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Section 1: 10-Q (10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
 
 
 
FORM 10-Q
 
 
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2016
Commission File Number 001-11302
 
 
 
 
36591127_image0a01.jpg
Exact name of registrant as specified in its charter:
 
 
Ohio
34-6542451
State or other jurisdiction of
incorporation or organization
I.R.S. Employer
Identification Number:
127 Public Square, Cleveland, Ohio
44114-1306
Address of principal executive offices:
Zip Code:
(216) 689-3000
Registrant’s telephone number, including area code:
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
  (Do not check if a smaller reporting company)
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Shares with a par value of $1 each
1,080,711,946 shares
Title of class
Outstanding at November 3, 2016


Table of Contents

KEYCORP
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
 
 
Page Number
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2

Table of Contents

Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
 
 
 
Item 4.

3

Table of Contents

 
PART II. OTHER INFORMATION
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
Throughout the Notes to Consolidated Financial Statements (Unaudited) and Management’s Discussion & Analysis of Financial Condition & Results of Operations, we use certain acronyms and abbreviations as defined in Note 1 (“Basis of Presentation and Accounting Policies”) that begins on page 10.

4

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements

Consolidated Balance Sheets
in millions, except per share data
September 30,
2016

December 31,
2015

September 30,
2015

 
(Unaudited)

 
(Unaudited)

ASSETS
 
 
 
Cash and due from banks
$
749

$
607

$
470

Short-term investments
3,216

2,707

1,964

Trading account assets
926

788

811

Securities available for sale
20,540

14,218

14,376

Held-to-maturity securities (fair value: $9,048, $4,848, and $4,940)
8,995

4,897

4,936

Other investments
747

655

691

Loans, net of unearned income of $1,069, $646, and $645
85,528

59,876

60,085

Less: Allowance for loan and lease losses
865

796

790

Net loans
84,663

59,080

59,295

Loans held for sale (a)
1,137

639

916

Premises and equipment
1,023

779

771

Operating lease assets
430

340

315

Goodwill
2,480

1,060

1,060

Other intangible assets
426

65

74

Corporate-owned life insurance
4,035

3,541

3,516

Derivative assets
1,304

619

793

Accrued income and other assets
3,480

3,290

3,346

Discontinued assets (including $3 and $4 million of portfolio loans at fair value, and $169 million of portfolio loans held for sale at fair value, see Note 12)
1,654

1,846

2,086

Total assets
$
135,805

$
95,131

$
95,420

LIABILITIES
 
 
 
Deposits in domestic offices:
 
 
 
NOW and money market deposit accounts
$
56,432

$
37,089

$
37,301

Savings deposits
5,335

2,341

2,338

Certificates of deposit ($100,000 or more)
4,601

2,392

2,001

Other time deposits
5,793

3,127

3,020

Total interest-bearing deposits
72,161

44,949

44,660

Noninterest-bearing deposits
32,024

26,097

25,985

Deposits in foreign office — interest-bearing


428

Total deposits
104,185

71,046

71,073

Federal funds purchased and securities sold under repurchase agreements
602

372

407

Bank notes and other short-term borrowings
809

533

677

Derivative liabilities
850

632

676

Accrued expense and other liabilities
1,739

1,605

1,562

Long-term debt
12,622

10,184

10,308

Total liabilities
120,807

84,372

84,703

EQUITY
 
 
 
Preferred stock
1,165

290

290

Common shares, $1 par value; authorized 1,400,000,000 shares; issued 1,256,705,117, 1,016,969,905, and 1,016,969,905 shares
1,257

1,017

1,017

Capital surplus
6,359

3,922

3,914

Retained earnings
9,260

8,922

8,764

Treasury stock, at cost (174,650,040, 181,218,648, and 181,685,035 shares)
(2,863
)
(3,000
)
(3,008
)
Accumulated other comprehensive income (loss)
(182
)
(405
)
(272
)
Key shareholders’ equity
14,996

10,746

10,705

Noncontrolling interests
2

13

12

Total equity
14,998

10,759

10,717

Total liabilities and equity
$
135,805

$
95,131

$
95,420

 
 
 
 

(a)
Total loans held for sale include Real estate — residential mortgage loans held for sale at fair value of $62 million at September 30, 2016.
See Notes to Consolidated Financial Statements (Unaudited).


5

Table of Contents

Consolidated Statements of Income
dollars in millions, except per share amounts
Three months ended September 30,
 
Nine months ended September 30,
(Unaudited)
2016

2015

 
2016

2015

INTEREST INCOME
 
 
 
 
 
Loans
$
746

$
542

 
$
1,875

$
1,597

Loans held for sale
10

10

 
23

29

Securities available for sale
88

75

 
237

217

Held-to-maturity securities
30

24

 
78

72

Trading account assets
4

5

 
17

15

Short-term investments
7

1

 
17

5

Other investments
5

4

 
10

14

Total interest income
890

661

 
2,257

1,949

INTEREST EXPENSE
 
 
 
 
 
Deposits
49

27

 
114

79

Bank notes and other short-term borrowings
2

2

 
7

6

Long-term debt
59

41

 
155

118

Total interest expense
110

70

 
276

203

NET INTEREST INCOME
780

591

 
1,981

1,746

Provision for credit losses
59

45

 
200

121

Net interest income after provision for credit losses
721

546

 
1,781

1,625

NONINTEREST INCOME
 
 
 
 
 
Trust and investment services income
122

108

 
341

328

Investment banking and debt placement fees
156

109

 
325

318

Service charges on deposit accounts
85

68

 
218

192

Operating lease income and other leasing gains
6

15

 
41

58

Corporate services income
51

57

 
154

143

Cards and payments income
66

47

 
164

136

Corporate-owned life insurance income
29

30

 
85

91

Consumer mortgage income
6

3

 
11

10

Mortgage servicing fees
15

11

 
37

33

Net gains (losses) from principal investing
5

11

 
16

51

Other income (a)
8

11

 
61

35

Total noninterest income
549

470

 
1,453

1,395

NONINTEREST EXPENSE
 
 
 
 
 
Personnel
594

426

 
1,425

1,223

Net occupancy
73

60

 
193

191

Computer processing
70

41

 
158

121

Business services and professional fees
76

40

 
157

115

Equipment
26

22

 
68

66

Operating lease expense
15

11

 
42

34

Marketing
32

17

 
66

40

FDIC assessment
21

8

 
38

24

Intangible asset amortization
13

9

 
28

27

OREO expense, net
3

2

 
6

5

Other expense
159

88

 
355

258

Total noninterest expense
1,082

724

 
2,536

2,104

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
188

292

 
698

916

Income taxes
16

72

 
141

230

INCOME (LOSS) FROM CONTINUING OPERATIONS
172

220

 
557

686

Income (loss) from discontinued operations, net of taxes of $1, ($2), $3, and $3 (see Note 12)
1

(3
)
 
5

5

NET INCOME (LOSS)
173

217

 
562

691

Less: Net income (loss) attributable to noncontrolling interests
1

(2
)
 

1

NET INCOME (LOSS) ATTRIBUTABLE TO KEY
$
172

$
219

 
$
562

$
690

Income (loss) from continuing operations attributable to Key common shareholders
$
165

$
216

 
$
540

$
668

Net income (loss) attributable to Key common shareholders
166

213

 
545

673

Per common share:
 
 
 
 
 
Income (loss) from continuing operations attributable to Key common shareholders
$
.17

$
.26

 
$
.61

$
.79

Income (loss) from discontinued operations, net of taxes


 
.01

.01

Net income (loss) attributable to Key common shareholders (b) 
.17

.26

 
.62

.80

Per common share — assuming dilution:
 
 
 
 
 
Income (loss) from continuing operations attributable to Key common shareholders
$
.16

$
.26

 
$
.60

$
.78

Income (loss) from discontinued operations, net of taxes


 
.01

.01

Net income (loss) attributable to Key common shareholders (b)
.17

.25

 
.61

.79

Cash dividends declared per common share
$
.085

$
.075

 
$
.245

$
.215

Weighted-average common shares outstanding (000)
982,080

831,430

 
880,824

839,758

Effect of convertible preferred stock


 


Effect of common share options and other stock awards
12,580

7,450

 
8,965

7,613

Weighted-average common shares and potential common shares outstanding (000) (c)
994,660

838,880

 
889,789

847,371

 
 
 
 
 
 

(a)
For the three months ended September 30, 2016, net securities losses totaled $6 million. For the three months ended September 30, 2015, net securities gains (losses) totaled less than $1 million. For the three months ended September 30, 2016, and September 30, 2015, we did not have any impairment losses related to securities.
(b)
EPS may not foot due to rounding.
(c)
Assumes conversion of common share options and other stock awards and/or convertible preferred stock, as applicable.
See Notes to Consolidated Financial Statements (Unaudited).

