KeyBank 2007 Annual Report Download - page 50

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MANAGEMENT’S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION & RESULTS OF OPERATIONS KEYCORP AND SUBSIDIARIES
Management of interest rate exposure. Management uses the results of
its various simulation analyses to formulate strategies to achieve the
desired risk profile within the parameters of Key’s capital and liquidity
guidelines. Specifically, management actively manages interest rate risk
positions by purchasing securities, issuing term debt with floating or fixed
interest rates, and using derivatives — predominantly in the form of
interest rate swaps, which modify the interest rate characteristics of
certain assets and liabilities.
Figure 31 shows all swap positions held by Key for asset/liability
management (“A/LM”) 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 a floating rate through a “receive
fixed, pay variable” interest rate swap. 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 100.
December 31, 2007 December 31, 2006
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
$ 7,138 $ 87 1.1 5.2% 5.0% $ 8,138 $ (2)
Receive fixed/pay variable —
conventional debt 4,813 161 16.9 5.5 5.2 5,164 (8)
Receive fixed/pay variable —
forward starting 4,600 116 2.5 4.9 4.9 250 —
Pay fixed/receive variable —
conventional debt 1,065 (18) 3.9 5.2 4.6 839 (11)
Foreign currency —
conventional debt 2,660 402 3.0 4.9 5.1 3,335 149
Basis swaps
b
————— 300 —
Total portfolio swaps $20,276 $748 5.6 5.2% 5.0% $18,026 $128
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, “Accounting for Derivative Instruments and Hedging Activities.”
FIGURE 31. 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 two years
of historical information, the model estimates the maximum potential
one-day loss with a 95% confidence level. Statistically, this means that
losses will exceed VAR, on average, five out of 100 trading days, or three
to four times each quarter.
Key manages exposure to market risk in accordance with VAR limits for
trading activity that have been approved by the Risk Capital Committee.
At December 31, 2007, the aggregate one-day trading limit set by the
committee was $4.4 million. Key is operating within these constraints.
During 2007, Key’s aggregate daily average, minimum and maximum
VAR amounts were $1.2 million, $.7 million and $2.1 million,
respectively. During 2006, Key’s aggregate daily average, minimum
and maximum VAR amounts were $1.1 million, $.7 million and $2.1
million, respectively.
In addition to comparing VAR exposure against limits on a daily basis,
management monitors loss limits, uses sensitivity measures and conducts
stress tests. Risk Management reports Key’s market risk exposure to
Key’s Risk Capital Committee and the Risk Management Committee of
the Board of Directors.
Liquidity risk management
Key defines “liquidity” as the ongoing ability to accommodate liability
maturities and deposit withdrawals, meet contractual obligations, and
fund asset growth and new business transactions at a reasonable cost,
in a timely manner and without adverse consequences. Liquidity
management involves maintaining sufficient and diverse sources of
funding to accommodate planned as well as unanticipated changes in
assets and liabilities under both normal and adverse conditions. In
addition, Key occasionally guarantees a subsidiary’s obligations in
transactions with third parties. Management closely monitors the
extension of such guarantees to ensure that Key retains ample liquidity
to satisfy these obligations.
Key manages liquidity for all of its affiliates on an integrated basis. This
approach considers the unique funding sources available to each entity,
as well as each entity’s capacity to manage through adverse conditions.
It also recognizes that adverse market conditions or other events that
could negatively affect the availability or cost of liquidity will affect the
access of all affiliates to money market funding.
Under ordinary circumstances, management monitors Key’s funding
sources and measures its capacity to obtain funds in a variety of
situations in an effort to maintain an appropriate mix of available and
affordable cash. Management has established guidelines or target ranges
for various types of wholesale borrowings, such as money market
funding and term debt, at various maturities. In addition, management