KeyCorp (KEY) 2003 Q1 法說會逐字稿

Good morning and welcome to KeyCorp's first quarter 2003 earnings results conference call.

This call is being recorded.

At this time, I would like to turn the call over to the chairman and chief executive officer, Mr. Henry Meyer.

Please go ahead.

Thank you again, operator.

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

We appreciate you taking some time to be a part of our discussion.

Joining me today for our presentation is our CFO, Jeff Weeden, and also available during the Q&A portion is our chief accounting officer, Lee Irving, our chief risk management officer, Kevin Blakely, our treasurer, Joe Vayda, and Vern Patterson from investor relations.

On slide two, you'll see our standard forward-looking disclosure statement.

As you know, it covers both our presentation and the Q&A period that will follow.

If you'll now turn to slide three, you can see our assessment of the quarter.

Key's first quarter fell short of our expectations.

Earnings were impacted by the weak economy and the continued uncertainty that has paralyzed decision-making for many companies and investors.

I know that you see the same economic reports that I do, but let me share just a few statistics that begin to paint the picture in terms of the business climate for KeyCorp.

For all of our industry, GDP estimates for the first quarter have continued to come down from 2.5% to now being 2% or less.

More KeyCorp-specific, during the first quarter, there were only five IPO's completed with a total value of just $540 million.

I believe this is the lowest quarterly number since the mid 1970's, and in January, there were no IPO's done, the first month with no IPO's since just after World War II.

The S & P 500 is down 25% from a year ago including a 3% drop in the first quarter of this year, and based on recent fund flow data, equity funds lost 11.5 billion during the first two months of this year.

My point is that revenue growth in this economic environment remains a challenge for Key and many of its peers based on earnings results I've seen this week.

Our first quarter was impacted by weak loan demand, especially in our commercial businesses, and contracting interest rate spreads that adversely impacted net interest income.

Weak markets both in terms of valuation and deal flow have continued to put pressure on our market-sensitive businesses.

During the first quarter, we saw a reduction in assets under management and lower revenue from Investment Banking and Capital Markets.

I do want to point out that even in today's environment, we are seeing some positive developments.

Average core deposits grew 8% from the year-ago quarter, and an annualized 12% from the fourth quarter of 2002.

New DVA openings were up 34% in the first quarter compared to the year-ago period.

Free checking has played a major role in our ability to attract new customers.

Online banking enrollments have continued to grow, standing at 33% of all of our DVA households.

And we've made great progress in integrating our recent acquisition in Colorado, Union Bank and Trust.

Deposit and loan balances are both above our original projections.

One of the areas that we continue to focus on, especially in light of the weak revenue trends, is expense management.

Our guidance for the first quarter suggested that expenses would rise modestly from fourth quarter levels.

By following a process we established with PEG and its legacy, continuous improvement, and with lower accruals for incentive payouts, we were able to reduce expenses by an annualized 7% from last quarter.

Expense levels were also down slightly from a year ago.

This was accomplished despite increases in pension and other employee benefits costs.

We will continue to evaluate staffing levels and make appropriate changes when it can be done without impacting customer service or our ability to grow our higher return businesses.

As you may have seen in recent media stories, we've also eliminated or postponed merit increases for most of the company until our performance improves.

There were also some positive signs in terms of asset quality.

NPL's declined for the second consecutive quarter, and net chargeoffs fell to their lowest level since the first quarter of 2001.

Jeff will get into more of the specifics, but we are certainly pleased to see some of the positive signs with these credit trends.

I also want to point out that our line of business reporting this quarter is consistent with the organizational changes that we previously announced.

This includes the alignment of Corporate and Investment Banking organizations under Tom Bunn, and simplifying our reporting for Consumer Finance and investment management.

Before I turn the call over to Jeff, I want to again reaffirm our strongly I feel about Key and the steps we've taken to improve our company.

We will continue to invest in our high growth businesses and stay focused on expense control, growing core deposits and improving asset quality.

I believe that this will sustain us during these slower times, and that we are very well positioned for the eventual economic rebound.

Let me take the call over to Jeff Weeden for a more detailed review of our quarter.

Jeff?

Thank you, Henry.

Turning to slide 4, Key reported earnings of 51 cents in the first quarter.

Total tax equivalent revenue declined $70 million from the previous quarter.

Net interest income was down 21 million, as the net interest margin declined 12 basis points to 3.86%.

Non-interest income declined 49 million, due in part to normal seasonal factors and continued weakness in market-sensitive revenue.

With revenue under pressure, maintaining our expense discipline was very important.

Total expenses were down $11 million from the fourth quarter, and $4 million from the same period one year ago.

This is after the impact as Henry discussed of higher pension costs and other employee benefits.

Average core deposits continue to grow in the current quarter, and stood 12% higher on an annualized basis from the fourth quarter and up 8% from the same period one year ago.

Net charge-offs and non-performing loans declined in the current quarter compared to both the fourth quarter and one year ago.

