KeyBank 2006 Annual Report Download - page 69

69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
Nonaccrual loans, other than smaller-balance homogeneous loans (i.e.,
home equity loans, loans to finance automobiles, etc.), are designated
“impaired.” Impaired loans and other nonaccrual loans are returned to
accrual status if management determines that both principal and interest
are collectible. This generally requires a sustained period of timely
principal and interest payments.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents management’s estimate of
probable credit losses inherent in the loan portfolio at the balance
sheet date. Management establishes the amount of the allowance for loan
losses by analyzing the quality of the loan portfolio at least quarterly, and
more often if deemed necessary.
Commercial loans are generally 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. Key’s charge-off policy for consumer loans is similar, but
takes effect when the payments are 120 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.
Management estimates the appropriate level of Key’s allowance for
loan losses by applying historical loss rates to existing loans with
similar risk characteristics. The loss rates used to establish the allowance
may be adjusted to reflect management’s current assessment of many
factors, including:
•changes in national and local economic and business conditions;
• changes in experience, ability and depth of Key’s lending management
and staff, in lending policies, or in the mix and volume of the loan
portfolio;
•trends in past due, nonaccrual and other loans; and
•external forces, such as competition, legal developments and regulatory
guidelines.
For an impaired loan, special treatment exists if the outstanding balance
is greater than $2.5 million, and the resulting allocation is deemed
insufficient to cover the extent of the impairment. In such cases, a specific
allowance is assigned to the loan. Management estimates the extent of
impairment by comparing the carrying amount of the loan with the
estimated present value of its future cash flows, including, if applicable,
the fair value of any collateral. A specific allowance also may be assigned
even when sources of repayment appear sufficient if management remains
uncertain about whether the loan will be repaid in full.
ALLOWANCE FOR CREDIT LOSSES ON
LENDING-RELATED COMMITMENTS
During the first quarter of 2004, management reclassified $70 million
of Key’s allowance for loan losses to a separate allowance for credit losses
inherent in lending-related commitments, such as letters of credit and
unfunded loan commitments. The separate allowance is included in
“accrued expense and other liabilities” on the balance sheet and totaled
$53 million at December 31, 2006, and $59 million at December 31,
2005. Management establishes the amount of this allowance by
considering both historical trends and current market conditions
quarterly, or more often if deemed necessary.
LOAN SECURITIZATIONS
Key sells education loans in securitizations. A securitization involves the
sale of a pool of loan receivables to investors through either a public or
private issuance (generally by a qualifying SPE) of asset-backed securities.
Securitized loans are removed from the balance sheet, and a net gain or
loss is recorded when the combined net sales proceeds and (if applicable)
residual interests differ from the loan’s allocated carrying amount. Net
gains and losses resulting from securitizations are recorded as one
component of “net gains from loan securitizations and sales” on the
income statement. A servicing asset also may be recorded if Key
purchases or retains the right to service securitized loans and receives
related fees that exceed the going market rate. Income earned under
servicing or administration arrangements is recorded in “other income.”
In some cases, Key retains one or more residual interests in securitized
loans in the form of an interest-only strip, residual asset, servicing
asset or security. Servicing assets are accounted for under SFAS No. 140,
as further described below under the heading “Servicing Assets.” All
other retained interests are accounted for as debt securities and classified
as either securities available for sale or trading account assets. Some of
the assumptions used in determining the fair values of Key’s retained
interests are disclosed in Note 8 (“Loan Securitizations, Servicing and
Variable Interest Entities”), which begins on page 83.
In accordance with Revised Interpretation No. 46, qualifying SPEs,
including securitization trusts, established by Key under SFAS No. 140,
areexempt from consolidation. Information on Revised Interpretation
No. 46 appears in this note under the heading “Basis of Presentation”
on page 67.
Key conducts a quarterly review to determine whether all retained
interests are valued appropriately in the financial statements. Management
reviews the historical performance of each retained interest as well as the
assumptions used to project futurecash flows, and revises assumptions and
recalculates the present values of cash flows as appropriate.
The present value of these cash flows is referred to as the “retained interest
fair value.” Generally,if the carrying amount of a retained interest
classified as securities available for sale exceeds its fair value, impairment
is indicated and recognized in earnings. Conversely, if the fair value of
the retained interest exceeds its carrying amount, the write-up to fair
value is recorded in equity as a component of “accumulated other
comprehensive income (loss),” and the yield on the retained interest is
adjusted prospectively. For retained interests classified as trading account
assets, any increase or decrease in the asset’s fair value is recognized in
“other income” on the income statement.
SERVICING ASSETS
Servicing assets that Key purchases or retains in a sale or securitization
of loans are reported at the lower of amortized cost or fair value ($282
million at December 31, 2006, and $275 million at December 31,
2005) and included in “accrued income and other assets” on the
balance sheet. In accordance with SFAS No. 140, fair value initially is
determined by allocating the previous carrying amount of the assets sold
or securitized to the retained interests and the assets sold based on their
relative fair values at the date of transfer. Fair value is determined by
estimating the present value of future cash flows associated with
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