KeyBank 2006 Annual Report Download - page 100

100
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
Key also provides liquidity facilities to several third-party commercial
paper conduits. These liquidity facilities, which expire at various dates
through October 30, 2009, obligate Key to provide funding of up to
$562 million in total, with individual facilities ranging from $10 million
to $100 million. The amounts available to be drawn, which are based
on the amount of current commitments to borrowers, totaled $561
million at December 31, 2006, but there were no drawdowns under these
committed facilities at that date.
Indemnifications provided in the ordinary course of business. Key
provides certain indemnifications primarily through representations and
warranties in contracts that are entered into 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. Amounts paid, if
any, with respect to these indemnifications have not had a significant effect
on Key’s financial condition or results of operations in the past.
Intercompany guarantees. KeyCorp and certain other Key affiliates
are parties to various guarantees that facilitate the ongoing business
activities of other Key affiliates. These business activities encompass debt
issuance, certain lease and insurance obligations, investments and
securities, and certain leasing transactions involving clients.
Key, mainly through its subsidiary bank, KBNA, is party to various
derivative instruments that are used for asset and liability management,
credit risk management and trading purposes. The primary derivatives
that Key uses are interest rate swaps, caps and futures, and foreign
exchange forward contracts. Generally, these instruments help Key
manage exposure to market risk, mitigate the credit risk inherent in the
loan portfolio and meet client’s financing needs. Market risk represents
the possibility that economic value or net interest income will be
adversely affected by changes in interest rates or other economic factors.
At December 31, 2006, Key had $210 million of derivative assets and
$51 million of derivative liabilities on its balance sheet that arose from
derivatives that were being used for hedging purposes. As of the same
date, derivative assets and liabilities classified as trading derivatives
totaled $881 million and $871 million, respectively. Derivative assets and
liabilities are recorded at fair value on the balance sheet.
COUNTERPARTY CREDIT RISK
The following table summarizes the fair value of Key’s derivative assets
by type. These assets represent Key’s exposure to potential loss, as
described below, before taking into account the effects of master netting
arrangements and other means used to mitigate risk.
Like other financial instruments, derivatives contain an element of
“credit risk” — the possibility that Key will incur a loss because a
counterparty, which may be a bank or a broker/dealer, fails to meet its
contractual obligations. This risk is measured as the expected positive
replacement value of contracts. To mitigate credit risk when managing
asset, liability and trading positions, Key deals exclusively with
counterparties that have high credit ratings.
Key uses two additional means to manage exposure to credit risk on
derivative contracts. First, Key generally enters into bilateral collateral
and master netting arrangements. These agreements provide for the net
settlement of all contracts with a single counterparty in the event of
default. Second, Key’s Credit Administration department monitors
credit risk exposure to the counterparty on each contract to determine
appropriate limits on Key’s total credit exposure and decide whether to
demand collateral. If Key determines that collateral is required, it is
generally collected immediately. Key generally holds collateral in the form
of cash and highly rated Treasury and agency-issued securities.
At December 31, 2006, Key was party to derivative contracts with 53
different counterparties. These derivatives include interest rate swaps
and caps, credit derivatives, energy derivatives and foreign exchange
contracts. Among these were contracts entered into to offset the risk of
client exposure. Key had aggregate exposure of $292 million on these
instruments to 27 of the 53 counterparties. However, at December 31,
2006, Key held approximately $153 million in pooled collateral to
mitigate that exposure, resulting in net exposure of $139 million. The
largest exposure to an individual counterparty was approximately
$81 million, which Key secured with approximately $69 million in
collateral.
ASSET AND LIABILITY MANAGEMENT
Fair value hedging strategies. Key uses interest rate swap contracts
known as “receive fixed/pay variable” swaps to modify its exposure to
interest rate risk. These contracts convert specific fixed-rate deposits,
short-term borrowings and long-term debt into variable-rate obligations.
As a result, Key receives fixed-rate interest payments in exchange for
variable-rate payments over the lives of the contracts without exchanges
of the underlying notional amounts.
The effective portion of a change in the fair value of a hedging 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 earnings with no corresponding
offset. Key recognized a net gain of approximately $2 million in 2006,
a net gain of approximately $1 million in 2005 and a net loss of
19. DERIVATIVES AND HEDGING ACTIVITIES
December 31,
in millions 2006 2005
Interest rate $ 697 $ 800
Credit 43 39
Foreign exchange 321 167
Equity 45 42
Energy 29 —
Total $1,135 $1,048
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