6

Table of Contents

Consolidated Statements of Comprehensive Income
in millions
Three months ended September 30,
 
Nine months ended September 30,
(Unaudited)
2016

2015

 
2016

2015

Net income (loss)
$
173

$
217

 
$
562

$
691

Other comprehensive income (loss), net of tax:
 
 
 
 
 
Net unrealized gains (losses) on securities available for sale, net of income taxes of ($18), $33, $93 and $35
(28
)
54

 
159

58

Net unrealized gains (losses) on derivative financial instruments, net of income taxes of ($24), $28, $32, and $37
(41
)
48

 
53

63

Foreign currency translation adjustments, net of income taxes of ($1), ($3), $3, and ($11)
(2
)
(5
)
 
5

(18
)
Net pension and postretirement benefit costs, net of income taxes of $1, ($15), $6, and ($12)
3

(24
)
 
6

(19
)
Total other comprehensive income (loss), net of tax
(68
)
73

 
223

84

Comprehensive income (loss)
105

290

 
785

775

Less: Comprehensive income attributable to noncontrolling interests
1

(2
)
 

1

Comprehensive income (loss) attributable to Key
$
104

$
292

 
$
785

$
774

 
 
 
 
 
 
See Notes to Consolidated Financial Statements (Unaudited).

7

Table of Contents

Consolidated Statements of Changes in Equity
 
Key Shareholders’ Equity
 
dollars in millions, except per share amounts
(Unaudited)
Preferred
Shares
Outstanding
(000)

Common
Shares
Outstanding
(000)

Preferred
Stock

Common
Shares

Capital
Surplus

Retained
Earnings

Treasury
Stock,
at Cost

Accumulated
Other
Comprehensive
Income (Loss)

Noncontrolling
Interests

BALANCE AT DECEMBER 31, 2014
2,905

859,403

$
291

$
1,017

$
3,986

$
8,273

$
(2,681
)
$
(356
)
$
12

Net income (loss)
 
 
 
 
 
690

 
 
1

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Net unrealized gains (losses) on securities available for sale, net of income taxes of $35
 
 
 
 
 
 
 
58

 
Net unrealized gains (losses) on derivative financial instruments, net of income taxes of $37
 
 
 
 
 
 
 
63

 
Foreign currency translation adjustments, net of income taxes of ($11)
 
 
 
 
 
 
 
(18
)
 
Net pension and postretirement benefit costs, net of income taxes of ($12)
 
 
 
 
 
 
 
(19
)
 
Deferred compensation
 
 
 
 
13

 
 
 
 
Cash dividends declared on common shares ($.215 per share)
 
 
 
 
 
(182
)
 
 
 
Cash dividends declared on Noncumulative Series A Preferred Stock ($5.8125 per share)
 
 
 
 
 
(17
)
 
 
 
Common shares repurchased
 
(31,267
)
 
 
 
 
(448
)
 
 
Series A Preferred Stock exchanged for common shares
(5
)
33

(1
)
 
 
 
1

 
 
Common shares reissued (returned) for stock options and other employee benefit plans
 
7,116

 
 
(85
)
 
120

 
 
Net contribution from (distribution to) noncontrolling interests
 
 
 
 
 
 
 
 
(1
)
BALANCE AT SEPTEMBER 30, 2015
2,900

835,285

$
290

$
1,017

$
3,914

$
8,764

$
(3,008
)
$
(272
)
$
12

 
 
 
 
 
 
 
 
 
 
BALANCE AT DECEMBER 31, 2015
2,900

835,751

$
290

$
1,017

$
3,922

$
8,922

$
(3,000
)
$
(405
)
$
13

Net income (loss)
 
 
 
 
 
562

 
 

Other comprehensive income (loss):
 
 
 
 
 
 
 
 
 
Net unrealized gains (losses) on securities available for sale, net of income taxes of $93
 
 
 
 
 
 
 
159

 
Net unrealized gains (losses) on derivative financial instruments, net of income taxes of $32
 
 
 
 
 
 
 
53

 
Foreign currency translation adjustments, net of income taxes of $3
 
 
 
 
 
 
 
5

 
Net pension and postretirement benefit costs, net of income taxes of $6
 
 
 
 
 
 
 
6

 
Deferred compensation
 
 
 
 
(8
)
 
 
 
 
Cash dividends declared on common shares ($.245 per share)
 
 
 
 
 
(207
)
 
 
 
Cash dividends declared on Noncumulative Series A Preferred Stock ($5.8125 per share)
 
 
 
 
 
(17
)
 
 
 
Common shares issued
 
239,735

 
240

2,591

 
 
 
 
Common shares repurchased
 
(6,122
)
 
 
 
 
(73
)
 
 
Issuance of Preferred Stock
14,021

 
875

 
(6
)
 
 
 
 
Common shares reissued (returned) for stock options and other employee benefit plans
 
12,691

 
 
(140
)
 
210

 
 
Net contribution from (distribution to) noncontrolling interests
 
 
 
 
 
 
 
 
(11
)
BALANCE AT SEPTEMBER 30, 2016
16,921

1,082,055

$
1,165

$
1,257

$
6,359

$
9,260

$
(2,863
)
$
(182
)
$
2

 
 
 
 
 
 
 
 
 
 
See Notes to Consolidated Financial Statements (Unaudited).

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Table of Contents

Consolidated Statements of Cash Flows
 
in millions
Nine months ended September 30,
(Unaudited)
2016
 
2015
OPERATING ACTIVITIES
 
 
 
Net income (loss)
$
562

 
$
691

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
Provision for credit losses
200

 
121

Depreciation, amortization and accretion expense, net
293

 
176

Increase in cash surrender value of corporate-owned life insurance
(76
)
 
(75
)
Stock-based compensation expense
66

 
47

FDIC reimbursement (payments), net of FDIC expense
7

 
(1
)
Deferred income taxes (benefit)
(63
)
 
(70
)
Proceeds from sales of loans held for sale
5,181

 
5,362

Originations of loans held for sale, net of repayments
(5,516
)
 
(5,428
)
Net losses (gains) on sales of loans held for sale
(92
)
 
(75
)
Net losses (gains) from principal investing
(16
)
 
(51
)
Net losses (gains) and writedown on OREO
3

 
2

Net losses (gains) on leased equipment
10

 
(8
)
Net securities losses (gains)
6

 
1

Net losses (gains) on sales of fixed assets
13

 
6

Net decrease (increase) in trading account assets
(138
)
 
(61
)
Other operating activities, net
420

 
(388
)
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
860

 
249

INVESTING ACTIVITIES
 
 
 
Cash received (used) in acquisitions, net of cash acquired
(481
)
 

Net decrease (increase) in short-term investments, excluding acquisitions
(509
)
 
2,305

Purchases of securities available for sale
(4,203
)
 
(3,314
)
Proceeds from sales of securities available for sale
4,248

 
11

Proceeds from prepayments and maturities of securities available for sale
2,867

 
2,357

Proceeds from prepayments and maturities of held-to-maturity securities
1,048

 
846

Purchases of held-to-maturity securities
(5,150
)
 
(770
)
Purchases of other investments
(28
)
 
