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Section 1: 10-Q (10-Q)

Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549 
 
 
FORM 10-Q
 
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2018

Commission File Number 001-11302
 
 
 
393331886_keycorplogocmykpage001a05.jpg
Exact name of registrant as specified in its charter:
 
 
Ohio
34-6542451
State or other jurisdiction of incorporation or organization:
I.R.S. Employer Identification Number:
127 Public Square, Cleveland, Ohio
44114-1306
Address of principal executive offices:
Zip Code:
(216) 689-3000
Registrant’s telephone number, including area code:
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   No 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  No 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐  (Do not check if a smaller reporting company)
Smaller reporting company
Emerging growth company
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Shares with a par value of $1 each
1,061,663,471 shares
Title of class
Outstanding at April 30, 2018


Table of Contents

KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
 
 
Page Number
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents

Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
Item 4.
 
PART II. OTHER INFORMATION
 
Item 1.
Item 1A.
Item 2.
Item 6.
 


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Table of Contents

PART I. FINANCIAL INFORMATION

Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations

Introduction

This section reviews the financial condition and results of operations of KeyCorp and its subsidiaries for the quarterly periods ended March 31, 2018, and March 31, 2017. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends in greater depth. When you read this discussion, you should also refer to the consolidated financial statements and related notes in this report. The page locations of specific sections and notes that we refer to are presented in the Table of Contents.

References to our “2017 Form 10-K” refer to our Form 10-K for the year ended December 31, 2017, which has been filed with the SEC and is available on its website (www.sec.gov) and on our website (www.key.com/ir).

Terminology

Throughout this discussion, references to “Key,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of KeyCorp and its subsidiaries. “KeyCorp” refers solely to the parent holding company, and “KeyBank” refers to KeyCorp’s subsidiary bank, KeyBank National Association.

We want to explain some industry-specific terms at the outset so you can better understand the discussion that follows.
 
We use the phrase continuing operations in this document to mean all of our businesses other than the education lending business and Austin. The education lending business and Austin have been accounted for as discontinued operations since 2009.
Our exit loan portfolios are separate from our discontinued operations. These portfolios, which are in a run-off mode, stem from product lines we decided to cease because they no longer fit with our corporate strategy. These exit loan portfolios are included in Other Segments.
We engage in capital markets activities primarily through business conducted by our Key Corporate Bank segment. These activities encompass a variety of products and services. Among other things, we trade securities as a dealer, enter into derivative contracts (both to accommodate clients’ financing needs and to mitigate certain risks), and conduct transactions in foreign currencies (both to accommodate clients’ needs and to benefit from fluctuations in exchange rates).
For regulatory purposes, capital is divided into two classes. Federal regulations currently prescribe that at least one-half of a bank or BHC’s total risk-based capital must qualify as Tier 1 capital. Both total and Tier 1 capital serve as bases for several measures of capital adequacy, which is an important indicator of financial stability and condition. As described under the heading “Regulatory capital requirements – Capital planning and stress testing” in the section entitled “Supervision and Regulation” that begins on page 8 of our 2017 Form 10-K, the regulators are required to conduct a supervisory capital assessment of all BHCs with assets of at least $50 billion, including KeyCorp. As part of this capital adequacy review, banking regulators evaluate a component of Tier 1 capital, known as Common Equity Tier 1, under the Regulatory Capital Rules. The “Capital” section of this report under the heading “Capital adequacy” provides more information on total capital, Tier 1 capital, and the Regulatory Capital Rules, including Common Equity Tier 1, and describes how these measures are calculated.


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Table of Contents

The acronyms and abbreviations identified below are used in the Management’s Discussion & Analysis of Financial Condition & Results of Operations as well as in the Notes to Consolidated Financial Statements (Unaudited). You may find it helpful to refer back to this page as you read this report.
ALCO: Asset/Liability Management Committee.
KAHC: Key Affordable Housing Corporation.
ALLL: Allowance for loan and lease losses.
KBCM: KeyBanc Capital Markets, Inc.
A/LM: Asset/liability management.
KCC: Key Capital Corporation.
AOCI: Accumulated other comprehensive income (loss).
KCDC: Key Community Development Corporation.
APBO: Accumulated postretirement benefit obligation.
KEF: Key Equipment Finance.
ASC: Accounting Standards Codification.
KMS: Key Merchant Services, LLC.
Austin: Austin Capital Management, Ltd.
KPP: Key Principal Partners.
BHCs: Bank holding companies.
KREEC: Key Real Estate Equity Capital, Inc.
Board: KeyCorp Board of Directors.
LCR: Liquidity coverage ratio.
Cain Brothers: Cain Brothers & Company, LLC.
LIBOR: London Interbank Offered Rate.
CCAR: Comprehensive Capital Analysis and Review.
LIHTC: Low-income housing tax credit.
CMBS: Commercial mortgage-backed securities.
LTV: Loan-to-value.
CME: Chicago Mercantile Exchange.
Moody’s: Moody’s Investor Services, Inc.
CMO: Collateralized mortgage obligation.
MRM: Market Risk Management group.
Common Shares: KeyCorp common shares, $1 par value.
N/A: Not applicable.
DIF: Deposit Insurance Fund of the FDIC.
NASDAQ: The NASDAQ Stock Market LLC.
Dodd-Frank Act: Dodd-Frank Wall Street Reform and
NAV: Net asset value.
Consumer Protection Act of 2010.
N/M: Not meaningful.
EBITDA: Earnings before interest, taxes, depreciation, and
NOW: Negotiable Order of Withdrawal.
amortization.
NPR: Notice of proposed rulemaking.
EPS: Earnings per share.
NYSE: New York Stock Exchange.
ERISA: Employee Retirement Income Security Act of 1974.
OCC: Office of the Comptroller of the Currency.
ERM: Enterprise risk management.
OCI: Other comprehensive income (loss).
EVE: Economic value of equity.
OREO: Other real estate owned.
FASB: Financial Accounting Standards Board.
OTTI: Other-than-temporary impairment.
FDIC: Federal Deposit Insurance Corporation.
PBO: Projected benefit obligation.
Federal Reserve: Board of Governors of the Federal
PCI: Purchased credit impaired.
Reserve System.
S&P: Standard and Poor’s Ratings Services,
FHLB: Federal Home Loan Bank of Cincinnati.
 a Division of The McGraw-Hill Companies, Inc.
FHLMC: Federal Home Loan Mortgage Corporation.
SEC: U.S. Securities and Exchange Commission.
FICO: Fair Isaac Corporation.
Series A Preferred Stock: KeyCorp’s 7.750%
First Niagara: First Niagara Financial Group, Inc.
Noncumulative Perpetual Convertible Preferred
(NASDAQ: FNFG).
Stock, Series A.
FNMA: Federal National Mortgage Association, or Fannie
TCJ Act: Tax Cuts and Jobs Act.
Mae.
TDR: Troubled debt restructuring.
FSOC: Financial Stability Oversight Council.
TE: Taxable-equivalent.
GAAP: U.S. generally accepted accounting principles.
U.S. Treasury: United States Department of the
GNMA: Government National Mortgage Association, or
Treasury.
Ginnie Mae.
VaR: Value at risk.
HelloWallet: HelloWallet, LLC.
VEBA: Voluntary Employee Beneficiary Association.
ISDA: International Swaps and Derivatives Association.
VIE: Variable interest entity.

Forward-looking statements

From time to time, we have made or will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements do not relate strictly to historical or current facts. Forward-looking statements usually can be identified by the use of words such as “goal,” “objective,” “plan,” “expect,” “assume,” “anticipate,” “intend,” “project,” “believe,” “estimate,” or other words of similar meaning. Forward-looking statements provide our current expectations or forecasts of future events, circumstances, results or aspirations. Our disclosures in this report contain forward-looking statements. We may also make forward-looking

5

Table of Contents

statements in other documents filed with or furnished to the SEC. In addition, we may make forward-looking statements orally to analysts, investors, representatives of the media, and others.

