10-Q
Table of Contents

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, 2013

Commission File Number 1-11302

 

LOGO

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  þ    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  þ    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer þ    Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)    Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

     Yes  ¨    No  þ

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    

      

              920,510,321 Shares              

Title of class      Outstanding at April 30, 2013


Table of Contents

KEYCORP

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

 

Item 1.   Financial Statements      Page Number      
 

Consolidated Balance Sheets — March 31, 2013 (Unaudited), December 31,  2012, and March 31, 2012 (Unaudited)

     5   
 

Consolidated Statements of Income (Unaudited) — Three months ended March 31, 2013  and 2012

     6   
 

Consolidated Statements of Comprehensive Income (Unaudited) — Three months ended March  31, 2013 and 2012

     7   
 

Consolidated Statements of Changes in Equity (Unaudited) — Three months ended March 31, 2013 and 2012

     8   
 

Consolidated Statements of Cash Flows (Unaudited) — Three months ended March 31,  2013 and 2012

     9   
  Notes to Consolidated Financial Statements (Unaudited)      10   
  Note 1. Basis of Presentation      10   
  Note 2. Earnings Per Common Share      13   
  Note 3. Loans and Loans Held for Sale      14   
  Note 4. Asset Quality      15   
  Note 5. Fair Value Measurements      30   
  Note 6. Securities      45   
  Note 7. Derivatives and Hedging Activities      49   
  Note 8. Mortgage Servicing Assets      57   
  Note 9. Variable Interest Entities      58   
  Note 10. Income Taxes      60   
  Note 11. Acquisitions and Discontinued Operations      61   
  Note 12. Securities Financing Activities      68   
  Note 13. Employee Benefits      70   
  Note 14. Trust Preferred Securities Issued by Unconsolidated Subsidiaries      71   
  Note 15. Contingent Liabilities and Guarantees      72   
  Note 16. Accumulated Other Comprehensive Income      75   
  Note 17. Shareholders’ Equity      76   

 

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Table of Contents
    Note 18. Line of Business Results      77   
    Report of Independent Registered Public Accounting Firm      81   

Item 2.

    Management’s Discussion & Analysis of Financial Condition & Results of Operations      82   
 

Introduction

     82   
   

Terminology

     82   
   

Selected financial data

     83   
   

Consolidated statements of income

     84   
   

Forward-looking statements

     87   
   

Economic overview

     88   
   

Long-term financial goals

     89   
   

Strategic developments

     90   
   

Demographics

     91   
   

Supervision and regulation

     92   
   

Regulatory reform developments

     92   
   

Supervisory and company run-stress testing

     92   
   

Enhanced prudential standards and early remediation requirements

     92   
   

Bureau of consumer financial protection

     92   
   

U.S. implementation of Basel III

     92   
  Highlights of Our Performance      94   
  Results of Operations      98   
   

Net interest income

     98   
   

Noninterest income

     102   
   

Trust and investment services income

     104   
   

Investment banking and debt placement fees

     104   
   

Operating lease income and other leasing gains

     104   
   

Cards and payments

     104   
   

Other income

     104   
   

Noninterest expense

     104   
   

Personnel

     105   
   

Operating lease expense

     105   
   

Intangible asset amortization

     106   
   

Other expense

     106   
   

Income taxes

     106   
  Line of Business Results      107   
   

Key Community Bank summary of operations

     107   
   

Key Corporate Bank summary of operations

     108   
   

Other Segments

     109   
  Financial Condition      110   
   

Loans and loans held for sale

     110   
   

Commercial loan portfolio

     110   
   

Commercial, financial and agricultural

     110   
   

Commercial real estate loans

     110   
   

Commercial lease financing

     111   
   

Commercial loan modification and restructuring

     111   
   

Extensions

     113   
   

Guarantors

     113   
   

Consumer loan portfolio

     113   
   

Loans held for sale

     114   
   

Loan sales

     114   
   

Securities

     115   

 

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Securities available-for-sale

     116   
   

Held-to-maturity securities

     117   
   

Other investments

     118   
   

Deposits and other sources of funds

     118   
   

Capital

     119   
   

CCAR and capital actions

     119   
   

Dividends

     119   
   

Common shares outstanding

     119   
   

Capital adequacy

     120   
   

Basel III

     121   
  Risk Management      123   
   

Overview

     123   
   

Market risk management

     125   
   

Trading market risk

     125   
   

Nontrading market risk

     127   
   

Net interest income simulation analysis

     128   
   

Economic value of equity modeling

     129   
   

Management of interest rate exposure

     129   
   

Liquidity risk management

     129   
   

Governance structure

     130   
   

Factors affecting liquidity

     130   
   

Managing liquidity risk

     130   
   

Long-term liquidity strategy

     131   
   

Sources of liquidity

     131   
   

Liquidity programs

     131   
   

Liquidity for KeyCorp

     131   
   

Our liquidity position and recent activity

     132   
   

Credit risk management

     132   
   

Credit policy, approval and evaluation

     132   
   

Allowance for loan and lease losses

     133   
   

Net loan charge-offs

     136   
   

Nonperforming assets

     139   
   

Operational risk management

     142   
    Critical Accounting Policies and Estimates      142   
    European Sovereign Debt Exposure      144   

Item 3.

    Quantitative and Qualitative Disclosure about Market Risk      145   

Item 4.

    Controls and Procedures      145   
PART II. OTHER INFORMATION   

Item 1.

    Legal Proceedings      145   

Item 1A.

    Risk Factors      145   

Item 2.

    Unregistered Sales of Equity Securities and Use of Proceeds      146   

Item 6.

    Exhibits      146   
    Signature      147   
    Exhibits      149   

Throughout the Notes to Consolidated Financial Statements (Unaudited) and Management’s Discussion & Analysis of Financial Condition & Results of Operations, we use certain acronyms and abbreviations as defined in Note 1 (“Basis of Presentation”), that begins on page 11.

 

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Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.   Financial Statements

Consolidated Balance Sheets

 

in millions, except per share data  

              March 31, 

                         2013  

            December 31, 
                       2012  
   

              March 31, 

                         2012  

 

 

 
    (Unaudited)            (Unaudited)   

ASSETS

     

Cash and due from banks

   $ 621        $ 584        $ 415    

Short-term investments

    3,081         3,940         3,605    

Trading account assets

    701         605         614    

Securities available for sale

    13,496         12,094         14,633    

Held-to-maturity securities (fair value: $3,779, $3,992 and $3,052)

    3,721         3,931         3,019    

Other investments

    1,059         1,064         1,188    

Loans, net of unearned income of $923, $957 and $1,282

    52,574         52,822         49,226    

Less: Allowance for loan and lease losses

    893         888         944    

 

 

Net loans

    51,681         51,934         48,282    

Loans held for sale

    434         599         511    

Premises and equipment

    930         965         937    

Operating lease assets

    309         288         335    

Goodwill

    979         979         917    

Other intangible assets

    159         171         15    

Corporate-owned life insurance

    3,352         3,333         3,270    

Derivative assets

    609         693         830    

Accrued income and other assets (including $50 of consolidated

     

LIHTC guaranteed funds VIEs, see Note 9)(a)

    2,884         2,774         3,070    

Discontinued assets (including $2,358 of consolidated education loan securitization trust VIEs (see Note 9) and $154 of loans in portfolio at fair value)(a)

    5,182         5,282         5,790     

 

 

Total assets

   $ 89,198        $ 89,236         $ 87,431    
 

 

 

   

 

 

   

 

 

 

LIABILITIES

     

Deposits in domestic offices:

     

NOW and money market deposit accounts

   $ 32,700        $ 32,380        $ 29,124    

Savings deposits

    2,546         2,433         2,075    

Certificates of deposit ($100,000 or more)

    2,998         2,879         3,984    

Other time deposits

    4,324         4,575         5,848    

 

 

Total interest-bearing

    42,568         42,267         41,031    

Noninterest-bearing

    21,564         23,319         19,606    

Deposits in foreign office — interest-bearing

    522         407         857    

 

 

Total deposits

    64,654         65,993         61,494    

Federal funds purchased and securities sold under repurchase agreements

    1,950         1,609         1,846    

Bank notes and other short-term borrowings

    378         287         324    

Derivative liabilities

    524         584         754    

Accrued expense and other liabilities

    1,352         1,387         1,424    

Long-term debt

    7,785         6,847         8,898    

Discontinued liabilities (including $2,151 of consolidated education loan securitization trust VIEs at fair value, see Note 9)(a)

    2,176         2,220         2,575    

 

 

Total liabilities

    78,819         78,927         77,315    

EQUITY

     

Preferred stock, $1 par value, authorized 25,000,000 shares:

     

7.75% Noncumulative Perpetual Convertible Preferred Stock, Series A, $100 liquidation preference; authorized 7,475,000 shares; issued 2,904,839, 2,904,839 and 2,904,839 shares

    291         291         291    

Common shares, $1 par value; authorized 1,400,000,000 shares; issued 1,016,969,905, 1,016,969,905 and 1,016,969,905 shares

    1,017         1,017         1,017    

Capital surplus

    4,059         4,126         4,116    

Retained earnings

    7,065         6,913         6,411    

Treasury stock, at cost (94,388,605, 91,201,285 and 60,868,267)

    (1,930)         (1,952)         (1,717)    

Accumulated other comprehensive income (loss)

    (162)         (124)         (19)    

 

 

Key shareholders’ equity

    10,340         10,271         10,099    

Noncontrolling interests

    39         38         17    

 

 

Total equity

    10,379          10,309         10,116    

 

 

Total liabilities and equity

   $ 89,198        $ 89,236        $ 87,431    
 

 

 

   

 

 

   

 

 

 
     

 

 

 

(a) The assets of the VIEs can only be used by the particular VIE and there is no recourse to Key with respect to the liabilities of the consolidated LIHTC or education loan securitization trust VIEs.

See Notes to Consolidated Financial Statements (Unaudited).

 

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Consolidated Statements of Income (Unaudited)

 

   

            Three months ended March 31, 

 
dollars in millions, except per share amounts   2013       2012    

 

 

INTEREST INCOME

   

Loans

   $ 548        $ 536    

Loans held for sale

    4         5    

Securities available for sale

    80         116    

Held-to-maturity securities

    18         12    

Trading account assets

    6         6    

Short-term investments

    2         1    

Other investments

    9         8    

 

 

Total interest income

    667         684    

INTEREST EXPENSE

   

Deposits

    45         77    

Federal funds purchased and securities sold under repurchase agreements

    1         1    

Bank notes and other short-term borrowings

    1         2    

Long-term debt

    37         51    

 

 

Total interest expense

    84         131    

 

 

NET INTEREST INCOME

    583         553    

Provision (credit) for loan and lease losses

    55         42    

 

 

Net interest income (expense) after provision for loan and lease losses

    528         511    

NONINTEREST INCOME (a)

   

Trust and investment services income

    95         96    

Investment banking and debt placement fees

    79         61    

Service charges on deposit accounts

    69         68    

Operating lease income and other leasing gains

    23         52    

Corporate services income

    45         44    

Cards and payments income

    37         29    

Corporate-owned life insurance income

    30         30    

Consumer mortgage income

    7         9    

Net gains (losses) from principal investing

    8         35    

Other income (b)

    32         18    

 

 

Total noninterest income

    425         442    

NONINTEREST EXPENSE

   

Personnel

    391         372    

Net occupancy

    64         64    

Computer processing

    39         41    

Business services and professional fees

    35         37    

Equipment

    26         26    

Operating lease expense

    12         17    

Marketing

    6         13    

FDIC assessment

    8         8    

Intangible asset amortization on credit cards

    8         —    

Other intangible asset amortization

    4         1    

Provision (credit) for losses on lending-related commitments

    3         —    

OREO expense, net

    3         6    

Other expense

    82         94    

 

 

Total noninterest expense

    681         679    

 

 

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES

    272         274    

Income taxes

    70         73    

 

 

INCOME (LOSS) FROM CONTINUING OPERATIONS

    202         201    

Income (loss) from discontinued operations, net of taxes of $4 and ($1) (see Note 11)

    3         (1)    

 

 

NET INCOME (LOSS)

    205         200    

Less: Net income (loss) attributable to noncontrolling interests

    1         —    

 

 

NET INCOME (LOSS) ATTRIBUTABLE TO KEY

   $ 204        $ 200    
 

 

 

   

 

 

 

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

   $ 196        $ 195    

Net income (loss) attributable to Key common shareholders

    199         194    

Per common share:

   

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

   $ .21        $ .21    

Income (loss) from discontinued operations, net of taxes

    —         —    

Net income (loss) attributable to Key common shareholders (c)

    .22         .20    

Per common share — assuming dilution:

   

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

   $ .21        $ .20    

Income (loss) from discontinued operations, net of taxes

    —         —    

Net income (loss) attributable to Key common shareholders (c)

    .21         .20    

Cash dividends declared per common share

   $ .05        $ .03    

Weighted-average common shares outstanding (000)

    920,316         949,342    

Weighted-average common shares and potential common shares outstanding (000) (d)

    926,051         953,971    
   

 

 
(a) The noninterest income line items have been changed for the current quarter and all prior quarters to reflect Key’s current business mix.

 

(b) For the three months ended March 31, 2013 and 2012, we did not have any impairment losses related to securities.

 

(c) EPS may not foot due to rounding.

 

(d) Assumes conversion of stock options and/or Preferred Series A, as applicable.

See Notes to Consolidated Financial Statements (Unaudited).

 

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Consolidated Statements of Comprehensive Income (Unaudited)

 

        

          Three months ended March 31, 

 
in millions        2013        2012    

 

 

Net income (loss)

    $   205         $ 200    

Other comprehensive income (loss), net of tax:

         

Net unrealized gains (losses) on securities available for sale, net of income taxes of ($13) and ($6)

     (22)         (11)    

Net unrealized gains (losses) on derivative financial instruments, net of income taxes of ($5) and $7

     (8)         12    

Foreign currency translation adjustments, net of income taxes

     (11)         6    

Net pension and postretirement benefit costs, net of income taxes

     3          2    

 

 

Total other comprehensive income (loss), net of tax

     (38)         9    

 

 

Comprehensive income (loss)

     167          209    

Less: Comprehensive income attributable to noncontrolling interests

     1          —    

 

 

Comprehensive income (loss) attributable to Key

    $    166         $ 209    
  

 

    

 

 

 

 

 

See Notes to Consolidated Financial Statements (Unaudited).

 

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Consolidated Statements of Changes in Equity (Unaudited)

 

     Key Shareholders’ Equity  
dollars in millions, except per
share amounts
   Preferred
Shares
Outstanding
(000)
     Common
Shares
Outstanding
(000)
          Preferred
Stock
     Common
Shares
     Capital
Surplus
     Retained
Earnings
    

Treasury
Stock,

at Cost

     Accumulated
Other
Comprehensive
Income (Loss)
     Noncontrolling
Interests
 

BALANCE AT DECEMBER 31, 2011

     2,905          953,008            $ 291         $ 1,017         $ 4,194         $ 6,246         $ (1,815)         $ (28)         $ 17    

Net income (loss)

                       200             

Other comprehensive income (loss):

                             

Net unrealized gains (losses) on securities available for sale, net of income taxes of ($6)

                             (11)       

Net unrealized gains (losses) on derivative financial instruments, net of income taxes of $7

                             12       

Foreign currency translation adjustments, net of income taxes

                             6       

Net pension and postretirement benefit costs, net of income taxes

                             2       

Deferred compensation

                    4                

Cash dividends declared on common shares ($.03 per share)

                       (29)             

Cash dividends declared on Noncumulative Series A

                             

Preferred Stock ($1.9375 per share)

                       (6)             

Common shares reissued (returned) for stock options and other employee benefit plans

        3,094                   (82)             98          

 

 

BALANCE AT MARCH 31, 2012

     2,905          956,102            $ 291         $ 1,017         $ 4,116         $ 6,411         $ (1,717)         $ (19)          $ 17    
  

 

 

    

 

 

       

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

BALANCE AT DECEMBER 31, 2012

     2,905          925,769            $ 291         $ 1,017         $ 4,126         $ 6,913         $ (1,952)         $ (124)          $ 38    

Net income (loss)

                       204                1    

Other comprehensive income (loss):

                             

Net unrealized gains (losses) on securities available for sale, net of income taxes of ($13)

                             (22)       

Net unrealized gains (losses) on derivative financial instruments, net of income taxes of ($5)

                             (8)       

Foreign currency translation adjustments, net of income taxes

                             (11)       

Net pension and postretirement benefit costs, net of income taxes

                             3       

Deferred compensation

                    4                

Cash dividends declared on common shares ($.05 per share)

                       (47)             

Cash dividends declared on Noncumulative Series A

                             

Preferred Stock ($1.9375 per share)

                       (5)             

Common shares repurchased

        (6,790)                         (65)          

Common shares reissued (returned) for stock options and other employee benefit plans

        3,602                   (71)             87          

 

 

BALANCE AT MARCH 31, 2013

     2,905          922,581            $ 291        $ 1,017        $ 4,059        $ 7,065        $ (1,930)        $ (162)        $ 39    
  

 

 

    

 

 

       

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

See Notes to Consolidated Financial Statements (Unaudited).

 

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Consolidated Statements of Cash Flows (Unaudited)

 

   

            Three months ended March  31,

 
in millions   2013      2012   

 

 

OPERATING ACTIVITIES

   

Net income (loss)

   $ 205        $ 200    

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

   

Provision (credit) for loan and lease losses

    55         42    

Depreciation, amortization and accretion expense, net

    61         48    

FDIC (payments) net of FDIC expense

    7         7    

Deferred income taxes (benefit)

    32         28    

Net losses (gains) and writedown on OREO

    3         6    

Net losses (gains) from loan sales

    (31)         (22)    

Net losses (gains) from principal investing

    (8)         (35)    

Provision (credit) for losses on lending-related commitments

    3         —    

(Gains) losses on leased equipment

    (5)         (27)    

Net decrease (increase) in loans held for sale excluding loan transfers from continuing operations

    (1,093)         (912)    

Net decrease (increase) in trading account assets

    (96)         9    

Other operating activities, net

    (206)         (435)    

 

 

NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES

    (1,073)         (1,091)    

INVESTING ACTIVITIES

   

Net decrease (increase) in short-term investments

    859         (86)    

Purchases of securities available for sale

    (2,755)         (2)    

Proceeds from sales of securities available for sale

    3         —   

Proceeds from prepayments and maturities of securities available for sale

    1,315         1,364    

Proceeds from prepayments and maturities of held-to-maturity securities

    210         96    

Purchases of held-to-maturity securities

    —         (1,005)    

Purchases of other investments

    (11)         (16)    

Proceeds from sales of other investments

    3         2    

Proceeds from prepayments and maturities of other investments

    20         24    

Net decrease (increase) in loans, excluding acquisitions, sales and transfers

    156         202    

Proceeds from loan sales

    1,345         1,195    

Purchases of premises and equipment

    (10)         (26)    

Proceeds from sales of premises and equipment

    8         —    

Proceeds from sales of other real estate owned

    5         12    

 

 

NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES

    1,148         1,760    

FINANCING ACTIVITIES

   

Net increase (decrease) in deposits

    (1,339)         (462)    

Net increase (decrease) in short-term borrowings

    433         122    

Net proceeds from issuance of long-term debt

    1,007         —    

Payments on long-term debt

    (30)         (572)    

Repurchase of Treasury Shares

    (65)         —    

Net proceeds from issuance of common shares

    8         —    

Cash dividends paid

    (52)         (35)    

 

 

NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES

    (38)         (947)    

 

 

NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS

    37         (278)    

CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD

    584         693    

 

 

CASH AND DUE FROM BANKS AT END OF PERIOD

   $ 621        $ 415    
 

 

 

   

 

 

 

 

 

Additional disclosures relative to cash flows:

   

Interest paid

   $ 110        $ 101    

Income taxes paid (refunded)

    25         3    

Noncash items:

   

Loans transferred to portfolio from held for sale

    —        $ 19    

Loans transferred to other real estate owned

   $ 7         5    

 

 

See Notes to Consolidated Financial Statements (Unaudited).

 

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Notes to Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

As used in these Notes, 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, KeyBank National Association.

The acronyms and abbreviations identified below are used in the Notes to Consolidated Financial Statements (Unaudited) as well as in the Management’s Discussion & Analysis of Financial Condition & Results of Operations. You may find it helpful to refer back to this page as you read this report.

References to our “2012 Form 10-K” refer to our Form 10-K for the year ended December 31, 2012, that has been filed with the U.S. Securities and Exchange Commission and is available on its website (www.sec.gov) or on our website (www.key.com/ir).

 

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ABO: Accumulated benefit obligation.

AICPA: American Institute of Certified Public Accountants.

ALCO: Asset/Liability Management Committee.

ALLL: Allowance for loan and lease losses.

A/LM: Asset/liability management.

AOCI: Accumulated other comprehensive income (loss).

APBO: Accumulated postretirement benefit obligation.

Austin: Austin Capital Management, Ltd.

BHCA: Bank Holding Company Act of 1956, as amended.

BHCs: Bank holding companies.

CCAR: Comprehensive Capital Analysis and Review.

CFPB: Bureau of Consumer Financial Protection.

CFTC: Commodities Futures Trading Commission.

CMO: Collateralized mortgage obligation.

Common Shares: Common Shares, $1 par value.

CPP: Capital Purchase Program of the U.S. Treasury.

DIF: Deposit Insurance Fund of the FDIC.

Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

ERISA: Employee Retirement Income Security Act of 1974.

ERM: Enterprise risk management.

EVE: Economic value of equity.

FASB: Financial Accounting Standards Board.

FDIA: Federal Deposit Insurance Act, as amended.

FDIC: Federal Deposit Insurance Corporation.

Federal Reserve: Board of Governors of the Federal Reserve System.

FHFA: Federal Housing Finance Agency.

FHLMC: Federal Home Loan Mortgage Corporation.

FINRA: Financial Industry Regulatory Authority.

FNMA: Federal National Mortgage Association.

FOMC: Federal Open Market Committee of the Federal Reserve Board.

FSOC: Financial Stability Oversight Council.

FVA: Fair value of pension plan assets.

GAAP: U.S. generally accepted accounting principles.

GNMA: Government National Mortgage Association.

HUD: U.S. Department of Housing and Urban Development.

IRS: Internal Revenue Service.

ISDA: International Swaps and Derivatives Association.

KAHC: Key Affordable Housing Corporation.

LIBOR: London Interbank Offered Rate.

 

LIHTC: Low-income housing tax credit.

LILO: Lease in, lease out transaction.

Moody’s: Moody’s Investor Services, Inc.

N/A: Not applicable.

NASDAQ: The NASDAQ Stock Market LLC.

N/M: Not meaningful.

NOW: Negotiable Order of Withdrawal.

NPR: Notice of proposed rulemaking.

NYSE: New York Stock Exchange.

OCC: Office of the Comptroller of the Currency.

OCI: Other comprehensive income (loss).

OFR: Office of Financial Research of the U.S. Department of Treasury.

OREO: Other real estate owned.

OTTI: Other-than-temporary impairment.

QSPE: Qualifying special purpose entity.

PBO: Projected benefit obligation.

PCCR: Purchased credit card relationship.

PCI: Purchased credit impaired.

S&P: Standard and Poor’s Ratings Services, a Division of The

McGraw-Hill Companies, Inc.

SCAP: Supervisory Capital Assessment Program administered

by the Federal Reserve.

SEC: U.S. Securities & Exchange Commission.

Series A Preferred Stock: KeyCorp’s 7.750% Noncumulative Perpetual Convertible Preferred Stock, Series A.

SIFIs: Systemically important financial companies, including BHCs with total consolidated assets of at least $50 billion and nonbank financial companies designated by FSOC for supervision by the Federal Reserve.

SILO: Sale in, lease out transaction.

SPE: Special purpose entity.

TDR: Troubled debt restructuring.

TE: Taxable equivalent.

U.S. Treasury: United States Department of the Treasury.

VaR: Value at risk.

VEBA: Voluntary Employee Beneficiary Association.

Victory: Victory Capital Management and/or Victory Capital Advisors

VIE: Variable interest entity.

XBRL: eXtensible Business Reporting Language.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

The consolidated financial statements include the accounts of KeyCorp and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Some previously reported amounts have been reclassified to conform to current reporting practices. The noninterest income line items reported on the consolidated statements of income have been changed for the current quarter and all prior quarters to reflect our current business mix.

The consolidated financial statements include any voting rights entities in which we have a controlling financial interest. In accordance with the applicable accounting guidance for consolidations, we consolidate a VIE if we have: (i) a variable interest in the entity; (ii) the power to direct activities of the VIE that most significantly impact the entity’s economic performance; and (iii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE (i.e., we are considered to be the primary beneficiary). Variable interests can include equity interests, subordinated debt, derivative contracts, leases, service agreements, guarantees, standby letters of credit, loan commitments, and other contracts, agreements and financial instruments. See Note 9 (“Variable Interest Entities”) for information on our involvement with VIEs.

 

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We use the equity method to account for unconsolidated investments in voting rights entities or VIEs if we have significant influence over the entity’s operating and financing decisions (usually defined as a voting or economic interest of 20% to 50%, but not controlling). Unconsolidated investments in voting rights entities or VIEs in which we have a voting or economic interest of less than 20% generally are carried at cost. Investments held by our registered broker-dealer and investment company subsidiaries (primarily principal investments) are carried at fair value.

We believe that the unaudited consolidated interim financial statements reflect all adjustments of a normal recurring nature and disclosures that are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full year. The interim financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our 2012 Form 10-K.

In preparing these financial statements, subsequent events were evaluated through the time the financial statements were issued. Financial statements are considered issued when they are widely distributed to all shareholders and other financial statement users, or filed with the SEC.

Offsetting Derivative Positions

In accordance with the applicable accounting guidance, we take into account the impact of bilateral collateral and master netting agreements that allow us to settle all derivative contracts held with a single counterparty on a net basis, and to offset the net derivative position with the related collateral when recognizing derivative assets and liabilities. Additional information regarding derivative offsetting is provided in Note 7 (“Derivatives and Hedging Activities”).

Accounting Guidance Adopted in 2013

Testing indefinite-lived intangible assets for impairment.  In July 2012, the FASB issued new accounting guidance that simplifies how an entity tests indefinite-lived intangible assets other than goodwill for impairment. It permits an entity to first assess qualitative factors to determine whether further testing for impairment of indefinite-lived intangible assets other than goodwill is required. This accounting guidance was effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 (January 1, 2013, for us). The adoption of this accounting guidance did not have a material effect on our financial condition or results of operations.

Offsetting disclosures.  In December 2011, the FASB issued new accounting guidance that requires an entity to disclose information about offsetting and related arrangements to enable financial statement users to understand the effect of those arrangements on the entity’s financial position. In January 2013, the FASB issued new accounting guidance that clarified the scope of the guidance to include derivatives, repurchase and reverse repurchase agreements, and securities lending and borrowing transactions. This accounting guidance was effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods (effective January 1, 2013, for us). Information about our offsetting and related arrangements is provided in Note 12 (“Securities Financing Activities”).

Reporting of amounts reclassified out of AOCI.  In February 2013, the FASB issued new accounting guidance that requires reclassifications of amounts out of AOCI to be reported in a new format. It will not require the reporting of any information that is not currently required to be disclosed under existing GAAP. This accounting guidance was effective prospectively for reporting periods beginning after December 15, 2012 (effective January 1, 2013, for us). The disclosures required by this accounting guidance are provided in Note 16 (“Accumulated Other Comprehensive Income”).

Accounting Guidance Pending Adoption at March 31, 2013

Reporting of cumulative translation adjustments upon the derecognition of certain investments.    In March 2013, the FASB issued new accounting guidance that addresses the accounting for the cumulative translation adjustment when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. This accounting guidance will be effective prospectively for reporting periods beginning after December 15, 2013 (effective January 1, 2014, for us). The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

 

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2.  Earnings Per Common Share

Our basic and diluted earnings per Common Share are calculated as follows:

 

   

Three months ended March 31, 

 
dollars in millions, except per share amounts                 2013                     2012    

 

 

EARNINGS

   

Income (loss) from continuing operations

    $ 202         $ 201    

Less: Net income (loss) attributable to noncontrolling interests

    1         —    

 

 

Income (loss) from continuing operations attributable to Key

    201         201    

Less: Dividends on Series A Preferred Stock

    5         6    

 

 

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

    196         195    

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

    3         (1)    

 

 

Net income (loss) attributable to Key common shareholders

    $ 199         $ 194    
 

 

 

   

 

 

 
   

 

 

WEIGHTED-AVERAGE COMMON SHARES

   

Weighted-average common shares outstanding (000)

    920,316         949,342    

Effect of dilutive convertible preferred stock, common share options and other stock awards (000)

    5,735         4,629    

 

 

Weighted-average common shares and potential common shares outstanding (000)

    926,051         953,971    
 

 

 

   

 

 

 
   

 

 

EARNINGS PER COMMON SHARE

   

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

    $ .21         $ .21    

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

    —         —    

Net income (loss) attributable to Key common shareholders (b)

    .22         .20    

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

    $ .21         $ .20    

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

    —         —    

Net income (loss) attributable to Key common shareholders — assuming dilution (b)

    .21         .20    

 

 

 

(a) In April 2009, we decided to wind down the operations of Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers. In September 2009, we decided to discontinue the education lending business conducted through Key Education Resources, the education payment and financing unit of KeyBank National Association. In February 2013, we decided to sell Victory to a private equity fund. As a result of these decisions, we have accounted for these businesses as discontinued operations. For further discussion regarding the income (loss) from discontinued operations see Note 11 (“Acquisitions and Discontinued Operations”).

 

(b) EPS may not foot due to rounding.

 

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3.  Loans and Loans Held for Sale

Our loans by category are summarized as follows:

 

in millions                       March 31, 
                               2013  
                    December 31, 
                               2012  
                        March 31, 
                               2012  
 

 

 

Commercial, financial and agricultural (a)

    $ 23,412         $ 23,242         $ 20,217    

Commercial real estate:

     

Commercial mortgage

    7,544         7,720         7,807    

Construction

    1,057         1,003         1,273    

 

 

Total commercial real estate loans

    8,601         8,723         9,080    

Commercial lease financing

    4,796         4,915         5,325    

 

 

Total commercial loans

    36,809         36,880         34,622    

Residential — prime loans:

     

Real estate — residential mortgage

    2,176         2,174         1,967    

Home equity:

     

Key Community Bank

    9,809         9,816         9,153   

Other

    401         423         507    

 

 

Total home equity loans

    10,210         10,239         9,660    

 

 

Total residential — prime loans

    12,386         12,413         11,627    

Consumer other — Key Community Bank

    1,353         1,349         1,212    

Credit cards

    693         729         —    

Consumer other:

     

Marine

    1,254         1,358         1,654    

Other

    79         93         111    

 

 

Total consumer other

    1,333         1,451         1,765    

 

 

Total consumer loans

    15,765         15,942         14,604    

 

 

Total loans (b) (c)

    $ 52,574         $ 52,822         $ 49,226    
 

 

 

   

 

 

   

 

 

 
     

 

 

 

(a) March 31, 2013 and December 31, 2012 loan balances includes $93 million and $90 million of commercial credit card balances, respectively.

 

(b) Excluded at March 31, 2013, December 31, 2012, and March 31, 2012, are loans in the amount of $5.1 billion, $5.2 billion and $5.7 billion, respectively, related to the discontinued operations of the education lending business.

 

(c) March 31, 2013 includes purchased loans of $204 million of which $22 million were PCI loans. December 31, 2012 includes purchased loans of $217 million of which $23 million were PCI loans.

Our loans held for sale are summarized as follows:

 

in millions                            March 31, 
                                2013  
                        December 31, 
                                   2012  
                                 March 31, 
                                2012  
 

 

 

Commercial, financial and agricultural

   $ 180          $ 29          $ 28    

Real estate — commercial mortgage

    196           477           362    

Real estate — construction

    —           —           15    

Commercial lease financing

    9           8           30    

Real estate — residential mortgage

    49           85           76    
 

 

 

     

 

 

     

 

 

 

Total loans held for sale

   $ 434          $ 599          $ 511    
 

 

 

     

 

 

     

 

 

 

 

 

Our quarterly summary of changes in loans held for sale as follows:

 

in millions                       March 31, 
                             2013  
                    December 31, 
                               2012  
                            March 31, 
                             2012  
 

 

 

Balance at beginning of the period

   $ 599          $ 628          $ 728    

New originations

    1,075           1,686           935    

Transfers from held to maturity, net

    19           38           19    

Loan sales

    (1,257)           (1,747)           (1,168)    

Loan draws (payments), net

    —           (4)           (3)    

Transfers to OREO / valuation adjustments

    (2)           (2)           —    

 

 

Balance at end of period

   $ 434          $ 599          $ 511    
 

 

 

     

 

 

     

 

 

 

 

 

 

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4. Asset Quality

We manage our exposure to credit risk by closely monitoring loan performance trends and general economic conditions. A key indicator of the potential for future credit losses is the level of nonperforming assets and past due loans.

Our nonperforming assets and past due loans were as follows:

 

in millions                         March  31, 
                  2013  
                          December 31, 
           2012  
                              March  31, 
                  2012  
 

 

 

Total nonperforming loans (a), (b)

       $ 650              $ 674              $ 666    

Nonperforming loans held for sale

    23           25           24    

OREO

    21           22           61    

Other nonperforming assets

    11           14           16    

 

 

Total nonperforming assets

       $ 705              $ 735              $ 767    
 

 

 

     

 

 

     

 

 

 

Nonperforming assets from discontinued operations - education lending (c)

       $ 15              $ 20              $ 19    
 

 

 

     

 

 

     

 

 

 
         

 

 

Restructured loans included in nonperforming loans (a)

       $ 178              $ 249              $ 184    

Restructured loans with an allocated specific allowance (d)

    52           114           47    

Specifically allocated allowance for restructured loans (e)

    30           33           18    

 

 

Accruing loans past due 90 days or more

       $ 83              $ 78              $ 169    

Accruing loans past due 30 through 89 days

    368           424           420    

 

 

 

(a) December 31, 2012, includes $72 million of performing secured loans that were discharged through Chapter 7 bankruptcy and not formally re-affirmed, as addressed in updated regulatory guidance issued in the third quarter of 2012. Such loans have been designated as nonperforming and TDRs.

 

(b) March 31, 2013 and December 31, 2012, excludes $22 million and $23 million of PCI loans, respectively.

 

(c) Includes approximately $4 million and $3 million of restructured loans at March 31, 2013 and December 31, 2012, respectively. There were no additional restructured loans at March 31, 2012. See Note 11 (“Acquisitions and Discontinued Operations”) for further discussion.

 

(d) Included in individually impaired loans allocated a specific allowance.

 

(e) Included in allowance for individually evaluated impaired loans.

We evaluate purchased loans for impairment in accordance with the applicable accounting guidance. Purchased loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that all contractually required payments will not be collected are deemed PCI and initially recorded at fair value without recording an allowance for loan losses. At the date of acquisition, the estimated gross contractual amount receivable of PCI loans totaled $41 million. The estimated cash flows not expected to be collected (the nonaccretable amount) was $11 million, and the accretable amount was approximately $5 million. The difference between the fair value and the cash flows expected to be collected from the purchased loans is accreted to interest income over the remaining term of the loans.

At March 31, 2013, the outstanding unpaid principal balance and carrying value of all PCI loans was $29 million and $22 million, respectively. Changes in the accretable yield during 2013 included accretion and net reclassifications of less than $1 million, resulting in an ending balance of $4 million at March 31, 2013.

At March 31, 2013, the approximate carrying amount of our commercial nonperforming loans outstanding represented 63% of their original contractual amount, total nonperforming loans outstanding represented 76% of their original contractual amount owed, and nonperforming assets in total were carried at 73% of their original contractual amount.

At March 31, 2013, our twenty largest nonperforming loans totaled $194 million, representing 30% of total loans on nonperforming status from continuing operations. At March 31, 2012, the twenty largest nonperforming loans totaled $215 million, representing 32% of total loans on nonperforming status.

Nonperforming loans and loans held for sale reduced expected interest income by $6 million for the three months ended March 31, 2013, and $25 million for the year ended December 31, 2012.

 

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The following tables set forth a further breakdown of individually impaired loans as of March 31, 2013, December 31, 2012 and March 31, 2012:

 

March 31, 2013

in millions

  Recorded 
              Investment
 
    (a)  

Unpaid 

Principal 
                Balance 

    (b)   Specific 
                Allowance 
       

Average 

Recorded 
                Investment 

 

 

 

With no related allowance recorded:

             

Commercial, financial and agricultural

   $ 93          $ 131           —          $ 63    

Commercial real estate:

             

Commercial mortgage

    87           140           —           88    

Construction

    48           175           —           48    

 

 

Total commercial real estate loans

    135           315           —           136    

 

 

Total commercial loans with no related allowance recorded

    228           446           —           199    

Real estate — residential mortgage

    15           15           —           18    

Home equity:

             

Key Community Bank

    64           64           —           65    

Other

    2           2           —           2    

 

 

Total home equity loans

    66           66           —           67    

Consumer other:

             

Marine

    3           3           —           1    

 

 

Total consumer other

    3           3           —           1    

 

 

Total consumer loans

    84           84           —           86    

 

 

Total loans with no related allowance recorded

    312           530           —           285    

With an allowance recorded:

             

Commercial, financial and agricultural

    15           23          $ 8           24    

Commercial real estate:

             

Commercial mortgage

    9           9           3           8    

Construction

    —           9           —           —    

 

 

Total commercial real estate loans

    9           18           3           8    

 

 

Total commercial loans with an allowance recorded

    24           41           11           32    

 

 

Real estate — residential mortgage

    18            18           1           18    

Home equity:

             

Key Community Bank

    26            25           14           24    

Other

    10            10           —           10    

 

 

Total home equity loans

    36            35           14           34    

Consumer other — Key Community Bank

    3            3            1           2    

Credit cards

    4            4            1           3    

Consumer other:

             

Marine

    47            47            5           53    

Other

    1            1            1           1    

 

 

Total consumer other

    48            48            6           54    

 

 

Total consumer loans

    109            108            23           111    

 

 

Total loans with an allowance recorded

    133            149            34           143    

 

 

Total

   $ 445           $ 679           $ 34          $ 428    
 

 

 

     

 

 

     

 

 

     

 

 

 
             

 

 

 

(a)

The Recorded Investment in impaired loans represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. This amount is a component of total loans on our consolidated balance sheet.

 

(b) The Unpaid Principal Balance represents the customer’s legal obligation to us.

 

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Table of Contents

December 31, 2012

in millions

  Recorded 
              Investment 
    (a)   Unpaid 
                Principal 
Balance 
    (b)   Specific 
                Allowance 
   

Average 

Recorded 
                Investment 

 

 

 

With no related allowance recorded:

           

Commercial, financial and agricultural

   $ 32          $ 64           —        $ 60    

Commercial real estate:

           

Commercial mortgage

    89           142           —         95    

Construction

    48           182           —         39    

 

 

Total commercial real estate loans

    137           324           —         134    

 

 

Total commercial loans with no related allowance recorded

    169           388           —         194    

Real estate — residential mortgage

    21           21           —         10    

Home equity:

           

Key Community Bank

    65           65           —         33    

Other

    3           3           —         1    

 

 

Total home equity loans

    68           68           —         34    

 

 

Total consumer loans

    89           89           —         44    

 

 

Total loans with no related allowance recorded

    258           477           —         238    

With an allowance recorded:

           

Commercial, financial and agricultural

    33           42          $ 12         48    

Commercial real estate:

           

Commercial mortgage

    7           7           1         51    

Construction

    —           —           —         6    

 

 

Total commercial real estate loans

    7           7           1         57    

 

 

Total commercial loans with an allowance recorded

    40           49           13         105    

 

 

Real estate — residential mortgage

    17           17           1         8    

Home equity:

           

Key Community Bank

    22           22           11         11    

Other

    9           9           1         5    

 

 

Total home equity loans

    31           31           12         16    

Consumer other — Key Community Bank

    2           2           2         1    

Credit cards

    2           2           —         1    

Consumer other:

           

Marine

    60           60           7         30    

Other

    1           1           —         1    

 

 

Total consumer other

    61           61           7         31    

 

 

Total consumer loans

    113           113           22         57    

 

 

Total loans with an allowance recorded

    153           162           35         162    

 

 

Total

   $ 411          $ 639          $ 35        $ 400    
 

 

 

     

 

 

     

 

 

   

 

 

 
           

 

 

 

(a)

The Recorded Investment in impaired loans represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. This amount is a component of total loans on our consolidated balance sheet.

 

(b) The Unpaid Principal Balance represents the customer’s legal obligation to us.

 

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Table of Contents

March 31, 2012

in millions

   Recorded 
          Investment
 
     (a)    Unpaid 
                Principal 
Balance 
     (b)    Specific 
                Allowance 
         

Average 

Recorded 
                Investment 

 

 

 

With no related allowance recorded:

                    

Commercial, financial and agricultural

    $ 77             $ 189            —            $ 83    

Commercial real estate:

                    

Commercial mortgage

     113              252            —             106    

Construction

     47              164            —             39    

 

 

Total commercial real estate loans

     160              416            —             145    

 

 

Total commercial loans with no related allowance recorded

     237              605            —             228    

Real estate — residential mortgage

     —              —              —             —    

Home equity:

                    

Key Community Bank

     —              —              —             —    

Other

     —              —              —             —    

 

 

Total home equity loans

     —              —              —             —    

Consumer other — Key Community Bank

     —              —              —             —    

Credit cards

     —              —              —             —    

Consumer other:

                    

Marine

     —              —              —             —    

Other

     —              —              —             —    

 

 

Total consumer other

     —              —              —             —    

 

 

Total consumer loans

     —              —              —             —    

 

 

Total loans with no related allowance recorded

     237              605              —             228    

With an allowance recorded:

                    

Commercial, financial and agricultural

     49              60            $ 19             55    

Commercial real estate:

                    

Commercial mortgage

     69              111              16             83    

Construction

     4              4              3             8    

 

 

Total commercial real estate loans

     73              115              19             91    

Commercial lease financing

     —              —              —              

 

 

Total commercial loans with an allowance recorded

     122              175              38             146    

 

 

Real estate — residential mortgage

     —              —              —             —    

Home equity:

                    

Key Community Bank

     —              —              —             —    

Other

     —              —              —             —    

 

 

Total home equity loans

     —              —              —             —    

Consumer other — Key Community Bank

     —              —              —             —    

Credit cards

     —              —              —             —    

Consumer other:

                    

Marine

     —              —              —             —    

Other

     —              —              —             —    

 

 

Total consumer other

     —              —              —             —    

 

 

Total consumer loans

     —              —              —             —    

 

 

Total loans with an allowance recorded

     122              175              38             146    

 

 

Total

    $ 359             $ 780             $ 38            $ 374    
  

 

 

       

 

 

       

 

 

       

 

 

 
                    

 

 

 

(a)

The Recorded Investment in impaired loans represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. This amount is a component of total loans on our consolidated balance sheet.

 

(b) The Unpaid Principal Balance represents the customer’s legal obligation to us.

For the three months ended March 31, 2013, and 2012, interest income recognized on the outstanding balances of accruing impaired loans totaled $2 million and $1 million, respectively.

At March 31, 2013, aggregate restructured loans (accrual, nonaccrual and held-for-sale loans) totaled $294 million, compared to $320 million at December 31, 2012, and $293 million at March 31, 2012. We added $34 million in restructured loans during the first three months of 2013, which were partially offset by $60 million in payments and charge-offs.

 

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A further breakdown of TDRs included in nonperforming loans by loan category as of March 31, 2013, follows:

 

 

March 31, 2013

dollars in millions

            Number
of loans
   

            Pre-modification
Outstanding

Recorded

Investment

   

            Post-modification
Outstanding

Recorded

Investment

 

 

 

LOAN TYPE

     

Nonperforming:

     

Commercial, financial and agricultural

    48        $ 58        $ 25    

Commercial real estate:

     

Real estate — commercial mortgage

    17         61         23    

Real estate — construction

    6         30         4    

 

 

Total commercial real estate loans

    23         91         27    

 

 

Total commercial loans

    71         149         52    

Real estate — residential mortgage

    347         21         21    

Home equity:

     

Key Community Bank

    1,479         75         74    

Other

    229         6         6    

 

 

Total home equity loans

    1,708         81         80    

Consumer other — Key Community Bank

    59         2         2    

Credit cards

    360         2         2    

Consumer other:

     

Marine

    302         41         20    

Other

    36         1         1    

 

 

Total consumer other

    338         42         21    

 

 

Total consumer loans

    2,812         148         126    

 

 

Total nonperforming TDRs

    2,883         297         178    

Prior-year accruing (a)

     

Commercial, financial and agricultural

    106         11         5    

Commercial real estate:

     

Real estate — commercial mortgage

    4         22         15    

Real estate — construction

    1         23         29    

 

 

Total commercial real estate loans

    5         45         44    

 

 

Total commercial loans

    111         56         49    

Real estate — residential mortgage

    121         12         12    

Home equity:

     

Key Community Bank

    147         15         15    

Other

    190         6         5    

 

 

Total home equity loans

    337         21         20    

Consumer other — Key Community Bank

    24         1         1    

Credit cards

    308         2         2    

Consumer other:

     

Marine

    263         30         30    

Other

    57         2         2    

 

 

Total consumer other

    320         32         32    

 

 

Total consumer loans

    1,110         68         67    

 

 

Total prior-year accruing TDRs

    1,221         124         116    

 

 

Total TDRs

    4,104        $ 421        $ 294    
 

 

 

   

 

 

   

 

 

 
     

 

 

 

(a) All TDRs that were restructured prior to January 1, 2013, and are fully accruing.

 

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A further breakdown of TDRs included in nonperforming loans by loan category as of December 31, 2012, follows:

 

 

December 31, 2012

dollars in millions

            Number
of loans
   

            Pre-modification
Outstanding

Recorded

Investment

   

            Post-modification
Outstanding

Recorded

Investment

 

 

 

LOAN TYPE

     

Nonperforming:

     

Commercial, financial and agricultural

    82        $ 76        $ 39    

Commercial real estate:

     

Real estate — commercial mortgage

    15         62         25    

Real estate — construction

    8         53         33    

 

 

Total commercial real estate loans

    23         115         58    

 

 

Total commercial loans

    105         191         97    

Real estate — residential mortgage

    372         28         28    

Home equity:

     

Key Community Bank

    1,577         87         82    

Other

    322         9         8    

 

 

Total home equity loans

    1,899         96         90    

Consumer other — Key Community Bank

    28         1         1    

Credit cards

    405         3         3    

Consumer other:

     

Marine

    251         30         29    

Other

    34         1         1    

 

 

Total consumer other

    285         31         30    

 

 

Total consumer loans

    2,989         159         152    

 

 

Total nonperforming TDRs

    3,094         350         249    

Prior-year accruing (a)

     

Commercial, financial and agricultural

    122         12         6    

Commercial real estate:

     

Real estate — commercial mortgage

    4         22         15    

 

 

Total commercial real estate loans

    4         22         15    

 

 

Total commercial loans

    126         34         21    

Real estate — residential mortgage

    101         10         10    

Home equity:

     

Key Community Bank

    76         5         5    

Other

    84         3         3    

 

 

Total home equity loans

    160         8         8    

Consumer other — Key Community Bank

    16         —         —    

Consumer other:

     

Marine

    117         31         31    

Other

    43         1         1    

 

 

Total consumer other

    160         32         32    

 

 

Total consumer loans

    437         50         50    

 

 

Total prior-year accruing TDRs

    563         84         71    

 

 

Total TDRs

    3,657        $ 434        $ 320    
 

 

 

   

 

 

   

 

 

 
     

 

 

 

(a) All TDRs that were restructured prior to January 1, 2012, and are fully accruing.

 

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Table of Contents

A further breakdown of TDRs included in nonperforming loans by loan category as of March 31, 2012, follows:

 

                           Pre-modification                   Post-modification    
           Outstanding       Outstanding    
March 31, 2012              Number       Recorded       Recorded    
dollars in millions    of loans       Investment       Investment    

 

 

LOAN TYPE

      

Nonperforming:

      

Commercial, financial and agricultural

     102       $ 105       $ 64    

Commercial real estate:

      

Real estate — commercial mortgage

     16         102         64    

Real estate — construction

     8         35         19    

 

 

Total commercial real estate loans

     24         137         83    

 

 

Total commercial loans

     126         242         147    

Real estate — residential mortgage

     43         5         5    

Home equity:

      

Key Community Bank

     27         3         3    

Other

     32         1         1    

 

 

Total home equity loans

     59         4         4    

Consumer other — Key Community Bank

     2         —         —    

Consumer other:

      

Marine

     48         28         28    

Other

     6         —         —    

 

 

Total consumer other

     54         28         28    

 

 

Total consumer loans

     158         37         37    

 

 

Total nonperforming TDRs

     284         279         184    

Prior-year accruing (a)

      

Commercial, financial and agricultural

     176         20         11    

Commercial real estate:

      

Real estate — commercial mortgage

     7         75         57    

Real estate — construction

     1         15         2    

 

 

Total commercial real estate loans

     8         90         59    

 

 

Total commercial loans

     184         110         70    

Real estate — residential mortgage

     113         12         12    

Home equity:

      

Key Community Bank

     88         7         7    

Other

     104         3         3    

 

 

Total home equity loans

     192         10         10    

Consumer other — Key Community Bank

     19         —         —    

Consumer other:

      

Marine

     140         15         15    

Other

     51         2         2    

 

 

Total consumer other

     191         17         17    

 

 

Total consumer loans

     515         39         39    

 

 

Total prior-year accruing TDRs

     699         149         109    

 

 

Total TDRs

                 983       $             428       $             293    
  

 

 

   

 

 

   

 

 

 
      

 

 

 

(a) All TDRs that were restructured prior to January 1, 2012, and are fully accruing.

We classify loan modifications as TDRs when a borrower is experiencing financial difficulties and we have granted a concession to the borrower without commensurate financial, structural, or legal consideration. All commercial and consumer loan TDRs, regardless of size, are evaluated for impairment individually to determine the probable loss content and are assigned a specific loan allowance if deemed appropriate. The financial effects of TDRs are reflected in the components that make up the allowance for loan and lease losses in either the amount of a charge-off or the loan loss provision. These components affect the ultimate allowance level. Additional information regarding TDRs for discontinued operations is provided in Note 11 (“Acquisitions and Discontinued Operations”).

Commercial loan TDRs are considered defaulted when principal and interest payments are 90 days past due. Consumer loan TDRs are considered defaulted when principal and interest payments are more than 60 days past due. There were 240 consumer loan TDRs with a combined recorded investment of $14 million which have experienced payment defaults during the first three months of 2013 arising from modifications resulting in TDR status during 2012. There were no significant payment defaults during the first three months of 2013 arising from commercial loans that were designated as TDRs during 2012.

 

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Table of Contents

The following table shows the concession types for our commercial accruing and nonaccruing TDRs and other selected financial data.

 

dollars in millions               March 31, 
2013  
                December 31, 
2012  
                March 31, 
2012  
 

 

 

Interest rate reduction

   $ 85        $ 104        $ 184    

Forgiveness of principal

    10         7         11    

Other modification of loan terms

    6         7         22    

 

 

Total

   $ 101        $ 118        $ 217    
 

 

 

   

 

 

   

 

 

 

Total commercial and consumer TDRs (a), (b)

   $ 294        $ 320        $ 293    

Total commercial TDRs to total commercial loans

    .27       .32       .63  

Total commercial TDRs to total loans

    .19         .22         .44    

Total commercial loans

   $ 36,809        $ 36,880        $ 34,622    

Total loans

    52,574         52,822         49,226    

 

 

 

(a) Commitments outstanding to lend additional funds to borrowers whose terms have been modified in TDRs are $33 million, $32 million, and $24 million at March 31, 2013, December 31, 2012, and March 31, 2012, respectively.

 

(b) Concession types for consumer accruing and nonaccruing TDRs consisted primarily of interest rate reductions and modifications due to updated regulatory guidance in the quarters ended March 31, 2013, December 31, 2012, and March 31, 2012, respectively.

Our policies for determining past due loans, placing loans on nonaccrual, applying payments on nonaccrual loans and resuming accrual of interest for our commercial and consumer loan portfolios are disclosed in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Nonperforming Loans” on page 120 of our 2012 Form 10-K. Pursuant to regulatory guidance issued in January 2012, the above-mentioned policy for nonperforming loans was revised effective for the second quarter of 2012. Beginning in the second quarter of 2012, any second lien home equity loan with an associated first lien that is 120 days or more past due or in foreclosure or for which the first mortgage delinquency timeframe is unknown, is reported as a nonperforming loan. This policy was implemented prospectively, and, therefore, prior periods were not restated or re-presented. Credit card loans on which payments are past due for 90 days are placed on nonaccrual status.

At March 31, 2013, approximately $51.5 billion, or 97.9%, of our total loans are current. At March 31, 2013, total past due loans and nonperforming loans of $1.1 billion represent approximately 2.1% of total loans.

 

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Table of Contents

The following aging analysis as of March 31, 2013, December 31, 2012, and March 31, 2012, of past due and current loans provides further information regarding Key’s credit exposure.

