KeyCorp (KEY) 2002 Q1 法說會逐字稿

Good morning, and welcome to KeyCorp's First Quarter Earnings Results Conference Call.

This call is being recorded.

At this time, I would like to turn the call over to the Chief Financial Officer, Mr. Brett Somers.

Mr. Somers, please go ahead, sir.

Thank you, Jennifer.

Good morning to all of you.

On behalf of KeyCorp, I'd like to welcome you to today's conference call.

We're also making this call available through a live web cast at key.com.

This call and the slides will be archived on our Investor Relations website from 3 p.m.

Eastern time today until 5 p.m. on April 26th.

Telephone playback is available at (402) 398-4261.

On Slide 2, you'll find our traditional Forward-looking Disclosure Statement.

We'll file copies of our slides and press release with the FCC on Form 8K today.

And, in keeping with regulation FD Guidelines, we'll limit our forward-looking statements to those matters covered in our formal presentation.

If you'll now turn to Slide 3, you'll see the outline for today's call.

Participating in our call today will be our Chairman and CEO, Henry Meyer; our Chief Accounting Officer, Lee Irving; and Kevin Blakely, who heads up Risk Management and Credit Quality.

Following our remarks, there will be an opportunity for you to ask questions.

Before I turn the call over to Henry, I'd just like to comment on some of our efforts to improve and expand our financial disclosure.

I'm sure you've noticed that in this morning's press release, we've expanded our line of business disclosure.

This was actually a process that started in 2001, when we started disclosing the results for each of our major lines of business.

And, with today's release, we are expanding what we did in 2001 by giving you summary financial information for each of our 10 primary lines of business, in addition to the three major business groups.

In our conference call, we'll also focus more on the line of business results.

We believe that the combination of this expanded information and the expanded disclosure that we provided in our annual report -- particularly around our home equity, commercial real estate, and equipment leasing activities -- should give you a clear look at our financial performance.

And now for some opening comments, let me turn the call over to Henry.

Thank you, Brent, and good morning to everyone.

Before I discuss some of our strategic initiatives, I want to just make a few comments on our first quarter results.

Overall, it was a very solid quarter for Key, with earnings of 56 cents per share, 1 cent above the consensus estimate.

I was certainly pleased with the strength in our net interest margin and our continued success in managing expenses.

Our first quarter results were achieved in a weak economic environment that is expected to show only modest improvement this year.

Our challenges, along with many of our peers, continued to be revenue growth, especially in our market-sensitive businesses, which will return when the economy picks up, and turning the corner on credit costs.

It's worth noting that Key's revenue trends have been impacted by softer loan growth in our core business and, to a larger degree, by our initiative to exit certain loan spread - thin spread portfolios in our commercial and auto businesses.

Overall, I am pleased with the progress we've made, and the first quarter results are certainly another step in the right direction.

But there is still more that needs to be done.

But I venture to say that Key has never been better positioned in terms of our balance sheet and our strategic focus to created shareholder value, as this current economic environment perks up.

Why is that?

Please turn to Slide 4.

We talk about enhancing accountability, and nowhere is this more evident than with our PEG Initiative.

In September of 2000, we announced our plans to improve our cost structure and reinvestment a portion of that saving in higher return businesses.

Our financial commitment to our shareholders was to realized expense saves of 200 million.

At this point, Key can declared PEG an absolute success.

As Lee will discuss in his presentation, the actual annual savings will be above 250 million.

PEG has also made a significant, and I'm convinced permanent, difference in our expense culture and the way we manage our business.

And while this financial environment has been difficult, PEG did address revenue.

And while many of those revenue ideas were implemented later in the process, we are - and we will continue to see - PEG revenue push the - push our numbers better as the economy rebounds.

The second point is an update on our efforts to exit some of our less attractive portfolios and refocus on our core business relationships.

Since we launched our strategy last May, we have shrunk the auto and commercial runoff portfolios by over $2 billion.

This process will continue well into next year, because it's not something that can be done in one week or one month.

But, obviously, the amount of runoff each quarter will decline as the portfolios get smaller.

For the sake of time, let me skip over the dividend point, as I think most of you are aware of Key's attractive dividend yield and consistent track record; albeit, I wouldn't have had that point in there if I didn't think it was an important issue in terms of the attractiveness of shares of KeyCorp.

The final two points really focus on the changes taking place at Key, and how we plan to improve our competitive position.

As many of you are aware, we've made some recent management changes with the addition of

to head up our Corporate Finance business, and

moving from McDonald over to head up our Corporate Middle Market business reporting to Tom.

Tom and Chris have been charged with integrating our corporate and investment banking businesses with aggressive goals in terms of revenue and deposit growth.

Consistent with this general topic, Brent and I announced this morning Brent's plan to retire from Key after the selection of his successor.

Brent has played an important role as part of our Senior Management Team to put in place many of the initiatives that have positioned us well for the future.

With these initiatives in place, Brent felt the time was right to pursuer his longer-term goals, which always have included activities beyond the corporate environment.

I am particularly pleased that Brent has agreed to continue in his position until we find his successor.

It's another example of the support he has demonstrated during his more than six years with us.

Brent has had a desire to retire early and pursue longer-term goals.

With our performance improvement initiatives now in place -- initiatives Brent was instrumental in developing, leading, and implementing - we agreed that this was a good time to make the transition.

We hired a recruiting firm to pursuer the best qualified and most diverse talent available.