Forward-looking statements, by their nature, are subject to assumptions, risks, and uncertainties, many of which are outside of our control. Our actual results may differ materially from those set forth in our forward-looking statements. There is no assurance that any list of risks and uncertainties or risk factors is complete. Factors that could cause our actual results to differ from those described in forward-looking statements include, but are not limited to:

deterioration of commercial real estate market fundamentals;
defaults by our loan counterparties or clients;
adverse changes in credit quality trends;
declining asset prices;
our concentrated credit exposure in commercial and industrial loans;
the extensive regulation of the U.S. financial services industry;
changes in accounting policies, standards, and interpretations;
operational or risk management failures by us or critical third parties;
breaches of security or failures of our technology systems due to technological or other factors and cybersecurity threats;
negative outcomes from claims or litigation;
failure or circumvention of our controls and procedures;
the occurrence of natural or man-made disasters, conflicts, or terrorist attacks, or other adverse external events;
evolving capital and liquidity standards under applicable regulatory rules;
disruption of the U.S. financial system;
our ability to receive dividends from our subsidiary, KeyBank;
unanticipated changes in our liquidity position, including but not limited to, changes in our access to or the cost of funding and our ability to secure alternative funding sources;
downgrades in our credit ratings or those of KeyBank;
a reversal of the U.S. economic recovery due to financial, political or other shocks;
our ability to anticipate interest rate changes and manage interest rate risk;
deterioration of economic conditions in the geographic regions where we operate;
the soundness of other financial institutions;
tax reform and other changes in tax laws, including the impact of the TCJ Act;
our ability to attract and retain talented executives and employees and to manage our reputational risks;
our ability to timely and effectively implement our strategic initiatives;
increased competitive pressure from banks and non-banks;
our ability to adapt our products and services to industry standards and consumer preferences;
unanticipated adverse effects of strategic partnerships or acquisitions and dispositions of assets or businesses;
our ability to realize the anticipated benefits of the First Niagara merger; and
our ability to develop and effectively use the quantitative models we rely upon in our business planning.

Any forward-looking statements made by us or on our behalf speak only as of the date they are made, and we do not undertake any obligation to update any forward-looking statement to reflect the impact of subsequent events or circumstances. Before making an investment decision, you should carefully consider all risks and uncertainties disclosed in our SEC filings, including this report on Form 10-Q and our subsequent reports on Forms 8-K, 10-Q, and 10-K and our registration statements under the Securities Act of 1933, as amended, all of which are or will upon filing be accessible on the SEC’s website at www.sec.gov and on our website at www.key.com/ir.



6

Table of Contents

Selected financial data          
      
Our financial performance for each of the last five quarters is summarized in Figure 1.

Figure 1. Selected Financial Data
 
2018
 
2017
dollars in millions, except per share amounts
First

 
Fourth

Third

Second

First

FOR THE PERIOD
 
 
 
 
 
 
Interest income
$
1,137

 
$
1,114

$
1,109

$
1,117

$
1,050

Interest expense
193

 
176

161

144

132

Net interest income
944

 
938

948

973

918

Provision for credit losses
61

 
49

51

66

63

Noninterest income
601

 
656

592

653

577

Noninterest expense
1,006

 
1,098

992

995

1,013

Income (loss) from continuing operations before income taxes
478

 
447

497

565

419

Income (loss) from continuing operations attributable to Key
416

 
195

363

407

324

Income (loss) from discontinued operations, net of taxes
2

 
1

1

5


Net income (loss) attributable to Key
418

 
196

364

412

324

Income (loss) from continuing operations attributable to Key common shareholders
402

 
181

349

393

296

Income (loss) from discontinued operations, net of taxes
2

 
1

1

5


Net income (loss) attributable to Key common shareholders
404

 
182

350

398

296

PER COMMON SHARE
 
 
 
 
 
 
Income (loss) from continuing operations attributable to Key common shareholders
$
.38

 
$
.17

$
.32

$
.36

$
.28

Income (loss) from discontinued operations, net of taxes

 




Net income (loss) attributable to Key common shareholders (a)
.38

 
.17

.32

.37

.28

Income (loss) from continuing operations attributable to Key common shareholders —
assuming dilution
.38

 
.17

.32

.36

.27

Income (loss) from discontinued operations, net of taxes — assuming dilution

 




Net income (loss) attributable to Key common shareholders — assuming dilution (a)
.38

 
.17

.32

.36

.27

Cash dividends paid
.105

 
.105

.095

.095

.085

Book value at period end
13.07

 
13.09

13.18

13.02

12.71

Tangible book value at period end
10.35

 
10.35

10.52

10.40

10.21

Market price:
 
 
 
 
 
 
High
22.15

 
20.44

19.37

19.10

19.53

Low
19.04

 
17.64

16.47

16.91

16.54

Close
19.55

 
20.17

18.82

18.74

17.78

Weighted-average common shares outstanding (000)
1,056,037

 
1,062,348

1,073,390

1,076,203

1,068,609

Weighted-average common shares and potential common shares outstanding (000) (b)
1,071,786

 
1,079,330

1,088,841

1,093,039

1,086,540

AT PERIOD END
 
 
 
 
 
 
Loans
$
88,089

 
$
86,405

$
86,492

$
86,503

$
86,125

Earning assets
122,961

 
123,490

122,625

121,243

120,261

Total assets
137,049

 
137,698

136,733

135,824

134,476

Deposits
104,751

 
105,235

103,446

102,821

103,982

Long-term debt
13,749

 
14,333

15,100

13,261

12,324

Key common shareholders’ equity
13,919

 
13,998

14,224

14,228

13,951

Key shareholders’ equity
14,944

 
15,023

15,249

15,253

14,976

PERFORMANCE RATIOS — FROM CONTINUING OPERATIONS
 
 
 
 
 
 
Return on average total assets
1.25
%
 
.57
%
1.07
%
1.23
%
.99
%
Return on average common equity
11.76

 
5.04

9.74

11.12

8.76

Return on average tangible common equity (c)
14.89

 
6.35

12.21

13.80

10.98

Net interest margin (TE)
3.15

 
3.09

3.15

3.30

3.13

Cash efficiency ratio (c)
62.9

 
66.7

62.2

59.3

65.8

PERFORMANCE RATIOS — FROM CONSOLIDATED OPERATIONS
 
 
 
 
 
 
Return on average total assets
1.24
%
 
.57
%
1.06
%
1.23
%
.98
%
Return on average common equity
11.82

 
5.07

9.77

11.26

8.76

Return on average tangible common equity (c)
14.97

 
6.39

12.25

13.98

10.98

Net interest margin (TE)
3.13

 
3.07

3.13

3.28

3.11

Loan-to-deposit (d)
86.9

 
84.4

86.2

87.2

85.6

CAPITAL RATIOS AT PERIOD END
 
 
 
 
 
 
Key shareholders’ equity to assets
10.90
%
 
10.91
%
11.15
%
11.23
%
11.14
%
Key common shareholders’ equity to assets
10.16

 
10.17

10.40

10.48

10.37

Tangible common equity to tangible assets (c)
8.22

 
8.23

8.49

8.56

8.51

Common Equity Tier 1
9.99

 
10.16

10.26

9.91

9.91

Tier 1 risk-based capital
10.82

 
11.01

11.11

10.73

10.74

Total risk-based capital
12.73

 
12.92

13.09

12.64

12.69

Leverage
9.76

 
9.73

9.83

9.95

9.81

TRUST ASSETS
 
 
 
 
 
 
Assets under management
$
39,003

 
$
39,588

$
38,660

$
37,613

$
37,417

OTHER DATA
 
 
 
 
 
 
Average full-time-equivalent employees
18,540

 
18,379

18,548

18,344

18,386

Branches
1,192

 
1,197

1,208

1,210

1,216

(a)
EPS may not foot due to rounding.
(b)
Assumes conversion of Common Share options and other stock awards as applicable.
(c)
See Figure 2 entitled “GAAP to Non-GAAP Reconciliations,” which presents the computations of certain financial measures related to “tangible common equity” and “cash efficiency.” The table reconciles the GAAP performance measures to the corresponding non-GAAP measures, which provides a basis for period-to-period comparisons.
(d)
Represents period-end consolidated total loans and loans held for sale divided by period-end consolidated total deposits.