 

March 31, 2013

in millions

      Current        30-59
    Days Past    
Due
    60-89
    Days Past    
Due
    90 and
Greater
    Days Past    
Due
        Nonperforming    
Loans
   

Total Past

Due and
    Nonperforming    
Loans

        Purchased    
Credit
Impaired
          Total    
      Loans    
 

 

 

LOAN TYPE

               

Commercial, financial and agricultural

   $ 23,134       $ 35       $ 74       $ 26       $ 142       $ 277       $      $ 23,412   

Commercial real estate:

               

Commercial mortgage

    7,368        35        14        11        114        174              7,544   

Construction

    1,024              —              27        33        —        1,057   

 

 

Total commercial real estate loans

    8,392        40        14        12        141        207              8,601   

Commercial lease financing

    4,728        34        11        11        12        68        —        4,796   

 

 

Total commercial loans

   $ 36,254       $ 109       $ 99       $ 49       $ 295       $ 552       $      $ 36,809   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Real estate — residential mortgage

   $ 2,037       $ 15       $      $      $ 96       $ 123       $ 16       $ 2,176   

Home equity:

               

Key Community Bank

    9,512        51        28        17        199        295              9,809   

Other

    371                          18        30        —        401   

 

 

Total home equity loans

    9,883        58        31        19        217        325              10,210   

Consumer other — Key Community Bank

    1,331                                21              1,353   

Credit cards

    668                    —        13        25        —        693   

Consumer other:

               

Marine

    1,202        18                    25        52        —        1,254   

Other

    76                    —                    —        79   

 

 

Total consumer other

    1,278        19                    26        55        —        1,333   

 

 

Total consumer loans

   $ 15,197       $ 108       $ 52       $ 34       $ 355       $ 549       $ 19       $ 15,765   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 51,451       $ 217       $ 151       $ 83       $ 650       $ 1,101       $ 22       $ 52,574   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

December 31, 2012

in millions

      Current        30-59
    Days Past    
Due
    60-89
    Days Past    
Due
    90 and
Greater
    Days Past    
Due
        Nonperforming    
Loans (a)
   

Total Past

Due and
    Nonperforming    
Loans

        Purchased    
Credit
Impaired
          Total      
Loans
 

 

 

LOAN TYPE

               

Commercial, financial and agricultural

   $ 23,030       $ 56       $ 34       $ 22       $ 99       $ 211       $      $ 23,242   

Commercial real estate:

               

Commercial mortgage

    7,556        21        11              120        161              7,720   

Construction

    943                          56        60        —        1,003   

 

 

Total commercial real estate loans

    8,499        22        13        10        176        221              8,723   

Commercial lease financing

    4,772        88        31              16        143        —        4,915   

 

 

Total commercial loans

   $ 36,301       $ 166       $ 78       $ 40       $ 291       $ 575       $     $ 36,880   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Real estate — residential mortgage

   $ 2,023       $ 16       $ 10       $      $ 103       $ 135      $ 16       $ 2,174   

Home equity:

               

Key Community Bank

    9,506        54        26        17        210        307              9,816   

Other

    387                          21        36        —        423   

 

 

Total home equity loans

    9,893        63        30        19        231        343              10,239   

Consumer other — Key Community Bank

    1,325                                24        —        1,349   

Credit cards

    706                    —        11        23        —        729   

Consumer other:

               

Marine

    1,288        23                    34        70        —        1,358   

Other

    87                                      —        93   

 

 

Total consumer other

    1,375        25        10              36        76        —        1,451   

 

 

Total consumer loans

   $ 15,322       $ 120       $ 60       $ 38       $ 383       $ 601       $ 19       $ 15,942   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

   $ 51,623       $ 286       $ 138       $ 78       $ 674       $ 1,176       $ 23       $ 52,822   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

(a) Includes $72 million of performing secured loans that were discharged through Chapter 7 bankruptcy and not formally re-affirmed as addressed in updated regulatory guidance issued in the third quarter of 2012. Such loans have been designated as nonperforming and TDRs.

 

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Table of Contents

March 31, 2012

in millions

   Current      30-59
Days Past
Due
     60-89
Days Past
Due
    

90 and Greater
Days Past

Due

     Nonperforming
Loans
     Total Past Due
and
Nonperforming
Loans
    

Total

Loans

 

 

 

LOAN TYPE

                    

Commercial, financial and agricultural

   $ 19,989      $ 25      $ 16      $ 19      $ 168      $ 228      $ 20,217  

Commercial real estate:

                    

Commercial mortgage

     7,532        7        11        82        175        275        7,807  

Construction

     1,170        19        7        11        66        103        1,273  

 

 

Total commercial real estate loans

     8,702        26        18        93        241        378        9,080  

Commercial lease financing

     5,140        126        22        15        22        185        5,325  

 

 

Total commercial loans

   $ 33,831      $ 177      $ 56      $ 127      $ 431      $ 791      $ 34,622  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Real estate — residential mortgage

   $ 1,852      $ 20      $ 8      $ 5      $ 82      $ 115      $ 1,967  

Home equity:

                    

Key Community Bank

     8,941        53        34        16        109        212        9,153  

Other

     476        9        6        4        12        31        507  

 

 

Total home equity loans

     9,417        62        40        20        121        243        9,660  

Consumer other — Key Community Bank

     1,189        9        4        9        1        23        1,212  

Consumer other:

                    

Marine

     1,576        30        11        7        30        78        1,654  

Other

     106        2        1        1        1        5        111  

 

 

Total consumer other

     1,682        32        12        8        31        83        1,765  

 

 

Total consumer loans

   $ 14,140      $ 123      $ 64      $ 42      $ 235      $ 464      $ 14,604  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $             47,971      $             300      $             120      $             169      $             666      $             1,255      $             49,226  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

The prevalent risk characteristic for both commercial and consumer loans is the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms. Evaluation of this risk is stratified and monitored by the assigned loan risk rating grades for the commercial loan portfolios and the regulatory risk ratings assigned for the consumer loan portfolios. This risk rating stratification assists in the determination of the ALLL. Loan grades are assigned at the time of origination, verified by credit risk management, and periodically reevaluated thereafter.

Most extensions of credit are subject to loan grading or scoring. This risk rating methodology blends our judgment with quantitative modeling. Commercial loans generally are assigned two internal risk ratings. The first rating reflects the probability that the borrower will default on an obligation; the second rating reflects expected recovery rates on the credit facility. Default probability is determined based on, among other factors, the financial strength of the borrower, an assessment of the borrower’s management, the borrower’s competitive position within its industry sector, and our view of industry risk within the context of the general economic outlook. Types of exposure, transaction structure, and collateral, including credit risk mitigants, affect the expected recovery assessment.

Credit quality indicators for loans are updated on an ongoing basis. Bond rating classifications are indicative of the credit quality of our commercial loan portfolios and are determined by converting our internally assigned risk rating grades to bond rating categories. Payment activity and the regulatory classifications of pass and substandard are indicators of the credit quality of our consumer loan portfolios.

Credit quality indicators for our commercial and consumer loan portfolios, excluding $22 million of PCI loans at March 31, 2013, based on bond rating, regulatory classification and payment activity as of March 31, 2013, and 2012 are as follows:

 

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Table of Contents

Commercial Credit Exposure

Credit Risk Profile by Creditworthiness Category (a)

 

March 31,

in millions

                                                                           

 

 
    Commercial, financial and
agricultural
              RE — Commercial                     RE — Construction                      Commercial Lease               Total  
RATING (b) (c)   2013     2012         2013     2012         2013     2012         2013     2012         2013     2012  

 

 

AAA — AA

   $ 222       $ 165          —       $        $      $        $ 548       $ 599         $ 771       $ 770   

A

    522        785         $ 75        62                        950        1,156          1,548        2,004   

BBB — BB

    21,120        17,231          6,529        6,007          866        788          3,043        3,193          31,558        27,219   

B

    672        848          426        568          23        165          165        236          1,286        1,817   

CCC — C

    875        1,188          512        1,167          166        316          90        141          1,643        2,812   

 

 

Total

   $       23,411       $       20,217         $       7,542       $       7,807         $       1,057       $       1,273         $       4,796       $       5,325         $       36,806       $       34,622   
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 
                           

 

 

 

(a) Credit quality indicators are updated on an ongoing basis and reflect credit quality information as of the dates indicated.

 

(b) Our bond rating to internal loan grade conversion system is as follows: AAA - AA = 1, A = 2, BBB - BB = 3 - 13, B = 14 - 16, and CCC - C = 17 - 20.

 

(c) Our internal loan grade to regulatory-defined classification is as follows: Pass = 1-16, Special Mention = 17, Substandard = 18, Doubtful = 19, and Loss = 20.

Consumer Credit Exposure

Credit Risk Profile by Regulatory Classifications (a) (b)

 

March 31,

in millions

 

 

 
             Residential — Prime           
GRADE    2013      2012  

 

 

Pass

   $ 12,029      $ 11,399  

Substandard

     339        228  

 

 

Total

   $ 12,368      $ 11,627  
  

 

 

    

 

 

 
     

 

 

Credit Risk Profile Based on Payment Activity (a) (b)

 

March 31,   Consumer — Key Community
Bank
          Credit cards                    Consumer — Marine                          Consumer — Other                  Total  
in millions   2013     2012         2013             2012         2013     2012         2013     2012         2013     2012  

 

 

Performing

   $ 1,349       $ 1,211         $ 680        —         $ 1,229       $ 1,624         $ 78       $ 110         $ 3,336       $ 2,945   

Nonperforming

                  13        —          25        30                        42        32   

 

 

Total

   $         1,352       $         1,212         $         693        —         $         1,254       $         1,654         $         79       $         111         $         3,378       $         2,977   
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 
                           

 

 

 

(a) Credit quality indicators are updated on an ongoing basis and reflect credit quality information as of the dates indicated.

 

(b) Our past due payment activity to regulatory classification conversion is as follows: pass = less than 90 days; and substandard = 90 days and greater plus nonperforming loans. Beginning in the second quarter of 2012, any second lien home equity loan with an associated first lien that is 120 days or more past due or in foreclosure or for which the first mortgage delinquency timeframe is unknown, is reported as a nonperforming loan in accordance with regulatory guidance issued in January 2012.

We determine the appropriate level of the ALLL on at least a quarterly basis. The methodology is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan and Lease Losses” on page 120 of our 2012 Form 10-K. We apply expected loss rates to existing loans with similar risk characteristics as noted in the credit quality indicator table above and exercise judgment to assess the impact of factors such as changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets.

For all commercial and consumer loan TDRs, regardless of size, as well as impaired commercial loans with an outstanding balance greater than $2.5 million, we conduct further analysis to determine the probable loss content and assign a specific allowance to the loan if deemed appropriate. We estimate the extent of impairment by comparing the recorded investment of the loan with the estimated present value of its future cash flows, the fair value of its underlying collateral, or the loan’s observable market price. A specific allowance also may be assigned — even when sources of repayment appear sufficient — if we remain uncertain about whether the loan will be repaid in full. On at least a quarterly basis, we evaluate the appropriateness of our loss estimation methods to reduce differences between estimated incurred losses and actual losses. The ALLL at March 31, 2013, represents our best estimate of the probable credit losses inherent in the loan portfolio at that date.

Although quantitative modeling factors such as default probability and expected recovery rates are constantly changing as the financial strength of the borrower and overall economic conditions change, there have been no changes to the accounting policies or methodology we used to estimate the ALLL.

 

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Table of Contents

Commercial loans generally are charged off in full or charged down to the fair value of the underlying collateral when the borrower’s payment is 180 days past due. Home equity and residential mortgage loans generally are charged down to the fair value of the underlying collateral when payment is 180 days past due. Credit card loans are charged off when payments are 180 days past due. All other consumer loans are charged off when payments are 120 days past due.

At March 31, 2013, the ALLL was $893 million, or 1.70% of loans, compared to $944 million, or 1.92% of loans, at March 31, 2012. At March 31, 2013, the ALLL was 137.38% of nonperforming loans, compared to 141.74% at March 31, 2012.

A summary of the allowance for loan and lease losses for the periods indicated is presented in the table below:

 

           

        Three months ended March 31,         

in millions           2013          2012  

 

Balance at beginning of period — continuing operations

    $      888       $   1,004  

Charge-offs

        (90)       (132) 

Recoveries

        41        31  

 

Net loans and leases charged off

        (49)       (101) 

Provision for loan and lease losses from continuing operations

        55        42  

Foreign currency translation adjustment

        (1)       (1) 

 

Balance at end of period — continuing operations

    $      893       $   944  
  

 

  

 

 

The changes in the ALLL by loan category for the periods indicated are as follows:

 

in millions      December 31,
2012 
               Provision             Charge-offs              Recoveries                  March 31,
2013 
 

 

 

Commercial, financial and agricultural

    $ 327         $ 13         $ (14)         $ 12         $ 338    

Real estate — commercial mortgage

     198          3          (13)          5          193    

Real estate — construction

     41          (13)         (1)          8          35    

Commercial lease financing

     55          9          (6)          4          62    

 

 

Total commercial loans

     621          12          (34)          29          628    

Real estate — residential mortgage

     30          10          (6)          —          34    

Home equity:

             

Key Community Bank

     105          17          (18)          2          106    

Other

     25          (3)         (6)          2          18    

 

 

Total home equity loans

     130          14          (24)          4          124    

Consumer other — Key Community Bank

     38          2          (9)          2          33    

Credit cards

     26          14          (8)          —          32    

Consumer other:

             

Marine

     39          2          (8)          5          38    

Other

     4          —          (1)          1          4    

 

 

Total consumer other:

     43          2          (9)          6          42    

 

 

Total consumer loans

     267          42          (56)          12          265    

 

 

Total ALLL — continuing operations

     888          54   (a)      (90)          41          893    

Discontinued operations

     55          6          (16)          4          49    

 

 

Total ALLL — including discontinued operations

    $ 943         $ 60         $ (106)         $ 45         $ 942    
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
             

 

 

 

(a) Includes $1 million of foreign currency translation adjustment.

 

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Table of Contents
in millions        December 31, 
2011  
               Provision             Charge-offs              Recoveries                  March 31, 
2012  
 

 

 

Commercial, financial and agricultural

    $ 334         $ (3)        $ (26)         $ 11         $ 316    

Real estate — commercial mortgage

     272          12         (23)          2          263    

Real estate — construction

     63          3         (11)          1          56    

Commercial lease financing

     78          (10)         (4)          4          68    

 

 

Total commercial loans

     747          2         (64)          18          703    

Real estate — residential mortgage

     37          4         (6)          1          36    

Home equity:

             

Key Community Bank

     103          14         (25)          2          94    

Other

     29          6         (8)          1          28    

 

 

Total home equity loans

     132          20         (33)          3          122    

Consumer other — Key Community Bank

     41          5         (10)          1          37    

Consumer other:

             

Marine

     46          9         (17)          7          45    

Other

     1          1         (2)          1          1    

 

 

Total consumer other:

     47          10         (19)          8          46    

 

 

Total consumer loans

     257          39         (68)          13          241    

 

 

Total ALLL — continuing operations

     1,004          41     (a)     (132)          31          944    

Discontinued operations

     104          5         (23)          4          90    

 

 

Total ALLL — including discontinued operations

    $ 1,108         $ 46        $ (155)        $ 35         $ 1,034    
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 
             

 

 

 

(a) Includes $1 million of foreign currency translation adjustment.

Our ALLL decreased by $51 million, or 5%, since the first quarter of 2012. This contraction was associated with the improvement in credit quality of our loan portfolios, which has trended more favorably over the past four quarters. Our asset quality metrics have shown continued improvement resulting in favorable risk rating migration and a reduction in our general allowance. Our general allowance encompasses the application of expected loss rates to our existing loans with similar risk characteristics, an assessment of factors such as changes in economic conditions and changes in credit policies or underwriting standards. Our delinquency trends showed continued improvement during 2012 and into 2013. We attribute this improvement to a more moderate level of lending activity, more favorable conditions in the capital markets, improvement in client income statements, and continued run off in our exit loan portfolio.

For continuing operations, the loans outstanding individually evaluated for impairment totaled $445 million, with a corresponding allowance of $34 million at March 31, 2013. Loans outstanding collectively evaluated for impairment totaled $52.1 billion, with a corresponding allowance of $859 million at March 31, 2013. At March 31, 2013, PCI loans evaluated for impairment totaled $22 million, with a corresponding allowance of less than $1 million. There was no provision for loan and lease losses on these PCI loans during the quarter ended March 31, 2013.

 

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Table of Contents

A breakdown of the individual and collective ALLL and the corresponding loan balances as of March 31, 2013, follows:

 

    Allowance         Outstanding  

March 31, 2013

in millions

  Individually
   Evaluated for
Impairment
    Collectively
   Evaluated for
Impairment
         Purchased
Credit
Impaired
                    Loans     Individually
    Evaluated for
Impairment
    Collectively
    Evaluated for
Impairment
    Purchased
Credit
        Impaired
 

 

 

Commercial, financial and agricultural

   $      $ 330        —         $ 23,412        $ 108       $ 23,303       $  

Commercial real estate:

               

Commercial mortgage

          190        —          7,544         96        7,446         

Construction

    —        35        —          1,057         48        1,009        —   

 

 

Total commercial real estate loans

          225        —          8,601         144        8,455         

Commercial lease financing

    —        62        —          4,796         —        4,796        —   

 

 

Total commercial loans

    11        617        —          36,809         252        36,554         

Real estate — residential mortgage

          33        —          2,176         33        2,127        16   

Home equity:

               

Key Community Bank

    14        92        —          9,809         90        9,717         

Other

    —        18        —          401         12        389        —   

 

 

Total home equity loans

    14        110        —          10,210         102        10,106         

Consumer other — Key Community Bank

          32        —          1,353               1,348         

Credit cards

          31        —          693               690        —   

Consumer other:

               

Marine

          33        —          1,254         50        1,204        —   

Other

                —          79               78        —   

 

 

Total consumer other

          36        —          1,333         51        1,282        —   

 

 

Total consumer loans

    23        242        —          15,765         193        15,553        19   

 

 

Total ALLL — continuing operations

    34        859        —          52,574         445        52,107        22   

Discontinued operations

          48        —          5,086  (a)            5,082        —   

 

 

Total ALLL — including discontinued operations

   $ 35       $ 907        —         $ 57,660        $ 449       $ 57,189       $ 22   
 

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 
               

 

 

 

(a)

Amount includes $2.5 billion of loans carried at fair value that are excluded from ALLL consideration.

A breakdown of the individual and collective ALLL and the corresponding loan balances as of December 31, 2012, follows:

 

    Allowance         Outstanding  

December 31, 2012

in millions

  Individually
   Evaluated for
Impairment
    Collectively
   Evaluated for
Impairment
         Purchased
Credit
Impaired
                    Loans     Individually
    Evaluated for
Impairment
    Collectively
    Evaluated for
Impairment
    Purchased
Credit
        Impaired
 

 

 

Commercial, financial and agricultural

   $ 12       $ 314        —         $ 23,242        $ 65       $ 23,176       $  

Commercial real estate:

               

Commercial mortgage

          198        —          7,720         96        7,621         

Construction

    —        41        —          1,003         48        955        —   

 

 

Total commercial real estate loans

          239        —          8,723         144        8,576         

Commercial lease financing

    —        55        —          4,915         —        4,915        —   

 

 

Total commercial loans

    13        608        —          36,880         209        36,667         

Real estate — residential mortgage

          29       $         2,174         38        2,120        16   

Home equity:

               

Key Community Bank

    11        94        —          9,816         87        9,726         

Other

          24        —          423         12        411        —   

 

 

Total home equity loans

    12        118        —          10,239         99        10,137         

Consumer other — Key Community Bank

          36        —          1,349               1,347        —   

Credit cards

    —        26        —          729               727        —   

Consumer other:

               

Marine

          32        —          1,358         60        1,298        —   

Other

    —              —          93               92        —   

 

 

Total consumer other

          35        —          1,451         61        1,390        —   

 

 

Total consumer loans

    22        244                15,942         202        15,721        19   

 

 

Total ALLL — continuing operations

    35        852                52,822         411        52,388        23   

Discontinued operations

    —        55        —          5,201  (a)            5,198        —   

 

 

Total ALLL — including discontinued operations

   $ 35       $ 907       $        $ 58,023        $ 414       $ 57,586       $ 23   
 

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 
               

 

 

 

(a) Amount includes $2.5 billion of loans carried at fair value that are excluded from ALLL consideration.

 

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A breakdown of the individual and collective ALLL and the corresponding loan balances as of March 31, 2012, follows:

 

     Allowance(a)      Outstanding(a)  
     Individually      Collectively            Individually      Collectively  

March 31, 2012

in millions

  

        Evaluated for

Impairment

    

        Evaluated for

Impairment

     Loans    

        Evaluated for

Impairment

    

        Evaluated for

Impairment

 

 

 

Commercial, financial and agricultural

    $ 19        $ 297        $ 20,217        $ 125        $ 20,092   

Commercial real estate:

             

Commercial mortgage

     16         247         7,807         182         7,625   

Construction

            53         1,273         52         1,221   

 

 

Total commercial real estate loans

     19         300         9,080         234          8,846   

Commercial lease financing

     —         68         5,325         —         5,325   

 

 

Total commercial loans

     38         665         34,622         359         34,263   

Real estate — residential mortgage

     —         36         1,967         —         1,967   

Home equity:

             

Key Community Bank

     —         94         9,153         —         9,153   

Other

     —         28         507         —         507   

 

 

Total home equity loans

     —         122         9,660         —         9,660   

Consumer other — Key Community Bank

     —         37         1,212         —         1,212   

Consumer other:

             

Marine

     —         45         1,654         —         1,654   

Other

     —                111         —         111   

 

 

Total consumer other

     —         46         1,765         —         1,765   

 

 

Total consumer loans

     —         241         14,604         —         14,604   

 

 

Total ALLL — continuing operations

     38         906         49,226         359         48,867   

Discontinued operations

     —         90         5,715    (b)      —         5,715   

 

 

Total ALLL — including discontinued operations

    $             38        $             996        $                 54,941        $             359        $             54,582   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 
             

 

 

 

(a)

There were no PCI loans at March 31, 2012.

 

(b)

Amount includes $2.8 billion of loans carried at fair value that are excluded from ALLL considerations.

The liability for credit losses inherent in lending-related unfunded commitments, such as letters of credit and unfunded loan commitments, is included in “accrued expense and other liabilities” on the balance sheet. We establish the amount of this reserve by considering both historical trends and current market conditions quarterly, or more often if deemed necessary. Our liability for credit losses on lending-related commitments has decreased by $13 million since the first quarter of 2012 to $32 million at March 31, 2013. When combined with our ALLL, our total allowance for credit losses represented 1.76% of loans at March 31, 2013, compared to 2.01% at March 31, 2012.

Changes in the liability for credit losses on lending-related commitments are summarized as follows:

 

             Three months ended March 31,           
in millions    2013       2012   

 

 

Balance at beginning of period

    $                 29        $                 45   

Provision (credit) for losses on lending-related commitments

            —   

 

 

Balance at end of period

    $ 32        $ 45   
  

 

 

    

 

 

 

 

 

 

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5. Fair Value Measurements

Fair Value Determination

As defined in the applicable accounting guidance, fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants in our principal market. We have established and documented our process for determining the fair values of our assets and liabilities, where applicable. Fair value is based on quoted market prices, when available, for identical or similar assets or liabilities. In the absence of quoted market prices, we determine the fair value of our assets and liabilities using valuation models or third-party pricing services. Both of these approaches rely on market-based parameters, when available, such as interest rate yield curves, option volatilities, and credit spreads, or unobservable inputs. Unobservable inputs may be based on our judgment, assumptions, and estimates related to credit quality, liquidity, interest rates, and other relevant inputs.

Valuation adjustments, such as those pertaining to counterparty and our own credit quality and liquidity, may be necessary to ensure that assets and liabilities are recorded at fair value. Credit valuation adjustments are made when market pricing does not accurately reflect the counterparty’s or our own credit quality. We make liquidity valuation adjustments to the fair value of certain assets to reflect the uncertainty in the pricing and trading of the instruments when we are unable to observe recent market transactions for identical or similar instruments. Liquidity valuation adjustments are based on the following factors:

 

¿  

the amount of time since the last relevant valuation;

 

¿  

whether there is an actual trade or relevant external quote available at the measurement date; and

 

¿  

volatility associated with the primary pricing components.

We ensure that our fair value measurements are accurate and appropriate by relying upon various controls, including:

 

¿  

an independent review and approval of valuation models and assumptions;

 

¿  

recurring detailed reviews of profit and loss; and

 

¿  

a validation of valuation model components against benchmark data and similar products, where possible.

We recognize transfers between levels of the fair value hierarchy at the end of the reporting period. Quarterly, we review any changes to our valuation methodologies to ensure they are appropriate and justified, and refine our valuation methodologies if more market-based data becomes available. The Fair Value Committee, which is governed by ALCO, oversees the valuation process for all lines of business and support areas, as applicable. Various Working Groups that report to the Fair Value Committee analyze and approve the valuation methodologies used to fair value assets and liabilities managed within specific areas. The Working Groups are discussed in more detail in the qualitative disclosures within this footnote and in Note 11 (“Acquisitions and Discontinued Operations”). Formal documentation of the fair valuation methodologies is prepared by the lines of business and support areas as appropriate. The documentation details the asset or liability class and related general ledger accounts, valuation techniques, fair value hierarchy level, market participants, accounting methods, valuation methodology, group responsible for valuations, and valuation inputs.

Additional information regarding our accounting policies for determining fair value is provided in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Fair Value Measurements” on page 122 of our 2012 Form 10-K.

Qualitative Disclosures of Valuation Techniques

Loans. Most loans recorded as trading account assets are valued based on market spreads for identical assets since they are actively traded. Therefore, these loans are classified as Level 2 because the fair value recorded is based on observable market data for similar assets.

Securities (trading and available for sale). We own several types of securities, requiring a range of valuation methods:

 

¿  

Securities are classified as Level 1 when quoted market prices are available in an active market for the identical securities. Level 1 instruments include exchange-traded equity securities.

 

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¿  

Securities are classified as Level 2 if quoted prices for identical securities are not available, and fair value is determined using pricing models (either by a third-party pricing service or internally) or quoted prices of similar securities. These instruments include municipal bonds; bonds backed by the U.S. government; corporate bonds; certain mortgage-backed securities; securities issued by the U.S. Treasury; money markets; and certain agency and corporate CMOs. Inputs to the pricing models include actual trade data (i.e., spreads, credit ratings, and interest rates) for comparable assets, spread tables, matrices, high-grade scales, option-adjusted spreads, and standard inputs, such as yields, benchmark securities, bids, and offers.

 

¿  

Securities are classified as Level 3 when there is limited activity in the market for a particular instrument. In such cases, we use internal models based on certain assumptions to determine fair value. Level 3 instruments consist of certain commercial mortgage-backed securities. Our Real Estate Capital line of business is responsible for the valuation process for these commercial mortgage-backed securities, which is conducted on a quarterly basis. The methodology incorporates a loan-by-loan credit review in combination with discounting the risk-adjusted bond cash flows. A detailed credit review of the underlying loans involves a screening process using a multitude of filters to identify the highest risk loans associated with these commercial mortgage-backed securities. Each of the highest risk loans identified is re-underwritten and loan specific defaults and recoveries are assigned. A matrix approach is used to assign an expected default and recovery percentage for the loans that are not individually re-underwritten. Bond classes will then be run through a discounted cash flow analysis, taking into account the expected default and recovery percentages as well as discount rates developed by our Finance area. Inputs for the Level 3 internal models include expected cash flows from the underlying loans, which take into account expected default and recovery percentages, market research, and discount rates commensurate with current market conditions. Changes in the credit quality of the underlying loans or market discount rate would impact the value of the bonds. An increase in the underlying loan credit quality or decrease in the market discount rate would positively impact the bond value. A decrease in the underlying loan credit quality or increase in the market discount rate would negatively impact the bond value.

The fair values of our Level 2 securities available for sale are determined by a third-party pricing service. The valuations provided by the third-party pricing service are based on observable market inputs, which include benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers, and reference data obtained from market research publications. Inputs used by the third-party pricing service in valuing CMOs and other mortgage-backed securities also include new issue data, monthly payment information, whole loan collateral performance, and “To Be Announced” prices. In valuations of state and political subdivisions securities, inputs used by the third-party pricing service also include material event notices.

On a quarterly basis, we validate the pricing methodologies utilized by our third-party pricing service to ensure the fair value determination is consistent with the applicable accounting guidance and that our assets are properly classified in the fair value hierarchy. To perform this validation, we:

 

¿  

review documentation received from our third-party pricing service regarding the inputs used in their valuations and determine a level assessment for each category of securities;

 

¿  

substantiate actual inputs used for a sample of securities by comparing the actual inputs used by our third-party pricing service to comparable inputs for similar securities; and

 

¿  

substantiate the fair values determined for a sample of securities by comparing the fair values provided by our third-party pricing service to prices from other independent sources for the same and similar securities. We analyze variances and conduct additional research with our third-party pricing service and take appropriate steps based on our findings.

Private equity and mezzanine investments. Private equity and mezzanine investments consist of investments in debt and equity securities through our Real Estate Capital line of business. They include direct investments made in specific properties, as well as indirect investments made in funds that pool assets of many investors to invest in properties. There is no active market for these investments, so we employ other valuation methods.

Private equity and mezzanine investments are classified as Level 3 assets since our judgment significantly influences the determination of fair value. Our Fund Management, Asset Management, and Accounting groups are responsible for reviewing the valuation models and determining the fair value of these investments on a quarterly basis. Direct investments in properties are initially valued based upon the transaction price. This amount is then adjusted to fair value based on current market conditions using the discounted cash flow method based on the expected investment exit date. The fair values of the assets are reviewed and adjusted quarterly. Periodically, a third-party appraisal is obtained for the investment to validate the specific inputs for determining fair value.

 

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Inputs used in calculating future cash flows include the cost of build-out, future selling prices, current market outlook, and operating performance of the investment. Investment income and expense assumptions are based on market inputs, such as rental/leasing rates and vacancy rates for the geographic- and property type-specific markets. For investments under construction, investment income and expense assumptions are determined using expected future build-out costs and anticipated future rental prices based on current market conditions, discount rates, holding period, the terminal cap rate and sales commissions paid in the terminal cap year. For investments that are in lease-up or are fully leased, income and expense assumptions are based on the current geographic market lease rates, underwritten expenses, market lease terms, and historical vacancy rates. Asset Management validates these inputs on a quarterly basis through the use of industry publications, third-party broker opinions, and comparable property sales, where applicable. Changes in the significant inputs (rental/leasing rates, vacancy rates, valuation capitalization rate, discount rate, and terminal cap rate) would significantly affect the fair value measurement. Increases in rental/leasing rates would increase fair value while increases in the vacancy rates, the valuation capitalization rate, the discount rate, and the terminal cap rate would decrease fair value.

Indirect investments are valued using a methodology that is consistent with accounting guidance that allows us to use statements from the investment manager to calculate net asset value per share. A primary input used in estimating fair value is the most recent value of the capital accounts as reported by the general partners of the funds in which we invest. The calculation to determine the investment’s fair value is based on our percentage ownership in the fund multiplied by the net asset value of the fund, as provided by the fund manager.

Investments in real estate private equity funds are included within private equity and mezzanine investments. The main purpose of these funds is to acquire a portfolio of real estate investments that provides attractive risk-adjusted returns and current income for investors. Certain of these investments do not have readily determinable fair values and represent our ownership interest in an entity that follows measurement principles under investment company accounting. The following table presents the fair value of our indirect investments and related unfunded commitments at March 31, 2013:

 

March 31, 2013

in millions

   Fair Value      Unfunded
Commitments
 

 

 

INVESTMENT TYPE

     

Passive funds (a)

     $                     17          $                     1    

Co-managed funds (b)

     22          1    

 

 

Total

     $ 39          $ 2    
  

 

 

    

 

 

 
     

 

 

 

(a) We invest in passive funds, which are multi-investor private equity funds. These investments can never be redeemed. Instead, distributions are received through the liquidation of the underlying investments in the funds. Some funds have no restrictions on sale, while others require investors to remain in the fund until maturity. The funds will be liquidated over a period of one to seven years.

 

(b) We are a manager or co-manager of these funds. These investments can never be redeemed. Instead, distributions are received through the liquidation of the underlying investments in the funds. In addition, we receive management fees. We can sell or transfer our interest in any of these funds with the written consent of a majority of the fund’s investors. In one instance, the other co-manager of the fund must consent to the sale or transfer of our interest in the fund. The funds will mature over a period of two to five years.

Principal investments. Principal investments consist of investments in equity and debt instruments made by our principal investing entities. They include direct investments (investments made in a particular company), as well as indirect investments (investments made through funds that include other investors).

Each investment is adjusted to fair value with any net realized or unrealized gain/loss recorded in the current period’s earnings. This process is a coordinated and documented effort by the Principal Investing Entities Deal Team (comprised of individuals from one of the independent investment managers who oversee these instruments), the Key Principal Partners (“KPP”) Controller and certain members of the KPP Controller’s staff, a member of Key’s senior management team, and the Investment Committee (comprised of individuals from Key and one of the independent investment managers). This process involves an in-depth review of the condition of each investment depending on the type of investment.

Our direct investments include investments in debt and equity instruments of both private and public companies. When quoted prices are available in an active market for the identical direct investment, we use the quoted prices in the valuation process, and the related investments are classified as Level 1 assets. However, in most cases, quoted market prices are not available for our direct investments, and we must perform valuations using other methods. These direct investment valuations are an in-depth analysis of the condition of each investment and are based on the unique facts and circumstances

 

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related to each individual investment. There is a certain amount of subjectivity surrounding the valuation of these investments due to the combination of quantitative and qualitative factors that are used in the valuation models. Therefore, these direct investments are classified as Level 3 assets. The specific inputs used in the valuations of each type of direct investment are described below.

Interest-bearing securities (i.e., loans) are valued on a quarterly basis. Valuation adjustments are determined by the Principal Investing Entities Deal Team and are subject to approval by the Investment Committee. Valuations of debt instruments are based on the Principal Investing Entities Deal Team’s knowledge of the current financial status of the subject company, which is regularly monitored throughout the term of the investment. Significant unobservable inputs used in the valuations of these investments include the company’s payment history, adequacy of cash flows from operations, and current operating results, including market multiples, and historical and forecast earnings before interest, taxation, depreciation, and amortization. Inputs can also include the seniority of the debt, the nature of any pledged collateral, the extent to which the security interest is perfected and the net liquidation value of collateral.

Valuations of equity instruments of private companies, which are prepared on a quarterly basis, are based on current market conditions and the current financial status of each company. A valuation analysis is performed to value each investment that is reviewed by the Principal Investing Entities Deal Team Member as well as reviewed and approved by the Chief Administrative Officer of one of the independent investment managers. Significant unobservable inputs used in these valuations include adequacy of the company’s cash flows from operations, any significant change in the company’s performance since the prior valuation, and any significant equity issuances by the company. Equity instruments of public companies are valued using quoted prices in an active market for the identical security. If the instrument is restricted, the fair value is determined considering the number of shares traded daily, the number of the company’s total restricted shares, and price volatility.

Our indirect investments are classified as Level 3 assets since our significant inputs are not observable in the marketplace. Indirect investments include primary and secondary investments in private equity funds engaged mainly in venture- and growth-oriented investing. These investments do not have readily determinable fair values. Indirect investments are valued using a methodology that is consistent with accounting guidance that allows us to estimate fair value based upon net asset value per share (or its equivalent, such as member units or an ownership interest in partners’ capital to which a proportionate share of net assets is attributed). The significant unobservable input used in estimating fair value is primarily the most recent value of the capital accounts as reported by the general partners of the funds in which we invest.

For indirect investments, management makes adjustments as deemed appropriate to the net asset value and only if it is determined that the net asset value does not properly reflect fair value. In determining the need for an adjustment to net asset value, management performs an analysis of the private equity funds based on the independent fund manager’s valuations as well as management’s own judgment. Significant unobservable inputs used in these analyses include current fund financial information provided by the fund manager, an estimate of future proceeds expected to be received on the investment, and market multiples. Management also considers whether the independent fund manager adequately marks down an impaired investment, maintains financial statements in accordance with GAAP, or follows a practice of holding all investments at cost.

The fair value of our indirect investments and related unfunded commitments at March 31, 2013, was $435 million and $89 million, respectively. Our indirect investments consist of buyout, venture capital, and fund of funds. These investments can never be redeemed. Instead, distributions are received through the liquidation of the underlying investments of the fund. An investment in any one of these funds can be sold only with the approval of the fund’s general partners. We estimate that the underlying investments of the funds will be liquidated over a period of one to nine years.

Derivatives. Exchange-traded derivatives are valued using quoted prices and, therefore, are classified as Level 1 instruments. However, only a few types of derivatives are exchange-traded. The majority of our derivative positions are valued using internally developed models based on market convention that use observable market inputs, such as interest rate curves, yield curves, LIBOR discount rates and curves, index pricing curves, foreign currency curves, and volatility surfaces (a three-dimensional graph of implied volatility against strike price and maturity). These derivative contracts, which are classified as Level 2 instruments, include interest rate swaps, certain options, cross currency swaps, and credit default swaps.

In addition, we have several customized derivative instruments and risk participations that are classified as Level 3 instruments. These derivative positions are valued using internally developed models, with inputs consisting of available market data, such as bond spreads and asset values, as well as unobservable internally-derived assumptions, such as loss probabilities and internal risk ratings of customers. These derivatives are priced monthly by our Market Risk Management group using a credit valuation adjustment methodology. Swap details with the customer and our related participation

 

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percentage, if applicable, are obtained from our derivatives accounting system, which is the system of record. Applicable customer rating information is obtained from the particular loan system and represents an unobservable input to this valuation process. Using these various inputs, a valuation of these Level 3 derivatives is performed using a model that was acquired from a third party. In summary, the fair value represents an estimate of the amount that the risk participation counterparty would need to pay/receive as of the measurement date based on the probability of customer default on the swap transaction and the fair value of the underlying customer swap. Therefore, a higher loss probability and a lower credit rating would negatively affect the fair value of the risk participations and a lower loss probability and higher credit rating would positively affect the fair value of the risk participations.

Market convention implies a credit rating of “AA” equivalent in the pricing of derivative contracts, which assumes all counterparties have the same creditworthiness. To reflect the actual exposure on our derivative contracts related to both counterparty and our own creditworthiness, we record a fair value adjustment in the form of a default reserve. The credit component is determined by individual counterparty based on the probability of default, and considers master netting and collateral agreements. The default reserve is classified as Level 3. Our Market Risk Management group is responsible for the valuation policies and procedure related to this default reserve. A weekly reconciliation process is performed to ensure that all applicable derivative positions are covered in the calculation, which includes transmitting customer exposures and reserve reports to trading management, derivative traders and marketers, derivatives middle office, and corporate accounting personnel. On a quarterly basis, Market Risk Management prepares the reserve calculation. A detailed reserve comparison with the previous quarter, an analysis for change in reserve, and a reserve forecast are provided by Market Risk Management to ensure that the default reserve recorded at period end is sufficient.

Other assets and liabilities. The value of our repurchase and reverse repurchase agreements, trade date receivables and payables, and short positions is driven by the valuation of the underlying securities. The underlying securities may include equity securities, which are valued using quoted market prices in an active market for identical securities, resulting in a Level 1 classification. If quoted prices for identical securities are not available, fair value is determined by using pricing models or quoted prices of similar securities, resulting in a Level 2 classification. For the interest rate-driven products, such as government bonds, U.S. Treasury bonds and other products backed by the U.S. government, inputs include spreads, credit ratings and interest rates. For the credit-driven products, such as corporate bonds and mortgage-backed securities, inputs include actual trade data for comparable assets, and bids and offers.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Certain assets and liabilities are measured at fair value on a recurring basis in accordance with GAAP. The following tables present these assets and liabilities at March 31, 2013, December 31, 2012 and March 31, 2012.

 

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Table of Contents

March 31, 2013

in millions

   Level 1      Level 2      Level 3      Total  

 

 

ASSETS MEASURED ON A RECURRING BASIS

           

Short-term investments:

           

Securities purchased under resale agreements

     —         $ 311         —         $ 311    

Trading account assets:

           

U.S. Treasury, agencies and corporations

     —         496         —         496    

States and political subdivisions

     —         46         $        49    

Collateralized mortgage obligations

     —         23         —         23    

Other mortgage-backed securities

     —         80         —         80    

Other securities

     $        41         —         46    

 

 

Total trading account securities

            686                694    

Commercial loans

     —                —         7    

 

 

Total trading account assets

            693                701    

Securities available for sale:

           

States and political subdivisions

     —         48         —         48    

Collateralized mortgage obligations

     —         12,918         —         12,918    

Other mortgage-backed securities

     —         487         —         487    

Other securities

     43         —         —         43    

 

 

Total securities available for sale

     43         13,453         —         13,496    

Other investments:

           

Principal investments:

           

Direct

     —         —         191         191    

Indirect

     —         —         435         435    

 

 

Total principal investments

     —         —         626         626    

Equity and mezzanine investments:

           

Direct

     —         —         —         —    

Indirect

     —         —         39         39    

 

 

Total equity and mezzanine investments

     —         —         39         39    

 

 

Total other investments

     —         —         665         665    

Derivative assets:

           

Interest rate

     —         1,499         27         1,526    

Foreign exchange

     57         14         —         71    

Energy and commodity

     —         115                120    

Credit

     —                       7    

Equity

     —         —         —         —    

 

 

Derivative assets

     57         1,630         37         1,724    

Netting adjustments(a)

     —         —         —         (1,115)    

 

 

Total derivative assets

     57         1,630         37         609    

Accrued income and other assets

            95         —         97    

 

 

Total assets on a recurring basis at fair value

     $                 107         $           16,182         $                 705         $           15,879    
  

 

 

    

 

 

    

 

 

    

 

 

 
           

 

 

LIABILITIES MEASURED ON A RECURRING BASIS

           

Federal funds purchased and securities sold under repurchase agreements:

           

Securities sold under repurchase agreements

     —         $ 494         —         $ 494    

Bank notes and other short-term borrowings:

           

Short positions

     $        373         —         376    

Derivative liabilities:

           

Interest rate

     —         1,027         —         1,027    

Foreign exchange

     54         14         —         68    

Energy and commodity

     —         113         $        114    

Credit

     —         10                11    

Equity

     —         —         —         —    

 

 

Derivative liabilities

     54         1,164                1,220    

Netting adjustments(a)

     —         —         —         (696)    

 

 

Total derivative liabilities

     54         1,164                524    

Accrued expense and other liabilities

     —                —         1    

 

 

Total liabilities on a recurring basis at fair value

     $ 57         $ 2,032         $        $ 1,395    
  

 

 

    

 

 

    

 

 

    

 

 

 
           

 

 

 

(a) Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with applicable accounting guidance. The net basis takes into account the impact of bilateral collateral and master netting agreements that allow us to settle all derivative contracts with a single counterparty on a net basis and to offset the net derivative position with the related collateral. Total derivative assets and liabilities include these netting adjustments.

 

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December 31, 2012

in millions

   Level 1      Level 2      Level 3      Total  

 

 

ASSETS MEASURED ON A RECURRING BASIS

           

Short term investments:

           

Securities purchased under resale agreements

     —         $ 271         —         $ 271    

Trading account assets:

           

U.S. Treasury, agencies and corporations

     —         383         —         383    

States and political subdivisions

     —         21         $        24    

Collateralized mortgage obligations

     —                —         8    

Other mortgage-backed securities

     —                —         4    

Other securities

     $        175         —         177    

 

 

Total trading account securities

            591                596    

Commercial loans

     —                —         9    

 

 

Total trading account assets

            600                605    

Securities available for sale:

           

States and political subdivisions

     —         49         —         49    

Collateralized mortgage obligations

     —         11,464         —         11,464    

Other mortgage-backed securities

     —         538         —         538    

Other securities

     43         —         —         43    

 

 

Total securities available for sale

     43         12,051         —         12,094    

Other investments:

           

Principal investments:

           

Direct

     —         —         191         191    

Indirect

     —         —         436         436    

 

 

Total principal investments

     —         —         627         627    

Equity and mezzanine investments:

           

Direct

     —         —         —         —    

Indirect

     —         —         41         41    

 

 

Total equity and mezzanine investments

     —         —         41         41    

 

 

Total other investments

     —         —         668         668    

Derivative assets:

           

Interest rate

     —         1,705         19         1,724    

Foreign exchange

     54         21         —         75    

Energy and commodity

     —         154                156    

Credit

     —                       8    

Equity

     —         —         —         —    

 

 

Derivative assets

     54         1,883         26         1,963    

Netting adjustments (a)

     —         —         —         (1,270)    

 

 

Total derivative assets

     54         1,883         26         693    

Accrued income and other assets

     —                —         3    

 

 

Total assets on a recurring basis at fair value

     $                 99         $           14,808         $                 697         $           14,334    
  

 

 

    

 

 

    

 

 

    

 

 

 
           

 

 

LIABILITIES MEASURED ON A RECURRING BASIS

           

Federal funds purchased and securities sold under repurchase agreements:

           

Securities sold under repurchase agreements

     —         $ 228         —         $ 228    

Bank notes and other short-term borrowings:

           

Short positions

     —         287         —         287    

Derivative liabilities:

           

Interest rate

     —         1,152         —         1,152    

Foreign exchange

     $ 55         20         —         75    

Energy and commodity

     —         149         $        150    

Credit

     —                       10    

Equity

     —         —         —         —    

 

 

Derivative liabilities

     55         1,330                1,387    

Netting adjustments (a)

     —         —         —         (803)    

 

 

Total derivative liabilities

     55         1,330                584    

Accrued expense and other liabilities

     —         49         —         49    

 

 

Total liabilities on a recurring basis at fair value

     $ 55         $ 1,894         $        $ 1,148    
  

 

 

    

 

 

    

 

 

    

 

 

 
           

 

 

 

(a) Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with applicable accounting guidance. The net basis takes into account the impact of bilateral collateral and master netting agreements that allow us to settle all derivative contracts with a single counterparty on a net basis and to offset the net derivative position with the related collateral. Total derivative assets and liabilities include these netting adjustments.

 

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March 31, 2012

in millions

   Level 1      Level 2      Level 3      Total  

 

 

ASSETS MEASURED ON A RECURRING BASIS

           

Short term investments:

           

Securities purchased under resale agreements

     —         $ 292         —         $ 292    

Trading account assets:

           

U.S. Treasury, agencies and corporations

     —         336         —         336    

States and political subdivisions

     —         122         —         122    

Collateralized mortgage obligations

     —         23         —         23    

Other mortgage-backed securities

     —         96         $        97    

Other securities

     $ 11         25         —         36    

 

 

Total trading account securities

     11         602                614    

Commercial loans

     —         —         —         —    

 

 

Total trading account assets

     11         602                614    

Securities available for sale:

           

States and political subdivisions

     —         62         —         62    

Collateralized mortgage obligations

     —         13,845         —         13,845    

Other mortgage-backed securities

     —         714         —         714    

Other securities

     12         —         —         12    

 

 

Total securities available for sale

     12         14,621         —         14,633    

Other investments:

           

Principal investments:

           

Direct

     18         —         226         244    

Indirect

     —         —         485         485    

 

 

Total principal investments

     18         —         711         729    

Equity and mezzanine investments:

           

Direct

     —         —         15         15    

Indirect

     —         —         42         42    

 

 

Total equity and mezzanine investments

     —         —         57         57    

 

 

Total other investments

     18         —         768         786    

Derivative assets:

           

Interest rate

     —         1,686         36         1,722    

Foreign exchange

     73         21         —         94    

Energy and commodity

     —         271         —         271    

Credit

     —         29                35    

Equity

     —                —         3    

 

 

Derivative assets

     73         2,010         42         2,125    

Netting adjustments (a)

     —         —         —         (1,295)    

 

 

Total derivative assets

     73         2,010         42         830    

Accrued income and other assets

            117         —         118    

 

 

Total assets on a recurring basis at fair value

     $                 115         $           17,642         $                 811         $           17,273    
  

 

 

    

 

 

    

 

 

    

 

 

 
           

 

 

LIABILITIES MEASURED ON A RECURRING BASIS

           

Federal funds purchased and securities sold under repurchase agreements:

           

Securities sold under repurchase agreements

     —         $ 394         —         $ 394    

Bank notes and other short-term borrowings:

           

Short positions

     $        318         —         324    

Derivative liabilities:

           

Interest rate

     —         1,213         —         1,213    

Foreign exchange

     64         20         —         84    

Energy and commodity

     —         266         $        267    

Credit

     —         33                34    

Equity

     —                —         3    

 

 

Derivative liabilities

     64         1,535                1,601    

Netting adjustments (a)

     —         —         —         (847)    

 

 

Total derivative liabilities

     64         1,535                754    

Accrued expense and other liabilities

     —                —         8    

 

 

Total liabilities on a recurring basis at fair value

     $ 70         $ 2,255         $        $ 1,480    
  

 

 

    

 

 

    

 

 

    

 

 

 
           

 

 

 

(a) Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with applicable accounting guidance. The net basis takes into account the impact of bilateral collateral and master netting agreements that allow us to settle all derivative contracts with a single counterparty on a net basis and to offset the net derivative position with the related collateral. Total derivative assets and liabilities include these netting adjustments.

 

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Changes in Level 3 Fair Value Measurements

The following table shows the change in the fair values of our Level 3 financial instruments for the three months ended March 31, 2013, and 2012. We mitigate the credit risk, interest rate risk, and risk of loss related to many of these Level 3 instruments by using securities and derivative positions classified as Level 1 or Level 2. Level 1 and Level 2 instruments are not included in the following table. Therefore, the gains or losses shown do not include the impact of our risk management activities.

 

in millions   Beginning
of Period
Balance
    Gains
(Losses)
Included in
Earnings
        Purchases     Sales     Settlements     Transfers
into
Level 3
    (e)   Transfers
out of
Level 3
    (e)   End of
Period
Balance
    (g)   Unrealized
Gains
(Losses)
Included in
Earnings
     

 

   

March 31, 2013

                           

Trading account assets

                           

Other mortgage-backed securities

    —      $     (b)         $ (4)        —                —          —             

Other securities

    —            (b)           —      $ (1)                —          —        $ 1     (b)

State and political subdivisions

  $       —                —                  —        $            

Other investments

                           

Principal investments

                           

Direct

    191        (4)      (c)   $ 4       —        —                —          191          (4)      (c)

Indirect

    436        12      (c)     6       (19)        —                —          435          4     (c)

Equity and mezzanine investments

                           

Direct

    —        —                —        —                —          —             

Indirect

    41        —                —        (2)                —          39             

Derivative instruments(a)

                           

Interest rate

    19        (3)      (d)           (1)        —      $           14     (f)   $ (2)          27             

Energy and commodity

              (d)           —        —                —                     

Credit

          (1)      (d)           —        1               —                     

March 31, 2012

                           

Trading account assets

                           

Other mortgage-backed securities

  $           35      $             2      (b)         $         (32)        —              $           (4)        $           1             

Other securities

    —            (b)           —      $               (3)                —          —        $               3     (b)

Other investments

                           

Principal investments

                           

Direct

    225            (c)   $             1       (1)        —                —          226          1     (c)

Indirect

    473        23      (c)     10       (21)        —                —          485          19     (c)

Equity and mezzanine investments

                           

Direct

    15        —                —        —                —          15          6     (c)

Indirect

    36            (c)     3       —        (1)      $ 3         —          42          4     (c)

Derivative instruments(a)

                           

Interest rate

    38        (5)      (d)     1       (1)        —        4         (1)          36             

Energy and commodity

    (1)        —                —        —                —          (1)             

Credit

    (21)        (5)      (d)           —        31               —                     
                           

 

 

(a) Amounts represent Level 3 derivative assets less Level 3 derivative liabilities.

 

(b) Realized and unrealized gains and losses on trading account assets are reported in “other income” on the income statement.

 

(c) Realized and unrealized gains and losses on principal investments and private equity and mezzanine investments are reported in “net gains (losses) from principal investing” on the income statement.

 

(d) Realized and unrealized gains and losses on derivative instruments are reported in “corporate services income” and “other income” on the income statement.

 

(e) Our policy is to recognize transfers into and transfers out of Level 3 as of the end of the reporting period.

 

(f) Transfers from Level 2 to Level 3 were the result of Level 3 unobservable inputs becoming significant to certain derivatives previously classified as Level 2.

 

(g) There were no issuances for the three-month periods ended March 31, 2013 and 2012.

 

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Assets Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities are measured at fair value on a nonrecurring basis in accordance with GAAP. The adjustments to fair value generally result from the application of accounting guidance that requires assets and liabilities to be recorded at the lower of cost or fair value, or assessed for impairment. The following table presents our assets measured at fair value on a nonrecurring basis at March 31, 2013, December 31, 2012, and March 31, 2012:

 

        March 31, 2013  
in millions             Level 1      Level 2      Level 3      Total  

 

 

ASSETS MEASURED ON A NONRECURRING BASIS

            

Impaired loans

      —         —         $ 18         $ 18   

Loans held for sale (a)

      —         —         12         12   

Accrued income and other assets

      —         $        14         16   

 

 

Total assets on a nonrecurring basis at fair value

      —         $               2         $               44         $               46   
 

 

    

 

 

    

 

 

    

 

 

 
            

 

 
        December 31, 2012  
in millions       Level 1      Level 2      Level 3      Total  

 

 

ASSETS MEASURED ON A NONRECURRING BASIS

            

Impaired loans

      —         —         $ 25         $ 25   

Loans held for sale (a)

      —         —                 

Accrued income and other assets

      —         $        20         22   

 

 

Total assets on a nonrecurring basis at fair value

      —         $        $ 54         $ 56   
 

 

    

 

 

    

 

 

    

 

 

 
            

 

 
        March 31, 2012  
in millions       Level 1      Level 2      Level 3      Total  

 

 

ASSETS MEASURED ON A NONRECURRING BASIS

            

Impaired loans

      —         —         $ 101         $ 101   

Loans held for sale (a)

      —         —         25         25   

Accrued income and other assets

      —         $ 30         16         46   

 

 

Total assets on a nonrecurring basis at fair value

      —         $ 30         $ 142         $ 172   
 

 

    

 

 

    

 

 

    

 

 

 
            

 

 

 

(a) During the first quarter of 2013, we transferred $1 million of commercial and consumer loans and leases from held-for-sale status to the held-to-maturity portfolio at their current fair value.

