KeyBank 2007 Annual Report Download - page 41

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
Figure 21 shows the remaining final maturities of certain commercial and
real estate loans, and the sensitivity of those loans to changes in interest
rates. At December 31, 2007, approximately 37% of these outstanding
loans were scheduled to mature within one year. Loans with remaining
final maturities greater than one year include $22.3 billion with floating
or adjustable rates and $5.6 billion with predetermined rates.
December 31, 2007 Within 1-5 Over
in millions 1 Year Years 5 Years Total
Commercial, financial and agricultural $10,277 $12,180 $2,340 $24,797
Real estate — construction 3,476 4,282 344 8,102
Real estate — residential and commercial mortgage 2,419 4,831 3,974 11,224
$16,172 $21,293 $6,658 $44,123
Loans with floating or adjustable interest rates
a
$17,868 $4,473
Loans with predetermined interest rates
b
3,425 2,185
$21,293 $6,658
a
Floating and adjustable rates vary in relation to other interest rates (such as the base lending rate) or a variable index that may change during the term of the loan.
b
Predetermined interest rates either are fixed or may change during the term of the loan according to a specific formula or schedule.
FIGURE 21. REMAINING FINAL MATURITIES AND SENSITIVITY OF CERTAIN LOANS
TO CHANGES IN INTEREST RATES
Securities
At December 31, 2007, the securities portfolio totaled just over $7.9
billion; $28 million of that amount was held-to-maturity securities
and the remainder was securities available for sale. In comparison, the
total portfolio at December 31, 2006, was $7.9 billion, including $7.8
billion of securities available for sale and $41 million of held-to-
maturity securities.
Securities available for sale. The majority of Key’s securities available-
for-sale portfolio consists of collateralized mortgage obligations
(“CMOs”). A CMO is a debt security that is secured by a pool of
mortgages or mortgage-backed securities. Key’s CMOs generate interest
income and serve as collateral to support certain pledging agreements.
At December 31, 2007, Key had $7.6 billion invested in CMOs and other
mortgage-backed securities in the available-for-sale portfolio, compared
to $7.3 billion at December 31, 2006.
Management periodically evaluates Key’s securities available-for-sale
portfolio in light of established asset/liability management objectives,
changing market conditions that could affect the profitability of the
portfolio, and the level of interest rate risk to which Key is exposed.
These evaluations may cause management to take steps to improve Key’s
overall balance sheet positioning.
In March 2007, management completed a comprehensive evaluation of
the securities available-for-sale portfolio and determined that a
repositioning of the portfolio was appropriate to enhance future financial
performance, particularly in the event of a decline in interest rates. As
a result, Key sold $2.4 billion of shorter-maturity CMOs and reinvested
the proceeds in mortgage-backed securities with higher yields and
longer expected average maturities. The weighted-average yield of
Key’s available-for-sale portfolio increased from 4.78% at December 31,
2006, to 5.22% at December 31, 2007, and the weighted-average
maturity of the portfolio increased from 2.6 years at December 31, 2006,
to 3.4 years at December 31, 2007. The repositioning also reduced Key’s
exposure to prepayment risk if interest rates decline by replacing the
CMOs sold with CMOs whose underlying mortgage loans have shorter
maturities and lower coupon rates. Key maintains a modest liability-
sensitive exposure to near-term changes in interest rates. Neither funding
nor capital levels were affected materially by this portfolio repositioning.
As a result of the sale of CMOs, Key recorded a net realized loss of $49
million ($31 million after tax, or $.08 per diluted common share)
during the first quarter of 2007. This net loss was previously recorded
in “net unrealized losses on securities available for sale” in the
accumulated other comprehensive income (loss) component of
shareholders’ equity.
In addition to changing market conditions, the size and composition of
Key’s securities available-for-sale portfolio could vary with Key’s needs for
liquidity and the extent to which Key is required (or elects) to hold these
assets as collateral to secure public funds and trust deposits. Although Key
generally uses debt securities for this purpose, other assets, such as
securities purchased under resale agreements, are occasionally used when
they provide more favorable yields or risk profiles.
As shown in Figure 22, all of Key’s mortgage-backed securities are issued
by government sponsored enterprises or the Government National
Mortgage Association and are traded in highly liquid secondary markets.
For more than 99% of these securities, management employs an outside
bond pricing service to determine the fair value at which they should be
recorded on the balance sheet. In performing the valuations, the pricing
service relies on models that consider security-specific details as well as
relevant industry and economic factors. The most significant of these inputs
are quoted market prices, interest rate spreads on relevant benchmark
securities and certain prepayment assumptions. Management uses a
purchased pricing model, along with inputs similar to those described
above to value a small portion (less than $5 million) of Key’s mortgage-
backed securities. Management must make additional assumptions,
beyond those relied upon by the pricing service for these aged securities.