(24
)
Proceeds from sales of other investments
204

 
107

Proceeds from prepayments and maturities of other investments
3

 
2

Net decrease (increase) in loans, excluding acquisitions, sales and transfers
(2,501
)
 
(3,061
)
Proceeds from sales of portfolio loans
100

 
89

Proceeds from corporate-owned life insurance
24

 
38

Purchases of premises, equipment, and software
(79
)
 
(40
)
Proceeds from sales of premises and equipment

 
1

Proceeds from sales of OREO
13

 
16

NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
(4,444
)
 
(1,437
)
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits, excluding acquisitions
4,147

 
(925
)
Net increase (decrease) in short-term borrowings
(2,193
)
 
86

Net proceeds from issuance of long-term debt
2,078

 
4,054

Payments on long-term debt
(533
)
 
(1,582
)
Issuance of preferred shares
519

 

Repurchase of common shares
(73
)
 
(448
)
Net proceeds from reissuance of common shares
5

 
19

Cash dividends paid
(224
)
 
(199
)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
3,726

 
1,005

NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS
142

 
(183
)
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD
607

 
653

CASH AND DUE FROM BANKS AT END OF PERIOD
$
749

 
$
470

Additional disclosures relative to cash flows:
 
 
 
Interest paid
$
308

 
$
256

Income taxes paid (refunded)
68

 
173

Noncash items:
 
 
 
Common stock issued to acquire First Niagara
$
2,831

 

Preferred stock issued to acquire First Niagara
350

 

Reduction of secured borrowing and related collateral
59

 
$
132

Loans transferred to portfolio from held for sale
8

 
1

Loans transferred to held for sale from portfolio
32

 
41

Loans transferred to OREO
15

 
16

 
 
 
 
See Notes to Consolidated Financial Statements (Unaudited).

9

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)
1. Basis of Presentation and Accounting Policies

As used in these Notes, references to “Key,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of KeyCorp and its subsidiaries. KeyCorp refers solely to the parent holding company, and KeyBank refers to KeyCorp’s subsidiary, KeyBank National Association. First Niagara Bank refers to First Niagara Bank, National Association, a subsidiary of KeyCorp as of September 30, 2016, which was subsequently merged with and into KeyBank in the fourth quarter of 2016.

The acronyms and abbreviations identified below are used in the Notes to Consolidated Financial Statements (Unaudited) as well as in the Management’s Discussion & Analysis of Financial Condition & Results of Operations. You may find it helpful to refer back to this page as you read this report.

References to our “2015 Form 10-K” refer to our Form 10-K for the year ended December 31, 2015, which was filed with the U.S. Securities and Exchange Commission and is available on its website (www.sec.gov) and on our website
(www.key.com/ir).

AICPA: American Institute of Certified Public Accountants.
KEF: Key Equipment Finance.
ALCO: Asset/Liability Management Committee.
KPP: Key Principal Partners.
ALLL: Allowance for loan and lease losses.
KREEC: Key Real Estate Equity Capital, Inc.
A/LM: Asset/liability management.
LCR: Liquidity coverage ratio.
AOCI: Accumulated other comprehensive income (loss).
LIBOR: London Interbank Offered Rate.
APBO: Accumulated postretirement benefit obligation.
LIHTC: Low-income housing tax credit.
Austin: Austin Capital Management, Ltd.
Moody’s: Moody’s Investor Services, Inc.
BHCs: Bank holding companies.
MRM: Market Risk Management group.
Board: KeyCorp Board of Directors.
N/A: Not applicable.
CCAR: Comprehensive Capital Analysis and Review.
NASDAQ: The NASDAQ Stock Market LLC.
CMBS: Commercial mortgage-backed securities.
NAV: Net asset value.
CMO: Collateralized mortgage obligation.
N/M: Not meaningful.
Common shares: KeyCorp common shares, $1 par value.
NOW: Negotiable Order of Withdrawal.
DIF: Deposit Insurance Fund of the FDIC.
NPR: Notice of proposed rulemaking.
Dodd-Frank Act: Dodd-Frank Wall Street Reform and
NYSE: New York Stock Exchange.
Consumer Protection Act of 2010.
OCC: Office of the Comptroller of the Currency.
EBITDA: Earnings before interest, taxes, depreciation, and
OCI: Other comprehensive income (loss).
amortization.
OREO: Other real estate owned.
EPS: Earnings per share.
OTTI: Other-than-temporary impairment.
ERISA: Employee Retirement Income Security Act of 1974.
PBO: Projected benefit obligation.
ERM: Enterprise risk management.
PCI: Purchased credit impaired.
EVE: Economic value of equity.
S&P: Standard and Poor’s Ratings Services, a Division
FASB: Financial Accounting Standards Board.
of The McGraw-Hill Companies, Inc.
FDIC: Federal Deposit Insurance Corporation.
SEC: U.S. Securities and Exchange Commission.
Federal Reserve: Board of Governors of the Federal Reserve
Series A Preferred Stock: KeyCorp’s 7.750%
System.
Noncumulative Perpetual Convertible Preferred Stock,
FHLB: Federal Home Loan Bank of Cincinnati.
Series A.
FHLMC: Federal Home Loan Mortgage Corporation.
SIFIs: Systemically important financial institutions
First Niagara: First Niagara Financial Group, Inc.
including BHCs with total consolidated assets of at least
(NASDAQ: FNFG).
$50 billion and nonbank financial companies designated
FNMA: Federal National Mortgage Association, or Fannie Mae.
by FSOC for supervision by the Federal Reserve.
FSOC: Financial Stability Oversight Council.
TDR: Troubled debt restructuring.
GAAP: U.S. generally accepted accounting principles.
TE: Taxable-equivalent.
GNMA: Government National Mortgage Association.
U.S. Treasury: United States Department of the Treasury.
ISDA: International Swaps and Derivatives Association.
VaR: Value at risk.
KAHC: Key Affordable Housing Corporation.
VEBA: Voluntary Employee Beneficiary Association.
KCC: Key Capital Corporation.
VIE: Variable interest entity.
KCDC: Key Community Development Corporation.
 

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The consolidated financial statements include the accounts of KeyCorp and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Some previously reported amounts have been reclassified to conform to current reporting practices.

The consolidated financial statements include any voting rights entities in which we have a controlling financial interest. In accordance with the applicable accounting guidance for consolidations, we consolidate a VIE if we have: (i) a variable interest in the entity; (ii) the power to direct activities of the VIE that most significantly impact the entity’s economic performance; and (iii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE (i.e., we are considered to be the primary beneficiary). Variable interests can include equity interests, subordinated debt, derivative contracts, leases, service agreements, guarantees, standby letters of credit, loan commitments, and other contracts, agreements, and financial instruments. See Note 10 (“Variable Interest Entities”) for information on our involvement with VIEs.

We use the equity method to account for unconsolidated investments in voting rights entities or VIEs if we have significant influence over the entity’s operating and financing decisions (usually defined as a voting or economic interest of 20% to 50%, but not controlling). Unconsolidated investments in voting rights entities or VIEs in which we have a voting or economic interest of less than 20% generally are carried at cost. Investments held by our registered broker-dealer and investment company subsidiaries (principal investing entities and Real Estate Capital line of business) are carried at fair value.
We believe that the unaudited consolidated interim financial statements reflect all adjustments of a normal recurring nature and disclosures that are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full year. The interim financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our 2015 Form 10-K.

In preparing these financial statements, subsequent events were evaluated through the time the financial statements were issued. Financial statements are considered issued when they are widely distributed to all shareholders and other financial statement users, or filed with the SEC.

Offsetting Derivative Positions

In accordance with the applicable accounting guidance, we take into account the impact of bilateral collateral and master netting agreements that allow us to settle all derivative contracts held with a single counterparty on a net basis, and to offset the net derivative position with the related cash collateral when recognizing derivative assets and liabilities. Additional information regarding derivative offsetting is provided in Note 8 (“Derivatives and Hedging Activities”).