We expect that search to take as long as six months, though we hope it will be quicker.

And, finally, I want to turn to some thoughts on enhanced clients' focus.

As successful as PEG has been, it's really just one of the cultural changes we're driving for.

And I can describe the focus of our effort in a simple phrase which we're using throughout the company - Put the Client First.

We do this by providing distinctive service, by deepening our relationships through extensive cross-sell, and by working together, which embraces our key value of teamwork and our one team philosophy.

We've undertaken two corporate initiatives in our design to reinforce this client-first bias.

These activities include enhancing service quality and expanding the use of continuous improvement tools.

The expanded use of continuous improvement tools is really

from the cultural change that PEG put in place to a continuing effort to make sure that that process stays with us, and that the culture continues to expand.

These are the activities that are going to define our culture, along with the cross-selling work we've already begun.

We'll be discussing these initiatives in greater detail with you in the future.

But I thought it was important to share my thoughts on how they'll continue the positive momentum from PEG and drive toward our revenue and deposit goals.

Now let me turn the call over to Lee Irving for some more detail on the quarter.

Lee?

Thanks, Henry.

We'll now go to Slide 5 to recap the financial highlights the first quarter.

Our 56 cents per share was a penny higher than the average of analysts' estimates.

And since the range of those estimates was 54 cents to 56 cents, it would appear that we've met or exceeded all of their individual expectations.

Like Henry said, from our perspective, it was, as you see here -- solid and clean, with no surprises, particularly no negative surprises.

If there was one aspect of our performance that truly stood out, in our opinion, it would have to be our overhead expense numbers.

With 661 million in non-interest expense, that was better than any quarter last year, even if you deduct goodwill amortization from each quarter last year.

It's $37 million less than first quarter 2001, or $17 million less, if you allow for the absence of 20 million of goodwill amortization from this year's first quarter.

I look back to see how long it's been since we had a quarter's non-interest expense as low as this most recent quarter, and I can find only one quarter since 1998 with a better showing, even allowing for the exclusion of goodwill amortization from all those quarters.

Now, let's go to Slide 6 to start examining the quarter in more detail.

Slide 6 shows net interest income and its two primary drivers - the net interest margin and average-earning assets for each of the last five quarters.

Net interest income was 702 million, which was $7 million higher than first quarter of a year ago on an earning asset base that was smaller by almost $5 billion, or 6 percent from that of First Quarter 2001.

At the bottom of the slide, you see our average earning assets, which fell for the fourth consecutive quarter from their peak, which occurred in First Quarter 2001.

Showing growth in average earning assets has been more difficult, not only because of economic conditions, but because of our deliberate strategy of shrinkage, or exiting, of certain portfolios.

During the quarter, our Auto Lease Portfolio averaged $1.9 billion dollars, more than $350 million less than in Fourth Quarter 2001.

Similarly, our Runoff Portfolio of Commercial Loans declined by an average of approximately 120 million.

The decline in our Prime Auto Portfolio, which we've also been downsizing, was approximately $100 million on average.

Altogether, that's about $570 million of deliberate shrinkage this quarter, well over 75% of the total reduction in average-earning assets.

These portfolios combined have been downsized by 2.1 billion since the second quarter of last year.

And a reasonable estimate is that, had we simply originated enough of these kinds of loans to keep the portfolios flat, our net interest income in the first quarter would have been about $8 million higher than the 702 million we showed.

But the net interest margin would have been squeezed by keeping these low-spread assets on the balance sheet.

So it's been a net interest income quality-for-quantity tradeoff and a better utilization of capital, among other good reasons to exit these businesses.

All that aside, the good news is that average earning assets may have bottomed out in January.

They rose on both February and March.

And, at March 31, they were 72.4 billion.

Home equity loans have shown more growth than any other earning asset, growing by over $800 million in the first quarter.

You can see from the net interest margin line on this slide, that the margin fell to 3.93% from the fourth quarter; this was as expected.

There is seasonality in our business and in our margin.

And every year, we can count on two things benefiting the fourth quarter margin, which don't repeat in the first quarter: one is a later surge every December in equipment leasing originations, as clients try to book deals for tax purposes just prior to year end; another is an upsurge in demand deposits.

In our Fourth Quarter Conference Call, we gave you a slide showing these seasonal factors as a reason for four basis points of the change in the margin from the third quarter's 385 to the fourth quarter's 398.

So let's now go to Slide 7 and see how that fourth quarter seasonality played out in the first quarter.

And here you can see that the components of the decrease in the margin from 398 to 393.

The reversal or end of the fourth quarter seasonality in leasing and DDA is responsible for three of the five basis point decrease.

Everything else netted to just two basis points.

Looking forward, I'd expect relative stability in our net interest margin with some downward pressure, but nothing precipitous.

And that comment pertains to the next couple of quarters, at the least.

Rest assured, our Treasury Group is constantly positioning and stress testing to both enhance and protect Key's net interest income and margin.

Now before I leave the topic of net interest margin, let me address the matter of our interest rate sensitivity.

You may have noted that our first quarter margin of 393 is 30 basis points higher than it was a year ago.

About half of this is attributable to a changed mix in both assets and liabilities and their related spreads.

About one quarter of it is due to simply managing, timing, and pricing well in a declining rate environment.

And understand that the margin increase, as sizable as it was, was accomplished with only a modest, prudent change in our interest rate sensitivity.

We gauge our sensitivity to rising rates by calculating what percentage of our net interest income is at risk with 200 basis point rise in rates over the ensuing 12 months.