And our capital ratios remain strong, giving us the flexibility to repurchase 2 million shares in the quarter, leaving 11.8 million shares remaining under our current authorization.

Turning to slide 5, the company's net interest income and the margin declined in the first quarter when compared to the fourth quarter levels.

The net interest margin was down 12 basis points from the fourth quarter, due to changes in earning asset mix, competitive deposit pricing, and less value from non-interest-bearing deposits.

As we said in our last earnings call, the rate cut by the Fed in November would put pressure on the net interest margin going forward due to competitive conditions in the marketplace.

In addition, soft commercial loan demand in the current economic environment has continued to put pressure on our ability to expand our earning asset base in the short run.

Average earning assets for the quarter were up 870 million, with the majority of the increase in short-term investments and the securities portfolio.

Our sensitivity in interest rates remains very modest.

Less than one half of 1% of net interest income is at risk to a 200 basis point increase over the next 12 months or a 50 basis point decrease over the next three months.

Slide 6 shows the trend in average loans outstanding for the company.

As you can see from this slide, 1Q03 versus 1Q02, total commercial loans in the core portfolio are down 1.8%.

This reflects the soft business economic environment.

On the consumer side, our core portfolio was up 7.7% year over year, reflecting the healthy demand we have experienced in the home equity lending throughout our branch network.

On slide 7, shows the continued success we are having in growing our core deposits throughout Key.

As you can see, the preference of customers is to move to MMDA's and NOW accounts from CD's.

Again, as we said earlier, core deposits increased 12% and 8% in the current quarter when compared to the fourth quarter and first quarter of last year.

Slide 8 reviews the changes in non-interest income from the last quarter to the current quarter.

Non-interest income on a sequential basis declined 49 million.

Trust and investment management fees remain soft due to market conditions and the company's decision to exit the 401(k) record-keeping business in 2002.

The sale and transfer of the 401(k) record-keeping business did not go as well as planned.

With more customers choosing to go with a provider other than the purchaser of the business.

This in turn resulted in a decline in certain fees under the arrangements and loss of some assets under management.

The full impact of the conversion of the 401(k) record-keeping business was felt in the quarter.

Investment Banking and letter of credit fees were down due to seasonal factor comparisons.

Deposit service charges declined in the consumer bank as a result of the impact of the free checking rolled out throughout the company in the fourth quarter of last year, as well as reduced overdraft charges experienced in the quarter.

Slide 9 shows the non-interest expense decreased $11 million in the first quarter to 657 million.

This again is an area that we have spent a lot of time concentrating on.

Personnel costs were up $9 million.

Pension costs alone for the company increased $9 million in the quarter, and other employee benefit costs increased $15 million.

Most of the other employee benefit cost increases are seasonal-related to employment taxes these increased costs were partially offset by reduced incentive accruals and lower head count.

As you can see, non-personnel costs remain well controlled for the company.

On slide 10, you'll find information pertaining to the loan charge-offs.

Focusing on the far right column, you'll see total net charge-offs for the quarter were 161 million.

Down 25 million from the fourth quarter level.

Charge-offs to the core reserve were 130 million and to the non-replenishable reserve were 31 million.

In the core portfolio, chargeoffs were down 14 million from the fourth quarter and consumer loan charge-offs declined $3 million.

Charge-offs to the non-replenishable reserve during the current quarter declined $8 million to 31 million.

As has been the company's practice, charge-offs to this reserve were from both loan sales of non-performing loans in the core portfolio and losses in the runoff portfolio.

Slide 11 covers our asset quality indicators.

Again, looking at the far right column, you'll see total non-performing loans finished the quarter at 904 million.

It's down 39 million or 4.1% from the prior quarter.

Non-performing loans now represent 1.44% of the overall loan portfolio, down seven basis points from the last quarter.

Non-performing assets at quarter end represented 1.54 % of total loans in ORE, down 5 basis points again from the prior quarter.

Total net charge-offs at 161 million represent 1.04 % of loans, down 14 basis points from the fourth quarter.

Our loan loss reserve declined modestly to finish the quarter at approximately 1.42 billion, or 2.27% of loans.

And the ratio of reserves to non-performing loans improved 3% to end the quarter at 157%.

Turning to slide 12, this slide provides an update on the runoff portfolio that was set up during the second quarter of 2001.

We continued to have success in reducing the size of the runoff portfolio.

Commitments have declined to 766 million and outstandings have been reduced to 496 million.

The non-replenishable reserve against which runoff portfolio losses and core portfolio non-performing loan sales are charged is down to 17 million at the end of the quarter, and will be fully utilized by the end of the second quarter, at which time we will stop reporting separately on this reserve.

As we stated last quarter, the majority of the remaining balances in the loan runoff portfolio are higher quality the majority of the remaining balances in the loan runoff portfolio are higher quality, single relationship credits that we will exit at their maturity.

