KeyCorp (KEY) 2002 Q2 法說會逐字稿

Please stand by, we're about to begin.

Good morning and welcome to KeyCorp's second quarter earnings release conference call.

This call is being recorded.

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

Mr. Somers, please go ahead, sir.

Thank you,

.

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 Webcast at key.com.

This call and the slides will be archived on our investor relations Web site from 3:00 PM Eastern Time today until 5:00 PM on July 26th.

Telephone playback is available at 402-398-4261.

On slide two, you'll find our traditional forward-looking disclosure statement.

We'll file copies of our slides and press release with the SEC on Form

today.

And in keeping with regulation

guidelines, we'll limit our forward-looking statements to those matters covered in our formal presentation.

If you'll now turn to slide number three, you'll see the outline for today's conference call.

Participating will be our Chairman and CEO, Henry Meyer; our Chief Accounting Officer,

; and

, who heads up risk management and credit quality.

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

With that brief introduction, let me turn the call over to Henry.

Thanks, Brent, and good morning to everyone.

Overall, it was another very solid and very clean quarter for Key, with earnings of 57 cents per share, which met our consensus number for the second quarter in a row.

Our results showed a modest pickup in revenue, which benefited from a stronger net interest margin and a slight increase in our fee-based businesses.

On the heels of our

program, core expenses continued to be basically flat from the year ago period.

I was also pleased to see some encouraging early signs on the asset quality front, especially in light of the weak economic climate.

Overall, our results were consistent with our expectations and demonstrated that the strategic actions we took last year are paying off.

Brent will spend some time on our third quarter outlook later in the presentation, but my observation would be that the second half of the year is shaping up to be a lot like the first half, with a stable but weak economy, especially here in the industrial Midwest.

Although manufacturing activity did pick up a little in the second quarter, our customers remain very cautious and lack conviction that a sustained economic recovery will take place before early 2003.

For Key, our number one priority remains growing revenue.

This means regaining our momentum in growing deposits, generating new profitable loans, and building on a very modest turnaround we've seen in our market-sensitive businesses.

Key will also benefit as we return over time to a more normal credit environment.

Now let me spend just a couple of minutes on slide number four, which highlights the progress we've made on our strategic initiatives.

Our plan to exit less attractive portfolios and refocus on our core relationship businesses continues on schedule.

Since we launched our strategy in May of 2001, we've reduced our

portfolio by nearly $2 billion, and the commercial run-off portfolio by almost $900 million.

As we look forward, our focus is on building our core relationship businesses.

This has been an effort that has really energized our team and produced some early successes in terms of cross-sell.

Let me offer just a couple of examples.

In the consumer banking area, our home equity campaign has attracted $2 billion in new loans this year.

Ten percent of this business came from new customers, which have been actively targeted for cross-sell opportunities.

One of our successes has been that over 85 percent of our home equity customers now have a

account with Key.

Our small business team is also seeing solid progress in growing deposits.

Non-interest bearing deposits are up nine percent year over year, which will produce $11 million in incremental net interest income over a year.

Our small business cross-sell ratio is also up 13 percent to 3.2 products per client.

And finally, the integration of our corporate and investment banking activities is really beginning to pay dividends.

During the second quarter, approximately 80 percent of our investment banking revenue came from franchise clients; a direct result of our commercial and investment bankers teaming up to expand existing relationships.

Clearly there is a lot left to be done in driving toward our revenue and deposit goals.

But overall, I'm very pleased with the progress we've made this year.

And our second quarter results are certainly another step in the right direction.

Now let me turn the call over to

for some more detail on the quarter -

.

Thanks, Henry.

Let's now go to slide five, which recaps the financial highlights of the second quarter.

I'm going to reiterate some of what Henry said about our 57 cent per share quarter, which was right in line with the consensus of analysts' estimates.

Three months ago I said in the conference call for first quarter earnings that from our perspective it was solid and clean, with no surprises.

Particularly no negative surprises.

And hopefully you'll agree that I can dust that off and use it again, because now we've got two consecutive solid, clean quarters with no surprises in the bag.

Revenue showed a little more life than in the first quarter and rose modestly.

Expenses were nearly flat to what in the first quarter was our second lowest quarterly amount since 1998.