Impaired loans. We typically adjust the carrying amount of our impaired loans when there is evidence of probable loss and the expected fair value of the loan is less than its contractual amount. The amount of the impairment may be determined based on the estimated present value of future cash flows, the fair value of the underlying collateral, or the loan’s observable market price. Impaired loans with a specifically allocated allowance based on cash flow analysis or the value of the underlying collateral are classified as Level 3 assets, while those with a specifically allocated allowance based on an observable market price that reflects recent sale transactions for similar loans and collateral are classified as Level 2.

The evaluations for impairment are prepared by the responsible relationship managers in our Asset Recovery Group and are reviewed and approved by the Asset Recovery Group Executive. The Asset Recovery Group is part of the Risk Management Group and reports to our Chief Credit Officer. These evaluations are performed in conjunction with the quarterly ALLL process.

Subject loans are evaluated for impairment on a quarterly basis. Loans included in the previous quarter’s review are reevaluated and if their values are materially different from the prior quarter evaluation, the underlying information (loan balance and in most cases, collateral value) is compared. Material differences are evaluated for reasonableness, and discussions are held between the relationship managers and their senior managers to understand the difference and determine if any adjustment is necessary. The inputs are developed and substantiated on a quarterly basis, based on current borrower developments, market conditions and collateral values.

The following two internal methods are used to value impaired loans:

 

  ¿  

Cash flow analysis considers internally developed inputs, such as discount rates, default rates, costs of foreclosure and changes in collateral values.

 

  ¿  

The fair value of the collateral, which may take the form of real estate or personal property, is based on internal estimates, field observations and assessments provided by third-party appraisers. We perform or reaffirm appraisals of collateral-dependent impaired loans at least annually. Appraisals may occur more frequently if the most recent appraisal does not accurately reflect the current market, the debtor is seriously delinquent or chronically past due, or

 

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there has been a material deterioration in the performance of the project or condition of the property. Adjustments to outdated appraisals that result in an appraisal value less than the carrying amount of a collateral-dependent impaired loan are reflected in the ALLL.

Impairment valuations are back-tested each quarter, based on a look-back of actual incurred losses on closed deals previously evaluated for impairment. The overall percent variance of actual net charge-offs on closed deals as compared to the specific allocations on such deals is considered in determining each quarter’s specific allocations.

Loans held for sale. Through a quarterly analysis of our loan portfolios held for sale, which include both performing and nonperforming loans, we determined that adjustments were necessary to record some of the portfolios at the lower of cost or fair value in accordance with GAAP. Loans held for sale portfolios adjusted to fair value totaled $12 million at March 31, 2013, $9 million at December 31, 2012, and $25 million at March 31, 2012.

Current market conditions, including updated collateral values, and reviews of our borrowers’ financial condition influenced the inputs used in our internal models and other valuation methodologies, resulting in these adjustments. The valuations are prepared by the responsible relationship managers or analysts in our Asset Recovery Group and are reviewed and approved by the Asset Recovery Group Executive. Actual gains or losses realized on the sale of various loans held for sale provide a back-testing mechanism for determining the appropriateness of our valuations of these loans held for sale that are adjusted to fair value.

Valuations of performing commercial mortgage and construction loans held for sale are conducted using internal models that rely on market data from sales or nonbinding bids on similar assets, including credit spreads, treasury rates, interest rate curves and risk profiles, as well as our own assumptions about the exit market for the loans and details about individual loans within the respective portfolios. Therefore, we have classified these loans as Level 3 assets. The inputs related to our assumptions and other internal loan data include changes in real estate values, costs of foreclosure, prepayment rates, default rates and discount rates.

Valuations of nonperforming commercial mortgage and construction loans held for sale are based on current agreements to sell the loans or approved discounted payoffs. If a negotiated value is not available, we use third-party appraisals, adjusted for current market conditions. Since valuations are based on unobservable data, these loans have been classified as Level 3 assets.

Direct financing leases and operating lease assets held for sale. Our Key Equipment Finance (KEF) Accounting and Capital Markets groups are responsible for the valuation policies and procedures related to these assets. The Managing Director of the KEF Capital Markets group reports to the President of our Equipment Finance line of business. A weekly report is distributed to both groups that lists all Equipment Finance deals booked in the warehouse portfolio. On a quarterly basis, the KEF Accounting group prepares a detailed held-for-sale roll-forward schedule that is reconciled to the general ledger and the above mentioned weekly report. KEF management uses the held-for-sale roll-forward schedule to determine if an impairment adjustment is necessary in accordance with lower of cost or fair value guidelines.

Valuations of direct financing leases and operating lease assets held for sale are performed using an internal model that relies on market data, such as swap rates and bond ratings, as well as our own assumptions about the exit market for the leases and details about the individual leases in the portfolio. The inputs based on our assumptions include changes in the value of leased items and internal credit ratings. These leases have been classified as Level 3 assets. Leases also may be valued using current nonbinding bids when they are available. These leases are classified as Level 2 assets. In a distressed market where market data is not available, an estimate of the fair value of the leased asset may be used to value the lease, resulting in a Level 3 classification. In an inactive market, the market value of the assets held for sale is determined as the present value of the future cash flows discounted at the current buy rate. KEF Accounting calculates an estimated fair value buy rate based on the credit premium inherent in the relevant bond index and the appropriate swap rate on the measurement date. The amount of the adjustment is calculated as book value minus the present value of future cash flows discounted at the calculated buy rate.

Goodwill and other intangible assets. On a quarterly basis, we review impairment indicators to determine whether we need to evaluate the carrying amount of the goodwill and other intangible assets assigned to Key Community Bank and Key Corporate Bank. We also perform an annual impairment test for goodwill. New accounting guidance that permits an entity to first assess qualitative factors to determine whether additional goodwill impairment testing is required became effective for us on January 1, 2012. We did not choose to utilize this qualitative assessment in our annual goodwill impairment testing performed during the fourth quarter of 2012. Fair value of our reporting units is determined using both an income approach (discounted cash flow method) and a market approach (using publicly traded company and recent transactions data), which are weighted equally.

 

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Inputs used include market-available data, such as industry, historical and expected growth rates, and peer valuations, as well as internally driven inputs, such as forecasted earnings and market participant insights. Since this valuation relies on a significant number of unobservable inputs, we have classified goodwill as Level 3. We use a third party valuation services provider to perform the annual, and if necessary, any interim, Step 1 valuation process, and to perform a Step 2 analysis, if needed, on our reporting units. Annual and any interim valuations prepared by the third-party valuation service provider are reviewed by the appropriate individuals within Key to ensure that the assumptions used in preparing the analysis are appropriate and properly supported. For additional information on the results of recent goodwill impairment testing, see Note 10 (“Goodwill and Other Intangible Assets”) on page on 171 of our 2012 Form 10-K.

The fair value of other intangible assets is calculated using a cash flow approach. While the calculation to test for recoverability uses a number of assumptions that are based on current market conditions, the calculation is based primarily on unobservable assumptions. Accordingly, these assets are classified as Level 3. Our lines of business, with oversight from our Accounting group, are responsible for routinely, at least quarterly, assessing whether impairment indicators are present. All indicators that signal impairment may exist are appropriately considered in this analysis. An impairment loss is only recognized for a held and used long lived asset if the sum of its estimated future undiscounted cash flows used to test for recoverability is less than its carrying value.

Our primary assumptions include attrition rates, alternative costs of funds and rates paid on deposits. For additional information on the results of other intangible assets impairment testing, see Note 10 (“Goodwill and Other Intangible Assets”) on page on 171 of our 2012 Form 10-K.

Other assets. OREO and other repossessed properties are valued based on inputs such as appraisals and third-party price opinions, less estimated selling costs. Generally, we classify these assets as Level 3, but OREO and other repossessed properties for which we receive binding purchase agreements are classified as Level 2. Returned lease inventory is valued based on market data for similar assets and is classified as Level 2. Assets that are acquired through, or in lieu of, loan foreclosures are recorded initially as held for sale at fair value less estimated selling costs at the date of foreclosure. After foreclosure, valuations are updated periodically, and current market conditions may require the assets to be marked down further to a new cost basis.

 

  ¿  

Commercial Real Estate Valuation Process: When a loan is reclassified from loan status to OREO because we took possession of the collateral, the Asset Recovery Group Loan Officer, in consultation with our OREO group, obtains a broker price opinion or a third-party appraisal, which is used to establish the fair value of the underlying collateral. The determined fair value of the underlying collateral less estimated selling costs becomes the carrying value of the OREO asset. In addition to valuations from independent third party sources, our OREO group also writes down the carrying balance of OREO assets once a bona fide offer is contractually accepted, through execution of a Purchase and Sale Agreement, where the accepted price is lower than the current balance of the particular OREO asset. The fair value of OREO property is re-evaluated every 90 days and the OREO asset is adjusted as necessary.

 

  ¿  

Consumer Real Estate Valuation Process: The Asset Management team within our Risk Operations group is responsible for valuation policies and procedures in this area. The current vendor partner provides monthly reporting of all broker price opinion evaluations, appraisals and the monthly market plans. Market plans are reviewed monthly, and valuations are reviewed and tested monthly to ensure proper pricing has been established and guidelines are being met. Risk Operations Compliance validates and provides periodic testing of the valuation process. The Asset Management team reviews changes in fair value measurements. The current vendor partner managed brokers review pricing monthly, while third-party broker price opinions are reviewed every 90 days, and the fair value is written down based on changes to the valuation. External factors are documented and monitored as appropriate.

Mortgage servicing assets are valued based on inputs such as prepayment speeds, earn rates, credit default rates, discount rates and servicing advances. We classify these assets as Level 3. Additional information regarding the valuation of mortgage servicing assets is provided in Note 8 (“Mortgage Servicing Assets”).

 

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Quantitative Information about Level 3 Fair Value Measurements

The range and weighted-average of the significant unobservable inputs used to fair value our material Level 3 recurring and nonrecurring assets at March 31, 2013, December 31, 2012, and March 31, 2012, along with the valuation techniques used, are shown in the following table:

 

March 31, 2013

dollars in millions

  Fair Value of
Level 3 Assets
    Valuation Technique  

Significant

Unobservable Input

  Range
(Weighted-Average)

 

 

Recurring

       

 

Other investments

  $ 191     Individual analysis of the condition of each investment    

— principal investments — direct:

       
     Debt instruments       EBITDA multiple   5.50 - 6.00% (5.90%)
     Equity instruments of private companies       EBITDA multiple (where applicable)   5.00 - 6.00% (5.80%)
      Revenue multiple (where applicable)   0.30 - 5.30% (4.05%)

 

Nonrecurring

       

 

Impaired loans

    18     Fair value of underlying collateral   Discount   0.00 - 100.00% (38.00%)

 

Goodwill

    979     Discounted cash flow and market data   Earnings multiple of peers   9.70 -14.20 (11.25)
      Equity multiple of peers   .95 - 1.17 (1.09)
      Control premium   N/A (30.00%)
      Weighted-average cost of capital   N/A (13.00%)
       

 

December 31, 2012

dollars in millions

  Fair Value of
Level 3 Assets
    Valuation Technique  

Significant

Unobservable Input

 

Range

(Weighted-Average)

 

 

Recurring

       

 

Other investments

  $ 181     Individual analysis of the condition of each investment    

— principal investments — direct:

       
     Debt instruments       EBITDA multiple   5.50 - 6.00% (5.90%)
     Equity instruments of private companies       EBITDA multiple (where applicable)   5.00 - 8.50% (6.10%)
      Revenue multiple (where applicable)   0.30 - 5.70% (4.80%)

 

Nonrecurring

       

 

Impaired loans

    25     Fair value of underlying collateral   Discount   0.00 - 100.00% (45.00%)

 

Goodwill

    979     Discounted cash flow and market data   Earnings multiple of peers   9.70  - 14.20 (11.25)
      Equity multiple of peers   .95  - 1.17 (1.09)
      Control premium   N/A (30.00%)
      Weighted-average cost of capital   N/A (13.00%)
       

 

March 31, 2012

dollars in millions

  Fair Value of
Level 3 Assets
    Valuation Technique  

Significant

Unobservable Input

 

Range

(Weighted-Average)

 

 

Recurring

       

 

Other investments

  $ 216     Individual analysis of the condition of each investment    

— principal investments — direct:

       
     Debt instruments       EBITDA multiple   5.30 - 6.50% (5.90%)
     Equity instruments of private companies       EBITDA multiple (where applicable)   5.50 - 12.00% (6.37%)
      Revenue multiple (where applicable)   0.20 - 4.70% (2.93%)

 

Nonrecurring

       

 

Impaired loans

    101     Fair value of underlying collateral   Discount   0.00 - 100.00% (31.00%)

 

Goodwill

    917     Discounted cash flow and market data   Earnings multiple of peers   8.30  - 11.90 (10.01)
      Equity multiple of peers   1.21  - 1.32 (1.27)
      Control premium   N/A (32.00%)
      Weighted-average cost of capital   N/A (15.00%)
       

 

 

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Fair Value Disclosures of Financial Instruments

The levels in the fair value hierarchy ascribed to our financial instruments and the related carrying amounts at March 31, 2013, December 31, 2012, and March 31, 2012 are shown in the following table.

 

     March 31, 2013  
            Fair Value  
in millions    Carrying
Amount
     Level 1      Level 2      Level 3      Netting
Adjustment
    Total    

ASSETS

                

Cash and short-term investments (a)

   $ 3,702      $ 3,391      $ 311                   $ 3,702    

Trading account assets (e)

     701        5        693      $ 3              701    

Securities available for sale (e)

     13,496        43        13,453                     13,496    

Held-to-maturity securities (b)

     3,721               3,779                     3,779    

Other investments (e)

     1,059               394        665              1,059    

Loans, net of allowance (c)

     51,681                      50,926              50,926    

Loans held for sale (e)

     434                      434              434    

Mortgage servicing assets (d)

     201                      244              244    

Derivative assets (e)

     609        57        1,630        37      $  (1,115 )  (f)      609    

LIABILITIES

                

Deposits with no stated maturity (a)

   $ 56,810             $ 56,810                   $ 56,810    

Time deposits (d)

     7,844      $ 522        7,460                     7,982    

Short-term borrowings (a)

     2,328        3        2,325                     2,328    

Long-term debt (d)

     7,785        2,781        5,482                     8,263    

Derivative liabilities (e)

     524        54        1,164      $ 2      $  (696 )  (f)      524    
     December 31, 2012  
            Fair Value  
in millions   

    Carrying

Amount

     Level 1      Level 2      Level 3      Netting
Adjustment
    Total    

ASSETS

                

Cash and short-term investments (a)

   $ 4,525      $ 4,254      $ 271                   $ 4,525    

Trading account assets (e)

     605        2        600      $ 3              605    

Securities available for sale (e)

     12,094        43        12,051                     12,094    

Held-to-maturity securities (b)

     3,931               3,992                     3,992    

Other investments (e)

     1,064               396        668              1,064    

Loans, net of allowance (c)

     51,934                      51,046              51,046    

Loans held for sale (e)

     599                      599              599    

Mortgage servicing assets (d)

     204                      238              238    

Derivative assets (e)

     693        54        1,883        26      $  (1,270 )  (f)      693    

LIABILITIES

                

Deposits with no stated maturity (a)

   $ 58,132             $ 58,132                   $ 58,132    

Time deposits (d)

     7,861      $ 408        7,612                     8,020    

Short-term borrowings (a)

     1,896               1,896                     1,896    

Long-term debt (d)

     6,847        2,807        4,585                     7,392    

Derivative liabilities (e)

     584        54        1,331      $ 2      $  (803 )  (f)      584    
     March 31, 2012  
            Fair Value  
in millions    Carrying
Amount
             Level 1              Level 2              Level 3      Netting
    Adjustment
                Total    

ASSETS

                

Cash and short-term investments (a)

   $ 4,021      $ 3,729      $ 292                   $ 4,021    

Trading account assets (e)

     614        11        602      $ 1              614    

Securities available for sale (e)

     14,633        12        14,621                     14,633    

Held-to-maturity securities (b)

     3,019               3,052                     3,052    

Other investments (e)

     1,188        18        402        768              1,188    

Loans, net of allowance (c)

     48,282                      47,348              47,348    

Loans held for sale (e)

     511                      511              511    

Mortgage servicing assets (d)

     183                      226              226    

Derivative assets (e)

     830        73        2,010        42      $  (1,295 )  (f)      830    

LIABILITIES

                

Deposits with no stated maturity (a)

   $ 50,805             $ 50,805                   $ 50,805    

Time deposits (d)

     10,689      $ 857        10,096                     10,953    

Short-term borrowings (a)

     2,170        6        2,164                     2,170    

Long-term debt (d)

     8,898        3,885        5,246                     9,131    

Derivative liabilities (e)

     754        64        1,535      $ 2      $  (847 )  (f)      754    

 

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Valuation Methods and Assumptions

 

(a) Fair value equals or approximates carrying amount. The fair value of deposits with no stated maturity does not take into consideration the value ascribed to core deposit intangibles.

 

(b) Fair values of held-to-maturity securities are determined by using models that are based on security-specific details, as well as relevant industry and economic factors. The most significant of these inputs are quoted market prices, interest rate spreads on relevant benchmark securities, and certain prepayment assumptions. We review the valuations derived from the models to ensure they are reasonable and consistent with the values placed on similar securities traded in the secondary markets.

 

(c) The fair value of loans is based on the present value of the expected cash flows. The projected cash flows are based on the contractual terms of the loans, adjusted for prepayments and use of a discount rate based on the relative risk of the cash flows, taking into account the loan type, maturity of the loan, liquidity risk, servicing costs, and a required return on debt and capital. In addition, an incremental liquidity discount is applied to certain loans, using historical sales of loans during periods of similar economic conditions as a benchmark. The fair value of loans includes lease financing receivables at their aggregate carrying amount, which is equivalent to their fair value.

 

(d) Fair values of mortgage servicing assets, time deposits and long-term debt are based on discounted cash flows utilizing relevant market inputs.

 

(e) Information pertaining to our methodology for measuring the fair values of these assets and liabilities is included in the sections entitled “Qualitative Disclosures of Valuation Techniques” and “Assets Measured at Fair Value on a Nonrecurring Basis” in this note.

We use valuation methods based on exit market prices in accordance with applicable accounting guidance. We determine fair value based on assumptions pertaining to the factors a market participant would consider in valuing the asset. A substantial portion of our fair value adjustments are related to liquidity. During 2011 and 2012, the fair values of our loan portfolios improved, primarily due to increasing liquidity in the loan markets. If we were to use different assumptions, the fair values shown in the preceding table could change. If a nonexit price methodology were used for valuing our loan portfolio for continuing operations, it would result in a premium of .52%. Also, because the applicable accounting guidance for financial instruments excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, the fair value amounts shown in the table above do not, by themselves, represent the underlying value of our company as a whole.

Education lending business. The discontinued education lending business consists of assets and liabilities (recorded at fair value) in the securitization trusts, as well as loans in portfolio (recorded at fair value), and loans in portfolio (recorded at carrying value with appropriate valuation reserves) that are outside the trusts. All of these loans were excluded from the table above as follows:

 

¿  

Loans at carrying value, net of allowance, of $2.6 billion ($2.2 billion at fair value) at March 31, 2013, and $2.6 billion ($2.3 billion at fair value) at December 31, 2012, and $2.8 billion ($2.4 billion at fair value) at March 31, 2012;

 

¿  

Portfolio loans at fair value of $154 million at March 31, 2013, and $157 million at December 31, 2012, and $74 million at March 31, 2012;

 

¿  

Loans in the trusts at fair value of $2.3 billion at March 31, 2013, and $2.4 billion at December 31, 2012, and $2.7 billion at March 31, 2012.

Securities issued by the education lending securitization trusts, which are the primary liabilities of the trusts, totaling $2.1 billion in fair value at March 31, 2013, and $2.2 billion in fair value at December 31, 2012, and $2.5 billion in fair value at March 31, 2012 are also excluded from the above table.

These loans and securities are classified as Level 3 because we rely on unobservable inputs when determining fair value since observable market data is not available.

Residential real estate mortgage loans. Residential real estate mortgage loans with carrying amounts of $2.2 billion at March 31, 2013, $2.2 billion at December 31, 2012, and $2 billion at March 31, 2012 are included in “Loans, net of allowance” in the above table.

Short-term financial instruments. For financial instruments with a remaining average life to maturity of less than six months, carrying amounts were used as an approximation of fair values.

 

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6. Securities

Securities available for sale. These are securities that we intend to hold for an indefinite period of time but that may be sold in response to changes in interest rates, prepayment risk, liquidity needs or other factors. Securities available for sale are reported at fair value. Unrealized gains and losses (net of income taxes) deemed temporary are recorded in equity as a component of AOCI on the balance sheet. Unrealized losses on equity securities deemed to be “other-than-temporary,” and realized gains and losses resulting from sales of securities using the specific identification method, are included in “other income” on the income statement. Unrealized losses on debt securities deemed to be “other-than-temporary” are included in “other income” on the income statement or AOCI in accordance with the applicable accounting guidance related to the recognition of OTTI of debt securities.

“Other securities” held in the available-for-sale portfolio are primarily marketable equity securities that are traded on a public exchange such as the NYSE or NASDAQ.

Held-to-maturity securities. These are debt securities that we have the intent and ability to hold until maturity. Debt securities are carried at cost and adjusted for amortization of premiums and accretion of discounts using the interest method. This method produces a constant rate of return on the adjusted carrying amount.

“Other securities” held in the held-to-maturity portfolio consist of foreign bonds and capital securities.

Unrealized losses on equity securities deemed to be “other-than-temporary,” and realized gains and losses resulting from sales of securities using the specific identification method, are included in “other income” on the income statement. Unrealized losses on debt securities deemed to be “other-than-temporary” are included in “other income” on the income statement or AOCI in accordance with the applicable accounting guidance related to the recognition of OTTI of debt securities.

The amortized cost, unrealized gains and losses, and approximate fair value of our securities available for sale and held-to-maturity securities are presented in the following tables. Gross unrealized gains and losses represent the difference between the amortized cost and the fair value of securities on the balance sheet as of the dates indicated. Accordingly, the amount of these gains and losses may change in the future as market conditions change.

 

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Table of Contents
        March 31, 2013  
in millions           Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

 

 

SECURITIES AVAILABLE FOR SALE

            

States and political subdivisions

  $     47       $        —       $ 48   

Collateralized mortgage obligations

      12,633         290       $             5         12,918   

Other mortgage-backed securities

      445         42         —         487   

Other securities

      41                —         43   

 

 

Total securities available for sale

  $     13,166       $ 335       $      $ 13,496   
 

 

    

 

 

    

 

 

    

 

 

 

 

 

HELD-TO-MATURITY SECURITIES

            

Collateralized mortgage obligations

  $     3,703       $ 58         —       $ 3,761   

Other securities

      18         —         —         18   

 

 

Total held-to-maturity securities

  $     3,721       $ 58         —       $ 3,779   
 

 

    

 

 

    

 

 

    

 

 

 

 

 
        December 31, 2012  
in millions       Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

 

 

SECURITIES AVAILABLE FOR SALE

            

States and political subdivisions

   $     47        $        —        $ 49   

Collateralized mortgage obligations

      11,148         316         —         11,464   

Other mortgage-backed securities

      491         47         —         538   

Other securities

      42                —         43   

 

 

Total securities available for sale

   $     11,728        $ 366         —        $ 12,094   
 

 

    

 

 

    

 

 

    

 

 

 

 

 

HELD-TO-MATURITY SECURITIES

            

Collateralized mortgage obligations

   $     3,913        $ 61         —        $ 3,974   

Other securities

      18         —         —         18   

 

 

Total held-to-maturity securities

   $     3,931        $ 61         —        $ 3,992   
 

 

    

 

 

    

 

 

    

 

 

 

 

 
        March 31, 2012  
in millions       Amortized
Cost
    

Gross

      Unrealized
Gains

     Gross
        Unrealized
Losses
    

Fair

            Value

 

 

 

SECURITIES AVAILABLE FOR SALE

            

States and political subdivisions

   $     59        $        —        $ 62   

Collateralized mortgage obligations

      13,405         440         —                 13,845   

Other mortgage-backed securities

      653         61         —         714   

Other securities

      11                —         12   

 

 

Total securities available for sale

   $     14,128        $             505         —        $ 14,633   
 

 

    

 

 

    

 

 

    

 

 

 

 

 

HELD-TO-MATURITY SECURITIES

            

Collateralized mortgage obligations

   $     3,001        $ 33         —        $ 3,034   

Other securities

      18         —         —         18   

 

 

Total held-to-maturity securities

   $     3,019        $ 33         —        $ 3,052   
 

 

    

 

 

    

 

 

    

 

 

 

 

 

 

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The following table summarizes our securities that were in an unrealized loss position as of March 31, 2013, December 31, 2012, and March 31, 2012.

 

        Duration of Unrealized Loss Position                 
        Less than 12 Months    12 Months or Longer    Total      
              Gross                    Gross                    Gross          
                  Unrealized                    Unrealized                      Unrealized          
  in millions      

    Fair Value    

 

   

Losses    

 

   

(a)  

 

  

    Fair Value    

 

   

Losses    

 

   

(a)  

 

  

Fair Value    

 

   

Losses     

 

   

(a)

 

 

   

  March 31, 2013

                     

  Securities available for sale:

                     

Collateralized mortgage obligations

    $     1,443         $     5              —           —              $ 1,443         $ 5        

Other mortgage-backed securities

      1           —              —           —              1           —        

Other securities

      20           —              $ 3           —              23           —        

 

   

  Total temporarily impaired securities

    $         1,464         $ 5              $ 3           —              $     1,467         $     5        
 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

   
                     

 

   

  December 31, 2012

                     

  Securities available for sale:

                     

Other securities

    $     31               —              $ 3           —              $ 34           —        

 

   

  Total temporarily impaired securities

    $     31           —              $ 3           —              $ 34           —        
 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

   
                     

 

   

  March 31, 2012

                     

  Securities available for sale:

                     

State and political divisions

    $       1           —              —           —              $ 1           —        

Collateralized mortgage obligations

      2           —              —           —              2           —        

  Held-to-maturity:

                     

 

   

  Total temporarily impaired securities

    $       3           —              —           —              $ 3           —        
 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

   
                     

 

   

 

(a) There were less than $1 million of gross unrealized losses for the periods ended December 31, 2012 and March 31, 2012.

At March 31, 2013, we had $5 million of gross unrealized losses related to 15 fixed-rate collateralized mortgage obligations that were invested in as part of our overall A/LM strategy. Since these securities have a fixed interest rate, their fair value is sensitive to movements in market interest rates. These unrealized losses are considered temporary since we expect to collect all contractually due amounts from these securities. Accordingly, these investments have been reduced to their fair value through OCI, not earnings. These securities have a weighted-average maturity of 4.1 years at March 31, 2013.

We regularly assess our securities portfolio for OTTI. The assessments are based on the nature of the securities, the underlying collateral, the financial condition of the issuer, the extent and duration of the loss, our intent related to the individual securities, and the likelihood that we will have to sell securities prior to expected recovery.

The debt securities identified to have OTTI are written down to their current fair value. For those debt securities that we intend to sell, or more-likely-than-not will be required to sell, prior to the expected recovery of the amortized cost, the entire impairment (i.e., the difference between amortized cost and the fair value) is recognized in earnings. For those debt securities that we do not intend to sell, or more-likely-than-not will not be required to sell, prior to expected recovery, the credit portion of OTTI is recognized in earnings, while the remaining OTTI is recognized in equity as a component of AOCI on the balance sheet. As shown in the following table, we did not have any impairment losses recognized in earnings for the three months ended March 31, 2013.

 

Three months ended March 31, 2013  
in millions       

 

 

Balance at December 31, 2012

       $  

Impairment recognized in earnings

     —   

 

 

Balance at March 31, 2013

       $             4   
  

 

 

 

 

 

 

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Realized gains and losses related to securities available for sale were as follows:

 

Three months ended March 31, 2013       
in millions       

 

 

Realized gains

     —    

Realized losses

     —    

 

 

Net securities gains (losses)

                   —    
  

 

 

 

 

 

At March 31, 2013, securities available for sale and held-to-maturity securities totaling $12.3 billion were pledged to secure securities sold under repurchase agreements, to secure public and trust deposits, to facilitate access to secured funding, and for other purposes required or permitted by law.

The following table shows securities by remaining maturity. CMOs and other mortgage-backed securities (both of which are included in the securities available-for-sale portfolio) as well the CMOs in the held-to-maturity portfolio are presented based on their expected average lives. The remaining securities, in both the available-for-sale and held-to-maturity portfolios, are presented based on their remaining contractual maturity. Actual maturities may differ from expected or contractual maturities since borrowers have the right to prepay obligations with or without prepayment penalties.

 

     Securities Available for Sale      Held-to-Maturity Securities  
March 31, 2013    Amortized      Fair      Amortized      Fair  
in millions    Cost      Value      Cost      Value  

 

 

Due in one year or less

    $ 830         $ 844         $ 10         $ 10    

Due after one through five years

     12,112          12,428          3,711          3,769    

Due after five through ten years

     221          221          —          —    

Due after ten years

     3          3          —          —    

 

 

Total

    $           13,166         $           13,496         $           3,721         $           3,779    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

 

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7. Derivatives and Hedging Activities

We are a party to various derivative instruments, mainly through our subsidiary, KeyBank. Derivative instruments are contracts between two or more parties that have a notional amount and an underlying variable, require a small or no net investment, and allow for the net settlement of positions. A derivative’s notional amount serves as the basis for the payment provision of the contract, and takes the form of units, such as shares or dollars. A derivative’s underlying variable is a specified interest rate, security price, commodity price, foreign exchange rate, index, or other variable. The interaction between the notional amount and the underlying variable determines the number of units to be exchanged between the parties and influences the fair value of the derivative contract.

The primary derivatives that we use are interest rate swaps, caps, floors, and futures; foreign exchange contracts; energy derivatives; credit derivatives; and equity derivatives. Generally, these instruments help us manage exposure to interest rate risk, mitigate the credit risk inherent in the loan portfolio, hedge against changes in foreign currency exchange rates, and meet client financing and hedging needs. As further discussed in this note:

 

¿  

interest rate risk represents the possibility that the EVE or net interest income will be adversely affected by fluctuations in interest rates;

 

¿  

credit risk is the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms; and

 

¿  

foreign exchange risk is the risk that an exchange rate will adversely affect the fair value of a financial instrument.

Derivative assets and liabilities are recorded at fair value on the balance sheet, after taking into account the effects of bilateral collateral and master netting agreements. These agreements allow us to settle all derivative contracts held with a single counterparty on a net basis, and to offset net derivative positions with related collateral, where applicable. As a result, we could have derivative contracts with negative fair values included in derivative assets on the balance sheet and contracts with positive fair values included in derivative liabilities.

At March 31, 2013, after taking into account the effects of bilateral collateral and master netting agreements, we had $137 million of derivative assets and a positive $80 million of derivative liabilities that relate to contracts entered into for hedging purposes. Our hedging derivative liabilities are in an asset position largely due to contracts with positive fair values as a result of master netting agreements. As of the same date, after taking into account the effects of bilateral collateral and master netting agreements and a reserve for potential future losses, we had derivative assets of $472 million and derivative liabilities of $604 million that were not designated as hedging instruments.

The Dodd-Frank Act, which is currently being implemented, may limit the types of derivative activities that KeyBank and other insured depository institutions may conduct. As a result, we may not continue to use all of the types of derivatives noted above in the future.

Additional information regarding our accounting policies for derivatives is provided in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Derivatives” on page 124 of our 2012 Form 10-K.

Derivatives Designated in Hedge Relationships

Net interest income and the EVE change in response to changes in the mix of assets, liabilities, and off-balance sheet instruments; associated interest rates tied to each instrument; differences in the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities; and changes in interest rates. We utilize derivatives that have been designated as part of a hedge relationship in accordance with the applicable accounting guidance to minimize the exposure and volatility of net interest income and EVE to interest rate fluctuations. The primary derivative instruments used to manage interest rate risk are interest rate swaps, which convert the contractual interest rate index of agreed-upon amounts of assets and liabilities (i.e., notional amounts) to another interest rate index.

We designate certain “receive fixed/pay variable” interest rate swaps as fair value hedges. These contracts convert certain fixed-rate long-term debt into variable-rate obligations, thereby modifying our exposure to changes in interest rates. As a result, we receive fixed-rate interest payments in exchange for making variable-rate payments over the lives of the contracts without exchanging the notional amounts.

Similarly, we designate certain “receive fixed/pay variable” interest rate swaps as cash flow hedges. These contracts effectively convert certain floating-rate loans into fixed-rate loans to reduce the potential adverse effect of interest rate decreases on future interest income. Again, we receive fixed-rate interest payments in exchange for making variable-rate

 

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payments over the lives of the contracts without exchanging the notional amounts. We also designate certain “pay fixed/receive variable” interest rate swaps as cash flow hedges. These swaps convert certain floating-rate debt into fixed-rate debt. We also use these swaps to manage the interest rate risk associated with anticipated sales of certain commercial real estate loans. The swaps protect against the possible short-term decline in the value of the loans that could result from changes in interest rates between the time they are originated and the time they are sold.

We also use interest rate swaps to hedge the floating-rate debt that funds fixed-rate leases entered into by our Equipment Finance line of business. These swaps are designated as cash flow hedges to mitigate the interest rate mismatch between the fixed-rate lease cash flows and the floating-rate payments on the debt.

We use foreign currency swap transactions to hedge the foreign currency exposure of our net investment in various foreign Equipment Finance entities. These entities are denominated in a non-U.S. currency. These swaps are designated as net investment hedges to mitigate the exposure of measuring the net investment at the spot foreign exchange rate.

During the first quarter of 2012 and prior years, Key had outstanding issuances of medium-term notes that were denominated in foreign currencies. The notes were subject to translation risk, which represented the possibility that the fair value of the foreign-denominated debt would change based on movement of the underlying foreign currency spot rate. The derivatives used for managing foreign currency exchange risk were cross currency swaps. The hedge converted the notes to a variable-rate U.S. currency-denominated debt, which was designated as a fair value hedge of foreign currency exchange risk.

Derivatives Not Designated in Hedge Relationships

On occasion, we enter into interest rate swap contracts to manage economic risks but do not designate the instruments in hedge relationships. Excluding contracts addressing customer exposures, the amount of derivatives hedging risks on an economic basis at March 31, 2013, was not significant.

Like other financial services institutions, we originate loans and extend credit, both of which expose us to credit risk. We actively manage our overall loan portfolio and the associated credit risk in a manner consistent with asset quality objectives and concentration risk tolerances to mitigate portfolio credit risk. Purchasing credit default swaps enables us to transfer to a third party a portion of the credit risk associated with a particular extension of credit. We may also sell credit derivatives to offset our purchased credit default swap position prior to maturity. Although we use credit default swaps for risk management purposes, they are not treated as hedging instruments.

We also enter into derivative contracts for other purposes, including:

 

¿  

interest rate swap, cap, and floor contracts entered into generally to accommodate the needs of commercial loan clients;

 

¿  

energy and base metal swap and options contracts entered into to accommodate the needs of clients;

 

¿  

futures contracts and positions with third parties that are intended to offset or mitigate the interest rate or market risk related to client positions discussed above; and

 

¿  

foreign exchange forward contracts and options entered into primarily to accommodate the needs of clients.

These contracts are not designated as part of hedge relationships.

 

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Fair Values, Volume of Activity and Gain/Loss Information Related to Derivative Instruments

The following table summarizes the fair values of our derivative instruments on a gross basis as of March 31, 2013, December 31, 2012, and March 31, 2012. The change in the notional amounts of these derivatives by type from December 31, 2012, to March 31, 2013, indicates the volume of our derivative transaction activity during the first quarter of 2013. The notional amounts are not affected by bilateral collateral and master netting agreements. Our derivative instruments are included in “derivative assets” or “derivative liabilities” on the balance sheet, as indicated in the following table:

 

     March 31, 2013      December 31, 2012      March 31, 2012  
            Fair Value             Fair Value             Fair Value  
in millions        Notional
Amount
     Derivative
Assets
     Derivative
Liabilities
     Notional
Amount
     Derivative
Assets
     Derivative
Liabilities
     Notional
Amount
     Derivative
Assets
     Derivative 
Liabilities 
 

 

 
Derivatives designated as hedging instruments:                           

Interest rate

    $ 20,067        $ 499        $ 27         $ 19,085        $ 579         $ 30        $ 15,368        $ 532         $ 20    

Foreign exchange

     202                3          196         —                 —         —          —    

 

 

Total

     20,269         500         30          19,281         579          37         15,368         532          20    
Derivatives not designated as hedging instruments:                           

Interest rate

     47,334         1,027         1,000          51,633         1,144          1,122         61,369         1,190          1,193    

Foreign exchange

     4,925         70         65          5,025         75          68         6,316         94          84    

Energy and commodity

     1,801         120         114          1,688         156          150         1,632         271          267    

Credit

     1,056                11          955         9          10         3,382         35          34    

Equity

     —         —         —                 —          —         18         3          3    

 

 

Total

     55,116         1,224          1,190          59,308         1,384          1,350          72,717         1,593          1,581    

Netting adjustments (a)

     —         (1,115)          (696)          —         (1,270)          (803)          —         (1,295)          (847)    

 

 

Net derivatives in the balance sheet

     75,385         609          524          78,589         693          584          88,085         830          754    

Other collateral(b)

     —         (123)          (436)          —         (163)          (475)          —         (174)          (620)    

 

 

Net derivative amounts

    $     75,385        $         486         $           88         $     78,589        $           530         $             109         $     88,085        $         656         $             134    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
                          

 

 

 

(a)

Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance. The net basis takes into account the impact of bilateral collateral and master netting agreements that allow us to settle all derivative contracts with a single counterparty on a net basis and to offset the net derivative position with the related cash collateral.

 

(b) Other collateral represents the amount that cannot be used to offset our derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance. The other collateral consists of securities and is exchanged under bilateral collateral and master netting agreements that allow us to offset the net derivative position with the related collateral. The application of the other collateral cannot reduce the net derivative position below zero. Therefore, any excess other collateral is not reflected above.

Fair value hedges. Instruments designated as fair value hedges are recorded at fair value and included in “derivative assets” or “derivative liabilities” on the balance sheet. The effective portion of a change in the fair value of an instrument designated as a fair value hedge is recorded in earnings at the same time as a change in fair value of the hedged item, resulting in no effect on net income. The ineffective portion of a change in the fair value of such a hedging instrument is recorded in “other income” on the income statement with no corresponding offset. During the three-month period ended March 31, 2013, we did not exclude any portion of these hedging instruments from the assessment of hedge effectiveness. While there is some immaterial ineffectiveness in our hedging relationships, all of our fair value hedges remained “highly effective” as of March 31, 2013.

The following table summarizes the pre-tax net gains (losses) on our fair value hedges for the three-month periods ended March 31, 2013, and 2012, and where they are recorded on the income statement.

 

    

Three months ended March 31, 2013

     
in millions    Income Statement Location
of Net Gains (Losses)
on Derivative
   Net Gains
        (Losses) on
Derivative
       Hedged Item    Income Statement Location
of Net Gains (Losses)
on Hedged Item
   Net Gains
(Losses) on
      Hedged Item
     

 

   

Interest rate

   Other income      $ (38)         Long-term debt    Other income      $ 38      (a)

Interest rate

  

Interest expense –

Long-term debt

     33                

 

   

Total

        $ (5)                 $ 38     
     

 

 

            

 

 

   
                  

 

   

 

    

Three months ended March 31, 2012

     
in millions    Income Statement Location
of Net Gains (Losses)
on Derivative
   Net Gains
(Losses) on
        Derivative
       Hedged Item    Income Statement Location
of Net Gains (Losses)
on Hedged Item
   Net Gains
(Losses) on
      Hedged Item
     

 

   

Interest rate

   Other income      $ (55)         Long-term debt    Other income      $ 52       (a)

Interest rate

  

Interest expense –

Long-term debt

     45                

Foreign exchange

   Other income             Long-term debt    Other income      (5)       (a)

Foreign exchange

  

Interest expense –

Long-term debt

            Long-term debt   

Interest expense –

Long-term debt

     (1)       (b)

 

   

Total

        $ (4)                 $ 46     
     

 

 

            

 

 

   
                  

 

   

 

(a) Net gains (losses) on hedged items represent the change in fair value caused by fluctuations in interest rates.

 

(b) Net gains (losses) on hedged items represent the change in fair value caused by fluctuations in foreign currency exchange rates.

Cash flow hedges. Instruments designated as cash flow hedges are recorded at fair value and included in “derivative assets” or “derivative liabilities” on the balance sheet. Initially, the effective portion of a gain or loss on a cash flow hedge is recorded as a component of AOCI on the balance sheet and is subsequently reclassified into income when the hedged transaction affects earnings (e.g., when we pay variable-rate interest on debt, receive variable-rate interest on commercial loans, or sell commercial real estate loans). The ineffective portion of cash flow hedging transactions is included in “other income” on the income statement. During the three-month period ended March 31, 2013, we did not exclude any portion of these hedging instruments from the assessment of hedge effectiveness. While there is some immaterial ineffectiveness in our hedging relationships, all of our cash flow hedges remained “highly effective” as of March 31, 2013.

 

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Considering the interest rates, yield curves, and notional amounts as of March 31, 2013, we would expect to reclassify an estimated $35 million of net losses on derivative instruments from AOCI to income during the next twelve months for our cash flow hedges. In addition, we expect to reclassify approximately $5 million of net gains related to terminated cash flow hedges from AOCI to income during the next twelve months. The maximum length of time over which we hedge forecasted transactions is 15 years.

Net investment hedges. In May 2012, we entered into foreign currency forward contracts to hedge our exposure to changes in the carrying value of our investments as a result of changes in the related foreign exchange rates. Instruments designated as net investment hedges are recorded at fair value and included in “derivative assets” or “derivative liabilities” on the balance sheet. Initially, the effective portion of a gain or loss on a net investment hedge is recorded as a component of AOCI on the balance sheet when the terms of the derivative match the notional and currency risk being hedged. The effective portion is subsequently reclassified into income when the hedged transaction affects earnings (e.g., when we dispose of a foreign subsidiary). At March 31, 2013, AOCI reflected unrecognized after-tax losses totaling $2 million related to cumulative changes in the fair value of our net investment hedge, which offset the unrecognized after-tax gains on net investment balances. The ineffective portion of net investment hedging transactions is included in “other income” on the income statement. However, there was no net investment hedge ineffectiveness as of March 31, 2013. We did not exclude any portion of our hedging instruments from the assessment of hedge effectiveness while these hedges were outstanding during the three-month period ended March 31, 2013.

The following table summarizes the pre-tax net gains (losses) on our cash flow and net investment hedges for the three month periods ended March 31, 2013 and 2012, and where they are recorded on the income statement. The table includes the effective portion of net gains (losses) recognized in OCI during the period, the effective portion of net gains (losses) reclassified from OCI into income during the current period, and the portion of net gains (losses) recognized directly in income, representing the amount of hedge ineffectiveness.

 

     Three months ended March 31, 2013  
in millions   

Net Gains (Losses)
Recognized in OCI

(Effective Portion)

    

Income Statement Location

of Net Gains (Losses)
Reclassified From OCI Into
Income (Effective Portion)

  

Net Gains

(Losses) Reclassified
From OCI Into Income
(Effective Portion)

     Income Statement Location
of Net Gains (Losses)
Recognized in Income
(Ineffective Portion)
  

Net Gains 
(Losses) Recognized 

in Income 
        (Ineffective Portion) 

 

 

 

Cash Flow Hedges

              

Interest rate

     $ (4)       Interest income – Loans     $ 22       Other income      —    

Interest rate

         

Interest expense –

Long-term debt

     (3)       Other income      —    

Interest rate

     (1)       Investment banking and debt placement fees      —       Other income      —    

 

 

Net Investment Hedges

              

Foreign exchange contracts

           Other Income      (3)       Other income      —    

 

 

Total

     $          $ 16            —    
  

 

 

       

 

 

       

 

 

 

 

 

 

     Three months ended March 31, 2012  
in millions   

Net Gains (Losses)
Recognized in OCI

(Effective Portion)

    

Income Statement Location

of Net Gains (Losses)
Reclassified From OCI Into
Income (Effective Portion)

  

Net Gains

(Losses) Reclassified
From OCI Into Income
(Effective Portion)

     Income Statement Location
of Net Gains (Losses)
Recognized in Income
(Ineffective Portion)
  

Net Gains 
(Losses) Recognized 

in Income 
        (Ineffective Portion) 

 

 

 

Interest rate

     $ 23        Interest income – Loans     $ 13       Other income      —    

Interest rate

     6       

Interest expense –

Long-term debt

     (2)       Other income      —    

Interest rate

     —        Investment banking and debt placement fees      —       Other income      —    

 

 

Total

     $ 29            $ 11            —    
  

 

 

       

 

 

       

 

 

 

 

 

The after-tax change in AOCI resulting from cash flow and net investment hedges is as follows:

 

in millions   

December 31,

2012

    

2013

Hedging Activity

    

Reclassification

of Gains to

Net Income

    

March 31,  

2013  

 

 

 

AOCI resulting from cash flow and net investment hedges

   $                         18      $                                      2      $                                  (10)       $                         10    

 

 

Nonhedging instruments. Our derivatives that are not designated as hedging instruments are recorded at fair value in “derivative assets” and “derivative liabilities” on the balance sheet. Adjustments to the fair values of these instruments, as well as any premium paid or received, are included in “corporate services income” and “other income” on the income statement.

 

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The following table summarizes the pre-tax net gains (losses) on our derivatives that are not designated as hedging instruments for the three month periods ended March 31, 2013, and 2012, and where they are recorded on the income statement.

 

     Three months ended March 31, 2013      Three months ended March 31, 2012  
in millions   

        Corporate 

Services 

Income 

     Other 
        Income 
                 Total      

    Corporate 

Services 
Income 

    

Other 

        Income 

                 Total  

 

 

NET GAINS (LOSSES)

                 

Interest rate

    $ 4          —         $ 4         $ 6          —         $ 6    

Foreign exchange

     12          —          12          9          —          9    

Energy and commodity

     1          —          1          5          —          5    

Credit

     —         $ (3)          (3)          —         $ (4)          (4)    

 

 

Total net gains (losses)

    $ 17         $ (3)         $ 14         $ 20         $ (4)         $ 16    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

Counterparty Credit Risk

Like other financial instruments, derivatives contain an element of credit risk. This risk is measured as the expected positive replacement value of the contracts. We use several means to mitigate and manage exposure to credit risk on derivative contracts. We generally enter into bilateral collateral and master netting agreements that provide for the net settlement of all contracts with a single counterparty in the event of default. Additionally, we monitor counterparty credit risk exposure on each contract to determine appropriate limits on our total credit exposure across all product types. We review our collateral positions on a daily basis and exchange collateral with our counterparties in accordance with ISDA and other related agreements. We generally hold collateral in the form of cash and highly rated securities issued by the U.S. Treasury, government-sponsored enterprises or GNMA. The cash collateral netted against derivative assets on the balance sheet totaled $440 million at March 31, 2013, $494 million at December 31, 2012, and $450 million at March 31, 2012. The cash collateral netted against derivative liabilities totaled $21 million at March 31, 2013, $27 million at December 31, 2012, and $2 million at March 31, 2012.

The following table summarizes our largest exposure to an individual counterparty at the dates indicated.

 

in millions   

March 31,

2013 

    

December 31,

2012 

    

March 31,

2012 

 

 

 

Largest gross exposure (derivative asset) to an individual counterparty

       $                            166           $                           182           $                           179   

Collateral posted by this counterparty

     58         66         57   

Derivative liability with this counterparty

     169         191         233   

Collateral pledged to this counterparty

     67         82         119   

Net exposure after netting adjustments and collateral

                    

 

 

The following table summarizes the fair value of our derivative assets by type. These assets represent our gross exposure to potential loss after taking into account the effects of bilateral collateral and master netting agreements and other means used to mitigate risk.

 

in millions   

March 31, 

2013  

    

December 31, 

2012  

    

March 31, 

2012  

 

 

 

Interest rate

       $                            984            $                            1,114        $                            1,117    

Foreign exchange

     18          23          34    

Energy and commodity

     45          47          121    

Credit

     2          3          6    

Equity

     —          —          2    

 

 

Derivative assets before collateral

     1,049          1,187          1,280    

Less: Related collateral

     440          494          450    

 

 

Total derivative assets

       $ 609            $ 693        $ 830    
  

 

 

    

 

 

    

 

 

 

 

 

We enter into derivative transactions with two primary groups: broker-dealers and banks, and clients. Since these groups have different economic characteristics, we have different methods for managing counterparty credit exposure and credit risk.

 

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We enter into transactions with broker-dealers and banks for various risk management purposes. These types of transactions generally are high dollar volume. We generally enter into bilateral collateral and master netting agreements with these counterparties. At March 31, 2013, for derivatives that have associated bilateral collateral and master netting agreements, we had gross exposure of $741 million to broker-dealers and banks. We had net exposure of $129 million after the application of master netting agreements and cash collateral; our net exposure to broker-dealers and banks at March 31, 2013, was an excess collateral position of $12 million after considering $141 million of additional collateral held in the form of securities.

We enter into transactions with clients to accommodate their business needs. These types of transactions generally are low dollar volume. We generally enter into master netting agreements with these counterparties. In addition, we mitigate our overall portfolio exposure and market risk by buying and selling U.S. Treasuries and Eurodollar futures, and entering into offsetting positions and other derivative contracts. Due to the smaller size and magnitude of the individual contracts with clients, collateral generally is not exchanged in connection with these derivative transactions. To address the risk of default associated with the uncollateralized contracts, we have established a default reserve (included in “derivative assets”) in the amount of $17 million at March 31, 2013, which we estimate to be the potential future losses on amounts due from client counterparties in the event of default. At December 31, 2012, the default reserve was $19 million. At March 31, 2013, for derivatives that have associated master netting agreements, we had gross exposure of $533 million to client counterparties. We had net exposure of $480 million on our derivatives with clients after the application of master netting agreements, collateral and the related reserve.

Credit Derivatives

We are both a buyer and seller of credit protection through the credit derivative market. We purchase credit derivatives to manage the credit risk associated with specific commercial lending and swap obligations. We may also sell credit derivatives, mainly single name credit default swaps, to offset our purchased credit default swap position prior to maturity. We previously sold index credit default swaps to diversify the concentration risk within our loan portfolio.

The following table summarizes the fair value of our credit derivatives purchased and sold by type as of March 31, 2013, December 31, 2012 and March 31, 2012. The fair value of credit derivatives presented below does not take into account the effects of bilateral collateral or master netting agreements.

 

     March 31, 2013      December 31, 2012      March 31, 2012  
in millions          Purchased               Sold       Net             Purchased      Sold       Net           Purchased             Sold              Net   

 

 

Single name credit default swaps

     $ (3)          $ 1          $ (2)          $ (1)          $ 1            —        $ (12)         $        $ (5)    

Traded credit default swap indices

     (1)            —          (1)            —            —            —          —                 6    

Other

     —            (1)          (1)            —          (1)          $ (1)          1          (1)         —    

 

 

Total credit derivatives

     $         (4)          $ —          $         (4)          $         (1)          $         —          $         (1)        $ (11)         $ 12         $ 1    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

Single name credit default swaps are bilateral contracts whereby the seller agrees, for a premium, to provide protection against the credit risk of a specific entity (the “reference entity”) in connection with a specific debt obligation. The protected credit risk is related to adverse credit events, such as bankruptcy, failure to make payments, and acceleration or restructuring of obligations, identified in the credit derivative contract. As the seller of a single name credit derivative, we would be required to pay the purchaser the difference between the par value and the market price of the debt obligation (cash settlement) or receive the specified referenced asset in exchange for payment of the par value (physical settlement) if the underlying reference entity experiences a predefined credit event. For a single name credit derivative, the notional amount represents the maximum amount that a seller could be required to pay. If we effect a physical settlement and receive our portion of the related debt obligation, we will join other creditors in the liquidation process, which may enable us to recover a portion of the amount paid under the credit default swap contract. We also may purchase offsetting credit derivatives for the same reference entity from third parties that will permit us to recover the amount we pay should a credit event occur.

A traded credit default swap index represents a position on a basket or portfolio of reference entities. As a seller of protection on a credit default swap index, we would be required to pay the purchaser if one or more of the entities in the index had a credit event. For a credit default swap index, the notional amount represents the maximum amount that a seller could be required to pay. Upon a credit event, the amount payable is based on the percentage of the notional amount allocated to the specific defaulting entity. During 2012, we suspended trading in traded credit default swap indices for purposes of diversifying concentration risk within our loan portfolio.

The majority of transactions represented by the “other” category shown in the above table are risk participation agreements. In these transactions, the lead participant has a swap agreement with a customer. The lead participant (purchaser of protection) then enters into a risk participation agreement with a counterparty (seller of protection), under which the counterparty receives a fee to accept a portion of the lead participant’s credit risk. If the customer defaults on the swap contract, the counterparty to the risk participation agreement must reimburse the lead participant for the counterparty’s

 

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percentage of the positive fair value of the customer swap as of the default date. If the customer swap has a negative fair value, the counterparty has no reimbursement requirements. If the customer defaults on the swap contract and the seller fulfills its payment obligations under the risk participation agreement, the seller is entitled to a pro rata share of the lead participant’s claims against the customer under the terms of the swap agreement.