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Table of Contents

Figure 2 presents certain non-GAAP financial measures related to “tangible common equity,” “return on tangible common equity,” “cash efficiency ratio,” certain financial measures excluding notable items, and “Common Equity Tier 1 under the Regulatory Capital Rules (estimates).”

Notable items include certain revenue or expense items that may occur in a reporting period which management does not consider indicative of ongoing financial performance. Management believes it is useful to consider certain financial metrics with and without merger-related charges and/or other notable items in order to enable a better understanding of Company results, increase comparability of period-to-period results, and to evaluate and forecast those results.

The tangible common equity ratio and the return on tangible common equity ratio have been a focus for some investors, and management believes that these ratios may assist investors in analyzing Key’s capital position without regard to the effects of intangible assets and preferred stock. Since analysts and banking regulators may assess our capital adequacy using tangible common equity, we believe it is useful to enable investors to assess our capital adequacy on these same bases. Figure 2 reconciles the GAAP performance measures to the corresponding non-GAAP measures.

Beginning in the first quarter of 2018, we no longer separately report merger-related charges. Prior to that, we reported merger-related charges as a result of our purchase of First Niagara on August 1, 2016. The definitive agreement and plan of merger to acquire First Niagara was originally announced on October 30, 2015. For every quarter of 2017, merger-related charges are included in the total for "notable items." The table below shows the computation of return on average tangible common equity excluding notable items, pre-provision net revenue excluding notable items, cash efficiency ratio excluding notable items, and return on average assets from continuing operations excluding notable items. Management believes that eliminating the effects of the merger-related charges and other notable items made it easier to analyze the results by presenting them on a more comparable basis.

Figure 2 also shows the computation for and reconciliation of pre-provision net revenue, which is not formally
defined by GAAP. We believe that eliminating the effects of the provision for credit losses makes it easier to analyze
our results by presenting them on a more comparable basis.

The cash efficiency ratio is a ratio of two non-GAAP performance measures. Accordingly, there is no directly comparable GAAP performance measure. The cash efficiency ratio excludes the impact of our intangible asset amortization from the calculation. We also disclose the cash efficiency ratio excluding notable items. We believe these ratios provide greater consistency and comparability between our results and those of our peer banks. Additionally, these ratios are used by analysts and investors as they develop earnings forecasts and peer bank analysis.

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be considered in isolation, nor as a substitute for analyses of results as reported under GAAP.


8

Table of Contents

Figure 2. GAAP to Non-GAAP Reconciliations
 
 
Three months ended
dollars in millions
3/31/2018
12/31/2017
9/30/2017
6/30/2017
3/31/2017
Tangible common equity to tangible assets at period-end
 
 
 
 
 
Key shareholders’ equity (GAAP)
$
14,944

$
15,023

$
15,249

$
15,253

$
14,976

Less:
Intangible assets (a)
2,902

2,928

2,870

2,866

2,751

 
Preferred Stock (b)
1,009

1,009

1,009

1,009

1,009

 
Tangible common equity (non-GAAP)
$
11,033

$
11,086

$
11,370

$
11,378

$
11,216

Total assets (GAAP)
$
137,049

$
137,698

$
136,733

$
135,824

$
134,476

Less:
Intangible assets (a)
2,902

2,928

2,870

2,866

2,751

 
Tangible assets (non-GAAP)
$
134,147

$
134,770

$
133,863

$
132,958

$
131,725

 
Tangible common equity to tangible assets ratio (non-GAAP)
8.22
%
8.23
%
8.49
%
8.56
%
8.51
%
Notable items
 
 
 
 
 
Merger-related charges

$
(56
)
$
(36
)
$
(44
)
$
(81
)
Impacts of tax reform and related actions

(30
)



Merchant services gain


(5
)
64


Purchase accounting finalization, net



43


Charitable contribution



(20
)

Total notable items

$
(86
)
$
(41
)
$
43

$
(81
)
Income taxes

(26
)
(13
)
16

(30
)
Reevaluation of certain tax related assets

147




Total notable items after tax

$
(207
)
$
(28
)
$
27

$
(51
)
Average tangible common equity
 
 
 
 
 
Average Key shareholders’ equity (GAAP)
$
14,889

$
15,268

$
15,241

$
15,200

$
15,184

Less:
Intangible assets (average) (c)
2,916

2,939

2,878

2,756

2,772

 
Preferred Stock (average)
1,025

1,025

1,025

1,025

1,480

 
Average tangible common equity (non-GAAP)
$
10,948

$
11,304

$
11,338

$
11,419

$
10,932

Return on average tangible common equity from continuing operations
 
 
 
 
 
Net income (loss) from continuing operations attributable to Key common shareholders (GAAP)
$
402

$
181

$
349

$
393

$
296

Plus:
Notable items, after tax

207

28

(27
)
51

 
Net income (loss) from continuing operations attributable to Key common shareholders after notable items (non-GAAP)
$
402

$
388

$
377

$
366

$
347

Average tangible common equity (non-GAAP)
10,948

11,304

11,338

11,419

10,932

Return on average tangible common equity from continuing operations (non-GAAP)
14.89
%
6.35
%
12.21
%
13.80
%
10.98
%
Return on average tangible common equity from continuing operations excluding notable items (non-GAAP)
14.89

13.62

13.19

12.86

12.87

Return on average tangible common equity consolidated
 
 
 
 
 
Net income (loss) attributable to Key common shareholders (GAAP)
$
404

$
182

$
350

$
398

$
296

Average tangible common equity (non-GAAP)
10,948

11,304

11,338

11,419

10,932

Return on average tangible common equity consolidated (non-GAAP)
14.97
%
6.39
%
12.25
%
13.98
%
10.98
%
Pre-provision net revenue
 
 
 
 
 
Net interest income (GAAP)
$
944

$
938

$
948

$
973

$
918

Plus:
Taxable-equivalent adjustment
8

14

14

14

11

 
Noninterest income (GAAP)
601

656

592

653

577

Less:
Noninterest expense (GAAP)
1,006

1,098

992

995

1,013

 
Pre-provision net revenue from continuing operations (non-GAAP)
$
547

$
510

$
562

$
645

$
493

Plus:
Notable items

86

41

(43
)
81

 
Pre-provision net revenue from continuing operations excluding notable items (non-GAAP)
547

596

603

602

574

Cash efficiency ratio
 
 
 
 
 
Noninterest expense (GAAP)
$
1,006

$
1,098

$
992

$
995

$
1,013

Less:
Intangible asset amortization
29

26

25

22

22

Adjusted noninterest expense (non-GAAP)
$
977

$
1,072

$
967

$
973

$
991

Less:
Notable items

85

36

60

81

Adjusted noninterest expense excluding notable items (non-GAAP)
$
977

$
987

$
931

$
913

$
910

Net interest income (GAAP)
$
944

$
938

$
948

$
973

$
918

Plus:
Taxable-equivalent adjustment
8

14

14

14

11

 
Noninterest income (GAAP)
601

656

592

653

577

Total taxable-equivalent revenue (non-GAAP)
$
1,553

$
1,608

$
1,554

$
1,640

$
1,506

Plus:
Notable items

1

5

(103
)

 
Adjusted noninterest income excluding notable items (non-GAAP)
$
1,553

$
1,609

$
1,559

$
1,537

$
1,506

Cash efficiency ratio (non-GAAP)
62.9
%
66.7
%
62.2
%
59.3
%
65.8
%
Cash efficiency ratio excluding notable items (non-GAAP)
62.9

61.3

59.7

59.4

60.4

Return on average total assets from continuing operations excluding notable items
 
 
 
 
 
Income from continuing operations attributable to Key (GAAP)
$
416

$
195

$
363

$
407

$
324

Plus:
Notable items, after tax

207

28

(27
)
51

 
Income from continuing operations attributable to Key excluding notable items, after tax (non-GAAP)
$
416

$
402

$
391

$
380

$
375

Average total assets from continuing operations (GAAP)
$
134,915

$
135,255

$
134,356

$
132,491

$
132,741

Return on average total assets from continuing operations excluding notable items (non-GAAP)
1.25
%
1.18
%
1.15
%
1.15
%
1.15
%
 

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Figure 2. GAAP to Non-GAAP Reconciliations, continued
dollars in millions
Three months ended March 31, 2018
Common Equity Tier 1 under the Regulatory Capital Rules (estimates)
 
