KeyBank 2008 Annual Report Download - page 83

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
to cease offering Payroll Online services since they were not of sufficient
size to provide economies of scale to compete profitably. As a result, $5
million of goodwill was written off during the fourth quarter of 2007.
In December 2006, Key announced that it sold the subprime mortgage
loan portfolio held by the Champion Mortgage finance business on
November 29, 2006, and also announced that it had entered into a
separate agreement to sell Champion’s loan origination platform. As a
result, $170 million of goodwill was written off during the fourth
quarter of 2006. Key sold the Champion Mortgage loan origination
platform on February 28, 2007. Additional information related to the
Champion disposition is included in Note 3 (“Acquisitions and
Divestitures”) under the heading “Divestitures” on page 87.
INTERNALLY DEVELOPED SOFTWARE
Key relies on both company personnel and independent contractors to
plan, develop, install, customize and enhance computer systems
applications that support corporate and administrative operations.
Software development costs, such as those related to program coding,
testing, configuration and installation, are capitalized and included in
“accrued income and other assets” on the balance sheet. The resulting
asset ($105 million at December 31, 2008, and $118 million at December
31, 2007) is amortized using the straight-line method over its expected
useful life (not to exceed five years). Costs incurred during the planning
and post-development phases of an internal software project are
expensed as incurred.
Software that is no longer used is written offto earnings immediately.
When management decides to replace software, amortization of such
software is accelerated to the expected replacement date.
DERIVATIVES USED FOR ASSET AND
LIABILITY MANAGEMENT PURPOSES
Key uses interest rate swaps and caps to hedge interest rate risk. These
derivative instruments modify the repricing characteristics of specified
on-balance sheet assets and liabilities.
Key’s accounting policies related to derivatives reflect the accounting
guidance in SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities,” and other related accounting guidance. In
accordance with this accounting guidance, all derivatives are recognized
as either assets or liabilities on the balance sheet at fair value.
Accounting for changes in fair value (i.e., gains or losses) of derivatives
differs depending on whether the derivative has been designated and
qualifies as part of a hedging relationship, and further, on the type of
hedging relationship. For derivatives that are not designated as hedging
instruments, the gain or loss is recognized immediately in earnings. A
derivative that is designated and qualifies as a hedging instrument
must be designated a fair value hedge, a cash flow hedge or a hedge of
anet investment in a foreign operation. Key does not have any derivatives
that hedge net investments in foreign operations.
“Effectiveness” measures the extent to which changes in the fair value
of a derivative instrument offset changes in the fair value of the hedged
item. If the relationship between the change in the fair value of the
derivative instrument and the fair value of the hedged item falls within
arange considered to be the industry norm, the hedge is considered
“highly effective” and qualifies for hedge accounting. A hedge is
“ineffective” if the offsetting difference between the fair values falls
outside the acceptable range.
Afair value hedge is used to limit exposure to changes in the fair value
of existing assets, liabilities and firm commitments caused by changes
in interest rates or other economic factors. Key recognizes the gain or loss
on these derivatives, as well as the related gain or loss on the underlying
hedged item, in earnings during the period in which the fair value
changes. If a hedge is perfectly effective, the change in the fair value of
the hedged item will be offset, resulting in no net effect on earnings.
Acash flow hedge is used to minimize the variability of future cash flows
that is caused by changes in interest rates or other economic factors. The
effective portion of a gain or loss on any cash flow hedge is reported as
acomponent of “accumulated other comprehensive income” and
reclassified into earnings in the same period or periods that the hedged
transaction affects earnings. Any ineffective portion of the derivative gain
or loss is recognized in earnings during the current period.
DERIVATIVES USED FOR CREDIT RISK
MANAGEMENT PURPOSES
Key uses credit derivatives, primarily credit default swaps, to mitigate
credit risk by transferring a portion of the underlying instruments’
credit risk to a third party. These instruments also are used to manage
portfolio concentration and correlation risks. Key also provides credit
protection to other lenders through the sale of credit default swaps.
Credit derivatives are recorded on the balance sheet at fair value, which
is based on the creditworthiness of the borrowers. Related gains or losses,
as well as the premium paid or received for credit protection, are
included in “investment banking and capital markets income” on the
income statement. Additional information regarding Key’s use of credit
derivatives is provided in Note 19 (“Derivatives and Hedging Activities”)
under the heading “Credit Derivatives” on page 117.
DERIVATIVES USED FOR TRADING PURPOSES
Key enters into derivative contracts to accommodate client needs and for
trading purposes. Derivatives used for trading purposes typically include
interest rate, credit and energy derivatives, foreign exchange forward
contracts, written and purchased options (including currency options)
and foreign currency derivatives. Additional information regarding
Key’s derivatives used for trading purposes is provided in Note 19.
All derivatives used for trading purposes arerecorded at fair value. Fair
value is calculated using applicable market variables such as interest rate
volatility and other relevant market inputs. Changes in fair value
(including payments and receipts) are recorded in “investment banking
and capital markets income” on the income statement.
OFFSETTING DERIVATIVE POSITIONS
Effective January 1, 2008, Key adopted the accounting guidance in FASB
Staff Position No. FIN 39-1, “Amendment of FASB Interpretation 39,”
and, consequently, also adopted the provisions of Interpretation No. 39,