KeyBank 2009 Annual Report Download - page 128

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES
We enter into derivative transactions with two primary groups: broker-
dealers and banks, and clients. Since these groups have different
economic characteristics, we have different methods for managing
counterparty credit exposure and credit risk.
We enter into transactions with broker-dealers and banks for various
risk management purposes and proprietary trading purposes. These
types of transactions generally are high dollar volume. We generally enter
into bilateral collateral and master netting agreements with these
counterparties. At December 31, 2009, after taking into account the
effects of master netting agreements, we had gross exposure of $1
billion to broker-dealers and banks. We had net exposure of $250
million after the application of master netting agreements and cash
collateral. Our net exposure to broker-dealers and banks at December
31, 2009, was reduced to $31 million by $219 million of additional
collateral held in the form of securities.
We enter into transactions with clients to accommodate their business
needs. These types of transactions generally are low dollar volume. We
generally enter into master netting agreements with these counterparties.
In addition, we mitigate our overall portfolio exposure and market risk
by entering into offsetting positions with broker-dealers and other
banks. Due to the smaller size and magnitude of the individual contracts
with clients, collateral generally is not exchanged in connection with these
derivative transactions. In order to address the risk of default associated
with the uncollateralized contracts, we have established a default
reserve (included in “derivative assets”) in the amount of $59 million at
December 31, 2009, which we estimate to be the potential future losses
on amounts due from client counterparties in the event of default. At
December 31, 2009, after taking into account the effects of master
netting agreements, we had gross exposure of $994 million to client
counterparties. We had net exposure of $852 million on our derivatives
with clients after the application of master netting agreements, cash
collateral and the related reserve.
CREDIT DERIVATIVES
We are both a buyer and seller of credit protection through the credit
derivative market. We purchase credit derivatives to manage the credit
risk associated with specific commercial lending and swap obligations.
We also sell credit derivatives, mainly index credit default swaps, to
diversify the concentration risk within our loan portfolio.
The following table summarizes the fair value of our credit derivatives
purchased and sold by type as of December 31, 2009 and 2008. The fair
value of credit derivatives presented below does not take into account
the effects of bilateral collateral or master netting agreements.
December 31, 2009 2008
in millions Purchased Sold Net Purchased Sold Net
Single name credit default swaps $ 5 $(3) $2 $155 $(104) $ 51
Traded credit default swap indices 2— 2 34 (47) (13)
Other (1) 4 3 — (8) (8)
Total credit derivatives $6 $ 1 $7 $189 $(159) $ 30
Single name credit default swaps are bilateral contracts, whereby the
seller agrees, for a premium, to provide protection against the credit
risk of a reference entity in connection with a specific debt obligation.
The protected credit risk is related to adverse credit events, such as
bankruptcy, failure to make payments, and acceleration or restructuring
of obligations specified in the credit derivative contract using standard
documentation terms governed by ISDA. As the seller of a single name
credit derivative, we would be required to pay the purchaser the
difference between par value and the market price of the debt obligation
(cash settlement) or receive the specified referenced asset in exchange for
payment of the par value (physical settlement) if the underlying reference
entity experiences a predefined credit event. For a single name credit
derivative, the notional amount represents the maximum amount that
aseller could be required to pay. In the event that physical settlement
occurs and we receive our portion of the related debt obligation, we 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. We also may purchase offsetting credit derivatives for the same
reference entity from third parties that will permit us to recover the
amount we pay should a credit event occur.
Atraded credit 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, we would be required to pay the purchaser if one
or more of the entities in the index had a credit event. For a credit default
swap index, the notional amount represents the maximum amount
that a seller could be required to pay. Upon a credit event, the amount
payable is based on the percentage of the notional amount allocated to
the specific defaulting entity.
The majority of transactions represented by the “other” category
shown in the above table are risk participation agreements. In these
transactions, the lead participant has a swap agreement with a customer.
The lead participant (purchaser of protection) then enters into a risk
participation agreement with a counterparty (seller of protection),
under which the counterparty receives a fee to accept a portion of the
lead participant’s credit risk. If the customer defaults on the swap
contract, the counterparty to the risk participation agreement must
reimburse the lead participant for the counterparty’s percentage of the
positive fair value of the customer swap as of the default date. If the
customer swap has a negative fair value, the counterparty has no
reimbursement requirements. The notional amount represents the
maximum amount that the seller could be required to pay. In the case
of customer default, the seller is entitled to a pro rata share of the lead
participant’s claims against the customer under the terms of the initial
swap agreement between the lead participant and the customer.
The following table provides information on the types of credit
derivatives sold by us and held on the balance sheet at December 31,
2009 and 2008. The payment/performance risk assessment is based on