Common Equity Tier 1 under current Regulatory Capital Rules
$
12,086

Adjustments from current Regulatory Capital Rules to the fully phased-in Regulatory Capital Rules:
 
Deferred tax assets and other intangible assets (d)

Common Equity Tier 1 anticipated under the fully phased-in Regulatory Capital Rules (e)
$
12,086

 
 
Net risk-weighted assets under current Regulatory Capital Rules
$
120,986

Adjustments from current Regulatory Capital Rules to the fully phased-in Regulatory Capital Rules:
 
Mortgage servicing assets (f)
700

All other assets
319

Total risk-weighted assets anticipated under the fully phased-in Regulatory Capital Rules (e)
$
122,005

 
 
Common Equity Tier 1 ratio under the fully phased-in Regulatory Capital Rules (e)
9.91
%
 
 
(a)
For the three months ended March 31, 2018, December 31, 2017, September 30, 2017, June 30, 2017, and March 31, 2017, intangible assets exclude $23 million, $26 million, $30 million, $33 million, and $38 million, respectively, of period-end purchased credit card relationships.
(b)
Net of capital surplus.
(c)
For the three months ended March 31, 2018, December 31, 2017, September 30, 2017, June 30, 2017, and March 31, 2017, average intangible assets exclude $24 million, $28 million, $32 million, $36 million, and $40 million, respectively, of average purchased credit card relationships.
(d)
Includes the deferred tax assets subject to future taxable income for realization, primarily tax credit carryforwards, as well as intangible assets (other than goodwill and mortgage servicing assets) subject to the transition provisions of the final rule.
(e)
The anticipated amount of regulatory capital and risk-weighted assets is based upon the federal banking agencies’ Regulatory Capital Rules (as fully phased-in on January 1, 2019); we are subject to the Regulatory Capital Rules under the “standardized approach.”
(f)
Item is included in the 10%/15% exceptions bucket calculation and is risk-weighted at 250%.

Long-term financial targets

Our long-term financial targets are as follows:

Generate positive operating leverage and a cash efficiency ratio in the range of 54.0% to 56.0%;
Maintain a moderate risk profile by targeting a net loan charge-offs to average loans ratio in the range of .40% to .60%; and
Achieve a return on tangible common equity ratio in the range of 15.00% to 18.00%.

Figure 3 shows the evaluation of our long-term financial targets for the three months ended March 31, 2018.

Figure 3. Evaluation of Our Long-Term Targets
 
Key Metrics (a)
1Q18

Targets
Positive operating leverage
Cash efficiency ratio (b)
62.9
%
54.0 - 56.0%
Moderate Risk Profile
Net loan charge-offs to average loans
.25
%
.40 - .60%
Financial Returns
Return on average tangible common equity (b)
14.89
%
15.00 - 18.00%
(a)
Calculated from continuing operations, unless otherwise noted.
(b)
Non-GAAP measure; see Figure 2 entitled “GAAP to Non-GAAP Reconciliations” for reconciliation.

Strategic developments

Our actions and results during the first three months of 2018 supported our corporate strategy described in the “Introduction” section under the “Corporate strategy” heading on page 38 of our 2017 Form 10-K.
 
Total revenue was up 3.1% compared to the first quarter of last year driven by a higher net interest margin, solid loan growth, and strong performance from our fee-based businesses. Excluding purchase accounting accretion, net interest income was up $43 million from the first quarter of 2017, driven by higher interest rates and well-managed deposit betas. The growth in average loans for the first quarter of 2018 was primarily in our commercial and industrial portfolio which was up 6.8% from a year ago, reflecting broad-based growth in commercial and industrial loans with middle-market clients. We had a record first quarter for investment banking and debt placement fees of $143 million, an increase of 12.6% from the year-ago quarter, as we benefited from the acquisition of Cain Brothers as well as continued growth in our core franchise.
Net loan charge-offs were .25% of average loans for the first three months of 2018, down from .27% for the same period one-year ago and below our targeted range. Total net loan charge-offs decreased during the first three months of 2018 compared to the year-ago period. Total loans charged off decreased in our commercial lease financing, home equity loan, and consumer indirect loan portfolios. Partially offsetting these decreases in loan charge-offs were increases in total loans charged off in our commercial and industrial and real estate — residential mortgage loan portfolios. Total loan loss recoveries were down slightly from the year-ago quarter.

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Capital management remains a priority for 2018. As previously reported, share repurchases of up to $800 million were included in the 2017 capital plan, which is effective through the second quarter of 2018. We completed $199 million of Common Share repurchases, including $156 million of Common Share repurchases in the open market and $43 million of Common Share repurchases related to employee equity compensation programs, in the first quarter of 2018 under this authorization.
Consistent with our 2017 capital plan, the Board declared a quarterly dividend of $.105 per Common Share for the first quarter of 2018. In the second quarter of 2018, the Board plans to consider a potential increase in our quarterly common share dividend, up to $.12 per share.
On March 29, 2018, we announced that we had entered into a definitive agreement to sell Key Insurance & Benefits Services, Inc. to USI Insurance Services. We acquired Key Insurance & Benefits Services, Inc. as a part of the 2016 merger with First Niagara. The transaction is subject to regulatory approvals and other customary closing conditions and is expected to close in the second quarter of 2018.

Demographics

We have two major business segments: Key Community Bank and Key Corporate Bank.

Key Community Bank serves individuals and small to mid-sized businesses by offering a variety of deposit and investment, lending, mortgage and home equity, credit card, and personalized wealth management products and business advisory services. Key Community Bank offers personal property and casualty insurance, such as home, auto, renters, watercraft, and umbrella policies. Key Community Bank also purchases retail auto sales contracts via a network of auto dealerships. These products and services are provided through our relationship managers and specialists working in our 15-state branch network, which is organized into ten internally defined geographic regions: Washington, Oregon/Alaska, Rocky Mountains, Indiana/Northwest Ohio/Michigan, Central/Southwest Ohio, East Ohio/Western Pennsylvania, Atlantic, Western New York, Eastern New York, and New England. In addition, some of these product capabilities are delivered by Key Corporate Bank to clients of Key Community Bank.

Key Corporate Bank is a full-service corporate and investment bank focused principally on serving the needs of middle market clients in seven industry sectors: consumer, energy, healthcare, industrial, public sector, real estate, and technology. Key Corporate Bank delivers a broad suite of banking and capital markets products to its clients, including syndicated finance, debt and equity capital markets, commercial payments, equipment finance, commercial mortgage banking, derivatives, foreign exchange, financial advisory, and public finance. Key Corporate Bank is also a significant servicer of commercial mortgage loans and a significant special servicer of CMBS. Key Corporate Bank delivers many of its product capabilities to clients of Key Community Bank.

Further information regarding the products and services offered by our Key Community Bank and Key Corporate Bank segments is included in this report in Note 18 (“Line of Business Results”).

Supervision and regulation

The following discussion provides a summary of recent regulatory developments and should be read in conjunction with the disclosure included in our 2017 Form 10-K under the heading “Supervision and Regulation” in Item 1. Business and under the heading “II. Compliance Risk” in Item 1A. Risk Factors.

Regulatory capital requirements

The final rule to implement the Basel III international capital framework (“Basel III”) was effective January 1, 2015, with a multi-year transition period ending on December 31, 2018 (“Regulatory Capital Rules”). The Basel III capital framework and the U.S. implementation of the Basel III capital framework are discussed in more detail in Item 1. Business of our 2017 Form 10-K under the heading “Supervision and Regulation - Regulatory capital requirements.”

Under the Regulatory Capital Rules, standardized approach banking organizations, such as KeyCorp and KeyBank, are required to meet the minimum capital and leverage ratios set forth in Figure 4 below. At March 31, 2018, Key had an estimated Common Equity Tier 1 Capital Ratio of 9.91% under the fully phased-in Regulatory Capital Rules. Also at March 31, 2018, based on the fully phased-in Regulatory Capital Rules, Key estimates that its capital and leverage ratios, after adjustment for market risk, would be as set forth in Figure 4.


