KEYCORP /NEW/ - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

Form 10-Q

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

For the Quarterly Period Ended March 31, 2005

o 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 þ No o

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

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		407,669,825 Shares
(Title of class)		(Outstanding at April 29, 2005)

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets


	March 31,			December 31,			March 31,
dollars in millions	2005			2004			2004
	(Unaudited)						(Unaudited)
ASSETS
Cash and due from banks	$	2,991		$	2,454		$	2,113
Short-term investments		1,763			1,472			2,042
Securities available for sale		7,123			7,451			7,463
Investment securities (fair value: $70, $74 and $99)		68			71			94
Other investments		1,434			1,421			1,157
Loans, net of unearned income of $2,181, $2,235 and $2,052		68,332			68,464			62,513
Less: Allowance for loan losses		1,128			1,138			1,306

Net loans		67,204			67,326			61,207
Premises and equipment		587			603			604
Goodwill		1,341			1,359			1,150
Other intangible assets		105			87			34
Corporate-owned life insurance		2,623			2,608			2,528
Accrued income and other assets		5,024			5,887			6,056

Total assets	$	90,263		$	90,739		$	84,448


LIABILITIES
Deposits in domestic offices:
NOW and money market deposit accounts	$	22,692		$	21,748		$	19,120
Savings deposits		2,011			1,970			2,067
Certificates of deposit ($100,000 or more)		4,809			4,697			4,850
Other time deposits		10,750			10,435			10,834

Total interest-bearing		40,262			38,850			36,871
Noninterest-bearing		11,891			11,581			10,826
Deposits in foreign office — interest-bearing		4,974			7,411			2,234

Total deposits		57,127			57,842			49,931
Federal funds purchased and securities sold under repurchase agreements		3,220			2,145			3,584
Bank notes and other short-term borrowings		2,820			2,515			2,588
Accrued expense and other liabilities		5,834			6,274			6,013
Long-term debt		14,100			14,846			15,333

Total liabilities		83,101			83,622			77,449

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		1,481			1,491			1,459
Retained earnings		7,416			7,284			6,960
Treasury stock, at cost (84,591,725, 84,319,111 and 79,735,678 shares)		(2,156	)		(2,128	)		(1,966	)
Accumulated other comprehensive income (loss)		(71	)		(22	)		54

Total shareholders’ equity		7,162			7,117			6,999

Total liabilities and shareholders’ equity	$	90,263		$	90,739		$	84,448

See Notes to Consolidated Financial Statements (Unaudited).

Consolidated Statements of Income (Unaudited)


	Three months ended March 31,
dollars in millions, except per share amounts	2005			2004

INTEREST INCOME
Loans	$	974		$	833
Investment securities		1			1
Securities available for sale		80			88
Short-term investments		10			9
Other investments		8			8

Total interest income		1,073			939

INTEREST EXPENSE
Deposits		206			161
Federal funds purchased and securities sold under repurchase agreements		25			10
Bank notes and other short-term borrowings		17			12
Long-term debt		131			95

Total interest expense		379			278


NET INTEREST INCOME		694			661
Provision for loan losses		44			81

Net interest income after provision for loan losses		650			580

NONINTEREST INCOME
Trust and investment services income		138			145
Service charges on deposit accounts		70			84
Investment banking and capital markets income		67			46
Letter of credit and loan fees		40			33
Corporate-owned life insurance income		28			27
Electronic banking fees		22			18
Net gains from loan securitizations and sales		19			25
Net securities losses		(6	)		—
Other income		76			53

Total noninterest income		454			431

NONINTEREST EXPENSE
Personnel		390			373
Net occupancy		91			58
Computer processing		51			44
Equipment		28			31
Professional fees		28			25
Marketing		25			23
Other expense		118			105

Total noninterest expense		731			659

INCOME BEFORE INCOME TAXES		373			352
Income taxes		109			102


NET INCOME	$	264		$	250


Per common share:
Net income	$	.65		$	.60
Net income — assuming dilution		.64			.59
Weighted-average common shares outstanding (000)		408,264			416,680
Weighted-average common shares and potential common shares outstanding (000)		413,762			421,572

See Notes to Consolidated Financial Statements (Unaudited).