As of March 31 a year ago, that percentage was a half of 1%; and at our last ALCO meeting, it was reported at 1%.

Our interest rate sensitivity has been managed in a very narrow band, as it has been for several years.

Now one of the other reasons for our net interest margin 30 basis point improvement from that of a year ago is a factor I first mentioned last quarter.

We became alert to the fact that portions of our equipment leasing portfolio have been, and always will be, subject to a lower tax rate than we had been using in our tax accrual.

This represents a permanently increased after-tax yield on that portfolio and results in a widening of our tax equivalent adjustment and, at the bottom of the income statement, improvement in our effective tax rate.

I said three months ago that there was some cumulative catch-up effect of recording this in the fourth quarter, and there was also some in the first quarter of this year.

But also, as I said three months ago, this will provide continual benefits in the future and is not non-recurrent.

Let's go to Slide 8.

And on Slide 8, we detail the major reasons for the change from fourth quarter to first quarter in our non-interest income, which is a net increase of $25 million.

Now, to analyze this properly, you need to remember that we took two charges in the fourth quarter, totaling $60 million, which went against non-interest income.

We were also the recipients of $10 million of stock in an insurance company which demutualized.

You'll also see this $10 million item on the Non-interest Expense Slide, which is next, since we donated that stock to the Key Charitable Foundation in the fourth quarter.

And, after factoring in these items, the real First Quarter 2002 changes in non-interest income were declines in investment banking fees and letter of credit and loan fees.

They both decreased by 10 million in the first quarter.

Both of them tend to be seasonally lower from fourth quarter to first quarter.

If there's a bit of good news on the non-interest income front, it's that March was a good month in investment banking and was also a month when brokerage fees finally showed some light.

One month doesn't make a trend, or even a quarter, but there's some small room for optimism here.

Now let's go to Slide 9.

Slide 9 shows the quarter-to-quarter change in non-interest expense.

And on this slide, you see the fourth quarter contribution expense from donating the $10 million of stock we received in the previously referred to demutualization.

Also factoring into the decline was the absence of amortization of goodwill pursuant to the related newly effective accounting standard.

Beyond that, our computer processing expense was $11 million less in the first quarter than the fourth quarter.

Part of that is reflective of the benefits of having an improved discipline around software capitalization, which went into effect about three years ago; and today it's paying off in a reduced burden of software amortization expense.

And, finally, it's worth noting here that when you aggregate every other category of non-interest expense, the net change from the fourth quarter was 0.

And that's somewhat remarkable, in that, generally, the first quarter features expense increases from new rent schedules going into effect, fresh start for FICA expense for all employees, and the like.

And I'll suggest this is just one more bit of evidence that the PEG Initiative has really improved the cost discipline at Key.

And speaking of PEG, let's now go the Slide 10 to give you our final PEG scorecard.

We've told you many times in the past that we'd complete PEG implementation by March 31, 2002.

And Henry's already told you today that, in fact, we did.

We also told you many times in the past that our cost savings goal for PEG was a net $200 million.

This chart, which we first showed you last quarter, gives you a frame of reference to see if we've done that, and we think it provides evidence that we indeed have.

We've updated the chart to show the change in the consumer price index since the last presentation.

And what this chart now shows is that, if the pre-PEG 1999 base of non-interest expense simply grew at the relatively low rate of inflation since then, our expense growth would have beaten inflation by $180 million by the end of 2001.

And if inflation keeps going in 2002, at the early part of the year rate of 21/2%, and we hit our target expenses for 2002, we'll be $250 million ahead of inflation's effects by the end of this year.

What I'm trying to show you with the small line-shaded section of the 2002 bar is the portion of our $2,770,000 target that has been used by our first quarter non-interest expense total of 661 million.

Now, to put this in perspective, we could average $703 million of non-interest expense per quarter for the last three quarters of 2002, and we'd still be able to hit our 2002 full-year target.

That would then make four years in a row of flat, non-interest expense; and inflation alone would have pushed it $250 million higher during that time.

We think we've made the point about PEG sufficiently to retire this slide after this quarter.

Let's move on to Slide 11 and take a look at some line of business results.

On Slide 11, we've given you a year-over-year comparison of total revenue and net income for our consumer banking lines of business.

We've chose year-over-year comparisons because of the seasonality in our company from fourth quarter to first quarter, some of which I've already discussed.

In the aggregate in consumer banking, not much has changed for either total revenue or net income since first quarter 2001.

You have to see the details to discern much in the way of changes within this group, and we gave you those details in today's Earnings Press Release.

We hope that the greatly expanded line of business data in the press release is useful to all in your analysis of Key.

As regards revenues, there was a net change of only $3 million, as small business and national home equity revenues rose nicely during the last 12 months, while retail banking fell and indirect lending feel a lot - 14.2%, to be precise.

The reason indirect lending fell a lot is due to our ceasing auto leasing originations and downsizing prime auto lending.

The reason national home equity revenues rose so much is because of the fact that we ceased securitizing and selling home equity originations and started putting them on the balance sheet.

These assets are terrific replacement assets for our sold credit card portfolio.

And nobody liked the gains we had on securitizations, anyway.

The cessation of securitizations is also the reason for the apparent disconnect between the rise in national home equity revenues and the nearly nonexistent net income for that line of business.

And what's happening here is that we took a home equity business with a mature company infrastructure that used to securitize for gains and essentially started its earning asset book from scratch, when we started keeping the loans for our own balance sheet.