Even allowing for the exclusion of goodwill amortization from all those quarters.

And finally on this slide, a fact due largely to improvement in our run-off loan portfolio, we had our first quarter-to-quarter decline in non-performing loans in three years.

Turning now to slide six, the height of the bars shows net interest income, which rose by $19 million quarter to quarter, as both the net interest margin and average earning assets grew.

What's perhaps most remarkable on this slide are the elements behind the year-over-year comparison.

There was an increase of $2 million in net interest income, despite the fact that average earning assets have declined by five percent or $4 billion since a year ago.

Offsetting that is the net interest margin increase of 21 basis points in that time to 3.98 percent.

And five basis points of that increase occurred in the most recent quarter.

It's especially appropriate to look now at the year-over-year changes in the margin and in the volume of earnings assets since the second quarter of last year is the quarter when Henry announced we'd be exiting auto leasing, downsizing indirect auto lending and creating a runoff pool of credit-only commercial loan relationships.

The deliberate shedding of this business is one of the reasons for the improvement in the margin and also accounts for 2.7 billion of the decline in average earning assets since a year ago.

The other 1.3 billion of the decline stems from the sale of one to four family mortgages last September.

As for earning asset volume, it rose very modestly in each successive month this year since January.

January should prove to be the year's low point.

Home equity, again lead the way, rising by 1.2 billion during the quarter while everything else fell by a net 600 million.

Average home equity loans have grown by $2 billion since the fourth quarter of last year and of particular interest is that essentially all of this came from our retail branch system, where the 30-day-and-more delinquency rate is only one percent and the annualized charge-off rate is only 25 basis points.

Growth from our other home equity lending channels has been modest.

One of those channels through which we acquire products from brokers and correspondence is actually down in volume year-to-date as we de-emphasize this source.

On slide seven now, you'll see the components of the five-basis point rise in the margin since the first quarter.

All of this could be attributed to improved spreads on deposits and an improved mix of deposits as demand deposit accounts continue to climb.

The only negative on the list of changes here is the contribution to the margin of loan fees, the least annuity like of the elements shown here.

The decline is consistent with the slowness of loan originations, especially commercial loan originations.

And now let's turn to slide eight.

Total non-interest income rose by $5 million from the first quarter as investment banking had a good three months, especially given the economic climate in which we're operating.

Investment banking fees rose by $13 million from the first quarter, moreover it was up $5 million from the year-ago quarter.

Trading and derivative income, the latter especially sensitive to loan originations volumes declined by $11 million from the first quarter.

Another point to make here is that trust and investment services income rose by $2 million in the quarter.

Given the performance of equity markets in June, I'd not expect another rise in this fee income category in the third quarter, but given the performance of equity markets this year, we'll gladly take the second quarter increase, small as it might be.

And now let's go to slide nine: non-interest expense.

Not much change here.

The $4 million rise is primarily due to increased salaries, a development we'd expect since, for the vast majority of our workforce, annual merit increases go into effect on April 1st, and although you don't see it here, let me note for you that when you take goodwill amortization expense out of last year's second quarter core non-interest expense, this year's 665 million is dead even with that of second quarter a year ago.

Our next three slides recap year-to-year changes in revenue and net income for our major business groups.

First, on slide ten, you see key consumer banking.

Revenue was up by $10 million as national home equity lending revenues rose by 15 million, and our indirect lending group fell five million due to our deliberate exit and downsizing strategies in auto leasing and lending.

Key consumer banking's net income rose by $8 million as retail banking, small business and national home equity all rose by a combined $11 million, or 12 percent, while indirect lending fell by $3 million.

The consumer banking group as a whole contributed 47 percent of consolidated net income in the second quarter of this year.

Going now to slide 11, Key corporate finance is featured.

Revenues declined by $15 million; specifically, non-interest income declined by $20 million and net interest income rose by $5 million.

A decline in trading income and lower gains from both loan sales and the residual values of leased equipment were the chief reasons.

Net income for the corporate finance group fell $5 million, as a $14 million increase in national equipment finance was more than offset by the combined declines in our corporate banking and national commercial real estate.

The corporate finance group as a whole contributed 41 percent consolidated net income in the second quarter of this year.

