KeyBank 2006 Annual Report Download - page 71

71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
Afair value hedge is used to limit exposure to changes in the fair value
of existing assets, liabilities and firm commitments caused by changes in
interest rates or other economic factors. Key recognizes the gain or loss
on these derivatives, as well as the related gain or loss on the underlying
hedged item, in earnings during the period in which the fair value
changes. If a hedge is perfectly effective, the change in the fair value of
the hedged item will be offset, resulting in no net effect on earnings.
Acash flow hedge is used to minimize the variability of future cash
flows that is caused by changes in interest rates or other economic
factors. The effective portion of a gain or loss on any cash flow hedge is
reported as a component of “accumulated other comprehensive income
(loss)” and reclassified into earnings in the same period or periods that the
hedged transaction affects earnings. Any ineffective portion of the
derivative gain or loss is recognized in earnings during the current period.
DERIVATIVES USED FOR CREDIT RISK
MANAGEMENT PURPOSES
Key uses credit derivatives — primarily credit default swaps — to
mitigate credit risk by transferring a portion of the risk associated
with the underlying extension of credit to a third party, and to manage
portfolio concentration and correlation risks. Key also provides credit
protection to other lenders through the sale of credit default swaps.
These derivatives arerecorded on the balance sheet at fair value, which
is based on the creditworthiness of the borrowers. Similar to derivatives
used for trading purposes, changes in fair value (including payments and
receipts), as well as the premium paid or received for credit protection,
are included in “investment banking and capital markets income” on the
income statement.
DERIVATIVES USED FOR TRADING PURPOSES
Key also enters into derivative contracts to make a market for clients and
for proprietarytrading purposes. Derivatives used for trading purposes
typically include financial futures, credit and energy derivatives, foreign
exchange forward and spot contracts, written and purchased options
(including currency options), and interest rate swaps, caps and floors.
All derivatives used for trading purposes arerecorded at fair value. Fair
value is determined by estimating the present value of future cash
flows. Changes in fair value (including payments and receipts) are
recorded in “investment banking and capital markets income” on the
income statement.
GUARANTEES
Key’s accounting policies related to certain guarantees reflect the
guidance in FASB Interpretation No. 45, “Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others.” Based on this guidance, Key has recognized
aliability, which is included in “accrued expense and other liabilities”
on the balance sheet, for the fair value of its obligation under certain
guarantees issued or modified on or after January 1, 2003.
If Key receives a fee for a guarantee requiring liability recognition, the
amount of the fee represents the initial fair value of the “stand ready”
obligation. If there is no fee, the fair value of the “stand ready”
obligation is determined using expected present value measurement
techniques, unless observable transactions for comparable guarantees are
available. The subsequent accounting for these “stand ready” obligations
depends on the nature of the underlying guarantees. Key accounts for its
release from risk under a particular guarantee when the guarantee
expires or is settled, or by a systematic and rational amortization
method, depending on the risk profile of the guarantee.
Additional information regarding guarantees is included in Note 18
(“Commitments, Contingent Liabilities and Guarantees”) under the
heading “Guarantees” on page 98.
REVENUE RECOGNITION
Key recognizes revenues as they are earned based on contractual terms,
as transactions occur, or as services are provided and collectibility is
reasonably assured. Key’s principal source of revenue is interest income.
This revenue is recognized on an accrual basis primarily according to
nondiscretionary formulas in written contracts such as loan agreements
or securities contracts.
STOCK-BASED COMPENSATION
Prior to January 1, 2006, Key used the fair value method of accounting as
outlined in SFAS No. 123, “Accounting for Stock-Based Compensation.”
Key voluntarily adopted this method of accounting effective January 1,
2003, when it transitioned from the accounting under Accounting
Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued
to Employees.” Key opted to apply the new rules of SFAS No. 123
prospectively to all awards as permitted under SFAS No. 148, “Accounting
for Stock-Based Compensation Transition and Disclosure.”
Effective January 1, 2006, Key adopted SFAS No. 123R, “Share-Based
Payment,” using the modified prospective method of transition. SFAS No.
123R, which replaces SFAS No. 123, requires stock-based compensation
to be measured using the fair value method of accounting, with the
measured cost to be recognized over the period during which the
recipient is required to provide service in exchange for the award. As of
the effective date, Key did not have any nonvested awards outstanding
that had not previously been accounted for using the fair value method.
Consequently,the adoption of SFAS No. 123R did not have a significant
impact on Key’s financial condition or results of operations. However,
the adoption of the new accounting standard did prompt three other
changes in Key’s accounting, as discussed below.
First, SFAS No. 123R changes the manner of accounting for forfeited
stock-based awards. Under the new standard, companies are no longer
permitted to account for forfeitures as they occur. Instead, companies that
have been using this alternative method of accounting for forfeitures must
now estimate expected forfeitures at the date the awards are granted and
record compensation expense only for those that are expected to vest.
As of the effective date, companies must estimate expected forfeitures and
reduce their related compensation obligation for expense previously
recognized in the financial statements. The after-tax amount of this
reduction must be presented on the income statement as a cumulative
effect of a change in accounting principle. Key’s cumulative after-tax
adjustment increased first quarter 2006 earnings by $5 million, or $.01
per diluted common share.
Previous Page
Search
Next Page
Contents