Loans Held for Sale

Our loans held for sale at September 30, 2016, December 31, 2016, and September 30, 2015, are disclosed in Note 4 (“Loans and Loans Held for Sale”).  Our commercial loans, which we originated and intend to sell, are carried at the lower of aggregate cost or fair value.  Beginning with the third quarter of 2016, we elected the fair value option for our real estate - residential mortgages.  Fair value is determined based on available market data for similar assets, expected cash flows, and appraisals of underlying collateral or the credit quality of the borrower.  Additional information regarding fair value measurements associated with our loans held for sale is provided in Note 6 (“Fair Value Measurements”).  If a loan is transferred from the loan portfolio to the held-for-sale category, any write-down in the carrying amount of the loan at the date of transfer is recorded as a charge-off.  Subsequent declines in fair value are recognized as a charge to noninterest income. Subsequent increases in fair for the real estate residential loans are recorded to noninterest income. When a loan is placed in the held-for-sale category, we stop amortizing the related deferred fees and costs.  The remaining unamortized fees and costs are recognized as part of the cost basis of the loan at the time it is sold.

Purchased Loans

We evaluate purchased loans for impairment in accordance with the applicable accounting guidance. Purchased performing loans that do not have evidence of deterioration in credit quality at acquisition are recorded at fair value at the acquisition date. Any premium or discount associated with purchased performing loans is recognized as an expense or income based on the effective yield method of amortization. Subsequent to the purchase date, the methods utilized to estimate the required ALLL for these loans is similar to originated loans; however, we record a provision for loan losses only when the required ALLL exceeds any remaining purchase discount.


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Purchased loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that all contractually required payments will not be collected, are deemed PCI. Revolving loans, including lines of credit and credit card loans, leases, and loans where cash flows cannot be reasonably estimated are excluded from PCI accounting. Purchased loans are initially recorded at fair value without recording an allowance for loan losses. Fair value of these loans is determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected, as adjusted for an estimate of future credit losses and prepayments, and then a market-based discount rate is applied to those cash flows. PCI loans that have similar risk characteristics, primarily credit risk, collateral type and interest rate risk, and are homogeneous in size, are pooled and accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. PCI loans that cannot be aggregated into a pool are accounted for individually.

Under the applicable accounting guidance for PCI loans, the excess of cash flows expected to be collected, measured as of the acquisition date, over the estimated fair value is referred to as the “accretable yield” and is recognized in interest income over the remaining life of the loan or pool using the effective yield method. Accordingly, PCI loans are not subject to classification as nonaccrual (and nonperforming) in the same manner as originated loans. Rather, acquired PCI loans are considered to be accruing loans because their interest income relates to the accretable yield recognized on the individual loan or pool and not to the contractual interest payments of the loan. The difference between the contractually required principal and interest payments as of the acquisition date and the cash flows expected to be collected is referred to as the “nonaccretable difference.” The nonaccretable difference, which is not accreted into income, reflects estimated future credit losses and uncollectible contractual interest expected to be incurred over the life of the PCI loan.

After we acquire loans determined to be PCI loans, actual cash collections are monitored to determine if they conform to management’s expectations. Revised cash flow expectations are prepared each period. A decrease in expected cash flows in subsequent periods may indicate impairment and would require us to establish an ALLL by recording a charge to the provision for loan losses. An increase in expected cash flows in subsequent periods initially reduces any previously established ALLL by the increase in the present value of cash flows expected to be collected, and requires us to recalculate the amount of accretable yield for the PCI loan or pool. The adjustment of accretable yield due to an increase in expected cash flows is accounted for as a change in estimate. The additional cash flows expected to be collected are reclassified from the nonaccretable difference to the accretable yield, and the amount of periodic accretion is adjusted accordingly over the remaining life of the PCI loan or pool.

A PCI loan may be derecognized either through receipt of payment (in full or in part) from the borrower, the sale of the loan to a third party, foreclosure of the collateral, or charge-off. If one of these events occurs, the loan should be removed from the loan pool, or derecognized if it is accounted for as an individual loan. PCI loans subject to modification are not removed from a PCI pool even if those loans would otherwise be deemed TDRs since the pool, and not the individual loan, represents the unit of account. Individually accounted for PCI loans that are modified in a TDR are no longer classified as PCI loans and are subject to TDR recognition.

Accounting Guidance Adopted in 2016

Business combinations. In September 2015, the FASB issued new accounting guidance that obligates an acquirer in a business combination to recognize adjustments to provisional amounts in the reporting period that the amounts were determined, eliminating the requirement for retrospective adjustments. The acquirer should record in the current period any income effects that resulted from the change in provisional amounts, calculated as if the accounting were completed at the acquisition date. This accounting guidance was effective prospectively for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us). Early adoption was permitted. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Fair value measurement. In May 2015, the FASB issued new disclosure guidance that eliminates the requirement to categorize investments measured using the net asset value practical expedient in the fair value hierarchy table. Entities are required to disclose the fair value of investments measured using the net asset value practical expedient so that financial statement users can reconcile amounts reported in the fair value hierarchy table to amounts reported on the balance sheet. This disclosure guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (March 31, 2016, for us) on a retrospective basis. Early adoption was permitted. The adoption of this disclosure guidance did not affect our financial condition or results of operations. We provide the disclosure related to this new guidance in Note 5 (“Fair Value Measurements”).

Cloud computing fees. In April 2015, the FASB issued new accounting guidance that clarifies a customer’s accounting for fees paid in a cloud computing arrangement. If a cloud computing arrangement includes a software license, then the customer

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should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a
service contract. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and could be implemented using either a prospective method or a retrospective method. Early adoption was permitted. We elected to implement this new accounting guidance using a prospective approach. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Imputation of interest. In April 2015, the FASB issued new accounting guidance that requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This accounting guidance was effective retrospectively for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us). Early adoption was permitted. The adoption of this accounting guidance did not have a material effect on our financial condition or results of operations.

Consolidation. In February 2015, the FASB issued new accounting guidance that changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The new guidance amends the current accounting guidance to address limited partnerships and similar legal entities, certain investment funds, fees paid to a decision maker or service provider, and the impact of fee arrangements and related parties on the primary beneficiary determination. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and was implemented using a modified retrospective basis. Retrospective application to all relevant prior periods and early adoption was permitted. The adoption of this accounting guidance did not affect our financial condition or results of operations. Our Principal Investing unit and the Real Estate Capital line of business have equity and mezzanine investments, which were subjected to the new guidance. We determined these investments are VIEs. We provide disclosures related to our variable interest entities as required by the new guidance in Note 9 (“Variable Interest Entities”).

Derivatives and hedging. In November 2014, the FASB issued new accounting guidance that clarifies how current guidance should be interpreted when evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. An entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, when evaluating the nature of a host contract. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and could be implemented using a modified retrospective basis. Retrospective application to all relevant prior periods and early adoption was permitted. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Consolidation. In August 2014, the FASB issued new accounting guidance that clarifies how to measure the financial assets and the financial liabilities of a consolidated collateralized financing entity. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and could be implemented using either a retrospective method or a cumulative-effect approach. Early adoption was permitted. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Stock-based compensation. In June 2014, the FASB issued new accounting guidance that clarifies how to account for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and could be implemented using either a retrospective method or a prospective method. Early adoption was permitted. We elected to implement this new accounting guidance using a prospective approach. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Accounting Guidance Pending Adoption at September 30, 2016

Consolidation. In October 2016, the FASB issued new accounting guidance that amends the previous consolidation guidance issued in February 2015, to require a decision maker that holds an interest in a VIE through an entity under common control to only consider its proportionate indirect interest in the VIE in determining whether the decision maker is the VIE’s primary beneficiary. This new guidance eliminates the requirement that a decision maker treat the common control party’s interest in the VIE as if the decision maker held the interest itself, an approach referred to as “full attribution.” The new guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us), and it must be applied retrospectively to all periods beginning with the fiscal year that the previous guidance was initially applied. Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

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Income taxes. In October 2016, the FASB issued accounting guidance requiring an entity to recognize any deferred taxes from an intra-entity transfer of an asset other than inventory when the transfer occurs. This accounting guidance will be effective for annual and interim reporting periods beginning after December 15, 2017 (effective January 1, 2018, for us) and should be implemented using a modified-retrospective approach. Early adoption is permitted but only as of the beginning of an annual reporting period for which financial statements have not yet been issued. We are currently evaluating the impact that this accounting guidance may have on our financial condition or results of operations.