The following table provides information on the types of credit derivatives sold by us and held on the balance sheet at March 31, 2013, December 31, 2012, and March 31, 2012. The notional amount represents the maximum amount that the seller could be required to pay. The payment/performance risk assessment is based on the default probabilities for the underlying reference entities’ debt obligations using a Moody’s credit ratings matrix known as Moody’s “Idealized” Cumulative Default Rates. The payment/performance risk shown in the table represents a weighted-average of the default probabilities for all reference entities in the respective portfolios. These default probabilities are directly correlated to the probability that we will have to make a payment under the credit derivative contracts.

 

     March 31, 2013     December 31, 2012     March 31, 2012  
dollars in millions    Notional
Amount
     Average
Term
(Years)
     Payment /
Performance
Risk
    Notional
Amount
     Average
Term
(Years)
     Payment /
Performance
Risk
    Notional
Amount
     Average
Term
(Years)
     Payment /
Performance
Risk
 

 

 

Single name credit default swaps

     $ 82         1.23         7.89  %      $ 146         0.92         11.62  %      $ 973         2.26         4.53  % 

Traded credit default swap indices

     —         —         —        —         —         —        497         2.78         2.09   

Other

     19         5.38         10.09        23         5.35         10.77        16         5.77         10.29   

 

 

Total credit derivatives sold

     $           101         —         —        $           169         —         —        $           1,486         —         —   
  

 

 

         

 

 

         

 

 

       

 

 

Credit Risk Contingent Features

We have entered into certain derivative contracts that require us to post collateral to the counterparties when these contracts are in a net liability position. The amount of collateral to be posted is based on the amount of the net liability and thresholds generally related to our long-term senior unsecured credit ratings with Moody’s and S&P. Collateral requirements also are based on minimum transfer amounts, which are specific to each Credit Support Annex (a component of the ISDA Master Agreement) that we have signed with the counterparties. In a limited number of instances, counterparties also have the right to terminate their ISDA Master Agreements with us if our ratings fall below a certain level, usually investment-grade level (i.e., “Baa3” for Moody’s and “BBB-” for S&P). At March 31, 2013, KeyBank’s ratings with Moody’s and S&P were “A3” and “A-,” respectively, and KeyCorp’s ratings with Moody’s and S&P were “Baa1” and “BBB+,” respectively. If there were a downgrade of our ratings, we could be required to post additional collateral under those ISDA Master Agreements where we are in a net liability position. As of March 31, 2013, the aggregate fair value of all derivative contracts with credit risk contingent features (i.e., those containing collateral posting or termination provisions based on our ratings) held by KeyBank that were in a net liability position totaled $457 million, which includes $435 million in derivative assets and $892 million in derivative liabilities. We had $441 million in cash and securities collateral posted to cover those positions as of March 31, 2013. The aggregate fair value of all derivative contracts with credit risk contingent features (i.e., those containing collateral posting or termination provisions based on our ratings) as of March 31, 2013, held by KeyCorp that were in a net liability position totaled $21 million, which consists solely of $21 million in derivative liabilities. We had $19 million in cash and securities collateral posted to cover those positions as of March 31, 2013.

The following table summarizes the additional cash and securities collateral that KeyBank would have been required to deliver had the credit risk contingent features been triggered for the derivative contracts in a net liability position as of March 31, 2013, December 31, 2012, and March 31, 2012. The additional collateral amounts were calculated based on scenarios under which KeyBank’s ratings are downgraded one, two or three ratings as of March 31, 2013, and take into account all collateral already posted. A similar calculation was performed for KeyCorp and additional collateral of $3 million would have been required as of March 31, 2013, and December 31, 2012. Additional collateral would not have been required as of March 31, 2012.

 

               March 31, 2013                         December 31, 2012                         March 31, 2012             
in millions    Moody’s      S&P      Moody’s      S&P      Moody’s      S&P  

 

 

KeyBank’s long-term senior unsecured credit ratings

     A3          A-          A3          A-          A3          A-    

 

 

One rating downgrade

   $             6       $             6       $             6       $             6       $             6       $             6   

Two rating downgrades

     11         11         11         11         11         11   

Three rating downgrades

     11         11         11         11         11         11   

 

 

KeyBank’s long-term senior unsecured credit rating currently is four ratings above noninvestment grade at Moody’s and S&P. If KeyBank’s ratings had been downgraded below investment grade as of March 31, 2013, payments of up to $13 million would have been required to either terminate the contracts or post additional collateral for those contracts in a net liability position, taking into account all collateral already posted. If KeyCorp’s ratings had been downgraded below

 

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investment grade as of March 31, 2013, payments of up to $3 million would have been required to either terminate the contracts or post additional collateral for those contracts in a net liability position, taking into account all collateral already posted.

 

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8. Mortgage Servicing Assets

We originate and periodically sell commercial mortgage loans but continue to service those loans for the buyers. We also may purchase the right to service commercial mortgage loans for other lenders. A servicing asset is recorded if we purchase or retain the right to service loans in exchange for servicing fees that exceed the going market rate. Changes in the carrying amount of mortgage servicing assets are summarized as follows:

 

     Three months ended March 31,    
  

 

 

 
in millions    2013       2012    

 

 

Balance at beginning of period

       $ 204           $ 173    

Servicing retained from loan sales

     9         8    

Purchases

     1         16    

Amortization

     (13)         (14)    

 

 

Balance at end of period

       $ 201           $ 183    
  

 

 

   

 

 

 

 

 

Fair value at end of period

       $                     244           $                     226    
  

 

 

   

 

 

 

 

 

The fair value of mortgage servicing assets is determined by calculating the present value of future cash flows associated with servicing the loans. This calculation uses a number of assumptions that are based on current market conditions. The range and weighted-average of the significant unobservable inputs used to fair value our mortgage servicing assets during the first quarter of 2013 and 2012, along with the valuation techniques, are shown in the following table:

 

March 31, 2013       Significant   Range
dollars in millions   Valuation Technique   Unobservable Input   (Weighted-Average)

 

             

 

Mortgage servicing assets

  Discounted cash flow   Prepayment speed   0.00 - 25.00% (8.60%) 
    Expected credit losses   1.00 - 3.00% (2.30%) 
    Residual cash flows discount rate   7.00 - 15.00% (8.90%) 
    Value assigned to escrow funds   0.24 - 2.56% (1.50%) 
    Servicing cost   924 - 24,099 (5,629) 
    Loan assumption rate   0.00 - 3.00% (2.38%) 
    Percentage late   0.00 - 2.00% (0.22%) 

 

 

March 31, 2012

      Significant   Range
dollars in millions   Valuation Technique   Unobservable Input   (Weighted-Average)

 

     

 

Mortgage servicing assets

  Discounted cash flow   Prepayment speed   0.00 - 25.00% (12.60%) 
    Expected credit losses   2.00 - 3.00% (2.51%) 
    Residual cash flows discount rate   7.00 - 15.00% (9.50%) 
    Value assigned to escrow funds   0.75 - 3.75% (2.00%) 
    Servicing cost   700 - 16,000 (2,548) 
    Loan assumption rate   0.00 - 3.00% (2.14%) 
    Percentage late   0.00 - 2.00% (0.22%) 

 

If these economic assumptions change or prove incorrect, the fair value of mortgage servicing assets may as a result change in the future. The volume of loans serviced, expected credit losses, and the value assigned to escrow deposits are critical to the valuation of servicing assets. At March 31, 2013, a 1.00% decrease in the value assigned to the escrow deposits would cause a $31 million decrease in the fair value of our mortgage servicing assets. An increase in the assumed default rate of commercial mortgage loans of 1.00% would cause a $3 million decrease in the fair value of our mortgage servicing assets.

Contractual fee income from servicing commercial mortgage loans totaled $22 million for both the three-month periods ended March 31, 2013, and 2012. We have elected to account for servicing assets using the amortization method. The amortization of servicing assets is determined in proportion to, and over the period of, the estimated net servicing income. The amortization of servicing assets for each period, as shown in the preceding table, is recorded as a reduction to fee income. Both the contractual fee income and the amortization are recorded in “other income” on the income statement.

Additional information pertaining to the accounting for mortgage and other servicing assets is included in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Servicing Assets” on page 125 of our 2012 Form 10-K and Note 11 (“Acquisitions and Discontinued Operations”) under the heading “Education lending” in this report.

 

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9. Variable Interest Entities

A VIE is a partnership, limited liability company, trust or other legal entity that meets any one of the following criteria:

 

¿  

The entity does not have sufficient equity to conduct its activities without additional subordinated financial support from another party.

 

¿  

The entity’s investors lack the power to direct the activities that most significantly impact the entity’s economic performance.

 

¿  

The entity’s equity at risk holders do not have the obligation to absorb losses or the right to receive residual returns.

 

¿  

The voting rights of some investors are not proportional to their economic interests in the entity, and substantially all of the entity’s activities involve, or are conducted on behalf of, investors with disproportionately few voting rights.

Our VIEs are summarized below. We define a “significant interest” in a VIE as a subordinated interest that exposes us to a significant portion, but not the majority, of the VIE’s expected losses or residual returns, even though we do not have the power to direct the activities that most significantly impact the entity’s economic performance.

 

     Consolidated VIEs      Unconsolidated VIEs  
in millions    Total
        Assets
     Total
        Liabilities
     Total
    Assets
     Total
        Liabilities
     Maximum 
    Exposure to Loss 
 

 

 

March 31, 2013

              

LIHTC funds

   $ 50       $ 63       $ 113                —   

Education loan securitization trusts

     2,358         2,151         N/A         N/A         N/A    

LIHTC investments

     N/A         N/A         793              $ 448   

 

 

Our involvement with VIEs is described below.

Consolidated VIEs

LIHTC guaranteed funds. KAHC formed limited partnerships, known as funds, that invested in LIHTC operating partnerships. Interests in these funds were offered in syndication to qualified investors who paid a fee to KAHC for a guaranteed return. We also earned syndication fees from the funds and continue to earn asset management fees. The funds’ assets primarily are investments in LIHTC operating partnerships, which totaled $37 million at March 31, 2013. These investments are recorded in “accrued income and other assets” on the balance sheet and serve as collateral for the funds’ limited obligations.

We have not formed new funds or added LIHTC partnerships since October 2003. However, we continue to act as asset manager and to provide occasional funding for existing funds under a guarantee obligation. As a result of this guarantee obligation, we have determined that we are the primary beneficiary of these funds. Additional information on return guarantee agreements with LIHTC investors is presented in Note 15 (“Contingent Liabilities and Guarantees”) under the heading “Guarantees.”

In accordance with the applicable accounting guidance for distinguishing liabilities from equity, third-party interests associated with our LIHTC guaranteed funds are considered mandatorily redeemable instruments and are recorded in “accrued expense and other liabilities” on the balance sheet. However, the FASB has indefinitely deferred the measurement and recognition provisions of this accounting guidance for mandatorily redeemable third-party interests associated with finite-lived subsidiaries, such as our LIHTC guaranteed funds. We adjust our financial statements each period for the third-party investors’ share of the funds’ profits and losses. At March 31, 2013, we estimated the settlement value of these third-party interests to be between zero and $20 million, while the recorded value, including reserves, totaled $36 million. The partnership agreement for each of our guaranteed funds requires the fund to be dissolved by a certain date.

Education loan securitization trusts. In September 2009, we decided to exit the government-guaranteed education lending business. Therefore, we have accounted for this business as a discontinued operation. In the past, as part of our education lending business model, we originated and securitized education loans. As the transferor, we retained a portion of the risk in the form of a residual interest and also retained the right to service the securitized loans and receive servicing fees. We have not securitized any education loans since 2006.

 

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We consolidated our ten outstanding education loan securitization trusts as of January 1, 2010. We were required to consolidate these trusts because we hold the residual interests and, as the master servicer, we have the power to direct the activities that most significantly influence the trusts’ economic performance. We elected to consolidate these trusts at fair value. The trust assets can be used only to settle the obligations or securities that the trusts issue; we cannot sell the assets or transfer the liabilities. The security holders or beneficial interest holders do not have recourse to us, and we do not have any liability recorded related to their securities. Further information regarding these education loan securitization trusts is provided in Note 11 (“Acquisitions and Discontinued Operations”) under the heading “Education lending.”

Unconsolidated VIEs

LIHTC nonguaranteed funds. Although we hold significant interests in certain nonguaranteed funds that we formed and funded, we have determined that we are not the primary beneficiary because we do not absorb the majority of the funds’ expected losses and do not have the power to direct activities that most significantly influence the economic performance of these entities. At March 31, 2013, assets of these unconsolidated nonguaranteed funds totaled $113 million. Our maximum exposure to loss in connection with these funds is minimal, and we do not have any liability recorded related to the funds. We have not formed nonguaranteed funds since October 2003.

LIHTC investments. Through Key Community Bank, we have made investments directly in LIHTC operating partnerships formed by third parties. As a limited partner in these operating partnerships, we are allocated tax credits and deductions associated with the underlying properties. We have determined that we are not the primary beneficiary of these investments because the general partners have the power to direct the activities that most significantly influence the economic performance of their respective partnerships and have the obligation to absorb expected losses and the right to receive benefits.

At March 31, 2013, assets of these unconsolidated LIHTC operating partnerships totaled approximately $793 million. At March 31, 2013, our maximum exposure to loss in connection with these partnerships is the unamortized investment balance of $354 million plus $94 million of tax credits claimed but subject to recapture. We do not have any liability recorded related to these investments because we believe the likelihood of any loss is remote. During the first three months of 2013, we did not obtain significant direct investments (either individually or in the aggregate) in LIHTC operating partnerships.

We have additional investments in unconsolidated LIHTC operating partnerships that are held by the consolidated LIHTC guaranteed funds. Total assets of these operating partnerships were approximately $994 million at March 31, 2013. The tax credits and deductions associated with these properties are allocated to the funds’ investors based on their ownership percentages. We have determined that we are not the primary beneficiary of these partnerships because the general partners have the power to direct the activities that most significantly impact their economic performance and the obligation to absorb expected losses and right to receive residual returns. Information regarding our exposure to loss in connection with these guaranteed funds is included in Note 15 under the heading “Return guarantee agreement with LIHTC investors.”

Commercial and residential real estate investments and principal investments. Our Principal Investing unit and the Real Estate Capital line of business make equity and mezzanine investments, some of which are in VIEs. These investments are held by nonregistered investment companies subject to the provisions of the AICPA Audit and Accounting Guide, “Audits of Investment Companies.” We are not currently applying the accounting or disclosure provisions in the applicable accounting guidance for consolidations to these investments, which remain unconsolidated. The FASB has indefinitely deferred the effective date of this guidance for such nonregistered investment companies.

 

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10. Income Taxes

Income Tax Provision

In accordance with the applicable accounting guidance, the principal method established for computing the provision for income taxes in interim periods requires us to make our best estimate of the effective tax rate expected to be applicable for the full year. This estimated effective tax rate is then applied to interim consolidated pre-tax operating income to determine the interim provision for income taxes.

The effective tax rate, which is the provision for income taxes as a percentage of income from continuing operations before income taxes, was 25.8% for the first quarter of 2013, 21.3% for the fourth quarter of 2012, and 26.6% for the first quarter of 2012. The effective tax rates are below our combined federal and state statutory tax rate of 37.2%, due primarily to income from investments in tax-advantaged assets such as corporate-owned life insurance and credits associated with investments in low-income housing projects.

Deferred Tax Asset

At March 31, 2013, from continuing operations, we had a federal deferred tax asset of $111 million and a state deferred tax liability of $10 million compared to a federal deferred tax asset of $129 million and a state deferred tax liability of $8 million at December 31, 2012, and a federal net deferred tax asset of $78 million and a state deferred tax liability of $23 million at March 31, 2012, included in “accrued income and other assets” on the balance sheet. To determine the amount of deferred tax assets that are more-likely-than-not to be realized, and therefore recorded, we conduct a quarterly assessment of all available evidence. This evidence includes, but is not limited to, taxable income in prior periods, projected future taxable income, and projected future reversals of deferred tax items. These assessments involve a degree of subjectivity and may undergo change. Based on these criteria, we have a valuation allowance of $3 million at March 31, 2013, and December 31, 2012, associated with certain state net operating loss carryforwards and state credit carryforwards. We did not have a valuation allowance at March 31, 2012.

Unrecognized Tax Benefits

As permitted under the applicable accounting guidance for income taxes, it is our policy to recognize interest and penalties related to unrecognized tax benefits in income tax expense.

 

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11. Acquisitions and Discontinued Operations

Acquisitions

Western New York Branches. On July 13, 2012, we acquired 37 retail banking branches in Western New York. This acquisition, was accounted for as a business combination. The acquisition date fair value of the assets and deposits acquired was approximately $2 billion. We received loans with a fair value of $244 million (including $25 million of PCI loans), $8 million of premises and equipment and assumed $2 billion of deposits. Cash of $1.8 billion was received to assume the net liabilities, and we recorded a core deposit intangible asset of $40 million and a goodwill asset of $62 million in the Key Community Bank reporting unit during the third quarter of 2012. All of the goodwill related to this acquisition is expected to be deductible for tax purposes.

A second closing of this acquisition occurred on September 14, 2012, when we acquired credit card assets with a fair value of approximately $68 million and remitted a cash payment of $68 million to the seller. We also recorded a purchased credit card relationship intangible asset of approximately $1 million and a rewards liability of approximately $1 million in the Key Community Bank reporting unit. No additional goodwill resulted from the acquisition of these credit card assets.

Key-Branded Credit Card Portfolio. On August 1, 2012, we acquired Key-branded credit card assets from Elan Financial Services, Inc. This acquisition was accounted for as an asset purchase. The fair value of the credit card assets purchased was approximately $718 million at the acquisition date. We also recorded a purchased credit card relationship intangible asset of approximately $135 million and a rewards liability of approximately $9 million in the Community Bank reporting unit.

Discontinued operations

Education lending. In September 2009, we decided to exit the government-guaranteed education lending business. As a result, we have accounted for this business as a discontinued operation.

“Income (loss) from discontinued operations, net of taxes” on the income statement includes (i) the changes in fair value of the assets and liabilities of the education loan securitization trusts and the loans at fair value in portfolio (discussed later in this note), and (ii) the interest income and expense from the loans and the securities of the trusts and the loans in portfolio at both amortized cost and fair value. These amounts are shown separately in the following table. Gains and losses attributable to changes in fair value are recorded as a component of noninterest income or expense. Interest income and expense related to the loans and securities are shown as a component of “Net interest income.”

The components of “income (loss) from discontinued operations, net of taxes” for the education lending business are as follows:

 

               Three months ended March  31,   
in millions    2013        2012    

 

 

Net interest income

     $ 28          $ 31    

Provision for loan and lease losses

     6          4    

 

 

Net interest income (expense) after provision for loan and lease losses

     22          27    

Noninterest income

     (16)          (18)    

Noninterest expense

     7          $ 9    

 

 

Income (loss) before income taxes

     (1)          —    

Income taxes

     $ (1)          —    

 

 

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

     —          —    
  

 

 

    

 

 

 

 

 

 

(a) Includes after-tax charges of $10 million and $14 million for the three-month periods ended March 31, 2013 and 2012, determined by applying a matched funds transfer pricing methodology to the liabilities assumed necessary to support the discontinued operations.

 

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The discontinued assets and liabilities of our education lending business included on the balance sheet are as follows:

 

in millions   

                March 31, 

2013 

               December 31,
2012 
                     March 31,
2012 
 

 

 

Trust loans at fair value

    $ 2,333        $ 2,369        $ 2,714   

Portfolio loans at fair value

     154         157         74   

Loans, net of unearned income of ($5), ($5) and ($2)

     2,599         2,675         2,927   

Less: Allowance for loan and lease losses

     49         55         90   

 

 

Net loans

     5,037         5,146         5,625   

Trust accrued income and other assets at fair value

     25         26         112   

Accrued income and other assets

     54         60         —   

 

 

Total assets

    $ 5,116        $ 5,232        $ 5,737   
  

 

 

    

 

 

    

 

 

 

Trust accrued expense and other liabilities at fair value

    $ 25        $ 22        $ 30   

Trust securities at fair value

     2,126         2,159         2,512   

 

 

Total liabilities

    $ 2,151        $ 2,181        $ 2,542   
  

 

 

    

 

 

    

 

 

 

 

 

The discontinued education lending business consists of assets and liabilities in the securitization trusts (recorded at fair value), as well as loans in portfolio (recorded at fair value) and loans in portfolio (recorded at carrying value with appropriate valuation reserves) that are held outside the trusts.

At March 31, 2013, portfolio loans recorded at carrying value include 345 TDRs with a recorded investment of approximately $4 million (pre-modification and post-modification). A specifically allocated allowance of approximately $1 million was assigned to these loans as of March 31, 2013. There have been no significant payment defaults. There are no significant commitments outstanding to lend additional funds to these borrowers. Additional information regarding TDR classification and ALLL methodology is provided in Note 4 (“Asset Quality”).

In the past, as part of our education lending business model, we originated and securitized education loans. The process of securitization involves taking a pool of loans from our balance sheet and selling them to a bankruptcy-remote QSPE, or trust. This trust then issues securities to investors in the capital markets to raise funds to pay for the loans. The interest generated on the loans pays holders of the securities issued. As the transferor, we retain a portion of the risk in the form of a residual interest and also retain the right to service the securitized loans and receive servicing fees.

As of January 1, 2010, we consolidated our ten outstanding securitization trusts since we hold the residual interests and are the master servicer with the power to direct the activities that most significantly influence the economic performance of the trusts.

The trust assets can be used only to settle the obligations or securities the trusts issue; we cannot sell the assets or transfer the liabilities. The loans in the consolidated trusts consist of both private and government-guaranteed loans. The security holders or beneficial interest holders do not have recourse to Key. Our economic interest or risk of loss associated with these education loan securitization trusts is approximately $207 million as of March 31, 2013. We record all income and expense (including fair value adjustments) through the “income (loss) from discontinued operations, net of tax” line item in our income statement.

We elected to consolidate these trusts at fair value. Carrying the assets and liabilities of the trusts at fair value better depicts our economic interest. The fair value of the assets and liabilities of the trusts is determined by calculating the present value of the future expected cash flows. We rely on unobservable inputs (Level 3) when determining the fair value of the assets and liabilities of the trusts because observable market data is not available. See further discussion regarding our valuation process later in this note.

At March 31, 2013 there are $148 million of loans that were purchased from two of the outstanding securitizations trusts pursuant to the legal terms of these particular trusts. These loans are held as portfolio loans and continue to be accounted for at fair value. These portfolio loans were valued using an internal discounted cash flow model, which was affected by assumptions for defaults, loss severity, discount rates and prepayments. These portfolio loans are considered to be Level 3 assets since we rely on unobservable inputs when determining fair value. See the following discussion regarding our valuation process for these loans as well as the trust loans and securities. Portfolio loans accounted for at fair value had a value of $154 million at March 31, 2013, $157 million at December 31, 2012, and $74 million at March 31, 2012.

 

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Corporate Treasury, within our Finance area, is responsible for the quarterly valuation process that determines the fair value of the loans and securities in our education loan securitization trusts as well as our student loans held in portfolio that are accounted for at fair value. Corporate Treasury provides these fair values to a Working Group Committee (“the Working Group”) comprising representatives from the line of business, Credit and Market Risk Management, Accounting, Business Finance (part of our Finance area), and Corporate Treasury. The Working Group is a subcommittee of the Fair Value Committee that is discussed in more detail in Note 5 (“Fair Value Measurements”). The Working Group reviews all significant inputs and assumptions and approves the resulting fair values.

The Working Group reviews actual performance trends of the loans and securities on a quarterly basis and uses statistical analysis and qualitative measures to determine assumptions for future performance. Predictive models that incorporate delinquency and charge-off trends along with economic outlooks assist the Working Group to forecast future defaults. The Working Group uses this information to formulate the credit outlook for each of the securitization trusts. Higher projected defaults, fewer expected recoveries, elevated prepayment speeds and higher discount rates would be expected to result in a lower fair value of the loans and securities in these securitization trusts as well as the portfolio loans at fair value. Default expectations and discount rate changes have the most significant impact on the fair values of the loans and securities. It is important to note that increased cash flow uncertainty, whether through higher defaults and prepayments or fewer recoveries, can result in higher discount rates for use in the fair value process for these loans and securities.

The valuation process for the education loan securitization trust and portfolio loans that are accounted for at fair value is based on a discounted cash flow analysis using a model purchased from a third party that is maintained by Corporate Treasury. The market for student loans, either whole-loan purchases or securitization, is relatively illiquid and has not recovered from the effects of the financial crisis. The valuation process begins with loan-by-loan-level data that is aggregated into pools based on underlying loan structural characteristics (i.e., current unpaid principal balance, contractual term, interest rate). Cash flows for these loan pools are developed using a financial model that reflects certain assumptions for defaults, recoveries, status change and prepayments.

A net earnings stream, taking into account cost of funding, is calculated and discounted back to the measurement date using an appropriate discount rate. This resulting amount is used to determine the present value of the loans, which represents their fair value to a market participant.

The unobservable inputs set forth in the following table are reviewed and approved by the Working Group on a quarterly basis. The Working Group determines these assumptions based on available data, discussions with appropriate individuals internal and external to Key, and the knowledge and experience of the Working Group members.

A similar discounted cash flow approach to that described above is used on a quarterly basis by Corporate Treasury to fair value the trust securities. In valuing these securities, the discount rates used are provided by a third-party valuation consultant. These discount rates are based primarily on secondary market spread indices for similar student loans and asset-backed securities and are developed by the consultant using market-based data. On a quarterly basis, the Working Group reviews the discount rate inputs used in the valuation process for reasonableness based on the historical and current market knowledge of the Working Group members.

A quarterly variance analysis reconciles valuation changes in the model used to calculate the fair value of the trust loans and securities and the portfolio loans at fair value. This quarterly analysis considers loan and securities runoff, yields, future default and recovery changes, and the timing of cash releases to us from the trusts. Back testing for expected defaults to actual experience is also performed as the impact of future defaults has a significant impact on the fair value of these loans and securities over time. In addition, our internal model validation group periodically performs a review to ensure the accuracy and validity of the model for determining the fair value of these loans and securities.

 

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The following table shows the significant unobservable inputs used to measure the fair value of the education loan securitization trust loans and securities and the portfolio loans accounted for at fair value as of March 31, 2013:

 

March 31, 2013

dollars in millions

         Fair Value of Level 3    
      Assets and Liabilities    
         Valuation
    Technique
       Significant
    Unobservable Input
     Range     
(Weighted-Average)     

 

Trust loans and

   $ 2,487      Discounted cash flow    Prepayment speed      4.00 - 13.50% (6.16%) 

portfolio loans

         Loss severity      2.00 - 80.00% (52.29%) 

accounted for at fair

         Discount rate      1.80 - 5.50% (3.89%) 

value

         Default rate      8.13 - 22.00% (13.84%) 

 

Trust securities

     2,126      Discounted cash flow    Discount rate      1.10 - 5.00% (3.29%) 

 

 

December 31, 2012

dollars in millions

         Fair Value of Level 3    
      Assets and Liabilities    
         Valuation
    Technique
       Significant
    Unobservable Input
    

Range     

(Weighted-Average)     

 

Trust loans and

   $ 2,526      Discounted cash flow    Prepayment speed      4.00 -26.00% (10.02%) 

portfolio loans

         Loss severity      2.00 - 80.00% (52.30%) 

accounted for at fair

         Discount rate      2.40 - 6.60% (4.79%) 

value

         Default rate      8.13 - 21.50% (13.44%) 

 

Trust securities

     2,159      Discounted cash flow    Discount rate      1.50 - 6.10% (4.14%) 

 

 

March 31, 2012

dollars in millions

         Fair Value of Level 3    
      Assets and Liabilities    
         Valuation
    Technique
       Significant
    Unobservable Input
     Range     
(Weighted-Average)     

 

Trust loans and

   $ 2,788      Discounted cash flow    Prepayment speed      4.00 - 26.00% (10.22%) 

portfolio loans

         Loss severity      2.00 - 80.00% (52.34%) 

accounted for at fair

         Discount rate      2.50 - 8.40% (4.70%) 

value

         Default rate      3.75 - 40.00% (18.58%) 

 

Trust securities

     2,512      Discounted cash flow    Discount rate      1.80 - 7.20% (4.10%) 

 

The following table shows the consolidated trusts’ assets and liabilities at fair value and the portfolio loans at fair value and their related contractual values as of March 31, 2013. At March 31, 2013, loans held by the trusts with unpaid principal balances of $33 million ($32 million on a fair value basis) and portfolio loans at fair value with unpaid principal balances of $5 million ($5 million on a fair value basis) were 90 days or more past due. Loans held by the trusts aggregating $13 million ($12 million on a fair value basis) were in nonaccrual status, while portfolio loans at fair value in nonaccrual status aggregated to less than $1 million on both a contractual amount and fair value basis. Portfolio loans at carrying value that are 90 days or more past due were $41 million and $46 million at March 31, 2013, and 2012, respectively. Portfolio loans at carrying value in nonaccrual (and nonperforming) status were $3 million and $2 million at March 31, 2013, and 2012, respectively. Our policies for determining past due loans, placing loans on nonaccrual, applying payments on nonaccrual loans and resuming accrual of interest are disclosed in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Nonperforming Loans” on page 120 of our 2012 Form 10-K.

 

March 31, 2013

in millions

               Contractual
Amount
    

Fair

Value

 

 

 

ASSETS

     

Portfolio loans

   $ 148      $ 154  

Trust loans

     2,357        2,333  

Trust other assets

     25        25  

LIABILITIES

     

Trust securities

   $             2,382      $                       2,126  

Trust other liabilities

     25        25  

 

 

 

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The following table presents the assets and liabilities of the trusts that were consolidated and are measured at fair value, as well as the portfolio loans that are measured at fair value on a recurring basis.

 

March 31, 2013

in millions

                   Level 1                      Level 2                      Level 3                      Total  

 

 

ASSETS MEASURED ON A RECURRING BASIS

           

Portfolio loans

     —         —        $ 154        $ 154   

Trust loans

     —         —         2,333         2,333   

Trust other assets

     —         —         25         25   

 

 

Total assets on a recurring basis at fair value

     —         —        $ 2,512        $ 2,512   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

LIABILITIES MEASURED ON A RECURRING BASIS

           

Trust securities

     —         —        $ 2,126        $ 2,126   

Trust other liabilities

     —         —         25         25   

 

 

Total liabilities on a recurring basis at fair value

     —         —        $ 2,151        $ 2,151   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

The following table shows the change in the fair values of the Level 3 consolidated education loan securitization trusts and portfolio loans for the three-month period ended March 31, 2013.

 

                 Portfolio      Trust      Trust             Trust  
     Student                  Student      Other      Trust      Other  
in millions    Loans      Loans                    Assets                 Securities                Liabilities  

 

 

Balance at December 31, 2012

    $ 157         $ 2,369         $ 26         $ 2,159         $ 22   

Gains (losses) recognized in earnings (a)

     —          43          —          59          —   

Purchases

     —          —          —          —          —   

Sales

     —          —          —          —          —   

Issuances

     —          —          —           —          —   

Settlements

     (3)          (79)          (1)          (92)           

 

 

Balance at March 31, 2013

    $ 154         $ 2,333         $ 25         $ 2,126         $ 25   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
              

 

 

 

(a) Gains (losses) were driven primarily by fair value adjustments.

Victory Capital Management and Victory Capital Advisors. On February 21, 2013, we agreed to sell our investment management subsidiary Victory Capital Management and its broker-dealer affiliate Victory Capital Advisors (collectively, “Victory”) to a private equity fund. As a result of this pending disposition by sale which is expected to close during the third quarter of 2013, we have accounted for this business as a discontinued operation.

The results of this discontinued business are included in “income (loss) from discontinued operations, net of taxes” on the income statement. The components of “income (loss) from discontinued operations, net of taxes” for Victory are as follows:

 

               Three months ended March  31,  
in millions    2013       2012   

 

 

Noninterest income

   $ 29       $ 30   

Noninterest expense

     21         24   

 

 

Income (loss) before income taxes

             

Income taxes

             

 

 

Income (loss) from discontinued operations, net of taxes

   $      $  
  

 

 

    

 

 

 

 

 

 

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The discontinued assets and liabilities of Victory that are classified as held for sale and measured at the lower of carrying value or fair value less cost to sell, included on the balance sheet and the related assets under management are as follows:

 

in millions                    March 31,
2013 
                 December 31,
2012 
                     March 31,
2012 
 

 

 

Cash and due from banks

    $       $       $  

Accrued income and other assets

     43         27         21   

 

 

Total assets

    $ 44        $ 28        $ 22   
  

 

 

    

 

 

    

 

 

 

Accrued expense and other liabilities

    $ 24        $ 38        $ 26   

 

 

Total liabilities

    $ 24        $ 38        $ 26   
  

 

 

    

 

 

    

 

 

 

 

 

Austin Capital Management, Ltd. In April 2009, we decided to wind down the operations of Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers. As a result, we have accounted for this business as a discontinued operation.

The results of this discontinued business are included in “income (loss) from discontinued operations, net of taxes” on the income statement. The components of “income (loss) from discontinued operations, net of taxes” for Austin are as follows:

 

               Three months ended March  31,  
in millions    2013        2012  

 

 

Noninterest expense

     —         $ 8    

 

 

Income (loss) before income taxes

     —          (8)    

Income taxes

    $ 2          (3)    

 

 

Income (loss) from discontinued operations, net of taxes

    $ (2)         $ (5)    
  

 

 

    

 

 

 

 

 

The discontinued assets and liabilities of Austin included on the balance sheet are as follows:

 

in millions                    March 31,
2013
               December 31,
2012
                     March 31,
2012
 

 

 

Cash and due from banks

    $ 22        $ 22        $ 30   

Accrued income and other assets

     —         —          

 

 

Total assets

    $ 22        $ 22        $ 31   
  

 

 

    

 

 

    

 

 

 

Accrued expense and other liabilities

    $       $       $  

 

 

Total liabilities

    $       $       $  
  

 

 

    

 

 

    

 

 

 

 

 

Combined discontinued operations. The combined results of the discontinued operations are as follows:

 

               Three months ended March  31,   
in millions    2013       2012   

 

 

Net interest income

    $ 28        $ 31    

Provision for loan and lease losses

            4    

 

 

Net interest income (expense) after provision for loan and lease losses

     22         27    

Noninterest income

     13         12    

Noninterest expense

     28         41    

 

 

Income (loss) before income taxes

            (2)    

Income taxes

            (1)    

 

 

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

    $       $ (1)    
  

 

 

    

 

 

 
     

 

 

 

(a) Includes after-tax charges of $10 million and $14 million for March 31, 2013 and 2012, respectively, determined by applying a matched funds transfer pricing methodology to the liabilities assumed necessary to support the discontinued operations.

 

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The combined assets and liabilities of the discontinued operations are as follows:

 

in millions                  March 31,
2013 
             December 31,
2012 
                   March 31,
2012 
 

 

 

Cash and due from banks

     $ 23         $ 23         $ 31   

Trust loans at fair value

     2,333         2,369         2,714   

Portfolio loans at fair value

     154         157         74   

Loans, net of unearned income of ($5), ($5), and ($2)

     2,599         2,675         2,927   

Less: Allowance for loan and lease losses

     49         55         90   

 

 

Net loans

     5,037         5,146         5,625   

Trust accrued income and other assets at fair value

     25         26         112   

Accrued income and other assets

     97         87         22   

 

 

Total assets

     $ 5,182         $ 5,282         $ 5,790   
  

 

 

    

 

 

    

 

 

 

Trust accrued expense and other liabilities at fair value

     $ 25         $ 22         $ 30   

Accrued expense and other liabilities

     25         39         33   

Trust securities at fair value

     2,126         2,159         2,512   

 

 

Total liabilities

     $ 2,176         $ 2,220         $ 2,575   
  

 

 

    

 

 

    

 

 

 

 

 

 

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12. Securities Financing Activities

We enter into repurchase and reverse repurchase agreements and securities borrowed transactions (securities financing agreements) primarily to finance our inventory positions, acquire securities to cover short positions, accommodate customers’ financing needs, and to settle other securities obligations. We account for these securities financing agreements as collateralized financing transactions. Repurchase and reverse repurchase agreements are recorded on the balance sheet at the amounts at which the securities will be subsequently sold or repurchased. Securities borrowed transactions are recorded on the balance sheet at the amounts of cash collateral advanced. While the right of setoff exists for our securities financing agreements, the assets and liabilities are reported on a gross basis. Repurchase agreements and securities borrowed transactions are included in “Accrued income and other assets” and reverse repurchase agreements in “Federal funds purchased and securities sold under repurchase agreements” on the balance sheet.

 

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The following table summarizes our securities financing agreements as of March 31, 2013, December 31, 2012, and March 31, 2012:

 

     March 31, 2013  
in millions   

            Gross Amount
Presented in

Balance Sheet

          Netting
          Adjustments
   

(a)

 

           Collateral    

(b)

 

   Net
         Amounts
 

 

 

Offsetting of financial assets:

                  

Reverse repurchase agreements

   $ 311          $ (195)         $ (111)         $  

Securities borrowed

     35            —           (34)            

 

 

Total

   $ 346          $ (195)         $ (145)         $  
  

 

 

       

 

 

      

 

 

      

 

 

 
                  

 

 

Offsetting of financial liabilities:

                  

Repurchase agreements

   $ 494          $ (195)         $ (299)           —   

 

 

Total

   $ 494          $ (195)         $ (299)           —   
  

 

 

       

 

 

      

 

 

      

 

 

 
                  

 

 

 

     December 31, 2013  
in millions   

            Gross Amount
Presented in

Balance Sheet

          Netting
          Adjustments
   

(a)

 

           Collateral    

(b)

 

   Net
         Amounts
 

 

 

Offsetting of financial assets:

                  

Reverse repurchase agreements

   $ 271          $ (95)         $ (172)         $  

Securities borrowed

     —            —           —           —   

 

 

Total

   $ 271          $ (95)         $ (172)         $  
  

 

 

       

 

 

      

 

 

      

 

 

 
                  

 

 

Offsetting of financial liabilities:

                  

Repurchase agreements

   $ 228          $ (95)         $ (133)           —   

 

 

Total

   $ 228          $ (95)         $ (133)           —   
  

 

 

       

 

 

      

 

 

      

 

 

 
                  

 

 

 

     March 31, 2012  
in millions   

            Gross Amount
Presented in

Balance Sheet

          Netting
          Adjustments
   

(a)

 

           Collateral    

(b)

 

   Net
         Amounts
 

 

 

Offsetting of financial assets:

                  

Reverse repurchase agreements

   $ 292          $ (137)         $ (147)         $  

Securities borrowed

     19            —           (18)            

 

 

Total

   $ 311          $ (137)         $ (165)         $  
  

 

 

       

 

 

      

 

 

      

 

 

 
                  

 

 

Offsetting of financial liabilities:

                  

Repurchase agreements

   $ 394            (137)         $ (257)           —   

 

 

Total

   $ 394            (137)         $ (257)           —   
  

 

 

       

 

 

      

 

 

      

 

 

 
                  

 

 

 

(a) Netting adjustments take into account the impact of master netting agreements that allow us to settle with a single counterparty on a net basis.

 

(b) These adjustments take into account the impact of bilateral collateral agreements that allow us to offset the net positions with the related collateral. The application of collateral cannot reduce the net position below zero. Therefore, any excess collateral is not reflected above.

Like other financing transactions, securities financing agreements contain an element of credit risk. To mitigate and manage credit risk exposure, we generally enter into master netting agreements and other collateral arrangements that give us the right, in the event of default, to liquidate collateral held and to offset receivables and payables with the same counterparty. Additionally, we establish and monitor limits on our counterparty credit risk exposure by product type. For the reverse repurchase agreements, we monitor the value of the underlying securities we have received from counterparties and either request additional collateral or return a portion of the collateral based on the value of those securities. We generally hold collateral in the form of highly rated securities issued by the US Treasury and fixed income securities. In addition, we may need to provide collateral to counterparties under our repurchase agreements and securities borrowed transactions. In general, the collateral we pledge and receive can be sold or repledged by the secured parties.

 

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13. Employee Benefits

Pension Plans

Effective December 31, 2009, we amended our cash balance pension plan and other defined benefit plans to freeze all benefit accruals and close the plans to new employees. We will continue to credit participants’ existing account balances for interest until they receive their plan benefits. We changed certain pension plan assumptions after freezing the plans.

The components of net pension cost for all funded and unfunded plans are as follows:

 

                            Three months ended March 31,   
in millions    2013        2012    

 

 

Interest cost on PBO

     $ 10          $ 12    

Expected return on plan assets

     (17)          (18)    

Amortization of losses

     5          4     

 

 

Net pension cost

     $ (2)          $ (2)    
  

 

 

    

 

 

 

 

 

Other Postretirement Benefit Plans

We sponsor a retiree healthcare plan in which all employees age 55 with five years of service (or employees age 50 with 15 years of service who are terminated under conditions that entitle them to a severance benefit) are eligible to participate. Participant contributions are adjusted annually. Key may provide a subsidy toward the cost of coverage for certain employees hired before 2001 with a minimum of 15 years of service at the time of termination. We use a separate VEBA trust to fund the retiree healthcare plan.

We also maintained a death benefit plan that provided a death benefit for a very limited number of (i) former Key employees who retired from their employment with Key prior to 1994; (ii) former Key employees who elect a grandfathered pension benefit under the KeyCorp Cash Balance Pension Plan; and (iii) Key employees who otherwise were provided a historical death benefit at the time of their termination. The death benefit plan was non-contributory, and we used a separate VEBA trust to fund the plan. In the fourth quarter of 2012, we used the assets of the VEBA trust to purchase insurance through a policy issued by a third-party insurance provider to fully fund the death benefits under the plan. All grandfathered employees’ death benefits are fully funded, administered, and paid by the third-party insurance provider, and the insurance company has accepted all funding obligations and administrative liability for the grandfathered employees’ death benefits. We accordingly terminated the death benefit plan and the VEBA effective December 31, 2012.

The components of net postretirement benefit cost for all funded and unfunded plans are as follows:

 

                            Three months ended March 31,   
in millions    2013        2012    

 

 

Interest cost on APBO

     $ 1           $ 1    

Expected return on plan assets

     (1)          (1)    

 

 

Net postretirement benefit cost

     —          —    
  

 

 

    

 

 

 

 

 

The Patient Protection and Affordable Care Act and Education Reconciliation Act of 2010, which were both signed into law in March 2010, changed the tax treatment of federal subsidies paid to sponsors of retiree health benefit plans that provide a benefit that is at least “actuarially equivalent” to the benefits under Medicare Part D. As a result of these laws, these subsidy payments became taxable in tax years beginning after December 31, 2012. The accounting guidance applicable to income taxes required the impact of a change in tax law to be immediately recognized in the period that includes the enactment date. The changes to the tax law regarding these subsidies did not affect us as we did not have a deferred tax asset recorded for Medicare Part D subsidies received.

 

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14. Trust Preferred Securities Issued by Unconsolidated Subsidiaries

We own the outstanding common stock of business trusts formed by us that issued corporation-obligated mandatorily redeemable trust preferred securities. The trusts used the proceeds from the issuance of their trust preferred securities and common stock to buy debentures issued by KeyCorp. These debentures are the trusts’ only assets; the interest payments from the debentures finance the distributions paid on the mandatorily redeemable trust preferred securities.

We unconditionally guarantee the following payments or distributions on behalf of the trusts:

 

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required distributions on the trust preferred securities;

 

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the redemption price when a capital security is redeemed; and

 

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the amounts due if a trust is liquidated or terminated.

The Dodd-Frank Act changes the regulatory capital standards that apply to BHCs by requiring the phase-out of the treatment of trust preferred securities and cumulative preferred securities as Tier 1 eligible capital. The three-year phase-out period will ultimately require us to treat our mandatorily redeemable trust preferred securities as Tier 2 capital. The Basel III NPR proposes rules implementing the phase-out of trust preferred securities as Tier 1 capital, consistent with the Dodd-Frank Act, as part of the implementation of Basel III. A more thorough discussion of current rulemaking underway in the U.S. to implement Basel III is in the “Supervision and regulation” portion of this report.

As of March 31, 2013, the trust preferred securities issued by the KeyCorp capital trusts represent $339 million, or 3.4% of our total qualifying Tier 1 capital, net of goodwill.

The trust preferred securities, common stock and related debentures are summarized as follows:

 

dollars in millions   

                Trust  Preferred
Securities,

Net of Discount

   

(a)

 

               Common
Stock
         

Principal

Amount of
Debentures,
            Net of Discount

   

(b)

 

   Interest Rate
            of Trust Preferred
Securities and
Debentures
   

(c)

 

   Maturity
      of Trust Preferred
Securities and
Debentures
 

 

 

March 31, 2013

                       

KeyCorp Capital I

       $ 156             $             $ 162           1.048          2028   

KeyCorp Capital II

     111                     115           6.875             2029   

KeyCorp Capital III

     144                     148           7.750             2029   

 

 

Total

       $ 411             $ 14              $ 425           4.970          —   
  

 

 

      

 

 

       

 

 

           

 

 

December 31, 2012

       $ 417             $ 14              $ 431           5.025          —   
  

 

 

      

 

 

       

 

 

           

 

 

March 31, 2012 (d)

       $ 1,190             $ 19              $ 1,209           6.625          —   
  

 

 

      

 

 

       

 

 

           

 

 

 

(a) The trust preferred securities must be redeemed when the related debentures mature, or earlier if provided in the governing indenture. Each issue of trust preferred securities carries an interest rate identical to that of the related debenture. Certain trust preferred securities include basis adjustments related to fair value hedges totaling $71 million at March 31, 2013, $77 million at December 31, 2012, and $144 million at March 31, 2012. See Note 7 (“Derivatives and Hedging Activities”) for an explanation of fair value hedges.

 

(b) We have the right to redeem these debentures: If the debentures purchased by KeyCorp Capital I are redeemed before they mature, the redemption price will be the principal amount, plus any accrued but unpaid interest. If the debentures purchased by KeyCorp Capital II or KeyCorp Capital III are redeemed before they mature, the redemption price will be the greater of: (a) the principal amount, plus any accrued but unpaid interest or (b) the sum of the present values of principal and interest payments discounted at the Treasury Rate (as defined in the applicable indenture), plus 20 basis points (25 basis points or 50 basis points in the case of redemption upon either a tax event or a capital treatment event for KeyCorp Capital III), plus any accrued but unpaid interest. When debentures are redeemed in response to tax or capital treatment events, the redemption price for KeyCorp Capital II and KeyCorp Capital III generally is slightly more favorable to us. The principal amount of certain debentures includes basis adjustments related to fair value hedges totaling $71 million at March 31, 2013, $77 million at December 31, 2012, and $144 million at March 31, 2012. See Note 7 for an explanation of fair value hedges. The principal amount of debentures, net of discount is included in Long-Term Debt on the balance sheet.

 

(c) The interest rates for the trust preferred securities issued by KeyCorp Capital II and KeyCorp Capital III are fixed. KeyCorp Capital I has a floating interest rate equal to three-month LIBOR plus 74 basis points that reprices quarterly. The total interest rates are weighted-average rates.

 

(d) Includes the trust preferred securities issued by KeyCorp Capital VII and KeyCorp Capital X, which were redeemed in full on July 12, 2012. The aggregate liquidation preference totaled $707 million.

 

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15. Contingent Liabilities and Guarantees

Legal Proceedings

The following discussion provides information on material developments in our legal proceedings during the first quarter of 2013. Additional information on our legal proceedings is available on pages 186-188 of our 2012 Form 10-K, Note 16 (“Commitments, Contingent Liabilities and Guarantees”) under the heading “Legal Proceedings.”

Austin Madoff-Related Claims. As previously reported, Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers, determined that its funds had suffered investment losses of up to approximately $186 million resulting from the crime perpetrated by Bernard L. Madoff and entities that he controlled. The investment losses borne by Austin’s funds stemmed from investments in a certain Madoff-advised hedge fund. Several lawsuits pending against Austin, KeyCorp, Victory Capital Management and certain employees and former employees (collectively, the “KeyCorp defendants”) alleging various claims, including negligence, fraud, breach of duties, and violations of federal securities laws and ERISA, were consolidated into one action styled In re Austin Capital Management, Ltd., Securities & Employee Retirement Income Security Act (ERISA) Litigation, pending in the United States District Court for the Southern District of New York. The KeyCorp defendants filed a motion to dismiss all of the claims in the consolidated amended complaint. On December 21, 2012, the court dismissed 14 of the plaintiffs’ 16 claims, including all of the plaintiffs’ securities law and state law claims. The plaintiffs’ two remaining claims are claims under ERISA. On January 4, 2013, the plaintiffs filed a motion for partial reconsideration of the court’s decision. On April 16, 2013, the court issued its opinion and denied the plaintiffs’ motion for reconsideration. An arbitration proceeding brought by one former Austin client, which was not consolidated into the foregoing proceeding, remains in abeyance.

As previously reported, the Department of Labor (the “Department”) asserted claims acting on behalf of ERISA investors. Those claims were settled with the Department for a total $47.8 million, a portion of which has been paid out of existing reserves and the balance of which is expected to be covered by our insurance policy as further described below. The settlements, excluding a portion payable to the Department, will be distributed to the ERISA investors who participated in the Austin investment in the Madoff-advised fund. The amounts distributed to the ERISA investors under the settlements with the Department will substantially reduce, but may not completely offset, the amounts that may be recoverable on the ERISA claims in the Southern District of New York proceeding described above.

We continue to monitor the qui tam action (brought by a plaintiff to recover on behalf of the state as well as for himself) against Austin, Victory Capital Management, and KeyCorp as well as certain employees and former employees in state court in New Mexico seeking recovery under New Mexico law for alleged losses sustained by certain New Mexico public investment funds.

The remaining costs associated with the Austin Madoff-related proceedings may be significant, and we have established reserves for our legal costs in the proceedings, consistent with applicable accounting guidance and the advice of our counsel. At this stage of the proceedings, however, we are unable to determine if the remaining claims would individually or in the aggregate reasonably be expected to have a material adverse effect on our consolidated results of operations. We continue to strongly disagree with the allegations asserted against us in these matters, and intend to vigorously defend them.

Based upon the information currently available to us, including the advice of counsel, we believe the settlement amounts paid to the Department and any liability for either or both of the litigation and arbitration proceedings, should be covered under the terms and conditions of our insurance policy, subject to a $25 million self-insurance deductible, which we believe we have met, and usual policy exceptions and limits.

Metyk litigation. As previously reported, two putative class actions were filed on September 21, 2010 in the United States District Court for the Northern District of Ohio (the “Northern District of Ohio”). The plaintiffs in these cases sought to represent a class of all participants in our 401(k) Savings Plan and alleged that the defendants in the lawsuit breached fiduciary duties owed to them under ERISA. These two putative class action lawsuits were substantively consolidated with each other in a proceeding styled Thomas Metyk, et al. v. KeyCorp, et al. (“Metyk”). A substantially similar class action, Taylor v. KeyCorp, et al., was dismissed from the Northern District of Ohio on August 12, 2010. This dismissal was affirmed by the United States Court of Appeals for the Sixth Circuit on May 25, 2012. On January 29, 2013, the Northern District of Ohio entered its order granting the defendants’ motion to dismiss the plaintiffs’ consolidated complaint for failure to state a claim and entered its final judgment terminating the Metyk proceeding. On February 19, 2013, plaintiffs filed a motion to set aside the final judgment and to permit the plaintiffs to file an amended complaint. On April 30, 2013, the court denied the motion to set aside the final judgment.

Other litigation. In the ordinary course of business, we are subject to various other litigation, investigations and administrative proceedings. These other matters may involve claims for substantial monetary relief. Due to the complex nature of these various other matters, it may be years before some matters are resolved. While it is impossible to ascertain the ultimate resolution or range of financial liability, based on information presently known to us, we do not believe there is any other matter to which we are a party, or involving any of our properties that, individually or in the aggregate, would reasonably be expected to have a material adverse effect on our financial condition. We note, however, that in light of the inherent uncertainty in legal proceedings there can be no assurance that the ultimate resolution will not exceed established reserves. As a result, the outcome of a particular matter, or a combination of matters, may be material to our results of operations for a particular period, depending upon the size of the loss or our income for that particular period.

Guarantees

We are a guarantor in various agreements with third parties. The following table shows the types of guarantees that we had outstanding at March 31, 2013. Information pertaining to the basis for determining the liabilities recorded in connection with these guarantees is included in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Guarantees” on page 128 of our 2012 Form 10-K.

 

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March 31, 2013

in millions

           Maximum Potential
Undiscounted
Future Payments
     Liability
                Recorded
 

 

 

Financial guarantees:

     

Standby letters of credit

     $ 10,563         $ 63   

Recourse agreement with FNMA

     1,164          

Return guarantee agreement with LIHTC investors

     20         20   

Written put options (a)

     2,021         30   

Default guarantees

     15         —   

 

 

Total

     $ 13,783         $ 120   
  

 

 

    

 

 

 

 

 

 

(a) The maximum potential undiscounted future payments represent notional amounts of derivatives qualifying as guarantees.

We determine the payment/performance risk associated with each type of guarantee described below based on the probability that we could be required to make the maximum potential undiscounted future payments shown in the preceding table. We use a scale of low (0-30% probability of payment), moderate (31-70% probability of payment) or high (71-100% probability of payment) to assess the payment/performance risk, and have determined that the payment/performance risk associated with each type of guarantee outstanding at March 31, 2013, is low.