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Figure 4. Pro Forma Ratios vs. Minimum Capital Ratios Calculated Under the Fully Phased-In Regulatory Capital Rules
Ratios (including capital conservation buffer)
Key
March 31, 2018
Pro forma
Minimum
January 1, 2018
Phase-in
Period
Minimum
January 1,  2019
Common Equity Tier 1 (a)
9.91
%
4.5
%
None
4.5
%
Capital conservation buffer (b)
 

1/1/16-1/1/19
2.5

Common Equity Tier 1 + Capital conservation buffer
 
4.5

1/1/16-1/1/19
7.0

Tier 1 Capital
10.73
%
6.0

None
6.0

Tier 1 Capital + Capital conservation buffer
 
6.0

1/1/16-1/1/19
8.5

Total Capital
12.64
%
8.0

None
8.0

Total Capital + Capital conservation buffer
 
8.0

1/1/16-1/1/19
10.5

Leverage (c)
9.76
%
4.0

None
4.0

(a)
See Figure 2 entitled “GAAP to Non-GAAP Reconciliations,” which presents the computation of Common Equity Tier 1 capital under the fully phased-in regulatory capital rules.
(b)
Capital conservation buffer must consist of Common Equity Tier 1 capital. As a standardized approach banking organization, KeyCorp is not subject to the countercyclical capital buffer of up to 2.5% imposed upon an advanced approaches banking organization under the Regulatory Capital Rules.
(c)
As a standardized approach banking organization, KeyCorp is not subject to the 3% supplemental leverage ratio requirement, which became effective January 1, 2018.

Revised prompt corrective action framework

The federal prompt corrective action (“PCA”) framework under the FDIA groups FDIC-insured depository institutions into one of five prompt corrective action capital categories: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” In addition to implementing the Basel III capital framework in the United States, the Regulatory Capital Rules also revised the prompt corrective action capital category threshold ratios applicable to FDIC-insured depository institutions such as KeyBank, with an effective date of January 1, 2015. The revised Prompt Corrective Action Framework table in Figure 5 identifies the capital category thresholds for a “well capitalized” and an “adequately capitalized” institution under the Prompt Corrective Action Framework.

Figure 5. "Well Capitalized" and "Adequately Capitalized" Capital Category Ratios under Revised PCA Framework
Prompt Corrective Action
 
Capital Category
Ratio
 
Well Capitalized (a)
Adequately Capitalized
Common Equity Tier 1 Risk-Based
 
6.5
%
4.5
%
Tier 1 Risk-Based
 
8.0

6.0

Total Risk-Based
 
10.0

8.0

Tier 1 Leverage (b)
 
5.0

4.0

(a)
A “well capitalized” institution also must not be subject to any written agreement, order, or directive to meet and maintain a specific capital level for any capital measure.
(b)
As a “standardized approach” banking organization, KeyBank is not subject to the 3% supplemental leverage ratio requirement, which became effective January 1, 2018.

We believe that, as of March 31, 2018, KeyBank (consolidated) satisfied the risk-based and leverage capital requirements necessary to be considered “well capitalized” for purposes of the PCA framework. However, investors should not regard this determination as a representation of the overall financial condition or prospects of KeyBank because the prompt corrective action framework is intended to serve a limited supervisory function. Moreover, it is important to note that the prompt corrective action framework does not apply to BHCs, like KeyCorp.

Recent regulatory capital-related developments

On September 27, 2017, the federal banking agencies issued a joint proposal to simplify certain aspects of the Regulatory Capital Rules for standardized approach banking organizations (the “Simplification Proposal”), including Key. In anticipation of the Simplification Proposal, on August 22, 2017, the agencies issued a companion proposal to extend the current capital treatment for certain items that are part of the Simplification Proposal and also subject to the multi-year transition period for the Regulatory Capital Rules, which ends on December 31, 2018 (the “Transitions Proposal”). The Transitions Proposal was published as a final rule in the Federal Register on November 21, 2017, and is expected to alleviate the burden that would have resulted from the continued phase-in of those capital requirements as the agencies seek public comment on and work to finalize the Simplification Proposal. The Simplification Proposal and the Transitions Proposal are discussed in more detail in Item 1. Business of our 2017 Form 10-K under the heading “Supervision and Regulation - Regulatory capital requirements - Recent regulatory capital-related developments.”

In December 2017, the Basel Committee released its final revisions to Basel III. The revisions seek to restore credibility in the calculation of risk-weighted assets and improve the comparability of regulatory capital ratios across banking organizations. The revisions are discussed in more detail in Item 1. Business of our 2017 Form 10-K under

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the heading “Supervision and Regulation - Regulatory capital requirements - Recent regulatory capital-related developments.”

The U.S. federal banking agencies released a statement announcing their support for the Basel Committee’s efforts, but cautioned that they will consider how to appropriately incorporate these revisions into the Regulatory Capital Rules, and that any proposed changes based on the Basel Committee revisions would be subject to notice-and-comment rulemaking. In view of the prohibition under the Dodd-Frank Act on the use of credit ratings in federal regulation, there is some uncertainty as to whether or how the agencies would implement the ratings-based aspects of the Basel Committee revisions to Basel III, as well as any other aspect of the Basel Committee revisions that permit the U.S. agencies to exercise home-country discretion, for example, due to differences in accounting or market practices, and legal requirements.

Subsequently, in February 2018, the Basel Committee released for public consultation a proposal to update the Pillar 3 disclosure framework, to more appropriately align it to the changes adopted under the Basel Committee’s final revisions to Basel III. The public consultation period ends on May 25, 2018. Before any action is taken by the federal banking agencies with respect to the revised Pillar 3 disclosure framework, it first must be adopted in final form by the Basel Committee, and the federal agencies must determine whether and to what extent they will implement the final revisions to Basel III released by the Basel Committee in December 2017.

Capital planning and stress testing

On December 7, 2017, the Federal Reserve released for public comment a package of proposals that would increase the transparency of its stress testing program while maintaining the Federal Reserve’s ability to test the resilience of the nation’s largest, most complex banks. The proposals responded to public and industry calls for more transparency around the CCAR program. The proposals are discussed in more detail in Item 1. Business of our 2017 Form 10-K under the heading “Supervision and Regulation - Regulatory capital requirements - Recent developments in capital planning and stress testing.”

In a separate release, published April 10, 2018, the Federal Reserve invited comment on a proposal to integrate certain aspects of the Federal Reserve’s Regulatory Capital Rules with the CCAR and stress test rules, in order to simplify the overall capital framework that is currently applicable to banking organizations subject to the capital plan rule (including KeyCorp).  Under the proposal, the Federal Reserve would (1) amend the capital conservation buffer requirement under the Regulatory Capital Rules by replacing the static risk-weighted assets component of the buffer with a new measure, the stress capital buffer, which would be based on the results of an individual banking organization’s annual supervisory stress test; (2) introduce a stress leverage buffer requirement that would replace the existing Tier 1 leverage requirement under CCAR; (3) modify certain assumptions under the supervisory stress test; (4) remove the 30% dividend payout ratio limitation as a criterion for heightened supervisory scrutiny of an organization’s capital plan; and (5) eliminate the CCAR quantitative objection. 

Under the proposed rule, a banking organization would not be subject to any limitations on capital distributions and discretionary bonus payments if it satisfies all minimum capital requirements and its capital conservation requirement (as amended to incorporate the stress capital buffer), stress leverage buffer requirement, and, if applicable, the advanced approaches capital conservation buffer requirement and supplementary leverage ratio standard (the latter two of which do not apply to KeyCorp). If it is adopted as a final rule, the proposal would be effective December 31, 2018; however, the stressed capital buffer and stress leverage buffer requirements would generally not be effective until October 1, 2019.  Key expects that the proposal would have a marginally favorable impact on its capital requirements.

Liquidity requirements

In October 2014, the federal banking agencies published a final rule to implement the Basel III liquidity coverage ratio (“Basel III LCR”) for U.S. banking organizations (the “Liquidity Coverage Rules”) that establishes a minimum LCR for certain internationally active bank and nonbank financial companies (excluding KeyCorp) and a modified version of the LCR (“Modified LCR”) for BHCs and other depository institution holding companies with over $50 billion in consolidated assets that are not internationally active (including KeyCorp). KeyBank will not be subject to the LCR or the Modified LCR under the Liquidity Coverage Rules unless the OCC affirmatively determines that application to KeyBank is appropriate in light of KeyBank’s asset size, level of complexity, risk profile, scope of operations, affiliation with foreign or domestic covered entities, or risk to the financial system.