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)


															Accumulated
												Treasury			Other
	Common Shares			Common		Capital			Retained			Stock,			Comprehensive			Comprehensive
dollars in millions, except per share amounts	Outstanding (000)			Shares		Surplus			Earnings			at Cost			Income (Loss)			Income

BALANCE AT DECEMBER 31, 2003		416,494		$	492	$	1,448		$	6,838		$	(1,801	)	$	(8	)
Net income										250								$	250
Other comprehensive income (losses):
Net unrealized gains on securities available for sale, net of income taxes of $35^a																61			61
Net unrealized gains on derivative financial instruments, net of income taxes of $1																2			2
Foreign currency translation adjustments																(1	)		(1	)

Total comprehensive income																		$	312

Deferred compensation							3
Cash dividends declared on common shares ($.31 per share)										(128	)
Issuance of common shares under employee benefit and dividend reinvestment plans		3,659					8						88
Repurchase of common shares		(8,000	)										(253	)


BALANCE AT MARCH 31, 2004		412,153		$	492	$	1,459		$	6,960		$	(1,966	)	$	54



BALANCE AT DECEMBER 31, 2004		407,570		$	492	$	1,491		$	7,284		$	(2,128	)	$	(22	)
Net income										264								$	264
Other comprehensive income (losses):
Net unrealized losses on securities available for sale, net of income taxes of ($27)^a																(46	)		(46	)
Net unrealized gains on derivative financial instruments, net of income taxes of $1																3			3
Foreign currency translation adjustments																(5	)		(5	)
Minimum pension liability adjustment, net of income taxes of ($1)																(1	)		(1	)

Total comprehensive income																		$	215

Deferred compensation							9
Cash dividends declared on common shares ($.325 per share)										(132	)
Issuance of common shares under employee benefit and dividend reinvestment plans		2,227					(19	)					56
Repurchase of common shares		(2,500	)										(84	)


BALANCE AT MARCH 31, 2005		407,297		$	492	$	1,481		$	7,416		$	(2,156	)	$	(71	)

(a) Net of reclassification adjustments.

See Notes to Consolidated Financial Statements (Unaudited)

Consolidated Statements of Cash Flow (Unaudited)


	Three months ended March 31,
in millions	2005			2004

OPERATING ACTIVITIES
Net income	$	264		$	250
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		44			81
Depreciation expense and software amortization		48			51
Net securities losses		6			—
Net gains from principal investing		(12	)		(10	)
Net gains from loan securitizations and sales		(19	)		(25	)
Deferred income taxes		3			2
Net (increase) decrease in mortgage loans held for sale		39			(125	)
Net increase in trading account assets		(94	)		(151	)
Other operating activities, net		(100	)		(40	)

NET CASH PROVIDED BY OPERATING ACTIVITIES		179			33
INVESTING ACTIVITIES
Cash used in acquisitions, net of cash acquired		(5	)		—
Net increase in other short-term investments		(197	)		(287	)
Purchases of securities available for sale		(597	)		(195	)
Proceeds from sales of securities available for sale		29			15
Proceeds from prepayments and maturities of securities available for sale		808			452
Proceeds from prepayments and maturities of investment securities		4			4
Purchases of other investments		(104	)		(117	)
Proceeds from sales of other investments		61			20
Proceeds from prepayments and maturities of other investments		29			32
Net increase in loans, excluding acquisitions, sales and divestitures		(1,234	)		(966	)
Purchases of loans		—			(33	)
Proceeds from loan securitizations and sales		1,268			1,194
Purchases of premises and equipment		(12	)		(27	)
Proceeds from sales of premises and equipment		6			4
Proceeds from sales of other real estate owned		15			15