We believe that the net income contribution for national home equity is now ready to start growing much more consistent with its revenue growth.

Stay tuned.

One more thing about national home equity - I encourage you all to look at Page 41 of our Annual Report 10K, and see what makes up home equity within Key.

For those who have the impression that home equity at Key is simply Champion Mortgage, and that Champion Mortgage is simply a sub-prime lender and, therefore, all of Key's Home Equity Portfolio is suspect, think again.

Our annual lays out clearly the fact that 58% of our home equity loans are originated in our bank branches and are carried in a retail banking line of business.

The rest of our home equity lending, including Champion, has a risk profile that shows a 77% average loan-to-value ratio and 83% first lien positions.

Now let's go to Slide 12.

And on Slide 12, we show in the year-to-year figures for Key Corporate Finance.

Total revenues grew by 26 million year-to-year, while net income grew by 24 million.

And here I'll focus the story on national equipment leasing, where growth is evident in these bar charts.

One of the factors at work here is the improved after-tax yields I referred to in my discussion of the net interest margin earlier.

That, and the absence of goodwill amortization, goes a long way toward explaining how net income for the business group could rise by nearly as much as its total revenues.

However, equipment leasing is a business that's been a standout success for Key for a long time.

Again, I'll refer you to our Annual Report in 10K, this time to Page 40.

And there you'll see a recap of our equipment leasing business since the year prior to our 1997 acquisition of

, which really stepped up our presence in the business.

We're seeing compound growth in receivables of 22% per year since 1996.

And it remains a fact that we've never experienced a single year in which we've had net residual loss experience.

Another thing for me to point out here is that, like home equity origination, not all leasing

are booked in the national equipment finance line of business.

About 25% of them are booked in corporate banking whenever a corporate bank customer also has used Key for lease financing.

So national equipment finance is a bigger contributor to Key than it might appear based just on its own line of business presentation.

And now let's go to Slide 13 - Key Capital Partners.

This group's experienced a year-to-year decline of $20 million in revenues.

Anyone who's in the investment banking or brokerage business needs no explanation of how weak the capital markets business has been for over a year now.

The good news on this chart is that we showed a year-to-year increase in net income despite that revenue decline, owing largely to a significant reduction in non-interest expense.

Non-interest expense declined by $25 million year to date in this group, and only 6 million of it was due to the absence of goodwill amortization; the rest of it, I'd attribute to PEG's success and the rationalization of the infrastructure in light of weak business conditions.

And, with that, I'm done for now.

I'll turn it over to Kevin Blakely to give you the story on Key's credit quality.

Kevin?

Thanks, Lee.

On Slide 14, you'll find a breakdown of our loan charge-offs.

In the Core Portfolio, we incurred 136 million in losses, spread evenly between the commercial and consumer sides.

This figure was fairly consistent with the fourth quarter of 2001 and is probably in the vicinity of what you'll see in the second quarter of 2002.

These levels of charge-offs tracked fairly well with where we forecast them to be at the beginning of the year.

We utilized approximately 70 million of our non-replenishing reserve during the quarter to absorb losses arising from the runoff pool.

The largest single contributor to our loan losses this quarter stems from the Structured Finance Portfolio.

Structure consisted - constituted nearly 20% of the Corporation's first quarter charge-offs, despite its rather diminutive size.

We anticipate a similar performance by Structured in the second quarter.

However, I'm pleased to say at this juncture, we are beginning to see the light at the end of the Structured tunnel.

Turning to Slide 15, you'll see a variety of key asset quality indicators.

Focusing on the second column, you'll note that our non-performing loans total $973 million, an increase of 63 million, or 7%, from the end of the year.

This increase was in line with our internal fourth quarter forecast.

Non-performing loans now represent 1.52% of the total loan portfolio.

Moving down to the bottom of the page, you'll see that the loan loss reserve finished the quarter at 1.6 billion.

This represents 2.51% of the loan portfolio and provides coverage ratio of 165% of non-performing loans.

The last two columns on Slide 15 are intended to give you an insight on key statistics of our Core Portfolio.

Slide 16 shows an update on our non-replenishing reserves.

The first two rows show dollar trends of commitments and outstandings in the runoff pool that was established a year ago.

Looking into the far right column, you can see that we continue to make good progress in reducing the portfolio size.

Commitments are down to 1.5 billion, and outstandings total 941 million.

The non-replenishable reserve totals 205 million, reflecting the reduction of 70 million taken against the first quarter.

We believe the 205 million remaining in the non-replenishable reserve represents ample coverage of loss potential within the runoff pool.

Non-performing loans residing in the runoff pool declined to 208 million from their previous level of 231 million.

On the next several slides, you'll find more detail on our overall Non-performing Portfolio.

We're trying to make our non-performers more transparent for you.

And you'll note that, this quarter, we've provided a little more specific detail in that regard.

On Slide 17, we discussed the size of our non-performers.

As I previously mentioned, non-performers increase - non-performing loans increased approximately 63 million, or 7%, this quarter.

The largest single addition for the 23 million credit originating in the Large Corporate Portfolio.

Moving down the slide, you can see how the size of our non-performers drop off.

Our tenth largest is 13 million, and our twentieth largest is 9 million.

On Slide 18, we are providing, for the first time, a broader distribution of our entire Non-performing Loan Portfolio by line of business.