Standby letters of credit. KeyBank issues standby letters of credit to address clients’ financing needs. These instruments obligate us to pay a specified third party when a client fails to repay an outstanding loan or debt instrument or fails to perform some contractual nonfinancial obligation. Any amounts drawn under standby letters of credit are treated as loans to the client; they bear interest (generally at variable rates) and pose the same credit risk to us as a loan. At March 31, 2013, our standby letters of credit had a remaining weighted-average life of 3.0 years, with remaining actual lives ranging from less than one year to as many as ten years.

Recourse agreement with FNMA. We participate as a lender in the FNMA Delegated Underwriting and Servicing program. FNMA delegates responsibility for originating, underwriting, and servicing mortgages, and we assume a limited portion of the risk of loss during the remaining term on each commercial mortgage loan that we sell to FNMA. We maintain a reserve for such potential losses in an amount that we believe approximates the fair value of our liability. At March 31, 2013, the outstanding commercial mortgage loans in this program had a weighted-average remaining term of 6.4 years, and the unpaid principal balance outstanding of loans sold by us as a participant was $3.6 billion. As shown in the preceding table, the maximum potential amount of undiscounted future payments that we could be required to make under this program is equal to approximately one-third of the principal balance of loans outstanding at March 31, 2013. If we are required to make a payment, we would have an interest in the collateral underlying the related commercial mortgage loan; any loss we incur could be offset by the amount of any recovery from the collateral.

Return guarantee agreement with LIHTC investors. KAHC, a subsidiary of KeyBank, offered limited partnership interests to qualified investors. Partnerships formed by KAHC invested in low-income residential rental properties that qualify for federal low income housing tax credits under Section 42 of the Internal Revenue Code. In certain partnerships, investors paid a fee to KAHC for a guaranteed return that is based on the financial performance of the property and the property’s confirmed LIHTC status throughout a fifteen-year compliance period. Typically, KAHC fulfills these guaranteed returns by distributing tax credits and deductions associated with the specific properties. If KAHC defaults on its obligation to provide the guaranteed return, KeyBank is obligated to make any necessary payments to investors. No recourse or collateral is available to offset our guarantee obligation other than the underlying income stream from the properties and the residual value of the operating partnership interests.

As shown in the previous table, KAHC maintained a reserve in the amount of $20 million at March 31, 2013, which we believe will be sufficient to cover estimated future obligations under the guarantees. The maximum exposure to loss reflected in the table represents undiscounted future payments due to investors for the return on and of their investments.

These guarantees have expiration dates that extend through 2018, but KAHC has not formed any new partnerships under this program since October 2003. Additional information regarding these partnerships is included in Note 9 (“Variable Interest Entities”).

Written put options. In the ordinary course of business, we “write” interest rate caps and floors for commercial loan clients that have variable and fixed rate loans, respectively, with us and wish to mitigate their exposure to changes in interest rates. At March 31, 2013, our written put options had an average life of 2.2 years. These instruments are considered to be guarantees, as we are required to make payments to the counterparty (the commercial loan client) based on changes in an

 

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underlying variable that is related to an asset, a liability, or an equity security that the client holds (i.e., the commercial loan client). We are obligated to pay the client if the applicable benchmark interest rate is above or below a specified level (known as the “strike rate”). These written put options are accounted for as derivatives at fair value, as further discussed in Note 7 (“Derivatives and Hedging Activities”). We typically mitigate our potential future payment obligations by entering into offsetting positions with third parties.

Written put options where the counterparty is a broker-dealer or bank are accounted for as derivatives at fair value but are not considered guarantees since these counterparties typically do not hold the underlying instruments. In addition, we are a purchaser and seller of credit derivatives, which are further discussed in Note 7.

Default guarantees. Some lines of business participate in guarantees that obligate us to perform if the debtor (typically a client) fails to satisfy all of its payment obligations to third parties. We generally undertake these guarantees for one of two possible reasons: either the risk profile of the debtor should provide an investment return, or we are supporting our underlying investment in the debtor. The terms of these default guarantees range from less than one year to as many as 6.2 years; some default guarantees do not have a contractual end date. Although no collateral is held, we would receive a pro rata share should the third party collect some or all of the amounts due from the debtor.

Other Off-Balance Sheet Risk

Other off-balance sheet risk stems from financial instruments that do not meet the definition of a guarantee as specified in the applicable accounting guidance, and from other relationships.

Liquidity facilities that support asset-backed commercial paper conduits. At March 31, 2013, we did not have any liquidity facilities remaining outstanding with any unconsolidated third-party commercial paper conduits. Our prior liquidity facility, which expired during the second quarter of 2012, obligated us to provide aggregate funding of up to a certain amount in the event that a credit market disruption or other factors prevented the conduit from issuing commercial paper.

Indemnifications provided in the ordinary course of business. We provide certain indemnifications, primarily through representations and warranties in contracts that we execute in the ordinary course of business in connection with loan sales and other ongoing activities, as well as in connection with purchases and sales of businesses. We maintain reserves, when appropriate, with respect to liability that reasonably could arise as a result of these indemnities.

Intercompany guarantees. KeyCorp and certain of our affiliates are parties to various guarantees that facilitate the ongoing business activities of other affiliates. These business activities encompass issuing debt, assuming certain lease and insurance obligations, purchasing or issuing investments and securities, and engaging in certain leasing transactions involving clients.

 

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16. Accumulated Other Comprehensive Income

Our changes in accumulated other comprehensive income for the three months ended March 31, 2013, are as follows:

 

in millions    Unrealized gains 
        (losses) on available 
for sale securities 
     Unrealized gains 
(losses) on derivative 
        financial  instruments 
             Foreign currency 
translation 
adjustment 
             Net pension and 
postretirement 
benefit costs 
               Total  

 

 

Balance at December 31, 2012

    $ 229         $ 18         $ 55         $ (426)        $ (124)    

Other comprehensive income before reclassification

     (22)          2          (7)          3          (24)    

Amounts reclassified fromaccumulated other comprehensive income (a)

     —          (10)          (4)          —          (14)    

 

 

Net current-period other comprehensive income

     (22)          (8)          (11)          3          (38)    

 

 

Balance at March 31, 2013

    $ 207         $ 10         $ 44         $ (423)        $ (162)    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
              

 

 

 

(a) See table below for details about these reclassifications.

 

Our reclassifications out of accumulated other comprehensive income for the three months ended March 31, 2013 are as follows:

 

in millions                   Amount Reclassified from
Accumulated Other
Comprehensive Income
    

Affected Line Item in the Statement 

Where Net Income is Presented 

 

Unrealized gains (losses) on derivative

    

financial instruments

    

Interest rate

   $ 22        Interest income — Loans 

Interest rate

     (3)        Interest expense — Long term debt 

Foreign exchange contracts

     (3)        Other income 
 

 

 

    
     16        Income (loss) from continuing operations before income taxes 
     6        Income taxes 
 

 

 

    
   $ 10        Income (loss) from continuing operations 
 

 

 

    

Foreign currency translation adjustment            

    
   $ 7        Corporate services income 
 

 

 

    
     7        Income (loss) from continuing operations before income taxes 
     3        Income taxes 
 

 

 

    
   $ 4        Income (loss) from continuing operations 
 

 

 

    

 

 

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17.  Shareholders’ Equity

Comprehensive Capital Plan

During the first quarter of 2013, Key completed $65 million of Common Share repurchases on the open market under Key’s 2012 capital plan submitted to the Federal Reserve in January 2012. On January 7, 2013, we submitted to the Federal Reserve and provided to the OCC under the annual CCAR process our 2013 capital plan. On March 14, 2013, the Federal Reserve announced that it did not object to our 2013 capital plan. At its March 2013 meeting, our Board authorized up to $426 million in repurchases of our Common Shares in the open market or through privately negotiated transactions. The authorization was expressly in addition to any amounts remaining under preexisting authority. Common Share repurchases under the current authorization are expected to be executed through the first quarter of 2014.

Our 2013 capital plan also proposed an increase in our quarterly Common Share dividend from $0.05 to $0.055 per share. The Board will evaluate the proposed dividend increase at its May meeting.

 

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18.  Line of Business Results

The specific lines of business that constitute each of the major business segments (operating segments) are described below.

Key Community Bank

Key Community Bank serves individuals and small to mid-sized businesses through its 14-state branch network.

Individuals are provided branch-based deposit and investment products, personal finance services and loans, including residential mortgages, home equity, credit card and various types of installment loans. In addition, financial, estate and retirement planning, asset management services, and Delaware Trust capabilities are offered to assist high-net-worth clients with their banking, trust, portfolio management, insurance, charitable giving, and related needs.

Small businesses are provided deposit, investment and credit products, and business advisory services. Mid-sized businesses are provided products and services that include commercial lending, cash management, equipment leasing, investment and employee benefit programs, succession planning, access to capital markets, derivatives, and foreign exchange.

Key Corporate Bank

Key Corporate Bank is a full-service corporate and investment bank focused principally on serving the needs of middle market clients in six industry sectors: consumer, energy, healthcare, industrial, public sector and real estate. Key Corporate Bank delivers a broad product 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 also delivers many of its product capabilities to clients of Key Community Bank.

Other Segments

Other Segments consist of Corporate Treasury, Community Development, Principal Investing and various exit portfolios.

Reconciling Items

Total assets included under “Reconciling Items” primarily represent the unallocated portion of nonearning assets of corporate support functions. Charges related to the funding of these assets are part of net interest income and are allocated to the business segments through noninterest expense. Reconciling Items also includes intercompany eliminations and certain items that are not allocated to the business segments because they do not reflect their normal operations.

The table on the following pages shows selected financial data for our two major business segments for the three-month periods ended March 31, 2013, and 2012.

The information was derived from the internal financial reporting system we use to monitor and manage our financial performance. GAAP guides financial accounting, but there is no authoritative guidance for “management accounting” — the way we use our judgment and experience to make reporting decisions. Consequently, the line of business results we report may not be comparable to line of business results presented by other companies.

The selected financial data are based on internal accounting policies designed to compile results on a consistent basis and in a manner that reflects the underlying economics of the businesses. In accordance with our policies:

 

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Net interest income is determined by assigning a standard cost for funds used or a standard credit for funds provided based on their assumed maturity, prepayment and/or repricing characteristics.

 

¿  

Indirect expenses, such as computer servicing costs and corporate overhead, are allocated based on assumptions regarding the extent to which each line of business actually uses the services.

 

¿  

The consolidated provision for loan and lease losses is allocated among the lines of business primarily based on their actual net charge-offs, adjusted periodically for loan growth and changes in risk profile. The amount of the consolidated provision is based on the methodology that we use to estimate our consolidated allowance for loan and lease losses. This methodology is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan and Lease Losses” on page 120 of our 2012 Form 10-K.

 

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¿  

Income taxes are allocated based on the statutory federal income tax rate of 35% (adjusted for tax-exempt interest income, income from corporate-owned life insurance and tax credits associated with investments in low-income housing projects) and a blended state income tax rate (net of the federal income tax benefit) of 2.2%.

 

¿  

Capital is assigned to each line of business based on regulatory requirements.

Developing and applying the methodologies that we use to allocate items among our lines of business is a dynamic process. Accordingly, financial results may be revised periodically to reflect enhanced alignment of expense base allocation drivers, changes in the risk profile of a particular business, or changes in our organizational structure.

 

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Three months ended March 31,    Key Community Bank     Key Corporate Bank  
dollars in millions    2013       2012       2013       2012    

 

 

SUMMARY OF OPERATIONS

        

Net interest income (TE)

    $ 361        $ 357        $ 187        $ 196    

Noninterest income

     188         175         192         182    

 

 

Total revenue (TE) (a)

     549         532         379         378    

Provision (credit) for loan and lease losses

     59         4         4         13    

Depreciation and amortization expense

     20         9         12         16    

Other noninterest expense

     420         427         197         206    

 

 

Income (loss) from continuing operations before income taxes (TE)

     50         92         166         143    

Allocated income taxes and TE adjustments

     19         34         61         52    

 

 

Income (loss) from continuing operations

     31         58         105         91    

Income (loss) from discontinued operations, net of taxes

     —         —         —         —    

 

 

Net income (loss)

     31         58         105         91    

Less: Net income (loss) attributable to noncontrolling interests

     —         —         —         —    

 

 

Net income (loss) attributable to Key

    $ 31        $ 58        $ 105        $ 91    
  

 

 

   

 

 

   

 

 

   

 

 

 
        

 

 

AVERAGE BALANCES (b)

        

Loans and leases

    $                 28,982        $                 25,981        $                 20,039        $                 18,584    

Total assets (a)

     31,478         28,223         23,860         22,847    

Deposits

     49,359         47,506         13,957         11,556    

 

 

OTHER FINANCIAL DATA

        

Net loan charge-offs (b)

    $ 47        $ 47        $ (1)        $ 25    

Return on average allocated equity (b)

     4.38       8.18       26.35       19.89  

Return on average allocated equity

     4.38         8.18         26.35         19.89    

Average full-time equivalent employees (c)

     8,830         8,707         1,924         2,020    

 

 

 

(a) Substantially all revenue generated by our major business segments is derived from clients that reside in the United States. Substantially all long-lived assets, including premises and equipment, capitalized software, and goodwill held by our major business segments, are located in the United States.

 

(b) From continuing operations.

 

(c) The number of average full-time equivalent employees has not been adjusted for discontinued operations.

 

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Other Segments     Total Segments     Reconciling Items     Key  
2013       2012       2013       2012       2013       2012       2013       2012    

 

 

 
  $ 39         $ 3          $ 587         $ 556          $ 2         $ 3          $ 589         $ 559     
  44         91          424         448          1         (6)         425         442     

 

 

 
  83         94         1,011         1,004         3         (3)         1,014         1,001    
  (7)         25         56         42         (1)         —         55         42    
  2         3         34         28         32         32         66         60    
  17         25          634         658          (19)         (39)         615         619     

 

 

 
  71         41         287         276         (9)         4         278         280    
  2         (9)         82         77         (6)         2         76         79    

 

 

 
  69         50         205         199         (3)         2         202         201    
  —         —         —         —         $ 3         (1)         3         (1)    

 

 

 
  69         50         205         199         —         1         205         200    
  1         —         1         —         —         —         1         —    

 

 

 
  $             68         $             50         $             204         $             199         —         $             1         $             204         $             200    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 
  $ 3,562         $ 4,825         $ 52,583         $ 49,390         $             43         $ 40         $ 52,626         $ 49,430    
  26,795         28,556         82,133         79,626         582         798         82,715         80,424    
  625         749         63,941         59,811         (306)         (180)         63,635         59,631    

 

 

 
  $ 3         $ 29         $ 49         $ 101         —         —         $ 49         $ 101    
  39.45       24.29       15.95       14.50       (.24)       .18       7.93       8.09  
  39.45         24.29         15.95         14.50         —         0.09         8.05         8.05    
  49         53         10,803         10,780         4,593         4,624         15,396         15,404    

 

 

 

 

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Report of Independent Registered Public Accounting Firm

Shareholders and Board of Directors

KeyCorp

We have reviewed the consolidated balance sheets of KeyCorp and subsidiaries (“Key”) as of March 31, 2013 and 2012, the related consolidated statements of income and comprehensive income for the three-month periods ended March 31, 2013 and 2012, and the related consolidated statements of changes in equity and cash flows for the three-month periods ended March 31, 2013 and 2012. These financial statements are the responsibility of Key’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Key as of December 31, 2012, and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for the year then ended not presented herein, and in our report dated February 26, 2013, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2012, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

 

 

 Signature here

 
     
     
 
Cleveland, Ohio      
May 1, 2013  

/s/ Ernst & Young LLP

 

 

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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 and year to date periods ended March 31, 2013 and 2012. 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 “2012 Form 10-K” refer to our Form 10-K for the year ended December 31, 2012, which has been filed with the SEC and is available on its website (www.sec.gov) or 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, Victory and Austin. The education lending business and Austin have been accounted for as discontinued operations since 2009. Victory was moved to held for sale and classified as discontinued operation in our first quarter 2013 financial reporting as a result of the sale of this business that was announced on February 21, 2013.

 

¿  

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 in the section entitled “Introduction” that begins on page 37 of our 2012 Form 10-K, the regulators conduct a review of capital adequacy for each of the country’s nineteen largest banking institutions, including KeyCorp. This regulatory assessment began in 2009 and has continued into 2013. As part of this capital adequacy review, banking regulators evaluated a component of Tier 1 capital, known as Tier 1 common equity. For a detailed explanation of total capital, Tier 1 capital and Tier 1 common equity and how they are calculated see the section entitled “Capital.”

Additionally, a comprehensive list of the acronyms and abbreviations used throughout this discussion is included in Note 1 (“Basis of Presentation”).

 

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Selected financial data

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

Figure 1. Selected Financial Data

 

     2013     2012  
dollars in millions, except per share amounts    First     Fourth     Third     Second     First  

 

 

FOR THE PERIOD

          

Interest income

     $ 667       $ 688       $ 671       $ 662       $ 684    

Interest expense

     84       87       99       124       131    

Net interest income

     583       601       572        538        553    

Provision (credit) for loan and lease losses

     55       57       109       21       42    

Noninterest income

     425       439       518       457       442    

Noninterest expense

     681       734       712       693       679    

Income (loss) from continuing operations before income taxes

     272       249       269       281       274    

Income (loss) from continuing operations attributable to Key

     201       196       216        222        201    

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

     3       7       3        14        (1)    

Net income (loss) attributable to Key

     204       203       219        236        200    

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

     196       190       211       217       195    

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

     3       7       3       14       (1)    

Net income (loss) attributable to Key common shareholders

     199       197       214         231         194    

 

 

PER COMMON SHARE

          

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

     $ .21       $ .21       $ .23       $ .23       $ .21    

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

           .01              .01        —    

Net income (loss) attributable to Key common shareholders(d)

     .22       .21       .23        .24        .20    

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

     $ .21       $ .20       $ .22        $ .23        $ .20    

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

           .01              .01        —    

Net income (loss) attributable to Key common shareholders — assuming dilution (d)

     .21       .21       .23        .24        .20    

Cash dividends paid

     .05       .05       .05       .05       .03    

Book value at period end

     10.89       10.78       10.64       10.43       10.26    

Tangible book value at period end

     9.78       9.67       9.54       9.45       9.28    

Market price:

          

High

     10.19       9.01       9.12       8.54       8.82    

Low

     8.29       7.96       7.46       6.80       7.26    

Close

     9.96       8.42       8.74       7.74       8.50    

Weighted-average common shares outstanding (000)

     920,316       925,725       936,223       944,648       949,342    

Weighted-average common shares and potential common shares outstanding (000)

     926,051       930,382       940,764       948,087       953,971    

 

 

AT PERIOD END

          

Loans

     $ 52,574       $ 52,822       $ 51,419       $ 49,605       $ 49,226    

Earning assets

     75,066       75,055       72,139       71,899       72,796    

Total assets

     89,198       89,236       86,950       86,523       87,431    

Deposits

     64,654       65,993       64,188       62,167       61,494    

Long-term debt

     7,785       6,847       6,119       7,521       8,898    

Key common shareholders’ equity

     10,049       9,980       9,960       9,864       9,808    

Key shareholders’ equity

     10,340       10,271       10,251       10,155       10,099    

 

 

PERFORMANCE RATIOS — FROM CONTINUING OPERATIONS

          

Return on average total assets

     .99   %      .96   %      1.00   %      1.03   %      1.01    % 

Return on average common equity

     7.96       7.58       8.41        8.84        8.08    

Return on average tangible common equity

     8.87       8.45       8.45       8.90       8.94    

Net interest margin (TE)(b)

     3.24       3.37       3.23        3.06        3.16    

Cash efficiency ratio(b)

     65.98       69.02       64.96       69.23       67.73    

 

 

PERFORMANCE RATIOS — FROM CONSOLIDATED OPERATIONS

          

Return on average total assets

     .94   %      .93   %      1.01   %      1.10   %      .93    % 

Return on average common equity

     8.08       7.86       8.57        9.47        8.04    

Return on average tangible common equity(b)

     9.01       8.77       9.56       10.46       8.90    

Net interest margin (TE)

     3.16       3.29       3.14        2.99        3.08    

Loan to deposit(c)

     86.95       85.77       86.24       86.38       86.97    

 

 

CAPITAL RATIOS AT PERIOD END

          

Key shareholders’ equity to assets

     11.59   %      11.51   %      11.79   %      11.74   %      11.55    % 

Key common shareholders’ equity to assets

     11.27       11.18       11.45       11.40       11.22    

Tangible common equity to tangible assets(b)

     10.24       10.15       10.39       10.44       10.26    

Tier 1 common equity(b)

     11.40       11.36       11.30       11.63       11.55    

Tier 1 risk-based capital

     12.19       12.15       12.10       12.45       13.29    

Total risk-based capital

     15.02       15.13       15.17       15.83       16.68    

Leverage

     11.36       11.41       11.37       11.35       12.12    

 

 

TRUST AND BROKERAGE ASSETS

          

Assets under management

     $         35,714       $         34,744       $         35,587       $         35,148       $         35,862    

Nonmanaged and brokerage assets

     37,115   (e)     35,550   (e)     34,322       33,803       33,021    

 

 

OTHER DATA

          

Average full-time-equivalent employees

     15,396       15,589       15,833       15,455       15,404    

Branches

     1,084       1,088       1,087       1,062       1,059    

 

 

 

(a)

In April 2009, we decided to wind down the operations of Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers. In September 2009, we decided to discontinue the education lending business conducted through Key Education Resources, the education payment and financing unit of KeyBank National Association. In February 2013, we decided to sell Victory to a private equity fund. As a result of these decisions, we have accounted for these businesses as discontinued operations. For further discussion regarding the income (loss) from discontinued operations see Note 11 (“Acquisitions and Discontinued Operations”).

(b) See Figure 8 entitled “GAAP to Non-GAAP Reconciliations,” which presents the computations of certain financial measures related to “tangible common equity,” “Tier 1 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.
(c) Represents period-end consolidated total loans and loans held for sale (excluding education loans in the securitizations trusts) divided by period-end consolidated total deposits (excluding deposits in foreign office).
(d) EPS may not foot due to rounding.
(e) This figure has been revised from what has previously been disclosed in our earnings release on April 18, 2013.

 

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Additional Consolidated Statements of Income

Our first quarter 2013 financial results include noninterest line items that reflect our current business mix and also account for Victory, which we have agreed to sell to a private equity fund, as a discontinued operation. The following consolidated statements of income for the periods indicated are presented consistently with our first quarter 2013 financial results.

 

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Figure 2. Consolidated Statements of Income (Unaudited)

 

         2013          2012  
dollars in millions    First      Fourth      Third      Second      First  

 

 

Interest income

              

Loans

     $ 548          $ 563          $ 538          $ 518          $ 536    

Loans held for sale

     4          5          5          5          5    

Securities available for sale

     80          85          93          105          116    

Held-to-maturity securities

     18          19          21          17          12    

Trading account assets

     6          3          4          5          6    

Short-term investments

     2          2          1          2          1    

Other investments

     9          11          9          10          8    

 

 

Total interest income

     667          688          671          662          684    

Interest expense

              

Deposits

     45          49          60          71          77    

Federal funds purchased and securities sold under repurchase agreements

     1          1          1          1          1    

Bank notes and other short-term borrowings

     1          2          1          2          2    

Long-term debt

     37          35          37          50          51    

 

 

Total interest expense

     84          87          99          124          131    

 

 

Net interest income

     583          601          572          538          553    

Provision (credit) for loan and lease losses

     55          57          109          21          42    

 

 

Net interest income (expense) after provision for loan and lease losses

     528          544          463          517          511    

Noninterest income (a)

              

Trust and investment services income

     95          95          94          90          96    

Investment banking and debt placement fees

     79          110          83          73          61    

Service charges on deposit accounts

     69          75          74          70          68    

Operating lease income and other leasing gains

     23          19          66          58          52    

Corporate services income

     45          41          39          44          44    

Cards and payments income

     37          38          37          31          29    

Corporate-owned life insurance income

     30          36          26          30          30    

Consumer mortgage income

     7          11          11          9          9    

Net gains (losses) from principal investing

     8          2          11          24          35    

Other income (b)

     32          12          77          28          18    

 

 

Total noninterest income

     425          439          518          457          442    

Noninterest expense

              

Personnel

     391          422          399          377          372    

Net occupancy

     64          69          65          62          64    

Computer processing

     39          38          42          43          41    

Business services and professional fees

     35          54          48          51          37    

Equipment

     26          27          27          27          26    

Operating lease expense

     12          12          13          15          17    

Marketing

     6          20          18          17          13    

FDIC assessment

     8          8          7          8          8    

Intangible asset amortization on credit cards

     8          8          6          —          —    

Other intangible asset amortization

     4          4          3          1          1    

Provision (credit) for losses on lending-related commitments

     3          (14)          (8)          6          —    

OREO expense, net

     3          1          1          7          6    

Other expense

     82          85          91          79          94    

 

 

Total noninterest expense

     681          734          712          693          679    

 

 

Income (loss) from continuing operations before income taxes

     272          249          269          281          274    

Income taxes

     70          53          51          54          73    

 

 

Income (loss) from continuing operations

     202          196          218          227          201    

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

     3          7          3          14          (1)    

 

 

Net income (loss)

     205          203          221          241          200    

Less: Net income (loss) attributable to noncontrolling interests

     1          —          2          5          —    

 

 

Net income (loss) attributable to Key

     $             204          $             203          $             219          $             236          $             200    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

     $ 196          $ 190          $ 211          $ 217          $ 195    

Net income (loss) attributable to Key common shareholders

     199          197          214          231          194    

Per common share

              

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

     $ .21          $ .21          $ .23          $ .23          $ .21    

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

     —          .01          —          .01          —    

Net income (loss) attributable to Key common shareholders (d)

     .22          .21          .23          .24          .20    

Per common share — assuming dilution

              

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

     $ .21          $ .20          $ .22          $ .23          $ .20    

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

     —          .01          —          .01          —    

Net income (loss) attributable to Key common shareholders (d)

     .21          .21          .23          .24          .20    

Cash dividends declared per common share

     $ .05          $ .05          $ .05          $ .05          $ .03    

Weighted-average common shares outstanding (000)

     920,316          925,725          936,223          944,648          949,342    

Weighted-average common shares and potential common shares outstanding (000) (e)

     926,051          930,382          940,764          948,087          953,971    

 

 

 

(a)

The noninterest income line items have been changed for all prior periods presented to reflect our current business mix.

 

(b)

For the three months ended March 31, 2013, December 31, 2012, September 30, 2012, June 30, 2012, and March 31, 2012, we did not have any impairment losses related to securities.

 

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(c)

In April 2009, we decided to wind down the operations of Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers. In September 2009, we decided to discontinue the education lending business conducted through Key Education Resources, the education payment and financing unit of KeyBank National Association. In February 2013, we decided to sell Victory to a private equity fund. As a result of these decisions, we have accounted for these businesses as discontinued operations. For further discussion regarding the income (loss) from discontinued operations see Note 11 (“Acquisitions and Discontinued Operations”).

 

(d)

Earnings per share may not foot due to rounding.

 

(e)

Assumes conversion of stock options and/or Preferred Series A shares, as applicable.

 

 

 

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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,” “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 statements in our 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 are not historical facts and, 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 actual results to differ from those described in forward-looking statements include, but are not limited to:

 

   

continued strain on the global financial markets as a result of economic slowdowns and concerns;

 

   

the slow progress of the U.S. economic recovery;

 

   

changes in trade, monetary and fiscal policies of various governmental bodies and central banks in the economies in which we operate;

 

   

our ability to anticipate interest rate changes correctly and manage interest rate risk presented through unanticipated changes in our interest rate risk position and/or short- and long-term interest rates;

 

   

changes in local, regional and international business, economic or political conditions in the regions where we operate or have significant assets;

 

   

current regulatory initiatives in the U.S., including the Dodd-Frank Act, subjecting us to a variety of new and more stringent legal and regulatory requirements and increased scrutiny from our regulators;

 

   

the deterioration of unemployment or real estate asset values or their failure to recover for an extended period of time;

 

   

adverse changes in credit quality trends;

 

   

our ability to determine accurate values of certain assets and liabilities;

 

   

adverse behaviors in securities, public debt, and capital markets, including changes in market liquidity and volatility;

 

   

unanticipated changes in our liquidity position, including but not limited to our ability to enter the financial markets to manage and respond to any changes to our liquidity position;

 

   

the soundness of other financial institutions;

 

   

our ability to satisfy new capital and liquidity standards such as those imposed by the Dodd-Frank Act and those adopted by the Basel Committee;

 

   

our ability to receive dividends from our subsidiary, KeyBank;

 

   

reductions of the credit ratings assigned to KeyCorp and KeyBank;

 

   

unexpected or prolonged changes in the level or cost of liquidity;

 

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our ability to secure alternative funding sources under stressed liquidity conditions;

 

   

our ability to timely and effectively implement our strategic initiatives;

 

   

operational or risk management failures;

 

   

breaches of security or failures of our technology systems due to technological, cybersecurity threats or other factors;

 

   

the occurrence of natural or man-made disasters or conflicts or terrorist attacks disrupting the economy or our ability to operate;

 

   

the adequacy of our risk management programs;

 

   

adverse judicial proceedings;

 

   

increased competitive pressure due to consolidation;

 

   

our ability to attract and/or retain talented executives and employees;

 

   

our ability to effectively sell additional products or services to new or existing customers;

 

   

our ability to manage our reputational risks;

 

   

unanticipated adverse effects of acquisitions and dispositions of assets, business units or affiliates; and

 

   

other risks and uncertainties discussed in Part 1, Item 1. Business under the heading “Supervision and Regulation” and Item 1A. Risk Factors, each in our 2012 Form 10-K.

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 our reports on Forms 8-K, 10-K and 10-Q 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.

Economic overview

Overall, the economy in the first quarter 2013 exceeded expectations, with GDP of 2.5%. Businesses continuing to hire and invest and consumers spent freely despite considerable headwinds. Strength, however, was concentrated in January and February, with the economy clearly losing momentum in March. The slowdown was broad-based, and reflected across multiple data points.

In the first three months of the year, payroll growth totaled 504,000 jobs, representing a modest slowdown from the fourth quarter of 2012. Monthly data was volatile, with a moderate pace of job creation in January, a spike in February, and a sharp deceleration in March. Unemployment declined through the quarter, falling to 7.6%, driven by continued contraction in the labor force. Civilian labor force participation fell to the lowest point since 1979, ending the quarter at 63.3%.

Consumption held up remarkably well early in the year, despite higher taxes related to the American Taxpayer Relief Act of 2012 and a spike in gas prices. For the quarter, consumer spending accelerated to 3.2%, well above expectations of a modest increase, and providing a significant source of upside risk for GDP. As in prior quarters, durable goods led gains, with vehicle sales averaging 15.3 million units on a seasonally adjusted annual rate basis, up 8% from one year ago. Consistent with other data, spending slowed in March, with retail sales declining 0.4%. Consumer sentiment was also depressed in the quarter, with the Conference Board Consumer Confidence measure twice falling below 60 for the first time since 2011. Inflation remains relatively tame, with energy prices driving a sharp increase in the headline rate in February before falling back in March. Inflation is well within the Federal Reserve’s comfort zone, with core personal consumption expenditures up just 1.3% as of February.

 

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The housing market remains an important bright spot for the economy, with notable improvement continuing across indicators in the first quarter of 2013. Demand is firming, rising to a rate of 5.0 million seasonally adjusted annual home sales in February, the fastest pace since the 2009 homebuyer tax credits. New home sales experienced similar gains, up 12.3% over the prior year. Inventory levels have fallen sharply as a result of increased demand and years of muted construction activity and as of the date of this report are now at just 4.7 months of supply for existing and 4.4 months for new homes. This factor is driving solid home price appreciation, with prices up 10.2% in February from one year ago. Builders are responding to these favorable trends, with housing starts exceeding 1.0 million in March, up 46.7% from the prior year. For the first quarter of 2013 overall, residential construction added 31 basis points to growth, which was consistent with the 2012 contribution.

Treasury yields broadly reflected trends in economic data, rising as the data improved in the first two months, but falling again toward quarter end as data disappointed. Other factors, however, were also at work. FOMC minutes through the quarter reflect a committee increasingly concerned about the price of quantitative easing and more open to the possibility of winding down asset purchases. The language clearly provided upward pressure on yields, but committee actions remained firmly accommodative, with the federal funds target rate near zero and monthly asset purchases totaling $85 billion. Yields on the 10-year UST moved as high as 2.06% in mid-March, until weak economic data, rising tensions in the Korean peninsula, and the Cyprus bail-out drove yields downward, ending the quarter at 1.85%.

Long-term financial goals

Our long-term financial goals are as follows:

 

¿  

Target a loan-to-core deposit ratio range of 90% to 100%;

 

¿  

Return to a moderate risk profile by targeting a net charge-off ratio range of .40% to .60%;

 

¿  

Grow high quality and diverse revenue streams by targeting a net interest margin in excess of 3.50%, and ratio of noninterest income to total revenue of greater than 40%;

 

¿  

Create positive operating leverage and target a cash efficiency ratio in the range of 60% to 65%; and

 

¿  

Achieve a return on average assets in the range of 1.00% to 1.25%.

Figure 3 shows the evaluation of our long-term financial goals for the first quarter of 2013.

Figure 3. Evaluation of Our Long-Term Financial Goals

 

KEY Business Model    Key Metrics(a)    1Q13      Targets     Action Plans

 

Core funded

  

 

Loan to deposit ratio (b)

  

 

 

 

87  %

 

  

  

 

 

 

90-100%

 

  

 

• Use integrated model to grow relationships and loans

 

• Improve deposit mix

 

Maintain a moderate risk profile

  

 

NCOs to average loans

  

 

 

 

.38  %

 

  

     .40-.60%     

• Focus on relationship clients

 

• Exit noncore portfolios

 

• Limit concentrations

 

• Focus on risk-adjusted returns

          
  

 

Provision to average loans

 

  

 

 

 

 

.42  %

 

 

  

 

    
          

 

Growing high quality,

diverse revenue streams

  

 

Net interest margin

  

 

 

 

3.24  %

 

  

  

 

 

 

> 3.50%

 

  

 

• Improve funding mix

 

• Focus on risk-adjusted returns

 

• Grow client relationships

 

• Capitalize on Key’s total client solutions and cross-selling capabilities

  

 

Noninterest income to total revenue

 

    

 

42  %

 

  

 

     > 40%     

 

Creating positive

operating leverage

   Cash efficiency ratio (c)   

 

 

 

66  %

 

  

  

 

 

 

60 - 65%

 

  

 

• Improve efficiency and effectiveness

 

• Better utilize technology

 

• Change cost base to more variable from fixed

 

Executing our strategies

 

  

 

Return on average assets

  

 

 

 

.99  %

 

  

  

 

 

 

1.00-1.25%

 

  

 

• Execute our client insight-driven relationship model

 

• Focus on operating leverage

 

• Improved funding mix with lower cost core deposits

 

(a) Calculated from continuing operations, unless otherwise noted.

 

(b) Represents period-end consolidated total loans and loans held for sale (excluding education loans in the securitization trusts) divided by period-end consolidated total deposits (excluding deposits in foreign office).

 

(c) Excludes intangible asset amortization; Non-GAAP measure: see Figure 4 for reconciliation.

 

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Strategic developments

We initiated the following actions during the first three months of 2013 to support our corporate strategy described in the “Introduction” section under the “Corporate Strategy” heading on page 41 of our 2012 Form 10-K.

 

¿  

On February 21, 2013, we announced an agreement to sell our investment management subsidiary, Victory Capital Management, and our broker-dealer affiliate, Victory Capital Advisors, to a private equity fund. The purchase price is $246 million, which will consist of $201 million of cash and a $45 million seller note payable to Key that is subject to adjustment at closing. We estimate that an after-tax gain in the range of $145 million to $155 million, subject to the final note valuation and terms and conditions of the sales contract, will be realized on this sale, which is expected to close in the third quarter of 2013. We are seeking no objection from the Federal Reserve to use the gain realized from the sale of Victory to repurchase Common Shares.

 

¿  

We have made progress on our efficiency initiative. Our cash efficiency ratio improved to 66.0% from 67.7% one year ago. We have realized $105 million in annualized expense savings and have made significant progress toward our $200 million goal by the end of 2013. During the second quarter of 2013, we expect to make further progress on our efficiency efforts as we consolidate branches and continue to work toward creating a variable cost base. Using our current levels of revenue and expense, these initiatives are intended to move us to our long-term efficiency ratio target range of 60% to 65%.

 

¿  

We completed $65 million of Common Share repurchases on the open market under our 2012 capital plan. Our authority to repurchase Common Shares under the 2012 capital plan expired on March 31, 2013.

 

¿  

On January 7, 2013, we submitted to the Federal Reserve and provided to the OCC under the annual CCAR process our 2013 capital plan. On March 14, the Federal Reserve announced that it did not object to our 2013 capital plan. Accordingly, at its March 2013 meeting, our Board authorized the repurchase of up to $426 million of our Common Shares in the open market or through privately negotiated transactions. Common Share repurchases under the new 2013 capital plan authorization are expected to be executed from the second quarter of 2013 through the first quarter of 2014.

 

¿  

Our 2013 capital plan also proposed an increase in our quarterly Common Share dividend from $0.05 to $0.055 per share. The Board will evaluate the proposed dividend increase at its May meeting.

 

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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, investment, lending, and personalized wealth management products and business advisory services. These products and services are provided through our relationship managers and specialists working in our 14-state branch network, which is organized into three internally defined geographic regions: Rocky Mountains and Northwest, Great Lakes, and Northeast.

Figure 4 shows the geographic diversity of Key Community Bank’s average deposits, commercial loans, and home equity loans.

Figure 4. Key Community Bank Geographic Diversity

 

     Geographic Region                         

Three months ended March 31, 2013

dollars in millions

   Rocky
Mountains and
Northwest
    Great Lakes     Northeast     Nonregion     (a)          Total  

 

 

Average deposits

   $ 15,834     $ 15,645     $       16,022     $ 1,858           $         49,359  

Percent of total

     32.1   %      31.7   %      32.5   %      3.7          %         100.0   % 

Average commercial loans

   $ 5,677     $ 4,131     $ 3,075     $ 2,202           $ 15,085  

Percent of total

     37.6   %      27.4   %      20.4   %      14.6          %         100.0   % 

Average home equity loans

   $ 4,621     $ 2,478     $ 2,564     $ 124           $ 9,787  

Percent of total

 

    

 

47.2

 

  % 

 

   

 

25.3

 

  % 

 

   

 

26.2

 

  % 

 

   

 

1.3

 

  

 

     

 

%

 

  

 

    

 

100.0

 

  % 

 

 

 

 

(a) Represents average deposits, commercial loan and home equity loan products centrally managed outside of our three Key Community Bank regions.

Key Corporate Bank is a full-service corporate and investment bank focused principally on serving the needs of middle market clients in six industry sectors: consumer, energy, healthcare, industrial, public sector and real estate. Key Corporate Bank delivers a broad product 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 also 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”).

 

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Supervision and regulation

Regulatory reform developments

On July 21, 2010, the Dodd-Frank Act became law. It was intended to address perceived deficiencies and gaps in the regulatory framework for financial services in the U.S., reduce the risks of bank failures, better equip the nation’s regulators to guard against or mitigate any future financial crises, and manage systemic risk through increased supervision of bank and nonbank SIFIs, such as KeyCorp and KeyBank. Further discussion concerning the Dodd-Frank Act, related regulatory developments, and the risks that they present to Key is available in under the heading “Supervision and Regulation” in Item 1. Business and under the heading “II. Compliance Risks” in Item 1A. Risk Factors of our 2012 Form 10-K. Many of the proposed rules referenced in our prior reports continue to remain pending. The following provides a summary of relevant regulatory developments relating to the Dodd-Frank Act or that relate to our results this quarter.

Supervisory and company-run stress testing

On March 7, 2013, the Federal Reserve published the results of its Dodd-Frank Annual Stress Test (“DFAST”), and on March 14, 2013, the Federal Reserve published the results of its CCAR. Each of these stress tests is required under the Dodd-Frank Act for certain banking organizations, including KeyCorp. On March 8, 2013, KeyCorp and KeyBank published the results of their annual company-run stress tests, which are also required by the Dodd-Frank Act. KeyCorp passed DFAST and, as previously reported, its 2013 capital plan under CCAR was not objected to by the Federal Reserve.

Enhanced prudential standards and early remediation requirements

On January 5, 2012, the Federal Reserve published proposed Regulation YY – Enhanced Prudential Standards – as part of its efforts to implement enhanced prudential standards and early remediation requirements to be imposed upon SIFIs pursuant to the Dodd-Frank Act. It generally applies to SIFIs like KeyCorp and includes a wide range of measures addressing issues such as risk-based capital requirements and leverage limits, liquidity requirements, single-counterparty credit limits, risk management, supervisory and company-run stress testing requirements, and early remediation. Comments to this proposed rule were due by April 30, 2012. We continue to monitor the implementation of this rule.

Bureau of Consumer Financial Protection

Title X of the Dodd-Frank Act created the CFPB as a new consumer financial services regulator. We are now subject to supervision, regulation and examination by the CFPB. The CFPB supervises banks and their affiliates, such as Key, with assets of more than $10 billion for compliance with federal consumer protection laws. The CFPB also regulates consumer financial products and services sold by banks and non-bank companies and has rule making authority with respect to federal consumer financial laws. Any new regulatory requirements promulgated by the CFPB or modifications in the interpretations of existing regulations could require changes to our consumer businesses. In addition, we may face potential enforcement actions by the CFPB and civil actions by state attorneys general for violation of various state and federal consumer protection laws.

On January 10, 2013, the CFPB issued its final rule to implement sections of the Dodd-Frank Act that will require lenders to verify a consumer’s ability to repay a mortgage loan. The rule establishes certain minimum requirements for creditors when making ability to pay determinations, and establishes certain protections from liability for mortgages meeting the definition of “qualified mortgages”. The final rule becomes effective on January 10, 2014. We are currently analyzing the final rule in order to determine its impact on Key’s mortgage lending business.

The CFPB issued its final rules on January 17, 2013, to implement sections of the Dodd-Frank Act addressing certain obligations of mortgage servicers to correct errors asserted by mortgage loan borrowers and to provide certain information requested by such borrowers. The final rules also: impose requirements on a mortgage servicer in connection with the force placement of collateral insurance; mandate certain notices prior to rate adjustments on adjustable-rate mortgages; and establish requirements for periodic disclosures to borrowers. These rules will apply directly to Key and to any third-party mortgage servicer engaged by Key, and become effective on January 10, 2014.

U.S. implementation of Basel III

On August 30, 2012, the federal banking agencies jointly published three separate NPRs seeking comment on proposed rules that would revise and replace their current capital rules in a manner consistent both with relevant provisions of the Dodd-Frank Act as well as the implementation of the Basel III capital framework. The comment period on these NPRs ended on October 22, 2012.

 

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One NPR (the “Basel III NPR”) proposes the majority of the revisions to international capital standards in Basel III, including a more restrictive definition of regulatory capital (such as providing for the phase-out of trust preferred securities as Tier 1 capital), higher minimum regulatory capital requirements, and the imposition of capital conservation and countercyclical capital buffers. It also proposes limitations on certain distributions and discretionary bonuses as well as revisions to the agencies’ prompt corrective action regulations. Another NPR (the “Standardized Approach NPR”) proposes new methodologies for determining risk-weighted assets, such as by expanding the number and type of exposure categories, providing a more comprehensive recognition of collateral and guarantees, and introducing or applying more risk-sensitive treatment for certain exposures (including certain high-volatility commercial real estate, corporate, equity, foreign, securitization, derivative, residential mortgage, and 90 day or more past due exposures). It also proposes detailed qualitative and quantitative public disclosure requirements relating to capital adequacy. The final NPR (the “Advanced Approaches NPR”) proposes to revise the current advanced approaches risk-based capital rule to incorporate certain aspects of Basel III as well as certain other revisions to the Basel capital framework published by the Basel Committee between 2009-2011. While Key and KeyBank are subject to the Basel III and Standardized Approach NPRs, they are not subject to the Advanced Approaches NPR.

Implementation of the Basel III final capital framework was proposed to begin on January 1, 2013, with minimum capital ratios and prompt corrective action requirements implemented by January 1, 2015, and the capital conservation buffer phased-in from January 1, 2016, through January 1, 2019. On November 9, 2012, however, the agencies issued a joint press release (the “November 2012 Release”) indicating that none of the Basel III, Standardized Approach, and Advanced Approaches NPRs would become effective on January 1, 2013, and that the agencies would take operational and other considerations into account when determining appropriate implementation dates and associated transition periods for them.

New Proposed Minimum Capital Requirements

As originally proposed, beginning January 1, 2013, banking organizations subject to the Basel III and Standardized Approach NPRs, like Key, would be required to meet the minimum capital and leverage ratios set forth in the following table. At March 31, 2013, Key had a Tier 1 common equity ratio of 11.4% under current Basel I. Also at March 31, 2013, based on the fully phased-in Basel III and Standardized Approach NPRs, Key estimates that its capital and leverage ratios, after adjustment for market risk pursuant to the new joint final market risk rule, would be as set forth Figure 5 below. There can be no guarantee, however, that the Basel III and Standardized Approach NPRs will be adopted in their current form, what changes may be made before adoption, or when ultimate adoption will occur.

Figure 5. Estimated Ratios vs. Proposed Minimum Capital Ratios Calculated Under the Fully Phased-In Basel III and Standardized Approach NPRs

 

Ratios (including Capital conservation buffer)   

Key

3-31-2013

Estimated

   

Proposed

Minimum

1-1-2013

   

(a)

    

Phase-in

Period

  (a)  

Proposed

Minimum

1-1-2019

   

(a)

 

Common Equity Tier 1

     10.3   %      3.5        %       1/1/13 - 1/1/15       4.5        %   

Capital conservation buffer (b)

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

Common Equity Tier 1 + Capital conservation buffer

       3.5        1/1/13 - 1/1/19       7.0    

Tier 1 Capital

     10.7       4.5        1/1/13 - 1/1/15       6.0    

Tier 1 Capital + Capital conservation buffer

       4.5        1/1/13 - 1/1/19       8.5    

Total Capital

     13.4       8.0        None       8.0    

Total Capital + Capital conservation buffer

       8.0        1/1/16 - 1/1/19       10.5    

Leverage (c)

     10.1       4.0        None       4.0    

 

   

 

(a) Per the November 2012 Release, the proposed implementation dates and phase-in time periods are subject to extension.

 

(b) Capital conservation buffer must consist of Common Equity Tier 1 capital. Key is not subject to the proposed countercyclical capital buffer of up to 2.5% imposed under the Advanced Approaches NPR.

 

(b) Key is not subject to the proposed 3% supplemental leverage ratio requirement imposed under the Advanced Approaches NPR.

Revised Prompt Corrective Action Standards

Under the Basel III NPR, the prompt corrective action capital category threshold ratios applicable to FDIC-insured depository institutions, such as KeyBank, are proposed to be revised effective January 1, 2015. Figure 6 identifies the proposed capital category threshold ratios for a well capitalized and an adequately capitalized institution under current law and the Basel III and Standardized Approach NPRs.

 

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Figure 6. Proposed Revised Prompt Corrective Action Well Capitalized and Adequately Capitalized Capital Category Ratios

 

Prompt Corrective Action       Capital Category  

 

   

 

 

 
                Well Capitalized             Adequately Capitalized  
   

 

 

   

 

 

 
Ratio                   Proposed       Current             Proposed       Current  

 

 

Common Equity Tier 1 Risk-Based

      6.5   %      N/A        4.5   %      N/A     

Tier 1 Risk-Based

      8.0       6.0   %      6.0       4.0  

Total Risk-Based

      10.0       10.0       8.0       8.0    

Tier 1 Leverage

      5.0       5.0       4.0       3.0 or 4.0     

 

 

We believe that, as of March 31, 2013, Key and KeyBank would meet all capital adequacy requirements under the Basel III and Standardized Approach NPRs on a fully phased-in basis if such requirements were currently effective. There can be no guarantee that the Basel III and Standardized Approach NPRs will be adopted in their current form, what changes may be made before adoption, or when ultimate adoption will occur.

As previously indicated, the prompt corrective action requirements only apply to FDIC-insured depository institutions and not to BHC’s. Nevertheless, if such prompt corrective action capital categories applied to BHCs, we believe that KeyCorp would meet all prompt corrective action capital and leverage ratio requirements for a well-capitalized capital category at March 31, 2013, under the Basel III and Standardized Approach NPRs on a fully phased-in basis if such requirements were currently effective.

Highlights of Our Performance

Financial performance

For the first quarter of 2013, we announced net income from continuing operations attributable to Key common shareholders of $196 million, or $.21 per Common Share. Our first quarter of 2013 results compare to net income from continuing operations attributable to Key common shareholders of $195 million, or $.20 per Common Share, for the first quarter of 2012.

Our taxable-equivalent net interest income was $589 million for the first quarter of 2013, and the net interest margin was 3.24%. These results compare to taxable-equivalent net interest income of $559 million and a net interest margin of 3.16% for the first quarter of 2012. Net interest income increased $30 million or 5.4% due to both growth in average earning assets and an improvement in the net interest margin as funding costs declined. Our current expectation, given the outlook for little change in interest rates, is for the net interest margin to trend lower from the first quarter level throughout 2013. We anticipate the net interest margin to decline by approximately four to seven basis points in the second quarter and continue with modest pressure of one to three basis points per quarter in the second half of the year.

Our noninterest income was $425 million for the first quarter of 2013, compared to $442 million for the year-ago quarter. Operating lease income and other leasing gains decreased $29 million primarily due to a $20 million gain on the early termination of a leveraged lease one year ago, and net gains (losses) from principal investing decreased by $27 million. These decreases were partially offset by an $18 million increase in investment banking and debt placement fees and a $14 million increase in other income.

Our noninterest expense was $681 million for the first quarter of 2013, compared to $679 million for the same period last year. Personnel expense increased $19 million due to several factors – an increase in technology contract labor; higher incentive compensation expense accruals; and severance expense associated with our efficiency initiative. Nonpersonnel expense decreased $17 million from one year ago. Marketing expense, operating lease expense and various other miscellaneous expenses decreased from the year ago quarter. These declines were partially offset by an increase of $11 million related to the amortization of the intangible assets associated with the third quarter 2012 acquisitions of the previously announced credit card portfolio as well as the branches in Western New York.

We have made progress on our efficiency initiative. We have realized $105 million in annualized expense savings, significant progress toward our $200 million goal by the end of 2013. During the second quarter of 2013, we expect to make further progress on our efficiency efforts as we consolidate branches and continue to work toward creating a variable cost base.

 

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Average loans were $52.6 billion for the first quarter of 2013, an increase of $3.2 billion or 6.5% compared to the first quarter of 2012. Commercial, financial and agricultural loans grew by $3.3 billion over the year-ago quarter, with strong growth across our corporate and middle market segments. In addition, the third quarter 2012 credit card portfolio and Western New York branch acquisitions added $1 billion of mostly consumer loans. This growth was partially offset by managed declines in the commercial real estate portfolio, the equipment lease portfolio, which included the early termination of certain leveraged leases in the exit portfolio in 2012, and run-off of consumer loans in the designated exit portfolio. Last quarter we provided an outlook for average total loan growth for 2013 in the mid to upper-single digit area, and we still anticipate average total loan growth for the year in the mid-single digit area of four to six percent, led by growth in commercial lending. We anticipate average earning assets for the balance of 2013 to be in a range of $74 to $76 billion.

Average deposits totaled $63.6 billion for the first quarter of 2013, an increase of $4 billion compared to the year-ago quarter. The growth reflects an increase in demand deposits of $2.9 billion and interest-bearing non-time deposits of $4.1 billion (including the impact of Key’s third quarter 2012 Western New York branch acquisition, which added $2 billion of mostly interest-bearing non-time deposits). This deposit growth was partially offset by $3 billion of run-off from one year ago in certificates of deposit and other time deposits.

Our provision for loan and lease losses was $55 million for the first quarter of 2013, compared to $42 million for the year-ago quarter. Our allowance for loan and lease losses was $893 million, or 1.70% of total period-end loans at March 31, 2013, compared to 1.92% at March 31, 2012.

At March 31, 2013, our nonperforming loans totaled $650 million and represented 1.24% of period-end portfolio loans, compared to 1.35% at March 31, 2012. Nonperforming assets at March 31, 2013, totaled $705 million and represented 1.34% of period-end portfolio loans and OREO and other nonperforming assets, compared to 1.55% at March 31, 2012. OREO balances declined $40 million from one year ago to $21 million at March 31, 2013.

During the first three months of 2013, we originated approximately $8.5 billion in new or renewed lending commitments to consumers and businesses, an increase of $.2 billion from the same period one year ago.

Our capital ratios remain strong. Our tangible common equity, Tier 1 common equity and Tier 1 risk-based capital ratios at March 31, 2013, are 10.24%, 11.40%, and 12.19%, respectively, compared to 10.26%, 11.55%, and 13.29%, respectively, at March 31, 2012. We have continued to return capital to our shareholders by repurchasing common shares and our quarterly common share dividends. In the first quarter, we repurchased 6.8 million common shares at an average cost of $9.56 per share. Additionally, we estimate that our Basel III Tier 1 common equity ratio under the Federal Reserve’s Basel III and Standard Approach NPRs as of March 31, 2013 is at 10.35%, which we believe will place us in a strong capital position relative to our peers on this measure.

Figure 7 shows our continuing and discontinued operating results for the current, past and year-ago quarters. Our financial performance for each of the past five quarters is summarized in Figure 1.

