KeyBank 2008 Annual Report Download - page 120

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
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that a seller could be required to pay under the credit derivative. In the
event that physical settlement occurs and Key receives its portion of the
related debt obligation, Key will join other creditors in the liquidation
process, which may result in the recovery of a portion of the amount paid
under the credit default swap contract. Key also may purchase offsetting
credit derivatives for the same reference entity from third parties that will
permit Key to recover the amount it pays should a credit event occur.
Acredit default swap index represents a position on a basket or
portfolio of reference entities. As a seller of protection on a credit
default swap index, Key would be required to pay the purchaser if one
or more of the entities in the index have a credit event. For a credit
default swap index, the notional amount represents the maximum
amount that a seller could be required to pay under the credit derivative.
Upon a credit event, the amount payable is based on the percentage of
the notional amount allocated to the specific defaulting entity.
The following table provides information on the types of credit derivatives
sold by Key and held on the balance sheet at December 31, 2008. This
table includes derivatives sold to diversify Key’s credit exposure and for
proprietary trading purposes. The payment/performance risk assessment
is based on the default probabilities for the underlying reference entities’
debt obligations using the credit ratings matrix provided by Moody’s,
specifically Moody’s “Idealized” Cumulative Default Rates, except as
noted below. The payment/performance risk shown below represents a
weighted-average of the default probabilities for all reference entities in
the respective portfolios. These default probabilities are directly correlated
to the probability of Key having to make a payment under the credit
derivative contracts.
December 31, 2008
dollars in millions
Average Payment/
Notional Term Performance
Amount (Years) Risk
Single name credit default
swaps $1,476 2.44 4.75%
Traded indexes 1,759 1.51 4.67
Other 59 1.50 Low
(a)
Total credit derivatives sold $3,294 — —
(a)
The other credit derivatives are not referenced to an entity’s debt obligation.
Management determined the payment/performance risk based on the probability
that Key could be required to pay the maximum amount under the credit derivative.
Key has determined that the payment/performance risk associated with the other
credit derivatives is low (i.e., less than or equal to 30% probability of payment).
20. FAIR VALUE MEASUREMENTS
Effective January 1, 2008, Key adopted SFAS No. 157, “Fair Value
Measurements,” for all applicable financial and nonfinancial assets
and liabilities. This accounting guidance defines fair value, establishes
aframework for measuring fair value and expands disclosures about fair
value measurements. SFAS No. 157 applies only when other guidance
requires or permits assets or liabilities to be measured at fair value; it does
not expand the use of fair value to any new circumstances. Additional
information pertaining to Key’s accounting policy for fair value
measurements is summarized in Note 1 (“Summary of Significant
Accounting Policies”) under the heading “Fair Value Measurements” on
page 82.
FAIR VALUE DETERMINATION
As defined in SFAS No. 157, fair value is the price to sell an asset or
transfer a liability in an orderly transaction between market participants
in Key’sprincipal market. Key has established and documented its
process for determining the fair values of its assets and liabilities,
where applicable. Fair value is based on quoted market prices, when
available, for identical or similar assets or liabilities. In the absence of
quoted market prices, management determines the fair value of Key’s
assets and liabilities using valuation models or third-party pricing
services. Both of these approaches rely on market-based parameters when
available, such as interest rate yield curves, option volatilities and
credit spreads, or unobservable inputs. Unobservable inputs may be
based on management’sjudgment, assumptions and estimates related to
credit quality, liquidity, interest rates and other relevant inputs.
Valuation adjustments, such as those pertaining to counterparty and
Key’s own credit quality and liquidity, may be necessary to ensure that
assets and liabilities are recorded at fair value. Credit valuation
adjustments aremade when market pricing is not indicative of the
counterparty’s credit quality. Most classes of derivative contracts are
valued using internally developed models based on market-standard
derivative pricing conventions, which rely primarily on observable
market inputs, such as interest rate yield curves and volatilities. Market
convention implies a credit rating of double-A equivalent in the pricing
of derivative contracts, which assumes all counterparties have the same
creditworthiness. In determining the fair value of derivatives,
management considers the impact of master netting and cash collateral
exchange agreements and, when appropriate, establishes a default
reserve to reflect the credit quality of the counterparty.
Liquidity valuation adjustments aremade when management is unable
to observe recent market transactions for identical or similar instruments.
Management adjusts the fair value to reflect the uncertainty in the
pricing and trading of the instrument. Liquidity valuation adjustments
are based on the following factors:
• the amount of time since the last relevant valuation;
• whether there is an actual trade or relevant external quote available
at the measurement date; and
• volatility associated with the primary pricing components.
Key has various controls in place to ensure that fair value measurements
are accurate and appropriate. These controls include:
•an independent review and approval of valuation models;
•adetailed review of profit and loss conducted on a regular basis; and
•validation of valuation model components against benchmark data
and similar products, where possible.