I apologize for the busyness of this slide, but there are some interesting things to note, and I couldn't bring them out without showing you all these numbers.

It should not be surprising that the middle market line of business contributes the largest dollar share of non-performing loans.

With total assets of 9.4 billion, it's one of our largest segments of our Loan Portfolio.

Despite the fact that the middle market line of business contains our manufacturing exposure, this relative contribution of problem assets is still quite manageable.

The areas that are truly noteworthy on this page are the two lines of business that have been highlighted.

You'll see that Healthcare and Structured Finance contribute 145 million and 132 million, respectively, to our non-performing book.

These figures represent nearly 30% of total non-performers, yet they arise from lines of business that represent slightly less than 5% of our Aggregate Loan Portfolio.

You can see from this chart that chief credit issues are substantially affected by portfolios that are finite in size.

The ratios in the far right hand column show a weighted relationship between the size of the Line of Business Loan Portfolio and the size of its non-performing loans.

You can clearly see that the drag on asset quality has occurred from Structured and Healthcare.

Again, these are portfolios that represent only 5% of Key's Total Loan Portfolio yet provided disproportional share of our problem assets.

With that, I'll now turn the meeting back over to Brent.

Thanks, Kevin.

If you'll turn to Slide 19, we'll share our views on the second quarter.

Our outlook for the second quarter assumes no significant improvement in the economy, with only slight growth in GDT this year.

We expect interest rates to remain fairly stable in the second quarter and begin drifting up in the second half of the year.

Using this economic forecast, we're expecting low single-digit revenue growth driven by slightly higher loan balances and a relatively stable net interest margin.

Our fee-based businesses should see some modest growth from the first quarter levels.

As Lee mentioned, expense management continues to be very important.

In the second quarter, we expect only a slight increase in expense levels, mainly due to annual merit/incentive increases that went into effect in early April.

Also, incentive levels are expected to rise modestly over time as we see some improvement in our market-sensitive business.

Consistent with general industry trends, we anticipate that credit quality will continue to deteriorate slightly.

Non-performing assets are expected to increase in this quarter in core net charge-offs in the continuing portfolio, which we provide for through the loan loss provision, will increase slightly.

As we look at the first-call estimates for the second quarter, the current EPS range 56 to 59 cents.

With the exception of the one estimate at the high end of the range, we would generally be comfortable with estimates for the second quarter.

The wild card remains credit costs which we believe, over the long run, represent significant positive upside for the company as the economy improves; but in the near term, it remains a challenge and a risk to any estimate we might provide.

In looking at the full year 2002, our current consens - the current consensus number is $2.37, which we think looks reasonable with an appropriate range of maybe a nickel or so on each side.

With those remarks, I'd like to turn the call back over to Jennifer, who can give us instructions for the Q&A portion of our call.

Thank you, sir.

A brief reminder - the question and answer session will be conducted electronically today.

Anyone wishing to ask a question may signal us by firmly pressing the "*" key, followed by the digit "1" on your touchtone phone.

We will take as many questions as time permits and will proceed in the order that you signal us.

As a reminder, there may be many callers holding to ask a question at one time.

We appreciate your patience.

We will pause a moment to assemble our roster.

We'll go first with

with

.

Good morning, gentleman.

And the question I have is, I guess, Henry said stay-tuned for more discussion on these in the future - But I would just like to get a sense of where we can see evidence of improved cross-sell, either in specific balance sheet items on a year-over-year basis to the income.

Good morning, Tom.

We are working on that.

We have just created in the first quarter a corporate executive in charge of these initiatives, reporting to the Senior Management Group but, basically, having my authority to work these issues out.

Your question is one that I've asked, and we're working on those metrics as we go forward.

I am instituting, and I think I've mentioned this to the group, a balance scorecard approach -- we're calling it a one-key scorecard for 2002.

And part of that is to come up with these metrics for all of our lines of business and sub-lines of business that include not just financial goals but metrics in terms of how we're proceeding on the strategic direction: metrics that include HR and employee issues, metrics that include customer satisfaction issues, and metrics that include cross-sell.

So, Tom, I don't have those to announce today.

It's not like we're just starting on them, but we haven't finished them.

And put a period at the end of the sentence, but there will be more on that to come.

Henry, are there any lines of businesses that are further along that process than others?

Yes, in fact, there are a couple of lines of business, Tom, that are finished at this point in time.

And Brent and I will be reviewing in the first quarter review, which will be our first balance scorecard one-key review, the metrics that they have in place - retail on the consumer side - are really quite far along.

This is a very hot button for Jack Kopnisky.

Not that anyone else is what I would say behind; it's just that Jack and that area of the bank are really way ahead.

And no evidence of progress to share with us along those lines yet?

No, because I haven't reviewed the notes

for the first quarter, as it relates to our one key scorecard.

That starts to be produced right now, and Brent and I will be having those meetings later this month.

Because it's new, you'll be seeing more about it after we've had a chance to fine-tune it to go through these reviews.

So the process is starting, Tom.

It's just that we're not sharing those numbers at this point in time; but we will be in the future.

Terrific.

Thanks, Henry.

Congratulations.

We'll take our next question from

with Lehman Brothers.

Thanks.

Morning, Henry.

Morning, Brent.

Question's really revolving around the lines of business.

I like the additional disclosure a lot.

One, what happened in the high network business?

But beyond that, Henry, where are you expec - what businesses are your expectations highest - where are your expectations highest?

And, if you could, you have your home equity business and national commercial real estate on home equity.

