KeyBank 2007 Annual Report Download - page 51

49
MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
assesses whether Key will need to rely on wholesale borrowings in the
future and develops strategies to address those needs.
Key uses several tools to actively manage and maintain liquidity on an
ongoing basis:
• Key maintains a portfolio of securities that generates monthly
principal and interest cash flows and payments at maturity.
• Key can usually access the whole loan sale and securitization markets
for a variety of loan types.
• KeyBank’s 955 branches 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 41.
• Several KeyCorp subsidiaries have access to funding through credit
facilities established with other financial institutions.
• Key has access to the term debt markets through the programs
described in the section entitled “Additional sources of liquidity” on
page 50.
Key generates cash flows from operations and from investing and
financing activities. Over the past three years, prepayments and maturities
of securities available for sale have been the primary sources of cash from
investing activities. Securities sold in connection with the repositioning
of the securities portfolio also provided significant cash inflow during the
first quarter of 2007. Investing activities such as lending and purchases
of new securities have required the greatest use of cash.
Key relies on financing activities, such as increasing short-term or long-term
borrowings, to provide the cash flow needed to support operating and
investing activities if that need is not satisfied by deposit growth.
Conversely, excess cash generated by operating, investing and deposit-
gathering activities may be used to repay outstanding debt. For example,
in 2005, Key relied on borrowings when loan growth exceeded deposit
growth. In 2006, cash generated by the sale of discontinued operations was
used to pay down short-term borrowings. During 2007, Key used short-
term borrowings to pay down long-term debt, while the net increase in
deposits funded the growth in portfolio loans and loans held for sale.
Key’s liquidity could be adversely affected by both direct and indirect
circumstances. An example of a direct (but hypothetical) event would be
a downgrade 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.
Management performs stress tests to determine the effect that a potential
downgrade in Key’s debt ratings or other market disruptions could
have on liquidity over various time periods. These debt ratings, which
are presented in Figure 32 on page 50, 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 could 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’s access to funding markets
and consider the potential adverse effect of core client activity on cash
flows. To compensate for the effect of these assumed liquidity pressures,
management considers alternative sources of liquidity 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 level or maturity of wholesale borrowings, purchasing
deposits from other banks, and developing relationships with fixed
income investors in a variety of markets. Management also measures Key’s
capacity to borrow using various debt instruments and funding markets.
Certain credit markets that Key participates in and relies upon as
sources of funding have been significantly disrupted and highly volatile
since July 2007. As a means of maintaining adequate liquidity, Key, like
many other financial institutions, has relied more heavily on the liquidity
and stability present in the short-term and secured credit markets since
access to unsecured term debt has been restricted. Short-term funding has
been available and cost effective. However, if further market disruption
were to also reduce the cost effectiveness and availability of these
funds for a prolonged period of time, management may need to secure
other funding alternatives.
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, 2007.
The Consolidated Statements of Cash Flows on page 64 summarize Key’s
sources and uses of cash by type of activity for each of the past three years.
Figure 29 on page 45 summarizes Key’s significant contractual cash
obligations at December 31, 2007, 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.