KeyBank 2006 Annual Report Download - page 70

servicing the loans. The estimate is based on a number of assumptions,
including the cost of servicing, discount rate, prepayment rate and
default rate. The amortization of servicing assets is determined in
proportion to, and over the period of, the estimated net servicing
income and is recorded in “other income” on the income statement.
Servicing assets are evaluated quarterly for possible impairment by
grouping the assets based on the types of loans serviced and their
associated interest rates and estimating the fair value of each group. If
the evaluation indicates that the carrying amount of the servicing assets
exceeds their fair value, the carrying amount would be reduced through
acharge to income in the amount of such excess.
PREMISES AND EQUIPMENT
Premises and equipment, including leasehold improvements, are stated
at cost less accumulated depreciation and amortization. Management
determines depreciation of premises and equipment using the straight-
line method over the estimated useful lives of the particular assets.
Leasehold improvements are amortized using the straight-line method
over the terms of the leases. Accumulated depreciation and amortization
on premises and equipment totaled $1.2 billion at December 31, 2006
and 2005.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the amount by which the cost of net assets acquired
in a business combination exceeds their fair value. Other intangible assets
primarily are customer relationships and the net present value of future
economic benefits to be derived from the purchase of core deposits. Other
intangible assets are amortized on either an accelerated or straight-line
basis over periods ranging from three to thirty years. Goodwill and other
intangible assets deemed to have indefinite lives are not amortized.
Under SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill
and certain intangible assets are subject to impairment testing, which
must be conducted at least annually. Key’s reporting units for purposes
of this testing are its major business groups: Community Banking and
National Banking.
The first step in impairment testing is to determine the fair value of each
reporting unit. If the carrying amount of a reporting unit exceeds its
fair value, goodwill impairment may be indicated. In such a case, Key
would estimate a purchase price for the reporting unit (representing the
unit’s fair value) and then compare that hypothetical purchase price to
the fair value of the unit’sassets (excluding goodwill) and liabilities. Any
excess of the estimated purchase price over the fair value of the reporting
unit’s assets and liabilities represents the implied fair value of goodwill.
An impairment loss would be recognized as a charge to earnings to the
extent the carrying amount of the reporting unit’s goodwill exceeds the
implied fair value of goodwill.
Key performs the goodwill impairment testing required by SFAS No. 142
in the fourth quarter of each year. Key’s annual goodwill impairment
testing was performed as of October 1, 2006, and management
determined that no impairment existed at that date. On December 1, Key
announced that it sold the nonprime mortgage loan portfolio held by the
Champion Mortgage finance business on November 29, and also
announced that it had entered into a separate agreement to sell
Champion’s loan origination platform. As a result, $170 million of
goodwill related to the Champion Mortgage finance business was
written off during the fourth quarter of 2006. During the fourth quarter
of 2004, $55 million of goodwill related to Key’s nonprime indirect
automobile lending business was written off.
INTERNALLY DEVELOPED SOFTWARE
Key relies on both company personnel and independent contractors to plan,
develop, install, customize and enhance computer systems applications that
support corporate and administrative operations. Software development
costs, such as those related to program coding, testing, configuration and
installation, are capitalized and included in “accrued income and other
assets” on the balance sheet. The resulting asset ($115 million at December
31, 2006, and $131 million at December 31, 2005) is amortized using the
straight-line method over its expected useful life (not to exceed five years).
Costs incurred during the planning and post-development phases of an
internal software project are expensed as incurred.
Software that is no longer used is written off to earnings immediately.
When management decides to replace software, amortization of such
software is accelerated to the expected replacement date.
DERIVATIVES USED FOR ASSET AND
LIABILITY MANAGEMENT PURPOSES
Key uses derivatives known as interest rate swaps and caps to hedge
interest rate risk. These instruments modify the repricing characteristics
of specified on-balance sheet assets and liabilities.
Key’s accounting policies related to derivatives reflect the accounting
guidance in SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities,” as revised and further interpreted by SFAS No. 149,
“Amendment of Statement 133 on Derivative Instruments and Hedging
Activities,” and other related accounting guidance. In accordance with
this accounting guidance, all derivatives are recognized as either assets
or liabilities on the balance sheet at fair value.
Accounting for changes in fair value (i.e., gains or losses) of derivatives
differs depending on whether the derivatives have been designated and
qualify as part of a hedging relationship, and further, on the type of
hedging relationship. For derivatives that are not designated as hedging
instruments, the gain or loss is recognized immediately in earnings. A
derivative that is designated and qualifies as a hedging instrument must
be designated a fair value hedge, a cash flow hedge or a hedge of a net
investment in a foreign operation. Key does not have any derivatives that
hedge net investments in foreign operations.
“Effectiveness” measures the extent to which changes in the fair value
of a derivative instrument offset changes in the fair value of the hedged
item. If the relationship between the change in the fair value of the
derivative instrument and the fair value of the hedged item falls within
arange considered to be the industry norm, the hedge is considered
“highly effective” and qualifies for hedge accounting. A hedge is
“ineffective” if the offsetting difference between the fair values falls
outside the acceptable range.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
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