KeyBank 2006 Annual Report Download - page 49

49
MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
This analysis is highly dependent upon assumptions applied to assets
and liabilities with noncontractual maturities. Those assumptions are
based on historical behaviors, as well as management’s expectations.
EVE complements net interest income simulation analysis since it
provides estimates of risk exposure beyond twelve and twenty-four
month horizons. Management takes preventative measures to ensure
that Key’s EVE will not decrease by more than 15% in response to an
immediate 200 basis point increase or decrease in interest rates. Key is
operating within these guidelines.
Management of interest rate exposure. Management uses the results
of its various simulation analyses to formulate strategies to achieve the
desired risk profile within the parameters of Key’s capital and liquidity
guidelines. Interest rate risk positions are actively managed through the
purchase of investment securities, the issuance of term debt with floating
or fixed interest rates, and the use of derivatives — predominantly in the
form of interest rate swaps. These swaps modify the interest rate
characteristics of certain assets and liabilities by converting them from
afixed rate to a floating rate, from a floating rate to a fixed rate, or from
one floating index to another.
Figure 30 shows the maturity structure for all swap positions held for
asset/liability management (“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. For
more information about how Key uses interest rate swaps to manage
its balance sheet, see Note 19 (“Derivatives and Hedging Activities”),
which begins on page 100.
December 31, 2006 December 31, 2005
Weighted-Average Rate
Notional Fair Maturity Notional Fair
dollars in millions Amount Value (Years) Receive Pay Amount Value
Receive fixed/pay variable —
conventional A/LM
a
$ 8,138 $ (2) 1.5 5.1% 5.4% $ 2,050 $ (8)
Receive fixed/pay variable —
conventional debt 5,164 (8) 16.5 5.4 5.5 5,961 85
Receive fixed/pay variable —
forwardstarting 250 — 2.7 5.1 5.3 1,000 —
Pay fixed/receive variable —
conventional debt 839 (11) 5.0 4.5 4.3 911 (20)
Foreign currency —
conventional debt 3,335 149 3.3 4.1 5.5 2,868 (137)
Basis swaps
b
300 — 1.2 5.4 5.4 13,000 (3)
Total portfolio swaps $18,026 $128 6.3 5.0% 5.4% $25,790 $ (83)
a
Portfolio swaps designated as A/LM areused to manage interest rate risk tied to both assets and liabilities.
b
These portfolio swaps are not designated as hedging instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.”
FIGURE 30. PORTFOLIO SWAPS BY INTEREST RATE RISK MANAGEMENT STRATEGY
Trading portfolio risk management
Key’s trading portfolio is described in Note 19.
Management uses a value at risk (“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 Key’s trading
portfolio. Using two years of historical information, the model estimates
the maximum potential one-day loss with a 95% confidence level.
Statistically,this means that losses will exceed VAR, on average, five out
of 100 trading days, or three to four times each quarter. Key’s Financial
Markets Committee has established VAR limits for Key’s trading units.
At December 31, 2006, the aggregate one-day trading limit set by the
committee was $4.4 million. In addition to comparing VAR exposure
against limits on a daily basis, management monitors loss limits, uses
sensitivity measures and conducts stress tests.
Key is operating within the above constraints. During 2006, Key’s
aggregate daily average, minimum and maximum VAR amounts were
$1.1 million, $.7 million and $2.1 million, respectively. During 2005,
Key’s aggregate daily average, minimum and maximum VAR amounts
were $2.1 million, $.8 million and $5.3 million, respectively.
As noted in the discussion of investment banking and capital markets
income on page 34, Key used interest rate swaps to manage the
economic risk associated with the sale of the indirect automobile loan
portfolio. Even though these derivatives werenot subject to VAR trading
limits, Key measured their exposure on a daily basis, and the results
are included in the VAR amounts indicated above for 2005. The daily
average, minimum and maximum VAR exposures for these derivatives
were $.8 million, zero and $3.6 million, respectively.
Credit risk management
Credit risk is the risk of loss arising from an obligor’s inability or
failure to meet contractual payment or performance terms. Like other
financial service institutions, Key makes loans, extends credit, purchases
securities and enters into financial derivative contracts, all of which
expose Key to credit risk.
Previous Page
Search
Next Page
Contents