MANAGEMENTGLYPH<213>S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES HIGHLIGHTS OF KEYGLYPH<213>S 2003 PERFORMANCE • Net income for 2003 was $903 million, or $2.12 per common share, compared with $976 million, or $2.27 per common share for 2002, and $132 million, or $.31 per share for 2001. • Key’s return on average equity was 13.08% for 2003, compared with a return of 14.96% for 2002 and 2.01% for 2001. • Key’s 2003 return on average total assets was 1.07%, compared with a return of 1.19% for 2002 and .16% for 2001. Key’s 2003 results reflect several improved performance trends: • Asset quality has continued to improve; the level of Key’s nonperforming loans has been on a downward trend since mid-2002. At December 31, 2003, nonperforming loans were at their lowest level since March 31, 2001. Additionally, net loan charge-offs for the fourth quarter of 2003 were at their lowest level since the first quarter of 2001. The primary measures of Key’s financial performance for 2003, 2002 and 2001 are summarized below. Figure 1 on page 12 summarizes Key’s financial performance for each of the past six years. The valuation and testing methodologies used in Key’s analysis of goodwill impairment are summarized in Note 1 under the heading “Goodwill and Other Intangible Assets” on page 53. The first step in testing for impairment is to determine the fair value of each reporting unit. If the carrying amount of any reporting unit exceeds its fair value, goodwill impairment may be indicated and a second step would be required. Two primary assumptions are used in determining these fair values: Key’s revenue growth rate and the future weighted average cost of capital (“WACC”). Key’s goodwill impairment testing for 2003 assumed a revenue growth rate of 6% and a WACC of 11.5%. Assuming Key’s principal investments include direct and indirect investments, predominantly in privately held companies. The fair values of these investments are estimated by considering a number of factors, including the investee’s financial condition and results of operations, values of public companies in comparable businesses, market liquidity, and the nature and duration of resale restrictions. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting Key’s financial condition and results of operations. The fair value of principal investments was $732 million at December 31, 2003; a 10% positive or negative variance in the fair value would increase or decrease Key’s earnings by $73 million ($46 million after tax), or $.11 per share. Valuation methodologies. Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable liquid markets for the items being valued. The outcomes of valuations performed by management have a direct bearing on the carrying amounts of assets and liabilities, including principal investments, goodwill, and pension and other postretirement benefit obligations. To determine the values of these assets and liabilities, as well as the extent to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, repayment rates and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect Key’s results of operations. In the normal course of business, Key is routinely subject to examinations and challenges from tax authorities regarding the amount of taxes due in connection with investments and business activities. Currently, the Internal Revenue Service is challenging Key’s tax treatment of certain leveraged lease investments. This and other challenges by tax authorities may result in adjustments to the timing or amount of Key’s taxable income or deductions or the allocation of income among tax jurisdictions. Management believes these challenges will be resolved without having any material effect on Key’s financial condition or results of operations. Key records a liability for the fair value of the obligation to stand ready to perform over the term of a guarantee, but there is a risk that Key’s actual future payments in the event of a default by a third party could exceed the liability recorded on Key’s balance sheet. See Note 18 for a comparison of the liability recorded and the maximum potential undiscounted future payments for the various types of guarantees that Key had outstanding at December 31, 2003. that only one of these two factors changes at a time, the second step of the impairment testing would be necessary if the revenue growth rate approximated negative 10% or the WACC was in the range of 17.5% to 26.5%, depending on the particular reporting unit. These sensitivities are hypothetical and not completely realistic since a change in one of these assumptions is evaluated without changing the other. In reality, a change in one assumption could affect the other. The primary assumptions used in determining Key’s pension and other postretirement benefit obligations and related expenses, including sensitivity analysis of these assumptions, are presented in Note 16 (“Employee Benefits”), which begins on page 73. When a potential asset impairment is identified through testing, observable changes in liquid markets or other means, management also must exercise judgment in determining the nature of the potential impairment (i.e., whether the impairment is temporary or other than temporary) in order to apply the appropriate accounting treatment. For example, unrealized losses on securities available for sale that are deemed temporary are recorded in shareholders’ equity, whereas those deemed “other than temporary” are recorded in earnings. Additional information regarding temporary and other-than-temporary impairment at December 31, 2003, is provided in Note 6 (“Securities”), which begins on page 61. Corporate improprieties related to revenue recognition have received a great deal of attention by regulatory authorities and the news media. Although all companies face the risk of intentional or unintentional misstatements, Key’s management believes that such misstatements are less likely in the financial services industry because most of the revenue (i.e., interest accruals) recorded is driven by nondiscretionary formulas based on written contracts, such as loan agreements. Revenue recognition 11 NEXT PAGE PREVIOUS PAGE SEARCH BACK TO CONTENTS