KeyBank 2005 Annual Report Download - page 60

59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
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nonaccrual, the interest accrued but not collected generally is charged
against the allowance for loan losses, and payments subsequently
received generally are applied to principal. However, if management
believes that all principal and interest on a nonaccrual loan ultimately
are collectible, interest income may be recognized as received.
Nonaccrual loans, other than smaller-balance homogeneous loans (i.e.,
home equity loans, loans to finance automobiles, etc.), are designated
“impaired.” Impaired loans and other nonaccrual loans are returned to
accrual status if management determines that both principal and interest
are collectible. This generally requires a sustained period of timely
principal and interest payments.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses represents management’s estimate of
probable credit losses inherent in the loan portfolio at the balance
sheet date. Key establishes the amount of the allowance for loan losses
by analyzing the quality of the loan portfolio at least quarterly, and more
often if deemed necessary.
Commercial loans are generally charged off in full or charged down to
the fair value of the underlying collateral when the borrower’s payment
is 180 days past due. Key’s charge-off policy for consumer loans is
similar, but takes effect when the payments on such loans are 120 days
past due. Home equity and residential mortgage loans are generally
charged down to the fair value of the underlying collateral when
payment is 180 days past due.
Allowance for impaired loans. An impaired loan is allocated an allowance
by applying an assumed rate of loss to the outstanding balance based
on the credit rating assigned to the loan. If the outstanding balance
is greater than $2.5 million, and the resulting allocation is deemed
insufficient to cover the extent of the impairment, a specific allowance is
assigned to the loan. Management estimates the extent of impairment by
comparing the carrying amount of the loan with the estimated present
value of its future cash flows, including, if applicable, the fair value of any
collateral. A specific allowance may also be assigned even when sources
of repayment appear sufficient, if management remains uncertain about
whether the loan will be repaid in full.
Allowance for nonimpaired loans. Management establishes an allowance
for nonimpaired loans by applying historical loss rates to existing
loans with similar risk characteristics. The loss rates used to establish the
allowance may be adjusted to reflect management’s current assessment
of many factors, including:
• changes in national and local economic and business conditions;
• changes in experience, ability and depth of Key’s lending management
and staff, in lending policies, or in the mix and volume of the loan
portfolio;
• trends in past due, nonaccrual and other loans; and
• external forces, such as competition, legal developments and regulatory
guidelines.
ALLOWANCE FOR CREDIT LOSSES ON
LENDING-RELATED COMMITMENTS
During the first quarter of 2004, management reclassified $70 million
of Key’s allowance for loan losses to a separate allowance for credit losses
inherent in lending-related commitments, such as letters of credit and
unfunded loan commitments. The separate allowance is included in
“accrued expense and other liabilities” on the balance sheet and totaled
$59 million at December 31, 2005. Management establishes the amount
of this allowance by considering both historical trends and current
market conditions quarterly, or more often if deemed necessary.
LOAN SECURITIZATIONS
Key sells education loans in securitizations. A securitization involves the
sale of a pool of loan receivables to investors through either a public or
private issuance (generally by a qualifying SPE) of asset-backed securities.
Securitized loans are removed from the balance sheet, and a net gain or
loss is recorded when the combined net sales proceeds and, if applicable,
residual interests differ from the loans’ allocated carrying amount. Net
gains and losses resulting from securitizations are recorded as one
component of “net gains from loan securitizations and sales” on the
income statement. A servicing asset also may be recorded if Key either
purchases or retains the right to service securitized loans and receives
related fees that exceed the going market rate. Income earned under
servicing or administration arrangements is recorded in “other income.”
In some cases, Key retains one or more residual interests in securitized
loans that may take the form of an interest-only strip, residual asset,
servicing asset or security. Servicing assets are accounted for under
SFAS No. 140, as further described below under the heading “Servicing
Assets.” All other retained interests are accounted for as debt securities
and classified as either securities available for sale or trading account
assets. Some of the assumptions used in determining the fair values of
Key’s retained interests are disclosed in Note 8 (“Loan Securitizations,
Servicing and Variable Interest Entities”), which begins on page 70.
In accordance with Revised Interpretation No. 46, qualifying SPEs,
including securitization trusts, established by Key under SFAS No. 140, are
exempt from consolidation. Information on Revised Interpretation No. 46
appears in this note under the heading “Basis of Presentation” on page 57.
Key conducts a quarterly review to determine whether all retained
interests are valued appropriately in the financial statements. Management
reviews the historical performance of each retained interest and the
assumptions used to project future cash flows, and revises assumptions
and recalculates the present values of cash flows as appropriate.
The present value of these cash flows is referred to as the “retained interest
fair value.” Generally, if the carrying amount of a retained interest classified
as securities available for sale exceeds its fair value, impairment is indicated
and recognized in earnings. Conversely, if the fair value of the retained
interest exceeds its carrying amount, the write-up to fair value is recorded in
equity as a component of “accumulated other comprehensive income (loss),”
and the yield on the retained interest is adjusted prospectively. For retained
interests classified as trading account assets, any increase or decrease in the
asset’s fair value is recognized in “other income” on the income statement.