Figure 7. Results of Operations

 

     Three months ended  
in millions, except per share amounts    3-31-13        12-31-12        3-31-12    

 

 

Summary of operations

        

Income (loss) from continuing operations attributable to Key

    $ 201         $ 196         $ 201    

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

     3          7          (1)    

 

 

Net income (loss) attributable to Key

    $ 204         $ 203         $ 200    
  

 

 

    

 

 

    

 

 

 

Income (loss) from continuing operations attributable to Key

    $ 201         $ 196         $ 201    

Less: Dividends on Series A Preferred Stock

     5          6          6    

 

 

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

     196          190          195    

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

     3          7          (1)    

 

 

Net income (loss) attributable to Key common shareholders

    $ 199         $ 197         $ 194    
  

 

 

    

 

 

    

 

 

 

Per common share — assuming dilution

        

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

    $ .21         $ .20         $ .20    

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

     —          .01          —    

 

 

Net income (loss) attributable to Key common shareholders (c)

    $                     .21         $                     .21         $                     .20    
  

 

 

    

 

 

    

 

 

 
        

 

 

 

(a) In April 2009, we decided to wind down the operations of Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers. In September 2009, we decided to discontinue the education lending business conducted through Key Education Resources, the education payment and financing unit of KeyBank National Association. In February 2013, we announced an agreement to sell Victory to a private equity fund. As a result of these decisions, Key has accounted for these businesses as discontinued operations. The income (loss) from discontinued operations for the periods presented was primarily attributable to fair value adjustments related to the education lending securitization trusts.

 

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(b) EPS may not foot due to rounding.

Figure 8 presents certain non-GAAP financial measures related to “tangible common equity,” “return on tangible common equity” and “Tier 1 common equity.” Tier 1 common equity, a non-GAAP financial measure, is a component of Tier 1 risk-based capital. Tier 1 common equity is not formally defined by GAAP or prescribed in amount by federal banking regulations. However, since analysts and banking regulators may assess our capital adequacy using tangible common equity and Tier 1 common equity, we believe it is useful to enable investors to assess our capital adequacy on these same bases. Figure 8 also reconciles the GAAP performance measures to the corresponding non-GAAP measures.

Traditionally, the banking regulators have assessed bank and BHC capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations. Since early 2009, the Federal Reserve has focused its assessment of capital adequacy on a component of Tier 1 common equity. Because the Federal Reserve has long indicated that voting common shareholders’ equity (essentially Tier 1 risk-based capital less preferred stock, qualifying capital securities and noncontrolling interests in subsidiaries) generally should be the dominant element in Tier 1 risk-based capital, this focus on Tier 1 common equity is consistent with existing capital adequacy categories. The Basel Committee’s final Basel III framework for strengthening international capital and liquidity regulation, which U.S. regulators propose to implement in the near future, also makes Tier 1 common equity a priority. Finally, the enactment of the Dodd-Frank Act also changed the regulatory capital standards that apply to BHCs by requiring regulators to create rules phasing out the treatment of trust preferred securities and cumulative preferred securities as Tier 1 eligible capital. At the end of a three-year phase-out period, our trust preferred securities are treated only as Tier 2 capital. The section “Supervision and regulation”, above, contains more information about these regulatory initiatives.

The table also shows the computation for pre-provision net revenue, which is not formally defined by GAAP. We believe that eliminating the effects of the provision for loan and lease 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. As such, there is no directly comparable GAAP performance measure. The cash efficiency performance measure removes the impact of our intangible asset amortization from the calculation. We believe this ratio provides greater consistency and comparability between our results and those of our peer banks. Additionally, this ratio is 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, or as a substitute for analyses of results as reported under GAAP.

 

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Figure 8. GAAP to Non-GAAP Reconciliations

 

     Three months ended  
dollars in millions    3-31-13       12-31-12       3-31-12    

 

 

Tangible common equity to tangible assets at period end

      

Key shareholders’ equity (GAAP)

    $ 10,340        $ 10,271        $ 10,099    

Less:            Intangible assets (a)

     1,024         1,027         932    

        Preferred Stock, Series A

     291         291         291    

 

 

        Tangible common equity (non-GAAP)

    $ 9,025        $ 8,953        $ 8,876    
  

 

 

   

 

 

   

 

 

 

Total assets (GAAP)

    $ 89,198        $ 89,236        $ 87,431    

Less:            Intangible assets (a)

     1,024         1,027         932    

 

 

        Tangible assets (non-GAAP)

    $ 88,174        $ 88,209        $ 86,499    
  

 

 

   

 

 

   

 

 

 

Tangible common equity to tangible assets ratio (non-GAAP)

     10.24       10.15       10.26  

Tier 1 common equity at period end

      

Key shareholders’ equity (GAAP)

    $ 10,340        $ 10,271        $ 10,099    

Qualifying capital securities

     339         339         1,046    

Less:            Goodwill

     979         979         917    

        Accumulated other comprehensive income (loss) (b)

     (204)         (172)         (70)    

        Other assets (c)

     106         114         69    

 

 

        Total Tier 1 capital (regulatory)

     9,798         9,689         10,229    

Less:            Qualifying capital securities

     339         339         1,046    

        Preferred Stock, Series A

     291         291         291    

 

 

        Total Tier 1 common equity (non-GAAP) (d)

    $ 9,168        $ 9,059        $ 8,892    
  

 

 

   

 

 

   

 

 

 

Net risk-weighted assets (regulatory) (c)

    $ 80,000        $ 79,734        $ 76,956    

Tier 1 common equity ratio (non-GAAP) (d)

     11.40       11.36       11.55  

Pre-provision net revenue

      

Net interest income (GAAP)

    $ 583        $ 601        $ 553    

Plus:            Taxable-equivalent adjustment

     6         6         6    

        Noninterest income

     425         439         442    

Less:            Noninterest expense

     681         734         679    

 

 

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

    $ 333        $ 312        $ 322    
  

 

 

   

 

 

   

 

 

 

Average tangible common equity

      

Average Key shareholders’ equity (GAAP)

    $ 10,279        $ 10,261        $ 9,992    

Less:            Intangible assets (average) (a)

     1,027         1,030         932    

        Preferred Stock, Series A (average)

     291         291         291    

 

 

        Average tangible common equity (non-GAAP)

    $ 8,961        $ 8,940        $ 8,769    
  

 

 

   

 

 

   

 

 

 

Return on average tangible common equity from continuing operations

      

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

    $ 196        $ 190        $ 195    

Average tangible common equity (non-GAAP)

     8,961         8,940         8,769    

Return on average tangible common equity from continuing operations (non-GAAP)

     8.87      8.45       8.94  

Return on average tangible common equity consolidated

      

Net income (loss) attributable to Key common shareholders

    $ 199        $ 197        $ 194    

Average tangible common equity (non-GAAP)

     8,961         8,940         8,769    

Return on average tangible common equity consolidated (non-GAAP)

     9.01       8.77       8.90  

Cash efficiency ratio

      

Noninterest expense (GAAP)

    $ 681        $ 734        $ 679    

Less:            Intangible asset amortization on credit cards

     8         8         —    

        Other intangible asset amortization

     4         4         1    

 

 

        Adjusted noninterest expense (non-GAAP)

    $ 669        $ 722        $ 678    
  

 

 

   

 

 

   

 

 

 

Net interest income (GAAP)

    $ 583        $ 601        $ 553    

Plus:            Taxable-equivalent adjustment

     6         6         6    

        Noninterest income (GAAP)

     425         439         442    

 

 

        Total taxable-equivalent revenue (non-GAAP)

    $                 1,014        $                 1,046        $                 1,001    
  

 

 

   

 

 

   

 

 

 

Cash efficiency ratio (non-GAAP)

     65.98       69.02       67.73   % 
      

 

 

 

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Figure 8. GAAP to Non-GAAP Reconciliations, continued

 

     Three months ended  
dollars in millions    3-31-13       12-31-12    

 

 

Tier 1 common equity under Basel III (estimates)

    

Tier 1 common equity under Basel I

    $ 9,168        $ 9,059    

Adjustments from Basel I to Basel III:

    

Cumulative other comprehensive income (e)

     (217)         (197)    

Deferred tax assets and other (f)

     (94)         (80)    

 

 

Tier 1 common equity anticipated under Basel III (d)

    $ 8,857        $ 8,782    
  

 

 

   

 

 

 

Total risk-weighted assets under Basel I

    $ 80,000        $ 79,734    

Adjustments from Basel I to Basel III:

    

Loan commitments less than one year

     813         951    

Residential mortgage and home equity loans

     3,144         1,855    

Other

     1,252         2,080    

 

 

Total risk-weighted assets under Basel III (g)

    $             85,609        $             84,620    
  

 

 

   

 

 

 

Tier 1 common equity ratio under Basel III

     10.35       10.38  

 

(a) Three months ended March 31, 2013 and December 31, 2012 exclude $114 million and $123 million, respectively, of period end purchased credit card receivable intangible assets. Three months ended March 31, 2013 and December 31, 2012 exclude $118 million and $126 million, respectively, of average ending purchased credit card receivable intangible assets.

 

(b) Includes net unrealized gains or losses on securities available for sale (except for net unrealized losses on marketable equity securities), net gains or losses on cash flow hedges, and amounts resulting from the application of the applicable accounting guidance for defined benefit and other postretirement plans.

 

(c) Other assets deducted from Tier 1 capital and net risk-weighted assets consist of disallowed intangible assets (excluding goodwill) and deductible portions of nonfinancial equity investments. There were no disallowed deferred tax assets at March 31, 2013, December 31, 2012, and March 31, 2012.

 

(d) Tier 1 common equity is a non-GAAP financial measure that is used by investors, analysts and bank regulatory agencies to assess the capital position of financial services companies. We review Tier 1 common equity along with other measures of capital as part of our financial analyses.

 

(e) Includes AFS mark-to-market, cash flow hedges on items recognized at fair value on the balance sheet, and defined benefit pension liability.

 

(f) Deferred tax asset subject to future taxable income for realization, primarily tax credit carryforwards, and the deductible portion of mortgage servicing assets.

 

(g) The amount of regulatory capital and risk-weighted assets estimated under Basel III (as fully phased-in on January 1, 2019) is based upon the federal banking agencies’ proposed rules to implementation Basel III and the Standardized Approach.

Results of Operations

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; and

 

¿  

asset quality.

To make it easier to compare results among 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 “taxable-equivalent basis” (i.e., as if it were all taxable and at the same rate). For example, $100 of tax-exempt income would be presented as $154, an amount that — if taxed at the statutory federal income tax rate of 35% — would yield $100.

Figure 9 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 taxable-equivalent net interest income to net interest income reported in accordance with GAAP for each of those quarters. The net interest margin is calculated by dividing annualized taxable-equivalent net interest income by average earning assets.

 

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Taxable-equivalent net interest income was $589 million for the first quarter of 2013, and the net interest margin was 3.24%. These results compare to taxable-equivalent net interest income of $559 million and a net interest margin of 3.16% for the first quarter of 2012. The increase in net interest income and the net interest margin was primarily a result of a change in funding mix from the redemption of certain trust preferred securities, maturity of long-term debt, and maturity of higher-costing certificates of deposit during 2012.

Compared to the fourth quarter of 2012, taxable-equivalent net interest income decreased by $18 million, and the net interest margin declined by 13 basis points. The decrease in net interest income was primarily due to a lower day count and a decline in the net interest margin, which was partially offset by an increase in average earning asset balances. The decline in the net interest margin was largely attributable to lower yields on loans and investment securities, an increase in short-term investments, and a change in funding mix.

Average earning assets for the first quarter of 2013, totaled $73.7 billion, compared to $71.4 billion for the first quarter of 2012. The increase is primarily attributable to commercial, financial and agricultural loans, which grew by $3.3 billion from the year-ago quarter. In addition, the credit card portfolio and Western New York branch acquisitions in the third quarter of 2012 added $1 billion of mostly consumer loans. This growth was partially offset by managed declines in the commercial real estate portfolio, the commercial lease financing portfolio, which included the early termination of certain leveraged leases in the exit portfolio in 2012, and run-off of consumer loans in the designated exit portfolio. In addition, total investments declined by $736 million compared to the year-ago quarter.

As shown in Figure 9, the yield was impacted by lower spreads on commercial loans, lower security yields, and an increase in lower yielding short-term investments.

 

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Figure 9. Consolidated Average Balance Sheets, Net Interest Income and Yields/Rates From Continuing Operations

 

     First Quarter 2013          Fourth Quarter 2012      
dollars in millions    Average
Balance
         Interest     (a)    Yield/
Rate
    (a)    Average
Balance
         Interest     (a)    Yield/
Rate
    (a)

 

ASSETS

                             

Loans (b), (c)

                             

Commercial, financial and agricultural

    $ 23,317       (h)     $ 218            3.78         $ 22,436       (h)     $ 213            3.77    

Real estate — commercial mortgage

     7,616            79            4.24            7,555            82            4.35      

Real estate — construction

     1,034            11            4.27            1,070            14            4.94      

Commercial lease financing

     4,843            47            3.92             4,869            49            4.01       

 

Total commercial loans

     36,810            355            3.92            35,930            358            3.96      

Real estate — residential mortgage

     2,173            25            4.58            2,164            26            4.70      

Home equity:

                             

Key Community Bank

     9,787            96            3.97            9,807            98            3.99      

Other

     413            8            7.70            411            9            8.23      

 

Total home equity loans

     10,200            104            4.12            10,218            107            4.16      

Consumer other — Key Community Bank

     1,343            25            7.58            1,339            32            9.63      

Credit cards

     704            22            12.61            714            23            13.15      

Consumer other:

                             

Marine

     1,311            20            6.29            1,403            22            6.16      

Other

     85            2            7.98            91            1            8.25      

 

Total consumer other

     1,396            22            6.39            1,494            23            6.29      

 

Total consumer loans

     15,816            198            5.00            15,929            211            5.30      

 

Total loans

     52,626            553            4.26            51,859            569            4.37      

Loans held for sale

     469            4            3.27            618            5            3.47      

Securities available for sale (b), (e)

     12,065            81            2.74            11,980            84            2.95      

Held-to-maturity securities (b)

     3,816            18            1.94            4,036            19            1.94      

Trading account assets

     710            6            3.44            606            3            1.91      

Short-term investments

     2,999            2            .22            2,090            2            .27      

Other investments (e)

     1,059            9            3.59            1,088            12            4.05      

 

Total earning assets

     73,744            673            3.67            72,277            694            3.85      

Allowance for loan and lease losses

     (896)                      (898)                

Accrued income and other assets

     9,867                      9,878                

Discontinued assets — education lending business

     5,216                      5,350                

 

Total assets

    $ 87,931                     $ 86,607                
  

 

 

                

 

 

             

LIABILITIES

                             

NOW and money market deposit accounts

    $ 31,946            14            .18           $ 31,058            14            .18      

Savings deposits

     2,473            1            .05            2,408            —            .06      

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

     2,911            14            1.99            2,992            16            2.15      

Other time deposits

     4,451            16            1.42            4,714            18            1.52      

Deposits in foreign office

     454            —            .25            874            1            .21      

 

Total interest-bearing deposits

     42,235            45            .43            42,046            49            .47      

Federal funds purchased and securities sold under repurchase agreements

     1,913            1            .15            1,702            1            .16      

Bank notes and other short-term borrowings

     387            1            1.75            306            2            1.97      

Long-term debt (f), (g)

     4,671            37            3.51            3,301            35            4.84      

 

Total interest-bearing liabilities

     49,206            84            .70            47,355            87            .73      

Noninterest-bearing deposits

     21,400                      21,889                

Accrued expense and other liabilities

     1,799                      1,747                

Discontinued liabilities — education lending business (d), (g)

     5,213                      5,321                

 

Total liabilities

     77,618                      76,312                

EQUITY

                             

Key shareholders’ equity

     10,279                      10,261                

Noncontrolling interests

     34                      34                

 

Total equity

     10,313                      10,295                

 

Total liabilities and equity

    $         87,931                     $       86,607                
  

 

 

                

 

 

             

Interest rate spread (TE)

               2.97                    3.12    

 

Net interest income (TE) and net interest margin (TE)

          589                  3.24               607                  3.37    
            

 

 

                

 

 

   

TE adjustment (b)

          6                      6           

 

Net interest income, GAAP basis

         $         583                     $         601           
       

 

 

                

 

 

        
                             

 

 

(a) Results are from continuing operations. Interest excludes the interest associated with the liabilities referred to in (d) below, calculated using a matched funds transfer pricing methodology.

 

(b) Interest income on tax-exempt securities and loans has been adjusted to a taxable-equivalent basis using the statutory federal income tax rate of 35%.

 

(c) For purposes of these computations, nonaccrual loans are included in average loan balances.

 

(d) Discontinued liabilities include the liabilities of the education lending business and the dollar amount of any additional liabilities assumed necessary to support the assets associated with this business.

 

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Figure 9. Consolidated Average Balance Sheets, Net Interest Income and Yields/Rates From Continuing Operations

 

Third Quarter 2012     Second Quarter 2012     First Quarter 2012  
 
 
Average 
Balance 
  
  
     Interest    (a)     
 
Yield/ 
Rate 
  
  (a) 
   
 
Average 
Balance 
  
  
     Interest    (a)     
 
Yield/ 
Rate 
  
   (a) 
   
 
Average 
Balance 
  
  
     Interest    (a)     
 
Yield/ 
Rate 
  
   (a) 

 

 

 
    $        21,473          $ 203          3.76     %      $ 20,606          $ 196          3.82     %      $ 20,031          $ 198          3.99     % 
  7,463           83          4.40          7,613          85          4.50          7,993          89          4.48     
  1,116           12          4.55          1,216          14          4.64          1,284          16          4.86     
  5,026          39          3.13          5,226          45          3.45          5,453          54          3.94     

 

 

 
  35,078          337          3.83          34,661          340          3.94          34,761          357          4.12     
  2,092          25          4.80          1,990          24          4.91          1,950          25          5.04     
  9,734          99          4.02          9,359          94          4.04          9,173          93          4.08     
  468          9          7.73          493          9          7.66          521          10          7.68     

 

 

 
  10,202          108          4.19          9,852          103          4.23          9,694          103          4.27     
  1,297          32          9.65          1,247          29          9.20          1,193          28          9.61     
  432          17          15.38          —          —          —          —          —          —     
  1,493          22          6.28          1,595          26          6.29          1,714          27          6.28     
  101          3          8.02          101          2          8.49          118          2          7.79     

 

 

 
  1,594          25          6.39          1,696          28          6.42          1,832          29          6.38     

 

 

 
  15,617          207          5.26          14,785          184          4.99          14,669          185          5.07     

 

 

 
  50,695          544          4.27          49,446          524          4.26          49,430          542          4.41     
  532          5          3.28          585          5          3.43          581          5          3.62     
  12,608          94          3.07          13,865          105          3.13          15,259          116          3.15     
  4,251          21          1.94          3,493          17          1.98          2,251          12          2.08     
  693          4          2.10          768          5          3.01          808          6          2.72     
  1,868          1          .24          2,608          2          .29          1,898          1          .29     
  1,134          8          3.01          1,177          10          3.21          1,169          8          2.78     

 

 

 
  71,781          677          3.78          71,942          668          3.74          71,396          690          3.91     
  (883)              (928)              (968)         
  9,907              9,866              9,996         
  5,471              5,673              5,799         

 

 

 
    $        86,276              $ 86,553              $ 86,223         

 

 

        

 

 

        

 

 

      
    $        30,176          14          .19          $ 29,106          13          .18          $ 28,328          15          .21     
  2,378          1          .06          2,085          —          .03          1,997          —          .06     
  3,420          22          2.53          3,858          27          2.85          4,036          29          2.91     
  5,158          23          1.76          5,645          30          2.13          6,035          33          2.19     
  666          —          .21          759          1          .24          769          —          .25     

 

 

 
  41,798          60          .57          41,453          71          .69          41,165          77          .76     
  1,822          1          .17          1,880          1          .20          1,850          1          .21     
  390          1          1.53          468          2          1.80          490          2          1.53     
  3,793          37          4.43          5,463          50          4.01          6,161          51          3.61     

 

 

 
  47,803          99          .83          49,264          124          1.02          49,666          131          1.07     
  20,878              19,610              18,466         
  1,900              1,902              2,289         
  5,449              5,658              5,793         

 

 

 
  76,030              76,434              76,214         
  10,222              10,100              9,992         
  24              19              14         

 

 

 
  10,246              10,119              10,009         

 

 

 
    $        86,276              $         86,553              $         86,223         

 

 

        

 

 

        

 

 

      
       2.95     %           2.72     %           2.84     % 

 

 

 
     578                  3.23     %         544                  3.06     %         559                  3.16     % 
    

 

 

        

 

 

        

 

 

 
     6               6               6       

 

 

 
     $         572               $         538               $         553       
  

 

 

        

 

 

        

 

 

   

 

 

 

 

(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.

 

(h) Commercial, financial, and agricultural average balance includes for the three months ended March 31, 2013, December 31, 2012, and September 30, 2012 includes $91 million, $90 million, and $54 million, respectively, of assets from commercial credit cards.

 

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Figure 10 shows how the changes in yields or rates and average balances from the prior year affected net interest income. The section entitled “Financial Condition” contains additional discussion about changes in earning assets and funding sources.

Figure 10. Components of Net Interest Income Changes from Continuing Operations

 

             From three months ended March  31, 2012        
to three months ended March 31, 2013
 
in millions     
 
Average
Volume
  
  
    

 

Yield/

Rate

  

  

    

 

Net

Change

  

 (a) 

 

 

INTEREST INCOME

        

Loans

    $ 34         $ (23)        $ 11     

Loans held for sale

     (1)         —          (1)    

Securities available for sale

     (22)         (13)         (35)    

Held-to-maturity securities

             (2)         6     

Trading account assets

     (1)                 —     

Short-term investments

             —          1     

Other investments

     (1)                 1     

 

 

Total interest income (TE)

     18          (35)         (17)    

 

INTEREST EXPENSE

        

NOW and money market deposit accounts

             (3)         (1)    

Savings deposits

     —                  1     

Certificates of deposit ($100,000 or more)

     (7)         (8)         (15)    

Other time deposits

     (7)         (10)         (17)    

Deposits in foreign office

     —          —          —     

 

 

Total interest-bearing deposits

     (12)         (20)         (32)    

Federal funds purchased and securities sold under repurchase agreements

     —                  —     

Bank notes and other short-term borrowings

     —          (1)         (1)    

Long-term debt

     (12)         (2)         (14)    

 

 

Total interest expense

     (24)         (23)         (47)   

 

 

Net interest income (TE)

    $                 42        $               (12)        $                 30     
  

 

 

    

 

 

    

 

 

 
        

 

 

(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.

Noninterest income

As shown in Figure 11, noninterest income was $425 million for the first quarter of 2013, compared to $442 million for the year-ago quarter, a decrease of $17 million, or 3.8%. Operating lease income and other leasing gains decreased $29 million primarily due to a $20 million gain on the early termination of a leveraged lease one year ago, and net gains (losses) from principal investing decreased by $27 million. These decreases were partially offset by an $18 million increase in investment banking and debt placement fees, a $14 million increase in other income, and an $8 million increase in cards and payments income.

Figure 11. Noninterest Income

 

       Three months ended March 31,        Change  
dollars in millions    2013        2012        Amount       Percent  

 

 

Trust and investment services income

    $ 95         $ 96         $ (1)          (1.0)   % 

Investment banking and debt placement fees

     79          61          18          29.5    

Service charges on deposit accounts

     69          68          1          1.5    

Operating lease income and other leasing gains

     23          52          (29)          (55.8)    

Corporate services income

     45          44          1          2.3    

Cards and payments income

     37          29          8          27.6    

Corporate-owned life insurance income

     30          30          —          —    

Consumer mortgage income

     7          9          (2)          (22.2)    

Net gains (losses) from principal investing

     8          35          (27)          (77.1)    

Other income (a)

     32          18          14          77.8    

 

 

Total noninterest income

    $               425         $               442         $             (17)          (3.8)   % 
  

 

 

    

 

 

    

 

 

    
           

 

 

 

(a) Included in these line items are Key’s “Dealer trading and derivatives income (loss).” Additional detail is provided in Figure 12.

 

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Figure 12. Dealer Trading and Derivatives Income (Loss)

 

        Three months ended March 31,         Change       
dollars in millions    2013        2012        Amount      Percent        

 

Dealer trading and derivatives income (loss), proprietary (a), (b)

     —         $                   3        $ (3)         N/M       

Dealer trading and derivatives income (loss), nonproprietary (b)

    $                 10          6                              4                         66.7       

 

Total dealer trading and derivatives income (loss)

   $ 10        $ 9        $        11.1       
              

 

 

(a) For the quarter ended March 31, 2013, income of $3 million related to fixed income, foreign exchange, interest rate, and energy derivative trading was offset by losses related to equity securities trading and credit portfolio management activities. For the quarter ended March 31, 2012, fixed income and equity securities trading activities constitute the majority of this amount. Income related to foreign exchange and interest rate derivative trading was less than $1 million and was offset by losses from our credit portfolio management activities.

 

(b) The allocation between proprietary and nonproprietary is made based upon whether the trade is conducted for the benefit of Key or Key’s clients rather than based upon the proposed rulemaking under the Volcker Rule. The prohibitions and restrictions on proprietary trading activities contemplated by the Volcker Rule and the rules proposed thereunder are not yet final. Therefore, the ultimate impact of the rules proposed under the Volcker Rule is not yet known.

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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Trust and investment services income

Trust and investment services are our largest source of noninterest income and consist of brokerage commissions, trust and asset management commissions, and insurance income. The assets under management that primarily generate these revenues are shown in Figure 13. For the three months ended March 31, 2013, trust and investment services income decreased $1 million, or 1% as compared to the same period one year ago.

A significant portion of our trust and investment services income depends on the value and mix of assets under management. At March 31, 2013, our bank, trust and registered investment advisory subsidiaries had assets under management of $35.7 billion, compared to $35.9 billion at March 31, 2012. As shown in Figure 13, a decrease in the securities lending portfolio was mostly offset by increases in the equity, fixed income, and money market portfolios. Our securities lending business has been declining due to our de-emphasis of this business resulting in lower transaction volumes, client departures, and fewer assets under management.

Figure 13. Assets Under Management

 

     2013      2012  
in millions    First       Fourth       Third       Second       First   

 

 

Assets under management by investment type:

              

Equity

    $ 19,659         $ 18,013         $ 18,266         $ 17,886         $ 18,966    

Securities lending

     2,879          3,147          3,900          4,292          4,640    

Fixed income

     10,697          10,872          10,621          10,280          10,303    

Money market

     2,479          2,712          2,800          2,690          1,953    

 

 

Total

    $ 35,714         $ 34,744         $ 35,587         $ 35,148         $ 35,862    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Proprietary mutual funds included in assets under management:

              

Equity

    $ 40         $ 38         $ 40         $ 39         $ 41    

Fixed income

     230          244          261          261          271    

 

 

Total

    $                 270         $                 282         $                 301         $                 300         $                 312    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
              

 

 

Investment banking and debt placement fees

Investment banking and debt placement fees, which consists of , syndication fees, debt and equity financing fees, financial advisor fees, gains on sales of commercial mortgages, and agency origination fees, increased $18 million, or 29.5% from the year-ago quarter primarily due to increased levels of debt and equity financings and advisor fees.

Operating lease income and other leasing gains

Operating lease income and other leasing gains decreased $29 million, or 55.8% for the first quarter of 2013 in our Equipment Finance line of business primarily due to a $20 million gain on the early termination of a leveraged lease one year ago. Product run-off also contributed to the decline in operating lease income and other leasing gains. Accordingly, as shown in Figure 14, operating lease expense also declined.

Cards and payments income

Cards and payments income, which consists of debit card, consumer and commercial credit card, and merchant services income, increased $8 million, or 27.6% from the year-ago quarter primarily due to the third quarter 2012 credit card portfolio acquisition.

Other income

Other income, which consists of gain on sale of certain loans, mortgage servicing revenue, net of amortization, other service charges, and certain dealer trading income, increased $14 million, or 77.8% from the year-ago quarter due to favorable results across several income categories.

Noninterest expense

As shown in Figure 14, noninterest expense was $681 million for the first quarter of 2013, compared to $679 million for the year-ago quarter, representing an increase of $2 million or 0.3%. Personnel expense increased $19 million, or 5.1%, driven by higher levels of technology contract labor and incentive compensation accruals along with an increase in severance associated with our efficiency initiative. Nonpersonnel expense decreased $17 million, or 5.5%, as increases in intangible asset amortization were more than offset by expense reductions across most expense categories.

 

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The amount of noninterest expense for the first quarter of 2013 attributable to our 2012 acquisition of 37 branches in Western New York and our acquired credit card portfolio is $28 million spread across several expense categories, including $4 million of personnel expense, $11 million of intangible asset amortization, and $5 million of loan servicing fees. During the first quarter of 2013, costs associated with our efficiency initiative totaling $15 million were also incurred, including $9 million of severance expense.

Figure 14. Noninterest Expense

 

     Three months ended March 31,      Change  
dollars in millions    2013        2012        Amount       Percent   

 

 

Personnel

    $ 391         $ 372         $ 19          5.1    % 

Net occupancy

     64          64          —          —    

Computer processing

     39          41          (2)          (4.9)    

Business services and professional fees

     35          37          (2)          (5.4)    

Equipment

     26          26          —          —    

Operating lease expense

     12          17          (5)                        (29.4)    

Marketing

     6          13          (7)          (53.8)    

FDIC assessment

     8          8          —          —    

Intangible asset amortization on credit cards

     8          —          8          N/M    

Other intangible asset amortization

     4          1          3          300.0    

Provision (credit) for losses on lending-related commitments

     3          —          3          N/M    

OREO expense, net

     3          6          (3)          (50.0)    

Other expense

     82          94          (12)          (12.8)    

 

 

Total noninterest expense

    $               681        $               679         $               2          .3    % 
  

 

 

    

 

 

    

 

 

    

Average full-time equivalent employees (a)

     15,396          15,404          (8)          (.1)   % 
           

 

 

 

(a) The number of average full-time-equivalent employees has not been adjusted for discontinued operations.

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

Personnel

As shown in Figure 15, personnel expense, the largest category of our noninterest expense, increased by $19 million, or 5.1%, when compared to the year-ago quarter. Salaries increased $3 million, or 1.4% as increased hiring of client-facing personnel including approximately 45 sales people added to our merchant processing business on February 1, 2013, annual merit increases and the impact of our 2012 acquisition of 37 branches in Western New York was largely offset by staff reductions related to our efficiency initiative. The efficiency initiative drove a $5 million, or 125% increase in severance expense. Higher levels of contract labor on technology initiatives resulted in a $6 million, or 50% increase while incentive compensation accruals increased $13 million, or 21.7% when compared to the year-ago quarter. Employee benefits decreased $5 million, or 7.8% compared to the same period one year ago primarily due to lower expense associated with the employee annual profit sharing contribution and lower medical expense. Stock-based compensation decreased $3 million, or 23.1% due to a change in the mix of cash-based and equity-based awards.

Figure 15. Personnel Expense

 

           Three months ended March 31,        Change      
dollars in millions    2013         

 

2012  

               Amount          Percent       

 

Salaries

    $ 222           $ 219           $ 3            1.4        %  

Technology contract labor, net

     18            12            6            50.0      

Incentive compensation

     73            60            13            21.7      

Employee benefits

     59            64            (5)            (7.8)      

Stock-based compensation

     10            13            (3)            (23.1)      

Severance

     9            4            5            125.0      

 

Total personnel expense

    $         391           $         372           $         19            5.1        %  
  

 

 

      

 

 

      

 

 

        

 

Operating lease expense

The $5 million, or 29.4% decrease in operating lease expense compared to the same period one year ago is attributable to product run-off. Income related to the rental of leased equipment is presented in Figure 11 as “operating lease income and other leasing gains.”

 

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Intangible asset amortization

Intangible asset amortization increased $11 million compared to the year-ago quarter as a result of the 2012 acquisitions of the credit card portfolio and 37 branches in Western New York.

Other expense

Other expense is comprised of various miscellaneous expense items. The $12 million, or 12.8% decrease in the current quarter compared to the year-ago quarter reflects fluctuations in several of those line items.

Income taxes

We recorded tax expense from continuing operations of $70 million for the first quarter of 2012, $53 million for the fourth quarter of 2012 and $73 million for the first quarter of 2012.

Our federal tax expense (benefit) differs from the amount that would be calculated using the federal statutory tax rate, primarily because we generate income from investments in tax-advantaged assets, such as corporate-owned life insurance, earn credits associated with investments in low-income housing projects, and make periodic adjustments to our tax reserves.

Additional information pertaining to how our tax expense (benefit) and the resulting effective tax rates were derived are included in Note 12 (“Income Taxes”) on page 175 of our 2012 Form 10-K.

 

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Line of Business Results

This section summarizes the financial performance and related strategic developments of our two major business segments (operating segments), Key Community Bank and Key Corporate Bank. Note 18 (“Line of Business Results”) describes the products and services offered by each of these business segments, provides more detailed financial information pertaining to the segments and explains “Other Segments” and “Reconciling Items.”

Figure 16 summarizes the contribution made by each major business segment to our “taxable-equivalent revenue from continuing operations” and “income (loss) from continuing operations attributable to Key” for the three-month periods ended March 31, 2013 and 2012.

Figure 16. Major Business Segments - Taxable-Equivalent (TE) Revenue from Continuing Operations and Income (Loss) from Continuing Operations Attributable to Key

 

       Three months ended March 31,        Change  
dollars in millions    2013       

 

2012  

     Amount        Percent   

 

 

REVENUE FROM CONTINUING OPERATIONS (TE)

           

Key Community Bank

    $ 549         $ 532         $ 17          3.2     % 

Key Corporate Bank

     379          378          1          0.3    

Other Segments

     83          94          (11)          (11.7)    

 

 

Total Segments

     1,011          1,004          7          0.7    

Reconciling Items

     3          (3)          6          N/M    

 

 

Total

    $ 1,014         $ 1,001         $ 13          1.3     % 
  

 

 

    

 

 

    

 

 

    

INCOME (LOSS) FROM CONTINUING OPERATIONS ATTRIBUTABLE TO KEY

           

Key Community Bank

    $ 31         $ 58         $ (27)          (46.6)    % 

Key Corporate Bank

     105          91          14          15.4      

Other Segments

     68          50          18          36.0    

 

 

Total Segments

     204          199          5          2.5     %

Reconciling Items

     (3)          2        $ (5)          N/M    

 

 

Total

    $             201         $             201                       —                       —      
  

 

 

    

 

 

    

 

 

    

 

 

Key Community Bank summary of operations

 

 

Seven consecutive quarters of average loan growth

 

Core deposits up $4.4 billion, or 11.7% from the prior year

As shown in Figure 17, Key Community Bank recorded net income attributable to Key of $31 million for the first quarter of 2013, compared to $58 million for the year-ago quarter.

Taxable-equivalent net interest income increased by $4 million, or 1.1% from the first quarter of 2012. Average loans and leases grew 11.6% while average deposits increased 3.9% from one year ago. The Western New York branch and credit card portfolio acquisitions contributed $31 million to net interest income, $1 billion to average loans and leases, and $2 billion to deposits. The positive contribution to net interest income from the acquisitions was partially offset by a lower earnings credit applied to deposits in the current period compared to the same period one year ago as a result of the continued low-rate environment.

Noninterest income increased by $13 million, or 7.4% from the year-ago quarter. Cards and payments income increased $8 million as a result of the third quarter 2012 credit card portfolio acquisition. Trust and investment services income increased $5 million, primarily due to an increase in assets under management resulting from strong market performance and increased production.

The provision for loan and lease losses increased by $55 million compared to the first quarter of 2012. Net loan charge-offs, including the 2012 credit card acquisition, of $47 million were flat compared to the same period one year ago.

Noninterest expense increased by $4 million, or .9% from the year-ago quarter. Expense reductions resulting from Key’s efficiency initiative and timing related to marketing expense substantially offset the increase in expenses associated with our Western New York branch and credit card portfolio acquisitions in the third quarter of 2012.

 

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Figure 17. Key Community Bank

 

      Three months ended March 31,       Change  
dollars in millions   2013       2012       Amount       Percent   

 

 

SUMMARY OF OPERATIONS

       

Net interest income (TE)

    $ 361         $ 357         $ 4         1.1     % 

Noninterest income

    188         175         13         7.4     

 

 

Total revenue (TE)

    549         532         17         3.2    

Provision (credit) for loan and lease losses

    59         4         55         N/M    

Noninterest expense

    440         436         4         .9    

 

 

Income (loss) before income taxes (TE)

    50         92         (42)         (45.7)    

Allocated income taxes (benefit) and TE adjustments

    19         34         (15)         (44.1)    

 

 

Net income (loss) attributable to Key

    $ 31         $ 58         $ (27)         (46.6)    % 
 

 

 

   

 

 

   

 

 

   

AVERAGE BALANCES

       

Loans and leases

    $ 28,982         $ 25,981         $ 3,001         11.6     % 

Total assets

    31,478         28,223         3,255         11.5    

Deposits

    49,359         47,506         1,853         3.9    

Assets under management at period end

   $         23,867         $         21,940         $         1,927                 8.8     % 

 

 

ADDITIONAL KEY COMMUNITY BANK DATA

 

                       
       Three months ended March 31,        Change  
dollars in millions   2013       2012       Amount       Percent   

 

 

NONINTEREST INCOME

       

Trust and investment services income

    $ 65         $ 60         $ 5         8.3     % 

Services charges on deposit accounts

    58         56         2         3.6    

Electronic banking fees

    33         25         8         32.0    

Other noninterest income

    32         34         (2)         (5.9)    

 

 

Total noninterest income

    $ 188         $ 175         $ 13         7.4     % 
 

 

 

   

 

 

   

 

 

   

 

 

AVERAGE DEPOSITS OUTSTANDING

       

NOW and money market deposit accounts

    $ 26,110         $ 23,067         $ 3,043         13.2     % 

Savings deposits

    2,463         1,988         475         23.9    

Certificates of deposits ($100,000 or more)

    2,498         3,441         (943)         (27.4)    

Other time deposits

    4,445         6,022         (1,577)         (26.2)    

Deposits in foreign office

    270         313         (43)         (13.7)    

Noninterest-bearing deposits

    13,573         12,675         898         7.1    

 

 

Total deposits

    $ 49,359         $ 47,506         $ 1,853         3.9     % 
 

 

 

   

 

 

   

 

 

   

 

 

HOME EQUITY LOANS

       

Average balance

    $ 9,787         $ 9,173        

Weighted-average loan-to-value ratio (at date of origination)

    70     %      70     %     

Percent first lien positions

    55         53        

 

     

OTHER DATA

       

Branches

    1,084         1,059        

Automated teller machines

    1,482         1,572        

 

     

Key Corporate Bank summary of operations

 

 

Investment banking and debt placement fees were up $19 million, or 32.2% from the prior year

 

Average loan balances up 7.8% from the prior year

 

Average deposits up 20.8% from the prior year

As shown in Figure 18, Key Corporate Bank recorded net income attributable to Key of $105 million for the first quarter of 2013, compared to $91 million for the same period one year ago.

Taxable-equivalent net interest income decreased by $9 million, or 4.6% compared to the first quarter of 2012. Average earning assets increased $1.2 billion, or 5.7% from the year-ago quarter. The benefit from the increase in average earning assets was offset by a decrease in earning asset spread driven by a change in the mix of new business volume and the run-off of higher yielding loans. Average deposit balances increased $2.4 billion, or 20.8% from the year-ago quarter; however, the deposit spread decreased as a result of the continued low-rate environment.

 

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Noninterest income increased by $10 million, or 5.5 % from the first quarter of 2012. Investment banking and debt placement fees increased $19 million, partially offset by a $7 million decrease in operating lease income and other leasing gains compared to the year-ago quarter.

The provision for loan and lease losses decreased by $9 million compared to the first quarter of 2012. There was a net loan recovery of $1 million for the first quarter of 2013 compared to net loan charge-offs of $25 million for the same period one year ago.

Noninterest expense decreased by $13 million, or 5.9% from the first quarter of 2012. This decline was driven by a reduction in operating expenses compared to the first quarter of 2012.

Figure 18. Key Corporate Bank

 

       Three months ended March 31,        Change  
dollars in millions    2013        2012        Amount       Percent   

 

 

SUMMARY OF OPERATIONS

           

Net interest income (TE)

      $ 187           $ 196           $ (9)         (4.6)   % 

Noninterest income

     192          182          10         5.5    

 

 

Total revenue (TE)

     379          378                 0.3    

Provision (credit) for loan and lease losses

     4          13          (9)         (69.2)    

Noninterest expense

     209          222          (13)         (5.9)    

 

 

Income (loss) before income taxes (TE)

     166          143          23         16.1    

Allocated income taxes and TE adjustments

     61          52                  17.3    

 

 

Net income (loss) attributable to Key

      $ 105           $ 91           $ 14         15.4    % 
  

 

 

    

 

 

    

 

 

    

AVERAGE BALANCES

           

Loans and leases

      $ 20,039           $ 18,584           $ 1,455         7.8    % 

Loans held for sale

     409          509          (100)         (19.6)    

Total assets

     23,860          22,847          1,013         4.4    

Deposits

     13,957          11,556          2,401         20.8    

Assets under management at period end

      $         11,847           $         13,922           $         (2,075)         (14.9)   % 

 

 
ADDITIONAL KEY CORPORATE BANK DATA                            
       Three months ended March 31,          Change  
dollars in millions    2013        2012        Amount       Percent   

 

 

NONINTEREST INCOME

           

Trust and investment services income

      $ 31           $ 36           $ (5)         (13.9)   % 

Investment banking and debt placement fees

     78          59          19         32.2    

Operating lease income and other leasing gains

     17          24          (7)         (29.2)    

Corporate services income

     30          33          (3)         (9.1)    

Other noninterest income

     36          30                 20.0    

 

 

Total noninterest income(a)

      $ 192           $ 182           $ 10         5.5    % 
  

 

 

    

 

 

    

 

 

    
           

 

 

Other Segments

Other Segments consist of Corporate Treasury, Community Development, Principal Investing and various exit portfolios. Other Segments generated net income attributable to Key of $68 million for the first quarter of 2013, compared to net income attributable to Key of $50 million for the same period last year. These results were primarily attributable to an increase in net interest income of $36 million and a decrease in the provision for loan and lease losses of $32 million. These improvements were partially offset by a decline in noninterest income of $48 million primarily due to decreases in operating lease income and other leasing gains of $22 million and net gains (losses) from principal investing of $27 million.

 

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Financial Condition

Loans and loans held for sale

At March 31, 2013, total loans outstanding from continuing operations were $52.6 billion, compared to $52.8 billion at December 31, 2012 and $49.2 billion at March 31, 2012. Loans related to the discontinued operations of the education lending business, which are excluded from total loans at March 31, 2013, December 31, 2012, and March 31, 2012, totaled $5.1 billion, $5.2 billion, and $5.7 billion, respectively. The increase in our outstanding loans from continuing operations over the past twelve months results primarily from increased lending activity in our commercial, financial and agricultural portfolio along with the previously discussed credit card portfolio and branch acquisition. For more information on balance sheet carrying value, see Note 1 (“Summary of Significant Accounting Policies”) under the headings “Loans” and “Loans Held for Sale” on pages 119-120 of our 2012 Form 10-K.

Commercial loan portfolio

Commercial loans outstanding were $36.8 billion at March 31, 2013, an increase of $2.2 billion, or 6.3%, compared to March 31, 2012.

Commercial, financial and agricultural.     Our Commercial, Financial and Agricultural loans, also referred to as “Commercial and Industrial,” represent 45% of our total loan portfolio at March 31, 2013, 44% at December 31, 2012 and 41% at March 31, 2012 and are the largest component of our total loans. These loans are comprised of fixed and variable rate loans to our large, middle market and small business clients. These period end loans increased $3.2 billion or 15.8% from the same period one year ago. This growth in our commercial and industrial portfolio is primarily attributable to our clients in the manufacturing, technology and healthcare industries. We are experiencing growth in new high credit quality loan commitments, and utilization with clients in our middle market segment, and in our Institutional and Capital Markets business. Additionally, we increased loans to real estate investment trust (“REIT”) clients and institutionally backed commercial real estate (“CRE”) Funds. REITs and institutional CRE Funds effectively enable us to lend to entities that generally have more diverse cash flows, lower debt levels and better access to the capital markets than private owners or developers.

Commercial real estate loans.   Our CRE lending business is conducted through two primary sources: our 14-state banking franchise, and KeyBank Real Estate Capital, a national line of business that cultivates relationships with owners of CRE located both within and beyond the branch system. This line of business deals primarily with nonowner-occupied properties (generally properties for which at least 50% of the debt service is provided by rental income from nonaffiliated third parties) and accounted for approximately 59% of our average year-to-date commercial real estate loans, compared to 71% one year ago. KeyBank Real Estate Capital generally focuses on larger owners and operators of commercial real estate.

CRE loans represent 16% of our total loan portfolio at March 31, 2013 compared to 18% one year ago. These loans include both owner and nonowner occupied properties which at March 31, 2013 represented 23% of our commercial loan portfolio compared to 26% one year ago. These loans have decreased $479 million, or 5.3%, to $8.6 billion at March 31, 2013, from $9.1 billion at March 31, 2012. This decrease in our CRE portfolio has resulted from many of our clients taking advantage of historically low long-term interest rates to refinance their loans in the permanent loan market. We have also been de-risking the portfolio by changing our focus from developers to owners of completed and stabilized CRE.

Figure 19 includes commercial mortgage and construction loans in both Key Community Bank and Key Corporate Bank. As shown in Figure 19, this loan portfolio is diversified by both property type and geographic location of the underlying collateral.

As shown in Figure 19, at March 31, 2013, our CRE portfolio included mortgage loans of $7.5 billion and construction loans of $1.1 billion, representing 14% and 2%, respectively, of our total loans. Nonowner-occupied loans represented 64% of our total loans and owner-occupied loans represented 36% of our total loans. The average size of mortgage loans originated during the first quarter of 2013 was $4.3 million, and our largest mortgage loan at March 31, 2013, had a balance of $73 million. At March 31, 2013, our average construction loan commitment was $4.2 million. Our largest construction loan commitment was $56.7 million, and our largest construction loan amount outstanding was $56.3 million.

Also shown in Figure 19, at March 31, 2013, 64% of our commercial real estate loans were for nonowner-occupied properties compared to 65% at March 31, 2012. Approximately 16% and 18% of these loans were construction loans at March 31, 2013 and 2012, respectively. Typically, these properties are not fully leased at the origination of the loan. The borrower relies

 

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upon additional leasing through the life of the loan to provide the cash flow necessary to support debt service payments. A significant decline in economic growth, and in turn, rental rates and occupancy would adversely affect our portfolio of construction loans.

Figure 19. Commercial Real Estate Loans

 

March 31, 2013    Geographic Region             Percent of             Commercial   
dollars in millions   

 

West 

     Southwest       Central       Midwest       Southeast       Northeast       Total       Total      Construction       Mortgage   

 

 

Nonowner-occupied:

                            

Retail properties

    $ 154         $ 145         $ 110         $ 140         $ 315         $ 193         $ 1,057          12.3     %     $ 177         $ 880    

Multifamily properties

     254          114          232          411          440          121          1,572          18.3         403          1,169    

Health facilities

     237          —          220          171          65          169          862          10.0         55          807    

Office buildings

     201          16          101          139          22          104          583          6.8         57          526    

Warehouses

     179          —          17          56          114          108          474          5.5         17          457    

Manufacturing facilities

     10          —          1          4          73          3          91          1.1         11          80    

Hotels/Motels

     50          —          —          30          52          15          147          1.7         —          147    

Residential properties

     8          —          23          43          25          28          127          1.5         79          48    

Land and development

     14          —          26          7          16          16          79          0.9         68          11    

Other

     86          —          27          49          147          190          499          5.7         18          481    

 

 

Total nonowner-occupied

     1,193          275          757          1,050          1,269          947          5,491          63.8         885          4,606    

Owner-occupied

     1,284          34          320          737          45          690          3,110          36.2         173          2,937    

 

 

Total

    $     2,477         $     309         $     1,077         $     1,787         $     1,314         $     1,637         $     8,601              99.9     %     $     1,058         $     7,543    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

 

Nonowner-occupied:

                            

Nonperforming loans

    $ 4         $ 18         $ —         $ 14         $ 45         $ 12         $ 93          N/M        $ 24         $ 69    

Accruing loans past due 90 days or more

     —          —          —          —          —          9          9          N/M         —          9    

Accruing loans past due 30 through 89 days

     1          —          —          8          —          —          9          N/M         —          9    

 

 

 

West –

   Alaska, California, Hawaii, Idaho, Montana, Oregon, Washington and Wyoming

Southwest –

   Arizona, Nevada and New Mexico

Central –

   Arkansas, Colorado, Oklahoma, Texas and Utah

Midwest –

  Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota and Wisconsin

Southeast –

   Alabama, Delaware, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, South Carolina, Tennessee, Virginia,
   Washington D.C. and West Virginia

Northeast –

  Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont

In the first three months of 2013, nonperforming loans related to nonowner-occupied properties decreased by $34 million from December 31, 2012 to $93 million at March 31, 2013 and also decreased by $70 million when compared to March 31, 2012.

Since March 31, 2012, our nonowner occupied commercial real estate portfolio has been reduced by approximately $428 million, or 7.2%, as many of our clients have taken advantage of opportunities to permanently refinance their loans at historically low interest rates.

If the economic recovery stalls, it may weaken the commercial real estate market fundamentals (i.e., vacancy rates, the stability of rental income and asset values), leading to reduced cash flow to support debt service payments. Reduced client cash flow would adversely affect our ability to collect such payments. Accordingly, the value of our commercial real estate loan portfolio could be adversely affected.

Commercial lease financing.   We conduct commercial lease financing arrangements through our Key Equipment Finance line of business and have both the scale and array of products to compete in the equipment lease financing business. Commercial lease financing receivables represented 13% of commercial loans at March 31, 2013, and 15% at March 31, 2012.

Commercial loan modification and restructuring

We modify and extend certain commercial loans in the normal course of business for our clients. Loan modifications vary and are handled on a case by case basis with strategies responsive to the specific circumstances of each loan and borrower. In many cases, borrowers have other resources and can reinforce the credit with additional capital, collateral, guarantees or income sources.

Modifications are negotiated to achieve mutually agreeable terms that maximize loan credit quality while at the same time meeting our clients’ financing needs. Modifications made to loans of creditworthy borrowers not experiencing financial difficulties and under circumstances where ultimate collection of all principal and interest is not in doubt are not classified as TDRs. In accordance with applicable accounting guidance, a loan is classified as a TDR only when the borrower is experiencing financial difficulties and a creditor concession has been granted.

 

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Our concession types are primarily interest rate reductions, forgiveness of principal, and other modifications. Loan extensions are sometimes coupled with these primary concession types. Because economic conditions have improved modestly and we have restructured loans to provide the optimal opportunity for successful repayment by the borrower, certain of our restructured loans have returned to accrual status and consistently performed under the restructured loan terms over the past year.

If the loan terms are extended at less than normal market rates for similar lending arrangements, our Asset Recovery Group is consulted to help determine if any concession granted would result in designation as a TDR. Transfer to our Asset Recovery Group is considered for any commercial loan determined to be a TDR. During the first quarter of 2013, there were $34 million of new restructured loans, of which $4 million related to commercial loans and $30 million to consumer loans.

For more information on concession types for our commercial accruing and nonaccruing TDRs, see Note 4 (“Asset Quality”).

Figure 20 quantifies restructured loans and TDRs. As of December 31, 2012, $72 million of secured loans discharged through Chapter 7 bankruptcy and not reaffirmed by the borrower were reclassified as consumer TDRs. Regardless of delinquency status, these loans were accounted for at the fair market value of the collateral less selling costs, are classified as nonaccrual, and are included in nonperforming loans.

Figure 20. Commercial TDRs by Note Type and Accrual Status

 

     March 31,       December 31,       September 30,       June 30,       March 31,   
in millions    2013       

 

2012  

     2012        2012        2012    

 

 

 

Commercial TDRs by Note Type

              

 

 

Tranche A

    $ 101         $ 117         $ 166         $ 188         $ 218    

 

 

Total Commercial TDRs

    $ 101         $ 117         $ 166         $ 188         $ 218    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

Commercial TDRs by Accrual Status

              

 

 

Nonaccruing

    $ 49         $ 96         $ 114         $ 133         $ 148    

Accruing

     52          21          52          55          70    

 

 

Total Commercial TDRs

    $ 101         $ 117         $ 166         $ 188         $ 218    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total Commercial and Consumer TDRs

    $               294         $               320         $               323         $               274         $               293    

 

 

We often use an A-B note structure for our TDRs, breaking the existing loan into two tranches. First, we create an A note. As the objective of this TDR note structure is to achieve a fully performing and well-rated A note, we focus on sizing that note to a level that is supported by cash flow available to service debt at current market terms and consistent with our customary underwriting standards. This note structure typically will include a debt coverage ratio of 1.2 or better of cash flow to monthly payments of market interest, and principal amortization of generally not more than 25 years. (These metrics are adjusted from time to time based upon changes in long-term markets and “take out underwriting standards” of our various lines of business.) Appropriately sized A notes are more likely to return to accrual status, allowing us to resume recognizing interest income. As the borrower’s payment performance improves, these restructured notes typically also allow for upgraded internal quality risk rating classification. Moreover, the borrower retains ownership and control of the underlying collateral (typically, commercial real estate), the borrower’s capital structure is strengthened (often to the point that fresh capital is attracted to the transaction), and local markets are spared distressed/fire sales.