Management believes the company's total reserves are adequate to handle the remaining exposure.

Slide 13 provides a summary of the changes in our non-performing loans during the past five quarters.

Again looking at the far right column, you can see the volume of new non-accrual loans decreased in the quarter, and payment flows on existing NPL's remain strong compared to prior quarters.

Slide 14 provides a breakdown of the revenue by our primary lines of business between the first quarter of last year and this year.

This slide points out the revenue challenges we are experiencing in our market-sensitive businesses in Corporate Banking and investment management.

The next slide shows the breakout of net income for the company by line of business for the first quarter between the two years.

As you can see, retail, Small Business and Consumer Finance now represent 43% of the consolidated earnings in the current quarter compared to 37% one year ago.

Slide 16 represents the company's tangible equity to asset ratio which stood at 6.71% at the end of March.

As I mentioned earlier, we repurchased 2 million shares in the current quarter and have remaining board authorization to repurchase up to an additional 11.8 million shares as of the end of March.

The company will continue to execute share repurchases in the open market in the coming quarters under this authorization.

And finally, turning to slide 17, as we look to the remainder of 2003, we still see a challenging revenue environment.

Expenses will be well controlled, and asset quality should be stable to improved.

The economy continues to affect financial markets and financial companies such as Key.

Our credit costs remain high and market-sensitive businesses continue to be under pressure.

With the above in mind, our 2003 projected EPS range is from 215 to 230 per share.

That concludes our remarks, and now I'll turn it back over to the operator to provide instructions for the Q and A portion of our call.

Operator?

Thank you, Mr. Meyer.

The question and answer session will be conducted electronically today.

Anyone wishing to ask a question may signal us by firmly pressing the star key followed by the digit 1 on your touchtone telephone.

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

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

We appreciate your patience.

It will be just one moment as we assemble our roster.

We'll take our first question from Tom McCandless from KBW.

Good morning.

I guess my question is for Joe Vayda.

I was a little disappointed in the margin, I know it's not all Joe's responsibility, but I think the company's position to investors is that they've been relatively rate-neutral, and the substantial decline in the margin would perhaps not indicate that.

I'm just wondering if you all could drill into what happened in your various discretionary asset pools that you use to help manage the balance sheet in the quarter that caused the net interest income coming from those activities to be less than you expected, and I heard your comments about commercial loan growth, but I'm just wondering if there was just far faster prepays in your asset-backed pools than you had thought.

Ok, Tom.

Let me field that question.

First of all, we have informed people that we do have exposure to both rising and falling interest rates, and that was in our previous release and commented on in last quarter's earnings call as well.

Much of what we, therefore, call negative convexity, exposure to declining rates has to do with the implied deposit floors on many of our products, and that's where, due to competitive factors, we're just unable to reduce rates on our deposit base to the same degree of financial market rates.

So that explains part of that issue.

You're also correct in the prepay situation as described, of course, that affects not only us but the entire industry, and it's largely due to mortgage products that are on the balance sheet.

That includes residential mortgages, mortgage-backed security portfolios which we know -- you know we have been investing in as well as home equity lending products.

The prepayments have accelerated in all areas, and it does affect our investment portfolio as well, and they have been more rapid than we had previously anticipated.

That is a market phenomena at this point.

Can you share with us in your opinion what is the wedded (ph) average duration of the discretionary assets and the blended yield?

Are you speaking specifically to the investment portfolio, Tom?

Yes, investment securities and available for sale.

Ok.

In our Treasury-managed portfolio, about 90% is in agency CMO paper, and these are the short traunches (ph).

We have stressed our buying in the average life range of two to four years.

Our average life at the end of the quarter was 2.4 years, and that is unchanged from the previous quarter.

If you look historically, we have kept that portfolio average life within the two- to three-year time frame.

We think that's relatively short.

That is by design.

Some of the positions that we put on were to protect against the sustained low rate environment, which we viewed as an exposure.

Frankly, both the level of rates as well as the length of time that we have been in a low rate environment is beyond what we had previously expected.

And those positions that were set up to protect us against that rate environment are not perpetuals.

They run off over time.

Again, that was by design, and it's been accentuated to some degree by the prepayment situation that we described earlier.

Ok.

Then sort of moving ahead, can you all give us a sense of your expectation for net interest income in the second quarter?

Would you expect it to be down?

From the first quarter?

Tom, this is Jeff Weeden.

I would anticipate that -- a couple things that will happen here in the second quarter as we start looking forward.

The margin will continue to be under pressure based upon the low rate environment that we're operating under at this time.

The second item on there that does benefit, obviously, is we go further into the year, we do gain an additional day in the second quarter and obviously two days in both the third and fourth quarter over the first, so that helps some.

We do need to have a little bit more growth coming out of some of our portfolios and getting some earning asset growth.

As you can see, we've had very good success on growing the core deposits and reducing our loan to deposit ratio, so from a strategic standpoint, that is working for us very, very well.

