UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 

Form 10-Q

[ü] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2004

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

(216) 689-6300

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 [ü]  No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ü]  No [  ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

KEYCORP

TABLE OF CONTENTS

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets

See Notes to Consolidated Financial Statements (Unaudited).

3

Consolidated Statements of Income (Unaudited)

See Notes to Consolidated Financial Statements (Unaudited).

4

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(a) Net of reclassification adjustments.

(b) For the three months ended September 30, 2004 and 2003, comprehensive income was $287 million and $165 million, respectively.

See Notes to Consolidated Financial Statements (Unaudited).

5

Consolidated Statements of Cash Flow (Unaudited)

See Notes to Consolidated Financial Statements (Unaudited).

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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.

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.

The Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” in January 2003. This accounting guidance significantly changed how companies determine whether they must consolidate an entity depending on whether the entity is a voting rights entity or a variable interest entity (“VIE”). Interpretation No. 46 was effective immediately for entities created after January 31, 2003. As permitted, Key elected to adopt Interpretation No. 46 effective July 1, 2003, for entities created before February 1, 2003. In December 2003, the FASB issued modifications to Interpretation No. 46 (Revised Interpretation No. 46) as described under the heading “Accounting Pronouncement Adopted in 2004” on page 9.

Key consolidates a voting rights entity if Key has a controlling financial interest in the entity. In accordance with Revised Interpretation No. 46, Key consolidates a VIE if it is exposed to the majority of the VIE’s expected losses and/or residual returns (i.e., Key is considered to be the primary beneficiary). Variable interests include equity interests, subordinated debt, derivative contracts, leases, service agreements, guarantees, standby letters of credit, loan commitments and other instruments.

Unconsolidated investments in voting rights entities or VIEs in which Key has significant influence over operating and financing decisions (usually defined as a voting or economic interest of 20% to 50%, but not a controlling interest) are accounted for using the equity method. Unconsolidated investments in voting rights entities or VIEs 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 (primarily principal investments) are carried at estimated fair value.

Prior to the adoption of Interpretation No. 46, KeyCorp generally determined whether consolidation of an entity was appropriate based on the nature and amount of equity contributed by third parties, the decision-making power granted to those parties and the extent of third-party control over the entity’s operating and financial policies. Entities controlled, generally through majority ownership, were consolidated and considered subsidiaries.

Qualifying special purpose entities, including securitization trusts, established by Key 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. Additional information on SFAS No. 140 is included in Note 1 (“Summary of Significant Accounting Policies”) of Key’s 2003 Annual Report to Shareholders under the heading “Loan Securitizations” on page 52.

Management believes that the unaudited condensed consolidated interim financial statements reflect all adjustments of a normal recurring nature and disclosures that 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 2003 Annual Report to Shareholders.

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Stock-Based Compensation

Through December 31, 2002, Key accounted for stock options issued to employees using the intrinsic value method outlined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” This method requires that compensation expense be recognized to the extent that the fair value of the stock exceeds the exercise price of the option at the grant date. Key’s employee stock options generally have fixed terms and exercise prices that are equal to or greater than the fair value of Key’s common shares at the grant date. As a result, Key generally had not recognized compensation expense related to stock options.

Effective January 1, 2003, Key adopted the fair value method of accounting as outlined in SFAS No. 123, “Accounting for Stock-Based Compensation.” Management applied this change prospectively to all awards in accordance with the transition provisions of SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure.”

SFAS No. 123 requires companies like Key that have used the intrinsic value method of accounting for employee stock options to provide pro forma disclosures of the net income and earnings per share effect of accounting for 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 employee stock option, but it is commonly used for this purpose. The estimated weighted-average fair value of options granted by Key during the nine-month periods ended September 30, 2004 and 2003, was $5.63 and $4.24, respectively.

The Black-Scholes model requires several assumptions, which management developed and updates based on historical trends and current market observations. The level of accuracy achieved in deriving the estimated fair value of options is directly related to the accuracy of the underlying assumptions. The assumptions pertaining to options issued during the three- and nine-month periods ended September&