The B note typically is an interest-only note with no required amortization until the property stabilizes and generates excess cash flow. This excess cash flow customarily is applied directly to the principal of the A note. We evaluate the B note when we consider returning the A note to accrual status. In many cases, the B note is charged off at the same time the A note is returned to accrual status. Alternatively, both A and B notes may be simultaneously returned to accrual if credit metrics are supportive.

Restructured nonaccrual loans may be returned to accrual status based on a current, well documented evaluation of the credit, which would include analysis of the borrower’s financial condition, prospects for repayment under the modified terms, and alternate sources of repayment such as the value of loan collateral. We wait a reasonable period (generally a minimum of six months) to establish the borrower’s ability to sustain historical repayment performance before returning the loan to accrual status. Sustained historical repayment performance prior to the restructuring also may be taken into account. The primary consideration for returning a restructured loan to accrual status is the reasonable assurance that the full contractual principal balance of the loan and the ongoing contractually required interest payments will be fully repaid. Although our policy is a guideline, considerable judgment is required to review each borrower’s circumstances.

 

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All loans processed as TDRs, including A notes and any non-charged-off B notes, are reported as TDRs during the calendar year in which the restructure took place.

Extensions.   Project loans typically are refinanced into the permanent commercial loan market at maturity, but sometimes they are modified and extended. Extension terms take into account the specific circumstances of the client relationship, the status of the project, and near-term prospects for both the client and the collateral. In all cases, pricing and loan structure are reviewed and, where necessary, modified to ensure the loan has been priced to achieve a market rate of return and loan terms that are appropriate for the risk. Typical enhancements include one or more of the following: principal paydown, increased amortization, additional collateral, increased guarantees, and a cash flow sweep. Some maturing construction loans have automatic extension options built in; in those cases, pricing and loan terms cannot be altered.

Loan pricing is determined based on the strength of the borrowing entity and the strength of the guarantor, if any. Therefore, pricing for an extended loan may remain the same because the loan is already priced at or above current market.

We do not consider loan extensions in the normal course of business (under existing loan terms or at market rates) as TDRs, particularly when ultimate collection of all principal and interest is not in doubt and no concession has been made. In the case of loan extensions where either collection of all principal and interest is uncertain or a concession has been made, we would analyze such credit under the accounting guidance to determine whether it qualifies as a TDR. Extensions that qualify as TDRs are measured for impairment under the applicable accounting guidance.

Guarantors.   We conduct a detailed guarantor analysis (1) for all new extensions of credit, (2) at the time of any material modification/extension, and (3) typically annually, as part of our on-going portfolio and loan monitoring procedures. This analysis requires the guarantor entity to submit all appropriate financial statements, including balance sheets, income statements, tax returns, and real estate schedules.

While the specific steps of each guarantor analysis may vary, the high level objectives include determining the overall financial conditions of the guarantor entities, including: size, quality, and nature of asset base; net worth (adjusted to reflect our opinion of market value); leverage; standing liquidity; recurring cash flow; contingent and direct debt obligations; and near term debt maturities.

Borrower and guarantor financial statements are required at least annually within 90-120 days of the calendar/fiscal year end. Income statements and rent rolls for project collateral are required quarterly. We may require certain information, such as liquidity, certifications, status of asset sales or debt resolutions, and real estate schedules to be provided more frequently.

We routinely seek performance from guarantors of impaired debt if the guarantor is solvent. We may not seek to enforce the guaranty if we are precluded by bankruptcy or we determine the cost to pursue a guarantor exceeds the value to be returned given the guarantor’s verified financial condition. We often are successful in obtaining either monetary payment or the cooperation of our solvent guarantors to help mitigate loss, cost and the expense of collections.

As of March 31, 2013, we had $5.7 million of mortgage and construction loans that had a loan-to-value ratio greater than 1.0, and were accounted for as performing loans. These loans were not considered impaired due to one or more of the following factors: (i) underlying cash flow adequate to service the debt at a market rate of return with adequate amortization; (ii) a satisfactory borrower payment history; and (iii) acceptable guarantor support.

Consumer loan portfolio

Consumer loans outstanding increased by $1.2 billion, or 7.9%, from one year ago. The home equity portfolio is the largest segment of our consumer loan portfolio. Approximately 96% of this portfolio at March 31, 2013, is derived from our Key Community Bank within our 14 state footprint. The remainder of the portfolio, which has been in an exit mode since the fourth quarter of 2007, was originated from the Consumer Finance line of business and is now included in Other Segments. Home equity loans in Key Community Bank increased by $656 million, or 7.2%, over the past twelve months as a result of stabilized home values, improved employment, and favorable borrowing conditions.

As shown in Figure 17, we hold the first lien position for approximately 55% of the Key Community Bank home equity portfolio at March 31, 2013, and 53% at March 31, 2012. For consumer loans with real estate collateral, we track borrower

 

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performance monthly. Regardless of the lien position, credit metrics are refreshed quarterly, including recent Fair Isaac Corporation scores as well as original and updated loan-to-value ratio. This information is used in establishing the ALLL. Our methodology is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan and Lease Losses” that begins on page 120 of our 2012 Form 10-K.

Regulatory guidance issued in January 2012 addressed specific risks and required actions within home equity portfolios associated with second lien loans. At March 31, 2013, 45% of our home equity portfolio is secured by second lien mortgages. On at least a quarterly basis, we continue to monitor the risk characteristics of these loans when determining whether our loss estimation methods are appropriate. This regulatory guidance related to the classification of second lien home equity loans was implemented prospectively, and therefore prior periods were not adjusted.

Figure 21 summarizes our home equity loan portfolio by source at the end of each of the last five quarters, as well as certain asset quality statistics and yields on the portfolio as a whole.

Figure 21. Home Equity Loans

 

     2013     2012  
dollars in millions    First      Fourth      Third      Second      First   

 

 

SOURCES OF PERIOD END LOANS

          

Key Community Bank

    $ 9,809        $ 9,816        $ 9,768        $ 9,601        $ 9,153    

Other

     401         423         409         479         507    

 

 

Total

    $           10,210        $           10,239        $           10,177        $           10,080        $           9,660    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

 

 

Nonperforming loans at period end

    $ 217        $ 231         (a), (b)     $ 189         (a), (b)     $ 158     (a)     $ 121    

Net loan charge-offs for the period

     20         (7)         67         28         30    

Yield for the period (c)

     4.12     %      4.16     %      4.19     %      4.23     %      4.27     % 

 

 

 

(a) Includes $48 million of performing home equity second liens that are subordinate to first liens and 120 days or more past due or in foreclosure, or for which the first mortgage delinquency timeframe is unknown. Such second liens are now being reported as nonperforming loans based upon regulatory guidance issued in January 2012.

 

(b) Includes $72 million of performing secured loans that were discharged through Chapter 7 bankruptcy and not formally re-affirmed as addressed in regulatory guidance that was updated in the third quarter of 2012. Such loans have been designated as nonperforming and TDRs.

 

(c) From continuing operations.

Loans held for sale

As shown in Note 3 (“Loans and Loans Held for Sale”), our loans held for sale decreased to $434 million at March 31, 2013 from $599 million at December 31, 2012 and totaled $511 million at March 31, 2012.

At March 31, 2013, loans held for sale included $196 million of commercial mortgages, which decreased by $166 million from March 31, 2012, and $49 million of residential mortgage loans, which decreased $27 million from March 31, 2012.

Loan sales

As shown in Figure 22, during the first three months of 2013, we sold $880 million of commercial real estate loans, $328 million of residential real estate loans, $69 million of commercial lease financing loans, and $38 million of commercial loans. Most of these sales came from the held-for-sale portfolio; however, $58 million of these loan sales related to the held-to-maturity portfolio. Sales of mortgage loans held by our real estate investment entity, leases and other loans not classified as held for sale generated net gains of $18 million in the first three months of 2013 and are included in “investment banking and debt placement fees,” “consumer mortgage income,” and “other income” on the income statement.

Loan sales classified as held for sale generated net gains of $13 million in the first three months of 2013 and are included in “investment banking and debt placement fees” and “other income” on the income statement.

Among the factors that we consider in determining which loans to sell are:

 

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our business strategy for particular lending areas;

 

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whether particular lending businesses meet established performance standards or fit with our relationship banking strategy;

 

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¿  

our A/LM needs;

 

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the cost of alternative funding sources;

 

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the level of credit risk;

 

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capital requirements; and

 

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market conditions and pricing.

Figure 22 summarizes our loan sales for the first three months of 2013 and all of 2012.

Figure 22. Loans Sold (Including Loans Held for Sale)

 

in millions    Commercial     

Commercial

Real Estate

    

Commercial

Lease

Financing

    

Residential

Real Estate

     Total  

 

 

2013

                                  

First quarter

    $ 38         $ 880         $ 69         $ 328         $ 1,315    

 

 

Total

    $ 38         $ 880         $ 69         $ 328         $ 1,315    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

2012

                                  

Fourth quarter

    $ 38         $ 1,233         $ 53         $ 493         $ 1,817    

Third quarter

     46          787          47          503          1,383    

Second quarter

     24          808          26          379          1,237    

First quarter

     36          715          22          400          1,173    

 

 

Total

    $ 144         $ 3,543         $ 148         $ 1,775         $ 5,610    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

 

Figure 23 shows loans that are either administered or serviced by us, but not recorded on the balance sheet. The table includes loans that have been sold.

   

 

Figure 23. Loans Administered or Serviced

  

in millions   

March 31, 

2013  

     December 31, 
2012  
     September 30, 
2012  
    

June 30, 

2012  

    

March 31, 

2012  

 

 

 

Commercial real estate loans

    $ 109,173         $ 107,630         $ 98,309         $ 97,329         $ 96,519    

Commercial lease financing

     516          520          519          517          538    

Commercial loans

     353          343          333          325          313    

 

 

Total

    $               110,042         $               108,493         $                 99,161         $                 98,171         $                 97,370    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

In the event of default by a borrower, we are subject to recourse with respect to approximately $1.2 billion of the $110 billion of loans administered or serviced at March 31, 2013. Additional information about this recourse arrangement is included in Note 15 (“Contingent Liabilities and Guarantees”) under the heading “Recourse agreement with FNMA.”

We derive income from several sources when retaining the right to administer or service loans that are sold. We earn noninterest income (recorded as “other income”) from fees for servicing or administering loans. This fee income is reduced by the amortization of related servicing assets. In addition, we earn interest income from investing funds generated by escrow deposits collected in connection with the servicing of commercial real estate loans.

Securities

Our securities portfolio totaled $17.2 billion at March 31, 2013, compared to $16 billion at December 31, 2012, and $17.7 billion at March 31, 2012. Available-for-sale securities were $13.5 billion at March 31, 2013, compared to $12.1 billion at December 31, 2012, and $14.6 billion at March 31, 2012. Held-to-maturity securities were $3.7 billion at March 31, 2013, compared to $3.9 billion at December 31, 2012, and $3 billion at March 31, 2012. Essentially all of our held-to-maturity securities portfolio was invested in CMOs at March 31, 2013.

As shown in Figure 24, all of our mortgage-backed securities, which include both securities available for sale and held-to-maturity securities, are issued by government-sponsored enterprises or GNMA, and are traded in highly liquid secondary markets. These securities are recorded on the balance sheet at fair value for the available-for-sale portfolio and at cost for the held-to-maturity portfolio. For more information about these securities, see Note 5 (“Fair Value Measurements”) under the heading “Qualitative Disclosures of Valuation Techniques” and Note 6 (“Securities”).

 

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Figure 24. Mortgage-Backed Securities by Issuer

 

in millions   

March 31, 

2013  

     December 31, 
2012  
    

March 31, 

2012  

 

 

 

FHLMC

    $ 8,108         $ 7,923         $ 8,864    

FNMA

     5,156          5,246          5,433    

GNMA

     3,844          2,746          3,262    

 

 

Total (a)

    $                 17,108         $                 15,915         $                 17,559    
  

 

 

    

 

 

    

 

 

 
        

 

 

 

(a) Includes securities held in the available-for-sale and held-to-maturity portfolios.

Securities available for sale

The majority of our securities available-for-sale portfolio consists of CMOs, which are debt securities secured by a pool of mortgages or mortgage-backed securities. CMOs generate interest income and serve as collateral to support certain pledging agreements. At March 31, 2013, we had $13.4 billion invested in CMOs and other mortgage-backed securities in the available-for-sale portfolio, compared to $12 billion at December 31, 2012, and $14.6 billion at March 31, 2012.

We periodically evaluate our securities available-for-sale portfolio in light of established A/LM objectives, changing market conditions that could affect the profitability of the portfolio, and the level of interest rate risk to which we are exposed. These evaluations may cause us to take steps to adjust our overall balance sheet positioning.

In addition, the size and composition of our securities available-for-sale portfolio could vary with our needs for liquidity and the extent to which we are required (or elect) to hold these assets as collateral to secure public funds and trust deposits. Although we generally use debt securities for this purpose, other assets, such as securities purchased under resale agreements or letters of credit, are used occasionally when they provide a lower cost of collateral or more favorable risk profiles.

Throughout 2012 and in the first quarter of 2013, our investing activities continued to complement other balance sheet developments and provide for our ongoing liquidity management needs. Our actions to not reinvest the monthly security cash flows at various times during this time period served to provide the liquidity necessary to address our funding requirements. These funding requirements included ongoing loan growth and occasional debt maturities, as well as the branch acquisition in July 2012 (including credit card assets obtained in September 2012) and the acquisition of Key-branded credit card assets in August 2012.

Figure 25 shows the composition, yields and remaining maturities of our securities available for sale. For more information about these securities, including gross unrealized gains and losses by type of security and securities pledged, see Note 6 (“Securities”).

Figure 25. Securities Available for Sale

 

dollars in millions     
 
 
States and
Political
    Subdivisions
  
  
  
   
 
 
    Collateralized
Mortgage
Obligations
  
  
  
   
 
 
 
Other
        Mortgage-
Backed
Securities
  
  
  
  
   
 
Other
        Securities
  
  (b) 
    Total       
 
 
    Weighted-
Average
Yield
  
  
  

 

 

March 31, 2013

            

Remaining maturity:

            

One year or less

     —      $ 842      $       —       $ 844         3.35    % 

After one through five years

   $ 14        11,900        471      $ 43         12,428         2.55   

After five through ten years

     34        176        11        —         221         2.34   

After ten years

     —        —              —                5.57   

 

 

Fair value

   $ 48      $ 12,918      $ 487      $ 43       $ 13,496         —   

Amortized cost

     47        12,633        445        41         13,166         2.60    % 

Weighted-average yield (c)

     5.99    %      2.49    %      5.26    %      —         2.60    %  (d)      —   

Weighted-average maturity

     5.4 years        2.8 years        2.4 years        1.8 years                    2.8 years        —   

 

 

December 31, 2012

            

Fair value

   $ 49      $ 11,464      $ 538      $ 43       $ 12,094         —   

Amortized cost

     47        11,148        491        42         11,728         2.91    % 

 

 

March 31, 2012

            

Fair value

   $ 62      $ 13,845      $ 714      $ 12       $ 14,633         —   

Amortized cost

     59        13,405        653        11         14,128         3.21    % 
            

 

 

 

(a) Maturity is based upon expected average lives rather than contractual terms.

 

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(b) Includes primarily marketable equity securities.

 

(c) Weighted-average yields are calculated based on amortized cost. Such yields have been adjusted to a taxable-equivalent basis using the statutory federal income tax rate of 35%.

 

(d) Excludes $43 million of securities at March 31, 2013, that have no stated yield.

Held-to-maturity securities

Federal Agency CMOs constitute essentially all of our held-to-maturity securities. The remaining balance is comprised of foreign bonds and capital securities. Figure 26 shows the composition, yields and remaining maturities of these securities.

Figure 26. Held-to-Maturity Securities

 

dollars in millions     

 

 

 

 

Collateralized

 

Mortgage

 

Obligations

  

 

  

 

  

   

 

 

Other

 

Securities

  

 

  

    Total       

 

 

 

 

Weighted- 

 

Average 

 

Yield 

  

 

  

 

  (a) 

 

 

March 31, 2013

        

Remaining maturity:

        

One year or less

     —       $ 10        $ 10          3.88     % 

After one through five years

   $ 3,703         8          3,711          1.92    

 

 

Amortized cost

   $ 3,703       $ 18        $ 3,721          1.92     % 

Fair value

     3,761         18          3,779          —     

Weighted-average yield

     1.92       2.99   %    (b)      1.92   %    (b)      —     

Weighted-average maturity

     2.8 years         1.3 years         2.8 years         —     

 

 

December 31, 2012

        

Amortized cost

   $ 3,913       $ 18        $ 3,931          1.92     % 

Fair value

     3,974         18          3,992          —     

 

 

March 31, 2012

        

Amortized cost

   $                     3,001       $                         18        $                     3,019                          1.98     % 

Fair value

     3,034         18          3,052          —     
        

 

 

 

(a) Weighted-average yields are calculated based on amortized cost. Such yields have been adjusted to a taxable-equivalent basis using the statutory federal income tax rate of 35%.

 

(b) Excludes $5 million of securities at March 31, 2013, that have no stated yield.

 

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Other investments

Principal investments — investments in equity and mezzanine instruments made by our Principal Investing unit — represented 59.1% of other investments at March 31, 2013. They include direct investments (investments made in a particular company) as well as indirect investments (investments made through funds that include other investors). Principal investments are predominantly made in privately held companies and are carried at fair value ($626 million at March 31, 2013, $627 million at December 31, 2012, and $729 million at March 31, 2012).

In addition to principal investments, “other investments” include other equity and mezzanine instruments, such as certain real estate-related investments that are carried at fair value, as well as other types of investments that generally are carried at cost.

Most of our other investments are not traded on an active market. We determine the fair value at which these investments should be recorded based on the nature of the specific investment and all available relevant information. This review may encompass such factors as the issuer’s past financial performance and future potential, the values of public companies in comparable businesses, the risks associated with the particular business or investment type, current market conditions, the nature and duration of resale restrictions, the issuer’s payment history, our knowledge of the industry, third-party data and other relevant factors. During the first three months of 2013, net gains from our principal investing activities (including results attributable to noncontrolling interests) totaled $8 million, which includes less than $1 million of net unrealized losses. These net gains are recorded as “net gains (losses) from principal investing” on the income statement. Additional information regarding these investments is provided in Note 5 (“Fair Value Measurements”).

Deposits and other sources of funds

Domestic deposits are our primary source of funding. During the first quarter of 2013, average domestic deposits were $63.2 billion and represented 86% of the funds we used to support loans and other earning assets, compared to $58.9 billion and 82% during the same quarter of 2012. The composition of our average deposits is shown in Figure 9 in the section entitled “Net interest income.”

The increase in average domestic deposits in the first quarter of 2013, compared to the first quarter of 2012, was due to the growth in demand deposits of $2.9 billion and interest-bearing non-time deposits of $4.1 billion (including the impact of our third quarter 2012 Western New York branch acquisition, which added $2 billion of mostly interest-bearing non-time deposits). This deposit growth was partially offset by $3 billion of run-off from one year ago in certificates of deposit and other time deposits. Improved funding mix and previous maturities of our certificates of deposit have reduced the cost of total deposits from .76% for the first quarter of 2012 to .43% for the first quarter of 2013.

Wholesale funds, consisting of deposits in our foreign office and short-term borrowings, averaged $2.8 billion during first quarter of 2013, compared to $3.1 billion during first quarter of 2012. The change from 2012 resulted from a $315 million decrease in foreign office deposits, a $103 million decrease in bank notes and other short-term borrowings, and a $63 million increase in federal funds purchased and securities sold under agreements to repurchase.

 

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Capital

At March 31, 2013, our shareholders’ equity was $10.3 billion, up $69 million from December 31, 2012. The following sections discuss certain factors that contributed to this change. For other factors that contributed to the change, see the Consolidated Statements of Changes in Equity.

CCAR and capital actions

As part of its ongoing supervisory process, the Federal Reserve requires BHCs like KeyCorp to submit an annual comprehensive capital plan and to update that plan to reflect material changes in a firm’s risk profile, business strategies, or corporate structure, including but not limited to changes in planned capital actions. As previously reported, on January 7, 2013, we submitted to the Federal Reserve and provided to the OCC under the annual CCAR process our 2013 capital plan. On March 14, the Federal Reserve announced that it did not object to our 2013 capital plan. At its March 2013 meeting, our Board authorized up to $426 million of Common Share repurchases in the open market or through privately negotiated transactions. The authorization was expressly in addition to any amounts remaining under preexisting authority. Common Share repurchases under the current authorization are expected to be executed through the first quarter of 2014.

Dividends

During the first quarter of 2013, we made a dividend payment of $.05 per share, or $47 million, on our Common Shares.

Also in first quarter of 2013, we made a quarterly dividend payment of $1.9375 per share, or $5 million, on our Series A Preferred Stock.

As previously reported, our 2013 capital plan also proposed an increase in our quarterly Common Share dividend from $0.05 to $0.055 per share. The Board will evaluate the proposed dividend increase at its May meeting. Other changes to future dividends may be evaluated by the Board of Directors based upon our earnings, financial condition, and other factors, including regulatory review. Further information regarding the capital plan process and CCAR is included in the “Supervision and Regulation” section of our 2012 Form 10-K in Item 1. Business under the heading “Capital Assessment and Review of Capital Actions.”

Common shares outstanding

Our Common Shares are traded on the NYSE under the symbol KEY with 31,673 holders of record at March 31, 2013. At March 31, 2013 our book value per Common Share was $10.89 based on 922.6 million shares outstanding at March 31, 2013, compared to $10.78 based on 925.8 million shares outstanding at December 31, 2012, and $10.26 based on 956.1 million shares outstanding at March 31, 2012. At March 31, 2013 our tangible book value per Common Share was $9.78 compared to $9.67 at December 31, 2012, and $9.28 at March 31, 2012.

Figure 27 shows activities that caused the change in outstanding Common Shares over the past five quarters.

Figure 27. Changes in Common Shares Outstanding

 

     2013      2012  
in thousands    First       Fourth       Third       Second       First   

 

 

Shares outstanding at beginning of period

     925,769          936,195          945,473          956,102          953,008    

Common shares issued (repurchased)

     (6,790)          (10,530)          (9,639)          (10,468)          —    

Shares reissued (returned) under employee benefit plans

     3,602          104          361          (161)          3,094    

 

 

Shares outstanding at end of period

                 922,581                      925,769                      936,195                      945,473                      956,102    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

As shown above, Common Shares outstanding decreased by 3.2 million shares during the first quarter of 2013 from share repurchases under 2012 capital plan and the net activity in our employee benefit plans.

At March 31, 2013, we had 94.4 million treasury shares, compared to 91.2 million treasury shares at December 31, 2012 and 60.9 million treasury shares at March 31, 2012. Going forward we expect to reissue treasury shares as needed in connection with stock-based compensation awards and for other corporate purposes.

Information on KeyCorp’s Common Share repurchase program is included in Part II, Item 2. “Unregistered Sales of Equity Securities and Use of Proceeds” of this report.

 

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Capital adequacy

Capital adequacy is an important indicator of financial stability and performance. All of our capital ratios remain in excess of regulatory requirements at March 31, 2013. Our capital and liquidity are intended to position us to weather an adverse credit cycle while continuing to serve our clients’ needs, as well as to adjust to the regulations currently being proposed by the federal banking agencies to implement Basel III and provisions of the Dodd-Frank Act. Our shareholders’ equity to assets ratio was 11.59% at March 31, 2013, compared to 11.51% at December 31, 2012 and 11.55% at March 31, 2012. Our tangible common equity to tangible assets ratio was 10.24% at March 31, 2013, compared to 10.15% at December 31, 2012 and 10.26% at March 31, 2012.

Banking industry regulators prescribe minimum capital ratios for BHCs like KeyCorp and their banking subsidiaries. Risk-based capital guidelines require a minimum level of capital as a percent of “risk-weighted assets.” Risk-weighted assets consist of total assets plus certain off-balance sheet and market risk items, subject to adjustment for predefined credit risk factors. Currently, banks and BHCs must maintain, at a minimum, Tier 1 capital as a percent of risk-weighted assets of 4.00% and total capital as a percent of risk-weighted assets of 8.00%. As of March 31, 2013, our Tier 1 risk-based capital ratio and our total risk-based capital ratios were 12.19% and 15.02%, respectively, compared to 12.15% and 15.13%, respectively, at December 31, 2012 and 13.29% and 16.51%, respectively at March 31, 2012.

Another indicator of capital adequacy, the leverage ratio, is defined as Tier 1 capital as a percentage of average quarterly tangible assets. BHCs that either have the highest supervisory rating or have implemented the Federal Reserve’s risk-adjusted measure for market risk — as we have — must maintain a minimum leverage ratio of 3.00%. All other BHCs must maintain a minimum ratio of 4.00%. As of March 31, 2013, our leverage ratio was 11.36%, compared to 11.41% at December 31, 2012 and 12.12% at March 31, 2012.

The enactment of the Dodd-Frank Act changes the regulatory capital standards that apply to BHCs by requiring regulators to create rules phasing out the treatment of capital securities and cumulative preferred securities as eligible Tier 1 capital. The three year phase-out period will ultimately result in our trust preferred securities issued by the KeyCorp capital trusts being treated only as Tier 2 capital. These changes in effect apply the same leverage and risk-based capital requirements that apply to depository institutions to BHCs, savings and loan holding companies, and nonbank financial companies identified as systemically important. The section titled “Supervision and Regulation” under Item 1. Business of our 2012 Form 10-K contains more detailed information regarding capital.

As of March 31, 2013, our Tier 1 risk-based capital ratio, leverage ratio, and total risk-based capital ratio were 12.19%, 11.36%, and 15.02%, respectively. The trust preferred securities issued by the KeyCorp capital trusts contribute $339 million or 42, 39, and 42 basis points to our Tier 1 risk-based capital ratio, Tier 1 leverage ratio, and total risk-based capital ratio, respectively, as of March 31, 2013. The proposed new minimum capital ratios together with the estimated capital ratios of Key at March 31, 2013, calculated on a fully phased-in basis under the Basel III and Standardized Approach NPRs are set forth in Figure 4 of this report.

Federal bank regulators group FDIC-insured depository institutions into five categories, ranging from “well-capitalized” to “critically undercapitalized.” A “well-capitalized” institution must meet or exceed the prescribed threshold ratios of 6.00% for Tier 1 risk-based capital, 5.00% for Tier 1 leverage capital, and 10.00% for total risk-based capital and must not be subject to any written agreement, order or directive to meet and maintain a specific capital level for any capital measure. If these provisions applied to BHCs, we believe we would qualify as “well-capitalized” at March 31, 2013, and we believe there has not been any change in condition or event since that date that would cause a change in capital category. Analysis on an estimated basis, accounting for the phase-out of our trust preferred securities as Tier 1 eligible (and therefore as Tier 2 instead) as of March 31, 2013, also determines that we would qualify as “well-capitalized” under current regulatory guidelines (Basel I), with the estimated Tier 1 risk-based capital ratio, estimated leverage ratio, and estimated total risk-based capital ratio being 11.77%, 10.97%, and 15.02%, respectively. Figure 5 in the “Supervision and regulation” section, above, discloses the proposed new threshold capital ratios for a “well capitalized” and an “adequately capitalized” institution. The regulatory defined capital categories serve a limited supervisory function. Investors should not use our estimated ratios as a representation of our overall financial condition or prospects of KeyCorp. A discussion of the regulatory capital standards and other related capital adequacy regulatory standards is included in the section “Supervision and Regulation” under Item 1. Business of our 2012 Form 10-K under the heading “Capital.”

Traditionally, the banking regulators have assessed bank and BHC capital adequacy based on both the amount and composition of capital, the calculation of which is prescribed in federal banking regulations. As a result of the financial crisis,

 

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the Federal Reserve has intensified its assessment of capital adequacy on a component of Tier 1 risk-based capital, known as Tier 1 common equity, and its review of the consolidated capitalization of systemically important financial companies, including KeyCorp. The capital modifications mandated by the Dodd-Frank Act and set forth in Basel III, which the Federal banking agencies have recently proposed to implement, are consistent with the renewed focus on Tier 1 common equity and the consolidated capitalization of banks, BHCs, and covered nonbank financial companies, which resulted from the financial crisis. Tier 1 common equity is neither formally defined by GAAP nor prescribed in amount by federal banking regulations; this measure is considered to be a non-GAAP financial measure. Figure 8 in the “Highlights of Our Performance” section reconciles Key shareholders’ equity, the GAAP performance measure, to Tier 1 common equity, the corresponding non-GAAP measure. Our Tier 1 common equity ratio was 11.40% at March 31, 2013, compared to 11.36% at December 31, 2012 and 11.55% at March 31, 2012.

Generally, for risk-based capital purposes, deferred tax assets that are dependent upon future taxable income are limited to the lesser of: (i) the amount of deferred tax assets that a financial institution expects to realize within one year of the calendar quarter-end date, based on its projected future taxable income for the year, or (ii) 10% of the amount of an institution’s Tier 1 capital. As we anticipated, at March 31, 2013, December 31, 2012 and March 31, 2012, we had no net deferred tax assets deducted from Tier 1 capital and risk-weighted assets. At March 31, 2013, for Key’s consolidated operations, we had a federal net deferred tax asset of $62 million and a state deferred tax liability of $15 million compared to a federal deferred tax asset of $83 and $29 million and a state deferred tax liability of $13 and $28 million at December 31, 2012 and March 31, 2012, respectively. We have recorded a valuation allowance of $3 million against the gross deferred tax assets associated with certain state net operating loss carryforwards and state credit carryforwards.

Basel III

Provisions of the Dodd-Frank Act and the Basel III NPR provide for the phase-out of Tier 1 capital treatment for capital securities. As a result, our outstanding trust preferred securities will eventually become Tier 2 capital. The “Supervision and regulation” section of this report contains a more detailed discussion of the Basel III NPR. Figure 5 in the “Supervision and regulation” section above discloses the proposed new minimum capital ratios together with the estimated capital ratios of Key at March 31, 2013, calculated on a fully phased-in basis under the Basel III and Standardized Approach NPRs. Given our strong capital position, we expect to be able to satisfy the Basel III capital framework when U.S. capital regulations corresponding to it are finalized. While we also have a strong liquidity position, the Basel III liquidity framework could require us and other U.S. banks to initiate additional liquidity management initiatives, including adding additional liquid assets, issuing term debt, and modifying our product pricing for loans, commitments, and deposits.

Figure 28 represents the details of our regulatory capital position at March 31, 2013, December 31, 2012 and March 31, 2012, under the existing Basel I standards.

 

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Figure 28. Capital Components and Risk-Weighted Assets

 

dollars in millions   

March 31, 

2013  

        

December 31, 

2012  

        

March 31, 

2012  

     

 

   

TIER 1 CAPITAL

              

Key shareholders’ equity

    $ 10,340           $ 10,271           $ 10,099      

Qualifying capital securities

     339            339            1,046      

Less:        

 

Goodwill

     979            979            917      
 

Accumulated other comprehensive income (a)

     (204)            (172)            (70)      
 

Other assets (b)

     106            114            69      

 

   
 

Total Tier 1 capital

     9,798            9,689            10,229      

 

   

TIER 2 CAPITAL

              

Allowance for losses on loans and liability for losses on lending-related commitments (c)

     975            972            966      

Net unrealized gains on equity securities available for sale

     1            —            1      

Qualifying long-term debt

     1,305            1,405            1,644      

 

   
 

Total Tier 2 capital

     2,281            2,377            2,611      

 

   
 

Total risk-based capital

    $ 12,079           $ 12,066           $ 12,840      
    

 

 

      

 

 

      

 

 

   

TIER 1 COMMON EQUITY

              

Tier 1 capital

    $ 9,798           $ 9,689           $ 10,229      

Less:

 

Qualifying capital securities

     339            339            1,046      
 

Series A Preferred Stock

     291            291            291      

 

   
 

Total Tier 1 common equity

    $ 9,168           $ 9,059           $ 8,892      
    

 

 

      

 

 

      

 

 

   

RISK-WEIGHTED ASSETS

              

Risk-weighted assets on balance sheet

    $ 63,913           $ 63,995           $ 61,280      

Risk-weighted off-balance sheet exposure

     16,542            16,575            16,069      

Less:

 

Goodwill

     979            980            917      
 

Other assets (b)

     358            367            397      

Plus:

 

Market risk-equivalent assets

     1,282            511            1,034      

 

   
 

Gross risk-weighted assets

     80,400            79,734            77,069      

Less:

 

Excess allowance for loan and lease losses

     —            —            113      

 

   
 

Net risk-weighted assets

    $ 80,400           $ 79,734           $ 76,956      
    

 

 

      

 

 

      

 

 

   

AVERAGE QUARTERLY TOTAL ASSETS

    $                   87,591           $                   86,239           $                   85,730      
    

 

 

      

 

 

      

 

 

   

CAPITAL RATIOS

              

Tier 1 risk-based capital

     12.19        %      12.15        %      13.29        %

Total risk-based capital

     15.02            15.13            16.68      

Leverage (d)

     11.36            11.41            12.12      

Tier 1 common equity

     11.40            11.36            11.55      
              

 

   

 

(a) Includes net unrealized gains or losses on securities available for sale (except for net unrealized losses on marketable equity securities), net gains or losses on cash flow hedges, and amounts resulting from the application of the applicable accounting guidance for defined benefit and other postretirement plans.

 

(b) Other assets deducted from Tier 1 capital and risk-weighted assets consist of disallowed deferred tax assets, disallowed intangible assets (excluding goodwill) and deductible portions of nonfinancial equity investments. There were no disallowed deferred tax assets at March 31, 2013, December 31, 2012, and March 31, 2012.

 

(c) The allowance for loan and lease losses included in Tier 2 capital is limited by regulation to 1.25% of the sum of gross risk-weighted assets plus low level exposures and residual interests calculated under the direct reduction method, as defined by the Federal Reserve. The allowance for loan and lease losses includes $44 million, $55 million, and $90 million at March 31, 2013, December 31, 2012, and March 31, 2012, respectively, of allowance classified as “discontinued assets” on the balance sheet.

 

(d) This ratio is Tier 1 capital divided by average quarterly total assets as defined by the Federal Reserve less: (i) goodwill, (ii) the disallowed intangible assets described in footnote (b), and (iii) deductible portions of nonfinancial equity investments; plus assets derecognized as an offset to AOCI resulting from the adoption and subsequent application of the applicable accounting guidance for defined benefit and other postretirement plans.

 

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Risk Management

Overview

Like all financial services companies, we engage in business activities and assume the related risks. The most significant risks we face are credit, liquidity, market, compliance, operational, strategic, and reputation risks. Our risk management activities are focused on ensuring we properly identify, measure and manage such risks across the entire enterprise to maintain safety and soundness and maximize profitability. Certain of these risks are defined and discussed in greater detail in the remainder of this section.

The KeyCorp Board of Directors (the “Board”) serves in an oversight capacity ensuring that Key’s risks are managed in a manner that is effective, balanced and adds value for the shareholders. The Board understands Key’s risk philosophy, approves the risk appetite, inquires about risk practices, reviews the portfolio of risks, compares the actual risks to the risk appetite and is apprised of significant risks, both actual and emerging, and determines whether management is responding appropriately. The Board challenges management and ensures accountability.

The Board’s Audit Committee assists the Board in oversight of financial statement integrity, regulatory and legal compliance, independent auditors’ qualifications and independence and all risk review functions including internal audit. The Audit Committee discusses policies related to risk assessment and risk management and the processes related to risk review and compliance. The Audit Committee has responsibility over financial reporting, compliance risk and legal matters, the implementation, management and evaluation of operational risk controls and information, security and fraud risk, and associated reputation and strategic risks.

The Board’s Risk Committee assists the Board in oversight of strategies, policies, procedures and practices relating to the management of credit risk, market risk, interest rate risk, and liquidity risk, including the actions taken to mitigate these risks, as well as reputational and strategic risks. The Risk Committee also oversees the maintenance of appropriate regulatory and economic capital, reviews the Enterprise Risk Management (ERM) reports, and approves any material changes to the charter of the ERM Committee.

The Audit and Risk Committees meet jointly, as appropriate, to discuss matters that relate to each committee’s responsibilities. In addition to regularly scheduled bi-monthly meetings, the Audit Committee convenes to discuss the content of our financial disclosures and quarterly earnings releases. Committee chairpersons routinely meet with management during interim months to plan agendas for upcoming meetings and to discuss emerging trends and events that have transpired since the preceding meeting. All members of the Board receive formal reports designed to keep them abreast of significant developments during the interim months.

Our ERM Committee, chaired by the Chief Executive Officer and comprising other senior level executives, is responsible for managing risk and ensuring that the corporate risk profile is managed in a manner consistent with our risk appetite. The ERM Program encompasses our risk philosophy, policy, framework and governance structure for the management of risks across the entire company. The ERM Committee reports to the Board’s Risk Committee. Annually, the Board reviews and approves the ERM Program, as well as the risk appetite and corporate risk tolerances for major risk categories. We use a risk-adjusted capital framework to manage risks. This framework is approved and managed by the ERM Committee.

Tier 2 Risk Governance Committees support the ERM Committee by identifying early warning events and trends, escalating emerging risks and discussing forward-looking assessments. Membership of the Risk Governance Committees includes representatives from each of the Three Lines of Defense. The First Line of Defense is the Line of Business primarily responsible to accept, own, proactively identify, monitor and manage risk. The Second Line of Defense comprises Risk Management representatives who provide independent, centralized oversight over all risk categories by aggregating, analyzing and reporting risk information. Risk Review provides the Third Line of Defense in their role to provide independent assessment and testing of the effectiveness, appropriateness and adherence to KeyCorp’s risk management policies, practices and controls.

The Chief Risk Officer ensures that relevant risk information is properly integrated into strategic and business decisions, ensures appropriate ownership of risks, provides input into performance and compensation decisions, assesses aggregate enterprise risk, monitors capabilities to manage critical risks, and executes appropriate Board and stakeholder reporting.

Federal banking regulators continue to emphasize with financial institutions the importance of relating capital management strategy to the level of risk at each institution. We believe our internal risk management processes help us achieve and maintain capital levels that are commensurate with our business activities and risks, and comport with regulatory expectations.

 

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Federal banking regulators continue to emphasize with financial institutions the importance of relating capital management strategy to the level of risk at each institution. We believe our internal risk management processes help us achieve and maintain capital levels that are commensurate with our business activities and risks, and comport with regulatory expectations.

 

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Market risk management

The cash flows and values of financial instruments change as a function of changes in market rates or prices, such as interest rates, foreign exchange rates, equity prices, commodity prices, credit spreads, or volatilities. These factors influence prospective yields, values, or prices associated with the instrument. For example, the value of a fixed-rate bond will decline when market interest rates increase, while the cash flows associated with a variable rate loan will increase when interest rates increase. The holder of a financial instrument is exposed to market risk when either the cash flows or the value of the instrument is tied to such external factors.

We manage our market risk differently based on whether the financial instrument is associated with trading or nontrading operations and activities. Our trading positions are carried at fair value with changes recorded in the income statement. These positions are subject to various market-based risk factors that impact the fair value of the financial instruments in the trading category. Our traditional banking loan and deposit products as well as long-term debt and certain short-term borrowings are nontrading positions. These positions are generally carried at the principal amount outstanding for assets and the amount owed for liabilities. The nontrading positions are subject to changes in economic value due to varying market conditions, primarily changes in interest rates.

Trading market risk

Key incurs market risk as a result of trading, investing, and client facilitation activities, principally within our investment banking and capital markets business. Key has exposures to a wide range of interest rates, equity prices, foreign exchange rates, credit spreads, and commodity prices, as well as the associated implied volatilities and spreads. Our primary market risk exposures are a result of trading activities in the derivative and fixed income markets and maintaining positions in these instruments. We maintain modest trading inventories to facilitate customer flow, make markets in securities, and hedge certain risks. The majority of our positions are traded in active markets.

Management of trading market risks.  Market risk management is an integral part of Key’s risk culture. The Market Risk Committee, headed by our Chief Market Risk Officer, along with the Risk Committee of our Board and the ERM Committee (collectively, the “Committees”) provide oversight of the management of trading market risks. Market risk policies and procedures have been defined and approved by the Market Risk Committee and take into account our tolerance for risk and consideration for the business environment. The Committees regularly review and discuss market risk reports prepared by our Market Risk Management group (“MRM”) that contain our market risk exposures and results of monitoring activities.

MRM is an independent risk management function that partners with the lines of business to identify, measure, and monitor market risks throughout our company. MRM is responsible for ensuring transparency of significant market risks, monitoring compliance with established limits, and escalating limit exceptions to appropriate senior management. Market risk is monitored through various measures, such as VaR, and through routine stress testing, sensitivity, and scenario analyses. MRM conducts stress tests for each covered position using historical worst case and standard shock scenarios. VaR, stressed VaR, and other analyses are prepared daily and distributed to appropriate management.

Covered positions.  We monitor the market risk of our covered positions, which includes all of our trading positions as well as all foreign exchange and commodity positions, regardless of whether the position is in a trading account. The trading account includes on-and off-balance sheet positions in financial instruments acquired with the intent to profit from price variations. All positions in the trading account are recorded at fair value, and changes in fair value are reflected in our consolidated statements of income. Information regarding our fair value policies, procedures and methodologies is provided in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Fair Value Measurements” on page 122 of our 2012 Form 10-K and Note 5 (“Fair Value Measurements”) in this report. Instruments that are used to hedge nontrading activities, such as bank issued debt and loan portfolios, equity positions that are not actively traded, and securities financing activities do not meet the definition of a covered position. MRM is responsible for identifying our portfolios as either covered or non-covered. The Covered Position Working Group develops the final list of covered positions, and a summary is provided to the Market Risk Committee.

Our significant portfolios of covered positions are detailed below. We analyze market risk by portfolios of covered positions, and do not separately measure and monitor our portfolios by risk type. The descriptions below incorporate the respective risk types associated with each of these portfolios.

 

   

Fixed income includes those instruments associated with our capital markets business and the trading of securities as a dealer. These instruments include positions in municipal bonds, bonds backed by the U.S. government, agency

 

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and corporate bonds, certain mortgage-backed securities, securities issued by the U.S. Treasury, money markets, and certain collateralized CMOs. The activities and instruments within the fixed income portfolio create exposures to interest rate and credit spread risks.

   

Foreign exchange includes foreign currency spots, forwards and options. We enter into contracts for these types of instruments primarily to accommodate the needs of clients. These activities result in exposures to foreign currency risk.

   

Interest rate derivatives include interest rate swaps, caps and floors, which are transacted primarily to accommodate the needs of commercial loan clients. In addition, we enter into interest rate futures to offset or mitigate the interest rate risk related to the client positions. The activities within this portfolio create exposures to interest rate risk.

   

Credit derivatives include credit default swaps, which are used to mitigate loan portfolio credit risk, and credit default swap indexes, which are used to manage the credit risk exposure associated with anticipated sales of certain commercial real estate loans. The transactions within the credit derivatives portfolio result in exposure to credit risk.

VaR and stressed VaR.  VaR is the estimate of the maximum amount of loss on an instrument or portfolio due to adverse market conditions during a given time interval within a stated confidence level. Stressed VaR is used to assess the extreme conditions on market risk within our trading portfolios. MRM calculates VaR and stressed VaR on a daily basis, and the results are distributed to appropriate management. VaR and stressed VaR results are also provided to our regulators and utilized in regulatory capital calculations.

We use a VaR simulation model to measure the potential adverse effect of changes in interest rates, foreign exchange rates, equity prices, and credit spreads on the fair value of our covered positions. Historical scenarios are customized for specific covered positions, and numerous risk factors are incorporated in the calculation. VaR is calculated using daily observations over a one-year time horizon, and approximates a 95% confidence level. Statistically, this means that we would expect to incur losses greater than VaR, on average, five out of 100 trading days, or three to four times each quarter. We also calculate VaR and stressed VaR at a 99% confidence level. Two years of historical data were used in the simulation during 2012. Beginning in February 2013, the simulation uses historical data from the previous year, as we believe it more appropriately reflects the current market conditions and the risks associated with our portfolios. This change resulted in a decrease in VaR results of approximately 2% at the 95% confidence level and 15% at the 99% confidence level. We also utilize factors to estimate the exposures that contain optionality features, such as options and cancellable provisions.

The VaR model is an effective tool in estimating ranges of possible gains and losses on our covered positions. However, there are limitations inherent in the VaR model since it uses historical results over a given time interval to estimate future performance. Historical results may not be indicative of future results, and changes in the market or composition of our portfolios could have a significant impact on the accuracy of the VaR model. We regularly review and enhance the modeling techniques, inputs and assumptions used. Our market risk policy includes the independent validation of our VaR model by Key’s Risk Management Group on an annual basis. The Model Risk Management Committee oversees the Model Validation Program, and results of validations are discussed with the ERM Committee.

MRM backtests our VaR model on a daily basis to evaluate its predictive power. The test compares VaR model results at the 99% confidence level to observed daily profit and loss. Results of backtesting are provided to the Market Risk Committee. Backtesting exceptions occur when trading losses exceed VaR. Actual losses did not exceed daily trading VaR on any day during the quarter ended March 31, 2013 and 2012.

We do not engage in correlation trading, or utilize the internal model approach for measuring default and credit migration risk. Our net VaR approach incorporates diversification, but our VaR calculation does not include the impact of counterparty risk and our own credit spreads on derivatives.

The aggregate VaR at the 99% confidence level for all covered positions was $1.4 million at March 31, 2013, and $1.8 million at March 31, 2012. The decrease in aggregate VaR was primarily due to reduced exposures in fixed income and credit derivatives as well as the change from using two years of historical data to one year for the VaR simulation. Figure 29 summarizes our VaR at the 99% confidence level for significant portfolios of covered positions for the first quarter of 2013 and 2012.

 

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Figure 29. VaR for Significant Portfolios of Covered Positions

 

                                                      2013                                                       2012  
                        Three months ended March 31                                                  Three months ended March 31                           
in millions    High     

 

Low

     Mean      March 31      High      Low      Mean      March 31  

 

 

Trading account assets:

                       

Fixed income

     0.8        0.3        0.5        0.5        1.9        0.4        1.0        0.4    

Derivatives:

                       

Interest rate

     0.6        0.2        0.2        0.2        1.2        0.1        0.5        0.1    

Foreign exchange

     0.1                             0.8               0.1        —    

Credit

     0.6        0.1        0.3        0.6        1.3        0.5        0.7        1.2    

 

 

Stressed VaR is calculated using our general VaR results at the 99% confidence level and applying certain assumptions. The aggregate stressed VaR for all covered positions was $4.2 million at March 31, 2013. Figure 30 summarizes our stressed VaR for significant portfolios of covered positions for the first quarter of 2013 as used for market risk capital charge calculation purposes. Stressed VaR was not calculated for market risk regulatory capital purposes during 2012.

Figure 30. Stressed VaR for Significant Portfolios of Covered Positions

 

                                                          2013                                                   
                       Three months ended March 31                          
in millions   

 

High

     Low      Mean      March 31   

 

 

Trading account assets:

           

Fixed income

     2.3        0.9        1.6        1.4   

Derivatives:

           

Interest rate

     1.8        0.7        0.7        0.7   

Foreign exchange

     0.4               0.1        —   

Credit

     1.7        0.3        1.0        1.7   

 

 

Internal capital adequacy assessment. Market risk is a component of our internal capital adequacy assessment. Our risk-weighted assets include a market risk equivalent asset position, which consists of a VaR component, stressed VaR component, and a specific risk add-on. Specific risk is the price risk of individual financial instruments, which is not accounted for by changes in broad market risk factors. Specific risk is measured through a standardized approach for positions where the VaR model does not capture specific risk. Specific risk calculations are run quarterly by MRM, and approved by the Chief Market Risk Officer. The VaR, stressed VaR, and specific risk components are added together to arrive at a total market risk equivalent assets calculation.

Nontrading market risk

Most of our market risk is derived from interest rate fluctuations. Interest rate risk, which is inherent in the banking industry, is measured by the potential for fluctuations in net interest income and the EVE. Such fluctuations may result from changes in interest rates and differences in the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities. We manage the exposure to changes in net interest income and the EVE in accordance with our risk appetite, and within Board approved policy limits.

Interest rate risk positions are influenced by a number of factors including the balance sheet positioning that arises out of consumer preferences for loan and deposit products, economic conditions, the competitive environment within our markets and changes in market interest rates that affect client activity and our hedging, investing, funding and capital positions. The primary components of interest rate risk exposure consist of gap risk, basis risk, yield curve risk and option risk.

 

¿  

“Gap riskis the exposure to changes in interest rates and occurs when the volume of interest-bearing liabilities and the volume of interest-earning assets they fund (for example, deposits used to fund loans) do not mature or reprice at the same time.

 

¿  

“Basis risk” is the exposure to asymmetrical changes in interest rate indexes and occurs when floating-rate assets and floating-rate liabilities reprice at the same time, but in response to different market factors or indexes.

 

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¿  

“Yield curve risk” is the exposure to non-parallel changes in the slope of the yield curve (where the yield curve depicts the relationship between the yield on a particular type of security and its term to maturity) and occurs when interest-bearing liabilities and the interest-earning assets they fund do not price or reprice to the same term point on the yield curve.

 

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“Option risk” is the exposure to a customer or counterparty’s ability to take advantage of the interest rate environment and terminate or reprice one of our assets, liabilities or off-balance sheet instruments prior to contractual maturity without a penalty. Option risk occurs when exposures to customer and counterparty early withdrawals or early prepayments are not mitigated with an offsetting position or appropriate compensation.

Oversight of nontrading market risk is governed by the Risk Committee of our Board, the ERM Committee and the ALCO. These committees regularly review various reports, including interest rate risk summaries, trends, peer comparisons, variance analyses, projections, and sensitivity analyses. The reviews generate a discussion of positions, trends and directives on interest rate risk and shape a number of our decisions. Guidance for the oversight and management of interest rate risk is provided through the asset/liability management policy, which is governed by the ALCO. We communicate with individuals within and outside of the company on a daily basis to discuss emerging issues.

Net interest income simulation analysis. The primary tool we use to measure our interest rate risk is simulation analysis. For purposes of this analysis, we estimate our net interest income based on the current and projected composition of our on- and off-balance sheet positions, accounting for recent and anticipated trends in customer activity. The analysis also incorporates assumptions for the current and projected interest rate environments, including a most likely macro-economic scenario. Simulation modeling assumes that residual risk exposures will be managed to within the risk appetite.

We measure the amount of net interest income at risk by simulating the change in net interest income that would occur if the federal funds target rate were to gradually increase or decrease over the next twelve months, and term rates were to move in a similar fashion. Our standard rate scenarios encompass a gradual increase or decrease of 200 basis points, but due to the low interest rate environment, a gradual decrease of 25 basis points over two months with no change over the following ten months is applied. After calculating the amount of net interest income at risk to interest rate changes, we compare that amount with the base case of an unchanged interest rate environment. We also perform regular stress tests and sensitivities on the model inputs that could materially change the resulting risk assessments. One set of stress tests and sensitivities assesses the effect of interest rate inputs on simulated exposures. Assessments are performed using different shapes of the yield curve, including a sustained flat yield curve, an inverted slope yield curve, changes in credit spreads, an immediate parallel change in market interest rates, and changes in the relationship of money market interest rates. Another set of stress tests and sensitivities assesses the effect of loan and deposit assumptions and assumed discretionary strategies on simulated exposures. Assessments are performed on changes to the following assumptions: the pricing of deposits without contractual maturities; changes in lending spreads; prepayments on loans and securities; other loan and deposit balance shifts; investment, funding and hedging activities; and liquidity and capital management strategies.

Simulation analysis produces only a sophisticated estimate of interest rate exposure based on judgments related to assumption inputs into the simulation model. We tailor assumptions to the specific interest rate environment and yield curve shape being modeled, and validate those assumptions on a regular basis. Our simulations are performed with the assumption that interest rate risk positions will be actively managed through the use of on- and off-balance sheet financial instruments to achieve the desired residual risk profile. However, actual results may differ from those derived in simulation analysis due to unanticipated changes to the balance sheet composition, customer behavior, product pricing, market interest rates, investment, funding and hedging activities, and repercussions from unanticipated or unknown events.

Figure 31 presents the results of the simulation analysis at March 31, 2013, and 2012. At March 31, 2013, our simulated exposure to changes in interest rates was moderately asset sensitive. Policy limits for risk management require the development of remediation plans to maintain residual risk within tolerance if simulation modeling demonstrates that a gradual increase or decrease in short-term interest rates over the next twelve months would adversely affect net interest income over the same period by more than 4%. As shown in Figure 31, we are operating within these limits.

Figure 31. Simulated Change in Net Interest Income

 

March 31, 2013                     

 

 

Basis point change assumption (short-term rates)

     -25           +200    

ALCO policy limits

     -4.00         %         -4.00  

 

 

Interest rate risk assessment

     -.92         %         1.85  

 

 
March 31, 2012                     

 

 

Basis point change assumption (short-term rates)

     -25           +200    

ALCO policy limits

     -4.00         %         -4.00  

 

 

Interest rate risk assessment

     -.96         %         3.16  

 

 

To support continued progress toward maximum employment and price stability, the FOMC expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens, and in particular expects to keep the federal funds rate at exceptionally low levels. Key will continue to monitor balance sheet flows and expects the benefit to rising rates to increase prior to any

 

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increase in the federal funds rate. Our current interest rate risk position could fluctuate to higher or lower levels of risk depending on the competitive environment and client behavior that may affect the actual volume, mix, maturity, and repricing characteristics of loan and deposit flows. As changes occur to both the configuration of the balance sheet and the outlook for the economy, management proactively evaluates hedging opportunities that may change our interest rate risk profile.