We just need to have some additional earning asset expansion at this point in time to help improve the net interest income going forward.

Just one final follow-up, if I may, Joe.

The CMO paper that you're buying, is that fixed rate or are those floating?

It's fixed rate paper, Tom.

Again, largely the early traunches of CMO structures.

Ok.

Thank you all very much.

We'll take our next question from Jeff Davis at FDN Securities.

Good morning.

Couple questions.

Guidance of 2.15 to 2.30, 51 cents this quarter, how do we make up the difference to take earnings up from here?

What sort of assumptions are you all working with?

Well, Jeff, this is Jeff Weeden, we're working with the assumption here that we'll have improvement as we go through the year from our market-sensitive businesses.

We think the first quarter, as we described, was a very difficult environment for these businesses, and as we progress through the year, we typically do show momentum on a seasonal basis.

First quarter historically has been our softest quarter of the year.

So we expect to build as we go through the year on fee-related income, and we also would anticipate that we would start, you know, with the economy improving to show some more loan growth on the commercial side from the current levels.

Expenses are going to continue to be extremely important to keep control of, and we are watching them as I think you can see from our first quarter numbers very, very closely.

So it's going to take expense discipline, improvement, stable to improving credit quality, growth in our core businesses and improvement in our market-sensitive-related revenues.

Jeff Davis: Ok.

But, Jeff, it doesn't sound like I hear you all say that things are picking up anytime soon.

It sounds like even the low end is going to be somewhat of a stretch unless the reserve is drawn down.

The day count issue for the dollars but the margin side will be down over the next quarter.

This is Henry, Jeff.

We have had a practice of not pulling down from the reserve and there are no aggressive assumptions in making that range.

I would only refer back as another important factor to slide 6, where we show at the bottom of that slide the runoff portfolios both consumer and commercial.

That portfolio started in May of 2001 at $5.6, $5.7 billion.

We've seen 4 billion of runoff, that is, a negative vector in terms of our loan growth.

While we still have 1.7 billion showing here, that will run off over a slower period in time which again will help the competitive, you know, area's geography that we're in.

We think that we've got a chance at seeing stable to some growth if the economy, you know, will help us a little bit, but I don't want to leave you with the impression that to make that range, we're going to be drawing down from the reserve or have any wild assumptions, aggressive assumptions in there.

As Jeff mentioned, and I think it's important to remember in terms of KeyCorp, and that is that our fourth quarter, because of a lot of the Capital Markets business, is usually our strongest with a drop-off in the first.

Not only did we get that drop-off, but we saw almost no business being done nationally, and we don't think Capital Markets activity will stay at these levels for all of 2003.

OK.

And there wasn't any implicit criticism.

Just the economy is what it is.

And a little bit different question, after the $17 million is used this quarter, does the provision match net charge-offs going forward, I guess with the third quarter, Henry?

Yes.

That's been our policy.

When we -- if we ever deviate from it, we'll have a damn good reason, but I'm not going to engineer earnings by drawing down on the reserve.

There may be a day if we continue to get out of some of the less-desirable portfolios where we look at a core reserve of 2.4 billion and say, wow, that's a lot.

We're not at that stage at this point in time, and unless the economy stays -- it isn't where I'd like to be, but I have learned that predicting the future is very difficult, but I would tell you I'm very, very confident that in 2003, we will be covering chargeoffs except for, as you pointed out, the 17 million that is probably going to be taken down in the second quarter.

Ok.

Thank you, gentlemen.

We'll go next to Michael Mayo at Prudential.

Hi.

How much in NPA's did you sell this quarter?

We sold about 44 million growth.

Ok.

And are all the stepped-up expenses for pension and other benefits in this quarter's numbers or do you have some more step-up expenses in the next quarter or two.

Mike, this is Jeff Weeden.

Everything for pension and employee benefits as well as there are some seasonal payroll tax items that hit companies a little bit harder in the first quarter, those are all embedded into the numbers.

We did not have any stock option grants in the first quarter.

We'd anticipate that option grants would occur in the second half of the current year.

So there will be a charge at that point in time when options are granted, and of course it also depends on the level of options that are granted at that time.

How much more would that be for expenses then?

We've estimated that would be approximately 2 cents.

2 cents a quarter?

No, for the balance of the year.

OK.

So 1 cent each third and fourth quarter?

That would be correct.

Ok.

The margin did go lower, but if I recall just a few quarters ago, and Jeff, obviously you aren't responsible for that, but when you looked at the interest rate sensitivities, you know, for a while there, KeyCorp was a lot more neutral than all the other banks which are asset-sensitive.

So kind of what went wrong with the interest rate modeling?

Well, I think we've got -- you know, I don't know if something went wrong here.

I would say that the way we were competing in the marketplace for deposits and the costs of those deposits is higher than perhaps what was modeled.