NET CASH PROVIDED BY INVESTING ACTIVITIES		71			111
FINANCING ACTIVITIES
Net decrease in deposits		(703	)		(931	)
Net increase in short-term borrowings		1,380			558
Net proceeds from issuance of long-term debt		1,227			654
Payments on long-term debt		(1,441	)		(710	)
Purchases of treasury shares		(84	)		(253	)
Net proceeds from issuance of common stock		40			67
Cash dividends paid		(132	)		(128	)

NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES		287			(743	)

NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS		537			(599	)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD		2,454			2,712

CASH AND DUE FROM BANKS AT END OF PERIOD	$	2,991		$	2,113



Additional disclosures relative to cash flow:
Interest paid	$	389		$	295
Income taxes paid		10			23
Noncash items:
Net transfer of loans to other real estate owned	$	20		$	31

See Notes to Consolidated Financial Statements (Unaudited).

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.

Key consolidates any voting rights entity in which it has a controlling financial interest. In accordance with Financial Accounting Standards Board (“FASB”) Revised Interpretation No. 46, a variable interest entity (“VIE”) is consolidated if Key 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 contracts, agreements and financial instruments.

Key uses the equity method to account for unconsolidated investments in voting rights entities or VIEs in which it 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). 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.

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. Information on SFAS No. 140 is included in Note 1 (“Summary of Significant Accounting Policies”) of Key’s 2004 Annual Report to Shareholders under the heading “Loan Securitizations” on page 57.

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 2004 Annual Report to Shareholders.

Stock-Based Compensation

Effective January 1, 2003, Key adopted the fair value method of accounting as outlined in SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure,” amended SFAS No. 123 to provide three alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock compensation: (i) the prospective method; (ii) the modified prospective method; and (iii) the retroactive restatement method. Key opted to apply the new accounting rules prospectively to all awards in accordance with the transition provisions of SFAS No. 148.

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 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 three-month periods ended March 31, 2005 and 2004, was $6.95 and $6.51, respectively.

The Black-Scholes model requires several assumptions, which management developed and updates based on historical trends and current market observations. The accuracy of these assumptions is critical to management’s ability to accurately estimate the fair value of options. The assumptions pertaining to options issued during the three-month periods ended March 31, 2005 and 2004, are shown in the following table.


	Three months ended March 31,
	2005			2004

Average option life	6.0 years			6.0 years
Future dividend yield		4.01	%		3.97	%
Share price volatility		.286			.292
Weighted-average risk-free interest rate		4.0	%		3.3	%

The model assumes that the estimated fair value of an option is amortized as compensation expense over the option’s vesting period. The pro forma effect of applying the fair value method of accounting to all forms of stock-based compensation (primarily stock options, restricted stock, performance shares, discounted stock purchase plans and certain deferred compensation-related awards) for the three-month periods ended March 31, 2005 and 2004, is shown in the following table and would, if recorded, have been included in “personnel expense” on the income statement.


	Three months ended March 31,
in millions, except per share amounts	2005		2004

Net income, as reported	$	264	$	250
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects:
Stock options expense		3		3
All other stock-based employee compensation expense		4		2


	Page Number
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets ¾ March 31, 2005, December 31, 2004 and March 31, 2004		3

Consolidated Statements of Income ¾ Three months ended March 31, 2005 and 2004		4

Consolidated Statements of Changes in Shareholders’ Equity ¾ Three months ended March 31, 2005 and 2004		5

Consolidated Statements of Cash Flow ¾ Three months ended March 31, 2005 and 2004		6

Notes to Consolidated Financial Statements		7

Report of Independent Registered Public Accounting Firm		30

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		31

Item 3. Quantitative and Qualitative Disclosure about Market Risk		68

Item 4. Controls and Procedures		68

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		68

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		68

Item 6. Exhibits		68

Signature		69

Exhibits		70
EX-15 Acknowledgement of Indep Reg Public Acct Firm
EX-31.1 Certification
EX-31.2 Certification
EX-32.1 Certification
EX-32.2 Certification

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