KeyCorp’s
Top Down & Bottom Up
Capital Reconcilement
Integration
• Bottom up economic capital estimations must be melded
with top down economic requirements
• Regulatory needs must be reconciled with true risk
2
Eric Falkenstein 4/14/99
KeyCorp’s Solution
• Key’s main capital ratio target is for a 6.25% tangible
equity/tangible asset ratio
• This is influenced by peer comparisons and regulatory
requirements
• To make this consistent with the bottom up approach, we
adjust the economic capital estimates proportionally to
match our top-down target
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Eric Falkenstein 4/14/99
Peer Comparisons
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Eric Falkenstein 4/14/99
KEYCORP
RISK-BASED CAPITAL RATIOS
8%
7%
6%
5%
Dec-97
Mar-98
Jun-98
Sep-98
Dec-98
Mar-99
Tier 1 Capital Ratio
Tangible Equity to Tangible Assets
Tangible Equity + TAPS To Tangible Assets
4/14/99
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
Banks Comprising the S&P Major Regional Bank Index (1)
Capital Ratios And Double Leverage Ratios
Sorted From Highest To Lowest
As of September 30, 1998
Tier I
Tangible
Total
Double
Capital
Equity/Tang. Leverage Risk-Based Leverage
Institution
Ratio
Assets (2) (3)
Ratio
Capital
Ratio
4.38
124.04
State Street Corporation
14.30
5.50
14.60
8.52
95.84
Union Planters Corporation
13.49
9.29
17.07
5.91
138.00
Republic New York Corporation
13.45
5.95
22.22
10.00
104.26
Synovus Financial Corp.
12.84
10.94
14.11
9.81
86.59
Fifth Third Bancorp (OH)
12.34
10.22
14.57
7.64
105.38
Regions Financial Corporation
11.04
8.49
12.93
7.71
94.01
Summit Bancorp
11.00
7.40
12.20
8.08
119.61
BB&T Corporation
10.00
7.10
14.80
6.70
121.10
Mercantile Bancorporation Inc
9.87
7.12
12.75
6.69
106.47
Northern Trust Corporation
9.40
6.90
12.70
8.70
94.04
Bank One Corporation
9.23
9.06
13.58
7.50
104.96
National City Corporation
8.81
7.42
12.69
7.97
115.24
Wachovia Corporation
8.22
8.67
11.30
5.91
107.10
Firstar Corporation
8.11
6.75
11.36
7.22
108.15
Wells Fargo & Company
8.06
6.19
9.92
8.02
133.27
SunTrust Banks, Inc.
7.49
7.10
12.83
5.70
122.99
PNC Bank Corp.
7.48
7.18
10.92
7.86
144.62
Bank of New York Company Inc.
7.48
7.24
11.59
8.11
108.75
Huntington Bancshares Inc.
7.37
6.52
11.19
5.78
111.84
KeyCorp (9/30/98)
7.01
6.88
11.61
5.93
113.84
KeyCorp (12/31/98 - estimate)
7.01
6.95
11.35
6.39
123.00
BankBoston Corporation
7.00
6.80
11.30
6.47
111.07
Fleet Financial Group, Inc.
6.88
7.16
11.21
5.60
119.13
U.S. Bancorp
6.80
7.00
11.40
4.86
138.31
Mellon Bank Corporation
6.78
7.06
11.22
8.55
108.21
Comerica, Inc.
6.38
7.64
10.66
Average: (Excluding KeyCorp)
6Median: (Excluding KeyCorp)
9.33
8.52
7.26
7.57
7.53
7.14
12.88
12.44
113.92
109.91
Moody's
Senior
Debt Rating (4)
A1
Baa1
A1
A3
A1
A1
A2
A2
A2
A1
Aa3
A1
Aa3
A3
Aa3
A1
A2
Aa3
A3
A1
A1
A2
A2
A1
A2
A2
Eric Falkenstein 4/14/99
Key’s Top Down View
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Eric Falkenstein 4/14/99
Optimal Capitalization Range
The optimal capitalization range is dependent on the business mix and management
targets for debt rating and beta. Given KeyCorp’s current business mix, a target debt
rating of single-A, and a beta of around 1.1, KeyCorp estimates that its optimal
capitalization range is a tangible equity/tangible asset ratio between 6.0% and 6.5%.
The charts below show how the impact of leverage on ROE and required return
results in an optimal capitalization range for maximizing shareholder value.