In the initial time, Mike, going back, perhaps, to last summer in the modeling, while rates were modeled to come down or to drop, it was a gradual drop over a period of several months.

When the Fed came in and cut rates in November, it had a much more dramatic impact.

The asset side adjusts in this particular case, adjusted more quickly than we were able to drop and reduce the rates on consumer deposits.

Some of these deposit rates at the time when the rates were cut were below 50 basis points, and so it becomes virtually impossible for you to pick up, you know, basis point for basis point reduction at that point in time.

So that did have an impact on us, and I think the other part that while we're growing the deposit side, we have had soft loan demand on the commercial side, and that's also putting pressure, if you will, on that margin.

How much did the prepayment in the investment portfolio hurt the margin this quarter?

Joe, do you know the impact of that?

Yes.

The combination of the MBS portfolio as well as the home equity portfolio, we're probably speaking about a third of the total margin change.

Ok.

And then lastly, tax rate, I guess, was a little below average.

Do you expect that to stay there or what?

Well, we would expect that the tax rate would begin to move back up again.

You know, it's dependent upon how much tax advantage income you have in relationship to your total income.

The expectation would be that it would rise for the balance of the year, Mike, and get back up to probably around the 32, 33% from the current level.

Actually just one last question.

I know you started free checking not that long ago.

Were you anticipating less overdraft fees and less deposit service charges when you implemented the plan, or are you kind of taking a second look and saying, well, maybe we need to tinker this approach?

No, we actually -- this is Henry, Mike.

We actually did -- we knew when we offered free checking on an expanded basis that the offset would be some reduction in service charge income, so we did that with our eyes open.

I also just wanted to reiterate what Jeff said in terms of I would not characterize our interest margin slippage as what went wrong, much more so, it was we got caught up.

You'll remember that in the third and fourth quarter of last year, we stayed pretty consistent, constant at about a 397, 398, while our peers were dropping on average in the third quarter six basis points and in the fourth quarter, 10 basis points.

That was because, as you just pointed out, we really did get some momentum on bringing in free DVA during that period and lower margin assets were running off in our runoff portfolio.

The Fed cut in November, however, made DVA worth that much less to us in terms of the alternative, so I think it's just a convergence of a number of smaller issues like a couple of basis points from the paydowns on the mortgage-backed securities that all caught us in the first quarter no worse than what I'm reading from, you know, our peer banks, some of them with an even much more dramatic, and they've dropped in the third and fourth.

So it isn't so much what went wrong, it's just the inevitability of this low-rate environment.

Ok.

Thanks a lot.

We'll go next to Jennifer Thompson at Putnam Lovell.

Could you give us color into the inflow of non-performing loans, in terms of was it mostly middle market, were there any concentrations?

And also if you could comment on watch list trends.

Kevin Blakely will comment.

Yeah, Jennifer.

The inflows into non-performers, there wasn't any specific portfolio where we saw a huge inflow.

There was a little bit of an increase here, a little bit of a decrease there.

We saw our biggest decrease in the structured finance portfolio, but I can't really pinpoint any one particular portfolio, Jennifer, where we saw significant deterioration.

It was more $10 million here, $5 million there, things of that nature.

And as far as the watch list, if we look at our level of internal criticized and classified, I would describe them as basically stable from the end of the fourth quarter through the end of the first quarter.

And if we rise above the criticized classified, I would say that the last categories of past loans actually decreased, the volume in the last category of past loans decreased from the fourth quarter to the first quarter, meaning that the pipeline is basically significantly drying up.

Just qualitatively, would you say that asset quality is a little better than you would have expected at this point?

Actually we saw a rather significant improvement in the fourth quarter.

We saw basically a stabilization in the first quarter.

Given as sluggish as the economy has been, I would say that we're pretty pleased with where things turned out.

Great.

Thanks very much.

We'll go next to John McDonald at UBS Warburg.

Good morning.

Morning, John.

Not sure if Rick is on the line, but could someone comment on how the fund flows have been at Victory?

Rick is not on the line, but I will comment with regard to some of the fund flows.

As I talked about, the 401(k) business, if you will, and just looking at the change, and we have the assets under management in our press release where they went from the fourth quarter from 61.7 billion down to 60.8 billion.

There's a decline in there of about 900 million. 2 billion of that decline really resulted from, again, this transferring of the 401(k) business from us to another provider, and so the actual other funds flows, even in a down market, did come in positively for the company in the first quarter.

Ok.

If I could ask Kevin too.

Kevin, what's your sense in terms of a normalized charge-off ratio over a cycle where you guys could be?

Could you just remind us of that?

Yeah, we're estimating probably in the vicinity of around 65 basis points.

On a normalized basis.

Thanks.

We'll take our next question today from David Pringle at Fulcrum.

Good morning.

Morning.

Could you take a little bit, you were -- let me back up.

I'd like to ask the same question this quarter I asked last quarter.

If everything stays the same, where does the margin end up?

