KeyBank 2005 Annual Report Download - page 37

36
MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
OFF-BALANCE SHEET ARRANGEMENTS AND
AGGREGATE CONTRACTUAL OBLIGATIONS
Off-balance sheet arrangements
Key is party to various types of off-balance sheet arrangements, which
could expose Key to contingent liabilities or risks of loss that are not
reflected on the balance sheet.
Variable interest entities. A variable interest entity (“VIE”) is a
partnership, limited liability company, trust or other legal entity that does
not have sufficient equity to conduct its activities without additional
subordinated financial support from another party, or for which the
voting rights of some investors are not proportional to their economic
interest in the entity, or whose investors lack one of three characteristics
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December 31,
dollars in millions 2005 2004
TIER 1 CAPITAL
Common shareholders’ equity
a
$ 7,678 $ 7,143
Qualifying capital securities 1,542 1,292
Less: Goodwill 1,355 1,359
Other assets
b
178 132
Total Tier 1 capital 7,687 6,944
TIER 2 CAPITAL
Allowance for losses on loans and
lending-related commitments 1,025 1,205
Net unrealized gains on equity
securities available for sale 43
Qualifying long-term debt 2,899 2,880
Total Tier 2 capital 3,928 4,088
Total risk-based capital $ 11,615 $11,032
RISK-WEIGHTED ASSETS
Risk-weighted assets
on balance sheet $ 76,724 $73,911
Risk-weighted off-balance
sheet exposure 25,619 23,519
Less: Goodwill 1,355 1,359
Other assets
b
785 649
Plus: Market risk-equivalent assets 1,064 733
Risk-weighted assets $101,267 $96,155
AVERAGE QUARTERLY
TOTAL ASSETS $ 92,206 $89,248
CAPITAL RATIOS
Tier 1 risk-based capital ratio 7.59% 7.22%
Total risk-based capital ratio 11.47 11.47
Leverage ratio
c
8.53 7.96
a
Common shareholders’ equity does not include net unrealized gains or losses on securities
available for sale (except for net unrealized losses on marketable equity securities) or net
gains or losses on cash flow hedges.
b
Other assets deducted from Tier 1 capital and risk-weighted assets consist of intangible assets
(excluding goodwill) recorded after February 19, 1992, deductible portions of purchased
mortgage servicing rights and deductible portions of nonfinancial equity investments.
c
This ratio is Tier 1 capital divided by average quarterly total assets less goodwill, the
nonqualifying intangible assets described in footnote (b) and deductible portions of
nonfinancial equity investments.
FIGURE 24. CAPITAL COMPONENTS
AND RISK-WEIGHTED ASSETS
associated with owning a controlling financial interest, as described in
Note 8 (“Loan Securitizations, Servicing and Variable Interest Entities”)
under the heading “Variable Interest Entities” on page 71. Revised
Interpretation No. 46, “Consolidation of Variable Interest Entities,”
requires VIEs to be consolidated by the party that is exposed to a
majority of the VIE’s expected losses and/or residual returns (i.e., the
primary beneficiary). This interpretation is summarized in Note 1
(“Summary of Significant Accounting Policies”) under the heading
“Basis of Presentation” on page 57 and Note 8.
Key is involved with certain VIEs in which it holds a significant
interest, but for which it is not the primary beneficiary. In accordance
with Revised Interpretation No. 46, these entities are not consolidated.
Key defines a “significant interest” in a VIE as a subordinated interest
that exposes Key to a significant portion, but not the majority, of the
VIE’s expected losses or residual returns. Key’s involvement with these
VIEs is described in Note 8 under the heading “Unconsolidated VIEs”
on page 72.
Loan securitizations. Key originates, securitizes and sells education
loans. A securitization involves the sale of a pool of loan receivables
to investors through either a public or private issuance (generally by a
qualifying special purpose entity (“SPE”)) of asset-backed securities.
Generally, the assets are transferred to a trust that sells interests in
the form of certificates of ownership. These transactions provide an
alternative source of funding for Key. In accordance with Revised
Interpretation No. 46, qualifying SPEs, including securitization trusts
established by Key under SFAS No. 140, are exempt from consolidation.
In some cases, Key retains a residual interest in self-originated, securitized
loans that may take the form of an interest-only strip, residual asset,
servicing asset or security. Key reports servicing assets in “accrued
income and other assets” on the balance sheet. Key accounts for all other
retained interests as debt securities and classifies them as either available-
for-sale securities or trading account assets. When Key retains an
interest in loans it securitizes, it bears risk that the loans will be prepaid
(which would reduce expected interest income) or not paid at all. In
the event that cash flows generated by the securitized loans become
inadequate to service the obligations of the trusts, the investors in the
asset-backed securities would have no further recourse against Key.
Additional information pertaining to Key’s retained interests in loan
securitizations is summarized in Note 1 under the heading “Loan
Securitizations” on page 59, Note 6 (“Securities”), which begins on
page 68, and Note 8 under the heading “Retained Interests in Loan
Securitizations” on page 70.
Commitments to extend credit or funding. Loan commitments provide
for financing on predetermined terms as long as the client continues
to meet specified criteria. These commitments generally carry variable
rates of interest and have fixed expiration dates or other termination
clauses. In many cases, a client must pay a fee to obtain a loan
commitment from Key. Since a commitment may expire without
resulting in a loan, the total amount of outstanding commitments may
significantly exceed Key’s eventual cash outlay. Further information about
Key’s loan commitments at December 31, 2005, is presented in Note 18
(“Commitments, Contingent Liabilities and Guarantees”) under the
heading “Commitments to Extend Credit or Funding” on page 83.