Statement of cash flows. In August 2016, the FASB issued new accounting guidance that clarifies how cash receipts and cash payments in certain specific transactions should be presented and classified in the statement of cash flows. These specific transactions include, but are not limited to, debt prepayment or extinguishment costs, contingent considerations made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate owned life insurance policies, and distributions from equity method investees. This guidance also clarifies that in instances of cash flows with multiple aspects that cannot be separately identified, classification should be based on the activity that is likely to be the predominant source of or use of cash flow. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2017 (effective January 1, 2018, for us) and should be implemented using a retrospective approach. Early adoption is permitted. We are currently evaluating the impact that this accounting guidance may have on our financial condition or results of operations.

Financial instruments. In June 2016, the FASB issued new accounting guidance that changes the methodology for recognizing credit losses related to financial instruments. Under current GAAP, a credit loss is not recognized until it is probable the loss has been incurred. The new accounting guidance eliminates that threshold and expands the information required for an entity to consider when developing an estimate of expected credit losses, including the use of forecasted information. Entities will be required to present financial assets measured on an amortized cost basis at the net amount that is expected to be collected. This new guidance will impact the accounting for our loans, debt securities available for sale, and liability for credit losses on unfunded lending-related commitments as well as purchased financial assets with a more than insignificant amount of credit deterioration since origination. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2019 (effective January 1, 2020, for us). Early adoption is permitted but only for interim and annual reporting periods beginning after December 15, 2018. This guidance must be implemented using a modified retrospective basis except a prospective approach must be used for debt securities for which an other-than-temporary impairment had been recognized before the effective date. A prospective transition approach also should be used for purchased financial assets with credit deterioration. We are currently evaluating the impact that this accounting guidance may have on our financial condition or results of operations.

Stock-based compensation. In March 2016, the FASB issued new accounting guidance that simplifies accounting for several aspects of share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and presentation on the statement of cash flows. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us). The method of transition is dependent on the particular amendment within the new guidance. Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Equity method investments. In March 2016, the FASB issued new accounting guidance that simplifies the transition to equity method accounting by eliminating the requirement for an investor to make retroactive adjustments to the investment, results of operations, and retained earnings on a step-by-step basis when an investment becomes qualified for equity method accounting. Instead, when an investment qualifies for the equity method due to an increase in ownership or degree of influence, an equity method investor is required to add the cost of acquiring the additional interest to the current basis of the previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for the equity method. This accounting guidance will be effective prospectively for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us). Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Derivatives and hedging. In March 2016, the FASB issued new accounting guidance that requires an entity to use a four-step decision model when assessing contingent call (put) options that can accelerate the payment of principal on debt instruments to determine whether they are clearly and closely related to their debt hosts. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us) and must be implemented using a modified retrospective basis. Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.


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Derivatives and hedgingIn March 2016, the FASB issued new accounting guidance that clarifies that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument does not, by itself, require dedesignation, but all other hedge accounting criteria must be met. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us) and can be implemented using either a prospective method or a modified retrospective method. Early adoption is permitted. We have elected to implement this new accounting guidance using a prospective method. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Extinguishment of liabilities. In March 2016, the FASB issued new accounting guidance that clarifies that liabilities related to the sale of prepaid stored-value products are financial liabilities, and breakage should be accounted for under the breakage guidance in the new revenue recognition accounting guidance. It also provides clarity on how prepaid product liabilities should be derecognized. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2017 (effective January 1, 2018, for us) and can be implemented using either a modified retrospective approach or retrospective approach. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Leases. In February 2016, the FASB issued new accounting guidance that requires a lessee to recognize a liability to make lease payments and a right of use asset representing its right to use an underlying asset during the lease term for both finance and operating leases. The definition of a lease was modified to exemplify the concept of control over an asset identified in the lease. Lease classification criteria remains substantially similar to criteria in current lease guidance. The guidance defines which payments can be used in determining lease classification. For short-term leases with a term of 12 months or less, lessees can make a policy election not to recognize lease assets and lease liabilities. Lessor accounting is largely unchanged. Leveraged leases that commenced before the effective date of the new guidance are grandfathered. New disclosures are required, and certain practical expedients are allowed upon adoption. This accounting and disclosure guidance will be effective for interim and annual reporting periods beginning after December 15, 2018 (effective January 1, 2019, for us) and should be implemented using the modified retrospective approach. Early adoption is permitted. We are currently evaluating the impact that this accounting guidance may have on our financial condition or results of operations.

Financial instruments. In January 2016, the FASB issued new accounting guidance that requires equity investments, except those accounted for under the equity method of accounting or consolidated, to be measured at fair value with changes recognized in net income. If there is no readily determinable fair value, the guidance allows entities the ability to measure investments at cost less impairment, whereby impairment is based on a qualitative assessment. The guidance eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost and changes the presentation of financial assets and financial liabilities on the balance sheet or in the footnotes. If an entity has elected the fair value option to measure liabilities, the new accounting guidance requires the portion of the change in the fair value of a liability resulting from credit risk to be presented in OCI. We have not elected to measure any of our liabilities at fair value, and therefore, this aspect of the guidance is not applicable to us. This accounting and disclosure guidance will be effective for interim and annual reporting periods beginning after December 15, 2017 (effective January 1, 2018, for us). For the guidance applicable to us, the accounting will be implemented on a prospective basis, whereby early adoption is not permitted. We are currently evaluating the impact that this accounting guidance may have on our financial condition or results of operations.

Going concern. In August 2014, the FASB issued new accounting guidance that requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. Disclosure is required when conditions or events raise substantial doubt about an entity’s ability to continue as a going concern. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us). Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Revenue recognition. In May 2014, the FASB issued new accounting guidance that revises the criteria for determining when to recognize revenue from contracts with customers and expands disclosure requirements. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides a five step model to be followed in making this determination. This accounting guidance can be implemented using either a retrospective method or a cumulative-effect approach. In August 2015, the FASB issued an update that defers the effective date of the revenue recognition guidance by one year. This new guidance will be effective for interim and annual reporting periods beginning after December 15, 2017 (effective January 1, 2018, for us). Early adoption is permitted but only for interim and annual reporting periods beginning after December 15, 2016. We have elected to implement this new accounting guidance using a cumulative-effect approach. We are currently in the process of gathering an inventory of contracts with customers and

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performing an in-depth assessment, though our preliminary analysis suggests that the adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations. There are many aspects of this new accounting guidance that are still being interpreted, and the FASB has issued updates to certain aspects of the guidance to address implementation issues. For example, the FASB issued accounting guidance in March 2016 to clarify principal versus agent considerations and additional guidance in April 2016 to clarify the identification of performance obligations and the licensing implementation guidance. In May 2016, the FASB issued narrow-scope improvements related to collectability, sales tax and noncash consideration, and practical expedients for contract modifications and completed contracts. While certain implementation issues relevant to the industry are still pending resolution, including trade date versus settlement date recognition for broker dealers and the applicability of interchange revenues for card issuing banks, our preliminary conclusions reached as to the application of the new guidance are not expected to be significantly affected. We will continue to evaluate any impact as additional guidance is issued and as our internal assessment progresses.

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2. Business Combination

First Niagara

On August 1, 2016 (the "Acquisition Date"), we acquired all of the outstanding common shares of First Niagara, the parent company of First Niagara Bank, for total consideration of approximately $4.0 billion and thereby acquired First Niagara Bank's approximately 390 branch locations across New York, Pennsylvania, Connecticut, and Massachusetts. The merger with First Niagara enabled us to expand in the New England market and into the Pennsylvania market, improve our core deposit base, and add additional scale in our banking operations. The results of First Niagara’s operations are included in our consolidated financial statements from the Acquisition Date.