This is The margin -- we would anticipate -- if everything remains status quo, that it would only drift down modestly.

We're really looking at something in approximately the 380 range for the balance of the year.

Thank you for answering that question.

You know, your CNI book was up a little bit quarter to quarter.

Could you talk about what you're seeing there, please?

Yeah.

Is that Henry?

Yes, it's Henry.

We're seeing not a lot of difference in our regions, but if I had to tell you that our weakest region -- if I had to pick that one, it's not the Midwest right now.

It's the northwest.

We're seeing loan volumes there that are behind our other three regions.

I read the same things you all do, although I don't listen to their conference calls, but our Midwest overlap banks are predicting a little bit better loan demand in the second, third and fourth quarter.

We actually have some encouraging discussions and pipeline, but they're not booked yet, so we want to be cautiously optimistic.

Thank you.

We'll take our next question from Gerard Cassidy at RBC Capital Markets.

Thank you.

Good morning.

Good morning.

Couple questions.

First is on the 401(k) transfer business, can you share with us some color of what happened, why maybe more of your customers didn't stay with the buyer.

And I don't recall, did you say who bought that business from you guys?

Yeah, Principal Group is where we ended up transferring that, and yes, we did misjudge it.

And let me tell you why.

Our performance had been very good, but as you all know, with bigger companies, publicly traded companies, we have been saying that you can't rent space on our balance sheet.

That you need to give us, we need to earn additional business.

What we miscalculated was that some of the additional business in CFO and treasurers' minds, very competitively placed, was in the 401(k) business that they gave us, the transfer business.

While we were very competitive, when we were going to stop doing that, instead of them saying, hey, we're happy, they said, hey, this is an opportunity for me, the company, to give some of that business to another one of our line or credit banks.

And I would tell you in almost total, that was where we misjudged.

We weren't as aware of how the divvying up of extra business was being done at corporations, so when it left us, because Key wasn't getting credit for additional business anymore, the companies, instead of just going with the Principal Group, decided to let a lot of other banks bid.

Ok.

And then the second question, in light of the fact that unemployment insurance claims seem to be a bit higher today than expected, there's talk now about the possibility of another Fed funds rate cut, maybe 25, 50 basis points.

If that was to happen, could you tell us what impact that might have on your guys' margins, and would that have you reconsider your outlook for earnings?

Well, I think if you look at an additional rate cut, because we have modeled that and looked at it in my comments, I said we do have negative convexity, if you will, so it would have potential impact obviously on prepays, and again, the competitive pressures that we would see in the marketplace for reducing deposit costs, but it would require us to go through and, you know, aggressively manage those particular costs on down.

But in our modeling, it does show that it would have a slight, you know, impact to the company over the next 12 months.

Thank you.

We'll go nets to Roger Lister at Morgan Stanley.

Good morning.

Wondering if you can tell us a feel for what's going on in terms of success with workouts and resolving loan issues.

I see you got payments this quarter of 75 million, which is down from last quarter but better than you've been doing earlier in the year.

What's happening on that side of the loan resolution?

Unidentified Actually we're pretty pleased with the way that the workout portfolios are going.

A lot of the workout was driven originally by structured finance and health care loans, which we for all intents and purposes stopped doing at the beginning of the year 2000.

Those portfolios have been seasoning for quite some time now.

It takes a while to work your way through them.

We are seeing quite a few successes in that regard.

So I would say that overall, we're pretty pleased with the direction that the workout portfolio is going.

I will also say that workouts like many other things are sort of a seasonal business too.

As we look back, we typically see a greater level of paydowns in the fourth quarter for whatever reason, but I think that, you know, as we look forward into 2003, we see some pretty good paydowns on the horizon too.

So we're sort of satisfied with the direction that our portfolio is going at this juncture.

This is Henry.

You know, our workout group is appropriately called the asset recovery group.

That's ARG for short.

But they have restructured, we brought a lot of talent into that group, and we really are seeing some -- I would be more positive, and then I get kicked by both Jeff and Kevin, but we're finally getting to the bottom of some of the troubles we're seeing, as Kevin indicated.

I think there's a light at the end of the tunnel, but as we all know with the uncertainty in this economy, it is way too early to raise a big victory flag, but through the first quarter and the first half of April, we're continuing to see a lot of small good signs in terms of the asset recovery group.

You've talked about the commercial side.

What's happening in terms of delinquencies and some of the early indicators on the consumer side, and any variations across the regions where you're operating?

I can tell you that our delinquencies from the end of December through the end of March were down almost across the board in almost every category.

I'm scanning the list here right now.

Indirect auto lease is one of the few areas where we actually saw a slight increase in the delinquency, and that's only because the size of that portfolio is shrinking so much.

So as I look down the list, you know, in totality, our delinquencies are down, and also about every category is also down.

And obviously that is a good early indicator of charge-offs to come.