And now on slide 12, Key Capital Partners revenues were just shy of those of second quarter a year ago.

Net income, however, rose by $10 million, due chiefly to a $15 million improvement in non-interest expense totals.

This was in turn due to a $6 million decrease in goodwill amortization and a net $9 million decrease in all other forms of overhead, as the infrastructure of this business group has been rationalized in light of the conditions of capital markets over the last year and more.

Key Capital Partners contributed 17 percent of consolidated net income in the second quarter of this year.

And the next slide deals with asset quality, and that means it's time for me to give it up to

-

.

OK.

Thanks,

.

On slide 13 you'll find information pertaining to loan losses we incurred during the second quarter.

Overall, we wrote off $202 million.

That represents a slight decrease from the first quarter's level of $206 million.

Consumer losses totaled approximately $59 million, a modest decrease from the $67 million we posted during the first quarter.

Commercial losses totaled approximately $144 million.

This number can be divided into two parts: those taken against the core portfolio and those charged against the non-replenishable reserve.

Losses taken against the core portfolio totaled $76 million, while those charged at a non-replenishable reserve amounted to $68 million.

The largest single loss this quarter stemmed from our structured finance portfolio, where we incurred a $6.5 million write-down.

On page 14, you'll find information on a variety of important asset quality ratios.

Focusing on the first two columns, you can see that our level of overall non-performing loans decreased by approximately $16 million.

This was a milestone, as it represents the first decline in non-performing loans since 1999.

As a percentage of the loan portfolio,

have decreased slightly from 1.52 percent to 1.50 percent.

Dropping to the bottom of this chart, you'll note that the overall allowance finished the quarter at $1.5 billion, or 2.4 percent of the portfolio.

I'd like to spend a minute on the two right-hand columns now.

They represent our core loan portfolio.

Between the fourth quarter of 2001 and the first quarter of 2002, non-performers in the core portfolio increased by approximately $85 million.

Between first and second quarters, they increased at a slower pace, about $60 million.

Going into the third quarter, we expect a slowdown to occur once again.

The increase in the second quarter was driven principally by several structured finance credits which were not part of the run-off portfolio, as well as a few middle market credits.

Net charge-offs taken in the core portfolio were relatively flat quarter to quarter.

Let's move on to slide 15, where you'll find information pertaining to the run-off portfolio and the non-replenishing reserve.

You can see that in the year since we created the runoff

we've made significant progress on its disposition.

Commitments are down to 1.1 billion and outstandings are down to 724 million.

We remain comfortable that our non-replenishing reserve will be adequate to cover remaining losses within the runoff

and to cover the occasional distress loan sales we do.

We believe that by the end of 2002 the segregation of the runoff portfolio will have largely served its purpose.

There are a number of inquiries that we get from the investment community regarding future asset quality trends.

I'd like to address some of these on slide 16.

As I do, however, remember that these are forward looking statements that are subject to change.

As the quality is closely tied to economic performance the direction of which seems to be meandering of late.

Nonetheless, we'd like to share a few insights with you.

We believe that our total level of non-performing loans should either level off or modestly decline in the balance of the year.

Total charge opts in the third quarter will be in the vicinity of the second quarter, all be it slightly lower.

We expect a little more improvement towards the end of the year as runoff

charges begin to dissipate.

At this juncture we see core portfolio

continuing in their current vicinity.

Overall, the volume of incoming new problem loans have slowed significantly compared to a year ago.

We anticipate some fluctuations in the volume of our

loans.

Some portfolios, like health care, are showing signs of improvement.

Some, like

, are showing modest deterioration.

This is not uncommon for this point in the business cycle.

As another bank CEO recently commented, we're not out of the woods yet but the trees seem to be getting thinner.

The consumer portfolio continues to perform quite well.

As we review our 30 plus day delinquencies across the overall portfolio, we notice that they are flat quarter to quarter.

In general, we are satisfied with the consumer performance to date.

I'll conclude my comments by saying that we remain comfortable with the level of our loan loss reserve at this juncture.

At more than 1.5 billion reserve represents more than 2.4 percent of the loan portfolio and 161 percent of non-performing loans.