The results of additional simulation analyses that make use of alternative interest rate paths and customer behavior assumptions indicate that net interest income improvement in a rising rate environment could be diminished, and actual results may be different than the policy simulation results in Figure 31. Net interest income improvements are highly dependent on the timing, magnitude, frequency, and path of interest rate increases and assumption inputs for deposit repricing relationships, lending spreads, and the balance behavior of transaction accounts. Given the unprecedented low level of interest rates, modeling future deposits, balances and repricing behavior is less certain.

We also conduct simulations that measure the effect of changes in market interest rates in the second and third years of a three-year horizon. These simulations are conducted in a manner similar to those based on a twelve-month horizon. To capture longer-term exposures, we calculate exposures to changes to the EVE as discussed in the following section.

Economic value of equity modeling. EVE complements net interest income simulation analysis as it estimates risk exposure beyond twelve-, twenty-four and thirty-six month horizons. EVE modeling measures the extent to which the economic values of assets, liabilities and off-balance sheet instruments may change in response to fluctuations in interest rates. EVE is calculated by subjecting the balance sheet to an immediate 200 basis point increase or decrease in interest rates, measuring the resulting change in the values of assets, liabilities and off-balance sheet instruments, and comparing those amounts with the base case of an unchanged interest rate environment. Because the calculation of EVE under an immediate 200 basis point decrease in interest rates in the current low rate environment results in certain interest rates declining to zero and a less than 200 basis point decrease in certain yield curve term points, we have modified the standard declining rate scenario to an immediate 100 basis point decrease. This analysis is highly dependent upon assumptions applied to assets and liabilities with non-contractual maturities. Those assumptions are based on historical behaviors, as well as our expectations. We develop remediation plans that would maintain residual risk within tolerance if this analysis indicates that our EVE will decrease by more than 15% in response to an immediate increase or decrease in interest rates. We are operating within these guidelines.

Management of interest rate exposure. We use the results of our various interest rate risk analyses to formulate A/LM strategies to achieve the desired risk profile while managing to our objectives for capital adequacy and liquidity risk exposures. Specifically, we manage interest rate risk positions by purchasing securities, issuing term debt with floating or fixed interest rates, and using derivatives — predominantly in the form of interest rate swaps, which modify the interest rate characteristics of certain assets and liabilities.

Figure 32 shows all swap positions that we hold for A/LM 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 a floating rate through a “receive fixed/pay variable” interest rate swap. The volume, maturity and mix of portfolio swaps change frequently as we adjust our broader A/LM objectives and the balance sheet positions to be hedged. For more information about how we use interest rate swaps to manage our risk profile, see Note 7 (“Derivatives and Hedging Activities”).

Figure 32. Portfolio Swaps by Interest Rate Risk Management Strategy

 

                                                              March 31,  2013                                                                        
                              Weighted-Average                                 March  31, 2012                 
dollars in millions    Notional
Amount
    

Fair

Value

    Maturity
(Years)
    

Receive

Rate

   

Pay

Rate

    Notional
Amount
    

Fair

Value

 

 

 

Receive fixed/pay variable — conventional A/LM (a)

    $ 15,290        $ 61          2.4        .7      .2     $ 9,465        $ 42     

Receive fixed/pay variable — forward starting A/LM

     —         —                 —        —        250         (1)    

Receive fixed/pay variable — conventional debt

     4,475         388          4.4        3.3        .3        5,306         445     

Pay fixed/receive variable — conventional debt

     234         (21)         10.3        .3        2.8        347         (18)    

 

 

Total portfolio swaps

    $ 19,999        $     428   (b)      3.0            1.3      .3     $ 15,368        $ 468   (b) 
  

 

 

    

 

 

          

 

 

    

 

 

 
                 

 

 

 

(a) Portfolio swaps designated as A/LM are used to manage interest rate risk tied to both assets and liabilities.

 

(b) Excludes accrued interest of $45 million and $44 million for March 31, 2013, and 2012, respectively.

Liquidity risk management

We define “liquidity” as the ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner and without adverse consequences. Liquidity management involves maintaining sufficient and diverse sources of funding to accommodate planned, as well as unanticipated, changes in assets and liabilities under both normal and adverse conditions.

 

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Governance structure

We manage liquidity for all of our affiliates on an integrated basis. This approach considers the unique funding sources available to each entity, as well as each entity’s capacity to manage through adverse conditions. The approach also recognizes that adverse market conditions or other events that could negatively affect the availability or cost of liquidity will affect the access of all affiliates to sufficient wholesale funding.

Oversight of the liquidity risk management process is governed by the Board’s Risk Committee, the KeyBank Board of Directors, the ERM Committee and the ALCO. These groups regularly review various liquidity reports, including liquidity and funding summaries, liquidity trends, peer comparisons, variance analyses, liquidity projections, hypothetical funding erosion stress tests and goal tracking reports. The reviews generate a discussion of positions, trends and directives on liquidity risk and shape a number of our decisions. When liquidity pressure is elevated, positions are monitored more closely and reporting is more intensive. We communicate with individuals within and outside of the company on a daily basis to discuss emerging issues.

Factors affecting liquidity

Our liquidity could be adversely affected by both direct and indirect events. An example of a direct event would be a downgrade in our public credit ratings by a rating agency. Examples of indirect events (events unrelated to us) that could impair our access to liquidity would be an act of terrorism or war, natural disasters, political events, or the default or bankruptcy of a major corporation, mutual fund or hedge fund. Similarly, market speculation, or rumors about us or the banking industry in general may adversely affect the cost and availability of normal funding sources.

Our credit ratings at March 31, 2013, are shown in Figure 33. We believe that these credit ratings, under normal conditions in the capital markets, will enable the parent company or KeyBank to issue fixed income securities to investors.

Figure 33. Credit Ratings

 

March 31, 2013         Short-Term
Borrowings
    

Senior

Long-Term

Debt

    

Subordinated
Long-Term

Debt

     Capital
Securities
    

Series A 

Preferred 

Stock 

 

 

 

KEYCORP (THE PARENT COMPANY)

                 

Standard & Poor’s

        A-2         BBB+         BBB         BBB-         BBB-    

Moody’s

        P-2         Baa1         Baa2         Baa3         Ba1    

Fitch

        F1         A-         BBB+         BB+         BB    

DBRS

        R-2(high)         BBB(high)         BBB         BBB         BB(low)    

KEYBANK

                 

Standard & Poor’s

        A-2         A-         BBB+         N/A         N/A    

Moody’s

        P-2         A3         Baa1         N/A         N/A    

Fitch

        F1         A-         BBB+         N/A         N/A    

DBRS

        R-1(low)         A(low)         BBB(high)         N/A         N/A    

 

 

Managing liquidity risk

We regularly monitor our funding sources and measure our capacity to obtain funds in a variety of scenarios in an effort to maintain an appropriate mix of available and affordable funding. In the normal course of business, we perform a monthly hypothetical funding erosion stress test for both KeyCorp and KeyBank. In a “heightened monitoring mode,” we may conduct the hypothetical funding erosion stress tests more frequently, and use assumptions so the stress tests are more strenuous and reflect the changed market environment. Our testing incorporates estimates for loan and deposit lives based on our historical studies. Erosion stress tests analyze potential liquidity scenarios under various funding constraints and time periods. Ultimately, they determine the periodic effects that major direct and indirect events would have on our access to funding markets and our ability to fund our normal operations. To compensate for the effect of these assumed liquidity pressures, we consider alternative sources of liquidity and maturities over different time periods to project how funding needs would be managed.

We maintain a Contingency Funding Plan that outlines the process for addressing a liquidity crisis. The plan provides for an evaluation of funding sources under various market conditions. It also assigns specific roles and responsibilities for managing liquidity through a problem period. As part of the plan, we maintain a liquidity reserve through balances in our

 

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liquid asset portfolio. During a problem period, that reserve could be used as a source of funding to provide time to develop and execute a longer-term strategy. The liquid asset portfolio at March 31, 2013, totaled $8.5 billion, consisting of $4.8 billion of unpledged securities, $1.3 billion of securities available for secured funding at the Federal Home Loan Bank of Cincinnati, and $2.4 billion of net balances of federal funds sold and balances in our Federal Reserve account. The liquid asset portfolio can fluctuate due to excess liquidity, heightened risk, or prefunding of expected outflows, such as debt maturities. Additionally, as of March 31, 2013, our unused borrowing capacity secured by loan collateral was $15.2 billion at the Federal Reserve Bank of Cleveland and $5.0 billion at the Federal Home Loan Bank of Cincinnati.

Long-term liquidity strategy

Our long-term liquidity strategy is to be predominantly funded by core deposits. However, we may use wholesale funds to sustain an adequate liquid asset portfolio, meet daily cash demands, and allow management flexibility to execute business initiatives. Key’s client-based relationship strategy provides for a strong core deposit base which, in conjunction with intermediate and long-term wholesale funds managed to a diversified maturity structure and investor base, supports our liquidity risk management strategy. We use the loan to deposit ratio as a metric to monitor these strategies. Our target loan to deposit ratio is 90-100% (at March 31, 2013, our loan to deposit ratio was 87%), which we calculate as total loans, loans held for sale, and nonsecuritized discontinued loans divided by domestic deposits.

Sources of liquidity

Our primary sources of liquidity include customer deposits, wholesale funding and liquid assets. If the cash flows needed to support operating and investing activities are not satisfied by deposit balances, we rely on wholesale funding or liquid assets. Conversely, excess cash generated by operating, investing and deposit-gathering activities may be used to repay outstanding debt or invest in liquid assets.

Liquidity programs

We have several liquidity programs, which are described in Note 15 (“Long-Term Debt”) on page 184 of our 2012 Form 10-K, that enable the parent company and KeyBank to raise funds in the public and private markets when the capital markets are functioning normally. The proceeds from most of these programs can be used for general corporate purposes, including acquisitions. Each of the programs is replaced or renewed as needed. There are no restrictive financial covenants in any of these programs.

In August 2012, KeyBank adopted a $20 billion Global Bank Note Program. This program is similar to prior KeyBank note programs and allows KeyBank to issue notes, domestically and abroad, with original maturities of seven days or more for senior notes or five years or more for subordinated notes. These notes may be denominated in U.S. dollars or in foreign currencies. Each note will be the sole obligation of KeyBank.

In the first quarter of 2013, Key’s outstanding note balance increased by $938 million. On January 29, 2013, Key issued $1 billion of Senior Bank Notes due February 1, 2018 under the Global Bank Note Program. These Notes have a coupon of 1.65% per annum and are not redeemable prior to maturity. Key also had maturities of $26 million in Euro medium-term notes. KeyCorp had no medium-term note maturities or trust preferred redemptions.

Liquidity for KeyCorp

The parent company has sufficient liquidity when it can service its debt; support customary corporate operations and activities (including acquisitions); support occasional guarantees of subsidiaries’ obligations in transactions with third parties at a reasonable cost, in a timely manner, and without adverse consequences; and pay dividends to shareholders.

We use three primary measures to assess parent company liquidity: net cash position, a cash coverage metric, and the liquidity gap. The net cash position measures the ability to fund debt maturing in 24 months or less with existing liquid assets. The cash coverage metric measures the ability to meet all projected obligations. The “liquidity gap” represents the difference between projected liquid assets and anticipated financial obligations over several time horizons. We generally issue term debt to manage our liquidity position within targeted ranges. The parent company generally maintains cash and short-term investments in an amount sufficient to meet projected debt maturities over the next 24 months. At March 31, 2013, KeyCorp held $2.0 billion in short-term investments, which we projected to be sufficient to meet our projected obligations, including the repayment of our maturing debt obligations for the periods prescribed by our policies.

 

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Typically, the parent company meets its liquidity requirements through regular dividends from KeyBank. Federal banking law limits the amount of capital distributions that a bank can make to its holding company without prior regulatory approval. A national bank’s dividend-paying capacity is affected by several factors, including net profits (as defined by statute) for the two previous calendar years and for the current year, up to the date of dividend declaration. During the first quarter of 2013, KeyBank and nonbank subsidiaries did not make any dividend payments to the parent. The parent did not make any capital infusions to KeyBank during the first quarter of 2013. As of March 31, 2013, KeyBank had fully utilized its regulatory capacity to pay dividends to KeyCorp.

Our liquidity position and recent activity

Over the past twelve months our liquid asset portfolio, which includes overnight and short-term investments, as well as unencumbered, high quality liquid securities held as protection against a range of potential liquidity stress scenarios, has decreased as a result of debt maturities, trust preferred securities redemptions, and net customer loan and deposit flows. However, the liquid asset portfolio still continues to exceed the amount we estimate would be necessary to manage through an adverse liquidity event by providing sufficient time to develop and execute a longer term solution. The issuance of $1 billion of Senior Bank Notes in January 2013 provided additional liquidity to support normal business flows and maintain our liquid asset portfolio within target levels.

From time to time, KeyCorp or KeyBank may seek to retire, repurchase or exchange outstanding debt, capital securities, preferred shares or Common Shares through cash purchase, privately negotiated transactions or other means. We periodically repurchase Common Shares in the open market or through privately negotiated transactions under a repurchase program authorized by our Board. Additional information on KeyCorp’s Common Share repurchase program is included in Part II, Item 2. Unregistered Sales of Equity Securities or Use of Proceeds of this report. Such transactions depend on prevailing market conditions, our liquidity and capital requirements, contractual restrictions, regulatory requirements and other factors. The amounts involved may be material, individually or collectively.

We generate cash flows from operations and from investing and financing activities. We have approximately $167 million of cash and cash equivalents and short-term investments in international tax jurisdictions as of March 31, 2013. As we consider alternative long-term strategic and liquidity plans, opportunities to repatriate these amounts would result in approximately $20 million in taxes to be paid. If we were to cease operations in all international tax jurisdictions, the total amount of taxes to be paid would increase to approximately $38 million. Accordingly, we have included the total amount as a deferred tax liability at March 31, 2013.

The consolidated statements of cash flows summarize our sources and uses of cash by type of activity for the three month periods ended March 31, 2013, and 2012.

Credit risk management

Credit risk is the risk of loss to us arising from an obligor’s inability or failure to meet contractual payment or performance terms. Like other financial services institutions, we make loans, extend credit, purchase securities and enter into financial derivative contracts, all of which have related credit risk.

Credit policy, approval and evaluation

We manage credit risk exposure through a multifaceted program. The Credit Risk Committee approves both retail and commercial credit policies. These policies are communicated throughout the organization to foster a consistent approach to granting credit.

Our credit risk management team is responsible for credit approval, is independent of our lines of business, and consists of senior officers who have extensive experience in structuring and approving loans. Only credit risk management members are authorized to grant significant exceptions to credit policies. It is not unusual to make exceptions to established policies when mitigating circumstances dictate, but most major lending units have been assigned specific thresholds to keep exceptions at a manageable level.

Loan grades are assigned at the time of origination, verified by the credit risk management team and periodically reevaluated thereafter. Most extensions of credit are subject to loan grading or scoring. This risk rating methodology blends our judgment with quantitative modeling. Commercial loans generally are assigned two internal risk ratings. The first rating reflects the probability that the borrower will default on an obligation; the second rating reflects expected recovery rates on the credit facility. Default probability is determined based on, among other factors, the financial strength of the borrower, an

 

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assessment of the borrower’s management, the borrower’s competitive position within its industry sector, and our view of industry risk within the context of the general economic outlook. Types of exposure, transaction structure and collateral, including credit risk mitigants, affect the expected recovery assessment.

Our credit risk management team uses risk models to evaluate consumer loans. These models, known as scorecards, forecast the probability of serious delinquency and default for an applicant. The scorecards are embedded in the application processing system, which allows for real-time scoring and automated decisions for many of our products. We periodically validate the loan grading and scoring processes.

We maintain an active concentration management program to encourage diversification in our credit portfolios. For individual obligors, we employ a sliding scale of exposure, known as hold limits, which is dictated by the strength of the borrower. Our legal lending limit is approximately $2 billion for any individual borrower. However, internal hold limits generally restrict the largest exposures to less than 20% of that amount. As of March 31, 2013, we had six client relationships with loan commitments net of credit default swaps of more than $200 million. The average amount outstanding on these six individual net obligor commitments was $58 million at March 31, 2013. In general, our philosophy is to maintain a diverse portfolio with regard to credit exposures.

We actively manage the overall loan portfolio in a manner consistent with asset quality objectives and concentration risk tolerances to mitigate credit risk. We utilize credit default swaps to transfer a portion of the credit risk associated with a particular extension of credit to a third party. At March 31, 2013, we used credit default swaps with a notional amount of $647 million to manage the credit risk associated with specific commercial lending obligations. We may also sell credit derivatives — primarily single name credit default swaps — to offset our purchased credit default swap position prior to maturity. At March 31, 2013, the notional amount of credit default swaps sold by us for the purpose of reducing our net credit default swap position was $5 million.

Credit default swaps are recorded on the balance sheet at fair value. Related gains or losses, as well as the premium paid or received for credit protection, are included in the trading income component of noninterest income.

We may also manage the loan portfolio using portfolio swaps and bulk purchases and sales. Our overarching goal is to manage the loan portfolio within a specified range of asset quality.

Allowance for loan and lease losses

At March 31, 2013, the ALLL was $893 million, or 1.70% of loans, compared to $944 million, or 1.92%, at March 31, 2012. The allowance includes $34 million that was specifically allocated for impaired loans of $445 million at March 31, 2013, compared to $38 million that was allocated for impaired loans of $359 million one year ago. For more information about impaired loans, see Note 4 (“Asset Quality”). At March 31, 2013, the allowance for loan and lease losses was 137.38% of nonperforming loans, compared to 141.74% at March 31, 2012.

Selected asset quality statistics for each of the past five years are presented in Figure 34. The factors that drive these statistics are discussed in the remainder of this section.

 

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Figure 34. Selected Asset Quality Statistics from Continuing Operations

 

              2013                                                                     2012                                           
dollars in millions    First          Fourth      Third       Second       First  

 

 

Net loan charge-offs

   $ 49           $ 58       $ 109       $ 77       $ 101    

Net loan charge-offs to average loans

     .38 %         .44       .86       .63       .82  

Allowance for loan and lease losses to annualized net loan charge-offs

     449.37                 384.85             204.78             286.74             232.39    

Allowance for loan and lease losses

   $ 893           $ 888        $ 888       $ 888       $ 944    

Allowance for credit losses (a)

     925             917          931         939         989    

Allowance for loan and lease losses to period-end loans

     1.70 %         1.68       1.73       1.79       1.92  

Allowance for credit losses to period-end loans

     1.76             1.74         1.81         1.89         2.01    

Allowance for loan and lease losses to nonperforming loans

     137.38             131.75         135.99         135.16         141.74    

Allowance for credit losses to nonperforming loans

     142.31             136.05         142.57         142.92         148.50    

Nonperforming loans at period end (b)

   $ 650           $ 674       $ 653       $ 657       $ 666    

Nonperforming assets at period end

     705             735         718         751         767    

Nonperforming loans to period-end portfolio loans

     1.24  %         1.28       1.27       1.32       1.35  

Nonperforming assets to period-end portfolio loans plus

           

OREO and other nonperforming assets

     1.34             1.39          1.39         1.51         1.55    
           

 

 

 

(a) Includes the allowance for loan and lease losses plus the liability for credit losses on lending-related unfunded commitments.

 

(b) March 31, 2013, December 31, 2012, and September 30, 2012 amounts exclude $22 million, $23 million, and $25 million, respectively of PCI loans acquired in July 2012.

 

We estimate the appropriate level of the ALLL on at least a quarterly basis. The methodology used is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan and Lease Losses on page 102 of our 2012 10-K.” Briefly, we apply expected loss rates to existing loans with similar risk characteristics and exercise judgment to assess the impact of factors such as changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets.

For all commercial and consumer TDRs, regardless of size, as well as impaired commercial loans with an outstanding balance greater than $2.5 million, we conduct further analysis to determine the probable loss content and assign a specific allowance to the loan if deemed appropriate. We estimate the extent of impairment by comparing the recorded investment of the loan with the estimated present value of its expected cash flows, the fair value of its underlying collateral or the loan’s observable market price. A specific allowance also may be assigned — even when sources of repayment appear sufficient — if we remain uncertain about whether the loan will be repaid in full. On at least a quarterly basis, we evaluate the appropriateness of our loss estimation methods to reduce differences between estimated incurred losses and actual losses. The ALLL at March 31, 2013, represents our best estimate of the probable credit losses inherent in the loan portfolio at that date.

As shown in Figure 35, our ALLL decreased by $51 million, or 5%, during the past twelve months. This contraction was associated with the improvement in credit quality of the loan portfolio, which has trended more favorably over the past twenty four months. Asset quality is improving and has resulted in favorable risk rating migration and a reduction in our general allowance. Our delinquency trends continue to decline while our roll rates keep improving. We attribute this improvement to improving economic activity, more favorable conditions in the housing market, and continued run off in our exit loan portfolio. Our liability for credit losses on lending-related commitments decreased by $13 million to $32 million at March 31, 2013, compared to the same period one year ago. When combined with our allowance for loan and lease losses, our total allowance for credit losses represented 1.76% of loans at the end of the first quarter of 2013, compared to 2.01% at the end of the first quarter of 2012. We expect the allowance to decrease as a percent of total loans during the remainder of 2013 as a result of the continued improvement in credit quality that is anticipated.

 

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Figure 35. Allocation of the Allowance for Loan and Lease Losses

 

     March 31, 2013     December 31, 2012     March 31, 2012  
dollars in millions    Amount     

Percent

of
Allowance

to Total

Allowance

   

Percent

of Loan

Type to
Total
Loans

    Amount     

Percent of
Allowance

to Total

Allowance

   

Percent

of Loan
Type to
Total
Loans

    Amount     

Percent of
Allowance
to Total

Allowance

   

Percent

of Loan
Type to
Total
Loans

 

 

 

Commercial, financial and agricultural

    $     338         37.9      44.5     $     327         36.8      44.0     $     316         33.5      40.2  

Commercial real estate:

                     

Commercial mortgage

     193         21.6        14.4        198         22.3        14.6        263         27.9        15.8    

Construction

     35         3.9        2.0        41         4.6        1.9        56         5.9        2.6    

 

 

Total commercial real estate loans

     228         25.5        16.4        239         26.9        16.5        319         33.8        18.4    

Commercial lease financing

     62         6.9        9.1        55         6.2        9.3        68         7.2        11.7    

 

 

Total commercial loans

     628         70.3        70.0        621         69.9        69.8        703         74.5        70.3    

Real estate — residential mortgage

     34         3.8        4.1        30         3.4        4.1        36         3.8        4.0    

Home equity:

                     

Community Banking

     106         11.9        18.6        105         11.8        18.6        94         9.9        18.6    

Other

     18         2.0        .8         25         2.8        .8        28         3.0        1.0    

 

 

Total home equity loans

     124         13.9        19.4        130         14.6        19.4        122         12.9        19.6    

Consumer other — Community Banking

     33         3.7        2.6        38         4.3        2.5        37         3.9        2.5    

Credit cards

     32         3.6        1.3        26         2.9        1.4        —         —        —    

Consumer other:

                     

Marine

     38         4.3        2.4        39         4.4        2.6        45         4.8        3.4    

Other

            .4        .2               .5        .2               .1        .2    

 

 

Total consumer other

     42         4.7         2.6        43         4.9        2.8        46         4.9        3.6    

 

 

Total consumer loans

     265         29.7        30.0        267         30.1        30.2        241         25.5        29.7     

 

 

Total loans (a)

    $ 893             100.0          100.0     $ 888             100.0          100.0     $ 944         100.0          100.0  
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
                     

 

 

 

(a) Excludes allocations of the allowance for loan and lease losses in the amount of $49 million, $55 million, and $90 million at March 31, 2013, December 31, 2012, and March 31, 2012, respectively, related to the discontinued operations of the education lending business.

Our provision (credit) for loan and lease losses was $55 million for first quarter of 2013, compared to $42 million for the year-ago quarter. Our net loan charge-offs were $49 million for the first quarter 2013 compared to $101 million for the first quarter of 2012. The increase in our provision is due to the growth in our loans from continuing operations over the past twelve months and updated regulatory guidance issued in 2012, partially offset by continued improvement in credit quality experienced in most of our loan portfolios. Additionally, we continue to reduce our exit loans and leases, as well as our exposure in our higher-risk businesses, including the residential properties portion of our construction loan portfolio, Marine/RV financing, and other selected leasing portfolios through the sale of certain loans, payments from borrowers or net charge-offs.

 

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Net loan charge-offs

Net loan charge-offs for the first quarter of 2013 totaled $49 million, or .38% of average loans. As compared to net loan charge-offs of $101 million, or ..82% for the same period last year. Figure 36 shows the trend in our net loan charge-offs by loan type, while the composition of loan charge-offs and recoveries by type of loan is presented in Figure 37.

Over the past twelve months, net loan charge-offs decreased $52 million. This decrease is attributable to improvement in asset quality statistics as shown in Figure 38. As shown in Figure 39, our exit loan portfolio experienced a total of $1 million in net loan recoveries for the first quarter of 2013. Net loan charge-offs for the fourth quarter of 2012 in our exit loan portfolio were $27 million. The decrease in net loan charge-offs in our exit loan portfolio were primarily driven by recoveries of previously charged off exit loans and leases.

Figure 36. Net Loan Charge-offs from Continuing Operations

 

             2013               2012  
dollars in millions   First      Fourth      Third      Second      First   

 

 

Commercial, financial and agricultural (a)

   $ 2        $ (8)        $ 7        $ 3        $ 15    

Real estate — Commercial mortgage

    8         28         21         9         21    

Real estate — Construction (a)

    (7)         3         2         4         10    

Commercial lease financing (a)

    2         3         (8)         10         —    

 

 

Total commercial loans

    5         26         22         26         46    

Home equity — Key Community Bank (a)

    16         (18)         62         21         23    

Home equity — Other

    4         11         5         7         7    

Credit cards

    8         9         2         —         —    

Marine

    3         14         6         7         10    

Other

    13         16         12         16         15    

 

 

Total consumer loans

    44         32         87         51         55    

 

 

Total net loan charge-offs

   $                   49        $                   58        $                   109        $                   77        $                   101    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
         

 

 

Net loan charge-offs to average loans

    .38    %      .44    %      .86    %      .63    %      .82    % 

Net loan charge-offs from discontinued
operations — education lending business

   $ 12        $ 15        $ 12        $ 12        $ 19    
         

 

 

 

(a) Credit amount indicates recoveries exceeded charge-offs.

 

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Figure 37. Summary of Loan and Lease Loss Experience from Continuing Operations

 

     Three months ended March 31,    
dollars in millions    2013       2012    

 

 

Average loans outstanding

    $ 52,626        $ 49,430    
  

 

 

   

 

 

 
    

 

 

Allowance for loan and lease losses at beginning of period

    $ 888        $ 1,004    

Charge-offs:

    

Commercial, financial and agricultural

     14         26    

Real estate — commercial mortgage

     13         23    

Real estate — construction

     1         11    

 

 

Total commercial real estate loans (a)

     14         34    

Commercial lease financing

     6         4    

 

 

Total commercial loans

     34         64    

Real estate — residential mortgage

     6         6    

Home equity:

    

Key Community Bank

     18         25    

Other

     6         8    

 

 

Total home equity loans

     24         33    

Consumer other — Key Community Bank

     9         10    

Credit cards

     8         —    

Consumer other:

    

Marine

     8         17    

Other

     1         2    

 

 

Total consumer other

     9         19    

 

 

Total consumer loans

     56         68    

 

 

Total loans charged off

     90         132    

Recoveries:

    

Commercial, financial and agricultural

     12         11    

Real estate — commercial mortgage

     5         2    

Real estate — construction

     8         1    

 

 

Total commercial real estate loans (a)

     13         3    

Commercial lease financing

     4         4    

 

 

Total commercial loans

     29         18    

Real estate — residential mortgage

     —         1    

Home equity:

    

Key Community Bank

     2         2    

Other

     2         1    

 

 

Total home equity loans

     4         3    

Consumer other — Key Community Bank

     2         1    

Consumer other:

    

Marine

     5         7    

Other

     1         1    

 

 

Total consumer other

     6         8    

 

 

Total consumer loans

     12         13    

 

 

Total recoveries

     41         31    

 

 

Net loans and leases charged off

     (49)         (101)    

Provision (credit) for loan and lease losses

     55         42    

Foreign currency translation adjustment

     (1)         (1)    

 

 

Allowance for loan and lease losses at end of period

    $ 893        $ 944    
  

 

 

   

 

 

 
    

 

 

Liability for credit losses on lending-related commitments at beginning of period

    $ 29        $ 45    

Provision (credit) for losses on lending-related commitments

     3         —    

 

 

Liability for credit losses on lending-related commitments at end of period (b)

    $ 32        $ 45    
  

 

 

   

 

 

 
    

 

 
    

Total allowance for credit losses at end of period

    $ 925        $ 989    
  

 

 

   

 

 

 
    

 

 

Net loan charge-offs to average loans

     .38       .82  

Allowance for loan and lease losses to annualized net loan charge-offs

     449.37         232.39    

Allowance for loan and lease losses to period-end loans

     1.70         1.92    

Allowance for credit losses to period-end loans

     1.76         2.01    

Allowance for loan and lease losses to nonperforming loans

     137.38          141.74    

Allowance for credit losses to nonperforming loans

     142.31         148.50    

Discontinued operations — education lending business:

    

Charge-offs

    $ 16        $ 23    

Recoveries

     4         4    

 

 

Net loan and lease charge-offs

    $ (12)        $ (19)    
  

 

 

   

 

 

 
    

 

 

 

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(a) See Figure 19 and the accompanying discussion in the “Loans and leases’ held for sale” section for more information related to our commercial real estate portfolio.

 

(b) Included in “accrued expense and other liabilities” on the balance sheet.

 

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Nonperforming assets

Figure 38 shows the composition of our nonperforming assets. These assets totaled $705 million at March 31, 2013, and represented 1.34% of portfolio loans, OREO and other nonperforming assets, compared to $735 million, or 1.39%, at December 31, 2012, and $767 million, or 1.55%, at March 31, 2012. See Note 1 under the headings “Nonperforming Loans,” “Impaired Loans,” and “Allowance for Loan and Lease Losses” beginning on page 120 of our 2012 Form 10-K for a summary of our nonaccrual and charge-off policies.

Figure 38. Summary of Nonperforming Assets and Past Due Loans from Continuing Operations

 

dollars in millions    March 31,  
2013  
    December 31,  
2012  
    September 30,  
2012  
    June 30,  
2012  
    March 31,  
2012  
 

 

 

Commercial, financial and agricultural

    $ 142        $ 99        $ 132        $ 141        $ 168    

Real estate — commercial mortgage

     114         120         134         172         175    

Real estate — construction

     27          56         53         68         66    

 

 

Total commercial real estate loans

     141         176         187         240         241    

Commercial lease financing

     12         16         18         18         22    

 

 

Total commercial loans

     295         291         337         399         431    

Real estate — residential mortgage

     96         103         83         78         82    

Home equity:

          

Key Community Bank

     199         210         171         141         109    

Other

     18         21         18         17         12    

 

 

Total home equity loans (a)

     217         231         189         158         121    

Consumer other — Key Community Bank

     3         2         3         2         1    

Credit card

     13         11         8         —         —    

Consumer other:

          

Marine

     25         34         31         19         30    

Other

     1         2         2         1         1    

 

 

Total consumer other

     26         36         33         20         31    

 

 

Total consumer loans

     355         383         316         258         235    

 

 

Total nonperforming loans

     650         674         653         657         666    

Nonperforming loans held for sale

     23         25         19         38         24    

OREO

     21         22         29         28         61    

Other nonperforming assets

     11         14         17         28         16    

 

 

Total nonperforming assets (b)

    $               705        $       735        $           718        $             751        $             767    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
          

 

 

Accruing loans past due 90 days or more

    $ 83        $ 78        $ 89        $ 131        $ 169    

Accruing loans past due 30 through 89 days

     368         424         354         362         420    

Restructured loans — accruing and nonaccruing (c)

     294         320         323         274         293    

Restructured loans included in nonperforming loans (c)

     178         249         217         163         184    

Nonperforming assets from discontinued operations — education lending business

     15         20         22         18         19    

Nonperforming loans to period-end portfolio loans

     1.24       1.28   %      1.27       1.32       1.35  

Nonperforming assets to period-end portfolio loans plus OREO and other nonperforming assets

     1.34         1.39         1.39         1.51         1.55    
          

 

 

 

(a) All of the increase in real estate – residential mortgage and $26 million of the increase in Total home equity loans from September 30, 2012 to December 31, 2012 was related to regulatory guidance issued in the second and third quarters of 2012.

 

(b) March 31, 2013, December 31, 2012, and September 30, 2012 amounts exclude $22 million, $23 million, and $25 million, respectively, of purchased impaired loans acquired in July 2012.

 

(c) Restructured loans (i.e., TDRs) are those for which Key, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. These concessions are made to improve the collectability of the loan and generally take the form of a reduction of the interest rate, extension of the maturity date or reduction in the principal balance. The majority of the increase in restructured loans included in nonperforming loans from September 30, 2012 to December 31, 2012 was related to regulatory guidance issued in the third quarter of 2012.

As shown in Figure 38, nonperforming assets decreased during the first quarter of 2013. Most of the reduction came from nonperforming loans in our Real estate — construction, Home equity — Key Community Bank, and Marine portfolios. These reductions were partially offset by an increase in nonperforming loans in our Commercial, financial, and agricultural portfolio. As shown in Figure 39, our exit loan portfolio accounted for $66 million, or 9.4%, of our total nonperforming assets at March 31, 2013, compared to $83 million, or 11.3%, at December 31, 2012.

At March 31, 2013, the carrying amount of our commercial nonperforming loans outstanding represented 63% of their contractual amount owed, total nonperforming loans outstanding represented 76% of their contractual amount owed, and nonperforming assets in total were carried at 73% of their original contractual amount.

At March 31, 2013, our twenty largest nonperforming loans totaled $194 million, representing 30% of total nonperforming loans.

 

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Figure 39 shows the composition of our exit loan portfolio at March 31, 2013 and December 31, 2012, the net charge-offs recorded on this portfolio for the first quarter of 2013 and the fourth quarter of 2012, and the nonperforming status of these loans at March 31, 2013 and December 31, 2012. The exit loan portfolio represented 5.2% of total loans and loans held for sale at March 31, 2013. Additional information about loan sales is included in this report under the heading “Loans held for sale” and “Loan sales.”

Figure 39. Exit Loan Portfolio from Continuing Operations

 

     Balance
               Outstanding              
    

Change

3-31-13 vs.

12-31-12

     Net Loan
Charge-offs
     Balance on
Nonperforming
Status
 
in millions      3-31-13         12-31-12            3-31-13     (c)      12-31-12         3-31-13         12-31-12   

 

 

Residential properties — homebuilder

    $ 29        $ 29        $ —         —        $       $ 10        $ 10   

Marine and RV floor plan

     29         33         (4)         $ (3)         —                10   

Commercial lease financing (a)

     966         997         (31)          (5)         —                 

 

 

Total commercial loans

     1,024         1,059         (35)          (8)                22         26   

Home equity — Other

     401         423         (22)                 11         18         21   

Marine

     1,254         1,358         (104)                 14         26         34   

RV and other consumer

     79         93         (14)          —                —          

 

 

Total consumer loans

     1,734         1,874         (140)                 26         44         57   

 

 

Total exit loans in loan portfolio

    $          2,758        $          2,933        $                 (175)         $               (1)        $               27        $               66        $               83   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Discontinued operations — education lending business (not included in exit loans above)(b)

    $ 5,086        $ 5,201        $ (115)         $ 12        $ 15        $ 15        $ 20   
                   

 

 

 

(a) Includes (1) the business aviation, commercial vehicle, office products, construction and industrial leases; (2) Canadian lease financing portfolios; and (3) all remaining balances related to LILO, SILO, service contract leases and qualified technological equipment leases.

 

(b) Includes loans in Key’s education loan securitization trusts.

 

(c) Credit amounts indicate recoveries exceeded charge-offs.

Figure 40 shows credit exposure by industry classification in the largest sector of our loan portfolio, “commercial, financial and agricultural loans.” Since December 31, 2012, total commitments and loans outstanding in this sector have increased by $265 million and $169 million, respectively, and have increased by $5.4 billion and $3.6 billion, respectively, from March 31, 2012.

Figure 40. Commercial, Financial and Agricultural Loans

 

                  Nonperforming Loans  

March 31, 2013

dollars in millions

    
 
Total
Commitments
  
  (a) 
   
 
Loans
Outstanding
  
  
     Amount        
 
Percent of Loans
Outstanding
  
  

 

 

Industry classification:

          

Services

    $ 10,197        $ 5,514        $ 67         1.2 

Manufacturing

     9,252         4,313         17         .4   

Public utilities

     5,784         1,619         —         —   

Financial services

     4,110         2,016                .1   

Wholesale trade

     3,677         1,741                .5   

Retail trade

     2,091         884                .3   

Mining

     1,896         783                .4   

Dealer floor plan

     1,518         1,178                .6   

Property management

     1,382         781         11         1.4   

Transportation

     1,316         877                .9   

Building contractors

     1,184         481         10         2.1   

Agriculture/forestry/fishing

     976         491                .4   

Insurance

     801         133         —         —   

Public administration

     623         442         —         —   

Communications

     340         220         —         —   

Individuals

                   —         —   

Other

     2,417         1,938                .2   

 

 

Total

    $ 47,568        $ 23,412        $ 142         .6 
  

 

 

   

 

 

    

 

 

    
          

 

 

 

(a) Total commitments include unfunded loan commitments, unfunded letters of credit (net of amounts conveyed to others), and loans outstanding.

The types of activity that caused the change in our nonperforming loans during each of the last five quarters are summarized in Figure 41. Loans returned to accrual status increased $43 million during first quarter of 2013 compared to the first quarter 2012, as market liquidity continued to improve.

 

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Figure 41. Summary of Changes in Nonperforming Loans from Continuing Operations

 

              2013                2012  
in millions    First      Fourth      Third      Second      First  

 

 

Balance at beginning of period

    $ 674         $ 653         $ 657         $ 666         $ 727    

Loans placed on nonaccrual status

     278          288          276          350          214    

Charge-offs

     (91)          (104)          (141)          (131)          (132)    

Loans sold

     (42)          (44)          (43)          (49)          (27)    

Payments

     (83)          (78)          (74)          (110)          (65)    

Transfers to OREO

     (7)          (7)          (10)          (6)          (15)    

Transfers to nonperforming loans held for sale

     —          (8)          —          (16)          —    

Transfers to other nonperforming assets

     —          (1)          —          (14)          —    

Loans returned to accrual status

     (79)          (25)          (12)          (33)          (36)    

 

 

Balance at end of period (a)

    $               650         $               674         $               653         $                 657         $                 666    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
              

 

 

 

(a) March 31, 2013, December 31, 2012, and September 30, 2012 amounts exclude $22 million, $23 million, and $25 million, respectively, of purchased credit

The types of activity that caused the change in our nonperforming loans held for sale during each of the last five quarters are summarized in Figure 42.

Figure 42. Summary of Changes in Nonperforming Loans Held for Sale from Continuing Operations

 

                  2013                    2012  
in millions    First       Fourth       Third       Second       First   

 

 

Balance at beginning of period

    $ 25         $ 19         $ 38         $ 24         $ 46    

Transfers in

     —          8          —          16          —    

Net advances / (payments)

     —          (1)          (1)          —          (1)    

Loans sold

     —          (1)          (17)          (1)          (1)    

Transfers to OREO

     —          —          (1)          —          —    

Valuation adjustments

     (2)          —          —          (1)          (1)    

Loans returned to accrual status / other

     —          —          —          —          (19)    

 

 

Balance at end of period

    $                  23         $                  25         $                    19         $                   38         $                  24    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

The types of activity that contributed to the change in our OREO during each of the last five quarters are summarized in Figure 43.

Figure 43. Summary of Changes in Other Real Estate Owned, Net of Allowance, from Continuing Operations

 

     2013      2012  
in millions    First       Fourth       Third       Second       First   

 

 

Balance at beginning of period

    $ 22         $ 29         $ 28         $ 61         $ 65    

Properties acquired — nonperforming loans

     7          7          11          6          15    

Valuation adjustments

     (3)          (2)          (2)          (7)          (7)    

Properties sold

     (5)          (12)          (8)          (32)          (12)    

 

 

Balance at end of period

    $                   21         $                   22         $                   29         $                   28         $                   61    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

 

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Operational risk management

Like all businesses, we are subject to operational risk, which is the risk of loss resulting from human error or malfeasance, inadequate or failed internal processes and systems, and external events. These events include, among other things, threats to our cybersecurity, as we are reliant upon information systems and the internet to conduct our business activities.

Operational risk also encompasses compliance risk, which is the risk of loss from violations of, or noncompliance with, laws, rules and regulations, prescribed practices, and ethical standards. Under the Dodd-Frank Act, large financial companies like Key will be subject to heightened prudential standards and regulation due to their systemic importance. This heightened level of regulation will increase our operational risk. We have created work teams to respond to and analyze the regulatory requirements that will be promulgated as a result of the enactment of the Dodd-Frank Act. Resulting operational risk losses and/or additional regulatory compliance costs could take the form of explicit charges, increased operational costs, harm to our reputation or foregone opportunities.

We seek to mitigate operational risk through identification and measurement of risk, alignment of business strategies with risk appetite and tolerance, and a system of internal controls and reporting. We continuously strive to strengthen our system of internal controls to improve the oversight of our operational risk and to ensure compliance with laws, rules and regulations. For example, an operational event database tracks the amounts and sources of operational risk and losses. This tracking mechanism helps to identify weaknesses and to highlight the need to take corrective action. We also rely upon software programs designed to assist in assessing operational risk and monitoring our control processes. This technology has enhanced the reporting of the effectiveness of our controls to senior management and the Board.

The Operational Risk Management Program provides the framework for the structure, governance, roles and responsibilities as well as the content to manage operational risk for Key. Primary responsibility for managing and monitoring internal control mechanisms lies with the managers of our various lines of business. The Operational Risk Committee, a senior management committee, oversees our level of operational risk and directs and supports our operational infrastructure and related activities. This committee and the Operational Risk Management function are an integral part of our ERM Program. Our Risk Review function periodically assesses the overall effectiveness of our Operational Risk Management Program and our system of internal controls. Risk Review reports the results of reviews on internal controls and systems to senior management and the Audit Committee, and independently supports the Audit Committee’s oversight of these controls.

Critical Accounting Policies and Estimates

Our business is dynamic and complex. Consequently, we must exercise judgment in choosing and applying accounting policies and methodologies. These choices are critical: not only are they necessary to comply with GAAP, they also reflect our view of the appropriate way to record and report our overall financial performance. All accounting policies are important, and all policies described in Note 1 (“Summary of Significant Accounting Policies”) beginning on page 117 of our 2012 Form 10-K should be reviewed for a greater understanding of how we record and report our financial performance.

In our opinion, some accounting policies are more likely than others to have a critical effect on our financial results and to expose those results to potentially greater volatility. These policies apply to areas of relatively greater business importance, or require us to exercise judgment and to make assumptions and estimates that affect amounts reported in the financial statements. Because these assumptions and estimates are based on current circumstances, they may prove to be inaccurate, or we may find it necessary to change them.

We rely heavily on the use of judgment, assumptions and estimates to make a number of core decisions, including accounting for the allowance for loan and lease losses; contingent liabilities, guarantees and income taxes; derivatives and related hedging activities; and assets and liabilities that involve valuation methodologies. In addition, we may employ outside valuation experts to assist us in determining fair values of certain assets and liabilities. A brief discussion of each of these areas appears on pages 120 through 128 of our 2012 Form 10-K.

At March 31, 2013, $15.9 billion, or 17.8%, of our total assets were measured at fair value on a recurring basis. Approximately 95.9% of these assets, before netting adjustments, were classified as Level 1 or Level 2 within the fair value hierarchy. At March 31, 2013, $1.4 billion, or 1.8%, of our total liabilities were measured at fair value on a recurring basis. Substantially all of these liabilities were classified as Level 1 or Level 2.

During the first quarter of 2013, $46 million, or .1%, of our total assets were measured at fair value on a nonrecurring basis. Approximately 17.3% of these assets were classified as Level 1 or Level 2. At March 31, 2013, there were no liabilities measured at fair value on a nonrecurring basis.

 

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In addition, the education lending securitization trusts assets and liabilities were included on the balance sheet at March 31, 2013 at fair value, in the amount of $2.4 billion and $2.2 billion, respectively.

During the first three months of 2013, we did not significantly alter the manner in which we applied our critical accounting policies or developed related assumptions and estimates.

 

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European Sovereign Debt Exposures

Our total European sovereign and non-sovereign debt exposure is presented in Figure 44.

Figure 44. European Sovereign and Non-sovereign Debt Exposures

 

March 31, 2013

in millions

    
 
 
Short- and Long-
Term Commercial
Total
  
  
  
(a) 
   
 
 
Foreign Exchange
and Derivatives
with Collateral
  
  
  
(b) 
   
 
Net
Exposure
  
  

 

 

France:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —         $ (11)        $ (11)    

Non-sovereign non-financial institutions

    $ 88          —          88    

 

 

Total

     88          (11)         77    

Germany:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          (8)         (8)    

Non-sovereign non-financial institutions

     345          —          345    

 

 

Total

     345          (8)         337    

Greece:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          —          —    

Non-sovereign non-financial institutions

     —          —          —    

 

 

Total

     —          —          —    

Iceland:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          —          —    

Non-sovereign non-financial institutions

     —          —          —    

 

 

Total

     —          —          —    

Ireland:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          —          —    

Non-sovereign non-financial institutions

     8          —          8    

 

 

Total

     8          —          8    

Italy:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          —          —    

Non-sovereign non-financial institutions

     85          —          85    

 

 

Total

     85          —          85    

Netherlands:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          11          11    

Non-sovereign non-financial institutions

     131          —          131    

 

 

Total

     131          11          142    

Portugal:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          —          —    

Non-sovereign non-financial institutions

     —          —          —    

 

 

Total

     —          —          —    

Spain:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          —          —    

Non-sovereign non-financial institutions

     70          —          70    

 

 

Total

     70          —          70    

Switzerland:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          2          2    

Non-sovereign non-financial institutions

     94          —          94    

 

 

Total

     94          2          96    

United Kingdom:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          (1)         (1)    

Non-sovereign non-financial institutions

     195          —          195    

 

 

Total

     195          (1)         194    

Other Europe: (c)

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          —          —    

Non-sovereign non-financial institutions

     134          —          134    

 

 

Total

     134          —          134    

Total Europe:

      

Sovereigns

     —          —          —    

Non-sovereign financial institutions

     —          (7)         (7)    

Non-sovereign non-financial institutions

     1,150          —          1,150    

 

 

Total

    $ 1,150         $ (7)        $ 1,143    
  

 

 

   

 

 

   

 

 

 
      

 

 

 

(a) This column represents our outstanding leases.

 

(b) This column represents contracts to hedge our balance sheet asset and liability needs, and to accommodate our clients’ trading and/or hedging needs. Our derivative mark-to-market exposures are calculated and reported on a daily basis. These exposures are largely covered by cash or highly marketable securities collateral with daily collateral calls.

 

(c) Other Europe consists of the following countries: Austria, Belarus, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Finland, Hungary, Lithuania, Luxembourg, Malta, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden, and Ukraine. Approximately 90% of our exposure in Other Europe is in Belgium, Finland, and Sweden.

Our credit risk exposure is largely concentrated in developed countries with emerging market exposure essentially limited to commercial facilities. At-risk exposures in the rest of the world, which are actively monitored by management, total $1 million.

 

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Item 3. Quantitative and Qualitative Disclosure about Market Risk

The information presented in the “Market risk management” section of the Management’s Discussion & Analysis of Financial Condition & Results of Operations is incorporated herein by reference.

Item 4. Controls and Procedures

As of the end of the period covered by this report, KeyCorp carried out an evaluation, under the supervision and with the participation of KeyCorp’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of KeyCorp’s disclosure controls and procedures. Based upon that evaluation, KeyCorp’s Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective, in all material respects, as of the end of the period covered by this report, in ensuring that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. No changes were made to KeyCorp’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, KeyCorp’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

As of March 31, 2013, KeyCorp and its subsidiaries are defendants or putative defendants in a variety of legal proceedings, in the form of regulatory/government investigations as well as private, civil litigation and arbitration proceedings. The private, civil litigations range from individual actions involving a single plaintiff to class action lawsuits. Investigations involve both formal and informal proceedings, by both government agencies and self-regulatory bodies. These legal proceedings are at varying stages of adjudication, arbitration or investigation and involve a variety of claims (including common law tort, contract claims, securities, ERISA, and consumer protection claims). At times, these legal proceedings may present novel claims or legal theories.

On at least a quarterly basis, we assess our liabilities and contingencies in connection with outstanding legal proceedings utilizing the latest information available. For those matters where it is probable that we will incur a loss and the amount of the loss can be reasonably estimated, we record a liability in our consolidated financial statements. These legal reserves may be increased or decreased to reflect any relevant developments on a quarterly basis. Where a loss is not probable or the amount of the loss is not estimable, we have not accrued legal reserves, consistent with applicable accounting guidance. Because the outcome of legal proceedings is inherently uncertain, based on information currently available to us, advice of counsel, and the availability of insurance coverage and indemnification from third parties, we believe that our established reserves are adequate and the liabilities arising from the legal proceedings will not have a material adverse effect on our consolidated financial condition. We note, however, that in light of the inherent uncertainty in legal proceedings there can be no assurance that the ultimate resolution will not exceed established reserves. As a result, the outcome of a particular matter, or a combination of matters, may be material to our results of operation for a particular period, depending upon the size of the loss or our income for that particular period.

The information presented in the Legal Proceedings section of Note 15 (“Contingent Liabilities and Guarantees”) of the Notes to our Consolidated Financial Statements is incorporated herein by reference.

Item 1A. Risk Factors

For a discussion of certain risk factors affecting us, see the section titled “Supervision and Regulation” in Part I, Item 1. Business, on pages 7-19 of our 2012 Form 10-K, Part 1, Item 1A: Risk Factors, on pages 19-31 of our 2012 Form 10-K, and our disclosure regarding Forward-looking statements in this Form 10-Q.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

From time to time, KeyCorp or its principal subsidiary, KeyBank, may seek to retire, repurchase or exchange outstanding debt of KeyCorp or KeyBank, and capital securities or preferred stock of KeyCorp through cash purchase, privately negotiated transactions or otherwise. Such transactions, if any, depend on prevailing market conditions, our liquidity and capital requirements, contractual restrictions and other factors. The amounts involved may be material.

As previously reported, as authorized by our Board and pursuant to our 2012 capital plan submitted to the Federal Reserve in January 2012 as part of CCAR and not objected to by the Federal Reserve, beginning in the second quarter of 2012, KeyCorp had authority to repurchase up to $344 million of our Common Shares for general repurchase and repurchases in connection with employee elections under our compensation and benefit programs.

During the first quarter of 2013, KeyCorp completed $65 million of Common Share repurchases on the open market under Key’s 2012 capital plan. On January 7, 2013, we submitted to the Federal Reserve and provided to the OCC under the annual CCAR process our 2013 capital plan. On March 14, 2013, the Federal Reserve announced that it did not object to our 2013 capital plan. At its March 2013 meeting, our Board authorized up to $426 million in repurchases of our Common Shares in the open market or through privately negotiated transactions. The authorization was expressly in addition to any amounts remaining under preexisting authority. Common Share repurchases under the current authorization are expected to be executed through the first quarter of 2014.

The following table summarizes Key’s repurchases of its Common Shares for the three months ended March 31, 2013.

Calendar month     
 
Total number of shares
repurchased
  
    (a) 
   
 
Average price paid
per share
  
  
    
 
 
Total number of shares purchased as
part of publicly announced plans or
programs
  
  
  
    
 
 
Maximum number of shares that may
yet be purchased as part of publicly
announced plans or programs
  
  
    (b) 

 

 

January 1 - 31

     777,205        $         9.31         773,360         19,678,259    

February 1 - 28

     3,518,632         9.48         3,204,465         16,446,936    

March 1 - 31

     3,486,590         9.65         2,812,482         13,922,496    

 

 

Total

     7,782,427        $ 9.54         6,790,307      
  

 

 

      

 

 

    
          

 

 

 

(a) Includes Common Shares deemed surrendered by employees in connection with Key’s stock compensation and benefit plans to satisfy tax obligations and repurchases in the open market.

 

(b) Calculated using the remaining general repurchase amount divided by the closing price of KeyCorp Common Shares on January 31, 2013 at $9.40, February 28, 2013 at $9.39, and March  31, 2013 at $9.96, plus our previously existing program shares available of 13,922,496.

Item  6. Exhibits

 

15    Acknowledgment of Independent Registered Public Accounting Firm.
31.1    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101    The following materials from KeyCorp’s Form 10-Q Report for the quarterly period ended March 31, 2013, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income, (iii) the Consolidated Statements of Changes in Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to Consolidated Financial Statements.

Information Available on Website

KeyCorp makes available free of charge on its website, www.key.com, its 2012 Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports as soon as reasonably practicable after KeyCorp electronically files such material with, or furnishes it to, the SEC.

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   

KEYCORP

  (Registrant)
Date: May 1, 2013  

/s/ Robert L. Morris

  By: Robert L. Morris
  Chief Accounting Officer

 

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