It doesn't mean that with a significant slowdown in consumer confidence in employment, that we wouldn't see delinquencies move back up, which would lead to charge-offs, but all of those early cycle improvements are a very good light at the end of the tunnel in terms of the ultimate P&L effect of charge-offs.

So maybe if the non-performers go down a little bit, that's a little bit of up side on the net interest margin, maybe people start paying on time?

It would take some pressure off certainly.

Thank you.

And we'll take our next question today from Nancy Bush at NAB Research.

Good morning.

Jeff, I think you made the comment that you needed some growth, and I'd like to ask about the growth plans there.

I mean, what are you guys doing on sort of the earning asset side to get more loans, et cetera?

Well, I think, you know, on the consumer side, we have had certainly success there with the home equity lending has continued to be strong for us as a company, and that's very much, of course, rate-driven by the level of interest rates that are in the marketplace.

On the commercial side, again it's just going to involve better execution going out and improvement in the confidence of our customers to begin to build up their inventory and have a positive outlook for the sales of their products and services.

I think eliminating some of the geopolitical issues out there will help with the confidence of consumers as well as businesses willing to go out and expand and take on additional inventory and plant and equipment.

There's certainly plenty of capacity as you know in the economy right now with capacity utilization in the mid 70's, low to mid 70's, but we're going to have to go out, we have to execute, we have to continue to call on customers.

Tom Bunn has reorganized his commercial unit.

It was announced last December.

That is in place.

He has been meeting with his management team.

They know the challenges.

It requires calling on customers and executing every day.

We were seeing, though, in the quarter from U.S.

Bancorp and several others the beginnings of some -- you know, some growth in middle market and Small Business and even in large corporate, so do you think it's a function of your region or competitive or is it all economy?

Nancy, it's Henry.

Some of it is the areas that we're in.

Some of it is a little bit of overall loan demand or loan growth that gets disguised or reduced by that run-off portfolio.

You know, we would have been in total loans without the run-off portfolio up about 2%, which is right in the middle of the pack of our peer banks.

Let me tell you what we're not going to do.

Tom Bunn is really focusing on a much more aggressive and managed sales process, but we are not going to reach on credit, which is something that we did in the past, and we got burned for it.

The truth is, we're not in the highest growth areas, although some of our regions have at times, both the Rockies and the northwest, been right up there geographically in terms of higher growth than the national average.

Right now they're not.

And our middle market companies, I've been out in our districts quite a bit in the last few months, and our customers at receptions come up and tell me how proud they are to be with Key, and oh, by the way, for the first time in their memory, they've managed their receivables down and their inventory down and they're not borrowing from us.

So I think the operating leverage is huge with just a little bit of rebound in terms of economic activity and we are doing through management a much more disciplined job of trying to get to the customers in our franchise market areas through the reorganization different people, different tools, and I'm not unhappy with where we are.

I don't want us to try to put loans on the books by reducing our credit standards.

When will the run-off portfolio have run off at present levels?

Are we sort of at a -- you know, are we looking at sort of two years before everything is gone and it goes very slowly from here unless you're really able to show some collective earning asset growth?

I think, Nancy, that you would hit exactly where we would be.

I don't think we're going to be using that negative run-off in 2003 as much of a number.

It's probably going to take two years to be honest in the high quality even investment grade single relationship in the run-off portfolio.

There's a couple of good loans.

They are investment grade.

They don't mature for another three years, but they'll be tag ends.

You know, they'll be inconsequential.

I think as Jeff said, that we're not going to make any more reference to the run-off portfolio after June of this year.

There will still be a billion dollars working its way down, but it will work its way down slowly, as opposed to the dramatic 4 billion run-off that we've seen in the 18 months, two years since we started the program.

Thank you.

We'll take the next question from Eileen Rooney at Fox-Pitt, Kelton.

It's Dennis Laplante.

Thank you.

The decline in deposit service charges from 100 down to 92 million year over year, is that all NSF charges?

And if so, just trying to get a sense of, I understand a lot of that is related to the free checking offerings that you're doing.

Could you give us kind of where you think that's going to kind of bottom out?

Dennis, this is Jeff Weeden.

I think in terms of overdraft fees this year versus last year, there's really no difference between the two years.

Where you have a decline is generally in a seasonal impact, people incur a lot of overdrafts with the holiday season, if you will, and also have you a decline as a result of two fewer days.

So you have fewer days plus your work through the holiday, and consumers tend to get refunds in the first quarter and get a little bit more flush with cash at that particular point in time.

We had the decline between the two years, as we look at just the general maintenance fees or charges associated with the free checking at this time, and I think we've started to reach a plateau, if you will, because the difference between the fourth quarter and the first quarter on those fees is virtually nonexistent.

And free checking -- this is Henry.

Free checking is free monthly service charge.

We still charge for overdrafts, and for everybody but my wife and kids, an occasional overdraft is a good piece of business.

I misspoke on the NSF, but basically -- you had talked about seasonal factors, Jeff.