With that, I'll turn it over to Brent Somers.

Thanks

.

On slide 18 you'll find our guidance for the third quarter.

Our outlook assumes a very modest economic recovery but it is happening slower than we had anticipated earlier in the year and we aren't assuming significant improvements through year end.

Based on this scenario, we would expect low, single digit revenue growth driven by slightly higher loan balances in a relatively stable net interest margin in the mid 390 range.

Our fee based businesses should show some growth but we have some risk here given the current state of turmoil in the equity markets and the potential impact on our market sensitive revenues.

As

mentioned, expense management continues to be important for us, especially in light of the weak economy and soft revenue trends.

In the third quarter we expect only a slight increase in expense levels.

Our earnings outlook for the next quarter is generally consistent with the current range of estimates somewhere in the 57 to 60 cent range with continued progress expected in the fourth quarter.

Based on our economic outlook for the year and some concern about market sensitive revenues, we would estimate at this point that for the year we will come in somewhere in the lower $2.30 range to the mid $2.30 range.

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

Thank you Mr. Somers.

And as a brief reminder, the question-and-answer session will be conducted electronically today.

Anyone wishing to ask a question may signal us by pressing the star key, followed by the digit one on your touchtone telephone.

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

As a reminder, there may be many callers holding to ask a question at one time, and we appreciate your patience.

We'll be pausing for just a moment to allow everyone the chance to respond.

And let's begin with

at Midwest Research.

Good morning.

Good quarter gentlemen.

Question, first of all, a clarification.

Core portfolio losses, could you repeat the expectations for the balance of the year on loss rates for that portfolio?

Yes, we believe that our core losses will remain in the current vicinity that they are in the second quarter.

OK, now the

ticked up a little bit though, so, in effect, though no follow-through in that charge-offs a couple quarters later.

No, not, we're anticipating that some of the improvements in some of our other credits will sort of offset that up tick.

We're expecting that the

for the core portfolio will begin to flatten out as the year progresses and we're not really anticipating much of a change at this juncture in our level of core charge-offs.

OK, and I want to jump ahead three or four quarters and not, maybe being a little bit out of line, but if the trends continue here, you build a little capital along the way, if the economy remains slow, but the asset quality gets better at least at the margin as you're talking about, or as it would seem to feel, do you guys come into the market maybe 1Q or 2Q of next year for buybacks, or is that still too far in the future?

this is Brent.

I think you hit the nail on the head.

With the economy improving and asset quality improving, we would come back into the market to repurchase some shares.

The point at which we do that will largely be determined by what happens in the economy and when the asset quality trends tend to become positive.

So I don't know exactly when that will happen, but we would be back in the market at that point.

OK, very good.

Thank you.

And we'll be going next to

with

.

Hi.

Couple questions.

First of all, how sustainable do you think the growth is in the home equity portfolio?

And also, you know, kind of where are you in terms of your deposit campaigns?

Obviously, you've had some initial success here.

Do you expect deposit trends to continue throughout the rest of the year?

this is Henry.

Yes, we're actually very early in our deposit campaign.

Some of that was a result of our March first quarter, balance score card review and a decision that, you know, we really needed to focus on that area.

So I think in all honesty, some of the deposit growth has had less to do with our initiative and more to do with what's happening in the general economy.

But because of that, I think we're going to continue to see throughout 2002 some good numbers as we mature in terms of our initiatives on deposit growth.

On the home equity side, you know as long as rates continue to be historically very low, we expect to see some growth - continuing growth - in our home equity portfolio.

Remember - and I think

said this - most of the growth in the second quarter came from our branches, our franchise centers.

But we also are benefiting from the math of just starting to put

home equity loans on our balance sheet just a little over two years ago.

So we continue to think that because we started with a zero base from a

perspective, that that portfolio, that asset category will continue to show growth through the remainder of this year.

OK.

And then just one follow-up on the credit quality outlook.

First of all, can you just refresh my memory?

Kind of - and I know this is difficult to predict, but if you could look into the future and say, you know in a normal economy, you know less volatility in the market, revival in commercial demand, say two percent

growth, you know, what do you think your continuing portfolio loss rate would be?