It seems like all the banks are talking about it being a growth business.

What's your competitive advantage there?

And what's your view that it will grow there?

And, on commercial real estate, a lot of investors seem to be getting worried about that business.

And, I guess, the question is, "Should we be?"

Let me go backward from your questions, Chip, and start with commercial real estate.

And the answer is, you should not be concerned with it as it relates to Key.

I think I've used this term in the past, but the credit quality in commercial real estate has been pristine.

That comes from a very difficult time that our company went through in the early '90s where commercial real estate was a problem for the industry.

But, basically, George Emmons and has crew have been underwriting with a different criteria in mind than we had been in the late '80s.

And, consequently, that portfolio has held up fabulously during this difficult time.

That is not to say that there isn't an issue or a problem at all in that portfolio, but it is still the strongest performing portfolio of any of ours.

And I would say, Chip, that we're cautiously optimistic about some of the economic news that we're seeing, which would take the focus on, you know, something happening bad in commercial real estate off the table, if we could see some economic upturn.

I think we also told people that we haven't had a cap on the balance sheet, as it relates to commercial real estate.

It's why we're so impressed with what George has been able to do in terms of moving assets off balance sheet in terms of -- you know, in 2001 and 2000, we added a couple of companies in the commercial real estate area - National Realty Funding and Newport - in an effort to find more alternatives to mov - to take care of our customers and move those assets off.

I think you asked - 'cause now I've talked so long, I've forgotten the question - I think you asked about the home equity business.

And I would tell you, Chip - and Lee alluded to this - but when we stopped doing gain on sale in early 2000, we told everyone - we haven't reinforced it a whole lot, but we told everyone it would take us about two years to take the balance sheet income from, starting at 0, to a point that it would cover the cost of - I think Lee said - a mature business.

We had, from gain on sale, been taking the profits over the life-present value basis up front.

We're just now reaching the point of the lines crossing, and I'm very confident that, if the portfolio didn't grow -- and the portfolio continues to grow because of the interest rate environment we're in - But if the portfolio didn't grow, we would see significant increases in terms of the contribution margin from 2003 over 2002, from 2004 over 2003 - numbers well above 20 and 30 and 40%, because 2002 - I can't give you a percentage - it's a black number, a positive contribution, versus a negative contribution in 2001, the first full year after we stopped.

So that business is coming alone very, very well.

You know, while I've got the floor - Our middle-market lending, Chip, is slower right now, but not any different than we're seeing in terms of national averages.

And we're looking for that business to come back as the economy starts just a little bit of a pick-up.

So while our core business has been slow, we're very confident that it won't stay slow forever, because inventories have been worked down everywhere; we see that in the national averages.

And our core businesses, especially without concentration in the manufacturing Midwest, are going to top here at some point in time.

And I think your first question, as I've been working backwards, was on high net worth.

And, clearly, we've made, I think, a lot of progress in pairing and aligning our brokers with our private bankers.

But in terms of the first quarter and the trends, brokerage is still a very slow business, and we're not either planning on huge turnarounds there; but we are confident that we've set a wonderful foundation.

In, I guess, a perverse sort of way, the economic downturn has helped KeyCorp in terms of better aligning investment banking with commercial, and much better aligning in terms of brokerage with private banking under our high net worth strategy.

And, again, I think Lee gave us some of the numbers.

I think we're down 25 million, in terms of the costs that we've taken on.

So I think the stage is very well set.

We just need to see the whites of the recovery before we can claim any, you know, significant trend reversals.

Thanks a lot.

Chip, this is Kevin.

I wanted to jump in on your commercial real estate question real quickly.

It's also important to bear in mind how diversified that portfolio is, both by geography as well as product type.

Approximately 40% or more of the portfolio is invested in multifamily housing, which is probably one of the least risky areas of any non-owner occupied commercial real estate lending.

Just to give you a quick snapshot of its asset quality - In the first quarter, we had $7 billion-plus dollars in loans outstanding.

We had $48 million on non-performing.

And, in the first quarter, we wrote off a total of $3 million out of that portfolio, which is down from 4.5 million in the fourth quarter of last year.

So, as Henry said, the asset quality has been very strong.

Thanks.

We'll go next to

, with J. P. Morgan.

Yes, congratulations on the good reporting.

I think it really enhances the quality of the information we have.

Just a couple of quick follow-ups.

First of all, on the tax rate - I know you've talked about it before, but can you just help us understand, how much would have been catch up in this first quarter?

And, therefore, as best you can estimate what the normalized rate is, going forward?

Sure,

, let me take a crack at that.

First, let me make it clear that what you're not seeing the effects of here is any redundant loss of strategy that a couple of our competitors have been very public on.

There isn't any strategy here that is employed that should be worrisome to anyone.

There're really three significant items that impacted our effective tax rate in the first quarter.

Actually, a couple of them were in effect last quarter, but I'll get to that in a minute.

And - the main point is that all of them will be in effect in all future quarters.

These are not non-recurring events.

A couple of them you should have seen in the reports of several of our competitors, because everybody stopped amortizing goodwill this quarter.

And simple calculation for Key shows you this - the absence of the nondeductible goodwill amortization creates a 2% drop in the effective tax rate.

That will continue as long as we continue to not amortize goodwill.

The second thing is that we had some legislation last year that allowed for dividends paid on employer stock held in 401K plans to be deducted.

And as long as we continue to pay dividends on our own stock in the 401K plan, we'll continue to enjoy that deduction.

