KeyBank 2006 Annual Report Download - page 55

55
MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
of wholesale borrowings, such as money market funding and term
debt. In addition, management assesses Key’s needs for future reliance
on wholesale borrowings and then develops strategies to address those
needs. Moreover, Key will, on occasion, guarantee a subsidiary’s
obligations in transactions with third parties. Management closely
monitors the extension of such guarantees to ensure that Key retains
ample liquidity in the event it must step in to provide financial support.
Key’s liquidity could be adversely affected by both direct and indirect
circumstances. An example of a direct (but hypothetical) event would
be adowngrade in Key’s public credit rating by a rating agency due to
deterioration in asset quality, a large charge to earnings, a decline in
profitability or other financial measures, or a significant merger or
acquisition. Examples of indirect (but hypothetical) events unrelated to
Key that could have an effect on Key’s access to liquidity would be
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 Key or the banking
industry in general may adversely affect the cost and availability of
normal funding sources.
In accordance with A/LM policy, Key performs stress tests to consider
the effect that a potential downgrade in its debt ratings could have on
liquidity over various time periods. These debt ratings, which are
presented in Figure 36 on page 56, have a direct impact on Key’s cost
of funds and ability to raise funds under normal as well as adverse
conditions. The results of the stress tests indicate that, following the
occurrence of an adverse event, Key can continue to meet its financial
obligations and to fund its operations for at least one year.The stress test
scenarios include major disruptions to Key’saccess to funding markets
and consider the potential adverse effect of core client activity on cash
flows. To compensate for the effect of these activities, alternative
sources of liquidity areincorporated into the analysis over different time
periods to project how fluctuations on the balance sheet would be
managed. Key actively manages several alternatives for enhancing
liquidity,including generating client deposits, securitizing or selling
loans, extending the maturity of wholesale borrowings, purchasing
deposits from other banks, and developing relationships with fixed
income investors. Management also measures Key’s capacity to borrow
using various debt instruments and funding markets.
Key maintains a liquidity contingency 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 effectively managing liquidity through a
problem period. Key has access to various sources of money market
funding (such as federal funds purchased, securities sold under repurchase
agreements, eurodollars and commercial paper) and also can borrow
from the Federal Reserve Bank’s discount window to meet short-term
liquidity requirements. Key did not have any borrowings from the
Federal Reserve Bank outstanding at December 31, 2006.
Key monitors its funding sources and measures its capacity to obtain
funds in a variety of wholesale funding markets in an effort to maintain
an appropriate mix of funds, considering both cost and availability. Key
uses several tools to actively manage and maintain sufficient liquidity on
an ongoing basis.
• Key maintains a portfolio of securities that generates monthly
principal cash flows and payments at maturity.
• Key can access the whole loan sale and securitization markets for a
variety of loan types.
• KBNA’s 950 KeyCenters generate a sizable volume of core deposits.
Management monitors deposit flows and uses alternative pricing
structures to attract deposits as appropriate. For more information
about core deposits, see the section entitled “Deposits and other
sources of funds,” which begins on page 42.
• Key has access to the term debt markets through various programs
described in the section entitled “Additional sources of liquidity” on
page 56.
In addition to cash flows from operations, Key’s cash flows come
from both investing and financing activities. Over the past three years,
prepayments and maturities of securities available for sale have been
primary sources of cash from investing activities. Loan securitizations
and sales also provided significant cash inflow during 2004.
Investing activities that have required the greatest use of cash include
acquisitions completed during the fourth quarter of 2004, lending and
purchases of new securities.
Key utilizes financing activities to meet the cash flow needs generated by
operating and investing activities that cannot be met by deposit growth.
These cash needs may be addressed by increasing short- and/or long-term
borrowings. Conversely, excess cash generated by operating, investing
and deposit-gathering activities may be used to repay outstanding debt.
During 2004, Key used the excess cash generated by deposit-gathering
activities to pay down both short- and long-termdebt. In 2005, borrowings
wereused to support loan growth in excess of deposit growth. In 2006,
cash generated by the sale of discontinued operations was used to pay
down short-termborrowings.
The Consolidated Statements of Cash Flow on page 66 summarize
Key’s sources and uses of cash by type of activity for each of the past
three years.
Figure 27 on page 46 summarizes Key’s significant contractual cash
obligations at December 31, 2006, by specific time periods in which
related payments are due or commitments expire.
Liquidity for KeyCorp (the “parent company”)
The parent company has sufficient liquidity when it can service its
debt, support customary corporate operations and activities (including
acquisitions), at a reasonable cost, in a timely manner and without
adverse consequences, and pay dividends to shareholders.
Management’s primary tool for assessing parent company liquidity is
the net short-term cash position, which measures the ability to fund debt
maturing in twelve months or less with existing liquid assets. Another
key measure of parent company liquidity is the “liquidity gap,” which
represents the difference between projected liquid assets and anticipated
financial obligations over specified time horizons. Key generally relies
upon the issuance of term debt to manage the liquidity gap within
targeted ranges assigned to various time periods.
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