KeyBank 2005 Annual Report Download - page 25

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
Taxable-equivalent net interest income for 2005 was $2.9 billion,
representing a $212 million, or 8%, increase from the prior year. There
were two principal causes of this growth: an increase in average earning
assets due to strong growth in all major components of the commercial
loan portfolio; and a higher net interest margin, which increased 6
basis points to 3.69%. (A basis point is equal to one one-hundredth of
a percentage point, meaning 6 basis points equals .06%.)
The net interest margin, which is an indicator of the profitability of the
earning assets portfolio, is calculated by dividing net interest income by
average earning assets. The improvement in the net interest margin
reflected 19% growth in average commercial loans, an 8% increase in
average core deposits and a 9% rise in average noninterest-bearing
funds, along with a slight asset-sensitive interest rate risk position in a
rising interest rate environment. The increase in the net interest margin
was offset in part by the effects of actions taken by Key to exit certain
assets that had higher yields and credit costs, which did not fit our
relationship banking strategy. In addition, Key’s interest rate spread,
representing the difference between the yield on average earning assets
and the rate paid for interest-bearing funds, contracted from 2004 as a
result of competitive pressure on loan and deposit pricing caused by
rising interest rates.
Average earning assets for 2005 totaled $78.9 billion, which was $4.5
billion, or 6%, higher than the 2004 level. Growth in commercial
lending, which was bolstered by the acquisitions of EverTrust and AEBF
during the fourth quarter of 2004, and an increase in loans held for sale
more than offset declines in consumer loans and short-term investments.
The decline in consumer loans was due primarily to loan sales.
In 2004, net interest income was $2.7 billion, representing a $61 million,
or 2%, decrease from 2003 as the negative effect of a lower net interest
margin more than offset an increase in average earning assets. Key’s
net interest margin contracted 15 basis points to 3.63%, while average
earning assets grew by $1.4 billion, or 2%, to $74.4 million. Growth in
our commercial lending and lease financing, and an increase in short-term
investments drove the increase, but these improvements were partially
offset by declines in consumer loans and securities available for sale. The
decline in consumer loans was due to loan sales and management’s
efforts to exit certain credit-only relationship portfolios.
Over the past two years, the growth and composition of Key’s loan
portfolio has been affected by the following actions:
• During the fourth quarter of 2004, Key acquired EverTrust, in
Everett, Washington, with a loan portfolio (primarily commercial real
estate loans) of approximately $685 million at the date of acquisition.
In the same quarter, Key acquired AEBF, with a commercial loan and
lease financing portfolio of approximately $1.5 billion.
• Key sold commercial mortgage loans of $2.2 billion during 2005
and $2.1 billion during 2004. Since some of these loans have been
sold with limited recourse (i.e., there is a risk that Key will be held
accountable for certain events or representations made in the sales),
Key established and has maintained a loss reserve in an amount
estimated by management to be appropriate. More information
about the related recourse agreement is provided in Note 18
(“Commitments, Contingent Liabilities and Guarantees”) under the
heading “Recourse agreement with Federal National Mortgage
Association” on page 85.
• Key sold education loans of $1.2 billion ($937 million through
securitizations) during 2005 and $1.3 billion ($1.1 billion through
securitizations) during 2004. Key has used the securitization market
for education loans as a means of diversifying our funding sources.
• Key sold other loans (primarily home equity and indirect consumer
loans) totaling $2.7 billion during 2005 and $2.9 billion during
2004. During the first quarter of 2005, Key completed the sale of $992
million of indirect automobile loans, representing the prime segment
of that portfolio. In April 2005, Key completed the sale of $635
million of loans, representing the nonprime segment. During the
fourth quarter of 2004, Key sold $978 million of broker-originated
home equity loans. The decision to sell these loans was driven by
management’s strategies for improving Key’s returns and achieving
desired interest rate and credit risk profiles.
Figure 6 shows how the changes in yields or rates and average balances
from the prior year affected net interest income. The section entitled
“Financial Condition,” which begins on page 29, contains more
discussion about changes in earning assets and funding sources.
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