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Under the Liquidity Coverage Rules, KeyCorp must calculate a Modified LCR on a monthly basis, and was required to satisfy a minimum Modified LCR requirement of 100% by January 1, 2017. At March 31, 2018, Key’s Modified LCR was above 100%. In the future, KeyCorp may change the composition of our investment portfolio, increase the size of the overall investment portfolio, and modify product offerings to enhance or optimize our liquidity position.

Net stable funding ratio

The federal banking agencies commenced the U.S. implementation of the Basel III net stable funding ratio (“NSFR”) in April and May 2016, with the release of a proposed rule to implement a NSFR requirement for certain internationally active banking organizations (excluding KeyCorp) and a modified version of the minimum NSFR requirement (“Modified NSFR”) for BHCs and other depository institution holding companies with over $50 billion in consolidated assets that are not internationally active (including KeyCorp), together with quarterly public disclosure requirements. The proposed rule would require banking organizations to satisfy a minimum NSFR requirement of 1.0 on an ongoing basis. However, banking organizations subject to the Modified NSFR (like KeyCorp) would be required to maintain a lower minimum amount of available stable funding, equal to 70% of the required stable funding under the NSFR. The proposed rule was scheduled to be effective on January 1, 2018; however, it has not been adopted in final form. The comment period for the NPR expired on August 5, 2016. If the proposed NSFR requirement is adopted as a final rule, then similar to actions taken in connection with the implementation of the Liquidity Coverage Rules, KeyCorp may adjust its balance sheet or modify product offerings to enhance its liquidity position.

Resolution and recovery planning

BHCs with at least $50 billion in total consolidated assets, like KeyCorp, are required to periodically submit to the Federal Reserve and FDIC a plan discussing how the company could be rapidly and efficiently resolved if the company failed or experienced material financial distress. Insured depository institutions with at least $50 billion in total consolidated assets, like KeyBank, are also required to submit a resolution plan to the FDIC. These plans are due annually, usually by December 31 of each year. For 2015, these resolution plans, the third required from
KeyCorp and KeyBank, were submitted on December 1, 2015. KeyCorp and KeyBank were not required to submit
resolution plans for 2016 because the FDIC and Federal Reserve deferred such requirement (for 38 firms, including
KeyCorp) until December 2017 and the FDIC deferred such requirement (for a number of insured depository
institutions, including KeyBank) until July 1, 2018. On December 1, 2017, KeyCorp submitted its resolution plan to the Federal Reserve and the FDIC. The Federal Reserve and FDIC make available on their websites the public sections of resolution plans for the companies, including KeyCorp and KeyBank, that submitted plans. The public section of the resolution plans of KeyCorp and KeyBank is available at http://www.federalreserve.gov/supervisionreg/resolution-plans.htm and https://www.fdic.gov/regulations/reform/resplans/.

On September 28, 2016, the OCC released final guidelines that establish standards for recovery planning by certain large OCC-regulated institutions, including KeyBank. The guidelines require such institutions to establish a comprehensive framework for evaluating the financial effects of severe stress events, and recovery actions an institution may pursue to remain a viable, going concern during a period of severe financial stress. Under the final guidelines, an institution’s recovery plan must include triggers to alert the institution of severe stress events, escalation procedures, recovery options, and a process for periodic review and approval by senior management and the board of directors. The recovery plan should be tailored to the complexity, scope of operations, and risk profile of the institution. Because KeyBank had average total consolidated assets of greater than $100 billion but less than $750 billion as reported on KeyBank’s Consolidated Reports of Condition and Income for the four most recent consecutive quarters prior to January 1, 2017, it was required to be in compliance with the guidelines not later than January 1, 2018. We believe that KeyBank is in compliance with the guidelines.


14

Table of Contents

Deposit insurance and assessments

As required under the Dodd-Frank Act, in March 2015, the FDIC approved a final rule to impose a surcharge on the quarterly deposit insurance assessments of insured depository institutions having total consolidated assets of at least $10 billion (like KeyBank). The surcharge is 4.5 cents per $100 of the institution’s assessment base (after making certain adjustments). The final rule became effective on July 1, 2016. As of July 1, 2016, KeyBank must pay a surcharge to assist in bringing the reserve ratio to the statutory minimum of 1.35%. Surcharges will continue through the quarter that the DIF reserve ratio reaches or exceeds 1.35%, but not later than December 31, 2018. If the reserve ratio does not reach 1.35% by December 31, 2018 (provided it is at least 1.15%), the FDIC will impose a shortfall assessment on March 31, 2019, on insured depository institutions with total consolidated assets of $10 billion or more (like KeyBank).

In December 2016, the FDIC issued a final rule that imposes recordkeeping requirements on insured depository institutions with two million or more deposit accounts (including KeyBank) in order to facilitate rapid payment of insured deposits to customers if the institutions were to fail. The rule requires those insured depository institutions to: (i) maintain complete and accurate data on each depositor’s ownership interest by right and capacity for all of the institution’s deposit accounts; and (ii) develop the capability to calculate the insured and uninsured amounts for each deposit owner within 24 hours of failure. The FDIC will conduct periodic testing of compliance with these requirements, and institutions subject to the rule must submit to the FDIC a certification of compliance, signed by the KeyBank chief executive officer, and deposit insurance coverage summary report on or before the mandatory compliance date and annually thereafter. The final rule became effective on April 1, 2017, with a mandatory compliance date of April 1, 2020. The FDIC has been releasing Frequently Asked Questions for Part 370 on a rolling basis, and has committed to continue this practice as institutions subject to the rule present issues associated with its implementation that require FDIC consultation.

Supervision and governance

On August 3, 2017, the Federal Reserve published an NPR to align its supervisory rating system for large financial
institutions, including KeyCorp, with the post-crisis supervisory programs for these firms (the “LFI Rating System”).
If adopted in final form, the LFI Rating System would provide a supervisory evaluation of whether an institution
possesses sufficient operational strength and resilience to maintain safe and sound operations through a range of
conditions, and assess an institution’s capital planning and positions, liquidity risk management and positions, and
governance and controls. Institutions subject to the LFI Rating System would be rated using the following scale:
Satisfactory, Satisfactory Watch, Deficient-1, and Deficient-2, with the Satisfactory Watch rating intended to be used
as a transitory rating to allow an institution time to remediate a concern identified during the supervisory evaluation.

The governance and controls component of the LFI Rating System is the subject of two separate, but related
proposals: (1) proposed guidance regarding supervisory expectations for boards of directors of large financial
institutions; and (2) proposed guidance regarding core principles for effective senior management, business
management, and independent risk management and controls for large financial institutions.

On January 4, 2018, the Federal Reserve released the final component of the proposed LFI Rating System proposed guidance regarding core principles for effective senior management, business management, and
independent risk management and controls for large financial institutions. The proposals and guidance are discussed in more detail in Item 1. Business of our 2017 Form 10-K under the heading “Supervision and Regulation - Other Regulatory Developments under the Dodd-Frank Act - Supervision and governance.”

ERISA fiduciary standard

In April 2016, the Department of Labor published final rules and amendments to certain prohibited transaction exemptions regarding which service providers would be regarded as fiduciaries under ERISA for making investment advice recommendations to: (i) certain retirement plan fiduciaries, participants, or beneficiaries; and (ii) owners or beneficiaries of individual retirement accounts and health savings accounts, among other retirement plans. The purpose of the rules is to place fiduciary obligations, rather than the lesser legal obligations that currently apply, on these service providers. Accordingly, the rules subject any financial institution making recommendations for either the purchase or sale of investments in or rollover of the respective retirement plan to certain fiduciary obligations under ERISA such as an impartial conduct standard and not selling certain investment products whose compensation may raise a conflict of interest for the advisor without entering into a contract providing certain disclosures and legal remedies to the customer. Under the Department of Labor’s original rules, the impartial

15

Table of Contents

standard requirement for financial institutions and their advisors was to become effective April 10, 2017. However, in response to a Presidential Order, the Department of Labor extended the effective date to June 9, 2017. The contract provisions were required to be in place by January 1, 2018. However, on November 29, 2017, the Department of Labor extended the applicability of the contract rules until July 1, 2019, while it continues to review requested comments concerning whether to modify, further delay, or rescind these rules in whole or in part. On March 15, 2018, the United States Court of Appeals for the Fifth Circuit invalidated the rule in its entirety. Other federal courts have upheld the rule. It is unclear what impact these decisions will have on the rules.