And then, secondly, you know you expressed some kind of conservatism in that you don't expect your continuing portfolio to come down in the second half.

Is that because you had an eight percent rise in your

out of the continuing portfolio?

Because, you know, generally speaking, it seems like, you know, based on watch list trends or inflows into

, you know some people are starting to get a little more optimistic.

, if I could respond to the first part of your question, probably in a good economic environment we would anticipate that losses might be in a normalized range of, say, 50 to 65 basis points, somewhere in that vicinity.

With regard to the second question, there's always a little bit of a lag time between the time a non-performer comes in to the time that it gets

by charge-off, restructure or restoration to good status.

All right.

Thank you.

And our next question comes from

with

.

Hi.

Two questions, the second on strategy, the first on asset quality.

Could you talk about your

results?

Any changes in classification or anything else that came out of that?

As far as the shared credit review is concerned, I would say that for the most part it was pretty much a non-event.

Probably typical of what has occurred in previous years.

Now you have to bear in mind that we don't know the full results of the

, but what we have seen so far has been pretty normal.

And a second more broad question, I think some time in the fourth quarter conference, Henry, you had said - and I'm very loosely paraphrasing, so please help me - that when the water starts coming back into this economy, Key's boat should, you know, hopefully rise faster than everybody's else's given the number of strategic changes and repositioning that you've done in the company.

I'm not saying that that's necessarily going to happen in the next 90 or 180 days, but do you feel confident that you have repositioned the company or there is still other moves to come in order to do that to anticipate revival of the economy?

Well there are no major -- there's always tweaking that goes on, as you know.

I will say that Key's stock performance this year, even with yesterday's disaster, we're still up for the year and through June 30th our KeyCorp stock has performed well above the median in terms of stock appreciation, not including the more substantial dividend that we pay.

So I think, to some degree, we're already starting to see the water lifting Key a little bit higher but no, we're not done.

We're not out of the runoff portfolio but as

said, I think we'll probably stop including that as a separate item either at the end of the fourth quarter of this year or possibly very early in 2003 and, you know, when we get to 50 to 65 basis points in

, even at the upper number which I think

gives himself a little bit of flexibility, I'd like to see us more in the middle of that range but in the middle of that range, that's a significant reduction in terms of

for KeyCorp that will flow right to shareholder value.

So I still think we aren't all the way there but that we've made a lot of the early, more significant moves and it's starting to benefit our shareholders.

Thanks.

We'll go next to

with Lehman Brothers.

Good morning.

A couple of questions.

One, BankOne released today and they're including in their numbers their options expense.

I wonder what your view of that is going forward, Henry, and then if you would, talk about the retail bank which seemed to have a very strong quarter but on a

quarter basis but year over year kind of flat and what is your expectation for retail.

Let me take,

, the first question on options.

Obviously we've been talking about that here.

You know, I think some of the companies that have announced they're going to be expensing may use restricted stock in different, you know, forms.

We're not uncomfortable at all with expensing stock options if everybody's doing it.

What we have trouble with is, some people doing it and some not.

I think we're all going to see some regulatory changes coming and, you know, we've looked at how we do against others and we're not worried about that at all.

So I think when that comes and everybody moves, I think it's very difficult for analysts or even me to decide some should and some shouldn't.

So we're just going to wait and see but we're very comfortable with it.

I'll ask

to just give you a further comment on that

.

, we, like most companies, have had to disclose what the pro forma effect would be had we expensed stock options and for us it's a relatively modest amount of delusion.

In fact, for each of the three years its been 6 cents a share, you know, and if you're thinking of us in earnings per share for the last two years in the 230 to 240 range, something like that, you're talking about 2 ½ percent delusion.

So the fact is that we've been disclosing it.

I think it's a relatively minor concern for us and probably for our industry as compared to the rest of U.S. industry.

And,

, the second half of our question or second part of your question was retail and I'll tell you, not like -- not unlike many of our competitors, we've really been focusing on the core businesses, much more than we have in the past.

And 2003 will be the first year in maybe a decade that at least as we look at things right now will be a net adder of branches.

This year, over the last approximately 15 months, we've opened 26 new branches, but we closed more than that as we got out of in-store banking, New Hampshire and the like, but we are investing in our franchise.