I was really kind of referring to Q1-Q1, the 100 to 92.

Is that all sort of the basic fees that you've waived now with the free checking, is that accounting for all that difference?

Yes, it is.

Ok.

And at this point, are we likely to see a further bottoming of those charges, you know, another ramp-down in terms of those numbers, or are we approaching an equilibrium between NSF and the maintenance fees?

I think we've reached equilibrium as far as what we would expect on those particular fees at this time.

Great.

In terms of the money market deposit growth linked quarter, it was pretty awesome, actually.

How much of that would you say is related to between the NOW and the MMDA numbers that you show?

I think it was close to a billion dollars.

I don't have the page in front of me now, but it was a billion dollars plus, as I recall.

How much of that is related to the free checking offerings?

Well, that, of course, free checking offerings would be in the non-interest-bearing accounts, so the increase that we have in the billion dollar plus in the NOW and MMDA accounts is coming from what we are paying interest on.

Dennis Laplante Ok.

So that's a separate promotional offering that you're providing?

Yes.

We're providing a bonus rate above the initial rate for a period of six months on certain deposit accounts at various levels of deposits with us in the MMDA account.

Ok.

Any geography that's driving that?

That's spread across all of our regions as far as the growth goes, Dennis.

Great.

Thanks for your time.

And we'll go next to Scott Siefers at Sandler O'Neill.

Good morning, everybody.

I was just curious, you guys have mentioned the health care portfolio specifically in past quarters when you're just talking about general asset quality trends.

Just curious how well the quality is holding up in that portfolio.

Ok.

Scott, the specific portfolio, I think that you were referring to was our assisted living portfolio.

Yeah.

Sorry.

And that's actually -- I think we're actually moving outside the tunnel.

We're no longer looking at the light at the end of the tunnel.

We are actually out of it.

We are down to around 212, $213 million in that portfolio now.

We did throw another one on non-performing this last quarter, but the pipeline is basically dried up for that portfolio.

I think we're pretty satisfied with the way that things are going now.

All right.

Thank you very much.

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

Good morning.

A couple quick questions.

First, with respect to your CNI business, do you know offhand what your current utilization rate is in your working capital line of credit portfolio within CNI?

And then I've got a question on expenses as a follow-up.

How much of the committed error are we funding.

Thanks.

I'm not certain I have that number right here with us.

We'll have to get back to you on how much is actually being funded.

I don't have the number.

I know from discussions with Tom Bunn and others that it's at one of the lowest levels, probably the lowest level we've seen because a lot of the payoffs that I talked about earlier are on the lines of credit, so I think our commitments are going to be very consistent and our usage is down, but we will get that number for you.

Appreciate it.

And secondly, on expenses, I know in kind of your strategic overview and guidance, you reference strong expense management.

Can you provide any type of color there?

Are you planning any type of additional head count reductions or, I guess, can you just kind of provide some color with respect to expenses?

Well, I think we're going to control expenses without getting into any specific details or what you're asking, if there are any special programs, et cetera, in the offing.

We are constantly evaluating our businesses and our expense levels, and obviously the revenue by business line, and so we're going through a constant strategic, you know, kind of review of the businesses on a regular basis to ensure that the expense levels are appropriate for the business opportunities that are there.

There's no specific program, if you will, to discuss.

On the other hand -- this is Henry -- I started off by saying I was disappointed in the performance in the first quarter.

To some degree, the economy is the same for everybody.

We cannot and I won't accept, the economy as an excuse, although I understand the economy is there, and if revenues are going to be below where people predicted, then they've got to manage their expense levels to the current revenue levels, which will mean, as Jeff said, we're going to be constantly looking at, but you can't wish expenses away.

You have to manage expenses away, and I'm going to take an aggressive approach on keeping our revenue and expense numbers in line, recognizing that I don't want to be cutting into the bone at the exact moment that the economy turns.

What we're trying to do is position Key to really have gotten a lot of these run-off portfolios, strategic decisions behind us.

The telltale success for our company is going to be the ability to generate revenue when the economy comes back a little bit, and in the meantime, we're going to be very aggressive on the lower performers or businesses that are not returning what we want from shareholder perspective.

Operator, we have time for one more question here.

Thank you.

We'll take today's last question as a follow-up from Jeff Davis at FTN Securities.

Actually mine were covered.

Thank you.

At this time, I'd like to turn the call back over to our speakers for any additional or closing remarks.

I just again -- we've gone an hour.

I appreciate everyone's taking the time to be with us, and again, if you've got any follow-ups, please don't hesitate to give Vern a call, and we will follow up on that one answer in terms of our loans to commitments, but we're not pleased with where we are, but we are doing the kinds of things that I think will help us get to that range.

We are comfortable in this environment with the range that Jeff indicated.

So with that, we'll close, and wish everyone a great day.

Thank you for your participation in today's conference, and you may disconnect at this time.