But probably the largest component of these is the permanent reduction in taxes on the residual portion of international equipment leasing that we do.

We started recognizing the benefits of this last quarter.

It's a voluminous portfolio.

And, in fact, we went back to the start with each of these, in order to calculate what the tax liability ought to be as of current.

And you saw some of the benefit of that last quarter.

You saw more of it this quarter.

You'll see some more next quarter.

And, in fact, this is permanently exempt from U.S. taxes, and we need not make that accrual anytime in the future.

To give you some perspective on how much this quarter might be more or less than other quarters, let me put it this way: I think that this quarter was about one cent better than last.

The change that did take place from last quarter is masked by the fact that, in the fourth quarter, we prudently and reasonably reserved for taxes at a higher rate than normal; and that kind of disguised or offset the benefits that we were enjoying a quarter ago.

And this quarter may prove to be one cent higher than next, due to the catch up that I referred to occurring in this quarter.

Hopefully, that takes care of it for you.

OK, I think so.

I have to think about it, though.

Well, call me later.

I'd be glad to discuss it.

OK, that's good.

And then my second question, which is totally unrelated -- And we've talked around this a bit already, but I just want to make sure I understand - relates to the revenue numbers shown in consumer banking on Page 4.

The revenue numbers in retail banking are down, both linked quarter and year-over-year.

And I just want to make sure I understand why that is.

OK, the primary driver there is just the diminished value of free funds.

And in the first quarter compared to the fourth quarter, also it dropped in the volume of free funds.

That's responsible for more than enough of the decline in all of consumer banking, as a matter of fact.

OK.

And so, as we go forward, a lot of the initiatives that you're working on in the retail bank and the like should be coming through the

here, right?

Yes, revenues in the consumer bank.

Right.

Yeah.

OK.

All right, great.

Thank you very much.

Our next question comes from

with Wellington Management.

Good morning.

Calling about the drop in service charges from the first quarter.

I had thought that rise in the second half came from changes in pricing on panic, and now it's dying back down again.

So is that due to some sort of customer backlash or something else going on?

Well, we don't think so, Mark.

There's a couple of things at work.

One is that, perhaps, we've had a glitch in our systems.

Our folks in the consumer bank think that something went astray there.

And I know the investigation is hot and heavy under way.

The only other factor that I can point to is that there are few days in the first quarter than the fourth quarter, and this is day-sensitive kind of matter.

But we're optimistic that we're going to see a return to service charges like you saw in the fourth quarter when we get to the second.

"Glitch" meaning you over reported in the second half of last year, or "glitch" meaning you waived too much in this quarter?

"Glitch" meaning that, perhaps, the need to charge a fee, or the ability to charge a fee, was not apparent to some of our customer service personnel in the first quarter.

I see.

OK, thanks.

Mark, Henry.

I know from my touch with all of the markets that there has not been a significant fee-directive backlash because of price increases, fee increases - many of the increases were to take it to the higher end of the market in each of our individual markets.

And most of those fees are ones that customers don't think much about, because they don't plan on ODs and some of the returned check kinds of issues.

So while I don't know what all the glitches are, or were, or will be.

I do know that there is not, at least at this time apparent to any of us, a customer backlash issue, as much as there may be, you know, one of these so-called glitches.

Yeah, and Mark, let me make clear and answer your question directly.

You're not seeing any reversal of last half of last year fees.

They're ours for keeps.

OK, thanks very much.

We'll go next to

with Loomis Sales.

Good morning.

Good morning,

.

Good morning.

Good morning.

Actually, most of my questions have been answered.

But I did want to ask about the tax rate again.

I was a little unclear.

So, are you saying two percentage points from like, say, the normalized tax rate that we saw last year will go away?

So, in effect, it'll go from, I don't know, like, in the mid-thirties range down to the low thirties range?

Yeah, Steve.

It's an easy one to do.

Just take our pretax income for this quarter...

Yeah.

And deduct $20 million from it, because that's a nondeductible goodwill that we didn't have to amortize this quarter.

Take the taxes we reported and divide it by that lower amount, and you would see that our tax rate would move up 2% from the one that was shown.

So it was 20%, right?

Well, you're talking about the - without the tax equivalent adjustment.

OK.

Can you just give me the rate to use going forward on my model?

It would be easier.

Steve, maybe this is one that you and I ought to discuss offline.

It really depends on whether you use the tax equivalent adjustment or you don't.

Well, then I'll ask one more question.

On the deposits, it looks like, you know, core deposit growth has been just a little bit sluggish.

And I know we discussed this last time I was out there.

But, you know, maybe Henry can comment on any new strategies that will be employed in the retail banks to boost deposit growth, and whether that would include, maybe, increasing pricing -- you know, instituting free checking maybe more aggressively, or anything along those lines.

Thanks.

Actually, Steve.

I'll take it from the whole of Key Bank perspective, because deposit growth is a corporate initiative.

We're working on it very hard in the corporate bank, where there are tremendous opportunities to make sure that our credit-receiving customers are paying us through deposit accounts.

And, odd as it may seem, in any bank, there are a number of institutions that have credit-only relationships.

And we want to minimize that here at Key.

That really hasn't been something that we've focused on.

So we think there's opportunity in the corporate bank.

We think that there's opportunity in the high net worth area, because there are still a lot of McDonald customers who do very good fee business with us but have their accounts at other institutions.

