KeyBank 2008 Annual Report Download - page 81

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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.
Acommercial loan generally is 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’slending 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.
Management estimates the extent of impairment by comparing the
carrying amount of the loan with the estimated present value of its
future cash flows, the fair value of its underlying collateral or the loan’s
observable market price. 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
$54 million at December 31, 2008, and $80 million at December 31,
2007. 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
Historically,Key has securitized education loans 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 has retained one or more residual interests in
securitized loans in the form of an interest-only strip, residual asset,
servicing asset or security. Key’s accounting for its servicing assets is
discussed 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.
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 77.
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 if considered to be “other-than-
temporary” or is recognized as a component of “accumulated other
comprehensive income” if deemed to be temporary. 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,” 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 measured at fair value initially, if practicable. 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, the discount rate, the prepayment rate and the default rate.
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. Key
has elected to remeasure servicing assets using the amortization method.
The amortization of servicing assets is determined in proportion to, and
over the period of, the estimated net servicing income and is recorded
in “other income” on the income statement.