KeyBank 2007 Annual Report Download - page 32

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
As a result of the rising interest rate environment in 2006, noninterest-
bearing funds were of significantly greater value as they added approximately
25 basis points to the net interest margin. Key’s net interest margin also
benefited from a slight asset-sensitive interest rate risk position. The increase
in the net interest margin was offset in part by the sale of certain assets that
had higher yields, but did not fit Key’s relationship banking strategy.
Additionally, during 2006, Key experienced tighter interest rate spreads as
a result of competitive pressure on loan and deposit pricing, and a change
in deposit mix, as consumers shifted funds from money market deposit
accounts to time deposits.
Average earning assets for 2006 totaled $79.5 billion, which was $3.5
billion, or 5%, higher than the 2005 level, due largely to the growth in
commercial loans.
Over the past two years, the growth and composition of Key’s earning
assets have been affected by the following loan sales, most of which came
from the held-for-sale portfolio:
• Key sold commercial mortgage loans of $3.8 billion ($238 million
through a securitization) during 2007 and of $2.6 billion during
2006. Since some of these loans have been sold with limited recourse
(i.e., there is a risk that Key will be held accountable for certain events
or representations made in the sales agreements), Key established and
has maintained a loss reserve in an amount estimated by management
to be appropriate. More information about the related recourse
agreement is provided in Note 18 (“Commitments, Contingent
Liabilities and Guarantees”) under the heading “Recourse agreement
with Federal National Mortgage Association” on page 98.
• Key sold education loans of $247 million during 2007 and $1.4
billion ($1.1 billion through a securitization) during 2006. Key uses
the securitization market for education loans to diversify funding
sources. Due to unfavorable market conditions, Key did not proceed
with an education loan securitization during 2007.
• Key sold other loans totaling $1.2 billion during 2007 and $3.2
billion during all of 2006. During the fourth quarter of 2006, Key sold
the $2.5 billion subprime mortgage loan portfolio held by the
Champion Mortgage finance business because the Champion business
no longer fit strategically with Key’s long-term business goals.
Figure 9 shows how the changes in yields or rates and average balances
from the prior year affected net interest income. The section entitled
“Financial Condition,” which begins on page 35, contains more
discussion about changes in earning assets and funding sources.
FIGURE 9. COMPONENTS OF NET INTEREST INCOME CHANGES
2007 vs 2006 2006 vs 2005
Average Yield/ Net Average Yield/ Net
in millions Volume Rate Change Volume Rate Change
INTEREST INCOME
Loans $170 $ 17 $187 $191 $660 $851
Loans held for sale 22 (10) 12 39 32 71
Securities available for sale 23 57 80 91120
Held-to-maturity securities (1) — (1) (1) (1) (2)
Trading account assets 268 (2) 5 3
Short-term investments 224 (4) 12 8
Other investments 9 (39) (30) (1) 29 28
Total interest income (TE) 227 33 260 231 748 979
INTEREST EXPENSE
NOW and money market deposit accounts (28) 80 52 41 309 350
Savings deposits — (1) (1) (1) — (1)
Certificates of deposit ($100,000 or more) 40 20 60 26 46 72
Other time deposits 76269 27 113 140
Deposits in foreign office 97 (8) 89 (12) 51 39
Total interest-bearing deposits 116 153 269 81 519 600
Federal funds purchased and securities sold
under repurchase agreements 102 (1) 101 (11) 47 36
Bank notes and other short-term borrowings 6410 (17) 29 12
Long-term debt (83) 13 (70) (5) 195 190
Total interest expense 141 169 310 48 790 838
Net interest income (TE) $ 86 $(136) $ (50) $183 $ (42) $141
The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each.
TE = Taxable Equivalent
Noninterest income
Noninterest income for 2007 was $2.2 billion, representing a $102
million, or 5%, increase from 2006. In 2006, noninterest income rose
by $60 million, or 3%, from 2005.
The sale of the McDonald Investments branch network accounted for
$25 million of the 2007 increase in noninterest income, as the $171
million gain from the sale was substantially offset by a reduction in the
level of trust and investment services income generated by the McDonald