Results of Operations

Earnings overview

The following chart provides a reconciliation of net income from continuing operations attributable to Key common shareholders for the three months ended March 31, 2017, to the three months ended March 31, 2018 (dollars in millions):
393331886_chart-d6d2103b863b5468bb4.jpg
The following discussion explains the key factors that caused these elements to change.

Net interest income

One of our principal sources of revenue 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:
 
the volume, pricing, mix, and maturity of earning assets and interest-bearing liabilities;
the volume and value of net free funds, such as noninterest-bearing deposits and equity capital;
the use of derivative instruments to manage interest rate risk;
interest rate fluctuations and competitive conditions within the marketplace;
asset quality; and
fair value accounting of acquired earning assets and interest-bearing liabilities.

To make it easier to compare both the results across several periods and the yields on various types of earning assets (some taxable, some not), we present net interest income in this discussion on a “TE basis” (i.e., as if all income were taxable and at the same rate). For example, $100 of tax-exempt income would be presented as $126, an amount that, if taxed at the statutory federal income tax rate of 21%, would yield $100. Prior to 2018, $100 of tax-exempt income would be presented as $154, an amount that, if taxed at the previous statutory federal income tax rate of 35%, would yield $100.


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Figure 6 shows the various components of our balance sheet that affect interest income and expense, and their respective yields or rates over the past five quarters. This figure also presents a reconciliation of TE net interest income to net interest income reported in accordance with GAAP for each of those quarters. The net interest margin, which is an indicator of the profitability of the earning assets portfolio less cost of funding, is calculated by dividing annualized TE net interest income by average earning assets.
393331886_chart-389c18a6acd82fa83aa.jpg
TE net interest income was $952 million for the first quarter of 2018, and the net interest margin was 3.15%, compared to TE net interest income of $929 million and a net interest margin of 3.13% for the first quarter of 2017, reflecting the benefit from higher interest rates and low deposit betas. First quarter 2018 net interest income included $33 million of purchase accounting accretion, a decline of $20 million from the first quarter of 2017. In 2018, we expect net interest income to be in the range of $3.95 billion to $4.05 billion.

393331886_chart-68cf39e7ad99ef70690.jpg393331886_chart-2eac0c0bc10c305995f.jpg
Average loans were $86.9 billion for the first quarter of 2018, an increase of $794 million compared to the first quarter of 2017, reflecting broad-based growth in commercial and industrial loans with middle-market clients, as well as strength in auto lending as the company expands into existing geographies and dealer relationships. In addition, reductions in commercial real estate loans over the past year reflect significantly higher debt placements and paydowns. For 2018, we anticipate average loans to be in the range of $88.5 billion to $89.5 billion.

Average deposits totaled $102.6 billion for the first quarter of 2018, an increase of $478 million compared to the year-ago quarter. Certificates of deposits and other time deposits increased $1.5 billion, reflecting strength in Key’s retail banking franchise and growth from commercial relationships. Additionally, consumer noninterest-bearing balances grew 10% from the prior year. NOW and money-market deposit accounts declined $792 million, partially driven by a shift to higher-yielding deposit products and the managed exit of certain higher cost corporate and public sector deposits. For 2018, we anticipate average deposits to be in the range of $104.5 billion to $105.5 billion.

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Figure 6. Consolidated Average Balance Sheets, Net Interest Income, and Yields/Rates from Continuing Operations
 
First Quarter 2018
 
Fourth Quarter 2017
dollars in millions
Average
Balance
Interest (a)
Yield/
Rate (a)
 
Average
Balance
Interest (a)
Yield/
Rate (a)
ASSETS
 
 
 
 
 
 
 
Loans (b), (c)
 
 
 
 
 
 
 
Commercial and industrial (d)
$
42,733

$
434

4.11
%
 
$
41,289

$
417

4.01
%
Real estate — commercial mortgage
14,085

165

4.76

 
14,386

167

4.60

Real estate — construction
1,957

22

4.64

 
1,967

23

4.55

Commercial lease financing
4,663

41

3.53

 
4,687

45

3.86

Total commercial loans
63,438

662

4.23

 
62,329

652

4.15

Real estate — residential mortgage
5,479

54

3.95

 
5,474

54

3.95

Home equity loans
11,877

134

4.56

 
12,128

134

4.39

Consumer direct loans
1,766

33

7.53

 
1,782

32

7.15

Credit cards
1,080

30

11.32

 
1,061

30

11.14

Consumer indirect loans
3,287

35

4.29

 
3,232

36

4.42

Total consumer loans
23,489

286

4.91

 
23,677

286

4.80

Total loans
86,927

948

4.41

 
86,006

938

4.33

Loans held for sale
1,187

12

4.10

 
1,420

13

3.81

Securities available for sale (b), (e)
17,889

95

2.06

 
18,447

93

1.97

Held-to-maturity securities (b)
12,041

69

2.30

 
11,121

61

2.20

Trading account assets
907

7

2.99

 
898

6

2.72

Short-term investments
2,048

8

1.51

 
3,684

12

1.29

Other investments (e)
723

6

2.96

 
725

5

2.80

Total earning assets
121,722

1,145

3.78

 
122,301

1,128

3.66

Allowance for loan and lease losses
(875
)
 
 
 
(871
)
 
 
Accrued income and other assets
14,068

 
 
 
13,825

 
 
Discontinued assets
1,304

 
 
 
1,358

 
 
Total assets
$
136,219

 
 
 
$
136,613

 
 
 
 
 
 
 
 
 
 
LIABILITIES
 
 
 
 
 
 
 
NOW and money market deposit accounts
$
53,503

46

.34

 
$
53,601

40

.29

Savings deposits
6,232

5

.29

 
6,372

3

.24

Certificates of deposit ($100,000 or more)
6,972

27

1.58

 
6,776

26

1.50

Other time deposits
4,865

13

1.12

 
4,771

13

1.05

Total interest-bearing deposits
71,572

91

.51

 
71,520

82

.45

Federal funds purchased and securities sold under repurchase
agreements
1,421

4

1.11

 
360


.08

Bank notes and other short-term borrowings
1,342

6

1.87

 
693

3

1.72

Long-term debt (f), (g)
12,465

92

2.95

 
13,140

91

2.76

Total interest-bearing liabilities
86,800

193

.90

 
85,713

176

.81

Noninterest-bearing deposits
30,984

 
 
 
32,278

 
 
Accrued expense and other liabilities
2,241

 
 
 
1,994

 
 
Discontinued liabilities (g)
1,304

 
 
 
1,359

 
 
Total liabilities
121,329

 
 
 
121,344

 
 
EQUITY
 
 
 
 
 
 
 
Key shareholders’ equity
14,889

 
 
 
15,268

 
 
Noncontrolling interests
1

 
 
 
1

 
 
Total equity
14,890

 
 
 
15,269

 
 
Total liabilities and equity
$
136,219

 
 
 
$
136,613

 
 
 
 
 
 
 
 
 
 
Interest rate spread (TE)
 
 
2.88
%
 
 
 
2.85
%
Net interest income (TE) and net interest margin (TE)
 
952

3.15
%
 
 
952

3.09
%
TE adjustment (b)
 
8

 
 
 
14

 
Net interest income, GAAP basis
 
$
944

 
 
 
$
938

 
 
 
 
 
 
 
 
 
(a)
Results are from continuing operations. Interest excludes the interest associated with the liabilities referred to in (g), calculated using a matched funds transfer pricing methodology.
(b)
Interest income on tax-exempt securities and loans has been adjusted to a TE basis using the statutory federal income tax rate in effect for that period.
(c)
For purposes of these computations, nonaccrual loans are included in average loan balances.
(d)
Commercial and industrial average balances include $120 million, $119 million, $117 million, $117 million, and $114 million of assets from commercial credit cards for the three months ended March 31, 2018, December 31, 2017, September 30, 2017, June 30, 2017, and March 31, 2017, respectively.