As we partner in this high worth - high net worth initiative -- A private banker and a broker, we're trying to bring those accounts over.

And on the retail side, a lot of the strategies that you've talked about, Jack Kopnisky and his people are very, very involved in trying to put forward.

So you're going to see the whole of Key Bank working on deposit growth.

It's not lost on us what our loaner-deposit ratio is, what our leverage ratio is; and we have made this one of three - three corporate initiatives, which means everyone's involved.

All right, thank you.

We'll go next to Gerard Cassidy with RBC Capital Markets.

Thank you.

Good morning, everyone.

A couple of questions - the first is on your comments regarding non-performing assets.

You expect them to continue the increase in the current quarter, albeit maybe not as seriously as they did last year.

Can you share with us - I noticed when you look at the breakdown of non-performing loans in the first quarter, that the rate of increase in the continuing portfolio was vaster than the total portfolio.

Do you expect that trend to continue in the second quarter?

Yes, we do.

The - actually, the runoff portfolio is beginning to become pretty well seasoned.

And we anticipate that the level of new incoming from the incoming non-performers in the runoff pool will begin to slow pretty - pretty significantly.

The - we expect that the increases that are going to be arising in the second quarter will largely be from the core portfolio.

And that's pretty much how we anticipated it would go when we did our forecasting at the end of the fourth quarter.

OK.

Did - The other question was - I noticed in the consolidated average balance sheets that the yields on the securities health per sell, if you look at that closely, there are 6.76% versus about 6.87 a year ago, which - the decline is quite modest, relative to the total decline of the asset yields.

Did the duration of the portfolio extend out, or what?

How were you guys able to hold that up so - excuse me - so well?

Well, I'm in the unfortunate position, all right?

As everyone's looking around trying to figure out who should answer that.

I think that's one of those questions -- unless one of you has got it -- cabbage that we'll get back to you one.

OK, that's not a problem.

, our treasurer, has maybe a - on that.

Joe?

I can't give a specific answer around the yield intact, Gerard.

But I will tell you we have not extended durations in the portfolio.

Anything significantly intact, I would expect it would be pretty much the same average-like and less.

OK, and then not to beat a dead horse to death, Lee, but maybe to save you from a dozen of us calling you - If I look at your tax rate in March '01, by just dividing what you reported there - 117 million by the 335 - I come out with a reported 35% tax rate.

In the most recent quarter, you just divide the 60 by the 300, and it's 20%.

Going forward as Steve asked or pointed out, are you going to continue with - Should we use a 30 to 32% rate now going forward, or is it 20%?

I can't believe this is something permanent going forward.

Gerard, I'm sorry that this is as complicated as it is.

But, actually, the strategies that led to it are very simplistic and not any that I have to worry about before the I.R.S.

Let me advise you that, to make things simple - including the tax equivalent adjustment - I suggest that you use an effective rate for us that's somewhere between 33 and 35% going forward.

That's great.

That's perfect.

I appreciate it, Lee.

Thanks.

Sure.

We'll go next to David George with A. G. Edwards.

Good morning, all.

My questions have been answered.

Thank you.

Our next question comes from

with Salomon Smith Barney.

My questions have been addressed, too.

But let me just follow up on one that I might have missed.

Regarding the question on the runoff portfolio.

I guess I've been looking at the reserve that's left with that of 205 million against the 1.5 billion commitments, and wondering if there is any need to increase that reserve.

I can pretty well rest assured right now,

, that we believe that our - the size of our reserve for the runoff portfolio is very adequate.

Very adequate.

A lot of what's in the runoff portfolio is investment-grade assets.

Yes,

, it's Henry.

One of the big differences in outstandings versus commitments in the runoff are the investment-grade lines of credit that we want to move out, or in some cases, revolvers.

Most of the troubled loans in there have been taken down or are now - have covenant violations that would not allow them to draw more.

So we're very comfortable now.

Unfortunately, I had to take two swings at that apple.

But we're very comfortable that the 205 will cover us in the entire workout portfolio.

OK, thanks.

And, actually, just one other question.

Were there any offsets in expenses to the low tax rate this quarter?

No.

No.

No.

This is solid, clean.

What you see is what you get.

We'll go next to Tom Purcell with Viking Global.

I was just looking at the - I have a question on the cost of funds.

You look like your cost of your CD book didn't come down much.

I'm wondering if you have anything rolling over that you might see in coming quarters that the cost of the CD book will come down from where it is today.

Thanks.

Joe?

I'll take the question.

This is

.

We do have in future quarters some higher-rate CDs that we know are maturing.

And we will be, obviously, looking to price the yield to the customer lower and look to retain those deposits, as well.

What's most important is the incremental spread, if you will, relative to our alternative sources.

And that also gives us an opportunity to increase that profitability.

Thank you.

Mr. Somers, we have no further questions at this time.

I'd like to turn it back over to you for any additional remarks.

Thank you, Jennifer.

Before we depart, let me remind you that this call and our slides will be archived, as I mentioned earlier, on our Investor Relations website beginning at 3 p.m. today until 5 p.m. on April 26th.

As I indicated earlier, you can also access the telephone playback of the call by calling the following number - (402) 398-4261.

If you have any additional questions, please feel free to call our Investor Relations staff or Lee, who so generously volunteered on the tax rate, who will be able to answer any of your questions.

Once again, thanks for joining our conference call, and we hope you have a good day.

Thank you.

That concludes today's conference.

Thank you for your participation.

You may disconnect at this time.