We are opening in new markets, and while the year-over-year comparison is tough, because we're net down a lot of branches,

is using the base of where we are now and he's really driving for our branches to focus on deposit growth, to focus on the basics that are really the historical background of the old Key and the new Key.

Thanks a lot.

And we'll be going next to

with RBC Capital Markets.

Thank you.

Good morning guys.

Question for you on the average balances that you provided for us in the press release.

You gave us obviously the assets and liabilities.

I noticed that the yields for the real estate construction portfolio seemed to have dropped over the last two quarters relative to the total asset yields.

A year ago they were, you know, the yield in the portfolio was greater than let's say your

portfolio.

In fact, it was greater than the total commercial home portfolio.

That's not the case today.

What's going on in that construction loan portfolio that's forcing the yields down, vis-à-vis the other sectors?

, I think you probably stumped the band with that detailed question and I'll promise you that I'll follow up when I've got a good answer.

I'll call you back with that.

I appreciate it, thank you.

We'll go next to

with Wellington Management.

Good morning.

My question was on the consumer bank, and while there was good deposit growth in the commercial bank, the average core deposits in consumer bank actually fell about one percent from first quarter to second quarter, which goes against the trend of the rest of the industry.

And I'm wondering why is that.

Were you pricing deposits down too aggressively in the second quarter?

It has a little bit of, to do with closing a branches and some of it being that we worked on our deposit initiative early in the second quarter, you know.

We were really in full force in June.

So we haven't seen much of the benefit there.

I tried to answer that earlier by saying, you know, I don't think you've seen all of the power of the initiatives that we've undertaken.

We're now offering free checking and free Internet banking in certain markets where we really do have a very competitive opportunity.

So there's nothing in those numbers, second quarter over first that really indicate where we can get it, and it's more influenced by a strategy that was status quo in the closing of branches.

OK, thanks very much.

Our next question comes from

with Morgan Stanley.

Yeah, can you give us a sense of the differences across the regions and how you're fairing between say the Pacific Northwest and the, you know, some more traditional Midwest areas, in terms of deposits and lending?

I'll take a general stab at it and ask, you know, either, any of my associates to chip in.

We saw a downturn in the Midwest well before we saw in other parts of our franchise areas.

Others now have caught up.

We've seen a slowdown in the Rockies and the northwest.

And we continue to see on a relative basis deterioration in our middle market and small business portfolios across our entire franchise.

Slightly higher in the Midwest and Northeast, but not substantially anymore.

So it's been a pretty broad-based geographic downturn.

And in terms of deposit growth, we haven't seen much geographic differentiation in terms of where deposits are growing or not growing.

I think most of the competition across our, you know, East to West Coast franchises has a lot of commonality and it's a very competitive marketplace.

Now looking at the sort of competitive marketplaces, you look out over the next few quarters and you think how your position

sort of interest rates and where interest rates are going and what's going to happen to deposits.

I mean everybody is talking about growing deposits.

There is clearly a benefit from the liquidity side of this, as people look for safety.

As you think about where the world is going, how are you positioned against changing rates and sort of changing volumes as you look out over the next, you know, two to four quarters.

Well we manage our interest rate sensitivity position within very tight tolerances.

And we are, at this point in time, liability sensitive.

But we've decreased that sensitivity a tad.

I think even in the face of rising rates, Key is an institution that might in fact still be liability sensitive.

But we try -

, we're between one percent is really our...

A little less than one percent.

We're a little less than one percent right now.

So we're not worried about that as much as we are the uncertainty of very volatile markets, like yesterday, that could move people into deposits for a longer period of time, as opposed to just a short-term holding pattern.

And we think we'll get our share, as people pretty generally have a lot of concerns about dealing with equity markets, given the volatility and the red numbers that we've been posting.

In that kind of sort of timeframe and concern about, you know, the economy maybe going the other way, are you worried about the extent to which you're becoming exposed on sort of home equity lending in terms of, you know, drop in house prices?

You know this sort of housing bubble.

How do you think about those things?

You know what sort of risks are you taking in terms of loan to value ratios, that kind of issue?

Well let me ask

, our treasurer, to talk a little bit about our interest rate sensitivity.

