KeyBank 2007 Annual Report Download - page 69

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
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. Management 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 are 120 days past due.
Home equity and residential mortgage loans generally are charged
down to the fair value of the underlying collateral when payment is 180
days past due.
Management estimates the appropriate level of Key’s allowance for
loan losses 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.
If an impaired loan has an outstanding balance greater than $2.5 million,
management conducts further analysis to determine the probable loss
content, and assigns a specific allowance to the loan if deemed appropriate
considering the results of the analysis and other relevant factors.
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 also may be assigned — even when sources of
repayment appear sufficient — if management remains uncertain about
whether the loan will be repaid in full.
LIABILITY FOR CREDIT LOSSES ON
LENDING-RELATED COMMITMENTS
The liability for credit losses inherent in lending-related commitments, such
as letters of credit and unfunded loan commitments, is included in
“accrued expense and other liabilities” on the balance sheet and totaled
$80 million at December 31, 2007, and $53 million at December 31, 2006.
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 typically sells education loans in securitizations when market
conditions are favorable. 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. A securitized
loan is 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 loan’s allocated carrying amount. Net
gains and losses resulting from securitizations are recorded as one
component of “net (losses) gains from loan securitizations and sales” on
the income statement. A servicing asset also may be recorded if Key
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 in the form of an interest-only strip, residual asset, servicing
asset or security. Further discussion of Key’s accounting for its servicing
assets is included below under the heading “Servicing Assets.” All
other retained interests are accounted for as debt securities and classified
as securities available for sale. 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 81.
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 is included in this note under the heading “Basis of Presentation”
on page 65.
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 as well as 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.” 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.
SERVICING ASSETS
Effective January 1, 2007, Key adopted SFAS No. 156, “Accounting for
Servicing of Financial Assets – an Amendment of FASB Statement No.
140,” which requires that newly purchased or retained servicing assets
and liabilities be initially measured at fair value, if practicable. SFAS No.
156 also requires the remeasurement of servicing assets and liabilities at
each subsequent reporting date using one of two methods: amortization
over the servicing period or measurement at fair value.
When no ready market value (such as quoted market prices or prices
based on sales or purchases of similar assets) is available to determine the
fair value of servicing assets, the fair value is determined by calculating
the present value of future cash flows associated with servicing the
loans. This calculation is based on a number of assumptions, including
the cost of servicing, discount rate, prepayment rate and default rate.
Key has elected to subsequently remeasure servicing assets using the
amortization method. The amortization of servicing assets is determined