MANAGEMENTGLYPH<213>S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES We actively manage our interest rate sensitivity through investment securities, debt issuance and derivatives. Interest rate swaps are the primary tool we use to modify our interest rate sensitivity and our asset and liability durations. During the past year, management has focused on interest rate swap maturities of two years or less to preserve the flexibility of changing from “liability sensitive” to “asset sensitive” in a relatively short period of time. The decision to use these instruments rather than securities, debt or other on-balance sheet alternatives depends on many factors, including the mix and cost of funding sources, liquidity and capital requirements, and interest rate implications. Figure 27 shows the maturity structure for all swap positions held for asset/liability management purposes. These positions are used to convert the contractual interest rate index of agreed-upon amounts of assets and liabilities (i.e., notional amounts) to another interest rate index. For example, fixed-rate debt is converted to floating rate through a “receive fixed, pay variable” interest rate swap. For more information about how Key uses interest rate swaps to manage its balance sheet, see Note 19 (“Derivatives and Hedging Activities”), which begins on page 80. Key’s investment and term debt portfolios are also used to manage interest rate risk. Details regarding these portfolios can be found in the discussion of securities, beginning on page 28, in Note 6 (“Securities”), which begins on page 61, and in Note 12 (“Long-Term Debt”) on page 69. Over the past two years, we have invested more heavily in collateralized mortgage obligations as opportunities to originate loans have been adversely affected by the soft economy, while our core deposits have grown significantly. These securities, the majority of which have relatively short average lives, have been used in conjunction with swaps to manage our interest rate risk position. One measure of our success in managing Key’s interest rate exposure is the performance of Key’s net interest margin relative to that of its peers. Figure 28 shows Key’s net interest margin for each of the last eight quarters compared with the peer median net interest margin represented by the Standard & Poor’s Regional and Diversified Bank indices. Each financial institution included in the peer group has a different business mix and product pricing structure that influences the level of its net interest margin. However, the volatility of the net interest margin over time is influenced by the level and direction of interest rate risk. As indicated in Figure 28, over the past eight quarters Key’s net interest margin has been more stable than the median net interest margin of the peer group. Since the first quarter of 2002, Key’s net interest margin decreased by 15 basis points to 3.78%, compared with a decrease of 45 basis points to 3.70% for our peers. a Portfolio swaps designated as A/LM are used to manage interest rate risk tied to both assets and liabilities. b These portfolio swaps are not designated as hedging instruments under SFAS No. 133. FIGURE 27. PORTFOLIO SWAPS BY INTEREST RATE RISK MANAGEMENT STRATEGY FIGURE 28. NET INTEREST MARGIN  (TAXABLE EQUIVALENT) December 31, 2003 December 31, 2002 Weighted-Average Rate Notional Fair Maturity Notional Fair dollars in millions Amount Value (Years) Receive Pay Amount Value Receive GLYPH<222>xed/pay variable GLYPH<209>  conventional A/LM a $12,275 $ 87 1.3 2.6% 1.2% $ 5,750 $ 170 Receive GLYPH<222>xed/pay variable GLYPH<209>  conventional debt 5,443 321 7.0 5.5 1.2 4,843 486 Receive GLYPH<222>xed/pay variable GLYPH<209>  forward starting GLYPH<209> GLYPH<209> GLYPH<209> GLYPH<209> GLYPH<209> 50 GLYPH<209> Pay GLYPH<222>xed/receive variable GLYPH<209>  conventional debt 1,496 (90) 5.2 1.9 5.7 1,833 (148) Pay GLYPH<222>xed/receive variable GLYPH<209>  forward starting 14 GLYPH<209> 2.1 3.2 4.2 16 GLYPH<209> Foreign currency GLYPH<209>  conventional debt 1,538 304 1.7 2.4 1.4 2,061 195 Basis swaps b 10,095 (2) .8 1.2 1.2 6,645 (3) Basis GLYPH<209> forward starting b 2,500 GLYPH<209> 2.0 1.2 1.3 GLYPH<209> GLYPH<209> Total portfolio swaps $33,361 $620 2.3 2.5% 1.4% $21,198 $ 700 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 4.50% 3.93% 3.98% 3.99% 3.98% 3.85% 3.73% 3.78% 4.15% 3.70% 3.86% 3.00% 3.25% 3.50% 3.75% 4.00% 4.25% KEY Peer Median S&P Regional & Diversified Bank Indices 36 NEXT PAGE BACK TO CONTENTS SEARCH PREVIOUS PAGE