Under the terms of the merger agreement, each outstanding share of First Niagara common stock was converted into the right
to receive 0.680 KeyCorp common shares and $2.30 in cash, for a total per share value of $10.26, based on the $11.70 closing price of KeyCorp’s stock on July 29, 2016. In the aggregate, First Niagara stockholders received 240 million shares of KeyCorp common stock. Also under the terms of the merger agreement, First Niagara employee stock options and restricted stock awards converted into options to purchase and receive KeyCorp common stock. These options and restricted stock awards had a fair value of $26 million on the date of acquisition. Our methodology for valuing employee stock options is disclosed in Note 15 ("Employee Benefits") under the heading "Stock Options" on page 195 of our 2015 Form 10-K. Our methodology for valuing restricted stock awards is disclosed in Note 15 ("Employee Benefits") under the heading "Long-Term Incentive Compensation Program" on page 196 of our 2015 Form 10-K.

In addition, at the time of the merger, each share of First Niagara preferred stock, Series B, was converted into the right to receive a share of KeyCorp preferred stock, Series C, a newly created series of KeyCorp preferred stock. Additional information on this series of preferred stock is provided in Note 18 ("Shareholders' Equity").

On October 7, 2016, First Niagara Bank merged with and into KeyBank, with KeyBank as the surviving entity. Systems and client conversion also occurred during the fourth quarter of 2016 in connection with the bank merger.

The acquisition of First Niagara constituted a business combination and was accounted for under the acquisition method of accounting. Accordingly, the assets acquired, the liabilities assumed, and the consideration paid were recorded at their estimated fair value as of the acquisition date. These fair value estimates are considered preliminary and are subject to change for up to one year after the Acquisition Date as additional information becomes available.

The following table provides the purchase price calculation as of the Acquisition Date and the identifiable assets purchased and the liabilities assumed at their estimated fair value. These fair value measurements are based on internal and third-party valuations.


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in millions
 
 
Consideration paid:
 
 
KeyCorp common stock issued
 
$
2,831

Cash payments to First Niagara stockholders
 
811

Exchange of First Niagara preferred stock for KeyCorp preferred stock
 
350

Total consideration paid
 
$
3,992

 
 
 
Statement of Net Assets Acquired at Fair Value:
 
 
ASSETS
 
 
Cash and due from banks and short-term investments
$
620

 
Investment securities
9,019

 
Other investments
297

 
Loans
23,504

 
Premises and equipment
276

 
Other intangible assets
388

 
Accrued income and other assets
1,449

 
Total assets
$
35,553

 
 
 
 
LIABILITIES
 
 
Deposits
$
28,993

 
Bank notes and other short-term borrowings
2,698

 
Accrued expense and other liabilities
444

 
Long-term debt
846

 
Total liabilities
$
32,981

 
 
 
 
Net identifiable assets acquired
 
2,572

Goodwill
 
$
1,420

 
 
 

We estimated the fair value of loans acquired from First Niagara by utilizing the discounted cash flow method within the income approach. This methodology aggregates the purchased loans by category and risk rating. Cash flows for each category were determined by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value based on a market rate for similar loans. There was no carryover of First Niagara’s allowance for loan losses associated with the loans we acquired. The valuation of the acquired loans was not completed prior to September 30, 2016, due to the relatively short time frame in which we had to complete the acquisition as well as the complexity involved in valuing loans. An estimate has been recorded based on the results of a valuation exercise conducted as of December 31, 2015, and applied to the August 1, 2016, balance of loans acquired from First Niagara. The valuation will be completed during the fourth quarter of 2016, and the value of the acquired loans will be adjusted accordingly.

Information about the acquired First Niagara loan portfolio as of the Acquisition Date is in the following table, and excludes lines of credit:
in millions
PCI
Contractual required payments receivable
$
1,132

Nonaccretable difference
109

Expected cash flows
1,023

Accretable yield
29

Fair value
$
994

 
 

At the First Niagara Acquisition Date, the contractual required payments receivable on the purchased non-impaired loans totaled $23.1 billion, with a corresponding fair value of $22.5 billion. The estimated cash flows not expected to be collected at the Acquisition Date were $466 million.

Intangible assets consisted of the core deposit intangible, the commercial purchased credit card receivable, the consumer purchased credit card receivable, and other intangible assets. The core deposit intangible asset recognized as part of the First Niagara merger of $356 million is being amortized over its estimated useful life of approximately ten years utilizing an accelerated method. The commercial purchased credit card receivables recognized as part of the First Niagara merger are being amortized over their estimated useful life of approximately six years utilizing an accelerated method. The consumer purchased credit card receivables recognized as part of the First Niagara merger are being amortized over their estimated useful life of approximately nine years utilizing an accelerated method.

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Goodwill of $1.4 billion was recorded as a result of the transaction and is not amortized for book purposes. $1.1 billion of goodwill was assigned to our Key Community Bank segment and $284 million of goodwill was assigned to our Key Corporate Bank segment. The goodwill recorded is not deductible for tax purposes. The following table shows the changes in the carrying amount of goodwill by reporting unit.

 
Key

Key

 
 
Community

Corporate

 
in millions
Bank

Bank

Total

BALANCE AT DECEMBER 31, 2014
$
979

$
78

$
1,057

Impairment losses based on results of interim impairment testing



Tax adjustment resulting from Pacific Crest Securities acquisition

3

3

BALANCE AT DECEMBER 31, 2015
979

81

1,060

Acquisition of First Niagara
1,136

284

1,420

BALANCE AT SEPTEMBER 30, 2016
$
2,115

$
365

$
2,480

 
 
 
 

Certificates of deposit were valued by projecting out the expected cash flows based on the contractual terms of the certificates of deposit. The fair values of savings and transaction deposit accounts acquired from First Niagara were assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. These cash flows were discounted based on a market rate for a certificate of deposit with a corresponding maturity.

Direct acquisition costs related to the First Niagara acquisition were expensed as incurred and amounted to $43 million for the nine months ended September 30, 2016. Professional fees and charitable contributions comprised the majority of these direct acquisition costs, franchise and business taxes and other noninterest expenses. These direct acquisition costs are part of our total merger-related charges.

The following table presents financial information regarding the former First Niagara operations included in our Consolidated
Statement of Income from the Acquisition Date through September 30, 2016, under the column “Actual from acquisition date through September 30, 2016.” These amounts do not include merger-related charges. In addition, the following table presents unaudited pro forma information as if the acquisition of First Niagara had occurred on January 1, 2015, under the “Pro forma” column. This pro forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of core deposit and other intangibles, and related income tax effects. Merger-related charges related to the First Niagara merger that we incurred during the nine months ended September 30, 2016, are not reflected in the unaudited pro forma amounts. The pro forma information does not necessarily reflect the results of operations that would have occurred had KeyCorp merged with First Niagara at the beginning of 2015. Cost savings are also not reflected in the unaudited pro forma amounts for the nine months ended September 30, 2016, and 2015.

 
Actual from acquisition
 
Pro forma
 
date through
 
Nine months ended September 30,
in millions
September 30, 2016
 
2016
2015
Net interest income (TE)
$
175

 
$
2,674

$
2,599

Noninterest income
53

 
1,625

1,635

Net income (loss) attributable to common shareholders
48

 
849

873

 
 
 
 
 


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3. Earnings Per Common Share

Basic earnings per share is the amount of earnings (adjusted for dividends declared on our preferred stock) available to each common share outstanding during the reporting periods. Diluted earnings per share is the amount of earnings available to each common share outstanding during the reporting periods adjusted to include the effects of potentially dilutive common shares. Potentially dilutive common shares include incremental shares issued for the conversion of our convertible Series A Preferred Stock, stock options, and other stock-based awards. Potentially dilutive common shares are excluded from the computation of diluted earnings per share in the periods where the effect would be antidilutive. For diluted earnings per share, net income available to common shareholders can be affected by the conversion of our convertible Series A Preferred Stock. Where the effect of this conversion would be dilutive, net income available to common shareholders is adjusted by the amount of preferred dividends associated with our Series A Preferred Stock.