HOW LEVERAGE IMPACTS ROE, REQUIRED RETURN, AND STOCK PRICE
High
High
ROE
High
Increasing
Decreasing
Credit Rating
Low
8
LEVERAGE
Beta
Low
High
KeyCorp Tangible Equity
Ratio Target: 6-6.5%
M
B
+ Ke
Low
. . .resulting in an “optimal”
leverage area for maximizing
shareholder value:
. . .while the post-tax math of
leverage versus required return
follows a different pattern . . .
Higher leverage initially leads to
higher ROE, but eventually high
debt costs put a cap on this . . .
Low
Low
High
Optimal
Leverage
Range
Beta: 1.1
Target Debt Rating: A
Low
High
Eric Falkenstein 4/14/99
Summary of Management Targets/Estimates
The following is a summary of the targets and estimates that
KeyCorp management has initially adopted for the purpose
of calculating economic capital allocations. They should be
reviewed at least annually and reaffirmed or amended, as
required.
Management Target/Estimate
9
Target debt rating
Single-A
Risk coverage level
99.5%
Optimal capitalization range
Tangible equity ratio between 6.0% and 6.5%
Eric Falkenstein 4/14/99
Capital Allocations Are A Function of the Risk
Coverage Level, Which Is Driven By Keycorp’s
Target Debt Rating. . .
Implied risk coverage level*
Rating agency
Tenor (Years)
risk rating
(S&P/Moody’s)
1
AA/Aa
99.97%
3
99.90%
5
99.63%
7
99.34%
10
98.99%
A/A
99.96%
99.79%
99.47%**
99.13%
98.47%
BBB/Baa
99.88%
99.28%
98.43%
97.53%
96.06%
* - A risk coverage level of 99.5% implies that economic capital will cover 99.5% of potential loss outcomes
** - FMCG recommends using the 5-year implied risk coverage level because five years is a mid-range maturity for the
senior debt that banks most frequently issue
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Eric Falkenstein 4/14/99
Top-Down Target
Top-Down
Total 6.25% Tangible Equity
.50%
Acquisition
Reserve
.75%
Special
Loss Reserve
5.00%
11
Risk-Based
Regulatory
Minimums
Eric Falkenstein 4/14/99
Reconcilement
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Eric Falkenstein 4/14/99
Reconcile Bottom-up Capital Allocations To
The Top-down Optimal Capitalization Range
$1.3B
$1.2B
Fixed Assets and
Goodwill
Other Intangible
Asset Risk
$200
Operational/Operating
Leverage Risk
$200
Interest Rate/
Market Risk
$200
Credit Risk
$500
Capital
($mm)
$200
Fixed Assets and
Goodwill*
$110
Other Intangible
Asset Risk
$220
Operational/Operating
Leverage Risk
$220
Interest Rate/
Market Risk
$550
Credit Risk
$100
Bottom-Up Allocation
(First-Cut)
Optimal Capitalization Level
(Final Capital Allocation)
------------------------
* -- Fixed assets and goodwill capital allocations are not adjusted as they are assigned using what is in essence a top-down methodology.
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Eric Falkenstein 4/14/99
Technical Point
• Since only up to 100% of an asset can be funded by equity,
items receiving 100% equity allocations are not affected by
the proportional adjustment (e.g., goodwill)
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Eric Falkenstein 4/14/99
Example
• Assume Key has $100 in assets, and thus a $6.25 top down
capital target
commercial
consumer
goodwill
Sum
Original
$ 2.00
$ 1.00
$ 1.00
$ 4.00
Adjusted
$ 3.50
$ 1.75
$ 1.00
$ 6.25
• Note after adjustment, the bottom up equals the top down
target
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Eric Falkenstein 4/14/99
Strategy Motivation
• The essence of the top down numbers is their relative
proportions, not their absolute levels
• As long as the bottom up numbers are close to the top
down numbers, distortions are secondary
• If bottom up and top down diverge too much, this should
motivate strategic behavior at the corporate level to bring
things back into balance
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Eric Falkenstein 4/14/99
The Future
• The Federal Reserve’s Board of Governors has put out a
discussion paper concerning the move towards internal
models for capital for credit, just as they use now for
market risk
• Our capital allocations anticipate this movement so that we
can hit the ground running when any change occurs
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Eric Falkenstein 4/14/99