And then

can comment on our home equity loan to values and the like.

Because we've got good numbers there, and we want to make sure people know them -

. veda: Thanks, Henry.

All of what you said pertains to home equity.

Interest rate risks are embedded in our overall interest sensitivity risk assessment.

And as Henry reported earlier, we have continued during the most recent quarter to maintain a liability-sensitive position, albeit modestly less liability-sensitive than we had been previously.

But all the flows on the balance sheet, including home equities, from a maturity standpoint, as well as predicted pre-payment activities, are embedded in that assessment.

If I could address the home equity business from a credit quality perspective, I guess as I look at the consumer business, if you're going to be in the consumer business, I think I'd rather have a loan on somebody's home than just about anything else.

As far as the volume of -- I mean the loan to value ratio that we have and the volume of first lean positions, in our national home equity business we have an average loan to value of approximately 76 percent and an average of first lean positions of 83 percent.

Those are very good numbers, by the way.

And, also, the majority of our growth in the second quarter came from the prime side of the portfolio too.

So I'm -- overall I'm pretty comfortable with being in the home equity business.

Thank you.

We'll go next to

with Prudential Securities.

: Good morning everybody.

I was just curious, did you sell any non-performers in the second quarter and then if so, did you sell them out of the runoff portfolio or where they in the continuing portfolio?

Yeah.

We did sell some non-performers.

I think they -- I'm going to give you a ballpark figure here.

It was probably around $25 million that were a non-performing status, excuse me, and some of them came out of the runoff

and some of them came out of the core portfolio.

: OK.

Thank you very much.

And our next question comes from

at Millennium Partners.

: Hi.

Actually this is

.

Thanks very much for taking the call.

Two questions.

First, I was wondering if you could update us on potential acquisitions down the road.

Well it's -- this is Henry.

You know, we continue to look for some of our fee income opportunities but there aren't a lot of deals being done right now.

You know, the equity markets and the uncertainty in the economy has slowed things down.

Clearly, as I've said before, our goal is to execute to get KeyCorp stock back up to where it's more competitive and then be able to do some of the smaller deals that fill in around our retail franchise, as well as add to our fee income businesses.

: OK.

And then if you could kind of -- if you can help -- specifically help me true up current guidance with guidance given in last quarter.

It looks like the numbers are drifting down a little bit and I was wondering if that's asset quality or maybe loan growth not kicking in sooner than expected.

No, I think it's really, as we're looking at the economy, that the recovery is not happening quite as quickly as we would have thought.

The -- some of the market revenue areas we're a little bit more concerned about given what's going on in the equity markets right now.

Loan growth is slower than what we would have thought.

So I think it's all related to kind of the -- kind of the continuing view of how fast or slow this economic recovery is or is not taking place.

Just as an example, you know, we're very proud of our assets under management and assets under control but when you see, you know, the market at 8500 as opposed to 9500, you know, while we don't price off of that index, we price off of people's portfolios but as a representative number, you know, our fees on a quarterly basis, we're not growing assets fast enough to make up for the decline in equity values.

So it's going to put some pressure on some of our, as Brent said, market sensitive areas.

: OK.

Thanks very much.

And we'll be going next to

with

.

Ms. Thompson, the line is . . .

: Oh, hi.

Good morning.

Sorry about that.

I had a question regarding the investment banking, capital markets business.

If you could just give us a little bit more color on what you saw this quarter compared to what you were expecting and if you can also comment on what your outlook is for the second half of they year, just a little bit more color on that.

Thanks.

Yeah,

, this is Brent, I would say investment banking ended up being a little bit better than we would have thought as we were at this point, you know, three months ago, came in a bit stronger.

As we look forward, there is some concern about the impact of the turmoil in the markets on potential deals.

The pipelines are pretty strong, but we're worried about whether or not those deals will turn into actual transactions this year, given what's going on in the markets.

: So is it more of a timing issue?

Is that what you're saying?

Yes, it's more of a timing issue

.

It's Henry.

You know, in 2001, we did a whopping total of nine investment banking equity deals.

We've already done in the mid 20's through the first six months of this year.

And we think the alignment, I think I said earlier that 80 percent of those deals in the second quarter came out of our franchise.