Our basic and diluted earnings per common share are calculated as follows:
 
 
Three months ended
September 30,
 
Nine months ended
September 30,
dollars in millions, except per share amounts
2016

2015

 
2016

2015

EARNINGS
 
 
 
 
 
Income (loss) from continuing operations
$
172

$
220

 
$
557

$
686

Less: Net income (loss) attributable to noncontrolling interests
1

(2
)
 

1

Income (loss) from continuing operations attributable to Key
171

222

 
557

685

Less: Dividends on Series A Preferred Stock
6

6

 
17

17

Income (loss) from continuing operations attributable to Key common shareholders
165

216

 
540

668

Income (loss) from discontinued operations, net of taxes (a)
1

(3
)
 
5

5

Net income (loss) attributable to Key common shareholders
$
166

$
213

 
$
545

$
673

WEIGHTED-AVERAGE COMMON SHARES
 
 
 
 
 
Weighted-average common shares outstanding (000)
982,080

831,430

 
880,824

839,758

Effect of convertible preferred stock


 


Effect of common share options and other stock awards
12,580

7,450

 
8,965

7,613

Weighted-average common shares and potential common shares outstanding (000) (b)
994,660

838,880

 
889,789

847,371

EARNINGS PER COMMON SHARE
 
 
 
 
 
Income (loss) from continuing operations attributable to Key common shareholders
$
.17

$
.26

 
$
.61

$
.79

Income (loss) from discontinued operations, net of taxes (a)


 
.01

.01

Net income (loss) attributable to Key common shareholders (c)
.17

.26

 
.62

.80

Income (loss) from continuing operations attributable to Key common shareholders — assuming dilution
$
.16

$
.26

 
$
.60

$
.78

Income (loss) from discontinued operations, net of taxes (a)


 
.01

.01

Net income (loss) attributable to Key common shareholders — assuming dilution (c)
.17

.25

 
.61

.79

 
 
 
 
 
 
 
(a)
In September 2009, we decided to discontinue the education lending business conducted through Key Education Resources, the education payment and financing unit of KeyBank. As a result of this decision, we have accounted for this business as a discontinued operation. For further discussion regarding the income (loss) from discontinued operations, see Note 12 (“Acquisition, Divestiture, and Discontinued Operations”).

(b)
Assumes conversion of common share options and other stock awards and/or convertible preferred stock, as applicable.

(c)
EPS may not foot due to rounding.

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4. Loans and Loans Held for Sale

Our loans by category are summarized as follows:
 
in millions
September 30,
2016

 
December 31,
2015

 
September 30,
2015

Commercial, financial and agricultural (a)
$
39,433

 
$
31,240

 
$
31,095

Commercial real estate:
 
 
 
 
 
Commercial mortgage
14,979

 
7,959

 
8,180

Construction
2,189

 
1,053

 
1,070

Total commercial real estate loans
17,168

 
9,012

 
9,250

Commercial lease financing (b)
4,783

 
4,020

 
3,929

Total commercial loans
61,384

 
44,272

 
44,274

Residential — prime loans:
 
 
 
 
 
Real estate — residential mortgage
5,509

 
2,242

 
2,267

Home equity loans
12,757

 
10,335

 
10,504

Total residential — prime loans
18,266

 
12,577

 
12,771

Consumer direct loans
1,764

 
1,600

 
1,612

Credit cards
1,084

 
806

 
770

Consumer indirect loans
3,030

 
621

 
658

Total consumer loans
24,144

 
15,604

 
15,811

Total loans (c), (d)
$
85,528

 
$
59,876

 
$
60,085

 
 
 
 
 
 
 
(a)
Loan balances include $117 million, $85 million, and $88 million of commercial credit card balances at September 30, 2016, December 31, 2015, and September 30, 2015, respectively.

(b)
Commercial lease financing includes receivables held as collateral for a secured borrowing of $76 million, $134 million, and $162 million at September 30, 2016, December 31, 2015, and September 30, 2015, respectively. Principal reductions are based on the cash payments received from these related receivables. Additional information pertaining to this secured borrowing is included in Note 18 (“Long-Term Debt”) beginning on page 208 of our 2015 Form 10-K.

(c)
At September 30, 2016, total loans include purchased loans of $22.4 billion of which $959 million were PCI loans. At December 31, 2015, total loans include purchased loans of $114 million, of which $11 million were PCI loans. At September 30, 2015, total loans include purchased loans of $119 million, of which $12 million were PCI loans.

(d)
Total loans exclude loans of $1.6 billion at September 30, 2016, $1.8 billion at December 31, 2015, and $1.9 billion at September 30, 2015, related to the discontinued operations of the education lending business. Additional information pertaining to these loans is provided in Note 12 (“Acquisition, Divestiture, and Discontinued Operations”).

Our loans held for sale are summarized as follows:
in millions
September 30,
2016

 
December 31,
2015

 
September 30,
2015

Commercial, financial and agricultural
$
56

 
$
76

 
$
74

Real estate — commercial mortgage
1,016

 
532

 
806

Commercial lease financing
3

 
14

 
10

Real estate — residential mortgage (a)
62

 
17

 
26

Total loans held for sale (b)
$
1,137

 
$
639

 
$
916

 
 
 
 
 
 

(a)
Real estate — residential mortgage loans held for sale at fair value at September 30, 2016. The fair value option was elected for real estate — residential mortgage loans held for sale during the third quarter of 2016 with the First Niagara acquisition. The contractual amount due on these loans totaled $61 million at September 30, 2016. Changes in fair value are recorded in "Consumer mortgage income" on the income statement.

(b)
Total loans held for sale exclude loans held for sale of $169 million at September 30, 2015, related to the discontinued operations of the education lending business. Additional information pertaining to these loans is provided in Note 12.


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Our quarterly summary of changes in loans held for sale follows:
in millions
September 30,
2016

 
December 31,
2015

 
September 30,
2015

Balance at beginning of the period
$
442

 
$
916

 
$
835

Purchases
48

 

 

New originations
2,857

 
1,655

 
1,673

Transfers from (to) held to maturity, net
2

 
22

 
24

Loan sales
(2,180
)
 
(1,943
)
 
(1,616
)
Loan draws (payments), net
(32
)
 
(11
)
 

Balance at end of period (a), (b)
$
1,137

 
$
639

 
$
916

 
 
 
 
 
 

(a)
Total loans held for sale include Real estate — residential mortgage loans held for sale at fair value of $62 million at September 30, 2016.

(b)
Total loans exclude loans held for sale of $169 million at September 30, 2015, related to the discontinued operations of the education lending business. Additional information pertaining to these loans is provided in Note 12.

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5. Asset Quality

We assess the credit quality of the loan portfolio by monitoring net credit losses, levels of nonperforming assets and delinquencies, and credit quality ratings as defined by management.

Nonperforming loans are loans for which we do not accrue interest income, and include commercial and consumer loans and leases, as well as current year TDRs and nonaccruing TDR loans from prior years. Nonperforming assets include nonperforming loans, nonperforming loans held for sale, OREO, and other nonperforming assets. Non-impaired acquired loans are placed on nonaccrual status and reported as nonperforming or past due using the same criteria applied to the originated portfolio. PCI loans cannot be classified as nonperforming loans or TDRs.

