet risk stems from financial instruments that do not meet
the definition of a guarantee as specified in Interpretation No. 45 and from
other relationships.
LIQUIDITY FACILITIES THAT SUPPORT ASSET-BACKED COMMERCIAL PAPER CONDUITS. Key
provides liquidity to all or a portion of two separate asset-backed commercial
paper conduits that are owned by third parties and administered by unaffiliated
financial institutions. These liquidity facilities obligate Key through February
15, 2005, to provide funding if such is required as a result of a disruption in
the markets or other factors. Additional information about these asset-backed
commercial paper conduits is summarized in Note 1 ("Basis of Presentation"),
which begins on page 7 and in Note 7 ("Variable Interest Entities"), which
begins on page 19.
Key provides liquidity to the conduits in the form of committed facilities of
$1.7 billion. The amount available to be drawn on these facilities was $700
million at March 31, 2003. However, there were no drawdowns under either of the
committed facilities at that time. Of the $1.7 billion of liquidity facility
commitments, $107 million is associated with a conduit program that is in the
process of being liquidated. Therefore, Key's commitment will decrease as the
assets in this conduit program decrease. Key's commitments to provide liquidity
are periodically evaluated by management.
INDEMNIFICATIONS PROVIDED IN THE ORDINARY COURSE OF BUSINESS. Key provides
certain indemnifications primarily through represe