KeyBank 2004 Annual Report Download - page 41

39
MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
early terminations and a lower volume of new interest rate swaps
related to conventional asset/liability management. During the fourth
quarter of 2004, we terminated receive fixed interest rate swaps with a
notional amount of $3.2 billion in advance of their maturity dates to
achieve our desired interest rate sensitivity position. These terminations
were completed because the growth of our fixed-rate loans and leases,
which was bolstered by the acquisition of AEBF, exceeded the growth
in fixed-rate liabilities.
The decision to use interest rate swaps rather than securities, debt or other
on-balance sheet alternatives depends on many factors, including the mix
and cost of funding sources, liquidity and capital requirements, and
interest rate implications. Figure 28 shows the maturity structure for all
swap positions held for asset/liability management purposes. These
positions are used to convert the contractual interest rate index of
agreed-upon amounts of assets and liabilities (i.e., notional amounts) to
another interest rate index. For example, fixed-rate debt is converted to
floating rate through a “receive fixed, pay variable” interest rate swap.
During 2004, Key issued $2.6 billion of fixed-rate debt and debt issued
in foreign denominated currencies. Conventional debt receive fixed
swaps and foreign currency swaps were executed as hedges that are highly
correlated to the underlying exposures. For more information about how
Key uses interest rate swaps to manage its balance sheet, see Note 19
(“Derivatives and Hedging Activities”), which begins on page 84.
Key’s securities and term debt portfolios are also used to manage
interest rate risk. Details regarding these portfolios can be found in the
discussion of securities, beginning on page 30, in Note 6 (“Securities”),
which begins on page 66, and in Note 12 (“Long-Term Debt”) on
page 73. Collateralized mortgage obligations, the majority of which have
relatively short average lives, have been used in conjunction with swaps
to manage our interest rate risk position.
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December 31, 2004 December 31, 2003
Weighted-Average Rate
Notional Fair Maturity Notional Fair
dollars in millions Amount Value (Years) Receive Pay Amount Value
Receive fixed/pay variable —
conventional A/LM
a
$3,400 $ 10 1.0 3.0% 2.3% $12,275 $ 87
Receive fixed/pay variable —
conventional debt 5,814 247 7.1 5.3 2.3 5,443 321
Pay fixed/receive variable —
conventional debt 1,173 (33) 4.3 2.6 4.8 1,496 (90)
Pay fixed/receive variable —
forward starting ————— 14 —
Foreign currency —
conventional debt 2,559 478 2.5 2.8 2.6 1,538 304
Basis swaps
b
9,500 (6) 1.1 2.1 2.0 10,095 (2)
Basis — forward starting
b
————— 2,500 —
Total portfolio swaps $22,446 $696 3.0 3.2% 2.4% $33,361 $620
a
Portfolio swaps designated as A/LM are used to manage interest rate risk tied to both assets and liabilities.
b
These portfolio swaps are not designated as hedging instruments under SFAS No. 133.
FIGURE 28. PORTFOLIO SWAPS BY INTEREST RATE RISK MANAGEMENT STRATEGY
Trading portfolio risk management
Key’s trading portfolio is described in Note 19.
Management uses a value at risk (“VAR”) simulation model to measure
the potential adverse effect of changes in interest rates, foreign exchange
rates, equity prices and credit spreads on the fair value of Key’s trading
portfolio. Using historical information, the model estimates the maximum
potential one-day loss with 95% probability by comparing the relative
change in rates to the current day’s rates and prices. During 2004,
Key’s aggregate daily average, minimum and maximum VAR amounts
were $1.6 million, $.8 million and $4.1 million, respectively. During
2003, Key’s aggregate daily average, minimum and maximum VAR
amounts were $1.2 million, $.7 million and $2.1 million, respectively.
VAR modeling is supplemented with other controls that Key uses to
mitigate the market risk exposure of the trading portfolio. For example,
we adhere to trading limits established by Key’s Financial Markets
Committee. At December 31, 2004, the aggregate one-day trading
limit set by the committee was $4.4 million. In addition, we have
established loss limits and we rely on certain sensitivity measures and
stress testing.
Credit risk management
Credit risk represents the risk of loss arising from an obligor’s inability
or failure to meet contractual payment or performance terms. It is
inherent in the financial services industry and results from extending
credit to clients, purchasing securities and entering into financial
derivative contracts.
Credit policy, approval and evaluation. Key manages its credit risk
exposure through a multi-faceted program. Independent committees
approve both retail and commercial credit policies. Once approved, these
policies are communicated throughout Key to ensure consistency in our
approach to granting credit.