Our nonperforming assets and past due loans were as follows:
in millions
September 30,
2016

December 31,
2015

September 30,
2015

Total nonperforming loans (a), (b)
$
723

$
387

$
400

OREO (c)
35

14

17

Other nonperforming assets
2

2


Total nonperforming assets (a)
$
760

$
403

$
417

Nonperforming assets from discontinued operations—education lending (d)
$
5

$
7

$
8

Restructured loans included in nonperforming loans (a)
$
149

$
159

$
159

Restructured loans with an allocated specific allowance (e)
68

69

71

Specifically allocated allowance for restructured loans (f)
38

30

29

Accruing loans past due 90 days or more
$
49

$
72

$
54

Accruing loans past due 30 through 89 days
317

208

271

 
 
 
 
 
(a)
Nonperforming loan balances exclude $959 million, $11 million, and $12 million of PCI loans at September 30, 2016, December 31, 2015, and September 30, 2015, respectively.
(b)
Includes carrying value of consumer residential mortgage loans in the process of foreclosure of approximately $175 million, $114 million, and $114 million at September 30, 2016, December 31, 2015, and September 30, 2015, respectively.
(c)
Includes carrying value of foreclosed residential real estate of approximately $27 million, $11 million, and $13 million at September 30, 2016, December 31, 2015, and September 30, 2015, respectively.
(d)
Restructured loans of approximately $22 million, $21 million, and $20 million are included in discontinued operations at September 30, 2016, December 31, 2015, and September 30, 2015, respectively. See Note 12 (“Acquisition, Divestiture, and Discontinued Operations”) for further discussion.
(e)
Included in individually impaired loans allocated a specific allowance.
(f)
Included in allowance for individually evaluated impaired loans.

We evaluate purchased loans for impairment in accordance with the applicable accounting guidance. Purchased loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that all contractually required payments will not be collected are deemed PCI. Several factors were considered when evaluating whether a loan was considered a PCI loan, including the delinquency status of the loan, updated borrower credit status, geographic information, and updated loan-to-values (LTV). In accordance with ASC 310-30, excluded from the purchased impaired loans were leases, revolving credit arrangements, and loans held for sale.

We estimated the fair value of loans acquired from First Niagara by utilizing the discounted cash flow method within the income approach See Note 2 ("Business Combinations") for further discussion over the fair value methodology. There was no carryover of First Niagara’s allowance for loan losses associated with the loans we acquired. The excess of a PCI loan's contractually required payments over the amount of its undiscounted cash flows expected to be collected is referred to as the nonaccretable difference. The nonaccretable difference, which is not accreted into income, reflects estimated future credit losses and uncollectible contractual interest expected to be incurred over the life of the PCI loan. The excess of cash flows expected to be collected over the carrying amount of the PCI loans is referred to as the accretable yield. This amount is accreted into interest income over the remaining life of the PCI loans or pools using the level yield method.

Over the life of PCI loans, Key evaluates the remaining contractual required payments receivable and estimates cash flows expected to be collected. Contractually required payments receivable may increase or decrease for a variety of reasons, for example, when the contractual terms of the loan agreement are modified, when interest rates on variable rate loans change, or when principal and/or interest payments are received. Cash flows expected to be collected on PCI loans are estimated by incorporating several key assumptions similar to the initial estimate of fair value. These key assumptions include probability of default, loss given default, and the amount of actual prepayments after the Acquisition Date. Increases in expected cash flows of PCI loans subsequent to acquisition are recognized prospectively through adjustment of the yield on the loans or pools over

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its remaining life, while decreases in expected cash flows are recognized as impairment through a provision for credit losses and an increase in the ALLL.

The difference between the fair value of a non-impaired acquired loan and contractual amounts due at the Acquisition Date is accreted into income over the estimated life of the loan. Contractually required payments represent the total undiscounted amount of all uncollected principal and interest payments.

The following table presents the PCI loans receivable balance at the First Niagara Acquisition Date:
August 1, 2016
PCI
in millions
Contractual required payments receivable
$
1,132

Nonaccretable difference
109

Expected cash flows
1,023

Accretable yield
29

Fair Value
$
994

 
 

At the First Niagara Acquisition Date, the contractual required payments receivable on the purchased non-impaired loans totaled $23.1 billion, with a corresponding fair value of $22.5 billion. The estimated cash flows not expected to be collected at the Acquisition Date were $466 million.

Key has PCI loans from two separate acquisitions, one in 2012 and one during the third quarter of 2016. At the 2012 acquisition date, the estimated gross contractual amount receivable of all PCI loans totaled $41 million. The estimated cash flows not expected to be collected (the nonaccretable amount) were $11 million, and the accretable amount was approximately $5 million. The following tables present the rollforward of the accretable yield and the beginning and ending outstanding unpaid principal balance and carrying amount of PCI loans for the three and nine months ended September 30, 2016, and September 30, 2015, and the twelve months ended December 31, 2015.

PCI Loans
 
Three Months Ended September 30,
 
2016
 
2015
in millions
Accretable Yield
Carrying Amount
Outstanding Unpaid Principal Balance
 
Accretable Yield
Carrying Amount
Outstanding Unpaid Principal Balance
Balance at beginning of period
$
5

$
11

$
16

 
$
5

$
12

$
18

Additions
29

 
 
 

 
 
Accretion

 
 
 

 
 
Net reclassifications from non-accretable to accretable

 
 
 

 
 
Payments received, net

 
 
 

 
 
Disposals

 
 
 

 
 
Balance at end of period
$
34

$
959

$
1,103

 
$
5

$
12

$
18

 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
2016
 
2015
in millions
Accretable Yield
Carrying Amount
Outstanding Unpaid Principal Balance
 
Accretable Yield
Carrying Amount
Outstanding Unpaid Principal Balance
Balance at beginning of period
$
5

$
11

$
17

 
$
5

$
13

$
20

Additions
29

 
 
 

 
 
Accretion
(1
)
 
 
 
(1
)
 
 
Net reclassifications from non-accretable to accretable
1

 
 
 
1

 
 
Payments received, net

 
 
 

 
 
Disposals

 
 
 

 
 
Balance at end of period
$
34

$
959

$
1,103

 
$
5

$
12

$
18

 
 
 
 
 
 
 
 

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Twelve Months Ended December 31,
 
2015
in millions
Accretable Yield
Carrying Amount
Outstanding Unpaid Principal Balance
Balance at beginning of period
$
5

$
13

$
20

Additions

 
 
Accretion
(1
)
 
 
Net reclassifications from non-accretable to accretable
1

 
 
Payments received, net

 
 
Disposals

 
 
Balance at end of period
$
5

$
11

$
17

 
 
 
 

At September 30, 2016, the approximate carrying amount of our commercial nonperforming loans outstanding represented 80% of their original contractual amount owed, total nonperforming loans outstanding represented 84% of their original contractual amount owed, and nonperforming assets in total were carried at 84% of their original contractual amount owed.

At September 30, 2016, our 20 largest nonperforming loans totaled $302 million, representing 42% of total loans on nonperforming status. At September 30, 2015, our 20 largest nonperforming loans totaled $112 million, representing 28% of total loans on nonperforming status.

Nonperforming loans and loans held for sale reduced expected interest income by $7 million and $19 million for the three and nine months ended September 30, 2016, and $4 million and $12 million for the three and nine months ended September 30, 2015.

The following tables set forth a further breakdown of individually impaired loans as of September 30, 2016, December 31, 2015, and September 30, 2015:
 
September 30, 2016
Recorded
Investment (a)
Unpaid Principal Balance (b)
Specific
Allowance
in millions
With no related allowance recorded:
 
 
 
Commercial, financial and agricultural
$
280

$
326


Commercial real estate:
 
 
 
Commercial mortgage
8

9


Construction
13

22


Total commercial real estate loans
21

31


Total commercial loans
301

357


Real estate — residential mortgage
21

21


Home equity loans
64

64


Consumer indirect loans
2

2


Total consumer loans
87

87


Total loans with no related allowance recorded
388

444


With an allowance recorded:
 
 
 
Commercial, financial and agricultural
$
37

38

$
16

Total commercial loans
37

38

16

Real estate — residential mortgage
31

31

3

Home equity loans
64

64

19

Consumer direct loans
2

3


Credit cards
3

3


Consumer indirect loans
31

31

1

Total consumer loans
131

132

23

Total loans with an allowance recorded
168

170

39

Total
$
556

$
614

$
39

 
 
 
 
 
(a)
The Recorded Investment represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. This amount is a component of total loans on our consolidated balance sheet.
(b)
The Unpaid Principal Balance represents the customer’s legal obligation to us.

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December 31, 2015
Recorded
Investment (a)