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The following discussion explains the composition of certain components of Key’s noninterest expense and the factors that caused those components to change. 

Personnel. As shown in Figure 13, personnel expense, the largest category of Key’s noninterest expense, rose by $57 million, or 4%, in 2003 and $58 million, or 4%, in 2002. The 2003 increase resulted from 

a rise in employee benefit (primarily pension) costs, a higher level of stock-based compensation expense and an increase in severance expense, offset in part by lower incentive compensation accruals. In 2002, the increase was due primarily to a rise in the cost of employee benefits and the effect of annual merit increases, most of which generally take effect during the second quarter. 

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Effective January 1, 2003, Key adopted the fair value method of accounting as outlined in SFAS No. 123, “Accounting for Stock-Based Compensation.” Additional information pertaining to this accounting change is included in Note 1 (“Summary of Significant Accounting Policies”) under the headings “Stock-Based Compensation” on page 54 and “Accounting Pronouncements Adopted in 2003” on page 55. 

The level of Key’s personnel expense continues to reflect the benefits derived from a competitiveness initiative completed in 2002, as well as the continuous improvement efforts that have evolved from it. Management will continue to evaluate staffing levels and make appropriate changes when they can be accomplished without damaging either customer service or our ability to develop higher return businesses. For 2003, the average number of full-time equivalent employees was 20,034, compared with 20,816 for 2002 and 21,555 for 2001. At December 31, 1999, the end of the quarter in which the competitiveness initiative was launched, the number of full-time equivalent employees was 24,568. 

Computer processing. The decrease in computer processing expense in both 2003 and 2002 was due primarily to a lower level of computer software amortization. These reductions were attributable to declines in the number of capitalized software projects. 

Equipment. The decrease in equipment expense in 2002 was driven by reductions in depreciation and rental expense stemming from cost management efforts and a competitiveness initiative. 

Professional fees. The 2003 increase in professional fees reflects additional costs incurred to enhance Key’s sales management systems. 

Amortization of intangibles. On January 1, 2002, Key stopped amortizing goodwill, consistent with the adoption of new accounting guidance applicable to all companies. This change reduced noninterest expense by approximately $79 million for 2002. In accordance with the new guidance, Key completed its transitional goodwill impairment testing during the first quarter of 2002, and determined that no impairment existed as of January 1, 2002. Key performed annual goodwill impairment testing as of October 1, 2003 and 2002, and 

determined that no impairment existed at those dates as well. Additional information pertaining to the new accounting guidance is included in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Goodwill and Other Intangible Assets” on page 53. 

## Income taxes 

The provision for income taxes was $339 million for 2003, compared with $336 million for 2002 and $102 million for 2001. The effective tax rate, which is the provision for income taxes as a percentage of income before income taxes, was 27.3% for 2003, compared with 25.6% for 2002 and 39.4% for 2001. In 2001, the effective tax rate was significantly distorted by the $150 million nondeductible write-down of goodwill recorded in the second quarter in connection with management’s decision to downsize Key’s automobile finance business. Excluding this charge, the effective tax rate for 2001 was 24.9%. 

As discussed below, Key has transferred the management of residual values of certain equipment leases to a foreign subsidiary in a lower tax jurisdiction. A smaller number of such leases were transferred in 2003 than in 2002, which contributed to the increase in the effective tax rate. The rate increase was moderated, however, by tax-exempt income from corporate-owned life insurance and credits associated with investments in low-income housing projects, both of which represented a higher percentage of income before income taxes in 2003 than in 2002. 

The effective tax rates for both 2003 and 2002 are substantially below Key’s combined statutory federal and state rate of 37.5% (37% in 2002), primarily because portions of the equipment leasing portfolio became subject to a lower income tax rate in the latter half of 2001 when Key transferred responsibility for the management of portions of that portfolio to a foreign subsidiary in a lower tax jurisdiction. Since Key intends to permanently reinvest the earnings of this subsidiary, no deferred income taxes have been recorded on those earnings in accordance with SFAS No. 109, “Accounting for Income Taxes.” Other factors that account for the difference between the effective and statutory tax rates in the current and prior year include tax deductions associated 

