MANAGEMENTGLYPH<213>S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES FIGURE 5. INVESTMENT MANAGEMENT SERVICES Year ended December 31, Change 2003 vs 2002 dollars in millions 2003 2002 2001 Amount Percent SUMMARY OF OPERATIONS Net interest income (TE) $250 $227 $224 $ 23 10.1% Noninterest income 556 623 677 (67) (10.8) Total revenue (TE) 806 850 901 (44) (5.2) Provision for loan losses 16 14 13 2 14.3 Noninterest expense 635 658 723 (23) (3.5) Income before income taxes (TE) 155 178 165 (23) (12.9) Allocated income taxes and TE adjustments 58 67 67 (9) (13.4) Net income $97 $111 $ 98 $(14) (12.6)% Percent of consolidated net income 11% 11% 74% N/A N/A AVERAGE BALANCES Loans $5,060 $4,827 $5,179 $ 233 4.8% Total assets 6,121 5,840 6,390 281 4.8 Deposits 6,084 3,920 3,675 2,164 55.2 TE = Taxable Equivalent, N/A = Not Applicable In 2002, Other Segments generated net income of $34 million, compared with a net loss of $12 million for the prior year. In 2002, net losses from principal investing activities decreased by $65 million ($41 million after tax), or 82%. This improvement was offset in part by a decrease in earnings attributable to funds transfer pricing. Noninterest expense decreased by $23 million, or 3%, in 2003, due primarily to a $19 million reduction in personnel expense and decreases in various indirect charges. Personnel expense declined as a result of intentional staff reductions, lower variable incentive compensation associated with revenue generation and the sale of the 401(k) plan recordkeeping business. Key’s principal source of earnings is net interest income. Net interest income is the difference between interest income received on earning assets (such as loans and securities) and loan-related fee income, and interest expense paid on deposits and borrowings. There are several factors that affect net interest income, including: Net interest income RESULTS OF OPERATIONS ADDITIONAL INVESTMENT MANAGEMENT SERVICES DATA December 31, in billions 2003 2002 Assets under management $68.7 $61.7 Nonmanaged and brokerage assets 66.4 65.0 • the volume, pricing, mix and maturity of earning assets and interest- bearing liabilities; • the use of derivative instruments to manage interest rate risk; • market interest rate fluctuations; and • asset quality. In 2002, net income increased primarily as a result of a $65 million, or 9%, reduction in noninterest expense, offset in part by a $54 million, or 8%, decrease in noninterest income. Lower personnel expense and a reduction in goodwill amortization following the 2002 adoption of a new accounting standard drove the improvement in noninterest expense. The decrease in noninterest income reflected weak conditions in the financial markets, which led to a decline in income from trust and investment services. The sale of the 401(k) plan recordkeeping business also reduced both noninterest income and noninterest expense. To make it easier to compare results among several periods and the yields on various types of earning assets, some of which are taxable and others which are not, we present net interest income in this discussion on a “taxable-equivalent basis” (i.e., as if it were all taxable and at the same rate). For example, $100 of tax-exempt income would be presented as $154, an amount that — if taxed at the statutory federal income tax rate of 35% — would yield $100. Figure 6, which spans pages 18 and 19, shows the various components of Key’s balance sheet that affect interest income and expense, and their respective yields or rates over the past six years. This figure also presents a reconciliation of taxable-equivalent net interest income for each of those years to net interest income reported in accordance with accounting principles generally accepted in the United States (“GAAP”). Other Segments consist primarily of Treasury, principal investing and the net effect of funds transfer pricing. These segments generated a net loss of $1 million for 2003, compared with net income of $34 million for 2002. The unfavorable change was due primarily to the net effect of funds transfer pricing. Internal funds transfer pricing rates used to assign credit for new deposits generated by the lines of business were higher than the yields available on various investment opportunities at the time. The decrease in earnings attributable to funds transfer pricing was offset in part by net principal investing gains of $40 million ($25 million after tax), compared with net losses of $14 million ($9 million after tax) for 2002. Other Segments NEXT PAGE PREVIOUS PAGE SEARCH BACK TO CONTENTS 17