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Table of Contents

Figure 6. Consolidated Average Balance Sheets, Net Interest Income, and Yields/Rates from Continuing Operations
Third Quarter 2017
 
Second Quarter 2017
 
First Quarter 2017
Average
Balance
Interest (a)
Yield/
Rate (a)
 
Average
Balance
Interest (a)
Yield/
Rate (a)
 
Average
Balance
Interest (a)
Yield/
Rate (a)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
41,416

$
414

3.97
%
 
$
40,666

$
409

4.04
%
 
$
40,002

$
373

3.77
%
14,850

169

4.51

 
15,096

187

4.97

 
15,187

164

4.39

2,054

23

4.51

 
2,204

31

5.51

 
2,353

26

4.54

4,694

46

3.89

 
4,690

50

4.33

 
4,635

44

3.76

63,014

652

4.11

 
62,656

677

4.34

 
62,177

607

3.95

5,493

54

3.92

 
5,509

52

3.77

 
5,520

54

3.94

12,314

136

4.41

 
12,473

135

4.31

 
12,611

131

4.22

1,774

33

7.26

 
1,743

31

7.07

 
1,762

30

6.97

1,049

30

11.34

 
1,044

29

11.04

 
1,067

29

11.06

3,170

37

4.64

 
3,077

38

5.02

 
2,996

37

4.91

23,800

290

4.85

 
23,846

285

4.77

 
23,956

281

4.75

86,814

942

4.31

 
86,502

962

4.46

 
86,133

888

4.17

1,607

17

4.13

 
1,082

9

3.58

 
1,188

13

4.28

18,574

91

1.96

 
17,997

90

1.97

 
19,181

95

1.95

10,469

55

2.12

 
10,469

55

2.09

 
9,988

51

2.04

889

7

2.74

 
1,042

7

3.00

 
968

7

2.75

2,166

6

1.21

 
1,970

5

.96

 
1,610

3

.79

728

5

2.46

 
687

3

1.87

 
709

4

2.26

121,247

1,123

3.68

 
119,749

1,131

3.78

 
119,777

1,061

3.57

(868
)
 
 
 
(864
)
 
 
 
(855
)
 
 
13,977

 
 
 
13,606

 
 
 
13,819

 
 
1,417

 
 
 
1,477

 
 
 
1,540

 
 
$
135,773

 
 
 
$
133,968

 
 
 
$
134,281

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
53,826

37

.27

 
$
54,416

34

.25

 
$
54,295

32

.24

6,697

5

.25

 
6,854

4

.21

 
6,351

1

.10

6,402

21

1.31

 
6,111

19

1.23

 
5,627

16

1.16

4,664

9

.81

 
4,650

9

.77

 
4,706

9

.76

71,589

72

.40

 
72,031

66

.36

 
70,979

58

.33

456


.23

 
466


.23

 
795

1

.32

865

3

1.49

 
1,216

4

1.43

 
1,802

5

1.06

12,631

86

2.75

 
11,046

74

2.68

 
10,833

68

2.54

85,541

161

.75

 
84,759

144

.68

 
84,409

132

.63

31,516

 
 
 
30,748

 
 
 
31,099

 
 
2,057

 
 
 
1,782

 
 
 
2,048

 
 
1,417

 
 
 
1,477

 
 
 
1,540

 
 
120,531

 
 
 
118,766

 
 
 
119,096

 
 
 
 
 
 
 
 
 
 
 
 
 
15,241

 
 
 
15,200

 
 
 
15,184

 
 
1

 
 
 
2

 
 
 
1

 
 
15,242

 
 
 
15,202

 
 
 
15,185

 
 
$
135,773

 
 
 
$
133,968

 
 
 
$
134,281

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2.93
%
 
 
 
3.10
%
 
 
 
2.94
%
 
962

3.15
%
 
 
987

3.30
%
 
 
929

3.13
%
 
14

 
 
 
14

 
 
 
11

 
 
$
948

 
 
 
$
973

 
 
 
$
918

 
 
 
 
 
 
 
 
 
 
 
 
(e)
Yield is calculated on the basis of amortized cost.
(f)
Rate calculation excludes basis adjustments related to fair value hedges.
(g)
A portion of long-term debt and the related interest expense is allocated to discontinued liabilities as a result of applying our matched funds transfer pricing methodology to discontinued operations.


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Table of Contents


Figure 7 shows how the changes in yields or rates and average balances from the prior year period affected net interest income. The section entitled “Financial Condition” contains additional discussion about changes in earning assets and funding sources.

Figure 7. Components of Net Interest Income Changes from Continuing Operations  
 
From three months ended March 31, 2017
 
to three months ended March 31, 2018
in millions
Average
Volume
Yield/
Rate
Net
Change (a)
INTEREST INCOME
 
 
 
Loans
$
8

$
52

$
60

Loans held for sale

(1
)
(1
)
Securities available for sale
(7
)
7


Held-to-maturity securities
11

7

18

Trading account assets



Short-term investments
1

4

5

Other investments

2

2

Total interest income (TE)
13

71

84

INTEREST EXPENSE
 
 
 
NOW and money market deposit accounts

14

14

Savings deposits

4

4

Certificates of deposit ($100,000 or more)
4

7

11

Other time deposits

4

4

Total interest-bearing deposits
4

29

33

Federal funds purchased and securities sold under repurchase agreements
1

2

3

Bank notes and other short-term borrowings
(2
)
3

1

Long-term debt
11

13

24

Total interest expense
14

47

61

Net interest income (TE)
$
(1
)
$
24

$
23

 
 
 
 
(a)
The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each.

Provision for credit losses
393331886_chart-a56052a107675b31aac.jpg
Our provision for credit losses was $61 million for the three months ended March 31, 2018, compared to $63 million for the three months ended March 31, 2017. The decrease of $2 million in our provision for credit losses was related to a decrease in net loan-charge offs during the first quarter of 2018 compared to one year ago. In 2018, we expect the provision to slightly exceed net loan charge-offs to provide for loan growth.

Noninterest income

As shown in Figure 8, noninterest income was $601 million for the first quarter of 2018, compared to $577 million for the year-ago quarter. Noninterest income represented 39% of total revenue for the three months ended March 31, 2018, compared to 38% for the three months ended March 31, 2017. In 2018, we expect noninterest income to be in the range of $2.5 billion to $2.6 billion.

The following discussion explains the composition of certain elements of our noninterest income and the factors that caused those elements to change.


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Table of Contents

Figure 8. Noninterest Income
393331886_chart-d0f573e52f485194bb5.jpg393331886_chart-a574eaf8d4845b93b91.jpg
(a)
Other noninterest income includes operating lease income and other leasing gains, corporate services income, corporate-owned life insurance income, consumer mortgage income, mortgage servicing fees, net gains (losses) from principal investing, and other income. See the "Consolidated Statements of Income" in Item 1. Financial Statements of this report.
393331886_chart-3e204fbc1d645f2a89c.jpg393331886_chart-79c69a32a386526db54.jpg393331886_chart-9259b330f9ed5c11943.jpg
Trust and investment services income 

Trust and investment services income consists of brokerage commissions, trust and asset management fees, and insurance income. The assets under management that primarily generate these revenues are shown in Figure 9. For the three months ended March 31, 2018, trust and investment services income decreased $2 million, or 1.5%, compared to the same period one year ago, primarily due to a decrease in fixed income brokerage commissions. 

A significant portion of our trust and investment services income depends on the value and mix of assets under management. At March 31, 2018, our bank, trust, and registered investment advisory subsidiaries had assets under management of $39.0 billion, compared to $37.4 billion at March 31, 2017. As shown in Figure 9, the increase in assets under management was primarily attributable to market growth over the past twelve months.


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Table of Contents

Figure 9. Assets Under Management 
in millions
March 31, 2018
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
Assets under management by investment type:
 
 
 
 
 
Equity
$
23,629

$
24,081

$
23,342

$
22,824

$
22,522

Securities lending
837

947

876

807

1,095