Unlike some of the other announcements from companies about their broker-dealer investment banking acquisitions, Key and MacDonald have aligned very well, but we need better markets to make sure those deals come to fruition.

We have outstanding pipeline.

We have commitments and engagement letters signed.

But our ability to get to market or do some of those deals is clearly dependent on market conditions and you know, after yesterday, it's a very, at least makes us question whether this is going to be the year, not whether it's going to happen

.

It's more, it's much more a matter of timing.

The alignment is there.

The number of deals are there.

The engagements are there.

It's just how fast can we ring the cash register and I think it'll take more solid, stable, maybe increased market than what we see right now.

: Great, and I just had a clarification question on an earlier question.

I think you said that around 25 million of sales out of

this quarter, some out of the runoff, would you say it was split basically evenly?

I'm just trying to get a sense of in-flows into

this quarter, in the core portfolio.

The in-flows into the

, yeah the, excuse me, the sales, which were approximately I would say around 27 million in total were probably broken down about one-third out of the core portfolio, I mean, non, I mean the runoff portfolio, and about two-thirds out of the core portfolio.

But overall, as I mentioned, quite a while ago, we believe that the trend in the core portfolio, non-performing is quite likely going to flatten out in the third quarter.

: Great.

Thank you very much.

And we'll take a follow-up question from

with Midwest Research.

Henry, could I get you to comment a little bit on how economic conditions vary by region, both commercial and consumer?

What you're seeing in the Midwest versus the West and Pacific Northwest in the

.

Well, as I indicated earlier

, the Midwest has seen the most trouble in terms of non-performers and losses in the core portfolios; our real bread and butter, which is middle market and small business.

And it's because of the higher concentration of industrial and manufacturing lending that goes on there.

But as we sit here in July, we have seen later, but still deterioration in our other three regions, such that there's no significant differentiation between the Northwest, the Rockies, the Midwest and the Northeast.

The Great Lakes continues to be the worst portfolio, but it's pretty universal.

You know it's marginal, but again, a higher concentration.

We think that that portfolio will continue to deteriorate even into a recovery.

That's why

has used the term "lag."

But traditionally, even after a defined inflection, which happens after the fact - but we see still see a number of companies that have just been hanging on.

They can't make it even in the, you know, eyes of the recovery, which is why we continue to think we've got another quarter or two of charge-offs at current levels.

But we're hoping that, you know, economic activity doesn't slip any further, in which case we think as we look at the early signs and the - you know how companies move down the credit quality ladder, that we're looking at some better numbers as we look forward.

Henry, what about commercial real estate in the various regions?

Any differences there, and any change at the margin since we last visited in May?

No.

To tell you that, you know, it's a solid - it's a pristine portfolio.

We are seeing a little bit of trouble on the edges.

And I don't remember the second quarter losses.

probably got them.

I do know that we were 17 basis points in the first quarter, and there was no significant deterioration.

But, like every portfolio, it's starting to, you know, just show a little bit of trouble on the edge.

I think - nothing.

There were no charge-offs in the second quarter.

So our commercial real estate portfolio continues to perform exceptionally well.

But, you know over long periods of time, with slow economic activity, and, you know we continue to read, as you all do, that a lot of companies are continuing to downsize, that's going to put some pressure on it.

But going a little bit up from zero isn't anything that worries us at all.

OK, thank you.

And gentlemen, it appears we have no further questions at this time.

I'd like to turn the call back over to Mr. Somers for any additional or closing remarks.

Operator, and everyone on the phone, in an effort to provide prompt customer service here we had our crackerjack crew go out and research the answer to Gerard Cassidy's question about why yields in the construction loan portfolio would appear to have come down faster than rates in the rest of the portfolio.

And the answer to that would appear to be -

, I hope you're still out there.

I call you back anyway to make sure.

But flowing rate construction loans represent about 98 percent of the total portfolio.

And that contrasts with about 85 percent in the remainder of the commercial, financial and agricultural loan portfolio.

So with the significant decline in short term rates over the last year, the construction loan portfolio has re-priced down faster than the rest of the portfolios.

Hopefully that's helpful.

Thank you, Brent.

Thanks,

, and thank you all.

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