KeyBank 2008 Annual Report Download - page 118

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
Management reviews Key’s collateral positions on a daily basis and
exchanges collateral with its counterparties in accordance with ISDA and
other related agreements. Key generally holds collateral in the form of cash
and highly rated securities issued by the U.S. Treasury, government-
sponsored enterprises or the Government National Mortgage Association.
The cash collateral netted against derivative assets on the balance sheet
totaled $974 million at December 31, 2008, and $562 million at
December 31, 2007. The cash collateral netted against derivative liabilities
totaled $586 million at December 31, 2008, and $254 million at
December 31, 2007.
At December 31, 2008, the largest gross exposure to an individual
counterparty was $443 million, which was secured with $159 million
in collateral. Additionally, Key had a derivative liability of $573 million
with this counterparty whereby Key pledged $232 million in collateral.
After taking into account the effects of a master netting agreement
and collateral, Key had a net exposure of ($57) million.
The following table summarizes the fair value of Key’s derivative assets
by type. These assets represent Key’s exposure to potential loss after
taking into account the effects of master netting agreements and other
means used to mitigate risk.
Key enters into derivative transactions with two primary groups: broker-
dealers and banks, and clients. Since these groups have different
economic characteristics, Key manages counterparty credit exposureand
credit risk in a different manner for each group.
Key enters into transactions with broker-dealers and banks for purposes
of asset/liability management, risk management and proprietary trading
purposes. These types of transactions generally arehigh dollar volume.
As discussed on the previous page, Key generally enters into bilateral
collateral and master netting agreements with these counterparties.
At December 31, 2008, Key had gross exposure of $2.312 billion to
broker-dealers and banks. However, after taking into account the
effects of master netting agreements and cash collateral held, Key had
net exposureof $112 million. Key’snet exposure to broker-dealers
and banks at December 31, 2008, was reduced to ($76) million by $188
million of additional collateral held in the form of securities.
Additionally, Key enters into transactions with clients to accommodate
their business needs. These types of transactions generally arelow
volume. Key generally enters into master netting agreements with these
counterparties as discussed on the previous page. In addition, Key
mitigates its overall portfolio exposure and market risk by entering into
offsetting positions with other banks. Due to the size and magnitude of
the individual contracts with clients, collateral is generally not exchanged
on these derivative transactions. In order to address the risk of default
associated with the uncollateralized contracts, Key has established a
reserve (included in “derivative assets”) in the amount of $35 million at
December 31, 2008, which management believes will be sufficient to
cover potential future losses on amounts due from client counterparties
in the event of default. At December 31, 2008, Key had gross exposure
of $1.994 billion to these counterparties. However, after taking into
account the effects of master netting agreements, cash collateral and the
related reserve, Key had net exposure of $1.784 million on its derivatives
with clients.
ASSET AND LIABILITY MANAGEMENT
Fair value hedging strategies. Key uses interest rate swap contracts to
modify its exposure to interest rate risk. For example, Key uses contracts
known as “receive fixed/pay variable” swaps to convert specific fixed-
rate deposits and long-term debt into variable-rate obligations. As a
result, Key receives fixed-rate interest payments in exchange for making
variable-rate payments over the lives of the contracts without exchanging
the underlying notional amounts.
The effective portion of a change in the fair value of a hedging instrument
designated as a fair value hedge is recorded in earnings at the same time
as a change in fair value of the hedged item, resulting in no effect on net
income. The ineffective portion of a change in the fair value of such a
hedging instrument is recorded in earnings with no corresponding
offset. Key recognized a net loss of $34 million in 2008, and net gains
of $2 million in both 2007 and 2006, related to the ineffective portion
of its fair value hedging instruments. In most cases, the hedging
relationship remained highly effective and continued to qualify for
hedge accounting treatment. During the fourth quarter of 2008, Key
recorded net losses of $39 million related to the volatility associated with
the hedge accounting applied to debt instruments. The majority of the
net losses are attributable to the restructuring of certain cash collateral
arrangements for hedges that reduced exposure to counterparty risk and
lowered the cost of borrowings. The ineffective portion recognized is
included in “other income” on the income statement. Key did not
exclude any portions of hedging instruments from the assessment of
hedge effectiveness in any of the above years.
Cash flow hedging strategies. Key enters into interest rate swap contracts
that effectively convert certain floating-rate assets or liabilities into
fixed-rate instruments to manage the potential adverse impact of interest
rate movements. For example, Key enters into “receive fixed/pay
variable” swaps that effectively convert floating-rate loans into fixed-
rate loans to reduce the potential adverse impact from interest rate
decreases on future interest income. These contracts allow Key to
receive fixed-rate interest payments in exchange for making a variable
rate payment over the lives of the contracts without exchanging the
underlying notional amounts. Similarly, Key has converted certain
floating-rate debt into fixed-rate debt by entering into interest rate
swap contracts.
December 31,
in millions 2008 2007
Interest rate $2,333 $ 850
Foreign exchange 279 492
Energy 214 52
Credit 42 13
Equity 234
Derivative assets before cash collateral 2,870 1,441
Less: Related cash collateral 974 562
Total derivative assets $1,896 $ 879